Prof.

Prashant Shukla

Quantitative Technique in management Accounting and Finance

LEARNING CURVES AND APPLICATIONS
"Practice makes perfect" is a familiar adage (Proverb) which is rarely true: "Practice increases
efficiency" can be new proverb that is true:
It was observed that when any new type repetitive operation is started (assembly line
operation) the first effort may take considerable time. But under repeated performance
of the operations, the direct labour (a human input) progressively shows a gradual
decline. The study of this phenomenon and representation of the nature of the
relationship between the direct labour (or labour costs) and the output forms the subject
of learning curve effect also called experience curve effect or manufacturing progress
function.
In 1925, the Commander of the Wright Patterson Air force Base in Dayton,
Ohio, observed that workers exhibited definite learning pattern in manufacturing operations.
Since these studies we now know that most aircraft manufacturing tasks experiences an 80%
learning rate. In other words, the average direct labour hours required to a factor of 0.8 as the
production quantity is doubled.
In other words, if the first aircraft assembled requires 100 direct labour hours, two aircraft
would average 0.8 x 100 = 80 labour hours. Four aircraft would average 0.8 x 64 =
64 labour hours, 8 would average 0.8 x 64 = 51.2 labour hours and so on.
One minus the percentage reduction is known as the learning rate. The learning rate in the
present example is 1 - 0.2 = 0.8 or 80 percent.
The learning curve concept has found many useful applications in managerial decisions in the
areas of marketing, new product start-up, bidding for tenders, make-or-buy decisions.
The factors that bring about a learning-curve effect are:
i) Labour Efficiency
Human being has the capacity to learn by repeated doing and improve on their
performance. Further with repetitive experience, maintenance and supervisory activities
also become more effective.
ii) New Process and Improved Methods
In the light of the experience gained progressively, improvements can be brought about
in the production processes, methods of operations by technical and industrial
Engineering studies.
iii) Product Redesign
The design of product can be improved, needless and costly features can be
eliminated by value analysis.

Prof. Prashant Shukla

iv) Product Standardization

- Over repetitive experience, reduction can be brought about in changeover and set-ups.
v) Scale Effects
-As volumes of activity increase the increase in capacity costs will be at a slower rate
bringing about economics of scale.
Management and labour are now consciously striving to reduce costs knowing that the learning
curve effect it is possible to do so.
It should be noted that while studying the costs, subject to learning curve effect, all costs
should be compared with reference total standard monetary basis.
Use of actual costs subject to inflationary pressures may give erroneous picture, where actual
direct labour has decreased it may appear that costs have not decreased because of the increase
in the labour cost rate. Hence, in any study of learning curve effect direct measurements
on some physical units (such as labours hours, machine-hours) should be used instead of
the rupee value costs.
Learning-curve Model:
The cost behavior under a learning curve effect may be expressed as a mathematical model
given under
Y = a X-b

(1)

Where, Y = Average direct labour hours per unit

A = Direct labour hours for the first unit (or batch)
X = Cumulative number of units produced to date
B = A constant called index of learning rate (0<b<1)
NOTE [In some literature the model may be expressed as Y = a Xb, without a
negative sign before b. In this case, the computed value of b will negative, whereas in the
model used in (1) the value of b will come out positive. The important point to note is that the
index over X will always be numerically negative.]
The Total labour hours for a cumulative production of X units denoted by L(X) will be L(X) =
XY, which may be expressed as a formula:
`
L(X) = XY = X.aX-b = aX (1-b)

. (2)

Another result often useful is that of incremental direct labour hour per unit or marginal direct
labour hour at a particular level of activity X.
It is well known from calculus that the incremental value of a function is the same as the
derivative (differential coefficient) of the function. Thus we have the following formula:
Marginal labour M(X) = (d/dx) L(X) = a (l-b) X-b = (1-b) Y . (3)

Prof. Prashant Shukla

It may be noted that the expression for both the direct labour Y and the marginal direct labour
contain the factor X-b multiplied by a constant. See'(l) and (3). This indicates that due to the
effect of learning curve both the average and marginal labour decrease at the same rate.
The functional form of the learning curve model is negative exponential. As X increase Y
should decrease continuously. However, it will be noted that the amount of decrease in Y goes
on diminishing. After a stage, the decrease in Y becomes almost insignificant and the average
Y almost remains constant for all practical purposes. While human beings do learn at a fast
rate initially, there is always a saturation limit beyond which no learning is perceptible.

Specification of Learning Curve Effect (Learning Rate):

The learning curve effect is expressed as a percentage p (less than 100 %).
The interpretation of p is that, whenever the output units is doubled the average direct labour
hours becomes p times the previous average.
(for p = 90% = 0.9)
Example:
X
1
2
4
8

Y
.
Y1 = 120 hours
Y2=0.9x 120=108
Y4=0.9x 108=97.2
Y8=0.9x97.2=87.48

We have now to relate the learning curve effect expressed as percentage p with
the learning curve index used in the model. Consider two levels of output Xl and X2 such
X2=2X1
From the model: Yl = aXl -b and Y2 = aX2-b
Or log Yl = Log a - b log Xl, log Y2 = log a - b log X2
on solving these two equations
Log Y2-logY1 = -b (log X2 - log X l)
Log (Y2/Yl) = -b (log X2/X1) = -b log2
Hence b = -log p / log2
Since Y2/Y1 = p
and X2/X1 = 2
Given below is table of values of p and corresponding b. You must learn how to
compute b given p. These computations can be done directly on a scientific calculator with log
function. Using a simple calculator the logarithms have to be read from a table then
commutations done on the calculator.
(You are advised to practice such computations!)
p
b

0.95
0.074

0.90
0.1520

0.85
0.2345

0.80
0.3219

0.75
0.4150

Prof. Prashant Shukla

Applications:
The application of learning curve is more important in case where the labour input in
an activity is large and the activity is complex.
The conducive to learning are ideal in the electronics, home appliance, construction,
ship building and machine shop areas. On the other hand, the industries which are
capital intensive such as petroleum refining would find the learning curve of little
value.
1. Pricing:
Since learning curve permit better cost predictions, it seems that they should be
employed in pricing decisions.
An extension of the pricing use of learning - curve data is in buying from a
supplier. Sometimes supplier will experience high initial outlays resulting, from the
fact that the supplier is the early stages of its learning curve relative to the job. A
purchasing firm might be willing initially to pay a higher price if the supplier
agrees to and subsequently lowers the price per unit.
2. Work scheduling:
Learning curves increase a firm's ability to predict their required labour input and make it
possible to forecast labour needs. These interns permit the firm to do a better job
scheduling maintenance and overhead activity, quality control, material purchasing and
promotion. Better forecasting and scheduling result in lower costs through better cost control
and improved customer relations.
3. Capital Budgeting:
One of the most important aspects in capital-budgeting problems is the timing of
cash flows. The learning effect suggests that unit cost usually assumed in capital budgeting
analysis. Further more, the learning curve permits improved estimates of production levels
that can' be attained and thus has implications for cash flows. These modifications
can be particularly important where the project start up period is large relative to life of the
project.
4. Motivation:
Costs are often controlled using standers and variances from standards. If these
standards are set without regard to the learning phenomenon, meaningless initial and
unfavorable variances may occur with resulting motivational impact.
A similar effect is apparent in evaluating divisional performance. Large activities in early
phases of activity will experience relatively higher costs and lower output than at later
stages. This should be considered when a division managers performance is evaluated.
5. External Reporting:
Learning influences profits through its effects on cost and output.
Assume a situation when there are early losses expected when the decision to
undertake the construction was made. If financial report are to be an aid in evaluation
and are to be consistent with decision making, some attempt should be made to
separate non recoverable losses from costs that are incurred as part of the learning
process.
Where there is good reason to believe that learning will take place, it is appropriate to

Prof. Prashant Shukla

capitalize some or all of a firms early losses as assets rather than mislead investors
into believing that the financial situation is unfavorable.
Example
(1) Suppose the Milner Aerospace Company has been producing a guidance system and knows
that the average labor hours per unit follows a learning curve. To date it has produced 150
units and these units required a total of 60,000 direct labour hours. For the first 50 units a total
28,500 DLH were required. The Milner Company is evaluating a bid to produce 100 additional
units and is interested in knowing the incremental DLH required for this new order.
Initially, we must compute the parameters of the Milner Companys Learning curve.
We know two points on the curve. When x1=50, y1=28, 500/50=570 and when x2=150
Y2 = 60,000/150 =400.
There fore we can use the preceding algebraic development to obtain.
400
Log --------570
b =- --------- = 0.322 (an 80 percent learning curve.)
150
Log -------50
Substituting back, we find
Log a = log 570 + o.322 log 50=3.3028
A=2009
With a=2012and b=0.322, the average number of DHL after 250 units are
produced is
Y = 2009(250)-0.322= 340.
Therefore the total DLH to produce 250 units is 250(340) = 85,000. Since 60,000
DLH were used to produce the first 150 units, the incremental DLH to produce the next 100
units equal: 85,000 - 60,000 = 25,000 DLH. Notice that this batch of 100 units
requires only 250 DLH per unit, whereas the first 50 unit labor costs. This point
clearly demonstrated in table 1, where we display for each batch of 50 units the
cumulative total DLH, the average DLH for that cumulative output, and the
marginal DLH (MDLH) M(X) to produce the last unit in each batch of 5 units.
Notice that both average and marginal DLH are following an 80 percent learning
curve: y200 = 0.8y1oo = 0.64y50 and MDLH200 = 0.8 MDLH100 = 0.64 MDLH50.
Table 1. Total Average and Incremental Cost for 50-Unit Batch
Cumulative
Output (X)
50
100
150
200
250

Total
DHL
L(x)
28500
45600
60000
72900
85000

Average DLH
for Cumulative
output (y)
570
456
400
365
340

Marginal DHL For 1st

item in each
batch
a(1-b)x-b=(1-b)y
387
310
272
248
231

Prof. Prashant Shukla

Clearly companies whose products are susceptible to learning curve effects can price
lower, counting on the increased business to move them even further along the learning
curve and making it difficult for competitor to dislodge them from a leading market
position. For the Milner Company its historical experience with the first 150 units yielded
an average of 400 DLH per unit for the next 100 units it produces. Moreover, if
it wins this order, it can expect the following order to have even lower marginal costs.
(2) The first unit of a new assembly took 240 direct labour hours. Compute the average labour,
total labour and incremental labour for output levels of 5, 10, 20, 50 units.
The assembly operation is subject to a learning effect of 85%.
(For j = 85%, the value b = 0.2345)
X
1
5
10
20
50

Y
240
240 x 5 = 164.55
240 x 10' = 139.87
24-Ox-2 0" =118.88
240 x 50" = 95.90

L(X)
240
822.76
1398.66
2377.66
4797.83

M(X)
240
145.69(for extra 4 units)
115.18(for extra 5 units)
98.10
80.57

(3) Prepare a schedule showing the average, total and incremental direct labour hours for
output levels of 1 to 16 in multiples of 2, for a new product subject to learning effect of
75%. The first unit direct labour was 120 hours.
(4) The first unit of a new model of a type-writer took 400 hours of Direct Labour.
Determine average labour hours when output becomes 4, 8? Find average labour for the
Third and the Fourth units. Find the average labour for the Fifth and the Sixth units. This
type of assembly is subject to learning effect of 90%.
(5) It is known the first unit of a new product took 100 hours of direct labour
and repeated assembly is expected to experience a learning effect of ##%. An accountant
prepared a statement showing the average, total and incremental labour at various output
levels. Unfortunately the statement prepaid got mutilated making some of the figures
indecipherable. The statement is reproduced below where ## signifies missing data you are
required d to fill in the missing figures
Output
X
1
3
6
16

Average
Labour Y
100 hrs
##
##
##

Total
Labour L
##
210.63
##
##

Incremental
Labour M
##
##
42.13
##

(Compute all figures to 2 places of decimal)

(6)A first batch of 25 transistors of a new model took for assembly a total of 250 hours of
DLH. It is required to manufacture another lot of 40 transistors. What will be the
average labour hours?
If a further lot of 100 units are to be assembled. What will be the average for the third lot? The
assembly is subject to 85% learning effect.

Prof. Prashant Shukla

(7) Assuming a learning rate of 80percent that is the average number of labour hours
required per unit is reduced by 20 percent as the quantity produced doubles.
Required:
(a) If the first 100 units require 100 hours, how many total hours will be required to
produce 200 units? How many additional hours are required for the second 100 units?
(b) Suppose the firm has an opportunity to bid on a contract that will raise its total output
from 200 to 500 units, how many labour hours will be involved?
(8) If an 80 percent learning model is assumed to apply to the individual for the Xth unit
and labour costs R 5 per hour, how much should it cost direct labour to produce 100 units if
the first unit takes eighty hours?
(9) A first batch of 25 cameras assembled took 200 direct labour hours. Find the cost of an
additional 40 units assembled and the cost for a second lot of another 60 units. The labour cost
is Rs. 15 per hour. The assembly experience 90% learning effect.
(10) Visa U and company have observed that a 90% teaming rate is applied to all
labour related cost each time a new model enters production. It is anticipated that 320
units will be manufactured during current year. Direct labour cost for the first lot of
10 units amounts to 1000 hours at a rate of Rs.8 per hour. VOH is assigned to the
product at the rate of Rs.2 per DLH. You are required to determine:
Total labour and related costs to manufacture 320 units of output.
(i) Average cost of (a) the first 40 units produced (b) the first 80 units(c) the first
I00units.
(ii) Incremental cost of (a) Units 41-80 and (b) Units 101-200.
(11) The SNS Co. Ltd. Makes parts for ship navigation system. It has previously made
About 10,000 parts exactly like the type ordered by the government for a new
Submarine. A new government order calls for 10,000 parts the company's cost records
yield the following cost data foe the 10,000 parts made to data.
Direct Material
Direct labour (8, 00,000 hours)
Setup costs (no labour)
Variable overhead (50% of DL)
Fixed overhead (allocated at Rs. 10 per DLH)

Rs. 100 lakhs

Rs. 640 lakhs
Rs. 6 lakhs
Rs. 320 lakhs
Rs. 80 lakhs
Rs.1146 lakhs.

Assuming an 80% learning rate on the average required and no change in unit
labour costs per hour, estimate company's additional costs accepting the order.
(12) Consider a company that acts as a subcontractor for parts used in the space
program. Assume the company has been requested to bid on a contract for 750 units
required in the assembly of the re-entry mechanism of a new space capsule. Thus the firm is
interested in the contract. The company had recently produced 250 of the items at the

Prof. Prashant Shukla

Following costs as indicated by the accounting records.

Direct Material
Direct labour (5,000 hours @Rs. 5/-)
Tolling (can be reused)
Variable overhead (20% of DL)
Fixed O/H (25% of DL)
Total cost

Rs.10,000
25,000
3,000
5,000
6,250
49,250

The company has retained a partial record of the total time required to produce the 250 units.
The data are first unit 122 hours, fifteen unit s 2724 hours, 250 units, 5,000 hours.
(13) Suraksha, an electronic firm have designed a new model of a fire alarm system and
assembled a first unit as a prototype for demonstration purposes. The DLH expected on
this unit was 260 hours at a labour rate of rs.30 per hour. The materials used had a cost
of Rs.37,600. Following successful demonstration of this equipment, the firm has
received an order for supply of 50 such units in the first six months and 75 units in the
second six months. Repeated assembly of this type is subject to a learning effect of
80%.
In order to popularize this demand, the firm will pass on the benefit accruing from the
learning curve effect to the consumers. For the first lot to be supplied in the first six
months the material will attract a 5% discount and for the second lot there will be 10%
discount. The firm calculates its VOH @ 75% direct labour and FOH @ 25% of the prime
cost. It is the policy of the firm is to set a selling price so as to yield 33.33%
gross margin.
Determine the selling price unit that should be set for the orders in each of the six
months.
(14) Bandookwala & Co., a fire arms manufacturer as designed a new type of gun and a first lot
of 25 guns assembled for test purpose had the following costs:
Direct materials
Direct labour
Variable overheads
Fixed overheads
Total costs

Rs. 24,500
22,500
16,875 proportional to
11,250 direct labour
75,125

BSF being satisfied with this gun have asked the lowest bid for supply of 1000 guns. The
company will pass on the benefits of learning of 85% to the client in setting the bid. The
company will set a selling price to earn 35% gross profit margin. Determine the unit
price that should be bid.
(15) EGM, manufacture electrical goods on behalf of various clients as per their
requirements. Currently having lost one major client, EGM is left with a large surplus
of skilled labour. This labour cannot be retrenched nor can additional be recruited. EGM
have located HHDG a marketing firm in household goods for whom it can offer
manufacturing facilities to find gainful work for the skilled labour that may be
otherwise be otherwise idle. EGM have compiled the following information so as
to arrive at a decision whether to undertake manufacture on behalf of HHDG.

Prof. Prashant Shukla

Capital outlay on special machine Rs.2 lakhs (machine having no salvage value).
Incremental overheads Rs.1 lakh per annum. Cost of materials Its. 180 per unit. Skilled labour
rate Rs.30 per hour. The contract if entered into must be for a period of three years and
HHDG will offer a unit price of Rs. 260 valid for all the three years. A first unit run took 10
hours of direct labour of a skilled workman.
It is expected that on repetitive production there will be learning effect of 82%.
HHDG will accept all the production that EGM is capable of it was also assessed that
the surplus skilled labour available will be adequate to manufacture 3000 units in the first
year.
The cost of capital for EGM is 18%.
You may assume that all cash flows occur at the year-end, except for the capital outlay that has
to be at the start of year 1.
What decision should EGM take with regard to acceptance of the contract for HHDG?
(16) GRM, a refrigerator manufacturer, currently buys the compressor from CMCO at
a unit price of Rs.2200. ASCMCO has been increasing the prices every year, GRM is
evaluating the economics of in-house manufacture. The coming year's requirements are 2000
units and it is expected to increase progressively in the future. As a test of its technical
capability in assembly of compressors a first lot of 100 compressors was assembled and
found to be of acceptable quality. Cost estimate, as shown under, was prepared based on this
test p production.
per unit
Lot 100
Rs.
80,000
800
Components (outside purchase)
Direct assembly labour
1, 20,000
1,200
Factory VOH#
90,000
900
Factory FOH**
48,000
480
General overheads++
33,800
338
Total cost

3,71,800

3,718

# charged at 75% of DL cost** charged at 40% of DL cost

++taken at 10% of the cost of material, DLH and Factory OH.
On the basis of the above analysis it was believed that would not be economical to go in for
in-house production.
However, the production manager pointed out that assemblies of this type is no
different from what the company has been doing for other items and the learning curve effect
of 80% could be assumed to be applicable for this item as more and more units are
produced, and this factor should be taken into account in deriving the cost, in particular
for the quantities required for the coming year.
What would be the decision on in-house assembly under this situation?
(17) An Electronics firm assembles on behalf of diverse clients various electronic
devices as per customer specifications. Recently, the firm has lost the business from one of
its major client, resulting in some surplus of skilled assembly labour. The firm has no avenue
to re-deploy these personnel nor is it willing to retrench them as such labour is not easy to

Prof. Prashant Shukla

get. Hence the firm is exploring for additional business that could use the surplus skilled
labour. One such opportunity has arisen, where a new company expected to have its own
factory in three years tome form now, would like to start assembly of one of their
products right now.
If this new opportunity is taken up then supplies of the assembly will have to
undertaken for the full three year period. The new company will accept whatever that is
produced and will pay a fixed price of Rs.350/- per unit for the 3-year period. A trial
assembly gave the data that cost of components used will be Rs. 190/- per unit and the first unit
took 16 hours of skilled labour. Repeated assembly of this type is subject to a learning curve
effect of 85%. The firm has estimated that it can assembly 2000 units during the first year.
The wage rate for the skilled personnel is Rs. 30/- per hour which will increase by 10% for
each year.
If assembly is undertaken then the firm will need to purchase a special machine at a cost
of Rs. 3 lakhs to start operations. The company has a cost of capital at the rate of 20%.
Assume that all cash inflows occur at the end of the year. Compute the production Levels for
each of the tree years and hence prepare a statement of cash flows. Would it be worthwhile
for the electronics firm to undertake this opportunity and if so what will be the ultimate
result?
(18) "Micronics" assemble various electronic gadgets on behalf of diverse clients.
A firm A has indicated a new burglar alarm and has approached Micronics to assemble
such alarms on their behalf. Firm A has indicated that the requirements will be for 300 units
in the first six-month and an additional 80 units during the next six-month. To assess its
capabilities, Micronics have assembled one test unit successfully. Based on this test
assembly, the following information/data have been complied.
-The assembly operations will have to be done in two departments A and B, in that
sequence. All inputs of components/materials will be in department A.
-Information obtained
Cost of components/materials Rs /unit
Direct labour used in 1st unit hours
Variable overhead recovery
(As a ratio to direct labour cost)
Fixed overhead as a ratio to direct
Labour costs
Learning curve effect
Spare capacity available total over
Each six-month periods (labour hours)
Profit mark-up on total cost

250*
16

10

50%
120%

50%
120%

58%
1500

80%
800

25%

15%

NOTE: *Components/material costs will be subject to a ten-percent discount during

the second six-month.
If overtime has to be worked in excess of regular capacity, then the rate will be at
one and-half times.
Determine the price to be quoted per unit in each of the two periods. Show the full
details of your workings in a neat tabular form.