Q Girish

Engineering (MCS-2004) Numerical

Monthly report (in part) for an expense centre in factory is: All figures in Rs. Lacs Actual Variance Direct Labour Indirect Labour Total Controllable Costs Department Fixed Costs Allocated Costs

66.34

100.13 0.21 (Favourable) 8.10 (Unfavourable) 168.47 8.50 (Unfavourable) 38.82 -------53.62 --------

Questions: 1. Why no variance is shown in two items? Is this correct approach in performance reporting? 2. Should overhead expenses mentioned above be included in Controllable Costs? Why? Why not?
Solution (a):

Variances between actual and budgeted departmental fixed costs are obtained simply by subtraction, since these costs are not affected by either the volume of sales or the volume of production. That’s why no variance is shown for departmental fixed costs.

Allocated costs are a share of the costs of a resource used by a project, where the same resource is also used by other activities. These are different to the Incurred costs because these costs are not exclusively related to any individual project. However, the cost of the resource still needs to be recovered, and making a fair and reasonable charge to all projects using the resource does this. The key difference between costs and Allocated costs is that the latter will be charged based upon an estimate, rather than actual cash values. Thus as it is charged based upon an estimate the budgeted figure is the same as the actual figure and hence no variances.

Solution (b): Overhead Expenses mentioned above should not be included in controllable costs because some costs are uncontrollable like fixed costs. . They don't vary with the change in short run managerial decisions and output. And some costs are controllable i.e. they can be managed and changed with the managerial decisions and output. As the above overhead expenses would have certain portion of fixed expenses this is hard to control. So, these should not be a part of controllable cost. Kiran Company (MCS-2004) Numerical

Budget versus Actual comparison for div Z of Kirancompany is as follows: Budget Actual Actual better (worse) than budget Sales and other income Variable expenses Fixed expenses Sales promotional expenses Operating profit Net working capital Fixed assets 800 480 120 40 160 400 160 740 436 120 28 156 412 148 (60) 44 0 12 4 12 (12)

(a)

Carry out and overall performance analysis to decide areas needing investigation.

From the given data, we see that there is a certain amount of variance between the budgeted operating profit and actual operating profit. In order to analyze the variances, we need to understand the key causal factors that affect profit, namely, revenues and cost structure. The profit budget has embedded in it certain expectations about the state of total industry, company’s market share, selling prices and cost structure. Results from variance computation are actionable if changes in actual results are analyzed against each of this expectation. Revenue variances, that is a negative Rs 60 lakhs, could be a result of selling price variance, mixed variance and/or volume variance. A combination of above three factors must have been unfavorable that is either the volume of sales must have been below the budgeted volumes ( this must be particularly true since actual variable expenses are less than budgeted) and/or the selling price must have been below expectation and/or the proportion of products sold with a higher contribution must have been less than budgeted. One more factor could have been the overall industry volume. However, this factor is beyond the managements control and largely dependent on the state of economy.

the net working capital is more than budgeted which indicates capital block in higher inventory. Sales promotional expenses also show a negative variance which could be a cause of lower sales volumes. Another issue is that the fixed assets are lower than the budget by Rs 12 lakhs which may indicate slower capacity expansion then expected or distressed sale of assets to tide over cash flow. sales volume could be improved by better marketing. (b) What are the remedial measures if any would you suggest based on analysis? The budgeted estimates may be too optimistic and far from reality. Better sales will ensure a higher inventory turnover. will ensure improve cash flow situation since less capital will be tied up in working capital.Variable expenses are directly proportional to volumes and hence as is evident are less than budgeted. A cause of concern is that despite lower sales. quality standards and promotional efforts. Better credit management to recover receivables. product mix could be improved by selling more of higher contribution products. . the management needs to take corrective action areas needing improvement. Given the estimates are correct. in that case depending upon the above analysis. one needs to ensure that estimates the as realistic as possible.

5ABC ltd. Hence cost management of Division X is better than Division Y.Q.2lacs Turnover of investments = = = (Sales/investment)*100 (500/100)*100 5 times Profit margin of X is better than profit margin of division Y. (MCS-2008) Numerical Particulars ROI Sales Investment EBIT Division X (Rs.) 28% 100 Lacs 25 lacs 7 Lacs Division Y (Rs. .) 26% 500 lacs 100 Lacs 26 lacs Analyze and comment upon performances of both the divisions Solution: Division X ROI Profit = = = (Profit / investment)* 100 (28/100)*25lacs 7lacs Profit margin = = = 7lacs (Profit/sales)*100 (7/100)*100 Turnover of investments = = = (Sales/investment)*100 (100/25)*100 4 times Division Y ROI Profit = = = (Profit / investment)* 100 (26/100)*100lacs 26lacs Profit margin = = = (Profit/sales)*100 (26/500)*100 5. Turnover of investment of division Y is better than Division X.

so it has more profitability but inspite of it.6% of ‘B’.000 *100 = 6.000 *100 = 10% Profit Margin for Division ‘B’ = 6. As it has good assets management shown by its turnoverof Division ‘B’ that is 3 times which is better than Division ‘A’.000/20.000/32.00.00. Details are given below:Particulars Divisional sales Divisional Investment Profit Div A 4000000 2000000 400000 Div B 9600000 3200000 640000 Analyse and comment on divisional performance of each.MCS 2006 (SUM NO 7) Q) Soniya Company has two Divisions: A & B.40.000/ 96. So it can become profitable organisation by improving Profit Margin .00. COMMENTS:Division ‘A’ – Although ‘A’ has more profit margin than Division ‘B’ that is 10% as compared to 6. division ‘A’ has lower turnover of investment that its assets management is bad than Division ‘B’. Division ‘B’ – Needs to improve profit margin by increasing sales and reduce variable cost and sales at same price or by reducing salesprice and increase the volume of sales so that its profit would improve.00. Return on Investment for both divisions is 20%.00.00.00.6% Turnover of Investment = Sales * 100 Investment Turnover of Investment for Division ‘A’ = 40. ANSWER As Profit Margin = Profit *100 Sales Profit Margin for Division ‘A’= 4. it can be improved by increased sales or reducing investment.000 = 3 times As Return on investment for both Divisions A and B is 20%.000 = 2 times Turnover of Investment for Division ‘B’ = 96.000 /40.

u. (Numerical) (MCS-2007) and same as Ananya Ltd (MCS 2009) (a) Define profit in this case and prepare a statement for both divisions and overall company. Variable Cost p. Amount(Rs.u.4 Div B Budgeted 9% 44 Actual 9% 50.B and C.u. Company charges 6% for current assets and 8 % for Fixed Assets.8 Q 2)Suresh Ltd.) 35 11 24 . while computing EVA relevant data are given below :Particulars Div A Budgeted Profit Current Assets Fixed Assets 360 400 1600 Actual 320 360 1600 Div B Budgeted 220 800 1600 Actual 240 760 1800 Div C Budgeted 200 1200 2000 Actual 200 1400 2200 Total Budgeted 780 2400 5200 Actual 760 2520 5600 Solution: Particulars Div A Budgeted ROA EVA 18% 208 Actual 16% 170.4 Div C Budgeted 6% -32 Actual 6% -60 Total Budgeted 10% 220 Actual 9% 160.Q5: Shandilya Ltd. Contribution p. has adopted Economic Value Added (EVA) technique for the appraisal of performance of its three divisions A. Solution: i) Profitability statement of Division A:- Particulars Selling price p. (MCS-2008) Numerical Shandilya Ltd.

if Division B opts for selling price p.u. Contribution p. Expected Total Total Fixed Net cost (Rs.50 maximizes profit for the Company as a whole. of Rs.u.u.u. = Variable cost p.u. of units) sales Total contribution Total Fixed cost Net profit (Rs. Expected (no.u. of contribution units) 90 80 50 42 42 42 48 38 8 2000 3000 6000 96000 114000 48000 90000 90000 90000 6000 24000 (42000) [Note: Total Variable cost p.42000.50. of Rs.) B (Rs.50 in order to maximize Company’s profit.35)] iii) Profitability statement of Company as a whole:- Expected sales Net profit of division A Net profit of Division Total Net profit (Rs.Contribution p.) profit sales (no. it would suffer a loss of Rs.u.80 maximizes profit for division B whereas selling price p.u. Division B would not select Selling price p. Solution: As per the calculation in part (a).) (Rs. (Rs. selling price p.) 6000 24000 (42000) (6000) 36000 42000 2000 3000 6000 (12000) 12000 84000 (b) State the selling price which maximizes profits for division B and company as a whole. of Rs.) 24 24 24 2000 3000 6000 48000 72000 144000 60000 60000 60000 (12000) 12000 84000 ii) Profitability statement of Division B:- Selling p. Comment on why the latter price is unlikely to be selected by division B.7) + Transfer price of intermediate product (Rs. Therefore. of Rs. However. . Total variable cost p.u.) (Rs.u.

000 5. B still has excess capacity) if A buys from the market If excess capacity of Div. will company as a whole benefit if div A buys from the market.) 1.100.MCS – 2007 Two Divisions A and B of Satyam Enterprises operate as Profit centers.000 If Div A purchase from outside.000 Since total purchase cost is lesser than the total outlay if transferred inside.000) Option C Amount (Rs.000 nos. 92. If the market price reduces by Rs.000 Units * Rs. 9.000 14. 950 = Rs. A purchase from outside? Justify your answers with figures.00.50.00. 14. 950 and Rs. 950 = Rs. 5. Naturally.) 92.00.000 95.000 Total outlay if transferred inside = 10. Div.00.000 Since total outlay if transferred inside is lesser than total purchase cost if bought from outside.000 Units * Rs.00. 1.50.00. 95. 3.50.00. 1.00. Division A normally purchases annually 10.000 Units * Rs. relevant cost is the lesser one i.000 92.00. What would be the effect on the company (assuming Div.000 Total opportunity cost if transferred inside = Rs.000 Total relevant cost becomes Rs.00.00. which has recently informed Div. should Div A purchase from outside) Total Purchase Cost = 10.000 95. whose variable and fixed costs per unit are respectively Rs.00. B.000 Units * Rs. 1000 per unit. 1000 = Rs.00. B.00.e.00.000 Units * Rs.00. Therefore.00.5 lacs.000 and overall benefit for the company would be Rs. overall benefit for the company would be Rs. 1.100. 95.e. relevant cost is the lesser one i.00.00.000 and overall benefit for the company would be Rs.00.00. Assuming that no alternate use exists for excess capacity in Div. should Div.00. Rs. A that it will increase selling price per unit to Rs. Div.00.00. Solution Option A ( Div A buys from outside) Total Purchase Cost = 10. 95.5 lacs.000) .50.000 95.000 1.A decided to purchase the components from open market available at Rs. B.00. 80 per unit and A buys from the market) Total Purchase Cost = 10. 14.000.000 95.000 (9.000 (3. 1.000 Units * Rs.000 b) Option C ( if excess capacity of Div B could be used for alternative sales at yearly cost savings of Rs 14. Particulars Total Purchase Cost Total outlay if transferred inside Total opportunity cost if transferred inside Total relevant cost Net advantage/disadvantage to company as a whole if it buys from inside Option A Amount (Rs. 95.00. 92. 80 per unit.) 1.000 Total outlay if transferred inside = 10. 1.000 Option B Amount (Rs. 920 = Rs.000 a) Option B ( if the market price is reduced by Rs. B could be used for alternative sales at yearly cost savings of Rs.1.00.000 = Rs. Div A should purchase from outside. of required components from Div. 950 = Rs. B is not happy and justified its decision to increase price due to inflation and added that overall company profitability will reduce and the decision will lead to excess capacity in Div.00.000 Total outlay if transferred inside = 10.

000 24.00.49.000 20.(Numerical) MCS – 2004 Division B of Shayanacompany contracted to buy from Div.60. compare Actual VsBudgetred Performance b) Its implications for Management Control? Solution: a) Particulars Budgeted (Rs. 120 per unit by mutual agreement.000 4. a) As Financial controller of Div. 20. Fixed overheads of Rs. Div.09. Material Cost of Rs. B from Div. A would require for this additional activity.000 4.17.000 20% Despite of increase in investment by 10%. .000 units of a components which goes into the final product made by Div.00. there is negligible difference in transfer price.00.00.600 Units Direct and Variable Labour Cost Material Cost Fixed Overheads Total Cost Transfer Price Profit Investment ROI = Profit/Investment 60 20 100 120 20 20 12.86 23. A.00. 20.00. A.4 lacs) and Rs.000 For 20. During the year.40.) 3.92. A was 19.20 lacs that Div. Also the sales have decreased by 400 units. Per Unit) 20 Budgeted (Total in Rs. Therefore we can say that additional investment has not achieved any positive results. The transfer price for this internal transaction was set at Rs.000 19.20 (lumpsum Rs.) 4.000 Actual (Rs.000 Units For 19. actual off take of Div.000 20% 57 11.600 units. Per Unit) 20 Actual (Total in Rs.200 4.200 119.00.000 22. This comprises of (per unit) Direct and Variable labour cost of Rs. A was able to reduce material consumption by 5% but its budgeted investment overshot by 10%.200 4.00. B.00.000 20.

000 . Comment. (20 * 2 lac units) 80.00. (20 * 2 lac units) 1.000 2. 10% on 12 lacs 1.20. B and Standard Cost of Product C.) (Rs.H. transfer prices for Products A.00.00.e.000 Transfer Price for Product A = 1.000 40.00.000 40.62. which then is sold to third division to be used as part of its Product C (sold to outside market).e. which is sold to another division as a component of its product B.) (Rs.00.000 2.H.) (Units) Product A 40 20 20 60 14 lacs 6 lacs 2 lacs Product B 60 20 20 60 3 lacs6 lacs 9 lacs 2 lacs Product C 20 40 40 20 3.20.) (Rs.00.000 40.000 = 81 2.) (Rs. 10% on 20 lacs 2.00. Answer (a):Standard Cost of Product A Outside material (40 * 2 lac units) Direct Labour (20 * 2 lac units) Variable O.000 + 10% on (FA + Inventory) i. Standard Cost per Unit *Purchase of outside material Direct.00.Q) Division of Aparna Company manufactures Product A. Average Inventory Net Fixed Assets Standard Production (Rs.) (Rs.000 Standard Cost of Product B Outside material (60 * 2 lac units) Direct Labour (20 * 2 lac units) Variable O. Labour Variable overhead *Fixed overhead per unit.20.60. (b) Product C could become uncompetitive since upstream margins are added.00.00.2 lacs 2 lacs (a) Determine from above data.000 1. to be paid by the buying division.000 + 10% on (FA + Inventory) i.00.01.000 1.62.000 40.00. Intra company transactions rule: standard cost plus a 10 percent return on fixed assets and inventory.00.

000 (b): While arriving at the cost of Product C. Another strategy for the company is to cut the margins added by Products A and B.00. So when it is sold to outside market.20.Transfer Price for Product A = 2. (20 * 2 lac units) 40.H.000 2.01.000 Standard Cost of Product C Outside material (20 * 2 lac units) Direct Labour (40 * 2 lac units) Variable O. This may do well to the product by making higher revenues and capturing the market share. But in the long run. it suffers a disadvantage from its competitors as far as pricing is concerned.6 2. as its price will normally be high compared to products of similar category.00. and then come out with Product C with a lower price tag on it.00. margins of Product A.000 80.000 = 100. and Product B. customers will distinguish between a good product and a bad product and the one with the best quality will survive.000 80. which in turn become an input to Product C.20.00. are added. So if the quality of product C is better than its competitors than only it can survive in this competitive market. . So it might become uncompetitive.00.00.H. which become an input to Product B.000 20. (40 * 2 lac units) Fixed O.

metricis return on assets. However. Compute and tabulate both return on assets and EVA on the basis of following information (Rs.fixed assets should be 5% and 10% respectively. lakhs) and comment on divisional performance. the controller has suggested management to switch over to economic value added(EVA) as the criterion rather than return on assets. D and E and the present performance. Solution: Working Note: Return on Assets = Profit * 100 Total Assets . B. C. Division Profit Fixed Assets Current Assets -A B 220 400 300 800 1600 160 ---- C ________ D E 100 600 1000 110 400 800 180 200 800 Controller feels corporate finance rates on current assets and.Q) Ananaya& Company comprises of five divisions A.

10*400) + (0.C.10*800) + (0.C.V.A. on Fixed Assets * Total Fixed Assets) + (W.C.05*800) = 30 lakhs E = 180 – (0.10*400) + (0.00% 6. EVA = Profit – (W.10*600) + (0.A.O.05*1600) = 100 lakhs C = 100 – (0.C.05*160) = 212 lakhs B = 220 – (0. lakhs) A B C D E 31.A = 300/960*100 = 31.* Capital Employed) In this case.A.05*800) = 120 lakhs Summary Division Return on Assets (R.A.) (Rs.25% 9.25% B = 220/2000*100 = 11% C = 100/1600*100 = 6.17% E = 180/1000*100 = 18% Economic Value Added (EVA) = Profit – (W.C.C.) Economic Value Added (E.A.25% D = 110/1200*100 = 9.25% 11.05*1000) = -10 lakhs D = 110 – (0. on Current Assets * Total Current Assets) A = 300 – (0.00% 212 100 -10 30 120 .17% 18.10*200) + (0.

O. Its current assets are the highest and this reflects that it has huge sums of money held up either in debtors or inventory or rather it is holding a large amount of cash which is not a good sign. 10. Division E is the second best both in terms of R.V. 2. 6. 4. Division B is a better performer than divisions C and D in terms of R. 8.Comments: 1. as well as E.O. A company which is into an expansion and overall growth mode primarily invests into fixed assets and this is also one of the major reasons why the performance of division A is the best amongst all. Also. Though division C has also invested a huge amount in fixed assets the advantage is offset due to the fact that it perhaps has a larger investment in current assets.A. but the major problem with this division is that it has a terrible working capital management. 5. The reason why division A has performed the best is that it has the best working capital management that can be reflected in the total amount invested in current assets and which is the least among the five divisions.V. .A. It appears from the above analysis that division A has performed the best among the five divisions.A. The above reason holds true for the poor performance of divisions C and D as can be seen that they have a huge amount invested in current assets which does not indicate good signs about their operational efficiency. 7. as well as E. Though division E has the same amount invested in current assets as that of division D and perhaps a lesser amount invested in fixed assets its profitability is much better and hence it has delivered a better performance. 9. it can be clearly noticed that divisions C and D seem to be in trouble. Division A has performed the best when seen in terms of return on assets and economic value added. 3.A.

therefore. Engineered expense centers Engineered expense centers are usually found a manufacturing operations. the costs incurred depend on managements judgment as to the appropriate amount under the circumstances.Currently.3 (A) Explain with justification which of the two (1) or (2) is more meaningful for expense control. Such units perform repetitive tasks for which standard costs can . (B) Can the supervisor be held responsible for all overhead expenses included? Why/why not? Ans. and similar units within the marketing organization may also be engineered expense centers. direct material. distribution. Summarized expenses for November. This label relate to two types of cost. accounts receivable. and the company motor pool.Q: 32 Pritam Engineering manufacturers (MCS-2005) Numerical Pritam Engineering manufacturing variety of metal product at many factories.39 actual 582 12552 711 3114 17329 21218 2413.2005 given to concerned Production Supervisor for comments is tabulated. personnel records and the cafeteria in the human resources department. All figures are in Rs.04 Budgeted at actual volume 720 11322 361 3096 13909 21040 2103. Warehousing. Engineered costs are those for which the “right” or “proper” amount can be estimated with reasonable reliability for example. From historical data. supplies. trucking.) Standard at nominal volume 720 12706 420 3600 14840 21040 2133. Management has. It is experiencing crisis. Item Management Supervision Indirect labour Idle time Materials. components. decided to detailed expense control system including responsibility budgets for overhead expense items at each factory. as may certain responsibility centers within administrative and support department for instance. In discretionary expense centers. scrap Allocated expenses Total per ton (Rs. and utilities. a factory’s costs for direct labor. shareholder records in the corporate secretary department. and payroll sections in the controller department. (A) There is two general types of expense centers: engineered and discretionary. accounts payable. Tools Maintenance. Controller developed a standard for each overhead expense item (relating expense to volume of activity). Discretionary costs (also called managed costs) are those for which not such engineered estimate is feasible. 000.

the type and level of production are prescribed. and specific quality standards are set. But it does not imply that valid engineered estimates can be made for each and every cost item. and the appropriate amounts to spend for R&D. So that manufacturing costs are not minimized at the expense of quality. and a host of other activities. if any. The output of these centers cannot be measured in monetary terms. with the differences’ in size reflecting other underlying deference’s in the two companies. public relations. These engineered expense centers are usually located within departments that are discretionary expense centers. while another company of similar size and in the same industry may have a staff 10 times as large. accounting. and most marketing activities. legal. The difference between the theoretical and the actual cost represents the efficiency of the expense center being measure. public relations.g.be developed. financial planning. human resources). Discretionary expense centers Discretionary expense centers include administrative and support units (e. but there is no objective way to judge which (if either) is right. industrial relations. In an engineered expense center. We emphasize that engineered expense centers have other important tasks not measured by cost alone. Rather it reflects management’s decisions regarding certain policies: whether to match or exceed the marketing efforts of competitors. Thus the term engineered expense center refers to responsibility centers in which engineered costs predominate. managers of engineered expense centers may be responsible for activities such as training and employee development that are not related to current production. their performance reviews should include an appraisal of how well they carry out these responsibilities. The term discretionary does into imply that managements judgment as to optimum cost is capricious or haphazard. Moreover. There are few. both decisions may be equally good under the circumstances. research and development operations. output multiplied by the standard cost of each unit produced measures what the finished product should have cost. Even in highly automated production departments. their supervisors are responsible for the quality of the products and volume of production as well as for efficiency. . The senior managers of each company may each be convinced that their respective decisions on staff size are correct. Therefore. the use of indirect labor and various services can vary with management’s discretion. responsibility centers in which all cost items are engineered. the level of services the company should provide to its customers. One company may have a small headquarters staff.

In a sense. Departments or business units comprising several of these smaller units are higher in the hierarchy. the entire company is a responsibility center. work shift. Materials. a company is a collection of responsibility centers. though the term is usually used to refer to units within the company and there for Supervisor is responsible for the uses of the Above stated Resources (over heads) like Indirect labor. These responsibility centers form a hierarchy. tools. maintenance. and other small organization units. From the standpoint of senior management and and the board of directors. (B) A responsibility center is an organization unit that is headed by a manager who is responsible for its activities. each of which is represented by a box on the organization chart. There for standard (1) is more meaningful for expenses control. we can easily estimate “proper” or “right” amount with responsible reliability. scrape and Management supervision by proper supervising supervisor can control the listed overhead expenses.As far as above stated over heads are concern. Ans. . At the lowest level are the centers of the sections. idle time.

examined the old TV (valued at Rs 3500 by TV trade magazine) and felt that she could get Rs 5000 for that TV offer repairing cabinet.SG Rs 114.  Original cost= $11420 ($14150= $2000 cash down payment + $4800 trade in allowance + $7350 bank loan)  Guide Book Value =$3500  Ms. resulting and servicing for which she would use services of SP and SG price chargeable to BTV by SP and SG are at market rates Rs235 for parts by SP and Rs 470 for services by SG.overhead fixed per sale are CTV Rs 835.Q:2005 )A TV dealership Veena Television (VT) is organized into four profit centers.BTV Rs 665.4 times SP.5 times SG and 1. Black and White.Shivangi Manager of BTV. Market price are arrived at after marking up cost by 3. colour TV. believed that she could sell the trade in at $5000  Other Cost: Rs235 for parts by SP and Rs 470 for services by SG When trade-in is recorded @ $4800 4800+470+235=5505. Compute the profitability of the transaction assuming sales commission of $250 for the trade in on a selling price of $5000  Compute at market price  At cost price  Gross and net profit each SOLUTION:  SP of New TV by CTV = $14150. Shivangi of BTV Dept.SP RS 32 . in one particular instance a new TV was sold for 14150(financed by cash rs2000. spare parts(SP) and servicing (SG) each headed by manager BTV in addition to BVTV sales.exchange price for old TV agreed by CTV manager )cost of new TV was Rs 11420. also sells old TV exchanged (under scheme) by customer while purchasing new TV . BTV pays a service commission of Rs 250 per TV sold . 5000-5505= (-505) Particulars Sales Selling commission Gross profit Overhead Servicing Net profit before common exp New TV 14150 0 2730 835 0 1895 OLD TV 5000 250 -505 665 470 -1640 Service 470 0 470 114 0 591 Parts 235 0 235 32 0 123 . Bank loan 7350and Rs 4800.

If the trade-in is recorded @ $3500 Particulars Sales Selling commission Gross profit Overhead Servicing Net profit before common exp New TV 14150 0 2730 835 0 1895 OLD TV 5000 250 1045 665 470 -340 Service 470 0 470 114 0 356 Parts 235 0 235 32 0 123 .

3. 950 and Rs.20. which has recently informed Div A that it will increase selling price p. (1000-80) = 920 . If the market price reduces by Rs.50.000 Company As A Whole The Company as a whole will benefit if Division ‘A’ buys inside from Division ‘B’.) BUY INSIDE Nil 9.5 lacs.000 Net Cash Outflow To The 10.C and Fixed cost p. 2. Div A decided to purchase the components from open market available at Rs.2006: sum(11) Two divisions A and B of sonali enterprises operate Profit centers.000 9.000 (Rs.00.000 9.00.20.u Division ‘A’ action BUY OUTSIDE (Rs.80 p.) Total Purchase Cost Total Outlay Cost Net Cash Outflow To The Company As A Whole 9. 2) If the market price reduces by Rs.) BUY INSIDE 10.uDiv B is not happy and justified its decision to increase price due to inflation and added that the overall company profitability will reduce and decision will lead to excess capacity in Div B.000 Nil 9. What would be the effect on the company (assuming Div B has still excess capacity) if A buys from market. should Div A purchase from outside? Justify your answers with figures ANSWER 1) Division ‘A’ action BUY OUTSIDE (Rs.50. whose V.50.1100.000 Nil Nil 9.u.u to Rs. Assuming that no alternate use exists for excess capacity in Div B. 14.u. Div A normally purchases annually 10000 nos. of required components from Div B. are Rs. will company benefit as a whole if Div A buys from the market.000 The Company as a whole benefit if ‘A’ buys from outside supplier at Rs.80 p. 1100.50.1000 p. 1. If excess capacity of Div B could be use for alternative sales at yearly costs savings of Rs.) Total Purchase Cost Total Outlay Cost (Rs.

3) If excess capacity of Div B could be use for alternative sales at yearly costs savings of Rs.000 8.55.) BUY INSIDE Nil 9.50.) Total Purchase Cost Total Outlay Cost Revenue From Using These Facilities Net Cash Outflow To The Company As A Whole 10.45.000 .000 Nil 1.00.000 (Rs.50. 14.000 9.5 lakhs Division ‘A’ action BUY OUTSIDE (Rs.

it would suffer a loss of Rs.60/unit. Solution: Particulars Cash inflow (a) Amount (Rs.1 Girish Engineering Ltd. division X would not accept the market offer.(b)] 30 20 . (Numerical) (MCS-2006) (1) On the basis of costing./unit) Amount (Rs. Lakh) Amount (Rs. (2) Is this offer beneficial to the company as a whole? Justify with figures.1000/unit) units * Cash outlay: Variable cost for division Y 5 (Working note) Material bought by division 25 (5000 units * Rs./unit) Cost of critical component 220 for division X Cost of other material Fixed & processing costs Total cost for division X Selling price of final product Net loss for division X Desired profit for division X 500 290 1010 1000 10 60 Thus on the basis of full actual cost incurred by division X.500/unit) X from outside Total cash outlay (b) Net cash inflow to Company as a whole [(a).10/unit if it accepts the market offer whereas its target profit margin is Rs. will the manager be interested in accepting the market offer? Solution: Particulars Amount (Rs. Lakh) 50 (5000 Rs. So.

100 p. Girish Engineering Ltd.100  An annual investment of Rs2.4 Cr.u.40 p.250000 resulting in RoI of 12. (desired profit margin).4 Cr.u.11 lakh per month So. divisions X & Y can negotiate a transfer price by taking into account full actual variable cost (Rs. is made by division Y exclusively to produce the component required by division X. Thus. = 400000/5000 = Rs. cash outflow associated with this investment is not relevant for the above concerned decision regarding accept the market offer. Working notes: Variable cost for division Y: Desired RoI =10% of Rs.a. i. total contribution for division Y would be Rs.4 lakh per month Fixed cost p.5 lakh Variable cost p. = Rs. Rs.2 lakh per month Fixed cost assigned to division X = Rs. is following 2 step transfer pricing method wherein the selling division charges actual variable cost along with profit mark-up & separately allocates a particular amount of fixed costs per month to the buying division. So.e. division X.u. (3) If yes. However.5% (250000/2000000) which is more than the desired RoI of 10%. this method of transfer pricing is not feasible as division X would suffer loss if it accepts the market offer under this scenario.Thus.24 lakh p. Therefore. for division Y would be Rs.) & half of fixed costs incurred by division Y that is assigned to division X (Rs. the Company as an entity would receive cash inflow of Rs. In this case.e. is assigned by division Y to division X but it does not imply that a special investment of Rs. for division Y = 500000/5000 = Rs.60 p.20 lakh. . p.50 (150 – 100). in the case of division X (buying division) & division Y (selling division). Solution: Currently.80 Contribution per month = Rs. total Variable cost per month for division Y = 11 lakh – 6 lakh = Rs. which would unnecessarily increase the costs for division X and thereby eat up its profit margin.10/unit. So.a. division X’s total costs would turn out to Rs.u. contribution p.u.e. the offer is beneficial to the company as a whole.) & add a mark-up of say Rs.940 (500 + 290 + 150) & would earn a profit margin of Rs.u. how should the company organize its transfer pricing mechanism? Illustrate.2.2. Taking into consideration only half of the fixed costs of selling division i.4 Cr. Also. division Y prevents shifting of any operational inefficiencies from selling division to buying division i.6 lakh Total sales value for division Y = 220 * 5000 = Rs.

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