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Test Questions-Relevant Cost for Decision Making

TEST QUESTIONS

1. What is meant by Decision making ?

2. What is Differential Costs ?

3. What is meant by Relevant Costs ?

4. What do you understand by relevant cost for Decision making ?

5. Describe the various steps involved in Rational Decision making.

6. ”The role of Management Accountant in deciding among alternative counsel action is crucial”. Explain this statement with special reference to special order acceptance.

7. What factors would you take into consideration in closing or suspending the business activity?

8. Discuss the basic differences between differential costing and marginal costing. State the applications of differential costing.

 

PROBLEMS AND SOLUTIONS

Problem 1. HR Ltd., makes a single product which sells for $ 30 per unit and there

is a great demand for the product. The variable cost of the product is $ 16 as detailed below.

$

Direct material                        8

Direct Labour (2 Hrs)             4

Variable overhead                   4

Total cost                                16

The labour force is currently working at full capacity and no extra time can be made available. Mr.  Goyal, a customer has approached the company with a request for the manufacture of a special order at $ 8, 000. The cost of the order would be $ 3000 for direct material and 600 labour hours will be required and variable overhead per hour should be

$ 2. Should the order be accepted or not.

Solution:

Sales Price                  = $ 30

Order amount              = $ 8000

No. of unit [8,000/30]             = 267

Cost details per unit

Direct material 3,000/267       =11.23

Direct labour (4/2 x 600 = 1,200)1,200/267

Variable Expenses (600 x 2 = 1,200)              = 4.49

total variable cost per unit                   = 20.21

Total variable cost for 267 units x $ 20.21 = $ 5,396

Sales value at special order = $ 8,000

Less : variable cost = $ 5,396

Contribution = $ 2,604

$ 2,604 is treated as an Additional Contribution and it will be an income to the concern. So the order may be accepted. .

 

Problem 2. A Company has a capacity of producing 1,00,000 units of a certain product in a month. The sales department reports that the following schedule of sales price is possible.

Volume of production                        Selling price per unit

60%                                                     0.90

70%                                                     0.80

80%                                                     0.75

90%                                                     0.67

100%                                                   0.61

The variable cost of manufacture between these levels ·is Re. 0.15 per unit. Fixed cost is $ 40,000.

You are required to prepare a statement showing incremental revenue and differential cost at each stage. At which volume of production, will the profit be maximum ?

If there is a bulk order at Re. 0.40 per unit for the balance capacity over the maximum profit volume for export and the price quoted will not affect the internal sale. Will you advise to accept this bid and why ?

Solution:

(a)                    Statement of incremental revenue and differential cost

Based upon the above calculation 80% capacity level is the maximum profit.

(b) Income from the bulk order :

20,000 units @ .40 Price per unit                   8,000

Less : Additional Variable cost (20,000 x .15)                       3,000

Additional Net Profit                         5000

It is decided to accept the bulk order. But fixed costs are not considered because fixed cost will be constant up to the production level of 1,00,000 units. This is the budgeted  production.

 

Problem 3. The Chennai Machinery & Co. manufactured and sold 1000 calculators last year at a price of Rs.800 each. The cost structure of a calculator is as follows.

$

Material                                               200

Labour                                                 100

Variable cost                                       50

Marginal cost                                      350

Factory overhead (Fixed)                   200

Total cost                                            550

Profit                                                   250

Sale price                                             800

Due to heavy competition, price has to be reduced to $ 750 for the coming year. Assuming no change in costs, state the number of calculators that would have to be sold at the new price to ensure the same amount of total profits as that of the last year.

Solution :

Profit for 1,000 calculators 1000 x 250 = $ 2,50,000

Computation of PN ratio = Contribution/sales x 100

Contribution = Sales- V.C.

= 750- 350 = 400

P/V ratio = 400/750 x 100 = 53.33%

Sales required to earn a profit of $ 2,50,000

=Fixed Cost + Profit /   P/V Ratio

= 2,00,000 + – 2,50,000 /53.33/100

= Rs.8,43,802

Sales in units = 8,43,802 /750 = 1125 calculator.

If the company is to sell 1,125 calculators only, it will earn the last year’s total profit

of 2,50,000 even in the reduction of selling price at $ 750/-.

 

Problem 4. Following information has been made available from the records of KRS

Ltd, manufacturing spare parts. ·

Cost price per

Direct material                                                $

X                                                         8.00

Y                                                         6.00

Direct wages

X                                                         24 hours@ 25 $ per hour

Y                                                         16 hours @25 $ per hour

Variable overheads                                         150% of wages

Fixed overheads                                              $750

Selling price of X                                            $25

Selling price of Y                                            $ 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.

(b) 400 units of Y only.

(c) 400 units of X and 100 units of Y.

(d) 150 units of X and 350 units of Y

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

Solution:                                 Marginal Cost Statement

Particulars                                           Product X                              Product y

$                                              $

Direct Material                                        8                                              6

Direct wages                                          6                                               4

Variable overheads

Total variable cost                                   23                                           16

Selling price                                            25                                            20

Less : Variable cost                                 23                                           16

Contribution                                            2                                              4

Alternative Sales Mix Decisions

(a) 250 units of X and 250 units of Y

$

Contribution : Product X, 250 x $ 2 = 500

Product Y, 250 x $ 4 = 1,000

1,500

Less : Fixed cost = 7 50

Profit 750

 

(b) 400 units of product Y

Contribution : Product Y : 400 x Rs.4 = 1,600

Less : Fixed cost = 750

Profit 850

 

(c) 400 units of product X and 100 units of Product Y

Contribution : Product X : 400 x $ 2 = 800

Product Y : 100 x $ 4 = 400

1,200

Less : Fixed cost = 750

Profit 450

 

(d) 150 units of Product X and 350 units of Product Y

Contribution : Product X : 150 x $ 2 = 300

Product Y : 350 x $ 4 = 1,400

1,700

Less : Fixed cost = 750

Profit 950

Result and Decision :

Among the four different sales mixes, (d) is the most profitable since it gives the maximum profit of $ 950/-. So it should be recommended.

Problem 5. The management of a company finds that the cost of making a component part is $ 10. While the same is available in the market at $ 9 with an assurance of continuous supply.

Give a suggestion whether to make or buy this part. Give also your view in case the supplier reduces the price from $ 9 to 8.00.

The cost information is as follows

Material                                               $ 3.50

Direct Labour                                      $ 4.00

Other variable expenses                      $1.00

Fixed expenses                                    $1.50

Total                                                    10.00

Solution :

In order to take decision regarding the making or buying the component part, fixed cost should not be considered. Because these will be incurred even if the part is produced or not. But if the part is produced, the following additional costs should be incurred.

$

Material                                               3.50

Direct Labour                                      4.00

Other variable Expenses                     1.00

Total cost                                            8.50

It is available in the market for $ 9.00. But the production cost of the part is $ 8.50. So the company gets contribution of .50 $ per part (9.00 – 8.50) even if it manufactures by itself.

If the same is available in the market at $. 8.00, the company should not manufacture the part. It is better to buy the part in the market. As per the above calculation it is better if the company manufacture the part itself.

 

Problem 6. The management of a company is thinking whether it should drop one item from the product line and replace it with another. Given below are present cost and output data.

Product                       Price                Variable Costs per unit          Percentage of sales

$                                  $                                              $

Book shelf                   60                                40                                            30%

Table                           100                              60                                            20%

Price                            200                              120                                          50%

Total fixed costs per year $ 7.50.000

Sales $ 25.00.000

The change under consideration consists in dropping the line of Tables and adding the line of cabinets. If this change is made, the manufacturer forecasts the following costs and output data.

Product                       Price                Variable Costs per unit          Percentage of sales

$                                  $                                              $

Book shelf                   60                                40                                            15%

Cabinet                        100                              60                                            10%

Bed                             200                              120                                          40%

Total fixed costs per year $ 7,50,000

Sales $ 26,00,000

Should this proposal be accepted or not ? comment.

 

Solution :             Comparative Profitability Statement

Comments : Based on the above calculation, the manufacturer will stand to gain in case he drops the production of tables in preference to cabinets. But the demand for cabinets should not be a temporary period.

Problem 7. Modern Cutting Machines & Co manufactures hand operated cutting machines. Prepare a schedule showing the differential costs and incremental revenue at each stage from the following data. At what volume the company should set its level of production ?

Output             Selling price     Total semifixed cost     Total variable cost       Total fixed cost

(No. in lakhs)  (per machine)         ($in lakhs)                 ($in lakhs)        ($in lakhs)

0.60                    240                          30                              83.6                     28.4

1.20                    220                           30                           163.6                      28.4

1.80                   200                          34                              255.6                     28.4

2.40                   180                           34                               315.6                   28.4

3.00                   160                           40                               355.6                   28.4

3.60                    140                          40                               380.6                   28.4

Solution :

Schedule showing the differential costs and incremental revenues

Comments : The company should set its level of output at 3,00,000 units. Because up to this level incremental revenue exceeds differential cost.

 

Problem 8. KKS Ltd having installed capacity of 1,00,000 units of a product is currently operating at 70% utilisation. At current levels of input prices, the FOB unit costs (after taking credit for applicable export incentives) work out as follows.

Capacity utilization                             FOB unit costs

%                                                         ($)

70                                                        97

80                                                        92

90                                                        87

100                                                       82

The company has received three foreign offers from different sources as under.

Source K 5000 units at $ 55 per unit FOB.

Source L 10,000 units at $ 52 per unit FOB.

Source C 10,000 units at $ 51 per unit FOB.

Advise the company as to whether any or all the export orders should be accepted or not.

Solution:

Statement showing differential cost of different capacity levels

Capacity    Production                FOB unit       Total       Differential                            Per unit

%                units          Cost ($.)      Cost ($)            cost                   Differential

Cost

70               70,000           97            67,90,000

80              80,000            92           73,60,00           5,70,000                        57

90             90,000             87          78,30,00             4,70,000                        47

100         1,00,000            82          82,00,000          3,70,000                         37                    

Statement showing Gain or Loss on accepting the various Export order

Comment : The Company should accept all the three export orders.

 

Problem 9. A company manufactures three products A, B and C. There are no common processes and the sale of one product does not affect prices or volume of sale of any other.

The company’s budgeted profit I Loss for 1998 has been abstracted thus.

Total                A                                 B                                 C

$                      $                                  $                                  $

Sales                                   3,00,000           45,000                     2,25,000                        30,000

Production costs

Variable:                            1,80,000               24,000                     1,44,000                       12,000

Fixed :                                60,000                   3,000                      48,000                            9,000

Total factory cost :             2,40,000               27,000                    1,92,000                       21,000

Selling admi, costs

Variable :              24,000              8,100                          8,100                            7,800

Fixed :                     6,000                2,100                         1,800                          2,100

Total cost                2,70,000           37,200                     2,01,900                       30.900

Profit                        30,000            7,800                       23,100                              -900

On the basis of the above, the board had almost decided to eliminate product C, on which a loss was budgeted. Meanwhile, they have sought your opinion. As the company’s Cost Accountant, what would you advise ? Give reasons for your answer.

Solution : Profitability Statement

Based upon the above computation product C is contributing $ 10,200 towards the fixed expenses of the company. If the product C is discontinued the profit of the company will be reduced to $ 19,800 [i.e., 30,000 - 10,200]. And the P/v ratio of product C is higher as compared to other products. Under this background it is advisable to continue the product C.

 

Problem 10. A radio manufacturing company finds that it costs $ 6.25 to make each component x 6640, while the same is available in the market at $ 4.85 each, with an assurance of continuous supply. The break up of cost is as follows :

Materials                                             $. 2. 75 each

Labour                                                 $   1. 75 each

Other variable cost                              $ 0.50each

Depreciation and other fixed cost       $ 1.25 each

should you make or buy ? 

Solution :

Variable cost of manufacturing is $ 5.00.

i.e., (6.25 – 1.25)

But the market price is $ 4.85

If the fixed cost of $ 1.25 is added, it is not profitable to make the component. Better to procure it from outside supply, because, if it purchases from outside supply it can get a profit of  15 .