CHAPTER 11 11.25- Product mix, relevant costs. (N.Meluman, adapted) Reliable Precision Tolls make cutting tools for metalworking operations. It makes 2 types of tools: A6, a regular cutting tool, and EX4, a high-precision high -precision tool. A6 is manufactured on regular machine, but EX4 must be manufactured on both regular machine & a high-precision machine. The following information are available:
Particulars Selling price Variable manufacturing cost per unit Variable marketing cost per unit Budgeted total fixed overhead costs Hours required to produce one unit on regular machine.
A6 (Rs.) 200 120 30 7,00,000 1.0
EX4 (Rs.) 300 200 70 11,00,000 0.5
Additional information includes the following: a) Company faces a capacity constraint on the regular machine of 50,000 hours per year. b) The capacity of the high-precision machine is not a constraint. c) Of the Rs.11,00,000 budgeted fixed overhead costs of EX4, Rs.6,00,000 are lease payments for the high-precision machine. The cost is charged entirely to EX4 because Reliable uses the machine exclusively to produce EX4.The company can cancel the lease agreement for the high-precision machine at any time without penalties. All other overhead costs are fixed and cannot be changed. Required to: 1. What product mix-that is how many units of A6 & E- will maximize company’s operating income?
2. Suppose company can increase the annual capacity of its regular machines by 15000 machine-hours at a cost of Rs. 3,00,000. Should company increase the capacity of the regular machines by 15000 machine-hours By how much will company’s operating income increases or decreases? 3. Suppose that the capacity of the regular machines has been increased to 65,000 hours. Company has been approached to supply 20,000 units of
another cutting tool, V2 for Rs.240 per unit. Company must either accept the order for all 20,000 units or reject it totally. V1 is exactly like A6 except that its variable manufacturing cost is Rs. 140 per unit. (it takes 1 hour to produce one unit of V2 on the regular machine, and variable marketing cost equals to Rs. 30 per unit). What product mix should the company choose to maximize operating income? 11-30: Closing down divisions: Vivek industries has four following operating divisions. The budgeted revenues & expenses for each division for 2016 are as follows:
Particulars Sales Cost of Goods sold Selling, general Administrative expenses Operating Income /loss
A (Rs.) 5,04,000 4,40,000 & 96,000
B (Rs.) 9,48,000 9,30,000 2,02,500
C (Rs.) 9,60,000 7,65,000 1,44,000
D (Rs.) 12,40,000 9,25,000 2,10,000
(32,000) (1,84,500) (51,000) (1,05,000)
Further analysis of costs reveals the following percentages of variables costs in each division: Particulars Cost of Goods sold Selling, general administrative expenses
A 90% & 50%
B 80% 50%
C 90% 60%
D 85% 60%
Closing down any division would result in savings of 40% of the fixed costs of that division. Top management is very concerned about the unprofitable divisions (A & B) and is considering closing them for the year. 1. Calculate the increase or decrease in operating income if Vivek closes division A. 2. Calculate the increase or decrease in operating income if Vivek closes down division B. 3. What other factors should the top MANAGEMENT of Vivek consider before making a decision?
11-32: Multiple choice. (CPA) Choose the best answer
1. The Beta Company manufactures slippers and sells them at Rs. 100 a pair. Variable manufacturing cost is Rs.45 a pair, and allocated fixed manufacturing cost is Rs.15 a pair. It has enough idle capacity available to accept a one-time-only special order of 20,000 pairs of slippers at a cost of Rs.60 a pair. Bata will not incur any, marketing costs as a result of the special order. What would be the effect on the operating income be if the special order could be accepted without affecting normal sales? (a) Rs.0, (b) Rs.3,00,000 increase, (c) Rs.9,00,000 increase, or (d) Rs.12,00,000 increase. 2. The Sona Steering Manufactures Part No. 498 for use in kits production line. The manufacturing cost per unit for 20,000 units of Part No. 498 is as follows: Rupees (Rs.) Direct Materials Direct manufacturing labour Variable manufacturing overhead Fixed manufacturing overhead allocated TOTAL MANUFACTURING COST PER UNIT
6.00 30.00 12.00 16 64
The Sundaram Fastners Company has offered to sell 20,000 units of Part No. 498 to Sona Steering for Rs.60 per unit. Sona steering will make a decision to buy the part from Sundaram Fastners if there is overall savings of at least Rs.25,000 for Sona Steering. If Sona Steering accepts Sundaram fastner’s offer, Rs.9 per unit of the fixed overhead allocated would be eliminated. Furthermore, Sona Steering has determined that the released facilities could be used to save relevant costs in the manufacture of Part No. 575. For Sona Steering to achieve an overall savings of Rs. 25,000, the amount of relevant cost that would have to be saved by using the released facilities in the manufacture of Part No.575 would be (a) Rs. 80,000 (b) Rs. 85,000 (c)Rs. 1,25,000 or (d)Rs. 1,40,000.
11-37: Opportunity Costs. (H.Scaefer) The Bajaj is working at full production capacity producing 10,000 units of a unique product, Rosebo. Manufacturing cost per unit for Rosebo is as follows:
Particulars Direct Materials Direct manufacturing Labour Manufacturing Overhead TOTAL MANUFACTURING COST
Amount (Rs) 20 30 50 100
Manufacturing overhead cost per unit is based on variable cost per unit of Rs. 20 and fixed cost of Rs. 30,000 (at full capacity of 10,000 units). Marketing cost, all variable, is Rs. 40 per unit, and the selling price is Rs. 200. A customer, Royal Company, has asked Bajaj to produce 2,000 units of Orangebo, a modification of Rosebo. Orangebo would require the same manufacturing processes as Rosebo. Royal has offered to pay Bajaj Rs. 150 for a unit of Orangebo and half the marketing cost per unit. Required: 1. What is the opportunity Cost to Bajaj of producing the 2,000 units of Orangebo? (Assume that no overtime is worked.) 2. The Reliable Corporation has offered to produce 2,000 of Rosebo for Bajaj so that Bajaj may accept the Royal offer. That is, if Bajaj accepts the Reliable offer, Bajaj would manufacture 8,000 units of Rosebo from Reliable. Reliable would charge Bajaj Rs.140 per unit to manufacture Rosebo. On the basis of financial considerations alone, should Bajaj accept the Reliable offer? Show calculations. 3. Suppose that Bajaj had been working at less than full capacity, producing 8,000 units of Rosebo at the time the Royal offer was made. Calculate the minimum price Bajaj should accept Rosebo at the time the Royal offer was made. Calculate the minimum price Bajaj should accept for Orangebo under these circumstances. (Ignore the previous Rs.150 selling price.)
11-40 Multiple choice, comprehensive problem on relevant costs. The following are the Parkar Company’s unit cost of manufacturing and, marketing a high-style pen at an output level of 20,000 units per month:
Manufacturing Costs Direct Materials Derect manufacturing labour
Rs. 10 12
Variable manufacturing indirect cost Fixed manufacturing indirect cost Marketing cost -Variable -Fixed
8 5 15 9
The following data refer only to the preceding data: there is no connection between the situations. Unless stated otherwise, assume a regular selling price of Rs.60 per unit. Choose the best answer to each question. Show the calculations. 1. In an inventory of 10,000 units of the high-style pen presented in the balance sheet, the appropriate unit cost to use is (a) Rs.30 (b) Rs.35 (c) Rs.50 (d) Rs.22 or (e) Rs.59. 2. The pen is usually produced and sale at the rate of 2,40,000 units per year (an average of 20,000 per month). The selling price is Rs.60 per unit, which yields total annual revenues of Rs.1,4400,000. Total costs are Rs.1,41,60,000, and operating income is Rs.2,40,000, or Rs.1 per unit. market Research estimates that unit sales could be increased by 10% if prices were cut to Rs.58. Assuming the implied cost-behaviour patterns continue, this action, if taken, would
a. Decrease operating income by Rs. 72,000. b. Decrease operating income by Rs.2 per unit (Rs.4,80,000) but increase operating income but 10% of revenues (Rs.14,40,000), for net increase of Rs.9,60,000. c. Decease fixed cost per unit by 10%, or Rs.1.4 per unit, and thus decrease operating income by Rs.0.6 (Rs.0.2-Rs.1.4) per unit. d. Increase unit sales to 2,64,000 units, which at the Rs.58 price would give total revenues of Rs.1,53,12,000 and leads to costs of Rs.59 per unit for 2,64,000 units, which would equal Rs.1,55,76,000, and result in an operating loss of Rs.2,64,000. e. None of these.
3. A contract with the government for 5,000 units of the pens calls for the reinvestment of all manufacturing costs plus a fixed fee of Rs. 10,000. No variable marketing costs are incurred on the government contract. You are asked to compare the following into alternatives:
SALE EACH MONTH TO Regular customers Government
ALTERNATIVE A 15000 units 0 units
ALTERNATIVE B 15,000 units 5,000 units
Operating income under alternative B is greater than that under alternative A by (a) Rs. 10,000 (b) Rs.25,000 (c) Rs.35,000 (d) Rs.3,000 or (e) none of these.
4. Assume the same data with respect to the government contract as in requirement 3 except that the two alternatives to be compared are: SALES EACH MONTH TO
ALTERNATIVE A
ALTERNATIVE B
Regular customers
20,000 units
15,000 units
Government
0 units
5,000 units
Operating income under alternative B relative to that under alternative A is (a) Rs.40,000 (b) Rs.30,000 (c) Rs.65,000 less, (d) Rs.5,000 greater, or (e) none of these. 5. The company wants to enter a foreign market in which price competition is keen. The company seeks a one-time-only special order for 10,000 units on a minimum unit-price. It expects that shipping costs for this order will amount to only Rs.7.5 per unit, but the fixed costs of obtaining the contract will be Rs.40,000. The company incurs no variable marketing costs other than shipping costs. Domestic business will be unaffected. The selling to break-even is (a) Rs.35 (b) Rs.41.5 (c) Rs. 42.5 (d) Rs. 30 or (e) Rs.50. 6. The company has an inventory of 1,000 units of pens that must be sold immediately at reduced prices. Otherwise, the inventory will be worthless. The unit cost that is relevant for establishing the minimum selling price is (a) Rs.45 (b) Rs.40 (c) Rs.30 (d) Rs.59 or (e) Rs.15. 7. A proposal is received from an outside supplier who will make and transport these high-style pens directly to the Parkar Company’s customers as sales orders are forwarded from Parkar’s sales staff. Parakar’s fixed marketing costs will be unaffected, but its variable marketing costs will be slashed by 20%. Parker’s plant will be idle, but its fixed manufacturing overhead will continue at 50% of the present levels. How much per unit
would the company be able to pay the supplier without decreasing the operating income? (a) Rs.47. (b) Rs39.5 (c) Rs.29.5 (d) Rs.53.5 or (e ) none of these.
