Accounting Techniques for decision making 2

(1)Opening stock of raw materials

+ purchase of raw materials + expenses on raw materials

(2) =
electricity

raw materials consumed + production usages + direct expenses viz Factory cost + Administrative expenses Cost of sales + Profit - losses Selling price

(4) = (6) =

(3)

closing stock of raw materials

prime cost + factory expenses + opening stock of work in - Closing stock of work in

process process

(5) =

Cost of production + Selling and distribution expenses + Opening stock of finished stock - Closing stock of finished stock

(7) =

Costing has been defined as the techniques and process of ascertaining cost of products r cost of services. Objectives:
i. ii.

iii.

To find out cost of products and cost of services To control cost of products and cost of services, so that it will not exceed the limit laid down. To reduce cost of products and cost of services. It facilitates preparation of estimates It helps in maximization of profit It helps in eliminating loss making activities It helps in taking following managerial decisions:
a. b. c. d. e. f. Price fixation Export price fixation Make or buy decision Continue or discontinue a product Replacement of men by machines and machines by better machines Profit planning Profit maximization is a key factor

Applications:
i. ii. iii. iv.

Marginal costing is the ascertainment of marginal cost by segregating fixed and variable cost and measurement of the effect of variation in the volume of output or product mix on profit level. Only prime cost plus variable overheads are included in finding out cost of production. Fixed costs are treated as period cost and charged to costing profit and loss account and not to a product. Applications:
i. ii. iii. iv. v. vi. vii. viii. ix.

Determination of optimum level of production. Continue or discontinue of a department an activity or a product line. Pricing of product or jobs. Export pricing Make or buy decision Pricing based on limiting or key factors Expand or buy decisions Profit planning Hire or purchase decision

Limitations:
i. ii.

The analysis of overheads into fixed or variables items may often present difficulties. Application of marginal costing is difficult in job costing and in joint products and by-products. The element of semi-variable cost creates problem.

It is the level of activity or volume of sales at which company is neither making profit nor incurring losses. It is a level of activities where there is no profit no loss. If we go beyond that point there is a profit, if we work less than that point there is a loss. Applications: are same as applications of Marginal Costing.

Example: 1

Satish company Ltd. has an unutilized capacity of 66,000 direct labour hours within its existing unutilized capacity. The company can produce any combination of product X, Y or Z without increase fixed costs. The company has supplied the following data:-

P R O D U C T S
X Estimated selling produce for unit Variable Manufacturing Cost per unit Fixed Cost (allocated) Standard hours required to produce unit Estimated No. of units that cold be sold Rs. 30 Rs. 20 Rs. 4 4 hours 7, 000 Y Rs. 36 Rs. 24 Rs. 6 6 hours 5, 000 Z Rs. 54 Rs. 36 Rs. 8 8 hours 4, 000

Which of the products and how many units of each product should you recommend to be produced and sold by the company?

Example: 2 A company is, at present, working at 80% of its capacity and producing 8000 units pee annum. It operates flexible budgetory control system. The following figures are available from its budget:

80% Rs.
1.
2. 3. 4.

100% Rs.

Sales
2. Fixed Expenses Semi- fixed expenses Variable cost

8, 00, 000
1, 50, 000 1, 00, 000 4, 00, 000 8, 000

10, 00, 000

1, 50, 000 1, 10, 000 5, 00, 000 10, 000

5. Units made

You are required to determine the differential cost of producing 2000 units by increasing capacity to 100 per cent. What would you recommend for an export price for 2000 units. Taking into account that overseas prices are much lower than indigenous price?

Example: 3 Following information has been made available from the cost records of united automobiles Ltd., manufacturing spare parts: Direct materials per unit X Rs. 8 Y Rs. 6 Direct wages X 24 hours @ 25 paise per hour Y 16 hours @ 25 paise per hour Variable overheads 150% of direct wages Fixed overheads (total) Rs. 750 Selling price X Rs. 25 Y Rs. 20 The directors want to be acquainted with the desirability of adopting any one of the following alternative sales mixes in the budget for the next period. a. 250 units of X and 250 units of Y

400 units of Y only 400 units of X and 100 units of Y 150 units of X and 350 units of Y

State which of the alternative sales mixes you would recommend to the management.

Example: 4

The sales turnover and profit during two years were as follows:Year 2010 2011 Seles Rs. 3, 00, 000 Rs. 3, 40, 000 Profit Rs. 40, 000 Rs. 50, 000

You are required to calculate

i.
ii. iii. iv. v.

P/V ratio
Break-even point The sales required to earn a profit of Rs. 80, 000 The profit made when sales are Rs. 5, 00, 000 Margin of safety at a profit of Rs. 1, 00, 000

Example: 5

An analysis of Sultan Manufacturing Co. Ld. Led to the following information: Cost element Variable Cost Fixed Costs (% of sales) Rs. Direct material 32.8 Direct labour 28.4 Factory overhead 12.6 1, 89, 900 Distribution overheads 4.1 58, 400 General administration overheads 1.1 66, 700
Budgeted sales are Rs. 18, 50, 000. You are required to determine: The break-even sales volume ; The profit at the budgeted sales volume; and iii. The profit if actual sales : a. Drop by 10% and b. Increase by 5% from budgeted sales.
i. ii.

Example: 6

From the following particulars you are required to calculate:

i. ii. iii. iv. v.

P/V ratio Break-even point for sales. Profit or Loss when sales are Rs. 5, 00, 000/Sales required to earn profit of Rs. 60, 000/-. Safety margin in the year 2011.

Year

Sales
Rs.

Profit
Rs. (-) 20, 000 80, 000

2010 2011

4, 00, 000 6, 00, 000

Example 7
X chemicals ltd has two factories with similar plant & machinery for manufacturing soda ash. The board of directors of the company has expressed the desire to merge them and to run them as one integrated unit. Following data are available in respect of these two factories.
Particulars Capacity in operation Turnover X 60% 120 lacs Y 100% 300 Lacs

Variable cost
Fixed cost

90 Lacs
25 Lacs

220 Lacs
40 Lacs

Find Out:

a. What should be the capacity of the merged factory to be operated for break even?
b. What is the profitability of working 80% of the integrated capacity? c. What turnover will give an overall profit of Rs. 60 lacs?

Solution to Example 7
Particulars 60% Turnover 120 X Equivalen t to 100% 200 150 50 300 220 80 500 370 130 400 296 104 Y Xy merged Xy at 80% Less 90 Variable cost Contribution 30

Less Fixed Expenses

Profit PV Ratio BEP Sales Capacity of merged plant capacity at BEP Desired Turnover= (Fixed cost+ Desired

25
5 25% 100 50%

25
25 25% 100

40
40 26.67% 150

65
65 26% 250

65
39 26% 250

(65+60)/X100 26

480.77 lacs

Example 8
A factory is currently working at 50% capacity and produces 10000 units. Estimate the profits of the company when it works at 60% and 80% capacity. At 60% working raw material cost increases by 2% and selling price falls by 2%. At 80 % working, raw material cost increases by 5% and selling price falls by 5%.At 50% capacity working, the product cost Rs 180 per unit and is sold at Rs. 200 per unit. The unit cost of Rs. 180 is made up as under.
Particulars Material Amt Rs. 100

Labour Factory Overheads

Adm. Overheads

30 30 (40% fixed)
20(50% fixed)

Example 9
A multi product company has the following costs and output data for the last year.

Particulars Sales mix Selling price

X 40% 20

Y 35% 25

Z 25% 30

Variable cost
Total fixed cost Total sales

10
150000 500000

15

18

The company proposes to replace product Z by product S. Estimated cost and output data are

Particulars Sales mix Selling price Variable cost Total fixed cost Total Sales

X 50% 20 10 150000 500000

Y 30% 25 15

S 20% 28 14

Analyse the proposed changes and suggest what decision the company should take.

Example 10
X ltd having an installed capacity of 100000 units of products is currently operating at 70% utilisation. At current level of input prices, The FOB unit cost works as follows.
Capacity utilisation(%) 70 80 FOB cost(Rs) 97 92

90 100

87 82

The company required three foreign offers from different sources as under. Source A 5000 units at 55 per unit FOB. Source B 10000 units at 52 per unit FOB. Source C 10000 units at 51 per unit FOB.

Advise the company as to whether any or all the export order should be exported or not.

Solution to example 10
Differential cost at different capacity utilisation
Capacit y% Prodn FOB @ unit different cost level 70000 80000 90000 100000 97 92 87 82 Total cost Diff cost Dcu

70 80 90 100

6790000 7360000 7830000 8200000 570000 470000 370000 57 47 37

Gain or loss on various export orders

Export order
A B C

Units

Capacity Dcu utilisatio n

75% 85% 95% 57 5000 @ 57 5000 @ 47 5000 @ 47 5000 @ 37

Total

Fob pric e
55 52 51

Sales revenue
275000 520000 510000

Gain

5000 10000 10000

285000 520000 420000

(10000) Nil 90000

1225000

1305000

80000

Example 11
Calculate from the following data 1. The value of the output at which the business breaks even 2. The % of capacity at which it breaks out.
Particulars Budget for the year 2012 based on 100% capacity 300000 200000 Estimated Shut Down expenses

Direct material Direct Wages

Factory Expenses
Selling & Dist. Exp Adm Exp Net Sales

300000
100000 100000 1200000

100000
50000 500000

Example 12
The following data are obtained from the records of xyz ltd.
Particulars Sales Total cost First 6 months 45000 40000 Last 6 months 50000 43000

There is no change in variable cost and that fixed exp are incurred equally in the two half year products.
Calculate for the year

1. PV ratio
2. Break even sales 3. % of margin of safety

4. If the desired profit is Rs.14000 calculate required sales value

5. If the desired profit is Rs.14000 and the current tax rate is 35%, calculate required sales value.

Example 13
The accounts of a company are expected to reveal a profit of 1400000 after charging fixed cost of 100000 for the year ended 31st dec 2011. The selling price of the product is Rs. 50 per unit and variable cost per unit is Rs. 20. Market investigations suggest the following responses to the price changes.
Alternatives
1 2 3

Selling price reduced by %

5% 7% 10%

Qnty sold increased by %

10% 20% 25%

Evaluate these alternatives and state which of the alternative on profitability consideration should be adopted for the forth coming year.

Solution to example 13
Break even units

Break even units with profit=

(Fixed cost + desired profit)/cont per unit.

=(1000000+1400000)/30
=80000 units
Alternati Units ve S.P per unit V.Cost per unit Cont per unit Total cont

1
2

88000
96000

47.50
46.50

20
20

27.50
26.50

2420000
2544000

3 1000002 should 45.00 20 25.00 2500000 Alternative be selected.

Example 14
V ltd budgets to make 100000 units of its product perfect. The variable cost is Rs.10 per unit while fixed cost is Rs.600000. The companys finance director has suggested the cost plus approach should be used for pricing with a mark up of 25%. The marketing director disagreed and has supplied the following inf.
Price per unit 18 20 22 Demand 84000 76000 70000

24
26

64000
54000

As management accountant of the company analyse the above proposal and comment.

Solution to example 14
Since additional qnty can be sold only by reducing the selling price the max cont and incremental cont will be revealed in decision making.
Qnty S.P per unit Rs. V.C per unit Rs. Cont per unit Rs. 8 10 12 Total Increme cont Rs. ntal cont. Rs. 672000 760000 840000 88000 80000

84000 76000 70000

18 20 22

10 10 10

64000
54000

24
26

10
10

14
16

896000
864000

56000
-32000

1.

The optimum level of output is the point at which the total contribution is max. Beyond the point, incremental cont. Becomes negative.

2.
3.

From the above, max cont is at 64000 units.

The finance directors suggestion of cost price plus would result in a price of (10+6)+25%=Rs.20 . At this level contribution is not max , it is still possible to increase the price.

4.

Since fixed cost Rs. 600000 are the same irrespective of the output.