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(2001) Amar Car Company Solution: (A) IF COMMON SPARE PARTS CONSTITUTES 80% OF PRODUCTION COSTS (1) Since

common spare parts are a large percentage of the final product cost it is advisable for the company to have total control over availability of these common spare parts. (2) If the spare parts division is integrated within the company it will reduce the loss in maintaining stocks of finished product which are incomplete due to unavailability of spare parts from external suppliers. (3) The advantages of manufacturing spare parts within the company will increase the servicing company capacity of the cars of the company since spare parts will be readily available to customers. (4) The spare parts division can produce & sell the surplus to customers in need of service & spare parts. (5) The after sales services of the company will improve since it does not have to really depend on external suppliers. (6) The company should recognize itself in such a way that the common spare parts are manufactured within the company rather than purchased from external suppliers. (7) The common spare parts which are used in all 3 lines are of considerable importance since they constitute 80% of the product costs. (8) External suppliers may create a lot of problem like shortage of supply, delay in delivery times, increase in costs, and reduction in quality. (9) Since product related innovations emerge in Division X and proceed to other divisions, the company would benefit by manufacturing the common spare parts internally since the common spare parts can be customized for the premium segment to by Division X (Line A). (B) IF COMMON SPARE PARTS CONSTITUTES 20% OF PRODUCTION COSTS (1) In such a case it is preferable to continue to purchase the products from external suppliers sine the common spare parts are only 20% of the product costs which is very nominal. (2) The company is advised to concentrate on the parts used in the three lines rather than control the common spare parts. (3) It is advisable to have a contractual agreement with external suppliers regarding quality, quantity, deliver time, credit period, discounts etc., such that it does not affect the other production schedules of the company. (4) Since common spare parts are only 20% of product cost it is advisable to source them from external suppliers since product related innovation i.e designing better cars and variety in different price segment have to be shared by Division X with other divisions Y & Z. (5) The process relaed innovation for example fuel efficiency, supply etc. which originate from division Z should be applied by the other divisions Y & Z. (6) The company can be organized and controlled in an efficient manner if they decentralized the three divisions X, Y & Z and convert each of them into profit center. The three division should follow proper budgeting taking into account the market segmentation which is the premium segment, mid-price segment and low end price segment. (7) The company should install a CRM system where first time buyers will buy cars of line C and upgrade in the future line B and later to line A.


PARTICULARS Budgeted Personnel Budget Rate per Person Budget Amount Actual Personnel Actual Cost per Person Actual Amount Personnel Variance Personnel Rate Variance Total Expense Variance

CENTRE A 46 28,932.456 13,30,893 46 30,112.043 13,85,154 NIL 54,261(A) 54,261(A)

CENTRE B 26 45,242.384 11,76,302 24 47,086.375 11,30,073 90,485(F) 44,256(A) 46,229(F)

COMMENTS EVALUTION OF THE EXPENSE CENTRES: (1) COMPARING Actual Amount with Budgeted Amounts show an Unfavorable Variance for Centre A of Rs. 54,261 and Centre B it showed a favorable Variance of Rs. 46,229. (2) The Total Expenses for Centre A which was Rs. 54,261(A) was due to difference in rate pai d to the same number of employees which must be investigated. The Rate difference was 4.08%, the reason for which must be ascertained, which could be due to either increase in Rates or due to overtime. (3) For Centre B the Total Expenses Variance was Rs. 46,229(F) which is primarily due to reduction in the number of personnel Employed which was only 24 as compared to the Budget of 26 Employees. This has led to a Favorable Variance of Rs. 90,485, but the Rate Variance was Rs. 44,256(A) (4) Hence the major concern is the rise in Rates paid to the Employees which for both centers shows an increase of 4.08%, the Reason for which must be Ascertained.

(2004, Q.11, Girish Engineering) (A)

(1) The two items i.e departmental fixed costs and allocated costs will show no veraiance since the departmental fixed cost will remain constant (Fixed) at all levels of production and has no variance. (2) The allocated costs are allocated by the head office to the division which is an expenses center and this allocation will remain constant as per the budget. (3) The correct approach in performance reporting is to analyse the variance in expenses which are directly related to the expenses center and which can be controlled. (4) Allocated cost should not be included in such performance reporting since it is not directly related to the division. (B) Table showing Expenses Center Evaluation (Lac) Particulars Direct labor & material Indirect labor, power etc. Total controllable costs Budget 100.34 59.83 160 Actual 100.13 68.34 168.47 Variance 0.21 (F) 8.51 (A) 8.30 (A)

(1) The total controllable cost includes direct labor and material & indirect labor, power etc. (2) Direct labor & material are directly related to production. Hence they are controllable but indirect labor, power etc. are not related to direct production & it could be in the nature of semi-variable expenses. Hence, they should not be included in controllable cost. (3) The variable component of indirect labor, power etc must be separated, analyzed & then included in the total controllable cost for a better evaluation of the expenses center. (4) The direct labor & material has shown a favorable variance of Rs.21000 which is beneficial to the company but the indirect labor & power etc. which has shown an unfavorable variance of Rs. 851000 has diminished the performance of the expenses center. (5) The management audit analyze and evaluate the reasons of such an unfavorable variance in indirect labor, power etc. and ascertain if the variance is due to internal or external factors like production, inefficiency, wastages, idle time or change in power rates, increase in number of labor hours etc.

(Q.11, 2006, Girish Engineering) Decision of Acceptance / Rejection of an offer of 5000 units Part 1) Acceptance of offer by Manager of Division X Particulars Transfer Price Variable Cost (Balancing Fig) Fixed Cost Total Cost Add: Profit Transfer Price/ sales Division Y Total --460000 400000 860000 240000 1100000 P.U --92 80 172 48 220 Division X Total 1100000 2500000 1450000 5050000 300000 5350000 Overall Co P.U 220 500 290 1010 60 1070 2960000 1850000 4810000 540000 5350000

The offer should not be accepted by the manager of Division X since his costing Rs. 1010 but the offer is only of Rs .1000 per unit. Working Notes: 1) Calculation of profit of Division Y Profit = 24000000 x 12% ------------------12 Profit = 2, 40,000 per month Part 2) Decision regarding benefit of offer to the company Particulars Sales (Offer) Less: Variable Cost (92+500) Contribution Less: Fixed Cost Profit Total Profit (5000x38) Amount (Per Unit) 1000 (592) 408 (370) 38 190000 per month

The company should accept this offer since there is a profit of Rs.190000 per month to the company Part 3) Transfer pricing is not accounting tool but acceptance or rejection of offer can be found by marginal cost analysis. Hence, the transfer price should be reduce but top management should not interfere base on the basic principle of transfer pricing with says that keep complete freedom to divisional managers to fixed their own transfer price.

Problem No 11 of Measuring and Controlling Profits & Assets Problems Sheet

(1) Calculation of Cash & Book Return on Net Worth Income Statement Particulars EBIT Add: Depreciation Less: Tax Cash Return Cash Return Cash Return on Net Worth = ------------- x 100 = Net Worth (2) Operating Return on Operating Investment: Calculation of operating Profit Income Statement Particulars Sales Less: Material Less: Labor Less: Factory Overhead Less: Selling & Distribution Operating Profit Calculation of Operating Investment Particulars Fixed assets Inventories Accounts receivable Cash Less: Current Liabilities Operating Investment Operating Profit = ----------------- x 100 = Operating Invt. Amount 440 128 160 20 240 508 112 --------- x 100 =22.05% 508 Amount 1120 426 291 168 123 112 Amount 116 40 15 141 141 --------- x 100 = 40.51% 360 - 2

(3) Calculation of relationship between return on assets, sales margin & assets turnover A. Calculation of return on assets (i) Calculation of Return (NPAT) Income Statement Particulars Sales Add: Other Income Less: Material Less: labor Less: Factory overheads Less: Selling & dist. Less: Interest Net profit before tax Less: Tax Net profit after tax (ii) Calculation of Total Assets Particulars Fixed assets Investment Inventories Accounts receivable Cash Operating Investment Amount 440 40 128 160 20 788 Amount 1120 04 426 291 168 123 25 91 15 76

NPAT Profit Margin = ------------- x 100 = Sales Sales Assets Turnover = ------------Total Assets

76 --------- x 100 = 6.79% 1120 1120 --------- = 1.421 times 788

ROA (Du Pont) = Profit Margin x Assets Turnover 6.79 x 1.421 = 9.65%

Q.1) Transfer Pricing is not an Accounting Tool. Comment with illustrations. Answer: 1. Some companies use the term TP to refer to the amount used in accounting , for transfer of goods & services between responsibility centres. But in MCS, TP is used to the value placed on transfer of goods and services in transaction where at least one of the two parties is a profit centre. 2. Transfer price involves a profit since an independent company would not transfer goods & services to another independent company at the cost or less, hence we exclude the mechanics of allocating cost in a cost accounting system since such costs do not include the profit element. 3. Transfer price in MCS is to be used in the same way as in transaction between independent companies. 4. The fundamental principal is that, the transfer price should be similar to the price that would be charged if the product was sold externally or purchase from outside vendors. 5. The profit included in transfer price is a notional profit, but in pure accounting it is a real profit since it includes transactions with external perties. 6. Transfer price is more of an internal mechanism of allocating profit as compared to accounting which is more of an external mechanism of real profit. 7. Transfer price depends upon the accounting profit sice all future decisions would be based on the current profit of the company. Hence Transfer pricing is not an Accounting Tool. Q.2) Explain with illustrations the different ways in which the profit objective of a profit centre can be stated and controlled. What role do corporate overhead allocations play in this process? Answer (A)Different ways in which profit objective of profit centre can be stated and achieve: The different ways in which the profit objective of a profit centre can be stated and controlled can be explained with the help of, types of profitability measurements used in evaluating a profit center. First, there is the measure of management performance, which focuses on how well the manager is doing. This measure is used for planning, coordinating, and controlling the profit centers day-to-day activities and as a device for providing the proper motivation for its manager. Second, there is the measure of economic performance, which focuses on how well the profit center is doing as an economic entity. The messages conveyed by these two measures may be quite different from each other. For eg: The management performance report for a branch store may show that the stores manager is doing an excellent job under the circumstances, while the economic performance report may indicate that because of economic and competitive conditions in its area the store is a losing proposition and should be closed. Types of Profitability Measures (Refer 2004 Q9 in short) (B) Role of corporate overhead allocations play: There are three arguments in favor of incorporating a portion of corporate overhead into the profit centers performance reports. First, corporate service units have a tendency to increase their power base and to enhance their own excellence without regard to their effect on the company as a whole. Allocating corporate overhead costs to profit centers increases the likelihood that profit center managers will question these costs, thus serving to keep head office spending in check. (Some companies have actually been known to sell their corporate jets because of complaints from profit center managers about the cost of these expensive items). Second, the performance of each profit center will become more realistic and more readily comparable to the performance of competitors who pay for similar services. Finally, when managers know that their respective centers will not show a profit unless all costs, including the allocated share of corporate overhead, are recovered, they are motivated to make optimum long-term marketing decisions as to pricing, product mix, and so forth, that will ultimately benefit (and even ensure the viability of) the company as a whole. If profit centers are to be charged for a portion of corporate overhead, this item should be calculated on the basis of budgeted, rather than actual, costs, in which case the budget and actual columns in the profit centers performance report will not complain about either the arbitrariness of the allocation or their lack of control over these costs, since their performance reports will show no variance in the overhead allocation. Instead, such variances would appear in the reports of the responsibility center that actually incurred these costs.