CA Bisesh Bibu Acharya

Cost Concept for Decision Making [Marginal Costing]

Marginal Costing (Decision Making)

− It is not a distinct method of costing as studied like job costing, process costing, etc. but a
technique used for a managerial decision making

Marginal (variable) cost

− The cost of one unit of product or service which would be avoided if that unit were if there
unit were not produced or provided

Marginal Costing
− Ascertainment of marginal cost and of the effect on profit of change in volume or type of
output by differentiating between fixed cost and variable cost

Differential Cost
− Increase or decrease in total cost or the change in specific elements of cost that result from
any variation in operations
❖ Only variable cost are relevant for decision making
❖ Fixed cost : Sunk cost = Irrelevant

Profit/Volume Ratio
P/v Ratio = Contribution x 100
Sales
PR| P/v Ratio = Change in contribution x 100
Change in Sales
|or| P/v Ratio = Change in Profit / Loss x 100
Change in Sales

Sales XX
Less: V.C XX
Contribution XX
Less: F.C XX
Profit XX

Break Even Analysis

− Level of activity at which there is neither a profit nor a loss.

− It is a minimum volume of sales to avoid making loss.
i.e. Sales revenue break even point = F.C + V.C
𝑇𝐹𝐶
BEP (in units) =𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛/ 𝑢𝑛𝑖𝑡
𝑇𝐹𝐶
BEP (in sales) = 𝑃\𝑣 𝑅𝑎𝑡𝑖𝑜

Cash Break – even point

− Point of sales volume at which total revenue is equal to total cash cost.

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𝐶𝑎𝑠ℎ 𝐹𝑖𝑥𝑒𝑑 𝐶𝑜𝑠𝑡

Cash BEP (in units) = 𝐶𝑎𝑠ℎ 𝐶𝑜𝑑𝑠𝑛𝑡𝑟𝑖𝑓𝑏𝑑𝑢𝑡𝑖𝑜𝑛 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡

Note: exclude non – cash items such as depreciation and deferred expenses.

Margin of Safety :-

Margin of safety = Total sales – Break even sales

𝑇𝑜𝑡𝑎𝑙 𝑠𝑎𝑙𝑒𝑠−𝑆𝑎𝑙𝑒𝑠 𝑎𝑡 𝐵𝑟𝑒𝑎𝑘𝑑 𝑒𝑣𝑒𝑛 𝑝𝑜𝑖𝑛𝑡
Margin of safety Ratio = × 100
𝑇𝑜𝑡𝑎𝑙 𝑆𝑎𝑙𝑒𝑠
Note: Profit= P|v Ratio × M|s Ratio × Sales

𝑃𝑟𝑜𝑓𝑖𝑡
Margin of safety = 𝑃|𝑣 𝑅𝑎𝑡𝑖𝑜
Total Sales = Break even point + Margin of Safety

Make on Buy Decision

(i) To make within the organization OR
(ii) To buy from the market

IF F.C. are unavoidable, V.C for production Vs Purchase cost from Markets,
Compare Them and choose the option with low cost.

Shut Down or continue Decision

Shut Down cost: The fixed cost which cannot be avoided during the temporary closure of a plant.
E.g. Depreciation, Rent
(i) Shut down point = (Total F.C – shut down cost) ÷ contribution / unit
|OR| 𝑐𝑎𝑙 𝑛 of Additional F.C and compare with contribution on running.

Key Factor Limiting Factor / Principal / Budget Factor

(i) Material - Source of RM
- Restriction by licences, quotas, etc.
(ii) Labour – Shortage of worker.
(iii) Plant – Insufficient capacity due to power shortage, etc

𝑇𝑜𝑡𝑎𝑙 𝑐𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑜𝑓 𝑎𝑙𝑙 𝑝𝑟𝑜𝑑𝑢𝑐𝑡𝑠𝑥

Overall P/V Ratio = ×100
𝑇𝑜𝑡𝑎𝑙 𝑠𝑎𝑙𝑒𝑠 𝑜𝑓 𝑎𝑙𝑙 𝑝𝑟𝑜𝑑𝑢𝑐𝑡
𝑇𝑜𝑡𝑎𝑙 𝐹.𝐶 𝑜𝑓 𝑎𝑙𝑙 𝑝𝑑𝑟𝑜𝑑𝑢𝑐𝑡
Overall BEP = 𝑂𝑣𝑒𝑟𝑎𝑙𝑙 𝑃/𝑣 𝑟𝑎𝑡𝑖𝑜
Individual BEP (in value) for a product = Individual sales value Mix ratio × overall BEP (in
value)

Cost Indifference Point (CIP)

➢ Level of activity at which total cost of two alternatives is same.
➢ Management is indifferent as to the choice out of two alternatives at this point.

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𝐹𝑖𝑥𝑒𝑑 𝐶𝑜𝑠𝑡 𝑢𝑛𝑑𝑒𝑟 𝐴𝑙𝑡𝑒𝑟𝑛𝑎𝑡𝑖𝑣𝑒 1−𝐹𝑖𝑥𝑒𝑑 𝐶𝑜𝑠𝑡 𝑢𝑛𝑑𝑒𝑟 𝐴𝑙𝑡𝑒𝑟𝑛𝑎𝑡𝑖𝑣𝑒 2

Cost Indifference Point = 𝑉𝐶 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 𝑢𝑛𝑑𝑒𝑟 𝐴𝑙𝑡𝑒𝑟𝑛𝑎𝑡𝑖𝑣𝑒 2−𝑉𝐶 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 𝑢𝑛𝑑𝑒𝑟 𝐴𝑙𝑡𝑒𝑟𝑛𝑎𝑡𝑖𝑣𝑒 1

Activity Level Decision

Below CIP Alternative with lower Fixed Cost
Above CIP Alternative with lower VC/unit
AT CIP Any alternative

Marginal Costing Vs Absorption Costing

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NUMERICAL QUESTIONS
Question 1
A company produces single product which sell7s for Rs. 20 per unit. Variable cost is Rs. 15 per
unit and Fixed overhead for the year is Rs. 6,30,000.
Required:
(a) Calculate sales value needed to earn a profit of 1 0% on sales.
(b) Calculate sales price per unit to bring BEP down to 1,20, 000 units.
(c) Calculate margin of safety sales if profit is Rs. 60,000.

Question 2
A company has fixed cost of Rs. 90,000, Sales Rs. 3,00,000 and Profit of Rs. 60,000. Required:
(i) Sales volume if in the next period, the company suffered a loss of Rs. 30, 000.
(ii) What is the margin of safety for a profit of Rs. 90,000?

Question 3
From the under mentioned figures calculate:
1. P/V ratio and the total fixed expenses;
2. Profit or loss arising from the sales of Rs. 12,000;
3. Sales required to earn a profit of Rs. 2,000;
4. Sales required to break- even.
Sales Rs. Profit Rs.
First period 14,433 385
Second period 18,203 1,139

Question 4
A company has three factories situated in North. East and south with its Head Office in Mumbai.
The Management has received the following summary report on the operations of each factory
for a period.
(Rs. in '000)
Sales Over/(under) Profit Over/(under) Budget
Actual Budget Actual
North 1,100 (400) 135 (180)
East 1,450 150 210 90
South 1,200 (200) 330 (110)
Calculate for each factory and for the company as a whole for the period;
i) Fixed costs.
ii) Break-even sales.

Question 5
The ratio of variable cost to sales is 70%. The break-even point occurs at 60% of the capacity sales.
Find the capacity sales when fixed costs are Rs. 90,000. also compute profit at 75% of the capacity
sales.

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Question No. 6
MNP Ltd sold 2,75,000 units of its product at Rs 37.50 per unit. Variable costs are Rs 17.50 per unit
(manufacturing costs of Rs 14 and selling cost Rs 3.50 per unit). Fixed costs are incurred uniformly
throughout the year and amount to Rs 35,00,000 (including depreciation of Rs15,00,000). There are no
beginning or ending inventories.
Required:
(i) Estimate breakeven sales level quantity and cash breakeven sales level quantity.
(ii) Estimate the P/V ratio.
(iii) Estimate the number of units that must be sold to earn an income (EBIT) of Rs 2,50,000.
(iv) Estimate the sales level achieve an after-tax income (PAT) of Rs 2,50,000. Assume 40% corporate
Income Tax rate.

Question 7
PQ Ltd. reports the following cost structure at two capacity levels:
(100% capacity)
2,000 units 1,500 units
Production overhead I Rs. 3 per unit Rs. 4 per unit
Production overhead II Rs. 2 per unit Rs. 2 per unit
If the selling price, reduced by direct material and labour is Rs. 8 per unit, what would be its break-
even point?

Question 8
Product Z has a profit-volume ratio of 28%. Fixed operating costs directly attributable to product
Z during the quarter II of the financial year2009-10 will be Rs.2,80,000.
Calculate the sales revenue required to achieve a quarterly profit of Rs. 70,000.

Question 9
A Company sells two products, J and K. The sales mix is 4 units of J and 3 units of K. The
contribution margins per unit are Rs.40 for J and Rs.20 for K. Fixed costs are Rs.6,16,000 per
month. Compute the break-even point

Question 10
The following are cost data for three alternative ways of processing the clerical work for cases
brought before the LC Court System:
A Semi Automatic B Fully Automatic C Manual
(Rs) (Rs) (Rs)
Monthly fixed costs
Occupancy 15,000 15,000 15,00
Maintenance contract 0 5,000 10,000
Equipment lease 0 25,000 1,00,000
15,000 45,000 1,25,000
Unit variable costs (per report):
Supplies Labour 40 80 20
5 hrs×40 1hr×60 0.25hr×80
or 200 or 60 or 20

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240 140 40
Required
i) Calculate cost indifference points. Interpret your results.
ii) If the present case load is 600 cases and it is expected to go up to 850 cases in near
future, which method is most appropriate on cost considerations ?

Question 11
ABC Ltd. can produce 4,00,000 units of a product per annum at 100% capacity. The variable
production costs are Rs. 40 per unit and the variable selling expenses are Rs. 12 per sold unit. The
budgeted fixed production expenses were Rs. 24,00,000 per annum and the fixed selling expenses
were Rs. 16,00,000. During the year ended 31st March, 2008, the company worked at 80% of its
capacity. The operating data for the year are as follows:
Production 3,20,000 units
Sales @Rs. 80 per unit 3,10,000 units
Opening stock of finished goods 40,000 units
Fixed production expenses are absorbed on the basis of capacity and fixed selling expenses are
recovered on the basis of period.
You are required to prepare Statements of Cost and Profit for the year ending 31st March, 2008:
(i) On the basis of marginal costing
(ii) On the basis of absorption costing.

Question 12
Mega Company has just completed its first year of operations. The unit costs on a normal costing
basis are as under:
Rs.
Direct material 4 kg @ Rs.4 = 16.00
Direct labour 3 hrs @ Rs.18 = 54.00
Variable overhead 3 hrs @ Rs.4 = 12.00
Fixed overhead 3 hrs @ Rs.6 = 18.00
100.00
Selling and administrative costs:
Variable Rs.20 per unit
Fixed Rs.7,60,000
During the year the company has the following activity:
Units produced = 24,000
Units sold = 21,500
Unit selling price = Rs.168
Direct labour hours worked = 72,000
Actual fixed overhead was Rs.48,000 less than the budgeted fixed overhead. Budgeted variable
overhead was Rs.20,000 less than the actual variable overhead. The company used an expected
actual activity level of 72,000 direct labour hours to compute the predetermine overhead rates.
Required:
(i) Compute the unit cost and total income under:
(a) Absorption costing
(b) Marginal costing
(ii) Under or over absorption of overhead.

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(iii) Reconcile the difference between the total income under absorption and marginal
costing.
Answer
(i) Computation of Unit Cost & Total Income
Unit Cost Absorption Costing Marginal Costing
(Rs.) (Rs.)
Direct Material 16.00 16.00
Direct Labour 54.00 54.00
Variable Overhead 12.00 12.00
Fixed Overhead 18.00 -
Unit Cost 100.00 82.00

Income Statement
Absorption Costing
Sales 36,12,000
(21500 × Rs. 168)
Less: Cost of goods sold (21500 × 100) 21,50,000
Less: Over Absorption 28,000 21,22,000
14,90,000
Less: Selling & Distribution Expenses 11,90,000
Profit 3,00,000
Sales 36,12,000
Less: Cost of goods sold (21500×82) 17,63,000
Add: Under Absorption 20,000 17,83,000
18,29,000
Less: Selling & Distribution Expenses 4,30,000
Contribution 13,99,000
Less: Fixed Factory and Selling & Distribution 11,44,000
Overhead (38,400 + 7,60,000)
Profit 2,55,000

(ii) Under or over absorption of overhead:

Budgeted Fixed Overhead Rs.
72,000 Hrs. × Rs. 6 4,32,000
Less: Actual Overhead was less than Budgeted Fixed Overhead 48,000
Actual Fixed Overhead 3,84,000
Budgeted Variable Overhead
72,000 Hrs. × Rs. 4 2,88,000
Add: Actual Overhead was higher than Budgeted 20,000
Budgeted 3,08,000

Both Fixed & Variable Overhead applied

72,000 Hrs. × Rs. 10 7,20,000
Actual Overhead (3,84,000 + 3,08,000) 6,92,000
Over Absorption 28,000

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(iii) Reconciliation of profit

Difference in profit: Rs. 3,00,000 – 2,55,000 = Rs. 45,000
Due to fixed factory Overhead being included in Closing Stock in Absorption Costing not in
Marginal Costing.
Therefore,
Difference in profit = Fixed Overhead Rate (Production – Sale)
18 (24,000 – 21,500) = Rs. 45,000

Question 13
Jay Kay Limited is a single product manufacturing company. The following information relates to
the months of May and June, 2003:
May June
Rs. Rs.
(i) Budgeted Costs and Selling prices:
Variable manufacturing cost per unit 2.00 2.20
Total fixed manufacturing cost .
(based on budgeted output of 25,000 units per month) 40,000 44,000
Total fixed marketing cost 14,000 15,400
Selling price per unit 5.00 5.50
(ii) Actual production and sales:
Units Units
Production 24,000 24,000
Sale 21,000 26,500
(iii) There was no stock of finished goods at the beginning of May, 2003. There was no wastage
or loss of finished goods during May or June, 2003.
(iv) Actual costs incurred corresponded to those budgeted for each month.
You are required to calculate the relative effects on the monthly operating profits of applying: (i)
Absorption costing and (ii) Marginal costing.
Answer
(a) Quantity tally :
May 2003 June 2003
Opening Stock units - 3,000
Production units 24,000 24,000
Total units 24,000 27,000
Sales units 21,000 26,500
Closing Stock units 3,000 500
Fixed manufacturing overheads Rs. 40,000 44,000
Budgeted output units 25,000 25,000
Fixed overheads absorption rate per unit Rs. 1.60 1.76

(i) Profitability based on absorption costing:

May 2003 June 2003

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Rs. Rs.
Sales:
May: 21,000 units @ Rs. 5.00 1,05,000
June: 26,500 units @ Rs. 5.50 1,45,750
Production Costs:
Variable: May 24,000 units @ Rs. 2.00 48,000
June 24,000 units @ Rs. 2.20 52,800
Fixed: May 24,000 units @ Rs. 1.60 38,400
June 24,000 units @ Rs. 1.76 42,240
Total production costs 86,400 95,040
Add: Opening stock
May Nil
June 3,000 units @ Res. 3.60* 10,800
Total 86,400 1,05,840
Less: Closing stock
May 3,000 units @ Rs. 3.60* 10,800
June 500 units @ Rs. 3.96 1,980
Production cost of goods sold 75,600 1,03,860
Marketing fixed costs 14,000 15,400
Total cost of goods sold 89,600 1,19,260
Profit (Sales - COGS) 15,400 26,490
Budgeted output
Actual output
Shortfall
Under recovery of fixed overheads
May 1,000 units @ Rs. 1.60 1,600
June 1,000 units @ Rs. 1.76 1,760
Net profit 13,800 24,730
* Total cost = VC + FC 2.00+1.60=3.60
May 2.20+1.76=3.96
June

(ii) Profitability based on marginal costing:

May 2003 June 2003
Rs. Rs.
Sales 1,05,000 1,45,750
Production cost - variable 48,000 52,800
Add: Opening stock
May Nil
June 6,000
Total 48,000 58,800
Less: Closing stock
May 3,000 units @ Rs. 2.00 6,000
June 500 units @ Rs. 2.20 1,100
Variable cost of goods sold 42,000 57,700
Contribution 63,000 88,050

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Fixed costs: May June

Production 40,000 44,000
Marketing 14,000 15,400
54,000 59,400
Net Profit 9,000 28,650

Question 14
Satish Enterprises are leading exporters of Kid's Toys. J Ltd. of U.S.A. have approached Satish
Enterprises for Exporting a special toy named "Jumping Monkey". The order will be valid for next
three years at 3,000 toys per month. The export price of the toy will be $4.
Cost data per toy is as follows :
Rs.
Materials 60
Labour 25
Variable overheads 20
Primary packing of the toy 15
The toys will be packed in lots of 50 each. For this purpose a special box, which will contain the
50 toys will have to be purchased, cost being Rs.400 per box.
Satish Enterprises will also have to import a special machine for making the toys. The cost of the
machine is Rs.24,00,000 and duty thereon will be at 12%. The machine will have an effective life
of 3 years , and depreciation is to be charged on straight-line method.
Apart from depreciation, annual fixed overheads is estimated at Rs.4,00,000, for the first year with
6% increase in the second year. Fixed overheads are incurred uniformly over the year.
Assuming the average conversion rate to be Rs. 50 per $, you are required to :
i) prepare a monthly and yearly profitability statements for the first year and second year
assuming the production at 3,000 today per month.
ii) Compute a monthly and yearly break even units in respect of the first year.
iii) In what contingency can there be a second break - even point for the month and for the year
as a whole?
iv) Have you any comments to offer on the above?

Question 15
Mahila Griha Udyog Industries is considering to supply its products - a special range of namkeens-
to a departmental store. The contract will last for 50 weeks, and the details are given below:
Material: Rs.
X (in stock - at original cost) 1,50,000
Y (on order - on contract) 1,80,000
Z (to be ordered) 3,00,000
Labour
Skilled 5,40,000
Non-skilled 3,00,000
Supervisory 1,00,000
General overheads 10,80,000

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Total cost 26,50,000

Price offered by department store 18,00,000
Net Loss 8,50,000

Should the contract be accepted if the following additional information is considered?

(i) Material X is an obsolete material. It can only be used on another product, the material for
which is available at Rs. 1,35,000 (Material X requires some adaptation to be used and cost
Rs.27,000).
(ii) Material Y is ordered for some other product which is no longer required. It now has residual
value of Rs.210,000).
(iii) Skilled labour can work on other contracts which are presently operated by semi-skilled
labour at a cost of Rs.5,70,000.
(iv) Non-skilled labour are specifically employed for this contract.
(v) Supervisor staff will remain whether or not the contract is accepted. Only two of them can
replace other positions where the salary is Rs.35,000.
Overheads are charged at 200% of skilled labour. Only Rs. 1,25,000 would be avoidable, if the
contract is not accepted.

Question 16
Ranka Builders has been offered a contract by Excel Ltd. to build for it five special Guest Houses
for use by top management. Each Guest House will be an independent one. The contract will be
for a period of one year and the offer price is Rs. One crore. In addition Excel Ltd. will also provide
2 grounds of land free of cost for the purpose of construction. The Chief Accountant of Ranka
Builders has prepared an estimate of the basis of which he has advised that the contract should
not be accepted at the price offered. His estimate was as follows:
Rs. in Lacs
Land (3 Grounds at Rs.20 lacs each) 60
Drawings and design 7
Registration 10
Materials:
Cement and Sand 6
Bricks and Tiles 4
Steel 10
Others (including interior decoration) 10
Labour-Skilled 12
-Unskilled 8
- Supervisor's Salary 5
Overheads General 12
Depreciation 006
Total Cost 150
The Accountant also provides the following information:
Land : The total requirement of land is 3 grounds costing Rs.20 lacs per ground Excel Ltd. will
provide 2 grounds free of cost.
Drawing and Design : These have already been prepared and 50% of the cost has already been
incurred. Materials:

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(i) Cement and sand are already in stock and are in regular use. If used for this contract, they
have to be replaced at a cost of Rs.8 lacs.
(ii) Bricks and tiles represent purchases made several months before for a different contract, they
have to be sold readily for a net Rs.5 lacs after meeting all further expensed.
(iii) Others: Material worthRs.2 lacs relating to interior decoration are in stock for which no
alternate use is expected in the near future. However they can be sold for Rs. 1 lac.
Labour:
(i) Skilled workers will be transferred to this project from another project. The Project Manager
claimed that if the men were returned to him, he could have earned the company an additional
Ps.2 lacs in terms of profits.
(ii) The supervisor undertakes various tasks in the sites and his pay and continuity of employment
will not be affected by the new contract if the contract is taken, he will devote half of his
time.
Overheads:
(i) The equipment that would be used on the contract was bought one year before for Rs.30 lacs
and is expected to last for five years. It can also be used on other contracts and the current
replacement price will be Rs.32 lacs and in a year's time it will be Rs.25 lacs.
(ii) The general overheads includes both specific and absorbed overheads. If the contract is not
undertaken, Rs.4 lacks of the same can be avoided.
Ranka Builders has also on hand another project, which would not be executed if the contract from
Excel Ltd. were to be accepted. The estimated profit on that project is Rs. 10 lacs.
In the light of information given above, you are required to indicate with reasons whether the
contract from, Excel Ltd. should be accepted or not.
Answer
M/s Ranka Builder's
Statement of relevant costs on the
Acceptance of contract form Excel Ltd.
(Figure in laksh of Rs.)
S.N. Particulars Basis for the Relevant cost Irrelevant cost
cost to be if the contract if the contract
relevant is accepted is accepted
(Rs.) (Rs.)
1 Land cost 20
(Refer to working note 1)
2 Drawings and design - 7
3 Registration Incremental 10 - (Sunk cost)
4 Materials:
Cement and sand Replacement 8
Bricks and tiles Opportunity 5
Steel Incremental 10
Others 9
5
6
(Sunk Cost)
Replacement cost of machine 7
7. Estimated profit Opportunity 10

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foregone on other project

foregone
Total 93

Decision : Since the offer price of contract is Rs.1 crore and its total relevant cost is Rs.93 lacs;
these figures clearly shows that the offer should be accepted.

Working notes :
1. Rs. (Lacs)
Total cost of 3 grounds of land 60
Cost of ground of land will be borne by Excel Ltd. 40
Cost of 1 ground of land will be borne by M/s Ranka Builders 20
2. Others material cost is Rs.10 lacs, it includes material worth Rs.2 lacs, relating to interior
decoration, which is a sunk cost, this material can be sold for Rs.1 lac, (which is a relevant
opportunity cost) and Rs.8 lacs, material is an incremental cost. Hence total relevant cost of
others material is Rs.9 lacs. (Rs.8 lacs, incremental + Rs.1 lac, opportunity cost).
3. Since the equipment can also be used on ths contract. Its current replacement price is Rs.32
lacs, and after one year its cost will be Rs.25 lacs. Therefore the relevant opportunity cost of
machine is:(Rs.32 lacs - Rs.25 lacs).

Question 17
AB Ltd. manufactures product 'X'. the company operates single shift of 8 hours for 300 days in a
year. The capital employed in the business is Rs. 18 crores.
The manufacturing operations of the company comprise of four production departments. The
company at present produces 9,000 units of product 'X' at maximum capacity. However, the
capacity utilization of all the four departments are not equal and the present individual capacity
utilizations are as under:
Department Capacity Utilisation %
A 75
B 100
C 70
D 50
The present return on capital of the company has gone down to 10% from the earlier cut-off rate
of 15% due to increased cost of production.
As the company cannot operate more than one shift, the management is considering two alternative
proposals to increase the return on capital employed.
Alternative I
To hire out the surplus capacity of departments A, C and D. The cost and revenue projections are
as under:
Department Hire Charges per Hour Incremental Cost per Hour
A 2,500 2,000
C 1,800 1,500
D 1,600 1,200
Alternative II

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To increase the installed capacity of the factory to 12,000 units by adding plant and machinery in
department B at a capital cost of Rs.4 crore. Any Balance surplus capacity in other departments
after meeting the increased volume to be hired out as per alternative I. The additional units would
fetch incremental revenue of Rs. 1,600 per unit.
You are required to evaluate the two proposals and suggest to the management, which of the two
proposals is to be accepted.
Answer
Working notes:
1. Statement of total available; utilized and surplus capacity hours when 9,000 units of product
'x' are produced.
Departments Available Capacity Hours Capacity utilized Surplus Capacity hours
(in %) (in hours)
(1) (2) (3) (4) = (2) × (3) (5) = (2) - (4)
A 2,400 75 1,800 600
(300 days × 8 hours)
B 2,400 100 2,400 NIL
C 2,400 70 1,680 720
D 2,400 50 1,200 1,200

2. Statement of total available, utilized and surplus capacity hours when 12,000 units of product
'X' are produced.
Production Available Capacity Balance Unit per hour Hours Surplus
Department capacity utilization on capacity required for capacity
hours 9,000 units hours 3,000 hours
Hours additional
units
(1) (2) (3) (4)=(2)×(3) (5) (6) (7) (8)=(5)-(7)
A 2,400 75 1,800 600 5 600 Nil
9000 units
1800 hrs.
B 2,400 100 2,400 Nil 3.75 800 Nil
9000 units
2400 hrs.
C 2,400 70 1,680 720 5.36 560 160
9000 units
1680 hrs.
D 2,400 50 1,200 1,200 7.5 400 800
9000 units
1200 hrs.
Alternative I
Statement of net Revenue (Under Alternative I)
Production Surplus Hire Total Incremental Total cost Net
Capacity charges per revenue in costs per (Rs. Lacs) revenue in
Hours hour (Rs. lacs) hour Rs. (Rs.)
(Refer to
W.N.-1)
(a) (b) (c)=(a)×(b) (d) (e)=(a)×(d) (f)=(c)-(e)
A 600 2,500 15.00 2,000 12.00 3.00
B 720 1,800 12.96 1,500 10.80 2.16
D 1,200 1,600 19.20 1,200 14.40 4.90

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Total 47.16 37.20 9.96

Add: Present income (10% of Rs. 180.00
1,800 lacs)
Total return 189.96
Return on investment
Total return 189.96
= Total investment × 100 = 1800 × 100 = 10.553%

Alternative II
Statement of Net Revenue when 12,000 units of product 'X' are produced and surplus plant
capacity (hours) in departments C and D hired out.
Production Surplus Hire Total Incremental Total cost Net
Capacity charges per revenue in costs per (Rs. Lacs) revenue in
Hours hour (Rs. lacs) hour Rs. (Rs.)
(Refer to
W.N.-2)
(1) (2) (3)=(1)×(2) (4) (5)=(1)×(4) (6)=(3)-(5)
C 160 1,800 2.88 1,500 2.40 0.48
D 800 1,600 12.80 1,200 9.60 3.20
Total 15.68 12.00 3.68
Add: Revenue (in lacs) earned on 3,000 additional units sale (3,000 units is × Rs. 1,600)48.00
Add: Present income on investment (10% × Rs. 1,800 lacs) 180.00
Total Return (in lacs) 231.69
231.68 lacs
Return on investment = 2200 lacs × 100 = 10.53%
Evaluation of two alternative proposals :
Since the return on investment under alternative I is more than that under alternative II; therefore
it should be accepted.

Question 18
A manufacturer produces three products whose cost data are as follows:
X Y Z
Direct materials (Rs. / Unit) 32.00 76.00 58.50
Direct Labour:
Deptt. Rate / hour (Rs.) Hours Hours Hours
1 2.50 18 10 20
2 3.00 5 4 7
3 2.00 10 5 20
Variable overheads (Rs.) 8 4.50 10.50
Fixed overheads (Rs.) 4,00,000 per annum.
The budget was prepared at a time, when market was sluggish. The budgeted quantities and selling
price are as under:
Product Budgeted quantity Selling price / unit

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(Units) (Rs.)
X 19,500 135
Y 15,600 140
Z 15,600 200
Later, the market improved and the sales quantities could be increased by 20 per cent for product
X and 25 per cent each for product Y and Z. The sales manager confirmed that the increased sales
could be achieved at the prices originally budgeted. The production manager stated that the output
could not be increased beyond the budgeted level due to the limitation of Direct labour hours in
department 2.
Required:
(i) Prepare a statement of budgeted profitability.
(ii) Set optimal product mix and calculate the optimal profit.

Question 19
A company operates its plant on single shift basis. It can produce upto 8,000 units of output per
month without overtime. The fixed costs on single shift basis of operation amount to Rs.30,000
per month. The average variable cost per unit is Rs.10.
The output can be increased upto 15,000 units per month by working overtime. This entails no
increase in fixed costs, but the variable costs per unit during overtime will be Rs. 12 inc excess of
8,000 units upto the capacity of 75,000 units.
If a second shift is worked, the maximum capacity of the second shift is 8,000 units per month.
The variable cost on second shift operation is Rs. 10.50 per unit and the incremental fixed cost
involved in the second shift is Rs. 6,000 per month.
Required
(i) If the company's demand for the product is 10,000 units, should the company work overtime
or second shift?
(ii) At what level of output will the company consider working second shift instead of working
overtime? State the range of output for overtime working and second shift operation.
(iii) During a particular month, the company predicted its demand to be 14,000 units and worked
second shift. At the end of the month it was discovered that the company's demand was only
11,000 units and the company accordingly produced only 11,000 units. Calculate the cost of
prediction error.

Solution
(i) Comparative Statement of Cost
(When demand for the product is 10,000 units)
Working overtime for Working second shift for
producing 2,000 units producing 2,000 units
Variable cost 24,000 21,000
Fixed cost Nil 6,000
Total cost 24,000 27,000
* 8000 units in fact are produced in the single shift.
Decision: The above comparative statement of cost clearly shows that resorting to overtime for
producing additional 2,000 units and 8,000 units in the single shift will be beneficial to the extent
of Rs.3,000 (Rs.27,000-Rs.24,000).

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(ii) Range of output for overtime working and second shift operation:
Let x be the number of units at which their total cost under overtime working and second shift
operation equalizes, i.e.
 units x Rs.12 + Rs.30,000 =  units x Rs.10.50 + Rs.36,000
On solving the above relation we get  = 4,000 units.
Range Method to be adopted
Above 8,000 units but less than 12,000 units Overtime working
At 12,000 units Any one method may be adopted
12,001 to 16,000 units Second shift working

(iii) Computation of Prediction error:

Cost Statement of producing 11,000 units
Options
Working overtime for Working second shift for producing
producing 3,000 3,000 additional units
additional units Rs.
Rs.
Cost of producing 8,000 units in first 1,10,000 1,10,000
shift
(8,000 units x Rs.10 + Rs.30,000)
Addition cost of producing 3,000 36,000 37,500
units (3,000 units x Rs.12) (3,000 units x Rs.10.50 + Rs.6,000)
Total cost 1,46,000 1,47,500

Prediction error: A comparison of total cost o producing 11,000 units under overtime working
and second shift working clearly shows a difference of Rs.1,500 (Rs.1,47,500 - Rs.1,46,000). The
difference of Rs.1,500 is due to prediction error.

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