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PAPER - 5 : COST MANAGEMENT

Question 1

(a) Define Total Quality Management? What are the six Cs forsuccessful implementation of TQM ?

(b) What steps are involved in value chain analysis approach forassessing competitive advantages?

(c) Carlon td! ma"es and sells a single product# the unitspecifications are as follo$s%

Direct Materials & % ' s! metre at s *+ per suare

metre

Machine Time % +!, unning hours

Machine cost pergross hour

% s! *++

-elling price % s! ./+++

Carlon td! reuires to fulfil orders for 0/+++ product units per period! There are no stoc" of product units at the beginning orend of the period under revie$! The stoc" level of material &remains unchanged throughout the period!

Carlon td! is planning to implement a Quality Management1rogramme (Q1M)! The follo$ing additional informationregarding costs and revenues are given as of no$ and afterimplementation of Quality Management 1rogramme!

2efore the implementationof QM1

3fter theimplementation

.!

04 of incoming materialfrom suppliers scrapped dueto poor receipt and storageorganisation!

.! educed to 54!

6!

*4 of material & input to themachine process is $asteddue to processing problems!

6! educed to 6!04

5!

7nspection and storage ofMaterial & costs e! . persuare metre purchased!

5! 8o change in the unitrate

*!

7nspection during the production cycle/ calibrationchec"s on inspection

*! eduction of *+4 ofthe existing cost!



FINAL EXAMINATION : MAY, 2005

euipment vendor ratingand other chec"s cost s!6/0+/+++ per period

0!

1roduction Qty! is increasedto allo$ for the do$ngradingof .6!04 of the productionunits at the final inspectionstage! Do$n graded unitsare sold as seconds at adiscount of 5+4 of thestandard selling price!

0! eduction to 9!04

,!

1roduction Quantity isincreased to allo$ for returnfrom customers (these arereplaced free of charge) dueto specification failure andaccount for 04 of unitsactually delivered tocustomer!

,! eduction to 6!04

9!

1roduct liability and otherclaims by customers isestimated at 54 of salesrevenue from standard

product sale!

9! eduction to .4!

'!

Machine idle time is 6+4 of:ross machine hrs used (i!e!running hour ; '+4 ofgross<hrs!)!

'! eduction to .6!04!

=!

-undry costs of 3dministration/ -elling andDistribution total > s!,/++/+++ per period!

=! eduction by .+4 ofthe existing!

.+!

1revention programme costss! 6/++/+++

.+!

7ncrease to s!,/++/+++!

The Total Quality Management 1rogramme $ill have areduction in Machine un Time reuired per product unit to+!0 hr!

euired%

(a) 1repare summaries sho$ing the calculation of (i) Total

4




production units (pre inspection)/ (ii) 1urchase ofMaterials & (suare metres)/ (iii) :ross Machine ours!

(b) @7n each case/ the figures are reuired for the situationboth before and after the implementation of the QualityManagement 1rogramme so that orders for 0/+++

product units can be fulfilled!

(b) 1repare 1rofit and oss 3ccount for Carlon td! for the period sho$ing the profit earned both before and afterthe implementation of the Total Quality 1rogramme!

Answer

(a) The total quality management is a set of concepts andtools for getting all employees focused on continuousimprovement in the eyes of the customer. Quality is animportant aspect of world-class manufacturing. The success of

Japanese companies is grass rooted in their long-termcommitment to improvement of quality. A world classmanufacturing approach demands that the quality must bedesigned into product and the production process, rather than anattempt to remove poor quality by inspection. This means thatthe obectives of quality assurance in a world- class-manufacturing environment, is not ust reect defective product,but to systematically investigate the cause of defects so thatthey can be gradually eliminated. Though the goal is !ero defect,the methodology is one of continuous improvement.

Six Cs of TQM

(i" #ommitment - $f a TQ% culture is to be developed, so thatquality improvement becomes normal part of everyone&s ob,a clear commitment, from the top must be provided. 'ithoutthis all else fails.

(ii" #ulture - Training lies at the centre of effecting a change -inculture and attitudes. egative perceptions must be changed

to encourage individual contributions.

(iii" #ontinuous improvement - TQ% is a process, not aprogram, necessitating that we are committed in the longterm to the never ending search for ways to do the obbetter.

(iv" #o-operation) The on-the-ob e*perience of allemployees must be fully utili!ed and their involvement andco-operation sought in the development of improvementstrategies and associated performance measures.

5




(v" #ustomer focus) +erfect service with !ero defects in all thatis acceptable at either internal or e*ternal levels.

(vi" #ontrol) ocumentation, procedures and awareness ofcurrent best practice are essential if TQ% implementationsare to function appropriately The need for controlmechanisms is frequently overlooed, in practice.

() %ost corporations define their mission as one of creatingproducts and services. $n contrast, the other companies areacutely aware of the strategic importance of individual activitieswithin their value chain, They are concentrating on thoseactivities that allow them to capture ma*imum value for theircustomers and themselves.

These firms use the value chain analysis approach to betterunderstand which segments, distribution channels, price points.product differentiation. selling prepositions and value chainconfiguration will yield them the greatest competitiveadvantage.

The way the value chain approach helps these organi!ations toassess competitive advantage includes the use of following stepsof analysis.

(i) !nterna" #ost ana"$sis - to determine the sources of

profitability and the relative cost positions of internal valuecreating processes

(ii) !nterna" %ifferentiation ana"$sis - to understand thesources of differentiation with internal value-creatingprocess and

(iii) &erti#a" "in'ae ana"$sis - to understand therelationships and associated costs among e*ternal suppliersand customers in order to ma*imi!e the value delivered tocustomers and to minimi!e the cost.

The value chain approach used for assessing competitive

advantages is an integral part of the strategic planning process./ie strategic planning, value chain analysis is a continuousprocess of gathering, evaluating and communicating informationfor business decision-maing.

(#) (a)

Existin After

TQM

Prora

6




e

i* Tota" +ro%u#tion

units

(Preins+e#tion)

Total sales

requirements

0,111 0,111

2pecification losses

03

401 4.03 540

0,401 0,540

owngrading atinspection ×

0.67

0.54

0,401

701

×0.84

0.70,540

95:

Total units before

inspection

:,111 0,095

ii Pur#,ase of

ateria" ./(S0

Mtr)

%aterial required to

meet pre inspection

production

requirement :,111 ×

6 2q%tr

96,111

2q%tr

0,095×6

2q%tr

99,;46

2q%tr

+rocessing loss ×8:

9

96,111

4,111

×0.87

0.499,;46

5,5;7

$nput to the process 01,111 90,9:0

2crapped material

×

80

0 01,111

4,:;4

×

87

;90,9:0

5,91:

Total purchases 04,:;4 9:,675

iii Gross Ma#,ine

ours

$nitial requirements

:,111 × 1.:

;,:11 0,095 × 1.0 4,775

$dle time ×

61

41;,:11

811×

0.67

0.544,775

;8:

7




<ross time 9,011 ;,5:7

() Profit an% "oss stateent

s s

2ales revenue 0,111

=nits× >s 5,111

01,11,111

01,11,111

2ales downgraded

701 =nits×>s 711

0,40,111

95: =nits × >s

711

4,85,411

00,40,111

04,85,411

#osts)

%aterial 04,:;4 2q %tr ×

>s 91

45,10,461

9:,6752q %tr ×

>s 91

56,79,691

$nspection and storage

costs 04,:;4 2q %tr ×>e

5

04,:;4 9:,6752q %tr ×

>e 5

9:,675

%achine cost 9,011 ?rs ×

>s 911

56,11,111

;,5:7 ?rs× >s

911

54,::,611

$nspection and othercost

4,01,111

4,01,111 × :13 5,01,111

+roduct liability (;3 ×

01,11,111

5,01,111

53 × 01,11,111 01,111

2undry cost of selling,distribution andadministration.

:,11,111

:,11,111 × 813 0,91,111

+reventive programme

cost

4,11,1

11

:,11,111

05,07,854

90,46,055

et profit ;,:7,166

7,:4,:68

Question 2

(a) C 1reserves produces Aams/ Marmalade and 1reserves! 3ll the products are produced in a similar fashion# the fruits are coo"ed

8




at lo$ temperature in a vacuum process and then blended $ithglucose syrup $ith added citric acid and pectin to help setting!

Margins are tight and the firm operates/ a system of standardcosting for each batch of Aam!

The standard cost data for a batch of raspberry Bam are

ruits extract *++ "gs s! ., per "g!

:lucose syrup 9++ "gs s! .+ per "g!

1ectin == "gs! 55!6 per "g!

Citric acid . "g at s! 6++ per "g!

abour .' hours s! 56!0+ perhour!

-tandard processing loss 54!

The climate conditions proved disastrous for the raspberry crop! 3s a conseuence/ normal prices in the trade $ere s! .= per "gfor fruits abstract although good buying could achieve somesavings! The impact of exchange rates for imported sugar plusthe minimum price fixed for sugarcane/ caused the price ofsyrup to increase by 6+4!

The retail results for the batch $ere >

ruit extract *6' "gs at s! .' per "g!

:lucose syrup 9*6 "gs at s! .6 per "g!

1ectin .60 "gs at s 56!' per "g!

Citric acid . "g at s! =0 per "g!

abour 6+ hrs! at s! 5+ per hour!

3ctual output $as ./.,* "gs of raspberry Bam!

Eou are reuired to%

(i) Calculate the ingredients planning variances that aredeemed uncontrollable!

(ii) Calculate the ingredients operating variances that aredeemed controllable!

(iii) Calculate the mixture and yield variances!

(iv) Calculate the total variances for the batch!

(b) F2alanced score card and performance measurement systemendeavours to create a blend of strategic measures/ outcomes

9




and drive measures and internal and external measuresG!Discuss the statement and explain the maBor components of abalanced score card!

(c) Hxplain clearly the terms esource -moothing and esourceevelling!

Answer

(a) 3etai"s of oriina" an% re4ise% stan%ar%s an%a#tua" a#,ie4e%

Oriina" stan%ar%s Re4ise% stan%ar%s A#tua"

@ruit 911 gs ×

>s5:

>s:,911 911 gs ×>s

58

>s7,:11 946 gs× >s

56

>s7,71

9

<lucose 711 gs ×

>s51

>s7,111 711 gs ×

>s54

>s 6,911 794 gs × >s

54

>s

6,819

+ectin 88 gs × >s

;;.4

>s

;46:.6

88 gs × >s

;;.4

>s

;46:.6

540gs×>s

;4.6

>s

9,511

#itric

acid

5 g× >s 411 >s 411 5 g× >s 411 >s 411 5 g× >s 80 >s 80

5,411 gs >s5:,66

:.6

5,411 gs >s58,96

:.6

5,48: gs >s41,6

1;

/abour >s 060.1 >s 060.1 >s :11

5,411 gs 57,975.6 5,411 gs 41,175.6 5,48: gs 45,91;

/oss ;: gs ;:gs 5;4

5,5:9gs >s

57,975.6

5,5:9gs >s

41,175.6

5,5:9 gs >s

45,91;

(i) P"annin 4arian#es

B @ruit e*tract (:,911 less 7,:11" >s5,411(Adverse"

<lucose syrup (7,111 less 6,911" >s5,911(Adverse"

Total >s4,:11(Adverse"

B (2td qty × 2td price less 2td qty ×

>evised 2td price"

(ii) !nre%ients o+eratin 4arian#es

10




Total (58,96:.6 less 41,61;" C >s 5,;5:.4(Adverse"

Ingredients Price variance

(>evised %aterial +rice D Actual %aterial +rice"× ( ActualQty #onsumed"

Iariance in s

@ruit e*tract (58 D 56" × 946 946(@"

<lucose syrup il

+ectin (;;.4 D ;4.6" × 540

01(@"

#itric acid (411 D 80" × 5 510(@"

06;(@"

Usage variance

(2td Qty on Actual +roduction less Actual Qty on Actual +roduction" × >evised 2td

+riceE=nit

s Iariance in s

@ruit e*tract (911 D 946" × 58

0;4(A"

<lucose syrup (711 D 794" ×

54

019(A"

+ectin (88 D 540" ×

;;.46:;.4(A"

#itric acid il

5,688.4(A"

(iii) Mix Variance

(Actual usage in std mi* less Actual usage in actual mi* " ×std price

Fariance in>s

@ruit e*tract (9;4 D 946" ×58 7:(@"

<lucose syrup (70: D 794" × 54 5:6 (@"

+ectin (51:.84 D 540" ×

;;.4:11.;(A"

#itric acid (5.16 D 5" ×411 5:(@"

;91.; (A"

11




Yield variance

(Actual yield D 2td yield from actual output" × 2td cost per unit ofoutput

C (5,5:9 D 5,48: × 1.87" × 55:9

6.5896: C 5,006.8(A"

Labour operating variance

060 D :11 C 50(A"

(i4) Total variance C +lanning variance G =sage Fariance G+rice Fariance G labour operating Fariance.

Hr Total Fariance C (4,:11" G ( 5,688.4 " G 06; G (50" C;8;5.4 (A".

() The balanced score card translates an organi!ation&s mission andstrategy into a comprehensive set of performance measures thatprovides the framewor for implementing its strategy. Thebalanced score card does not focus solely on achieving financialobectives. $t is an approach, which provides information tomanagement to assist in strategic policy formulation andachievement. $t emphasi!es the need to provide the user with aset of information, which addresses all relevant areas ofperformance in an obective and unbiased manner. As amanagement tool it helps companies to assess overallperformance, improve operational processes and enablesmanagement to develop better plans for improvements.

%aor components of a balanced scorecard - The components ofbalanced score cards varies form business to business. A welldesigned balanced scorecard combines financial measures ofpost performance with measures of firm&s drivers of futureperformance. The specific obectives and measures of anorgani!ation-balanced scorecard can be derived from the firm&svision and strategy. <enerally, balanced score card has thefollowing four perspectives from which a company&s activity canbe evaluated.

(i) Financial perspective: @inancial perspective measures theresults that the organi!ation delivers to its staeholders. Themeasures are) operating income, revenue growth, revenuesfrom new products, gross margin percentage, cost reductionin ey areas, economic value added, return on investment.

(ii) Customer perspective: The customer perspectiveconsiders the business through the eyes of customers,measuring and reecting upon customer satisfaction.

12




The measures are) - maret share. customer satisfaction,customer retention percentage, time taen to fulfilcustomer&s requests.

(iii) Internal business perspective: The internalperspective focuses attention on the performance of the eyinternal processes, which drive the business such asinnovative process, operation process and post-salesservices.

(i4) Learning & growt perspective: The measure are)-employee education I sills levels, employee turnover ratio,information system availability, percentage of employeesuggestion implemented etc.

(#) Resour#e Soot,in) $t is a networ technique used forsmoothening pea resource requirement during different periodsof the proect networ. =nder this technique the total profitduration is maintained at the minimum level. The resourcesrequired for completing different activities of profit aresmoothened by utilising floats available on non-critical activities.

These non-critical activities having floats are rescheduled orshifted so that a uniform demand on resources is achieved. Theconstraint is on the profit duration time.

Resour#e e4e""in: $t is also a networ technique used forreducing the requirement of particular resource due to itspaucity. $t utili!es the large floats available on non-criticalactivities of the proect and thus cuts down the demand on theresources.

$n resource levelling, the ma*imum demand of a resource shouldnot e*ceed the available limit at any point of time. To achievethis, non-critical activities are rescheduled by utilising theirfloats. $t may lead to enlarging the completion time of theproect. The constraint here is on the limit of the resourceavailability.

Question 6

(a) During the last 6+ years/ J tdKs manufacturing operation hasbecome increasingly automated $ith ComputerLcontrolled robotsreplacing operators! J currently manufactures over .++

products of varying levels of design complexity! 3 single plant$ise overhead absorption rate/ based on direct labour hours/ isused to absorb overhead costs!

7n the uarter ended March/ JKs manufacturing overhead costs

13




$ere%

(s!+++)

Huipment operation expenses .60

Huipment maintenance expense 60

Wages paid to technicians '0

Wages paid to -tore men 50

Wages paid to despatch staff *+

5.+

During the uarter/ the company revie$ed the Cost 3ccounting-ystem and concluded that absorbing overhead costs toindividual products on a labour hour absorption basis ismeaningless! Nverhead costs should be attributed to productsusing an 3ctivity 2ased Costing (32C) system and the follo$ing$as identified as the most significant activities%

(i) eceiving component consignments from suppliers

(ii) -etting up euipment for production runs

(iii) Quality inspections

(iv) Despatching goods as per customerKs orders!

7t $as further observed that in the shortLterm JKs overheadsare *+4 fixed and ,+4 variable! 3pproximately/ half thevariable overheads vary in relating to direct labour hours$or"ed and half vary in relation to the number of ualityinspections!

Huipment operation and maintenance expenses areapportioned as%

• Component stores .04 / manufacturing 9+4 and goodsdispatch .04

TechnicianKs $ages are apportioned as %

• Huipment maintenance 5+4 / set up euipment for production runs *+4 and uality inspections 5+4

During the uarter %

(i) a total of 6+++ direct labour hours $ere $or"ed (paid ats! .6 per hr!)

(ii) ='+ components consignments $ere received from

14




suppliers

(iii) .+6+ production runs $ere set up

(iv) ,*+ uality inspections $ere carried out

(v) *6+ orders $ere dispatched to customers!

JKs production during the uarter included components / -and T! The follo$ing information is available%

Component

Component

Component

- T

Direct labour rs $or"ed 60 *'+ 0+

Direct Material s! ./6++ s!6/=++

s! ./'++

ComponentConsignments ecd!

*6 6* 6'

1roduction runs ., .' .6

Quality 7nspections .+ ' .'

Nrders (goods)despatched

66 '0 *,

Quantity produced 0,+ .6/'++ 6/*++

euired%

(.) Calculate the unit cost of / - and T components/ using JKsexisting cost accounting system!

(6) Hxplain ho$ an 32C system $ould be developed using theinformation given! Calculate the unit cost of components /- and T using 32C system!

(b) 3n electronics firm $hich has developed a ne$ type of fireLalarmsystem has been as"ed to uote for a prospective contract! Thecustomer reuires separate price uotations for each of thefollo$ing possible orders%

Nrder 8umber of fireLalarm systems

irst .++

-econd ,+

Third *+

The firm estimates the follo$ing cost per unit for the first order%

Direct materials s! 0++

15




Direct labour

Deptt! 3 (ighly automatic) 6+ hours at s! .+ per hour

Deptt! 2 (-"illed labour) *+ hours at s! .0 per hour

Iariable overheads 6+4 of direct labour

ixed overheads absorbed%

Deptt! 3 s! ' per hour

Deptt! 2 s! 0 per hour

Determine a price per unit for each of the three orders/assuming the firm uses a mar" up of 604 on total costs andallo$s for an '+4 learning curve! Hxtract from '+4 earningcurve table%

5.1 5.; 5.9 5.0 5.: 5.7 5.6 5.8 4.1

K3

511.1

85.7 68.0 67.: 6:.5 69.9 6;.1 65.0 61.1

& represents the cumulative total volume produced to dateexpressed as a multiple of the initial order!

E is the learning curve factor/ for a given & value/ expressed as a

percentage of the cost of the initial order!

Answer

(a) (1) 2ingle factory direct labour hour overhead rate C

4,111

;,51,1>s C >s 500 per direct labour hour

Co+utation of unit #ost ( existin s$ste)

R (Rs) S(Rs) T(Rs)

irect labourcost L >s 54per hour

;11 0,7:1 :11

irect material 5,411 4,811 5,611

Hverheads(direct labour hours× >s 500 perhour

;,670 79,911 7,701

0,;70 6;,1:1 51,501

16




Quantity+roduced (o"

0:1 54,611 4,911

#ost per unit 8.:1 :.98 9.4;

(2) AM# system involves the following stages,

5. $dentifying the maor activities that tae place in anorganisation.

4. #reating a cost pool Ecost centre for each activity

;. etermining the cost driver for each activity

9. Assigning the cost of activities to cost obects (e.g.

products, components, customers etc"

The most significant activities have been identified e.g.receiving components consignments from suppliers, settingup equipment for production runs, quality inspections, anddespatching orders to customers. The following shows theassignment of the costs to these activities,

(s/+++)

eceivi

ng

supplies

-et

ups

Quality

inspecti

on

Despatc

h

Total

Nquipment operation

e*penses

56.70 67.0

1

56.70 540

%aintenance ;.70 57.0

1

;.70 40

Technicians wages

initially allocated to

%aintenance(;13 of >s

60,111C >s 40,011 and

then reallocated on same

basis on maintenance"

;.6; 57.6

0

;.64 40.0

Malance of technicians

wages allocated to set

ups and quality

inspections

;9.1

1

40.01 08.0

1

2tores wages - >eceiving ;0 ;0

espatch wages -

espatch

91 91

:5.;; 50:.

60

40.01 ::.;4 ;51

17




Note : Nquipment operation e*penses and %aintenanceallocated on the basis 503,713 and 503 as specified in thequestion.

The ne*t stage is to identify the cost drivers for each activityand establish cost driver rates by dividing the activity costsby a measure of cost driver usage for the period. Thecalculations are as follows )-

>eceiving supplies (861

:5,;;>s" C >s :4.06 per component.

+erforming set ups (5,141

5,0:,6" C >s 50;.77 per set up

espatching goods (941

;4,::" C >s 507.8; per despatch

Quality inspection (:91

01,40" C >s ;8.69 per quality inspection

@inally, costs are assigned to components based on their costdriver usage. The assignments are as follows,

(s) -(s) T(s)irect labour ;11 0,7:1 :11

irectmaterials

5,411 4,811 5,611

>eceivingsupplies

4,:46.;: 5,015.84 5,704.49

+erforming setups

4,9:1.;4 4,7:7.6: 5,690.49

Quality

inspections

;86.91 ;56.74 757.54

espatchinggoods

;,979.9: 5;,949.10 7,4:9.76

Total costs 51,9:5.09 4:,:74.00 5;,878.;6

o of unitsproduced

0:1 54,611 4,911

#ost per unit 56.:64 4.16 0.64

@or components, the overhead costs have been assigned as

18




follows,

(#omponent >"

>eceiving supplies (94 receipts at >s :4.06"

+erforming set ups (5: production runs at >s 50;.77"

Quality inspections (51 at >s ;8.69"

espatching goods ( 44 at >s 507.8;".

() (i) Pri#e +er unit for first or%er of 177 units

s s

irectmaterial

011.11

irect labour ept A 41 ?rs L 51 C 411

ept M 91 ?rs L 50 C :11

611.11

FariableHverhead

413 of >s 611 5:1.11

@i*edHverhead

ept A 41 ?rs L 6 C 5:1

ept M 91 ?rs L 0 C 411

;:1.11

Total cost 5,641.11

+rofit 403 900.11

2elling priceper unit

4,470.11

(ii) Pri#e +er unit for se#on% or%er of 87 units

/earning will be applicable only in department M.

#umulative output becomes 511 units G :1 units C 5:1 unitsi.e 5.: times for which learning is 6:.5 3 from the tables.

Therefore Total ?rs for 5:1 units C 5:1 units ×91 × .6:5 C

0,051.9 ?rs Therefore ?rs for :1 units C ?rs for 5:1 units less ?rs for511 units

Hr 0051.9 less 91 × 511 C 5051.9 ?rs

Therefore ?rs per unit C:1

9.5051C 40.57

Calculation o! selling price per unit

19




>s

irect materials 011.11

irect labour ept A 41 ?rs L 51 C411

ept M 40.57 ?rs L 50C ;77.00

077.00

FariableHverhead

413 of 077.00 550.05

@i*ed Hverhead ept A 41 ?rs L6C 5:1

ept M 40.57 ?rs

L0C540.60

460.60

Total cost 5,976.85

+rofit 403 ;:8.7;

2elling price perunit

5,696.:9

(iii) Pri#e +er unit for t,ir% or%er of 97 units

#umulative output becomes 511 G :1 G 91 C 411 units i.e. 4times for which learning is 613 from the table

Total ?rs for 411 units C 411 ×91 × .61 C :,911 ?rs

?rs for 91 units C ?rs for 411 units less ?rs for 5:1 unitsHr :,911 less 0051.9 C 668.: ?rs

Therefore ?rs per unit C91

:.668C 44.49

Calculation o! selling price per unit

sirect materials 011.11

irect labour ept A 41 ?rs L 51 C411.11

ept M 44.49 L 50 C;;;.:1

0;;.:1

Fariable Hverhead 413 of 0;;.:1 51:.74

@i*ed Hverhead ept A 41 ?rs L 6 C 5:1

ept M 44.49 ?rs L 0 C555.41

475.41

Total cost 5,955.04

+rofit 403 ;04.66


5,7:9.91

20




Question 9

(a) FThe diverse use of routinely recorded cost data give rise to afundamental danger information prepared for one purpose canbe grossly misleading in another contextG!

Discuss to $hat extent the above statement is valid and explain your conclusion!

(b) Hxplain different types of Competitive pricing ?

(c) td! has spare capacity in t$o of its manufacturingdepartments > Department * and Department 0! 3 fiveLday$ee" of *+ hours is $or"ed/ but there is only enough internal$or" for 5 days per $ee" so that 6 days per $ee" (., hours)could be available in each department! td! has sold this timeto another manufacturer/ but there is some concern about the

profitability of this $or"!

The accountant has prepared a table giving the hourly operatingcost in each department! The summarised figures are as follo$s%

Department * Department 0s! s!

1o$er costs *+ ,+abour costs *+ 6+

Nverhead costs *+ *+.6+ .6+The labour is paid on a time basis and there is no charge in the$ee"ly $age bill $hether or not the plant is $or"ing at fullcapacity! The overhead figures are based on firmKs currentoverhead absorption rates (fixed and variable) $hen thedepartments are operating at =+4 of full capacity (assume a 0+$ee" year)! The budgeted fixed overhead attributed todepartment * is s! 5,/+++ p!a! and that for Deptt! 0 s!0+/*++ p!a!

3s a short term measure the company has been selling

processing time to another manufacturer s! 9+ per hour ineither departments! The customer is $illing to continue thisarrangement and to purchase any spare time available/ but td! is considering the introduction of a ne$ product on a minorscale to absorb the spare capacity!

Hach unit of the ne$ product $ould reuire *0 minutes in Deptt!* and 6+ minutes in Deptt! 0! The variable cost of the reuiredinput material is s! .+ per unit! The mar"et study indicated asfollo$s%

21




(i) $ith a selling price of s! .++/ the demand $ould be ./0++units p!a!

(ii) $ith a selling price of s! ..+/ the demand $ould be ./+++units p!a!

(iii) $ith a selling price of s! .6+/ the demand $ould be 0++units p!a!

Eou are reuired to calculate the best $ee"ly programme for thespare time in the t$o manufacturing departments/ to determinethe best price to charge for the ne$ product and to uantity the$ee"ly gain that this programme and price should yield!

Answer

(a) A database should be maintained with costs appropriately codedand classified so that relevant cost information can be e*tractedto help managers mae better decisions. @uture costs ratherthan past costs are required for decision maing. Thereforecosts e*tracted from the data base should be adusted to mae itrelevant for that purpose. @or e*ample, consider a situationwhere a company is negotiating a contract for the sale of one ofits products with a customer in an overseas country which is notpart of the normal maret. $f the company has temporary e*cess

capacity and the contract is for 511 units for the month only,then the direct labour cost will remain the same irrespective ofwhether the contract is undertaen or not. The direct labourcost will therefore be irrelevant. /et us now assume that thecontract is for 511 units per month for three years and thecompany has e*cess capacity. @or long term decisions, directlabour will be relevant cost because if the contract is notundertaen, direct labour can be deployed or made redundant=ndertaing the contract will result in additional labour costs.

() 'here a company sets its price mainly on the consideration ofwhat its competitors are charging, its pricing under such

situation is called competitive pricing. Two types of competitivepricing are)

(i) Goin rate Pri#in - under this method, the firm tries toeep its price at the average level charged by the industry.2uch pricing is useful where it is difficult to measure costs.Adoption of such pricing will not only yield fair return butwould be least disruptive for industryOs harmony. =nderhighly competitive conditions in homogenous product maret(such as food, raw materials and te*tiles" the company hasno pricing decision to mae.

22




(ii) Sea"e% i% +ri#in #ompetitive pricing is adopted insituations where firms compete for obs on the basis of bids.

The bid is the firms offer price, and it is a prime e*ample ofpricing based on the e*pectations of how competitors willprice rather than on a rigid relation based on the concernsown costs or demand. The obective of the firm in biddingsituation is to get the contract and therefore it tries to set itsprices lower than the other bidding firms.

(#) The relevant cost of producing the new product is the variablecost plus the lost contribution from selling the processing time toanother manufacturer. $t is given that, the main product will

absorb ; days per wee.

Calculation o! variable overead rates

ept. 9 ept. 0

ormal ?rs.per annum

(1.8×91 hr×01 ws"

5,611 hrs 5,611hrs

@i*ed H.?. rateEhr.(>s."

41(;:,111E5,611"

46(01,911E5611"

Total H.?. rateEhr(given" (>s."

91 91

Thus variable H?rateEhr (>s."

41 54

The variable costs per hour are)

epartment 9 ) +ower #ost >s 91 G Fariable #ost >s 41 C >s :1

epartment 0 ) +ower #ost >s :1 G Fariable #ost >s 54 C >s 74

Note: labour costs are fi*ed (given".

$f the new product is not developed, dept. 9 shall sell unusedprocessing time at >s. 71 per hour. $t is not profitable for ept. 0

to sell processing time at >s. 71 per hour since the variable costsis more at >s. 74. Therefore the relevant cost per processinghour are

ept. 9 >s. 71 (>s. :1 variable cost G >s. 51 lost contribution forselling processing time"

ept. 0 >s. 74

"elevant cost !or producing te new product

>s

23




irect %aterial (<iven" 51.11

ept. 9, variable operating cost (1.70 hr ×>s. 71" 04.01

ept. 0 variable operating cost (1.;; hr. × >s. 74" 49.11

>elevant cost 6:.01

#dditional contribution !or various selling prices$demand levels

s! s! s!


511 551 541

>estricted demand(=nits"

B 51:7 5111 011

>elevant cost (>s" 6:.01 6:.01 6:.01

#ontribution (>s" 5;.01 4;.01 ;;.01

Total #ontribution(>s"

59,919.01 4;,011 5:,701

Bept 9 (611 ?rs ×

;

9" C 5,1:7 units

B

ept. 0(611 ?rs × ;" C 4911 units?ence selling 5111 units L >s. 551 per unit will achieve

optimum contribution.

Computation o! spare time !or production o! %'''units pa

Department *

Department 0

Time required per unit (?ours"

9

;

;

5

Total time for producing 5,111units (?ours"

701 ;;9

Time available (?ours" 611 611

2pare time (?ours" 01 9::

2pare time per wee (?ours" 5 8.;4

Therefore ept 9 can sell 5 hr. per wee at >s. 71 per hour.

24




$t is not profitable to sell spare capacity of 8.;4 hrs. E wee at thee*isting rate of >s. 71 per hour.

;ee'"$ ain fro t,is +rorae

>s.

2elling price 551

Iariable cost

irect materials 51

ept. 9 variable operating cost 1.70×:1 90

ept. 0 variable operating cost 1.;;×74 49

78#ontribution E unit ;5

'eely sale 41 units

Additional contribution E wee :41

+lus contribution of selling 5 hr (selling price Dvariable cost C 71-:1"

51

Total contribution :;1

'ithout the new product the weely contribution

5: hours × >s. 51 per hr

5:1

Additional gain for introducing the new product 971

Question 5

(a) F2ecause a single budget system is normally used to serveseveral purposes/ there is a danger that they may conflict $itheach otherG! Do you agree? Discuss!

(b) 32 Cycles td! has 6 divisions/ 3 and 2 $hich manufacturebicycle! Division 3 produces bicycle frame and Division 2assembles rest of the bicycle on the frame! There is a mar"etfor subLassembly and the final product! Hach division has beentreated as a profit centre! The transfer price has been set at thelongLrun average mar"et price! The follo$ing data are availableto each division%

Hstimated selling price of final product s! 5/+++ p!u!

ong run average mar"et price of subLassembly

s! 6/+++ p!u!

7ncremental cost of completing subLassembly in division 2

s! ./0++ p!u!

7ncremental cost in Division 3 s! ./6++ p!u!

25




euired%

(i) 7f Division 3Ks maximum capacity is ./+++ p!m! and sales tothe intermediate are no$ '++ units/ should 6++ units betransferred to 2 on longLterm average price basis!

(ii) What $ould be the transfer price/ if manager of Division 2should be "ept motivated?

(iii) 7f outside mar"et increases to ./+++ units/ should Division 3continue to transfer 6++ units to Division 2 or sell entire

production to outside mar"et?

(c) Determine the selling price per unit to earn a return of .64 net

on capital employed (net of Tax *+4)!

The cost of production and sales of '+/+++ units per annum are%

Material s! */'+/+++ abour s! ./,+/+++

Iariableoverhead

s! 5/6+/+++ ixedoverhead

s! 0/++/+++

The fixed portion of capital employed is s! .6 lacs and thevarying portion is 0+4 of sales turnover!

Answer

(a) A single budget system may be conflicting in planning andmotivation, and planning and performance evaluation roles asbelow)

(i" +lanning and motivation roles D emanding budgets thatmay not be achieved may be appropriate to motivatema*imum performance but they are unsuitable for planningpurposes. @or these, a budget should be a set based oneasier targets that are e*pected to be met.

(ii" +lanning and performance evaluation roles D @or planningpurposes budgets are set in advance of the budget periodbased on an anticipated set of circumstances or

environment. +erformance evaluation should be based on acomparison of active performance with an adusted budgetto reflect the circumstance under which managers actuallyoperated.

() (i" $n this case there are two options available D

(a" 2ell at the sub assemblystage (after completion of iv.A" L >s. 4111E-

26




$ncremental cost in iv. A >s 5,411E-

#ontribution >s 611E-

(b" 2ell at the final product stage >s. ;,111

#ost at iv. A and iv. M>s(5411G5011"

>s 4,711

#ontribution >s ;11

Therefore it is profitable to sell at the subassembly stagebecause of higher contribution, provided there is a maret.

?ence, if there is maret at intermediate stage, first priority

is to sell intermediary (sub assembly". Therefore, 611 unitsshould be sold as sale of intermediary.

The balance capacity available of (5111 D 611" C 411 unitsshould be transferred to M and M should complete theassembly and sell as final product, since the company canearn >s. ;11 per unit for each unit of such sale.

(ii" $f M iv. receives the subassembly at maret price of >s.4,111, plus its own incremental cost of >s. 5,011 will givetotal cost of >s. ;,011, thereby yielding a loss of >s. ;011 D>s. ;111 C >s. 011 per unit, whereas the company maes aprofit of >s. ;11 per unit.

$n order to eep the manager of iv. M motivated, the profitearned of >s. ;11 per unit should be shared between A andM. ?ence transfer price will be variable cost of iv. A G 013of profit earned in the final product C 5411 G 501 C >s.5,;01

(iii" Moth iv. A and the #ompany mae higher contribution byselling to intermediate maret. $f the maret demandincreases to 5,111 units, the full quantity should be soldoutside as intermediary and nothing should be transferred toiv. M.

(#) >eturn of 543 net (after ta* of 913" on capital employed isequivalent to 543 ÷ (5 D 1.9" C 413 (gross" on capital employed.

/et selling price per unit to be P*O

2ince Total sales C Total cost G profit

i.e. 61,111 * C 59,:1,111 G 413 (54,11,111 G 1.0 ×

61,111*"

or, 61,111 * C 59,:1,11 G 4,91,111 G 6,111*

27




or, 74,111 * C 57,11,111

or, P*O C111,74

11,11,57C >s. 4;.:5

?ence selling price per unit will be >s. 4;.:5

Question 8

(a) Hxplain $hich features of the -ervice organisations may create problems for the application of activityLbased costing!

(b) 3 company manufactures t$o products 3 and 2/ involving three

departments > Machining/ abrication and 3ssembly! The process time/ profit<unit and total capacity of each departmentis given in the follo$ing table%

Machining

(ours)

abrication

(ours)

3ssembly

(ours)

1rofit

(s)!

3 . 0 5 '+

2 6 * . .++

Capacit y

96+ ./'++ =++

-et up inear 1rogramming 1roblem to maximise profit! What$ill be the product Mix at Maximum profit level ?

(c) 3 product comprised of .+ activities $hose normal time and costare given as follo$s%

3ctivity 8ormal Time(days)

8ormal cost

.L6 5 0+

6L5 5 0

6L* 9 9+

6L0 = .6+

5L0 0 *6

*L0 + +

0L, , 0*

,L9 * ,9

,L' .5 .5+

9L' .+ .,,

7ndirect cost s! = per day!

28




(i) Dra$ the net$or" and identify the critical path!

(ii) What are the proBect duration and associated cost ?

(iii) ind out the total float associated $ith each activity!

Answer

(a) The following may create problem for adoption of AM# system inservice organisation D

(i) @acility sustaining costs (such as property, rents etc."represent a significant portion of total costs and may only beavoidable if the organisation ceases business. $t may be

impossible to establish appropriate cost drivers.

(ii) $t is often difficult to define products where they are ofintangible nature. #ost obects can therefore be difficult tospecify.

(iii) %any service organisations have not previously had acosting system and much of the information required to setup a AM# system will be non-e*istent. Therefore introductionof AM# may be e*pensive.

() %a*imi!e ! C 61* G 511y subect to * G 4y ≤ 741

0* G 9y ≤ 5611

;* G y ≤ 811

* ≥ 1 y ≥ 1

where * C o. of units of A

y C o. of units of M

My the addition of slac variables s5, s4 and s; the inequalitiescan be converted into equations. The problem thus become

! C 61* G 511y subect to * G 4y G s5 C 741

0* G 9y G s4 C 5611

;* G y Gs; C 811and * ≥ 1, y ≥ 1, s5 ≥ 1, s4 ≥ 1, s; ≥ 1

Table $

61 511

1 1 1

+rofitEunit

Qty. K 25 24 2;

29




25 1 741 Ι 4 5 1 1;:

4

741=

24 1 5611

0 9 1 5 1 5611E9C 901

2; 1 811 ; Ι 1 1 5 811E5 C811

etevaluationrow

61 511

1 1 1

5611 D 741 ×9E4 C ;:1 811 - 741×5E4 C 091

0 D $×4 C ; ; - 5× C 0E4

9 D 4 × 4 C1 $ D 4 ×5E4 C 1

1 - $×4 C - 4 1 D $ ×5E4 C- 5E4

$ - 1×4 C $ 1 D 1 ×5E4 C 1

1 - 1×4 C 1 $- 1×5E4 C $

Table 4)61 51

11 1 1

+rogra

m

+rofitE

unit

Qt

y.

K 25 24 2;

K 511 ;:1

$ 1 1 ;:1÷

5E4C741

24 1 ;:1

; 1 −4 5 1 ;:1÷

;C541

2; 1 091

0E4

1 −

5E4

1 $ 091÷

0E4C45:

etevaluat

ion row

;1 1 −

01

1 1

;:1 D ;:1 × 5E: C ;11 091 D ;:1 × 0E: C 491

- ; ×5E: C 1 0E4 D; × 0E: C 1

5- 1× 5E:C5 1 D 1 × 0E: C 1

- -4 × 5E: C 0E: -5E4 - -4 ×0E: C 7E:

1 D 5 ×5E: C - 5E: 1 D 5 × 0E: C -0E:

1 D 1 ×5E: C 1 5-1 × 0E: C 5

30




Table ;)61 511 1 1 1

+rogram +rofitEunit

Qty. K 25 24 2;

K 511 ;11 1 $ 0E: -5E: 1

61 541 $ 1 −4E; 5E; 1

2; 1 491 1 1 7E: -0E: $

etevaluationrow

1 1 -011E:

G5:1E;

G511E:

-61E; 1

C:

56 C

:

:1−

All the values of the net evaluation row of Table ; are either !eroor negative, the optimal program has been obtained.

?ere C 541, y C ;11 and the ma*imum profit

C 61×541 G 511× ;11 C 8:11 G ;1,111

C >s. ;8,:11.

(c"

#ritical path A < ? J

5------4-------0-------:---------7---------6

(ii" A < ? J is the critical path having normalproect duration

; + 8 + : + 9 +51 C ;4 days

ormal proect cost)- irect cost C >s. 719

31




$ndirect cost (;4×8" C 466

<<2

(iii" #alculation of total float

Activity t(days"

N@ /@ @loat (/@DN@"

5-4 ; ; ; 1

4-; ; : 7 5

4-9 7 51 54 4

4-0 8 54 54 1

;-0 0 55 54 5

9-0 1 51 54 4

0-: : 56 56 1

:-7 9 44 44 1

:-6 5; ;5 ;4 5

7-6 51 ;4 ;4 1

32

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