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(1)

Managerial Accounting

and Control

1.Lilac Flour Meal

2.Hospital Supply Inc.

(2)
(3)

Process costing

 Process costing is a method of costing used mainly in manufacturing

where units are continuously mass-produced through one or more

processes.

 In process costing, it is the process that is costed (unlike job costing

where each job is costed separately). The method used is to take the total

cost of the process and average it over the units of production.

 Process costing is adopted when there is mass production through a

sequence of several processes. Example include chemical, flour and glass

manufacturing

(4)

4

Process 1

Process 2

Process 3

Direct material

Direct labour

overheads

Finished goods

Cost of goods sold

Direct material

Direct labour

overheads

Direct material

Direct labour

overheads

(5)

Process Cost Systems

 In a process cost system, costs are tracked through a series of connected

manufacturing processes or departments; used for large volume production of

uniform products

 An accounting system used to apply costs:

To similar products

That are mass-produced

In a continuous fashion

Manufacturing process can be clearly segregated in to clearly identifiable

processes or departments.

 Process costing is appropriate for industries: chemicals, food processing,

breweries, petroleum refining, metal manufacturing, steel making, paper

industry etc.

 Process costing assumes a sequential flow of costs from one process to another

as units of output passes through a specified production process.

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8

Accounting for Process Costing

• Costs are accumulated by each process

• Each process maintains its process account

• The process account is debited with the costs incurred and

credited with goods completed and transferred to other process

account

• When the goods are completed, they will be transferred to

finished goods account

• When the goods are sold, the amount will be transferred to the

cost of goods sold account

(9)

9 Process A Material 500 Labour 100 Overhead200 Process B 800 800 800 Process B Process A800 Material 50 Labour 150 Overhead100 Process C 1100 1100 1100 Process C Process B 1100 Material 80 Labour 110 Overhead 210 Finished Gds 1500 1500 1500 Finished Goods

Process C 1500 Cost of GDs Sold 1300 Bal c/d 200

(10)

Lilac Flour Meal

 Processed Wheat to produce White flour (60%), Suji (10%), Wholemeal Flour (10%) and Bran (20%)

 The purchase price of wheat and operating cost up to the point of separation of end products were treated as Joint Costs.

 Packing, Selling and distribution cost incurred after the sieving stage was identified with individual products and treated as Separable costs.

 At Present: The average unit cost for each product was arrived at by dividing the total joint costs by the

combined output of the four products.

Joint Costs 1665000

Seperable Costs 55620

Total 17,20,620

Profit 21,780

(11)

Monthly Wheat Input = 900 tons Product Production in % Production in tons Joint Cost allocated on the basis of production quantities (Rs.) Joint Cost Per Ton (Rs.) Separable Costs per Ton (Rs.)

Total Cost Per Ton (Rs.) Sales Price per Ton (Rs.) Profit (Loss) per ton (Rs.) Profit (Loss) for Total Output (Rs.) White flour 60 540 999000 1850 78 1928 2100 172 92880 Suji 10 90 166500 1850 84 1934 2480 546 49140 Wholemeal flour 10 90 166500 1850 34 1884 2000 116 10440 Bran 20 180 333000 1850 16 1866 1140 -726 -130680 900 16,65,000 1850 21780

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Product Production in % Production in tons Sales Value Per ton (Rs.) Total Sales Value (Rs.) % of Total Sales Value Joint Cost allocated on the basis of Sales Value Allocated Cost Per ton Separable Costs per Ton (Rs.) Total Cost Per Ton Profit (Loss) per ton (Rs.) Profit (Loss) for Total Output (Rs.) White flour 60 540 2100 1134000 65.08 1083780 2007 78 2005 15 8100 Suji 10 90 2480 223200 12.81 213300 2370 84 2454 26 2340 Wholemeal flour 10 90 2000 180000 10.33 172260 1914 34 1948 52 4680 Bran 20 180 1140 205200 11.78 195660 1087 16 1103 37 6660 900 1742400 100.00 1665000 21780

(13)

Methods of allocating the Joint Cost

1. Net Realisable Value Method

2. Relative Sales Value Method

3. Physical Unit Method

4. Weighted Average Method

5. Profit Method

(14)

Net Realisable Value (NRV) Method

• It is based on the assumption that the processing costs incurred

subsequent to the split-off point contribute nothing to profit i.e., the

increase in the products sales value is equal to the separable costs.

Joint Costs 1665000

White flour Suji WholeMeal Bran Total

Selling Price per ton (Rs.) 2100 2480 2000 1140 Prodn in tons 540 90 90 180

Sales Value (Rs.) 1134000 223200 180000 205200 1742400 Seperable Cost per ton (Rs.) 78 84 34 16

Total Separable Cost 42120 7560 3060 2880

NRV (Sales- Separable costs) 1091880 215640 176940 202320 1686780

NRV weight 0.65 0.13 0.10 0.12

Jt Cost Allocation (NRV Approach) 1077781 212856 174655 199708

(15)

Relative Sales Value Method

• As per this method the joint cost is allocated on the basis of the market

value of the products manufactured.

• Assumption is: if a product is having higher sales price it costs more to

produce and hence market value is the basis to allocate joint cost.

Joint Costs 1665000

White flour

Suji

WholeMeal

Bran

Total

Selling Price per ton (Rs.) 2100 2480 2000 1140

Prodn in tons 540 90 90 180

Sales Value (Rs.) 1134000 223200 180000 205200 1742400

Sales weight 0.65 0.13 0.10 0.12

Jt Cost on Sales Value (SalesValueWt X Jt Cost) 1083626 213285 172004 196085

(16)

Physical Unit Method

• On the basis of units manufactured

White flour Suji WholeMeal Bran Total

Prodn in tons 540 90 90 180 900

Physical Unit Method

Output Proportion 0.6 0.1 0.1 0.2

Joint Cost on PU 999000 166500 166500 333000

Per Ton Jt Cost 1850 1850 1850 1850

(17)

Weighted Average Method

• When Products are heterogeneous, the weighted average approach can be used.

• This method by logic superior to the physical unit method as it assigns weight to each individual product and thus recognises the unique importance of each product.

• The weight factor may be the time required to process the units, the production procedure, Sale price, Amount of prime cost ( direct labour and direct material ) used for each product etc.

Joint Costs 1665000

White flour Suji WholeMeal Bran Total

Prodn in tons 540 90 90 180 900

Weighted Average Method

Wheat Consumption weight 4 3 2 1

Weighted Output 2160 270 180 180 2790

Ratio 0.77 0.10 0.06 0.06

Joint Cost (Weighted Average) 1289032 161129 107419 107419 1665000

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Profit Margin Method

• This method is based on the assumption that profits are earned on the

total cost incurred and not on the joint cost only.

White flour Suji WholeMeal Bran Total

Selling Price per ton (Rs.) 2100 2480 2000 1140

Prodn in tons 540 90 90 180

Sales Value (Rs.) 1134000 223200 180000 205200 1742400

Sales weight 0.65 0.13 0.10 0.12

Jt Cost on Sales Value (SalesValueWt X Jt Cost) 1083626 213285 172004 196085

Per Ton Cost 2007 2370 1911 1089

Seperable Cost per ton (Rs.) 78 84 34 16

Total Separable Cost 42120 7560 3060 2880 55620

Joint Cost 1665000

Total Cost 1720620

Profit 21780

Profit Margin 1.25

Profit Margin (Selling price x profit margin) 26.25 31 25 14.25

Production Cost (Selling Price- Profit) 2074 2449 1975 1126

Joint Cost allocated/ton (Prod Cost - Seperable

(19)

Example:

MMC manufactures memory modules in two step process. Chip

fabrication and module assembly. In chip fabrication, each batch of raw

silicon wafers yields 500 standard chips and 500 deluxe chips. Chips are

classified as standard and deluxe on the basis of their density ( number of

memory bits on each chip). Standard chips have 500 memory bits per chip

and deluxe chips have 1000 memory bits per chip. Joint costs to process

each batch are $24000.

In module assembly each batch of standard chips is converted in to standard

memory modules at a separately identified cost of $1000 and then sold for

$8500. Each batch of deluxe chips is converted into deluxe memory modules

at a separately identified cost of $1500 and then sold for $25000.

Q1. Allocate joint costs of each batch.

Q2. Which method should MMC use?

Q3. MMC can further process each batch to 500 standard memory modules to yield 400 DRAM products at an additional costs of $1600. The selling price per DRAM product will be $26.

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Net Realizable Value Standard Delux Total Step I Units Price Value Units Price Value

Sale Value Given 500 $8,500 $42,50,000 500 $25,000 $125,00,000 $167,50,000

Memory Bits per chip Given 500 1000

Step 2

Sperable Cost Given $1,000 $5,00,000 $1,500 $7,50,000

NRV at Split Off Pt $7,500 $37,50,000 $23,500 $117,50,000 $155,00,000 Total NRV of Both

products at Spilt off Pt $31,000

Joint Cost Given $24,000

Weightege 24% 76%

Joint Cost allocated $5,806 $18,194

Unit Jt Cost $11.6 $18.2

Total Cost per Chip $6,806 $19,694

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Physical Unit Method

Physical Meausres of Total Production 500 1000

Weightage 33% 67%

Joint Cost Alloted $8,000 $16,000

Total Cost $9,000 $17,500

Unit Jt cost divide/no of units $16.0 $16.0

Net Realizable Value Standard Delux Total Step I Units Price Value Units Price Value

Sale Value Given 500 $8,500 $42,50,000 500 $25,000 $125,00,000 $167,50,000

Memory Bits per chip Given 500 1000

Step 2

Sperable Cost Given $1,000 $5,00,000 $1,500 $7,50,000

NRV at Split Off Pt $7,500 $37,50,000 $23,500 $117,50,000 $155,00,000

Total NRV of Both

products at Spilt off Pt $31,000

(22)

Sales Value Method

Standard Delux

Sales Value $42,50,000 $125,00,000

Sales Value Proportion 25.4% 74.6%

Joint Cost Allocaiton $6,089.55 $17,910.45

Seperable Cost $1,000 $1,500

Total Cost $7,089.55 $19,410.45

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(25)

Question 1

Total fixed costs (TFC) = fixed costs per unit times normal volume =($660 + $770)*3,000 = $4,290,000. Contribution margin per unit = unit price minus unit variable costs = $4,350 - $2,070 = $2,280.

units 1,882 280 , 2 $ $4,290,000 me even volu Break    461 , 185 , 8 $ 350 , 4 $ 2,070 -$4,350 / $4,290,000 sales          even Break (actually, 1,882 *$4,350 = $8,186,700)

Question 1

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Question 2

Impact: Before Price Reduction After Price Reduction Difference Price ... $ 4,350 $ 3,850 $ (500) Quantity ... 3,000 3,500 500 Revenue ... $13,050,000 $13,475,000 $ 425,000 Variable mfg. costs ... ( 5,385,000) (6,282,500) (897,500) Variable mktg. costs ... (825,000) (962,500) (137,500) Contribution margin ... 6,840,000 6,230,000 (610,000) Fixed mfg. costs ... (1,980,000) (1,980,000) -- Fixed mktg. costs ... (2,310,000) (2,310,000) -- Income ... $ 2,550,000 $ 1,940,000 $(610,000)

Recommendation:

Lowering

prices

reduces income. Other

factors, such as the

reduction of available

capacity

and

the

capacity and the impact

on market share, could

also affect the decision.

(27)

Question 3

Recommendation: Don't accept contract

Government revenue = (500 * $1,795) +.125 ($1,980,000) + $275,000 = $1,420,000,

(28)

Minimum price = variable mfg costs + shipping costs + order costs = $1,795 + $410 + $22,000/1,000 = $2,227

At this price per unit, the $2,227,000 of differential costs caused by the 1,000-unit order will just be uncovered. Some students solve for this price using the break-even formula (UR = unit revenue):

Q UVC UR TCF   units 1,000 2,205 UR 22,000   $22,000 = 1,000UR - $2,205,000 $2,227,000 = 1,000UR $2,227 = UR

Question 4

(29)

Question 6

All Production

In-house

Total revenue $13,050,000

Total variable manufacturing costs (5,385,000)

Total variable marketing costs (825,000)

Total contribution margin 6,840,000

Total fixed manufacturing costs (1,980,000)

Total fixed marketing costs 2,310,000

Payment to contractor --Income $ 2,550,000 1,000 Units Contracted $13,050,000 $3,590,000 $770,000 8,690,000 1,386,000 2,310,000 2,444,000 2,550,000 $4,994,000 - X = $2,550,000 X = $2,444,000 or $2,444 per unit maximum purchase price

(30)

Question 7

All Production In-house Total revenue $13,050,000 Total variable manufacturing costs (5,385,000) Total variable marketing costs (825,000) Total contribution margin 6,840,000 Fixed manufacturing (1,980,000) Fixed marketing 2,310,000 Contractor --Income $ 2,550,000

Contract 1,000 Regular Hoists and Produce 800 Modified Hoists

Regular (In) Regular (Out) Modified Total $8,700,000 (3,590,000) (550,000) 4,560,000 $4,350,000 (220,000) 4,130,000 $3,960,000 (2,420,000) (440,000) 1,100,000 $17,010,000 (6,010,000) (1,210,000) 9,790,000 (1,980,000) (2,310,000) $2,950,000 $ 2,550,000

(31)

Example: ILAB manufactures design tables. ILAB has a policy of adding a 20% markup to full costs and currently has excess capacity. Assume the cost driver for variable and fixed manufacturing overhead costs is the number of output units. The following information pertains to the company's normal operations per month:

Output units = 30,000 tables

Machine-hours = 8,000hours

Direct manufacturing labor-hours =10,000 hours

Direct materials per unit = Rs. 50

Direct manufacturing labor per hour = Rs. 6

Variable manufacturing overhead cos = Rs. 161,250 per month

Fixed manufacturing overhead costs = Rs. 600,000 per month

Product and process design costs = Rs. 450,000 per month

Marketing and distribution costs = Rs. 562,500 per month

ILAB is approached by an overseas customer to fill a one-time-only special order for 2,000 units. All cost relationships remain the same except for a one-time setup charge of Rs. 20,000. No additional design, marketing, or distribution costs will be incurred. What is the minimum acceptable bid per unit on this one-time-only special order? For long-run pricing of the coffee tables, what price will most likely be used by the company?

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Rs.

Direct materials Rs. 50.00

Direct manufacturing labor (Rs.6 x 10,000) / 30,000 2

Variable manufacturing (Rs.161,250 / 30,000) 5.375

Setup (Rs. 20,000 / 2,000) 10

Minimum acceptable bid Rs. 67.38

Direct materials 50.00

Direct manufacturing labor ($6 x 10,000)/30,000 2

Variable manufacturing ($161,250/30,000) 5.375

Fixed manufacturing ($600,000/30,000) 20

Product and process design costs ($450,000/30,000) 15

Marketing and distribution ($562,500/30,000) 18.75

Full cost per unit 111.125

Markup (20%) 22.225

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(35)

Rs. B-Po-1 355230.92 Less B-PO-2 107621.19 Equals B-PO-3 247609.73 Less B-PO-4A 96155.16 Less B-PO-4B 89651.49 Equals B-PO-5 61803.08

(36)

Rs. B-PA-1 206261.48 Less B-PA-2 72305.19 Equals B-PA-3 133956.29 Less B-PA-4A 32343.98 Less B-PA-4B 51502.33 Equals B-PA-5 50109.98

(37)

Rs. B-C-1 81361.56 Less B-C-2 54718.73 Equals B-C-3 26642.83 Less B-C-4A --Less B-C-4B 2299.83 Equals B-C-5 24343.00

(38)

Rs. D-Po-1 99898.50 Less D-PO-2 40619.18 Equals D-PO-3 59279.32 Less D-PO-4A 13608.73 Less D-PO-4B 15937.68 Equals D-PO-5 29732.91

(39)

Rs. D-PA-1 23318.21 Less D-PA-2 3866.94 Equals D-PA-3 19451.27 Less D-PA-4A 4068.32 Less D-PA-4B 5517.93 Equals D-PA-5 9865.02

(40)

Rs. D-C-1 14514.51 Less D-C-2 9883.79 Equals D-C-3 4630.72 Less D-C-4A --Less D-C-4B 591.66 Equals D-C-5 4039.06

(41)

Mumbai Location

Moti Heera Analysis

Alternative Choice Decisions: Differencial Costs

Mumbai Poster Paint Commercial Location Total

EX 3 EX 4 EX 5

Income 3,55,231 2,06,261 81,363 6,42,855

Variable Cost 1,07,621 72,305 54,719 2,34,645 Contribution to Mumbai Fixed OH 2,47,610 1,33,956 26,644 4,08,210

Sunk Cost 96,155 32,344 1,28,499

Escapable Fixed Cost 89,651 51,502 2,300 1,43,453

Total Fixed Cost 1,85,806 83,846 2,300 2,71,952

Contributin to Local Company OH 61,804 50,110 24,344 1,36,258

Mumbai OH 89,482

Contribution to Company OH and Profits 46,776

Fixed Cost to Sales 0.52 0.41 0.03 0.42 Break Even 2,66,565 1,29,103 7,024 4,28,274 Location Cont./ Sales Ratio 0.17 0.24 0.30 0.21 Cont to Sales (P/v Ratio) 0.70 0.65 0.33 0.63

(42)

Delhi Location

Delhi Poster Paint Commercial

EX 6 EX 7 EX 8

Income 99,899 23,318 14,516 1,37,733 Variable Cost 40,619 3,867 9,884 54,370 Contribution to Delhi Fixed OH 59,280 19,451 4,632 83,363 Sunk Cost 13,608 4,068 17,676 Escapable Fixed Cost 15,938 5,518 592 22,048

Total Fixed Cost 29,546 9,586 592 39,724 Contributin to Local Company OH 29,734 9,865 4,040 43,639

Delhi OH 31,011

Contribution to Company OH and Profits 12,628

Company OH

Company Profit/Loss

Fixed Cost to Sales 0.30 0.41 0.04 0.29 Break Even 49,791 11,492 1,855 65,632 Location Cont./ Sales Ratio 0.30 0.42 0.28 0.32 Cont to Sales (P/v Ratio) 0.59 0.83 0.32 0.61

(43)

Moti Heera Analysis

Alternative Choice Decisions: Differencial Costs

Mumbai Poster Paint Commercial Location Total Company TOTAL EX 3 EX 4 EX 5

Income 3,55,231 2,06,261 81,363 6,42,855

Variable Cost 1,07,621 72,305 54,719 2,34,645 Contribution to Mumbai Fixed OH 2,47,610 1,33,956 26,644 4,08,210 Sunk Cost 96,155 32,344 1,28,499 Escapable Fixed Cost 89,651 51,502 2,300 1,43,453

Total Fixed Cost 1,85,806 83,846 2,300 2,71,952

Contributin to Local Company OH 61,804 50,110 24,344 1,36,258

Mumbai OH 89,482

Contribution to Company OH and Profits 46,776

Fixed Cost to Sales 0.52 0.41 0.03 0.42 Break Even 2,66,565 1,29,103 7,024 4,28,274 Location Cont./ Sales Ratio 0.17 0.24 0.30 0.21 Cont to Sales (P/v Ratio) 0.70 0.65 0.33 0.63

Delhi Poster Paint Commercial EX 6 EX 7 EX 8

Income 99,899 23,318 14,516 1,37,733 7,80,588 Variable Cost 40,619 3,867 9,884 54,370 2,89,015 Contribution to Delhi Fixed OH 59,280 19,451 4,632 83,363 4,91,573 Sunk Cost 13,608 4,068 17,676 1,46,175 Escapable Fixed Cost 15,938 5,518 592 22,048 1,65,501

Total Fixed Cost 29,546 9,586 592 39,724

Contributin to Local Company OH 29,734 9,865 4,040 43,639 1,79,897

Delhi OH 31,011 1,20,493

Contribution to Company OH and Profits 12,628 59,404

Company OH 1,00,061

Company Profit/Loss (40,657)

Fixed Cost to Sales 0.30 0.41 0.04 0.29 0.53 Break Even 49,791 11,492 1,855 65,632

Location Cont./ Sales Ratio 0.30 0.42 0.28 0.32 Cont to Sales (P/v Ratio) 0.59 0.83 0.32 0.61

(44)
(45)

 A relevant cost is a cost that differs between alternatives. Relevant cost, in cost accounting, refers to the incremental and avoidable cost of implementing a business decision.

 An avoidable cost can be eliminated in whole or in part, by choosing one alternative over another.

 Avoidable costs are relevant costs. Unavoidable costs are irrelevant costs.  Relevant costs are also known as differential, or incremental costs.

 When making a particular decision-relevant costs are those that may change, depending on the decision taken. Therefore, any increase or decrease in future cash flows as a result of a decision is an indication of relevant cost.

(46)

Examples: Types of Non-Relevant (irrelevant) Costs:

(i). Sunk Cost: Sunk cost is expenditure which has already been incurred in the past. Sunk Cost do not affect future costs and cannot be changed by any current or future action, hence these costs are irrelevant in decision making. Sunk cost is irrelevant because it does not affect the future cash flows of a business.

(ii). Committed Costs: Committed costs are costs that will occur in the future, but that cannot be changed. Future costs that cannot be avoided are not relevant because they will be incurred

irrespective of the business decision being considered.

(iii). Non-Cash Expenses: Non-cash expenses such as depreciation and amortisation are not relevant because they do not affect the cash flows of a business.

(iv). General Overheads: If any general and administrative overheads which are not affected by the decisions under consideration can be ignored. It depends to the situation and nature of the business operation.

(47)

Relevant Costs for Decision Making: Following alternative decision areas

can be explored further in the context of Relevant Costing.

1.

Make or buy decision/ To produce or to purchase?

2.

Drop or retain a segment.

3.

Utilization of constrained resources.

(48)

Southwestern Company needs 1,000 motors in its manufacture of automobiles. It can buy the motors from Jinx Motors for Rs.1,250 each. South western’s plant can manufacture the motors for the following costs per unit:

Direct materials Rs 500 Direct manufacturing labor Rs 250 Variable manufacturing overhead Rs 200 Fixed manufacturing overhead Rs 350 Total Rs 1,300

If Southwestern buys the motors from Jinx, 70% of the fixed manufacturing overhead applied will not be avoided.

Required:

(49)

Should the production line be dropped?

Vulcan swimming cloth pvt. ltd. Is considering to drop one of its product

line. A recent product income statement for the product line is as follows:

Rs.

Revenue 950,760

Cost of goods sold 861840

Gross margin 88920

Selling and administrative expenses 136800

Net Loss (47,880)

Factory overhead accounts for 35 percent of cost of goods sold and is one third fixed. These data are believed to reflect conditions in the immediate future.

(50)

Contribution Margin Analysis

Revenue

Rs.950,760

Variable costs of goods sold:

Total cost of

sales

861,840

Less: Fixed costs

(861,840 x 35% x 1/3 =

100,548)

100,548

761,292

Contribution margin (over variable and

fixed

costs)

(51)

Tamex Company is presently making a part that is used in one of its products. The unit product cost is:

Direct materials ... Rs. 9

Direct labor 5

Variable manufacturing overhead ... 1 Depreciation of special equipment ...

(The special equipment has no resale value.) 3 Supervisor’s salary ... 2 General factory overhead ...

(Common costs allocated on the basis of direct labor-hours) 10 Total unit product cost... Rs. 30

The costs above are based on 20,000 parts produced each year. An outside supplier has offered to provide the 20,000 parts for only Rs. 25 per part. Should this offer be accepted?

(52)

Dimond Company needs 10,000 engines for the cars they are producing; they can either buy these engines from outside suppliers or make them themselves. Here are the traditional costs for making the product internally.

Per Unit (Rs.) Total (Rs.)

Material 200 2,000,000

Labour 100 1,000,000

Applied Variable Costs 100 1,000,000

Total 400 4,000,000

it costs the company Rs. 400 per engine to make, however they could in fact buy the engines from a supplier at a cost of Rs. 420 per unit. Making seems to be the best option. However, if the company buy in the engines it can use the staff and facilities to produce another product which gives us a contribution of Rs.50. Whether the Dimond Company should manufacture the product or should it buy from the outsider.

(53)

Due to the declining popularity of digital watches, Sweiz Company’s digital watch line has not reported a profit for several years. An income statement for last year follows:

Segment Income Statement—Digital Watches

Sales ... Rs. 500,000 Less variable expenses:

Variable manufacturing costs ... Rs. 120,000 Variable shipping costs ... 5,000

Commissions ... 75,000 200,000 Contribution margin ... 300,000 Less fixed expenses:

General factory overhead*... 60,000 Salary of product line manager ... 90,000 Depreciation of equipment** ... 50,000 Product line advertising ... 100,000 Rent—factory space*** ... 70,000

General administrative expense* ... 30,000 400,000 Net operating loss ... Rs. (100,000)

* Allocated common costs that would be redistributed to other product lines if digital watches were dropped.

** This equipment has no resale value and does not wear out through use. *** The digital watches are manufactured in their own facility.

(54)

Case 26-1: Import Distributors, Inc.

Import Distributors, Inc. (IDI) imported appliances and distributed them to

retail appliance stores in the Rocky Mountain States. IDI carried three broad

lines of merchandise: audio equipment , television equipment and kitchen

appliances. Each three lines accounted for about one third of total IDI sales

revenues. Although each line was referred to by IDI managers as a

“department”, until 1994 the company did not prepare departmental income

statements.

In late 1993, departmental accounts were set-up in anticipation of preparing

quarterly income statements by department starting 1994. Although in first

quarter of 1994, IDI had earned net income amounting to 4.3 per cent of

sales, the television department (TVD) has shown gross margin that is too

small to cover the department’s operating expenses:

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(56)

The TVD’s poor performance prompted the company’s accountant to

suggest that perhaps the department should be discontinued. This

suggestion led to much discussion among the management group,

particularly concerning two issues:

First, was the first quarter of the year representative enough of longer

term results to consider discontinuing the TVD?

And second, would discontinuing TVD cause a drop in sales in the other

two departments?

One manager however stated that “ even if the quarter was typical and

other sales would not be hurt, I am still not convinced that we would be

better off by dropping the TVD.

(57)

Forgone gross

margin

$(189,930)

Cost savings:

Personnel

$10,140

Department

12,393

Inventory taxes

37,274

Delivery costs

32,248

Sales commissions

80,621

Interest costs

23,708

Total savings

1,96,384

Impact on

operating profit

$ 6,454

(58)

Tipton one stop decorators sells paint and paint supplies, carpets, and wallpapers at a single store location in Mumbai. Al though the company has been very profitable over the years, management has seen a significant decline in wallpaper sales and earnings. Recent figures are presented below.

Particulars Paint & Paint Supplies (Rs) Carpets (Rs) Wallpaper (Rs)

Sales 3,80,000 4,60,000 1,40,000

Variable Costs 2,28,000 3,22,000 1,12,000

Fixed Costs 56,000 75,000 45,000

Total Costs 2,84,000 3,97,000 1,57,000

Operating Income 96,000 63,000 (17,000) Loss

Tipton is studying whether to drop wallpaper business because of the changing market and accompanying loss. If the wallpaper business is dropped, the following changes are expected to occur:

a). The vacated space will be remodelled at a cost of Rs 12,400 and will be devoted to an expanded line of high-end carpet business. The sales of carpet are expected to increase by Rs 1,20,000, and the line’s overall contribution margin ratio will rise by 5%.

b). Tipton can cut wallpaper’s fixed cost by 40%. The remaining fixed cost will continue to be incurred.

c). Customers who purchased wallpaper often bought paint and paint supplies; hence sales of paint and paint supplies are expected to fall by 20%.

(59)

Tipton will be worse off by Rs12, 800 if it discontinues wallpaper sales. Hence should not shut down the division. But Why? And How?

Paint and

Supplies Carpeting Wallpaper

Sales……….. Rs 380,000 Rs 460,000 Rs 140,000

Less: Variable costs…. 228,000 322,000 112,000

Existing Contribution margin…. Rs 152,000 Rs 138,000 Rs 28,000 If wallpaper is closed, then:

Loss of wallpaper contribution margin…... Rs (28,000)

Remodeling………. (12,400)

Added profitability from carpet sales*…… 65,000

Fixed cost savings (Rs45,000 x 40%)………. 18,000

Decreased contribution margin from paint and supplies

(Rs152,000 x 20%)……….. (30,400)

Increased advertising……….. (25,000)

Income (loss) from closure……… Rs (12,800)

* The current contribution margin ratio for carpeting is 30% (Rs138,000 ÷ Rs460,000). This ratio will increase to 35%, producing a new contribution for the line of Rs 203,000 [(Rs 460,000 + Rs 120,000) x 35%]. The end result is that carpeting’s contribution margin will rise by Rs 65,000 (Rs 203,000 - Rs138,000), boosting firm profitability by the same amount.

(60)

Jamestown Candle works has just received a request from the Williamsburg Foundation for 800 candles to be used in a special event for major donors. The candles will be used as the only illumination in the reception room and will be given out as gifts to the donors as they leave. The candles will be imprinted with the Williamsburg Foundation logo. This sale will have no effect on the company’s normal sales to retail outlets. The normal selling price of a candle of about the size and weight of the special candles is $3.95 and its unit product cost is $2.30, as shown below:

Direct materials $1.35 Direct labor 0.15 Manufacturing overhead 0.80

Unit product cost $2.30

The variable portion of the manufacturing overhead is $0.05 per candle; the other $0.75 represents fixed manufacturing costs that would not be affected by this special order.

Jamestown Candle works would have to order a special candle mold in which the Williamsburg Foundation logo is inscribed. Such a mold would cost $800. In addition, the Williamsburg Foundation wants a special wick containing gold-like thread that would add $0.20 to the cost of each candle. Because of the large size of the order and the charitable nature of the work, the Williamsburg Foundation has asked to pay only $2.95 each for this candle. If accepted, what effect would this order have on the company’s net operating income?

(61)

Per Unit Total for 800 Candles Incremental revenue ... $2.95 $2,360 Incremental costs: Variable costs: Direct materials ... 1.35 1,080 Direct labor ... 0.15 120 Variable manufacturing overhead ... 0.05 40

Special wick ... 0.20 160

Total variable cost... $1.75 1,400 Fixed cost:

Special mold ... 800

Total incremental cost ... 2,200 Incremental net operating income ... $ 160

(62)

Ensign Company makes two products, X and Y. The current constraint is Machine N34. Selected data on the products follow:

X Y

Selling price per unit $60 $50

Less variable expenses per unit 36 35

Contribution margin $24 $15

Contribution margin ratio 40% 30%

Current demand per week (units) 2,000 2,200 Processing time required on

Machine N34 per unit 1.0 minute 0.5 minute

Machine N34 is available for 2,400 minutes per week, which is not enough capacity to satisfy demand for both product X and product Y. Should the company focus its efforts on product X or product Y?

References

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