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IMTH/AFM013

Ciron Pharmaceuticals

In the summer of 96, three brothers with entrepreneurial spirit Manu Shah, Ratan Shah and Kirti Shah eventually decided to give shape to their dreams Ciron Pharmaceuticals. Located in the spacious Laxmi Industrial Estate, adjacent to the Jogeshwari railway station, Ciron Pharmaceuticals was the culmination of the untiring and dedicated efforts of the three brothers to make a mark of their own in the big bad world of the Pharmaceutical industry. While Manu and Kirti were commerce graduates, Ratan had a B.Pharm degree. As a result they complemented each others skill sets. Ratan took care of manufacturing; Manu looked over accounting and general administration while Kirti handled sales. The firm specialized in production of three brands of tablets Paramol, Ibupara and Acelofen Plus. Each tablet comprises of active (main ingredient) and a host of excipients (binders, fillers, coatings and sorbents to name a few). Examples of excipients include talcum powder, pharma grade sugar, carnuba wax, guar gum, colours, etc. The active ingredient for Paramol was Paracetamol, while Ibupara and Acelofen Plus contained Ibuprofen and Aceclofenac respectively over and above Paracetamol. Each of these drugs had different combinations of excipients. Paramol and Ibupara contained just 3 excipients while Acelofen Plus contained 8 excipients. The year 2008-09 saw their turnover increase from 15 million to 18 million. For the next year they had set an ambitious target of 20 million. The firm continued to maintain an overall 8% net profit over the last five years. Paramol contributed about 12% of overall sales, while Ibupara and Acelofenac Plus contributed about 42% and 46% respectively. However in terms of profitability, the situation was not as rosy as it appeared. The first two gave a net profit of 15% and 18%; while Acelofenac Plus suffered a loss of 3%. April 2009 passed by and the results were more or less identical. Manu Shah decided to hire the services of Nitesh Malde, a reasonably well known consultant and who incidentally happened to be his childhood friend. Nitesh had pursued his MBA from a reputed B-School in Mumbai after having practiced as a Chartered Accountant for three years. Manu had come prepared for the first meeting with Nitesh. He handed over a sheet containing necessary information (Exhibit 1) for analysis. Manu Shah: Our costing process is very simple. We know exactly how much active and excipient goes into production of each batch of tablets. Run time labor hour per batch is also known and hence labor cost can also be determined. The overheads are assigned to production on the basis of run labor cost.

This case was prepared by Professor Vishwanthan Iyer of IMT Hyderabad based on his past engagements with the company as statutory auditor. Data and details have been appropriately modified to mask sensitive information about the operations of the company. This case is intended to be used for class discussion and is in no way designed to present illustrations of either correct or incorrect handling of a business situation.

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IMTH/AFM013

Nitesh Malde: Fine. So based on this approach you have concluded that Aclofenac Plus is posting a loss of 3%. Manu Shah: Yes. Bulk of our gross revenue comes from Aclofen Plus. Given the competition, we cannot increase the price any more. Ideally we expect a net margin of 8% from all three products. As of now, Ibupara is subsidizing Aclofen Plus. Its delivering a supernormal profit of 18% plus. Nitesh agreed to look into the matter over the next couple of days and promised to get back. In the meanwhile, he discussed this case with his assistant Sandip Tripathy and asked him to give his analysis. After going through the details (Exhibit 1), Sandip felt there was a problem with the existing method of assignment of overheads to the products. He decided to assign setup cost directly, storekeepers salary on the basis on material cost, supervisors salary on the basis of run labor cost and the remaining overheads on machine hour. His logic was simple. Setup cost can be directly identified, storekeepers job is to handle material and record inventory movement and supervisors job is to oversee the production. As drug manufacturing is more technology intensive than labor intensive, he decided to use machine hour as the basis for allocating the remaining overheads. Based on these revised assumptions Sandip recomputed the profitability only to find some startling results. First, Paramols net margin was almost 25% higher than Ibupara and that Acelofen plus was actually delivering a 5% profit instead of a loss of 3%. Is this really possible, he pondered. If at half the price Paramol can give such impressive returns, then Manu Shah should focus more on this product rather than Ibupara, he thought. He presented these extraordinary results to Nitesh Malde. Impressed by his subordinates effort, he encouraged Sandip to dig further. Nitin explained about Activity Based Costing (ABC), a modern approach to Cost Accounting. Such an approach, he opined, would depict cost more accurately through a deeper understanding both of the activities involved and the resources consumed by each of those activities. Enthusiastic as always, Sandip wasted no time in gathering information about ABC from the internet and gave a thorough reading. He soon realized that to implement ABC, he needs a profound understanding about the nature of activities associated with each of the overhead costs. Accordingly he decided to visit the factory for gaining firsthand information about the nature of activities involved in the process. At the factory, he first interacted with the storekeeper. He found that on a typical day, about 80% of the storekeepers time was spent on recording the receipt of raw materials and/or its issue for the production process. The remaining time was spent on recording the batch-wise inflow and outflow of finished products. Next he visited the Quality control Department. Their task was to enforce GMP (Good Manufacturing Practice) regulations and ensuring that the tablets produced
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IMTH/AFM013

match the required standards. Essentially, they take out some sample from every batch of tablets produced and certify its quality. Thereafter he met the Supervisor of the plant. On his interactions, he realized it makes more sense to distribute his salary on the basis of total labor hours rather than run labor cost. He went on to observe their packaging and transporting process. Although the number of boxes dispatched was different for each of the product, there was only one packaging per dispatch. It occurred to him that using number of dispatches could be a more logical method for allocating the packaging and transporting cost rather than labor or machine hours. On his way out, he met Manu Shah and confirmed his observations. To this, Mr. Shah added that machine maintenance expenses, depreciation and electricity charges were directly proportional to the usage of the machinery and hence could be apportioned using machine hours. Armed with this new set of information, he decided to re-estimate the costs and arrive at product wise profitability. He had no clue of what surprises were awaiting him at the end of this process

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IMTH/AFM013

Exhibit 1 Basic Details about the company


Paramol Tablets per strip Strips per box (SKU) Tablets per batch No of batches manufactured / sold No of boxes despatched at a time Selling price per box (Rs) Raw Material Active 10 20 15000 20 300 120 Ibupara 10 20 12000 45 150 240 Acelofen plus 10 10 8000 60 240 150

Paracetamol (100%) Ibuprofin (40%) Aceclofenac (33%) Paracetamol (60%) Paracetamol (67%) 3 3240 360 3600 5 8 13 100 150 8 3 5472 288 5760 7 12 19 100 150 15 8 4320 480 4800 4 15 19 100 150 12

Total Excipients required Cost of Active (per batch) Cost of Excipients (per batch) Material Cost (per batch) Labor Setup time in hrs (per batch) Run time in hrs (per batch) Total time in hrs (per batch) Wage rate - Setup time (per hour) Wage rate - run time (per hour) Machine hours (per batch) Overhead Expenses for April Storekeeper's salary Supervisor's salary Quality Control Electricity charges Maintenance Expenses Depreciation Packing & Transporting

22,625 45,100 45,000 77,750 65,310 1,78,825 64,500 4,99,110

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