Q Girish Engineering (MCS-2004) Numerical

Responsibility budgeting was introduced in a medium sized organization Girish

Engineering.

Monthly report (in part) for an expense centre in factory is:

All figures in Rs. Lacs

Actual Variance
Direct Labour 100.13 0.21 (Favourable)
Indirect Labour 66.34 8.10 (Unfavourable)
Total Controllable Costs 168.47 8.50 (Unfavourable)
Department Fixed Costs 38.82 --------
Allocated Costs 53.62 --------

Questions:
1. Why no variance is shown in two items? Is this correct approach in performance
reporting?
2. Should overhead expenses mentioned above be included in Controllable Costs?
Why? Why not?

Solution (a):

Variances between actual and budgeted departmental fixed costs are

obtained simply by subtraction, since these costs are not affected by
either the volume of sales or the volume of production. That’s why no
variance is shown for departmental fixed costs.

Allocated costs are a share of the costs of a resource used by a project,

where the same resource is also used by other activities. These are
different to the Incurred costs because these costs are not exclusively
related to any individual project. However, the cost of the resource still
needs to be recovered, and making a fair and reasonable charge to all
projects using the resource does this.
The key difference between costs and Allocated costs is that the latter
will be charged based upon an estimate, rather than actual cash
values. Thus as it is charged based upon an estimate the budgeted
figure is the same as the actual figure and hence no variances.

Solution (b):
Overhead Expenses mentioned above should not be included in
controllable costs because some costs are uncontrollable like fixed
costs. . They don't vary with the change in short run managerial
 decisions and output. And some costs are controllable i.e. they can be
managed and changed with the managerial decisions and output.
As the above overhead expenses would have certain portion of fixed
expenses this is hard to control. So, these should not be a part of
controllable cost.
Kiran Company (MCS-2004) Numerical

Budget versus Actual comparison for div Z of Kirancompany is as follows:

Budg Actua Actual better

et l (worse) than
budget

Sales and other income 800 740 (60)

Variable expenses 480 436 44

Fixed expenses 120 120 0

Sales promotional expenses 40 28 12

Operating profit 160 156 4

Net working capital 400 412 12

Fixed assets 160 148 (12)

(a) Carry out and overall performance analysis to decide areas

needing investigation.

From the given data, we see that there is a certain amount of variance
between the budgeted operating profit and actual operating profit. In
order to analyze the variances, we need to understand the key causal
factors that affect profit, namely, revenues and cost structure. The profit
budget has embedded in it certain expectations about the state of total
industry, company’s market share, selling prices and cost structure.
Results from variance computation are actionable if changes in actual
results are analyzed against each of this expectation.

Revenue variances, that is a negative Rs 60 lakhs, could be a result of

selling price variance, mixed variance and/or volume variance. A
combination of above three factors must have been unfavorable that is
either the volume of sales must have been below the budgeted volumes
( this must be particularly true since actual variable expenses are less
than budgeted) and/or the selling price must have been below
expectation and/or the proportion of products sold with a higher
contribution must have been less than budgeted.

One more factor could have been the overall industry volume. However,
this factor is beyond the managements control and largely dependent on
the state of economy.

Variable expenses are directly proportional to volumes and hence as is

evident are less than budgeted.

Sales promotional expenses also show a negative variance which could be

a cause of lower sales volumes.

A cause of concern is that despite lower sales, the net working capital is
more than budgeted which indicates capital block in higher inventory.

Another issue is that the fixed assets are lower than the budget by Rs 12
lakhs which may indicate slower capacity expansion then expected or
distressed sale of assets to tide over cash flow.

(b) What are the remedial measures if any would you suggest
based on analysis?

The budgeted estimates may be too optimistic and far from reality, one
needs to ensure that estimates the as realistic as possible. Given the
estimates are correct, in that case depending upon the above analysis,
the management needs to take corrective action areas needing
improvement, sales volume could be improved by better marketing,
quality standards and promotional efforts, product mix could be improved
by selling more of higher contribution products. Better sales will ensure a
higher inventory turnover. Better credit management to recover
receivables, will ensure improve cash flow situation since less capital will
be tied up in working capital.
Q.5ABC ltd. (MCS-2008) Numerical

Particulars Division X (Rs.) Division Y (Rs.)

ROI 28% 26%
Sales 100 Lacs 500 lacs
Investment 25 lacs 100 Lacs
EBIT 7 Lacs 26 lacs

Analyze and comment upon performances of both the divisions

Solution:

Division X
ROI = (Profit / investment)* 100
Profit = (28/100)*25lacs
= 7lacs

Profit margin = (Profit/sales)*100

= (7/100)*100
= 7lacs

Turnover of investments = (Sales/investment)*100

= (100/25)*100
= 4 times

Division Y
ROI = (Profit / investment)* 100
Profit = (26/100)*100lacs
= 26lacs

Profit margin = (Profit/sales)*100

= (26/500)*100
= 5.2lacs

Turnover of investments = (Sales/investment)*100

= (500/100)*100
= 5 times

Profit margin of X is better than profit margin of division Y. Turnover of investment of division Y is better than
Division X.

Hence cost management of Division X is better than Division Y.

MCS 2006 (SUM NO 7)

Q) Soniya Company has two Divisions: A & B. Return on Investment for both divisions is 20%.
Details are given below:-

Particulars Div A Div B

Divisional sales 4000000 9600000

Divisional Investment 2000000 3200000

Profit 400000 640000

Analyse and comment on divisional performance of each.

ANSWER

As Profit Margin = Profit *100

Sales

Profit Margin for Division ‘A’= 4,00,000 /40,00,000 *100 = 10%

Profit Margin for Division ‘B’ = 6,40,000/ 96,00,000 *100 = 6.6%

Turnover of Investment = Sales * 100

Investment

Turnover of Investment for Division ‘A’ = 40,00,000/20,00,000 = 2 times

Turnover of Investment for Division ‘B’ = 96,00,000/32,00,000 = 3 times

As Return on investment for both Divisions A and B is 20%.

COMMENTS:-

Division ‘A’ – Although ‘A’ has more profit margin than Division ‘B’ that is 10% as compared to
6.6% of ‘B’, so it has more profitability but inspite of it, division ‘A’ has lower turnover of
investment that its assets management is bad than Division ‘B’, it can be improved by increased sales
or reducing investment.

Division ‘B’ – Needs to improve profit margin by increasing sales and reduce variable cost and sales
at same price or by reducing salesprice and increase the volume of sales so that its profit would
improve. As it has good assets management shown by its turnoverof Division ‘B’ that is 3 times
which is better than Division ‘A’. So it can become profitable organisation by improving Profit
Margin

Q5: Shandilya Ltd. (MCS-2008) Numerical

Shandilya Ltd. has adopted Economic Value Added (EVA) technique for the appraisal of performance of its
three divisions A,B and C. Company charges 6% for current assets and 8 % for Fixed Assets, while computing
EVA relevant data are given below :-

Particulars Div A Div B Div C Total

Budgeted Actual Budgete Actual Budgete Actual Budgete Actual

d d d

Profit 360 320 220 240 200 200 780 760

Current Assets 400 360 800 760 1200 1400 2400 2520

Fixed Assets 1600 1600 1600 1800 2000 2200 5200 5600

Solution:

Particulars Div A Div B Div C Total

Budgeted Actual Budgete Actual Budgeted Actua Budgete Actual

d l d

ROA 18% 16% 9% 9% 6% 6% 10% 9%

EVA 208 170.4 44 50.4 -32 -60 220 160.8

Q 2)Suresh Ltd. (Numerical) (MCS-2007) and same as Ananya Ltd (MCS 2009)

(a) Define profit in this case and prepare a statement for both divisions and overall company.

Solution:

i) Profitability statement of Division A:-

Particulars Amount(Rs.)
Selling price p.u. 35
Variable Cost p.u. 11
Contribution p.u. 24

Contribution p.u. Expected sales Total contribution Total Fixed cost Net profit (Rs.)
(no. of units) (Rs.)
24 2000 48000 60000 (12000)
24 3000 72000 60000 12000
24 6000 144000 60000 84000
 ii) Profitability statement of Division B:-

Selling p.u. Total Contribution Expected Total Total Fixed Net profit
variable p.u. sales (no. of contribution cost (Rs.) (Rs.)
cost p.u. units)
90 42 48 2000 96000 90000 6000
80 42 38 3000 114000 90000 24000
50 42 8 6000 48000 90000 (42000)
[Note: Total Variable cost p.u. = Variable cost p.u. (Rs.7) + Transfer price of intermediate product
(Rs.35)]

iii) Profitability statement of Company as a whole:-

Expected sales Net profit of division A Net profit of Division Total Net profit
(Rs.) B (Rs.)
2000 (12000) 6000 (6000)
3000 12000 24000 36000
6000 84000 (42000) 42000

(b) State the selling price which maximizes profits for division B and company as a whole.
Comment on why the latter price is unlikely to be selected by division B.

Solution:
As per the calculation in part (a), selling price p.u. of Rs.80 maximizes profit for division B
whereas selling price p.u. of Rs.50 maximizes profit for the Company as a whole. However, if
Division B opts for selling price p.u. of Rs.50 in order to maximize Company’s profit, it would
suffer a loss of Rs.42000. Therefore, Division B would not select Selling price p.u. of Rs.50.
 MCS – 2007
Two Divisions A and B of Satyam Enterprises operate as Profit centers. Division A normally
purchases annually 10,000 nos. of required components from Div. B; which has recently
informed Div. A that it will increase selling price per unit to Rs.1,100. Div.A decided to
purchase the components from open market available at Rs. 1000 per unit. Naturally, Div. B is
not happy and justified its decision to increase price due to inflation and added that overall
company profitability will reduce and the decision will lead to excess capacity in Div. B, whose
variable and fixed costs per unit are respectively Rs. 950 and Rs. 1,100.
Assuming that no alternate use exists for excess capacity in Div. B, will company as a whole
benefit if div A buys from the market.
If the market price reduces by Rs. 80 per unit. What would be the effect on the company
(assuming Div. B still has excess capacity) if A buys from the market
If excess capacity of Div. B could be used for alternative sales at yearly cost savings of Rs. 14.5
lacs, should Div. A purchase from outside?
Justify your answers with figures.
Solution
Option A ( Div A buys from outside)
Total Purchase Cost = 10,000 Units * Rs. 1000 = Rs. 1,00,00,000
Total outlay if transferred inside = 10,000 Units * Rs. 950 = Rs. 95,00,000

Since total outlay if transferred inside is lesser than total purchase cost if bought from outside,
relevant cost is the lesser one i.e. Rs. 95,00,000 and overall benefit for the company would be Rs.
5,00,000
a) Option B ( if the market price is reduced by Rs. 80 per unit and A buys from the market)
Total Purchase Cost = 10,000 Units * Rs. 920 = Rs. 92,00,000
Total outlay if transferred inside = 10,000 Units * Rs. 950 = Rs. 95,00,000
Since total purchase cost is lesser than the total outlay if transferred inside, relevant cost is the
lesser one i.e. 92,00,000 and overall benefit for the company would be Rs. 3,00,000

b) Option C ( if excess capacity of Div B could be used for alternative sales at yearly cost
savings of Rs 14.5 lacs, should Div A purchase from outside)
Total Purchase Cost = 10,000 Units * Rs. 1,000 = Rs. 1,00,00,000
Total outlay if transferred inside = 10,000 Units * Rs. 950 = Rs. 95,00,000
Total opportunity cost if transferred inside = Rs. 14,50,000
Total relevant cost becomes Rs. 1,00,00,000
If Div A purchase from outside, overall benefit for the company would be Rs. 9,50,000.
Therefore, Div A should purchase from outside.

Particulars Option A Option B Option C

Amount Amount Amount
Total Purchase Cost 1,00,00,000 92,00,000 1,00,00,000
Total outlay if transferred inside 95,00,000 95,00,000 95,00,000
Total opportunity cost if transferred inside - - 14,50,000
Total relevant cost 95,00,000 92,00,000 1,00,00,000
Net advantage/disadvantage to company as a 5,00,000 (3,00,000) (9,50,000)
whole if it buys from inside
(Numerical) MCS – 2004

Division B of Shayanacompany contracted to buy from Div. A, 20,000 units of a

components which goes into the final product made by Div. B. The transfer price for this

internal transaction was set at Rs. 120 per unit by mutual agreement. This comprises of

(per unit) Direct and Variable labour cost of Rs. 20; Material Cost of Rs.60; Fixed

overheads of Rs.20 (lumpsum Rs.4 lacs) and Rs.20 lacs that Div. A would require for this

additional activity. During the year, actual off take of Div. B from Div. A was 19,600

units. Div. A was able to reduce material consumption by 5% but its budgeted

investment overshot by 10%.

a) As Financial controller of Div. A, compare Actual VsBudgetred Performance

b) Its implications for Management Control?

Solution:

a)

Particulars For 19,600

20,000Budgeted Actual Actual
Units (Total in Rs.) (Rs. Per Unit) (Total in Rs.)

Budgeted
Direct and 20 4,00,000 20 3,92,000

Variable Labour

Cost
Material Cost 60 12,00,000 57 11,17,200
Fixed Overheads 20 4,00,000 4,00,000
Total Cost 100 20,00,000 19,09,200
Transfer Price 120 24,00,000 119.86 23,49,200
Profit 20 4,00,000 4,40,000
Investment 20 20,00,000 22,00,000
ROI = 20% 20%

Profit/Investment

Despite of increase in investment by 10%, there is negligible difference in transfer price. Also the

sales have decreased by 400 units. Therefore we can say that additional investment has not achieved

any positive results.

 Q) Division of Aparna Company manufactures Product A, which is sold to another division
as a component of its product B; which then is sold to third division to be used as part of its
Product C (sold to outside market). Intra company transactions rule: standard cost plus a
10 percent return on fixed assets and inventory, to be paid by the buying division.
Standard Cost per Unit Product A Product B Product C

*Purchase of outside material (Rs.) 40 60 20

Direct. Labour (Rs.) 20 20 40
Variable overhead (Rs.) 20 20 40
*Fixed overhead per unit. (Rs.) 60 60 20
Average Inventory (Rs.) 14 lacs 3 lacs6 lacs
Net Fixed Assets (Rs.) 6 lacs 9 lacs 3.2 lacs
Standard Production (Units) 2 lacs 2 lacs 2 lacs

(a) Determine from above data, transfer prices for Products A, B and Standard Cost of
Product C.
(b) Product C could become uncompetitive since upstream margins are added. Comment.

Answer
(a):Standard Cost of Product A
Outside material (40 * 2 lac units) 80,00,000
Direct Labour (20 * 2 lac units) 40,00,000
Variable O.H. (20 * 2 lac units) 40,00,000

1,60,00,000
+ 10% on (FA + Inventory)
i.e. 10% on 20 lacs 2,00,000

1,62,00,000

Transfer Price for Product A = 1,62,00,000 = 81

2,00,000

Standard Cost of Product B

Outside material (60 * 2 lac units) 1,20,00,000
Direct Labour (20 * 2 lac units) 40,00,000
Variable O.H. (20 * 2 lac units) 40,00,000

2,00,00,000
+ 10% on (FA + Inventory)
i.e. 10% on 12 lacs 1,20,000

2,01,20,000
 Transfer Price for Product A = 2,01,20,000 = 100.6
2,00,000

Standard Cost of Product C

Outside material (20 * 2 lac units) 40,00,000
Direct Labour (40 * 2 lac units) 80,00,000
Variable O.H. (40 * 2 lac units) 80,00,000
Fixed O.H. (20 * 2 lac units) 20,00,000
2,20,00,000

(b): While arriving at the cost of Product C, margins of Product A, which become an input to Product
B, and Product B, which in turn become an input to Product C, are added. So when it is sold to
outside market, it suffers a disadvantage from its competitors as far as pricing is concerned, as its
price will normally be high compared to products of similar category. So it might become
uncompetitive.
But in the long run, customers will distinguish between a good product and a bad product and the one
with the best quality will survive. So if the quality of product C is better than its competitors than only
it can survive in this competitive market.
Another strategy for the company is to cut the margins added by Products A and B, and then come out
with Product C with a lower price tag on it. This may do well to the product by making higher
revenues and capturing the market share.
Q) Ananaya& Company comprises of five divisions A, B, C, D and E and
the present performance. metricis return on assets. However, the
controller has suggested management to switch over to economic value
added(EVA) as the criterion rather than return on assets. Compute and
tabulate both return on assets and EVA on the basis of following
information (Rs. lakhs) and comment on divisional performance.

Division Profit Fixed Assets Current Assets

--

A 300 800 160

- - ----

B 220 400 1600

C 100 600 1000

________

D 110 400 800

E 180 200 800

Controller feels corporate finance rates on current assets and.fixed assets should
be 5% and 10% respectively.

Solution:

Working Note:

Return on Assets = Profit * 100

Total Assets
 A = 300/960*100 = 31.25%

B = 220/2000*100 = 11%

C = 100/1600*100 = 6.25%

D = 110/1200*100 = 9.17%

E = 180/1000*100 = 18%

Economic Value Added (EVA) = Profit – (W.A.C.C.* Capital Employed)

In this case,

EVA = Profit – (W.A.C.C. on Fixed Assets * Total Fixed Assets) + (W.A.C.C. on

Current Assets * Total Current Assets)

A = 300 – (0.10*800) + (0.05*160) = 212 lakhs

B = 220 – (0.10*400) + (0.05*1600) = 100 lakhs

C = 100 – (0.10*600) + (0.05*1000) = -10 lakhs

D = 110 – (0.10*400) + (0.05*800) = 30 lakhs

E = 180 – (0.10*200) + (0.05*800) = 120 lakhs

Summary

Divisio Return on Assets (R.O.A.) Economic Value Added

n (E.V.A.) (Rs. lakhs)

A 31.25% 212

B 11.00% 100

C 6.25% -10

D 9.17% 30

E 18.00% 120

Comments:

1. It appears from the above analysis that division A has performed the best
among the five divisions.
2. Also, it can be clearly noticed that divisions C and D seem to be in trouble.

3. Division A has performed the best when seen in terms of return on assets and
economic value added.

4. The reason why division A has performed the best is that it has the best
working capital management that can be reflected in the total amount invested
in current assets and which is the least among the five divisions.

5. The above reason holds true for the poor performance of divisions C and D as
can be seen that they have a huge amount invested in current assets which
does not indicate good signs about their operational efficiency.

6. A company which is into an expansion and overall growth mode primarily

invests into fixed assets and this is also one of the major reasons why the
performance of division A is the best amongst all.

7. Though division C has also invested a huge amount in fixed assets the
advantage is offset due to the fact that it perhaps has a larger investment in
current assets.

8. Division E is the second best both in terms of R.O.A. as well as E.V.A.

9. Though division E has the same amount invested in current assets as that of
division D and perhaps a lesser amount invested in fixed assets its profitability
is much better and hence it has delivered a better performance.

10.Division B is a better performer than divisions C and D in terms of R.O.A. as

well as E.V.A. but the major problem with this division is that it has a terrible
working capital management. Its current assets are the highest and this
reflects that it has huge sums of money held up either in debtors or inventory
or rather it is holding a large amount of cash which is not a good sign.
Q: 32 Pritam Engineering manufacturers (MCS-2005) Numerical
Pritam Engineering manufacturing variety of metal product at many
factories.Currently. It is experiencing crisis, Management has, therefore, decided
to detailed expense control system including responsibility budgets for overhead
expense items at each factory. From historical data, Controller developed a
standard for each overhead expense item (relating expense to volume of
activity). Summarized expenses for November,2005 given to concerned
Production Supervisor for comments is tabulated. All figures are in Rs. 000.
Item Standard at nominal Budgeted at actual actual
volume volume
Management 720 720 582
Supervision
Indirect labour 12706 11322 12552
Idle time 420 361 711
Materials, Tools 3600 3096 3114
Maintenance, 14840 13909 17329
scrap
Allocated 21040 21040 21218
expenses
Total per ton 2133.04 2103.39 2413.3
(Rs.)

(A) Explain with justification which of the two (1) or (2) is more meaningful for
expense control.
(B) Can the supervisor be held responsible for all overhead expenses
included? Why/why not?

Ans. (A) There is two general types of expense centers: engineered

and discretionary. This label relate to two types of cost. Engineered
costs are those for which the “right” or “proper” amount can be
estimated with reasonable reliability for example, a factory’s costs for
direct labor, direct material, components, supplies, and utilities.
Discretionary costs (also called managed costs) are those for which not
such engineered estimate is feasible. In discretionary expense centers,
the costs incurred depend on managements judgment as to the
appropriate amount under the circumstances.

Engineered expense centers

Engineered expense centers are usually found a manufacturing
operations. Warehousing, distribution, trucking, and similar units
within the marketing organization may also be engineered expense
centers, as may certain responsibility centers within administrative
and support department for instance, accounts receivable, accounts
payable, and payroll sections in the controller department;
personnel records and the cafeteria in the human resources
department; shareholder records in the corporate secretary
department; and the company motor pool. Such units perform
repetitive tasks for which standard costs can be developed. These
engineered expense centers are usually located within departments
that are discretionary expense centers.
In an engineered expense center, output multiplied by the standard
cost of each unit produced measures what the finished product
should have cost. The difference between the theoretical and the
actual cost represents the efficiency of the expense center being
measure.
We emphasize that engineered expense centers have other
important tasks not measured by cost alone; their supervisors are
responsible for the quality of the products and volume of production
as well as for efficiency. Therefore, the type and level of production
are prescribed, and specific quality standards are set. So that
manufacturing costs are not minimized at the expense of quality.
Moreover, managers of engineered expense centers may be
responsible for activities such as training and employee
development that are not related to current production; their
performance reviews should include an appraisal of how well they
carry out these responsibilities.
There are few, if any, responsibility centers in which all cost items
are engineered. Even in highly automated production departments,
the use of indirect labor and various services can vary with
management’s discretion. Thus the term engineered expense center
refers to responsibility centers in which engineered costs
predominate. But it does not imply that valid engineered estimates
can be made for each and every cost item.
Discretionary expense centers
Discretionary expense centers include administrative and support
units (e.g. accounting, legal, industrial relations, public relations,
human resources), research and development operations, and most
marketing activities. The output of these centers cannot be
measured in monetary terms.
The term discretionary does into imply that managements judgment
as to optimum cost is capricious or haphazard. Rather it reflects
management’s decisions regarding certain policies: whether to
match or exceed the marketing efforts of competitors; the level of
services the company should provide to its customers; and the
appropriate amounts to spend for R&D, financial planning, public
relations, and a host of other activities.
One company may have a small headquarters staff, while another
company of similar size and in the same industry may have a staff
10 times as large. The senior managers of each company may each
be convinced that their respective decisions on staff size are
correct, but there is no objective way to judge which (if either) is
right; both decisions may be equally good under the circumstances,
with the differences’ in size reflecting other underlying deference’s
in the two companies.
As far as above stated over heads are concern, we can easily
estimate “proper” or “right” amount with responsible reliability.
There for standard (1) is more meaningful for expenses control.

Ans. (B) A responsibility center is an organization unit that is

headed by a manager who is responsible for its activities. In a
sense, a company is a collection of responsibility centers, each of
which is represented by a box on the organization chart. These
responsibility centers form a hierarchy. At the lowest level are the
centers of the sections, work shift, and other small organization
units. Departments or business units comprising several of these
smaller units are higher in the hierarchy. From the standpoint of
senior management and and the board of directors, the entire
company is a responsibility center, though the term is usually used
to refer to units within the company and there for Supervisor is
responsible for the uses of the Above stated Resources (over heads)
like Indirect labor, idle time, Materials, tools, maintenance, scrape
and Management supervision by proper supervising supervisor can
control the listed overhead expenses.
 Q:2005 )A TV dealership Veena Television (VT) is organized into four profit centers.
colour TV, Black and White, spare parts(SP) and servicing (SG) each headed by
manager BTV in addition to BVTV sales; also sells old TV exchanged (under scheme)
by customer while purchasing new TV . in one particular instance a new TV was sold
for 14150(financed by cash rs2000, Bank loan 7350and Rs 4800;exchange price for old
TV agreed by CTV manager )cost of new TV was Rs 11420.Shivangi Manager of BTV,
examined the old TV (valued at Rs 3500 by TV trade magazine) and felt that she could
get Rs 5000 for that TV offer repairing cabinet, resulting and servicing for which she
would use services of SP and SG price chargeable to BTV by SP and SG are at market
rates Rs235 for parts by SP and Rs 470 for services by SG. Market price are arrived at
after marking up cost by 3.5 times SG and 1.4 times SP. BTV pays a service
commission of Rs 250 per TV sold .overhead fixed per sale are CTV Rs 835;BTV Rs
665;SP RS 32 ;SG Rs 114.

Compute the profitability of the transaction assuming sales commission of $250 for the
trade in on a selling price of $5000

➢ Compute at market price

➢ At cost price
➢ Gross and net profit each

SOLUTION:
➢ SP of New TV by CTV = $14150.
➢ Original cost= $11420 ($14150= $2000 cash down payment + $4800
trade in allowance + $7350 bank loan)
➢ Guide Book Value =$3500
➢ Ms. Shivangi of BTV Dept, believed that she could sell the trade in at $5000
➢ Other Cost: Rs235 for parts by SP and Rs 470 for services by SG
When trade-in is recorded @ $4800

Particulars New TV OLD TV Service Parts

Sales 14150 5000 470 235
Selling commission 0 250 0 0
Gross profit 2730 -505 470 235
Overhead 835 665 114 32
Servicing 0 470 0 0
Net profit before common exp 1895 -1640 591 123
4800+470+235=5505; 5000-5505= (-505)

If the trade-in is recorded @ $3500

 Particulars New TV OLD TV Service Parts
Sales 14150 5000 470 235
Selling commission 0 250 0 0
Gross profit 2730 1045 470 235
Overhead 835 665 114 32
Servicing 0 470 0 0
Net profit before common exp 1895 -340 356 123
 2006: sum(11)
Two divisions A and B of sonali enterprises operate Profit centers. Div A normally
purchases annually 10000 nos. of required components from Div B, which has recently
informed Div A that it will increase selling price p.u to Rs. 1100. Div A decided to
purchase the components from open market available at Rs.1000 p.uDiv B is not happy
and justified its decision to increase price due to inflation and added that the overall
company profitability will reduce and decision will lead to excess capacity in Div B,
whose V.C and Fixed cost p.u. are Rs. 950 and Rs.1100.
1. Assuming that no alternate use exists for excess capacity in Div B, will company
benefit as a whole if Div A buys from the market.
2. If the market price reduces by Rs.80 p.u. What would be the effect on the
company (assuming Div B has still excess capacity) if A buys from market.
3. If excess capacity of Div B could be use for alternative sales at yearly costs
savings of Rs. 14.5 lacs, should Div A purchase from outside?
Justify your answers with figures
ANSWER

1) Division ‘A’ action

BUY OUTSIDE (Rs.) (Rs.) BUY INSIDE

Total Purchase Cost 10,00,000 Nil

Total Outlay Cost Nil 9,50,000

Net Cash Outflow To The 10,00,000 9,50,000

Company As A Whole
The Company as a whole will benefit if Division ‘A’ buys inside from Division ‘B’.

2) If the market price reduces by Rs.80 p.u

Division ‘A’ action

BUY OUTSIDE (Rs.) (Rs.) BUY INSIDE

Total Purchase Cost 9,20,000 Nil

Total Outlay Cost Nil 9,50,000

Net Cash Outflow 9,20,000 9,50,000

To The Company
As A Whole

The Company as a whole benefit if ‘A’ buys from outside supplier at Rs. (1000-80) = 920

3) If excess capacity of Div B could be use for alternative sales at yearly costs savings of
Rs. 14.5 lakhs

Division ‘A’ action

 BUY OUTSIDE (Rs.) (Rs.) BUY INSIDE

Total Purchase Cost 10,00,000 Nil

Total Outlay Cost Nil 9,50,000

Revenue From 1,45,000

Using These
Facilities
Net Cash Outflow 8,55,000 9,50,000
To The Company
As A Whole
 1 Girish Engineering Ltd. (Numerical) (MCS-2006)

(1) On the basis of costing, will the manager be interested in accepting the market offer?

Solution:

Particulars Amount (Rs./unit) Amount (Rs./unit)

Cost of critical component 220
for division X
Cost of other material 500
Fixed & processing costs 290
Total cost for division X 1010
Selling price of final product 1000
Net loss for division X 10
Desired profit for division X 60

Thus on the basis of full actual cost incurred by division X, it would suffer a loss of
Rs.10/unit if it accepts the market offer whereas its target profit margin is Rs.60/unit. So,
division X would not accept the market offer.

(2) Is this offer beneficial to the company as a whole? Justify with figures.

Solution:

Particulars Amount (Rs. Lakh) Amount (Rs. Lakh)

Cash inflow (a) 50 (5000 units *
Rs.1000/unit)
Cash outlay:
Variable cost for division Y 5 (Working note)
Material bought by division 25 (5000 units * Rs.500/unit)
X from outside
Total cash outlay (b) 30
Net cash inflow to Company 20
as a whole [(a)- (b)]
Thus, the Company as an entity would receive cash inflow of Rs.20 lakh. So, the offer is
beneficial to the company as a whole.

Working notes:-

• Variable cost for division Y:

Desired RoI =10% of Rs.2.4 Cr. p.a. = Rs.24 lakh p.a. i.e. Rs.2 lakh per month

Fixed cost assigned to division X = Rs.4 lakh per month

Fixed cost p.u. = 400000/5000 = Rs.80

Contribution per month = Rs.6 lakh

Total sales value for division Y = 220 * 5000 = Rs.11 lakh per month

So, total Variable cost per month for division Y = 11 lakh – 6 lakh = Rs.5 lakh

Variable cost p.u. for division Y = 500000/5000 = Rs.100

• An annual investment of Rs2.4 Cr. is assigned by division Y to division X but it

does not imply that a special investment of Rs.2.4 Cr. is made by division Y
exclusively to produce the component required by division X. Therefore, cash
outflow associated with this investment is not relevant for the above concerned
decision regarding accept the market offer.

(1) If yes, how should the company organize its transfer pricing mechanism?
Illustrate.

Solution:

Currently, Girish Engineering Ltd. is following 2 step transfer pricing method wherein the
selling division charges actual variable cost along with profit mark-up & separately
allocates a particular amount of fixed costs per month to the buying division. However, in
the case of division X (buying division) & division Y (selling division), this method of
transfer pricing is not feasible as division X would suffer loss if it accepts the market
offer under this scenario. So, divisions X & Y can negotiate a transfer price by taking into
account full actual variable cost (Rs.100 p.u.) & half of fixed costs incurred by division Y
that is assigned to division X (Rs.40 p.u.) & add a mark-up of say Rs.10/unit. Taking into
consideration only half of the fixed costs of selling division i.e. division Y prevents
shifting of any operational inefficiencies from selling division to buying division i.e.
division X, which would unnecessarily increase the costs for division X and thereby eat
up its profit margin. In this case, division X’s total costs would turn out to Rs.940 (500 +
290 + 150) & would earn a profit margin of Rs.60 p.u. (desired profit margin). Also,
contribution p.u. for division Y would be Rs.50 (150 – 100). Thus, total contribution for
division Y would be Rs.250000 resulting in RoI of 12.5% (250000/2000000) which is
more than the desired RoI of 10%.