Question 1.

Analysis of cost structure of MRF limited

Please refer the Excel Sheet

Classification of cost
Cost can be classified in following broad categories
 Based on Nature:
1. Material
2. Labour
3. Other
 Based on Function
1. Production/Manufacturing
2. Administrative
3. Selling
4. Distribution
5. Research and development
 Based on identification
1. Direct
2. Indirect
 Based on Behavior
1. Fixed
2. Variable
3. Semi-variable

Considering above classification, all costs of MRF ltd have been plotted as per different
classification basis as below

Classification of cost
Amount in Basis of classification
Percentage
Particulars Crores Behavio
of Total cost identifiably Function Nature
(Mar'20) ur
             
Materia
COGS 9508.91 63.72% Direct Production Variable
l
             
Employee
Administrati
Benefit 1320.51 8.85% Indirect Labour Fixed
ve
Expenses
             
Finance Administrati
274.26 1.84% Indirect Other Fixed
Cost ve
             
 Depreciatio
n and Administrati
980.62 6.57% Indirect Other Fixed
amortizatio ve
n cost
             
Power and
720.79 4.83% Indirect Production other Variable
Fuel
             
Selling
828.9 5.55% Indirect Selling Other Variable
Expenses
             
Other Semi-
1288.33 8.63% Indirect Others Other
Expenses Variable

Analysis of cost Structure:

 Tyre industry being raw material intensive, Material cost forms the major part of total
cost.
 Most of the raw material used in tyres are petro-based and hence the price and cost are
volatile as they are directly linked to global crude oil prices
 Employment benefit expenses are stable at around 8.26% of Total revenue
 Employee relations has been a concern in this industry as many Industry peers of
MRF along with MRF have faces lockouts, resulting in production losses and lower
employee productivity indirectly increasing the cost of production
 Selling expenses are around 5.18 % of Total revenue. Major part of selling expenses
comes from advertisement and Freight & Distribution charges. Advertisement cost
arises from the idea to invest in brand building although the brand awareness is very
low in bus and truck tyre vertical but relatively higher in car vertical
 Depreciation cost stands at around 6.13% of Total revenue. Depreciation is provided
on straight line basis on all assets except for renewable energy saving devices, which
is charged on reducing balance basis
 Finance Cost is at 1.72 % of total revenue which is at par with industry standard.
Finance cost forms a very small percentage of total cost at 1.84% of total cost. Due to
its lower participation, fluctuations in finance cost would not impact the overall cost
structure majorly
 Power and Fuel are at around 5 % of total cost

Question 2.
Application of the concept of two-dimensional Activity based costing analysis in an
automobile firm.

For every company there is an ongoing need to improve the cost management system to
capture the cost information accurately for its various products manufacture and services
provided. Many organizations have converted to ABC costing system from traditional costing
approach to achieve this objective. In ABC costing approach, cost of each activity is collected
in functional activity cost pool and then applied to products and services based on individual
cost drivers. In this way, cost is allocated based on events and transitions that occurs in
manufacturing a product or providing a service.

A two-dimensional activity-based model follows two approaches or more popularly know as

two views, Cost assignment viewpoint and Process view. Process view is from perspective of
activity-based management. In simpler terms, A process of using ABC information to
improve process and manage cost is called as Activity based management (ABM)

Resource cost

Performance
Root Causes Activity Triggers Activities Measures
Measure

Cost Objects

The vertical dimension in above diagram represents the cost allocation view from cost of
resources to the cost objects. Cost reduction is the main objective of this dimension All
activity cost is collected in activity cost pools and based on activity drivers, cost are assigned
to cost objects such as products, services, customers.
The horizontal dimension depicts the process view of ABC costing model. The focus here is
on the activity. i.e. the process followed. It includes analysis of activities with its root causes
and activity triggers and then evaluating it through performance measures.

Two-dimensional ABC model in context of automobile industry

 Identification of various activities: All activities shall be divided into homogenous

activity pools such as assembly of automobiles, Painting of automobiles, Inspection of
manufactured automobiles
 Analysis of activity: This includes understanding of root cause and activity triggers
of each activity and fixing the performance measures such as time taken, quality. Also
cost related to each activity will be identified here.
 Cost assignment: After identification of all cost, now cost will be assigned here for
each activity cost pool as mapped
 Calculations of activity drivers: In order to assign costs from activity pool, we need
a cost driver. For e.g “Number of tests done” is a activity cost driver for cost pool of
“Inspection”
 Allocating the costs to cost objects: On the basis of cost drivers identified, costs are
being assigned to cost objects such as manufactured automobiles, Spare parts and post
sales services.
 Reporting: After all the cost are allocated to cost objects, the accurate costs will be
determined for fixing the sale price of products and charges for the service. Also
performance of each activity will be evaluated with and objective of cost reduction.

Diagrammatic representation if activity cost pool and cost drivers

Overhead cost

Setting up Manufacture Assembly Painting Inspection

of of of cars of and testing
Machines Accessories automobil of
and parts es post automobiles
Do you think an activity based costing system will
alleviate the problems of
the traditional costing system? Support your answer
with reasons.

Yes, adoption of activity-based costing system will

alleviate the problem of the traditional costing system
due to following reasons

 Unlike traditional costing, ABC considers

multiple cost drivers which helps in allocating
cost correctly

 In traditional costing, cost can be overallocated

on one product and under allocated to other
product. This can result in erroneous cost
assignment and incorrect sales price. This
scenario can be avoided in ABC costing as cost
are allocated based on the events and
transaction utilised in the process of
manufacturing the product or providing of
service

 There is no scope of any process improvement

in traditional costing approach, while in ABC
model each activity is analysed and scrutinized
more critically for improvement.

 In two-dimensional ABC model, each activity is

scrutinized in depth to understand it’s activity
triggers and root causes. Also, it is understood
through various performance measures such as
time taken, quality of output on how well a
activity is performed and whether it meets the
requirement of company and customers. This
 enables in identification of inefficient process
and drive our focus in improvement which
would result in achieving cost reduction which
is not offered by traditional costing system.

 ABC enables in determination of accurate profit

margins more precisely than traditional costing
system

 ABC costing provides more in-depth

information about the cost of the product than
traditional costing as cost are allocated based on
activity offering better understanding and
justification of all overheads allocated to cost
objects

Question 3. Implementation of standard costing

system

Standard costing is a mechanism which is used as a tool

of cost control and budgeting. As per this the standard
costing system, the estimated cost (Standard cost) and
actual cost are compared and the variances arising out
of them are examined to understand the root causes of
such variances.

In order to implement the standard costing system in a

auto ancillary company manufacturing bearings,
following steps are involved.

 Determination of cost center:

Cost Centre is the internal function of the

organization which directly does not add to
profit but still incurs cost. Definition of such
cost centers becomes necessary for establishing
cost and responsibilities

 Classification of cost:
 All cost in the organization is classified based
on the nature or behavior into pools such as
Material cost, Labor cost, direct cost, indirect
cost, Production overhead, Administrative cost,
Fixed cost, Variable cost etc.
Such bifurcation is necessary for analysis and
better control of cost

 Establishment of a committee:

Before implementing any system there should

be a committee or a certain group of people who
monitors each activity on day to day basis and
dedicatedly working towards its successful
implementation and to assume responsibilities
to tackle any challenger coming along the way

 Setting up of standards and responsibilities

Standards in terms of cost and quality must be

set in order to compare with the actuals to find
out possible reasons for variances. Standards set
must be practical and ideal for fair comparison
with actuals.
Responsibilities in terms of ownership of the
variances also should be determined at the
beginning.

 Collection of data relating to actual costs

incurred:

The collection of details of actual cost incurred

is the most vital step, as it is one of the key
factors in determination of variances. There
should be a system in place to capture this data
accurately and in timely manner.

 Computation of Variances:

When standards are predetermined and there are

systems in place to capture accurate actual data,
computation of variance should not be a
difficult task. Based of this variance only,
organization investigates the causes and takes
appropriate actions to improve the process and
control

 Reconciliation of profits:

Primary rationale for implementation of

 standard costing system is having better internal
control. For such a purpose profit needs to be
reconciled. The gap between the budgeted profit
and actual profit needs to be understood through
variance analysis. Any shortfall in budgeted
profit must be report and a significant variance
is to be addressed on priority

Pros and cons of implementing standard

costing system

Pros:

 Implementation of standard costing system

makes the entire organization cost conscious
and employee becomes aware about the fact that
cost reduction can be achieved through
everyone’s joint efforts

 There will be root cause analysis of variance

and improvisation of processes and internal
controls, cost reduction is bound to happen
along with significant reduction in wastages.

 Performance of respective function can be

appropriately analyzed, and appropriate action
can be taken to avoid any shortfall in process or
controls.

 Responsibilities and ownership of a particular

process can be fixed

 Standard costing system can be used as a tool

for decision making and planning

 Employees can be motivated through various

incentive and remuneration schemes based on
the performance evaluation

Cons:

 Standard costing is very expensive and time-

 consuming system

 It is very difficult to set standard with high level

of accuracy

 When it comes to variance, it is very difficult to

determines its materiality as it is very subject
concept which depends on various factors.

 Generally, while performance evaluation under

standard costing system, favorable variance are
ignored and only unfavorable variances are
considered for analysis. This approach can
create a lower moral among employees.

 Due to nature of standard costing system,

Manager’s freedom to action is seized

Challenges and opportunities in implementing standard

costing system

Opportunities:

 It provides the basis for performance evaluation

of function, department and personnel
 Fixing responsibilities becomes easier
 Employees can be motivated by creating an
awareness among them that how combined
efforts of all would result into cost reduction
 Standard costing can be used as a tool to
improve employee productivity through various
incentive schemes based on performance

 Standard costing system forms the basis for

decision making

 Standard costing gives an opportunity for cost

reduction and minimization of wastages

Challenges:

 Setting up a fair standard with higher level of

 accuracy is a very challenging task.

 Determination of materiality of variance is a

challenge being its subjective nature.

 Framing of incentive scheme based on

variances which does not lead to unfavorable
outcomes on from purchasing materials
managers.

 Adhering to the structure outlined under

standard costing system can take away the
freedom of action from respective managers.

Question 4.

consider the following table,

Particulars Weekend Project Tool Mart

Gross Sales
20,00,000 49,00,000
Selling price
per order 40,000
No of orders
50
Sales return in
Qty 3
Net sales in Qty 47(50-3) 155(175-20)
Net Sales in
18,80,000 (40000* 47) 43,40,000(28000*155)
Rupees
Cost of goods 13,16000(18,80,000 30,38,000(43,40,000 *
sold *70%)
5,64,000 (18,80,000- 13,02,000 (43,40,000-
Gross Profit
13,16,000) 30,38,000)
Customer
related cost 2,45,100
Profit on each 3,18,900 (5,64,000- 3,84,000(13,02,000-
customer 2,45,100)
Percentage of
Profit 16.96%
Analysis and recommendations

 Profit percentage from Tool mart is lower

compared to other customers. This is majorly
attributable to the higher customer related cost
than others. Power Corporation should examine
this critical and find ways to reduce this cost

 There is potential to reduce the percentage of

cost of goods sold and ways to improve gross
margins must be explored

 Reasons for stock returns must be examined to

understand the process gap or any flaw in
internal control

 Power corporation must start charging premium

on rush orders to increase the overall revenue

Question 5.

Consider the below table

Particulars
Sales Revenue 49,00,000
Units sold 70000 Units
70
Selling price per
(49,00,000/70000
unit
)
   
variable cost per
Rs 20
unit
Contribution per
Rs 50 (70-20)
unit
Total fixed cost 28,00,000

Taking data from table,

 Breakeven point = Total Fixed cost

Contribution per unit

= 28,00,000 / 50

= 56,000 Units

Scenario no. 1: Company is facing hectic competition and price war and is unable to raise
their market share. The management desires to lower the firm's break-even point

Below listed are few ways in which a entity can reduce its breakeven point given the
condition that company is unable to increase the selling price

 Reduction in total fixed cost: by reducing the total fixed cost and assuming the
contribution remains same, the company will able to lower its break-even point

 Reduction in variable cost per unit: Contribution per unit is result of two factors.
Selling price and variable cost per unit. As we cannot increase the selling price, the
only way in which firm can lower the break- even point is by reducing its variable
cost per unit
Scenario no. 2: The Company anticipates a hike in the marked variable cost per unit and
projects all other costs to remain constant. Consequently, the management desires to
maintain the firm's current break-even point.

Contribution= Sales – Variable cost

If there is rise in variable cost, keeping the selling price constant, contribution per unit tends
to decrease. This will impact the break-even point as it would end up on higher side.

From the details of scenario, we can understand that company desires to maintain its current
break-even point keeping all other cost constant, which means that there won’t be any
changes in total fixed cost. Here in such a situation the only way to maintain the current
breakeven point is to Increase selling price to maintain the current contribution per unit,
which will eventually maintain the current breakeven point
Question 6.

Consider the following table,

Abhinav Akshay
Particulars
Chennai Hyderabad
     
Turnover (Revenue) 20,00,000 20,00,000
     
5,00,000 (Balancing 1550000 (Balancing
Less: variable Cost
Figure) Figure)
     
Contribution 15,00,000 4,50,000
     
1350000 (Balancing 3,00,000 (Balancing
Less: Fixed Cost
Figure) Figure)
     
Profit 150000 (Given) 150000 (Given)
It is assumed the Akshay runs a operating unit in Hyderabad and Abhinav runs a operating
unit in Chennai. This assumption is derived from the fact that Akshat believed to operate the
unit with highly efficient manual labor which and Abhinav preferred automated production
process. We can clearly observe from the table that variable cost in Hyderabad is higher due
to manual labor force and fixed cost is higher in Chennai due to automated production
process.

A Chennai unit having automated process will tend to have higher break-even point due to its
higher fixed costs. Higher the breakeven point, higher are the sale units required to be sold to
recover its fixed cost. This situation is a potential to report losses. Even the safety margins
with higher fixed cost are very narrow.
However, the automated production system tends to have a greater throughput. Greater
throughput comes with greater potential of profitability, but increased risk and greater profit
potential go hand in hand.
In tough times like recession, company with automated production process will face survival
crises as it will be difficult to adjust to falling consumer demand and falling prices of goods
and services with higher fixed cost, However it will be relatively easier for a company with
intensive labor production process due to its lower fixed cost commitment

Conclusion:
Considering all above facts, If I were the venture capitalist, I would choose to fund the
Hyderabad location which is more labor-intensive production process

Question 7.

Evaluation of new collection strategy

Please refer the excel sheet for summary of current cash collection strategy

Current collection strategy

Particulars January'20 February'20 March'20
Revenue 5,00,000 5,30,000  
Cash Receipts      
2,00,000 2,12,000
Cash Sales: (5,00,000*40%) (5,30,000*40%)  
Credit Sales      
January 2,10,000 (3,00,000* 90,000 (3,00,000*
Sale 70%) 30%)  
February 2,22,600 95,400
Sale   ( 3,18,000*70%) (3,18,000*30%)

Review of Sarah’s (New) collection strategy

The main objective of any cash collection strategy is to collected maximum amount of cash
in least amount of time. Let’s analyze Sarah’s collection strategy keeping this objective in
mind.

 Credit sales have been increased from 60% to 80%. This strategy is adopted to
increase the sales as most customers prefer credit purchase over cash purchase,
but the shortfall is that this strategy will negatively impact the working capital
structure of the company.
  Another shortfall of increasing the credit sales is that it will deplete the cash
reserves which can be invested to returns. There is clear loss of such opportunity
gain in such a scenario
 In current cash collection strategy, the, 70% of credit revenue was recovered in
same month and remaining 30% is recovered in subsequent month. However, in
Sarah’s collection strategy, only 15% is collected in current month while 75% of
credit revenue is collected in subsequent month.

Cleary, the collection of the major portion of credit revenue is deferred by a

month in new collection strategy. When it comes to cash collection strategy, the
sooner is the better. Even the principle of time value suggests that a rupee
received today is more valuable than a rupee received tomorrow. The Sarah’s
collection strategy is not aligned with this basic principle.

 Sarah has introduced a sales-based commission for all sales force in order to
improve the sales. The effectiveness of this strategy should be analyzed along
with the additional sales generated from this approach.

 By adopting Sarah’s collection strategy, the uncollectible amount stands at 10%,

which was nil in current cash collection strategy.

A strategy with greater credit period will always have greater risk of credit going
bad than a strategy where credit period is shorter. Sarah’s collection strategy has
offered greater credit periods to its customer that what was offered currently. This
approach has resulted in uncollected amount of 10%

Conclusion:
We have identified many shortfalls in Sarah’s cash collection strategy, but the upside is that
there has been a dramatic increase in sales volume.
To conclude, Sarah’s collection strategy should be continued if the gain achieved from
increase sales volume less commissions of sales force, opportunity cost and uncollected
amount is positive.

Question 8.
Standard costing is a mechanism which is used as a tool of cost control. As per this system,
the estimated cost and actual cost are compared and the variances among them are deeply
analyzed to understand the root causes of such variances.

How would an unfavorable price variance on a particular purchase affect the overall
price variance for the year and the manager's bonus?

A unfavorable price variance occurs when,

(Standard Price – Actual Price) * Actual Quantity = Negative Value

To avoid a situation of unfavorable price variance, actual purchases must be lower that
estimated or standard cost.
The overall price variance is the sum total price variances of all products. So, any variance,
whether favorable or unfavorable will affect the overall price variance accordingly. Here the
unfavorable price variance will end up reducing the net favorable balance if any
As the purchase manager is paid bonus based on the net favorable material price variance, if
there are no sufficient favorable variable balance accumulated on account of purchases of
other products, then unfavorable price variance on this particular purchase would wipe out
the bonus of materials purchasing manager.

Would the use of the materials price variance as a basis for the manager's bonus lead to
a
desirable or undesirable behavioral outcome?

The job of the materials purchasing manager is to ensure that the products of required quality
are being procured at most economical prices while looking for opportunities in the market.
Such an function in the organization should not be under any biasing while performing its
duties. If any kind of remuneration is linked to material price variance, then more chances are
there that purchasing manager will have certain preferences and inclination to ensure
maximum remuneration to him, which may not be beneficial to the organization. This will
not be a justice to his role.

Thus, use of materials price variance as basis for manger’s bonus will lead to a undesirable
behavioral outcome.

Question 9. Evaluate the continuity of the shoe department and justify your answer
Please refer the excel sheet.
Clothing Accessories
Particulars Shoes (Rs) Total
(Rs) (Rs)
7,22,5 2,20, 9,42,5
Sales  
00 000 00
4,33,5 1,28, 5,61,5
Less: Variable cost  
00 000 00
2,90,0 25, 42 3,57,0
Less: Fixed Cost
00 000 ,000 00
16
Remodeling cost      
,000
7,23,5 25, 1,86, 9,34,5
Total cost
00 000 000 00
Operating Profit
-1,000 -25,000 34,000 8,000
(Loss)

Workings,
 Sales:

Clothing sales would be reduced by 15 % from 8,50,000 to 7,22,500. There would be

no sales in shoe department. Accessories sales will increase to 2,20,000 (1,50,000+
70,000).

 Variable cost:

Variable cost current is at 60% of sales for clothing. Taking that into consideration
variable cost will be reduced to 4,33,500. As there are no sales, there wont be any
variable cost for Shoe department. In case of accessories, for initial sales of 1,50,000/-
, the variable cost will be 55% of sales and for incremental sales of 70,000 the
variable cost will be 65% of total sales as contribution margin mentioned is 35%.
Putting it together it comes to 5,61,500 (82500+45500).

 Fixed Cost:

Fixed cloth for clothing won’t change. A salaried salesperson at shoe department is
terminated, hence the reduced fixed cost of shoe department will stand at 25,000
(70,000 – 45000) as other departmental fixed cost shall continue. There won’t be any
changes in fixed cost of accessories.
 Remodeling cost:

Remodeling cost is only being incurred in accessories department

Conclusion: We can observe from the table that the total profit of Fab Fashion Pvt Ltd
declines from
55,500 (50,000-20,000+25,500) to 8,000 (34,000-25,000-1,000)

Therefore, the loss if shoe department is closed will be (55,500 – 8000) = 47500

It is advisable to continue and not consider closing the shoe operation.

Question 10.

Here we have a situation to decide whether to provide the food facility inhouse or to
outsource the food services

Let’s examine the total cost incurred in case of each scenario

Scenario 1: St Luke’s hospital provides the food service inhouse
Consider the below table for cost computation.
Particulars Amount (Rs)
8,90,
Food cost
000
85
Labour
,000
Variable 35
Overhead ,000
Less: Net (8
Income 0,000)
Net cost 9,30,000

Note: Allocated fixed overhead of Rs 60,000 is not considered as this is allocated cost and it
is irrelevant in decision making

Scenario 1: St Luke’s hospital outsources the food services to NIFS

Consider the below table for cost computation.

Particulars Amount (Rs)

Food cost -
Labour (85000*10%)
8,500
Variable Overhead (35000*10%)
3,500
(9
Less: Net Income (80000* 115 %)
2,000)
NIFS charges (250 Beds *365 days*70% 8,94,
occupancy*Rs 14 for each patient served) 250
Net cost 8,14,250

Note: Allocated fixed overhead of Rs 60,000 is not considered as this is allocated cost and it
is irrelevant in decision making

Conclusion: There is a net gain of Rs 1,15,750 (9,30,000 – 814250) from outsourcing food
service and also NIFS is offering improved menu, It is advisable that the food services should
be outsourced to NIFS

Question 11.
Let’s examine the situation based on various scenarios

Scenario 1: If Icon Pvt ltd pays another 50,000 as demanded by UKL for manufacturing
and continues the manufacturing of Shirts.

Revenue that would be earned = 25000 units of T-shirts * 50 T-shirt = Rs 12,50,000

Less: Rs 3,30,00 (Estimated future marketing cost)
Less: Rs 50,000 (Additional amount demanded by UKL for manufacturing rights)
Here, the net benefit would be Rs 8,70,000 (12,50,000 - 3,30,000 -50,000)

Notes:
 Here, already paid costs such as initial amount paid to UKL of 85,000 and
Manufacturing cost of 4,10,000 paid to date are not considered as these are sunk cost
and in relevant costing sunk cost are irrelevant for decision making.
 Cost of T-shirts manufactured is not considered as this cost is independent of decision
being taken. This cost is non-avoidable, irrespective of any decision taken. Hence this
cost becomes irrelevant here

Scenario 2: If Icon Pvt ltd decides to fight a lawsuit against UKL and UKL ends up
winning the case (As they have a strong case as per lawyer of Icon Pvt Ltd)
There would be no revenue, nor any cost would be required to incurred in this case. However,
the initial amount of 85,000 paid to UKL will be not be recovered. But as this is sunk cost, it
is irrelevant for any decision making

So, the Net gain here is nil.

Observing the above two scenarios closely, it is recommended that Icon Pvt ltd accepts the
offer of UKL to pay additional 50,000 for manufacturing rights.

Question 12:

The service department is not involved directly in the production of goods and services in an
organization. They provide services that helps the organization to produce and deliver the
products or services. For example, the human resources department is recruiting manpower to
work on the production side of the organization and they also cater to the needs of the
employees or the workforce to ensure smooth sailing of production chain.

The scenario in the problem states two aspects:

1. The department is evaluated on the basis of performance of profit
2. The performance of the department has lowered this year because of the allocation of
general and administrative costs being much higher than the last.

In the current year, even though there is a slight increase in service revenue the sales
have decreased.
We know that, costs must be assigned to that certain cost objective that caused it.
There are three broad reasons why costs are allocated: -

 To Motivate: Costs influence management behaviour and promote their vision

for the future.
 To have an estimate or compute income and asset valuations: Costs of goods
sold and the inventory are calculated based on the costs allocated to the
products. They help in planning and evaluation for the managers.
 Justifiable costs and reimbursements: Perhaps to justify a price of a product or
service for which the cost is associated directly.
Furthermore, lets understand the different types of Allocation –
 Allocation of joint costs to the respective responsibility centres: Those costs
which are jointly used by all different departments. Example – Rent for the
office space each department has occupied.
 Reallocation of costs one centre to another centre: Suppose, one department
provides services or products to another department, the costs and expenses
therewith are transferred along with the product and service provided.
Example – General Administration and Legal department in an industrial firm.
 Allocation of costs of an organizational unit to its output: This cost includes
the above two types of costs mentioned. When a paediatrics unit in an hospital
allocates the costs to the patient visited.
However, all the three are similar fundamentally. In certain companies where
in they involve in the manufacturing, the manufacturing overheads costs are
assigned to production and services department. But in some cases, as in the
case of the Dirt Bike Sale and Services Company, service department is the
main operating department. Hence based on the performance, as evaluated by
Rex Mathew, the service department was reallocated General and
Administration expenses based on the sales it generated in the previous year.