Managerial Accounting and Control

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Managerial Accounting and Control

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Managerial Accounting
and Control
1.Lilac Flour Meal
2.Hospital Supply Inc.
3. Moti Hera Private Ltd.

Introduction to Process costing

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

Direct material
Direct labour
overheads
Direct material
Direct labour
overheads
Direct material
Direct labour
overheads

Process 1

Process 2

Process 3

Finished goods

Cost of goods sold
4

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.

Process Cost Accounting System

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
8

Process A

Material 500
Labour 100
Overhead200
800

Process B

Process B

800

800

Process A800
Material 50
Labour 150
Overhead100

Process C

1100

Process C

Process B 1100
Material 80
Labour 110
Overhead 210
1500

1100

1100

Finished Goods

Finished Gds 1500

Process C 1500

Cost of GDs Sold
Bal c/d

1500

1500

1300
200
1500

9

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
Seperable Costs
Total
Profit
Profit margin

1665000
55620
17,20,620
21,780
1.266%

Monthly Wheat Input = 900 tons

Product

White flour
Suji
Wholemeal flour
Bran

Production Production
in %
in tons

60
10
10
20

Joint Cost
allocated
on the
Joint Cost
basis of
Per Ton
production (Rs.)
quantities
(Rs.)

540
999000
90
166500
90
166500
180
333000
900 16,65,000

1850
1850
1850
1850
1850

Separable
Total Cost Per
Costs per
Ton (Rs.)
Ton (Rs.)

78
84
34
16

1928
1934
1884
1866

Sales
Price per
Ton (Rs.)

2100
2480
2000
1140

Profit
Profit
(Loss) for
(Loss) per Total
ton (Rs.)
Output
(Rs.)

172
92880
546
49140
116
10440
-726 -130680
21780

Product

Production Production Sales Value Total Sales % of Total Joint Cost
Allocated Separable Total Cost Profit
Profit (Loss)
in %
in tons
Per ton
Value (Rs.) Sales
allocated on the Cost Per Costs per Per Ton (Loss) per for Total
(Rs.)
Value
basis of Sales ton
Ton (Rs.)
ton (Rs.) Output (Rs.)
White flour
60
540
2100 1134000 65.08 Value 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

Methods of allocating the Joint Cost
1.
2.
3.
4.
5.

Net Realisable Value Method
Relative Sales Value Method
Physical Unit Method
Weighted Average Method
Profit Method

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
Selling Price per ton (Rs.)
Prodn in tons
Sales Value (Rs.)
Seperable Cost per ton (Rs.)
Total Separable Cost
NRV (Sales- Separable costs)
NRV weight
Jt Cost Allocation (NRV Approach)
Per Ton Joint Cost

2100
540
1134000
78

Suji
2480
90
223200

42120

84
7560

1091880
0.65
1077781
1996

215640
0.13
212856
2365

WholeMeal
2000
90
180000
34

Bran
1140
180
205200

Total
1742400

16
3060

2880

176940
0.10
174655
1941

202320
0.12
199708
1109

1686780

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

Selling Price per ton (Rs.)
Prodn in tons
Sales Value (Rs.)
Sales weight
Jt Cost on Sales Value (SalesValueWt X Jt Cost)
Per Ton Cost

White flour Suji
2100
2480
540
90
1134000 223200
0.65
0.13
1083626
213285
2007
2370

WholeMeal
2000
90
180000
0.10
172004
1911

Bran
1140
180
205200
0.12
196085
1089

Total
1742400

Physical Unit Method
• On the basis of units manufactured
Joint Costs
Prodn in tons
Physical Unit Method
Output Proportion
Joint Cost on PU
Per Ton Jt Cost

1665000
White flour
540
0.6
999000
1850

Suji
90
0.1
166500
1850

WholeMeal
90
0.1
166500
1850

Bran
180
0.2
333000
1850

Total
900

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

Assuming Each Product is unique

1665000

Prodn in tons
Weighted Average Method
Wheat Consumption weight
Weighted Output
Ratio
Joint Cost (Weighted Average)

White flour
540

Suji
90

WholeMeal
90

Bran
180

4

3

2

1

2160
0.77
1289032

270
0.10
161129

180
0.06
107419

180
0.06
107419

Total
900

2790
1665000

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
Selling Price per ton (Rs.)
Prodn in tons
Sales Value (Rs.)
Sales weight
Jt Cost on Sales Value (SalesValueWt X Jt Cost)
Per Ton Cost
Seperable Cost per ton (Rs.)
Total Separable Cost
Joint Cost
Total Cost

2100
2480
540
90
1134000 223200
0.65
0.13
1083626 213285
2007
2370
78
84
42120
7560

2000
90
180000
0.10
172004
1911
34
3060

1140
180
205200
0.12
196085
1089
16
2880

Profit
Profit Margin
Profit Margin (Selling price x profit margin)
Production Cost (Selling Price- Profit)
Joint Cost allocated/ton (Prod Cost - Seperable
Cost)

Total
1742400

55620
1665000
1720620
21780
1.25

26.25
2074

31
2449

25
1975

14.25
1126

1996

2365

1941

1110

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.

MMC manufactures
Net Realizable Value
Step I
Sale Value
Memory Bits per chip
Step 2
Sperable Cost
NRV at Split Off Pt
Total NRV of Both
products at Spilt off Pt
Joint Cost

Given
Given
Given

Standard
Delux
Total
Units Price
Value
Units Price
Value
500 $8,500 $42,50,000 500 $25,000 $125,00,000 $167,50,000
500
1000
$1,000 $5,00,000
$7,500 $37,50,000

$1,500
$7,50,000
$23,500 $117,50,000 $155,00,000
$31,000
$24,000

Given

Weightege
Joint Cost allocated
Unit Jt Cost
Total Cost per Chip

24%
$5,806
$11.6
$6,806

76%
$18,194
$18.2
$19,694

Net Realizable Value
Standard
Delux
Total
Step
I
Units Price
Value
Units Price
Value
Physical
Unit Method
Sale Value
Given
500 $8,500 $42,50,000 500 $25,000 $125,00,000 $167,50,0
Memory Bits per chip
Given
500
1000
Physical Meausres of Total Production
500
1000
Step 2
Weightage
33%
67%
Sperable
Cost
Given
$1,000 $5,00,000
$1,500
$7,50,000
Joint
CostOff
Alloted
$8,000
$16,000 $155,00,0
NRV
at Split
Pt
$7,500 $37,50,000
$23,500 $117,50,000
Total
Cost
$9,000
$17,500
Total
NRV
of Both
products
Spilt off Pt
$31,0
Unit Jtatcost
divide/no of units
$16.0
$16.0
Joint Cost
Given
$24,0

Sales Value Method
Sales Value
Sales Value Proportion
Joint Cost Allocaiton
Seperable Cost
Total Cost
Jt Cost per unit

Standard
$42,50,000
25.4%
$6,089.55
$1,000
$7,089.55
$12.18

Delux
$125,00,000
74.6%
$17,910.45
$1,500
$19,410.45
$17.91

Hospital Supply Inc

Hospital Supply Inc

Question 1
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.

Break  even volu me 

$4,290,000
 1,882 units
$2,280

 $4,350 - 2,070 
Break  even sales  $4,290,000 / 
  $8,185,461
$4,350


(actually, 1,882 *$4,350 = $8,186,700)

Question 2
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.

Impact:
Price
..................................................
Quantity
..................................................
Revenue
..................................................
Variable mfg.
costs
..................................................
Variable mktg.
costs
..................................................
Contribution
margin
...............................................
Fixed mfg.
costs
..................................................
Fixed mktg.
costs
..................................................
Income
............................................

Before Price
Reduction
$
4,350

After Price
Reduction
$
3,850

Difference
$
(500)

3,000

3,500

500

$13,050,000

$13,475,000

$ 425,000

( 5,385,000)

(6,282,500)

(897,500)

(825,000)

(962,500)

(137,500)

6,840,000

6,230,000

(610,000)

(1,980,000)

(1,980,000)

--

(2,310,000)

(2,310,000)

--

$ 2,550,000

$ 1,940,000

$(610,000)

Question 3

Recommendation: Don't accept contract

Government revenue = (500 * $1,795) +.125 ($1,980,000) + $275,000 = $1,420,000,
assuming the government's "share" of March fixed manufacturing costs is .125 (500/4,000).

Question 4
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):

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

Question 6
Total revenue
Total variable manufacturing costs

Total variable marketing costs

Total contribution margin
Total fixed manufacturing costs
Total fixed marketing costs
Payment to contractor

Income

All Production
In-house
$13,050,000
(5,385,000)
(825,000)

6,840,000
(1,980,000)
2,310,000
--

$ 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

Question 7

Contract 1,000 Regular Hoists and
Produce 800 Modified Hoists

All Production
In-house
Regular (In)

Total revenue
Total variable
manufacturing
costs
Total variable
marketing costs

Total
contribution
margin
Fixed
manufacturing
Fixed
marketing
Contractor
Income

$13,050,000
(5,385,000)

(825,000)
6,840,000

Regular (Out)

Modified

Total

$8,700,000 $4,350,000

$3,960,000 $17,010,000

(3,590,000)

(2,420,000) (6,010,000)

(550,000)

(220,000)

(440,000)

(1,210,000)

4,560,000

4,130,000

1,100,000

9,790,000

(1,980,000)

(1,980,000)

2,310,000

(2,310,000)

-$ 2,550,000

$2,950,000
$ 2,550,000

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?

Direct materials
Direct manufacturing labor (Rs.6 x 10,000) / 30,000
Variable manufacturing (Rs.161,250 / 30,000)
Setup (Rs. 20,000 / 2,000)
Minimum acceptable bid

Rs.
Rs. 50.00
2
5.375
10
Rs. 67.38

Direct materials
Direct manufacturing labor ($6 x 10,000)/30,000
Variable manufacturing ($161,250/30,000)
Fixed manufacturing ($600,000/30,000)
Product and process design costs ($450,000/30,000)
Marketing and distribution ($562,500/30,000)
Full cost per unit
Markup (20%)
Estimated selling price

50.00
2
5.375
20
15
18.75
111.125
22.225
133.35

Moti and Heera (Private) Limited (A) & (B)

Moti and Heera (Private) Limited (A) & (B)

Bombay Poster Plant
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

Bombay Paint Plant
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

Bombay Commercial Department
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

Delhi Poster Plant
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

Delhi Paint Plant
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

Delhi Commercial Department
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

Mumbai Location
Moti Heera Analysis
Alternative Choice Decisions: Differencial Costs

Mumbai
Income
Variable Cost
Contribution to Mumbai Fixed OH
Sunk Cost
Escapable Fixed Cost
Total Fixed Cost
Contributin to Local Company OH
Mumbai OH
Contribution to Company OH and Profits
Fixed Cost to Sales
Break Even
Location Cont./ Sales Ratio
Cont to Sales (P/v Ratio)

Poster
Paint
Commercial
Location Total
EX 3
EX 4
EX 5
3,55,231
2,06,261
81,363
6,42,855
1,07,621
72,305
54,719
2,34,645
2,47,610
1,33,956
26,644
4,08,210
96,155
32,344
1,28,499
89,651
51,502
2,300
1,43,453
1,85,806
83,846
2,300
2,71,952
61,804
50,110
24,344
1,36,258
89,482
46,776
0.52
2,66,565
0.17
0.70

0.41
1,29,103
0.24
0.65

0.03
7,024
0.30
0.33

0.42
4,28,274
0.21
0.63

Delhi Location
Delhi
Income
Variable Cost
Contribution to Delhi Fixed OH
Sunk Cost
Escapable Fixed Cost
Total Fixed Cost
Contributin to Local Company OH
Delhi OH
Contribution to Company OH and Profits

Poster
Paint
Commercial
EX 6
EX 7
EX 8
99,899
23,318
14,516
40,619
3,867
9,884
59,280
19,451
4,632
13,608
4,068
15,938
5,518
592
29,546
9,586
592
29,734
9,865
4,040

1,37,733
54,370
83,363
17,676
22,048
39,724
43,639
31,011
12,628

Company OH
Company Profit/Loss
Fixed Cost to Sales
Break Even
Location Cont./ Sales Ratio
Cont to Sales (P/v Ratio)

0.30
49,791
0.30
0.59

0.41
11,492
0.42
0.83

0.04
1,855
0.28
0.32

0.29
65,632
0.32
0.61

Moti Heera Analysis
Alternative Choice Decisions: Differencial Costs

Mumbai
Income
Variable Cost
Contribution to Mumbai Fixed OH
Sunk Cost
Escapable Fixed Cost
Total Fixed Cost
Contributin to Local Company OH
Mumbai OH
Contribution to Company OH and Profits
Fixed Cost to Sales
Break Even
Location Cont./ Sales Ratio
Cont to Sales (P/v Ratio)

Delhi
Income
Variable Cost
Contribution to Delhi Fixed OH
Sunk Cost
Escapable Fixed Cost
Total Fixed Cost
Contributin to Local Company OH
Delhi OH
Contribution to Company OH and Profits

Poster
Paint
Commercial
Location Total Company TOTAL
EX 3
EX 4
EX 5
3,55,231
2,06,261
81,363
6,42,855
1,07,621
72,305
54,719
2,34,645
2,47,610
1,33,956
26,644
4,08,210
96,155
32,344
1,28,499
89,651
51,502
2,300
1,43,453
1,85,806
83,846
2,300
2,71,952
61,804
50,110
24,344
1,36,258
89,482
46,776
0.52
2,66,565
0.17
0.70
Poster
EX 6
99,899
40,619
59,280
13,608
15,938
29,546
29,734

0.41
1,29,103
0.24
0.65
Paint
EX 7
23,318
3,867
19,451
4,068
5,518
9,586
9,865

0.03
7,024
0.30
0.33
Commercial
EX 8
14,516
9,884
4,632
592
592
4,040

0.42
4,28,274
0.21
0.63

1,37,733
54,370
83,363
17,676
22,048
39,724
43,639
31,011
12,628

Company OH
Company Profit/Loss
Fixed Cost to Sales
Break Even
Location Cont./ Sales Ratio
Cont to Sales (P/v Ratio)

7,80,588
2,89,015
4,91,573
1,46,175
1,65,501
1,79,897
1,20,493
59,404
1,00,061
(40,657)

0.30
49,791
0.30
0.59

0.41
11,492
0.42
0.83

0.04
1,855
0.28
0.32

0.29
65,632
0.32
0.61

0.53

Relevant Costing

Relevant cost for Decision Making
 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.

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.

Relevant Costs for Decision Making: Following alternative decision areas
can be explored further in the context of Relevant Costing.
1.
2.
3.
4.

Make or buy decision/ To produce or to purchase?
Drop or retain a segment.
Utilization of constrained resources.
Special order.

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
Direct manufacturing labor
Variable manufacturing overhead
Fixed manufacturing overhead
Total

Rs 500
Rs 250
Rs 200
Rs 350
Rs 1,300

If Southwestern buys the motors from Jinx, 70% of the fixed manufacturing overhead
applied will not be avoided.
Required:
Should the company make or buy the motors?

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:

Revenue
Cost of goods sold
Gross margin
Selling and administrative expenses
Net Loss

Rs.
950,760
861840
88920
136800
(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.

Contribution Margin Analysis

Revenue
Variable costs of goods sold:
Total cost of
sales

Less: Fixed costs
(861,840 x 35% x 1/3 =
100,548)
Contribution margin (over variable and
fixed
costs)

Rs.950,760

861,840

100,548

761,292

Rs.189,468

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?

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
Labour
Applied Variable Costs
Total

200
100
100
400

2,000,000
1,000,000
1,000,000
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.

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 ......................................................................
Less variable expenses:
Variable manufacturing costs ............................
Variable shipping costs ......................................
Commissions .....................................................
Contribution margin ..............................................
Less fixed expenses:
General factory overhead*.................................
Salary of product line manager ..........................
Depreciation of equipment** ............................
Product line advertising .....................................
Rent—factory space*** ....................................
General administrative expense* .......................
Net operating loss ..................................................

Rs. 500,000
Rs. 120,000
5,000
75,000

60,000
90,000
50,000
100,000
70,000
30,000

200,000
300,000

400,000
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.
Should the company retain or drop the digital watch line?

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:

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.

Impact of Discontinuing Television Department
Forgone gross
$(189,930)
margin
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
Impact on
operating profit

1,96,384
$

6,454

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
Sales
Variable Costs
Fixed Costs
Total Costs
Operating Income

Paint & Paint Supplies (Rs)
3,80,000
2,28,000
56,000
2,84,000
96,000

Carpets (Rs)
4,60,000
3,22,000
75,000
3,97,000
63,000

Wallpaper (Rs)
1,40,000
1,12,000
45,000
1,57,000
(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 highend 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%.
d). The firm will increase advertising expenditure by Rs. 25,000 to promote the expanded carpet business.

the division. But Why? And How?

Sales……………………..
Less: Variable costs….
Existing Contribution margin….
If wallpaper is closed, then:

Paint and
Supplies

Carpeting

Wallpaper

Rs 380,000
228,000
Rs 152,000

Rs 460,000
322,000
Rs 138,000

Rs 140,000
112,000
Rs 28,000

Loss of wallpaper contribution margin…...
Remodeling…………………………………….
Added profitability from carpet sales*……
Fixed cost savings (Rs45,000 x 40%)……….
Decreased contribution margin from paint and supplies
(Rs152,000 x 20%)……………..
Increased advertising………………………..
Income (loss) from closure…………………

Rs (28,000)
(12,400)
65,000
18,000
(30,400)
(25,000)
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.

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
Direct labor
Manufacturing overhead
Unit product cost

$1.35
0.15
0.80
$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?

Incremental revenue ............................................
Incremental costs:
Variable costs:
Direct materials ...........................................
Direct labor..................................................
Variable manufacturing overhead ...............
Special wick ................................................
Total variable cost............................................
Fixed cost:
Special mold ................................................
Total incremental cost .........................................
Incremental net operating income .......................

Per Unit
$2.95

1.35
0.15
0.05
0.20
$1.75

Total for 800
Candles
$2,360

1,080
120
40
160
1,400
800
2,200
$ 160

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

Selling price per unit
Less variable expenses per unit
Contribution margin
Contribution margin ratio
Current demand per week (units)
Processing time required on
Machine N34 per unit

X
$60
36
$24
40%
2,000

Y
$50
35
$15
30%
2,200

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?

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