Differential cost Analysis / Decision Making

Solution of Exercise No. 01

Req: 1
Differential cost between 80% level of activity and 90% level of activity

Normal Capacity 90,000 units (100% level of activity)

=========
At 90% Level of activity (90,000 units x 90%) 81,000 units
At 80% Level of activity (90,000 units x 80%) 72,000 units
Differential units 9,000 units

Differential Cost = 9,000 units x 12 variable production cost

Differential Cost = 108,000

======

Req: 2
Differential cost of producing 5,000 units

Additional cost incurred in fixed cost = 10,000

Variable cost (5,000 units x 12) = 60,000
Differential cost = 70,000
=======
Req: 3
Per unit cost of 95,000 units

Variable cost (95,000 units x 12) = 1,140,000

Fixed Cost (240,000 + 10,000) = 250,000
Total Cost incurred = 1,390,000
=========

Per unit cost = 1,390,000 = 14.63

95,000 units

Req: 4
Per unit differential production cost of 5,000 units

Per unit differential cost = 70,000 = 14

5,000 units
Solution of Ex. 2:

Required No. 1: Average annual differential Cost for the first 5 years (including
income tax):

Cost of merchandise = 385,000

Depreciation of equipment = 30,000
Marketing Expenses = 10,000
Differential ware house rent = 25,000
Cost excluding Income Tax = 450,000
Amount of Income Tax:
Sales revenue = 500,000
Less: Cost of sales = (450,000)
INCOME = 50,000

Income Tax (50,000 x 46%) = 23,000

AVERAGE ANNUAL DIFFERENTIAL COST FOR
THE FIRST 5 YEARS = 473,000
========

Required No. 2: Minimum Annual net income

Minimum Annual net income = (Investment in the proposal / 2) x rate of return
= (Rs. 150,000 / 2) = Rs. 75,000 x 11%
= Rs. 8,250
=======

Required No.3: Estimated annual differential income:

Differential Sales revenue = 500,000
Less: Differential cost (including income tax) = 473,000
Rate of return required = 8,250 = (481,250)
ESTIMATED ANNUAL DIFFERENTIAL
INCOME = 18,750
=========

Required No. 4: Estimated Cash flow during third year:

Cash Inflows:
Sales revenue = Rs. 500,000
Cash Outflows:
Differential Cost = 473,000
Less: Non Cash expenses:
Depreciation Exp. = (30,000) = Rs. 443,000
ESTIMATED CASH INFLOW DURING THIRD YEAR = Rs. 57,000
===========
Solution of Ex. 3

ABC Company
Projected Income Statement
For the period ended ---

Sales (5,000 kgs. X 1.80) = 9,000

Less: Cost of goods sold:

Direct material used (0.6 + 0.01 = 0.61 x 5,000 kgs.) = 3,050

Direct Labor used (0.5 x 5000 kgs.) = 2,500
Factory Overhead – Variable Cost:
Indirect labor (0.2 x 5,000 kgs.) = 1,000
Power (0.02 x 5,000 kgs.) = 100
Supplies (0.02 x 5,000 kgs.) = 100
Maintenance and
Repair (0.027 x 5,000 kgs.)= 135
Insurance (0.007 x 5,000 kgs.) = 35

Additional Cost incurred to accept an order

Additional payroll taxes = 210
Depreciation on new machine
(3,000 / 24 months) = 125 = 335 = 1,705

COST OF GOODS SOLD = (7,255)

Gross margin to accept an order = 1,745
=======

Note: All per unit rates are calculated on the basis of 30,000 units.
Solution of Ex. 4
Req 1:

Conclusion:
The company should accept a special order, because it is currently working
below 100% normal capacity i.e. 62.5% and from this order it will cover the
variable manufacturing cost.

Working No. 1
Sales price per unit = Rs. 10.00

Less: Variable Manufacturing cost

Direct Material = 5.00
Direct Labor = 3.00
Variable FOH cost = 0.75 = (Rs. 8.75)
Gross contribution margin = Rs. 1.25
=========
Working No. 2
Contribution margin = Rs. 1.25
Less: Variable marketing expenses = (Rs. 0.25)
Net contribution margin = Re. 01
=========

Req 2:
The company will pay at most Rs. 8.75 to outside supplier because it covers the
variable manufacturing cost.

Req 3:

Where direct costing is involved the unit cost will be Rs. 8.75 because it is
variable cost of manufacturing a product.

Req 4:

Contribution margin at present level of activity:

Sales price = Rs. 15
Variable cost = Rs. 09
Contribution margin = Rs. 6 x 10,000 units = Rs. 60,000

Contribution margin at increase level of activity 10%:

Sales price = Rs. 14
Variable cost = Rs. 09
Contribution margin = Rs. 5 x 11,000 units = Rs. 55,000
Reduction on contribution margin = Rs. 5,000
=========
Solution of Ex. 6
Req 1:
Differential Cost Analysis for special order

Sales price per unit = 0.1225

Less: Variable cost per unit
Direct Material = 0.040
Direct Labor = 0.021
Variable FOH = 0.010
Variable marketing expenses = 0.005 = (0.0760)
Contribution Margin per unit = 0.0465
=======

Differential Contribution margin = 0.0465 x 3,600,000 units

= Rs. 167,400
===========
Solution of Ex. 7
Req 1:
Relevant cost per unit
Part A4 Part B5

Direct Material 0.40 8.00

Direct Labor 1.00 4.70
Variable Factory overhead (40%) 1.60 0.80
Relevant Cost per unit 3.00 13.50
=== ====
Req 2:

Part A4 Part B5

Purchase price per unit 5.00 15.00

Relevant unit cost (3.00) (13.50)
Potential saving per unit on production 2.00 1.50
Machine hour required for production 4 hours 2 hours

Potential saving per unit per machine hour 2 / 4 = 0.5 1.5 / 2 = 0.75

Available Idle machine hours = 30,000 hours

Used in production Part B5 (8,000 units x 2 hours per unit) = 16,000 hours
Available hours for the production of Part A4 = 14,000 hours
============

Units required of Part A4 = 6,000 units.

Per unit required machine hours = 4 hours

Available hours = 14,000 hours

Available hours used in production of Part A4
(14,000 hours / 4 hours per unit) = 3,500 units

Total units needed = 6,000 units

Units produced for available hours = 3,500 units
Purchase from outsider = 2,500 units
==========
SOLUTION OF EXCERCISE NO. 8:

Cost to Manufactured Part No. 1700

Direct Material Cost per unit = 2
Direct Labor Cost per unit = 12
Variable Factory overhead per unit = 5
Variable cost per unit = 19

Units required to produce = 5,000 units

=========

Cost to manufacture (5,000 units x Rs. 19) = Rs. 95,000

Fixed Cost eliminated (5,000 units x Rs. 3) = Rs. 15,000
Saving from alternative use of facilities = Rs. 40,000
SAVING TO MANUFACTURED (5,000 units)= Rs. 150,000

COST TO PURCHASE PART 1700 (5,000 units x 27)= Rs. 135,000

SAVING FROM BUYING INSTEAD OF MAKING = Rs. 15,000
===========
Solution of Exercise No. 10:

ALTERNATIVE “A”
Ex Present Variable Cost:
Variable Cost to manufacture= Rs. 285,000
Variable Cost of Expenses = Rs. 270,000 = Rs 555,000

Ex Proposed Variable Cost: (52% of Sales revenue)

Sales Revenue = Rs. 925,000
New Variable Cost ===========
(Rs. 925,000 x 52%) = (Rs. 481,000)
REDUCTION IN VARIABLE COST = Rs. 74,000

Ex Present Fixed Cost:

Fixed Cost to manufacture = Rs. 304,200
Fixed Cost of Expenses = Rs. 125,800 = Rs 430,000

New Fixed Cost = Rs. 480,000

INCREASE IN FIXED COST = Rs. 50,000
ADVANTAGE IN ALTERNATIVE A = Rs. 24,000
==========
ALTERNATIVE “B”
Zee revenue increase by 50%, which also increase the Zee variable cost by
50%
Incremental Zee Revenue (Rs. 575,000 x 50%) = Rs. 287,500
Less: Incremental Zee Variable cost
Variable Cost (Rs. 150,000+Rs. 80,000)
= Rs. 230,000 x 50% = Rs. 115,000
ZEE Incremental Contribution Margin = Rs. 172,500
Add: Rental income from space used for Ex product = Rs. 157,500
Reduction in fixed cost due to discontinuation = Rs. 30,000
BENEFIT IN PRODUCTION OF ZEE = Rs. 360,000

Reduction in Ex revenue due discontinuation = Rs. 925,000

Less: Ex Variable Cost = Rs. (555,000)
Reduction in Ex- Contribution margin = Rs. 370,000
DISADVANTAGE IN ALTERNATIVE “B” = Rs. 10,000
============