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					Cost Academy                                                                              PAGE -1
                                           MAY 1981

Question 1

       A cement manufacturing company is facing the problem of transportation of limestone
       from its quarry. The quarry is suitable 25 kgs. away and the only means of transport
       available is the roadways. The Company has received quotations from some of the local
       transporters at Rs. 12, Rs. 12.50 and Rs. 12.50 and Rs. 13 per tonne of limestone
       transported, with an escalation clause in respect of diesel oil costs.

       The quantity of limestone to be transported per month is 24,000 tonnes.

       While examining the feasibility of department transport the following facts came to be
       reorganised :

       a)   Two types of trucks are available in the market, namely 10 Tonners and 8 Tonners.

       b)   Details of operating costs for the trucks :

                                                          10 Tonner            8 Tonner

            Purchase price                                Rs. 2.5 lakhs       Rs. 2.0 lakhs
            Estimated useful life                         5 years             5 years
            Residual value                                Rs. 40,000           Rs. 20,000
            Km. Per litre of diesel                       3 km.               4 km.
            Estimated Repairs and Maintenance
            Cost per truck                                Rs. 2,000 p.m.      Rs. 1,600 p.m.
            Vehicle and Road Tax per quarter              Rs. 600             Rs. 600

       c)   Cost of diesel per litre                      Rs. 2.00

       d)   Cost of finance for purchase of trucks        12% p.a.

       e)   Each vehicle can run 5 trips (up and down) each day, and can run on an average for
            24 days in a month

       f)   Drivers will have to be recruited according to the number of trucks to be purchased.
            In addition, one extra driver for every 5 vehicles will be required for the entire fleet.
            A driver will cost Rs. 400 per month

       g)   An additional transport supervisor would be required at a cost of Rs. 1,000 per
            month.

       h)   Yet another possibility is to hire sufficient number of trucks (8 Tonners only) from a
            transport company at the rate of Rs. 6,000 per month per truck. The transport
            company will undertake to pay repairs and maintenance costs as well as vehicle
            and Road tax. The cement company has to bear the cost of drivers, supervisor and
            other operational costs.

       You are required to advise the Board on an appropriate choice among the above
       alternatives, considering also the option of entrusting the job to the transport operators.
Cost Academy                                                                              PAGE -2
Answer

                             Cement Manufacturing Company
             Statement Showing Operational Costs of Transportation of Limestone
                                   Under 3 Alternatives

                                                     I                  II                  III
                                                    Own                Own                 Hire
                                                 10 Tonner           8 Tonner            8 Tonner

       No. of working days p.m.                       24                 24                  24
       No. of daily trips                              5                  5                   5
       Total No. of trips                            120                120                 120
       Load Carried (Tonnes)                       1,200                960                 960
       No. of Trucks required for
           24,000 tonnes.                             20                 25                  25
       No. of kms run (120  50)                   6,000              6,000               6,000

       Running Cost :                              Rs.                 Rs.                 Rs.

       Diesel Oil                                80,000              75,000              75,000
       Repairs & Maintenance                     40,000              40,000                 —
       Vehicle & Road Tax                         4,000               5,000                 —
       Depreciation                              70,000              75,000              75,000
       Salaries :
       Drivers                                    8,000              10,000              10,000
       Additional Driver                          1,600               2,000               2,000
       Transport Supervisor                       1,000               1,000               1,000
       Hire Charges                                  —                   —                   —
       Interest cost                             50,000              50,000              ____—
                                               2,54,600            2,58,000            2,38,000
       Limestone Transported                     24,000              24,000              24,000
                    (Tonnes)
       Cost of Transportation                 Rs. 10.61           Rs. 10.75            Rs. 9.92
                  Per tonne.

       It is better to hire 8 Tonner Trucks as this is the cheapest alt ernative. Entrusting the job
       to transporters is not at all advisable as the lowest cost itself is Rs. 12/ - per tonne which
       is higher than the highest of the above 3 alternatives.

       Working Notes :        10 Tonner    8 Tonner
                                     6,000                     6,000
       (i)   Cost of diesel oil :   ———–  2  20 = Rs. 80,000 ———  2 25 = Rs. 75,000
                                       3                         4

                                  600                           600
       (ii) Vehicle of Road Tax : ——–  20 = Rs. 4,000          ——–  25 = Rs. 5,000
                                   3                             3

                              2,50,000 – 40,000     1 2,00,000 – 20,000      1
       (iii) Depreciation :   —————————–  —  20 —————————  —  25
                                     5             12        5              12
                                      = Rs. 70,000             = Rs. 75,000

                                                          1                   1
       (iv) Interest cost     :    250, 000  20  12%  —– 20,000  25 12%  —–
                                                         12                   12
       = Rs. 50,000           = Rs. 50,000
Cost Academy                                                                             PAGE -3

Question 2

       a)    An enthusiastic marketing manager suggests to his Managing Director that if only
             he is permitted to reduce the selling price of a product by 20 percent, he would be
             able to achieve a 30 per cent increase in sales volume. The Managing Director,
             finding that the sales volume increase exceeds in perc entage the extent of
             requested reduction in price, gives the clearance. You are given the following
             information:

                    Present Selling price per unit      …                   Rs. 7.50
                    Present volume of Sales             …              200,000 Nos.
                    Total Variable Costs                …              Rs. 10,50,000
                    Total Fixed Costs                   …               Rs. 3,60,000

             Assuming no changes in the cost pattern in the coming period,

       i)    Examine the consequences of the Managing Director’s decision assuming that 30%
             increase in sales is realised.

       ii)   AT what volume of sales can be present quantum of profits be sustained, after
             effecting the price reduction?

       b)    What is the significant of determining contribution per unit of key factor or limiting
             factor? Explain with suitable illustrations.

Answer

       a)    (i) Statement showing the present result and the resul t after implementing the
                 Market Manager’s suggestion:

                                                              Present              Proposed
                                                               result                result

             Unit Selling price (Rs.)                            7.50                 6.00
             Sales Volume (Nos.)                             2,00,000             2,60,000
             Unit Variable Cost (Rs.)                            5.25                 5.25
             Unit Contribution (Rs.)                             2.25                 0.75
             Total contribution (Rs.)                        4,50,000             1,95,000
             Total fixed cost (Rs.)                          3,60,000             3,60,000
             Profit (Loss) Rs.                                 90,000           (1,65,000)

       The decision, if implemented will lead to a considerable loss of Rs. 1,65,000, despite
       the 30% increase in sales, compared to current profit position of Rs. 90,000. The net
       effect of the decision will be an effective drop in profit by Rs. 2,25,000.

       (ii) The volume of sales at which the profits will be sustained after effecting the price
            reductions.

                                    Present profits              Rs. 90,000
                                    Total fixed costs           Rs. 3,60,000
                                                                    ————
             Total contribution required to
             Sustain present profit level                       Rs. 4,50,000
             Unit contribution after price
                                 change.                         Rs.     0.75
             (Rs. 6 – Rs. 5.25)
             Sales volume required to recover
Cost Academy                                                                               PAGE -4
            the contribution of Rs. 4,50,000: 4,50,000 ÷ 0.75 = 6,00,000 No s.

            Thus a 200 percent increase over present volume is required to justify a 20 percent
            reduction in price, without affecting profit.

       b)   Contribution is the difference between sales price and marginal or variable costs. It
            contributes towards fixed costs and profit. Fixed costs remain constant in total
            during the short-term period. Therefore, the more the amount of contribution, the
            more will be the ultimate profit. The concept of contribution helps to determine the
            break-even point, profitability of products, department, etc., to select product mix for
            profit maximisation, and to fix selling prices under different circumstances, such as
            trade depression, export sales, price discrimination etc. Contribution is the surer
            test whether a product or process is worthwhile to continue among different
            products or process. Another factor which is also equally important is the ‘key
            factor’, or ‘limiting factor’, or ‘governing factor’, or ‘principal factor’. This is the
            factor the extent of whose influence must first be assessed in order to ensure
            maximisation of profits. Generally sale is the limiting factor, but sometimes
            materials, labour capital and plant capacity may be limiting factors. When
            contribution and key factor are known, on can assess the relative pro fitability with
            the help of this ratio :–
                                                     Contribution
                                      Profitability = ——————–
                                                       Key factor

            When rupee sales is the key factor, profitability is determined by contribution to
            sales ratio or P/V ratio; when labour is in short supply profitability is dete rmined by
            dividing the contribution by labour hours and so on. The following illustration
            explains this:

            Illustration: Suppose a company produces two products X and Y The following
            information is available:

                                                 Product X               Product Y
                                                    Rs.                     Rs.

                Sales Price                     200                        128
                Direct material                  80                         80
                Direct labour hours
                (Rs. 0.50 per hour)          20 hrs.                     4 hrs.
            Variable overhead—100% of direct wages
            Fixed overhead—Rs. 6,000

                 Now if the labour is in short supply, determine the profitability of products. In
                 this illustration labour hours are the key factor. Therefore, the firm should
                 produce that produce which gives higher contribution per labour hour. This is
                 calculated below:–

       Product
                                                      X                               Y
                                                     Rs.                             Rs.

       Sales Price                                   200                          128
       Less Marginal cost—
                                       Rs.                         Rs.

       Direct material                  80            80
       Direct wages                     10             2
       Variable overhead                10           100             2               84
Cost Academy                                                                              PAGE -5
                                     —–           ——             —–            —–
       Contribution per unit                      100                          44
                                                  ——                           —–
                            100                         44
       P/V Ratio =         ——  100 = 50%               ——  100 = 34.4%
                           200                          128
       Contribution per labour
                            Contrn.               100                          44
       hour or key factor = ———–—                 ——                           ——
                           Lab. Hrs.               20                           4
       = Rs. 5 per hr.     = Rs. 11 per hr.

       It is obvious from the above that during labour shortage, product Y is more profitable
       than product X, though contribution per unit or P/V ratio is higher in case product X. IN
       the normal circumstances, a product which yields the highest P/V ratio is the best to
       produce but when any other resources or input is in short supply which is known as key
       factor or limiting factor, and the quantity of it required for one unit of two products is
       different, then contribution has to be linked with the limiting factor to maximise the
       profits of the firm. Thus determination of contribution per unit of key factor or limiting
       factor enables the management to utilise scarce or limited resources in such a way as
       to maximise the total profits of the firm.

Question 3

       An engineering company manufactures a single product whose standard cost structure
       is as follows:–
       Rs.

               Direct material 2.4 kgs. at Rs. 30 per kg. …                  72.00
               Direct Labour 6 Hours at Rs. 4 per hour    …                  24.00
               Factory Overhead 6 Hours at Rs. 0.75 per hour                    …           4.50
                                                                         ———–
             Total                                                        100.50
                                                                         ———–
           The factory overhead is based on the following flexible budget : –
                                     80%               90%            100%            110%
                                     ———              ———            ———              ———
           Production (units)        6000             6750            7500            8250
                                     ———              ———            ———              ———
                                      Rs.              Rs.             Rs.             Rs.

           Variable overheads        18,000            20,250         22,500         24,750
           Fixed overheads           11,250            11,250         11,250         11,250
                                     ———               ———            ———            ———
                                     29,250            31,500         33,750         36,000
                                     –———              ———–           ———–           ———–

           Actual data for the month of January 1981

           Budget production             …    7500 units
           Materials used                …    19240 kgs. at Rs. 31 per kg.
           Direct labour                 …    46830 Hours at Rs. 4.20 per hour
           Actual factory overhead       …    Rs. 36,340
           Production completed          …    7620 units
           Details of Work in-progress
           Opening                       …    120 units, materials fully supplied, 50%.
           converted.
Cost Academy                                                                                    PAGE -6
           Closing                          …       100 units, materials fully supplied, 50%.
           converted.



           Determine and analyse :

           i)     Material cost variance.

           ii)    Labour cost variance.

           iii)   overhead cost variance.

Answer

           Statement Showing Standard and Actual Costs of Actual Production :

                                            Standard                          Actual
                                  Qty.      Rate   Amount            Qty.      Rate       Amount
                                            Rs.      Rs.                        Rs.        Rs.
           Direct
           Materials (Rs.)      18,240      30        5,47,200     19,240      31.00     5,96,440
           Direct
           Labour (Hrs.)        45,660          4     1,82,640     46,830       4.20     1,96,686
           Factory
           Overheads                                    34,245                             36,340
                                                     ————–                              ————–
           (7,610  4.50)                             7,64,085                           8,29,466
                                                     ————–                              ————–

       Variance :

           Materials Cost Variance :            Standard Material Cost – Actual material Cost
                                                Rs. 5,47,200 – Rs. 5,96,440 = Rs. 49,240 (A)

           Material Price Variance:             Actual Quantity (Standard Price – Actual Price)
                                                = 19,240  (Rs. 30 – Rs. 31) = Rs. 19,240 (A)

           Material Usage Variance :            Standard Rate (Standard Qty. = Actual Qty)
                                                30 (18,240 – 19,240) = Rs. 30,000 (A)

           Direct Labour Cost Variance : Standard Labour Cost – Actual Labour Cost
                                         = Rs. 1,82,640 – Rs. 1,96,686 = Rs. 14,046 (A)

           Labour Rate Variance :               Actual Hrs. (Std. Rate – Actual Rate)
                                                46,830 (Rs. 4 = Rs. 4.20) = Rs. 9,366 (A)

           Labour Efficiency Variance:          Standard Rate (Std. Hrs. – Actual Hrs.)
                                                = Rs. 4.00 (45,660 – 46,830) = Rs. 4,680 (A)

           Factory Overheads Cost Variance : Overheads absorbed – Actual Overheads
                                        = Rs. 34,245 – 36,340 = Rs. 2,095 (A)

           Factory Overhead Budget or Expenditure variance : Rs. 36,340 – Rs. 34,080
                                                          = Rs. 2,260 (A)

           Factory Overhead Volume Variance: Std. Overhead Rate (Budgeted – Volume –
           Actual Volume) : 1.50 (7,500 – 7,610) = Rs. 165 (F)
Cost Academy                                                                              PAGE -7

            Capacity Variance:                Std. Overhead Rate per hr. (Budgeted Capacity –
                                              Actual hrs.) = 0.25 (45,660 – 46,830) = Rs. 292.50
                                              (A)

       Note : Capacity variance and efficiency variance are parts of volum e variance.
       Hence Rs. 457.50 (F) + 292.50 (A) + Rs. 165 (F)

       In the absence of information about actual overheads, variable overhead expenditure
       variance has not been computed.

       Working Notes :

       1.   No. of equivalent units of output for which material was introduced :

                                              No. of            Degree              Equivalent
                                              Units         of completions            units

       Closing stock of work-in-
       progress                               100               100%                  100
       Add: Production completed            7,620               100%                7,620
                                            ———                                     ———
       Total                                7,720                                   7,720

       2.   No. of equivalent units of output for which labour and overhead were incurred :

                                              No. of            Degree              Equivalent
                                              Units         of completions            units

       Closing stock of work-in-
       progress                               100                50%                   50
       Add: Production completed            7,620               100%                7,620
                                            ———                                     ———
                                            7,720                                   7,670

       Less: Opening Stock of
       work-in-progress                       120                 50%                  60
                                            ———                                     ———
                                            7,600                                   7,610
                                            ———                                     ———

       3.   Standard quantity of materials : 7,600  2.4 kgs = 18,240 kgs.

       4.   Standard labour hrs. for actual
            equivalent units of output:                  7,610  6 = 45,660 hrs.

       5.   Standard labour hrs. required
            for budgeted production:                     7,500 units  6 = 45,000 hrs.

       6.   Standard fixed overhead
            recovery rate per hour:                      Rs. 11,250 ÷ 45,000 = Re. 0.25

Question 4

       Distinguish between management Information system, Budgetary Control system and
       Standard Costing and Variance Accounting. State how each of them assists in
       management control.
Cost Academy                                                                           PAGE -8
Answer

       Management Information System : It means the internal communications net work of the
       business, providing necessary intelligence to plan, execute and control. It is an
       integrated, man-machine system for providing information to support the operations and
       managerial and decision making functions in an organisation. The system may utilise
       computer hardware and software, manual procedures, management and decision
       models and a data base. The system must provide the relevant information needed by
       management at various levels for the purpose of planning decision making and control.

       Budgetary Control System : It refers to the establishment of budgets relating the r
       esponsibilities of executives to the requirements of a policy and the continuous
       comparison of actual with budgeted results, either to secure by individual action
       objective of that policy, or to provide a basis for the revision. It ensures control over
       performances and costs in the different parts of a business.

       Standard Costing and variance Accounting : Standard costing and Variance accounting
       means the preparation and use of standard cots, their comparison with actual costs and
       analysis of variance to their causes and points of incidence. It is a technique which can
       be applied to all types of costing. Standard costing is very useful in those industries
       which produce standardised products and repetitive in nature. The difference between
       standard cost and actual cost is termed as cost variance. The computation of the
       various variances and their disposal may form part of variance accounting. The variance
       accounting would help in tracing the origin and causes of the variances then to take
       steps to reduce these variances to the extent possible.

       Thus management information system provides managers at various levels with
       information required by them to carry out their job of planning, decision making and
       control. Management Information System is the total of all the systems and governs
       every aspect of an organisation. It supplies all types of information at all the levels of
       management to do the job and to get the job done, as the case may be. Supplying
       information continuously and periodically for planning , decision making and control
       relating to any aspect of an undertaking is the subject matter of

				
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