@cmaupdates20 SCM - SPM Notes Part 2

ADVANCED
STRATEGIC COST
MANAGEMENT
Volume 2 [Block - C, D & E]
For CA-CMA - Final Level
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Contents
CA Final-SCM CMA Final
Block Chapter Page No
New Old SCM SPM
CA Final Syllabus of ICAI ✓ ✓
CMA Final Syllabus of ICMAI ✓ ✓
The Three Tier Preparation Model 10 ✓ ✓ ✓ ✓
How to Make Notes 11 ✓ ✓ ✓ ✓
The Day before CA Final Costing Exam 12 ✓
The Exam Hall Strategy 14 ✓ ✓ ✓ ✓
How to Study Theories 15 ✓ ✓ ✓ ✓
How to Approach a Question 16 ✓ ✓ ✓ ✓
Graph Pages - for Linear Programming 17 – 28 ✓ ✓ ✓
1. Traditional vs Strategic Cost Management 31 – 44 ✓ ✓ ✓
2. Standard Costing 45 – 91 ✓ ✓ ✓
A 3. Performance Evaluation Models 92 – 130 ✓ ✓ ✓
4. Learning Curve Theory 131 – 145 ✓ ✓ ✓
5. Relevant Costing 146 – 183 ✓ ✓ ✓
B 6. Divisional Transfer Pricing 184 – 215 ✓ ✓ ✓
7. LP-Formulations and Graphical Methods 216 – 236 ✓ ✓ ✓
8. CVP Analysis 237 – 260 ✓ ✓ ✓
9. Make or Buy Decisions 261 – 275 ✓ ✓ ✓
10. Key Factors 276 – 291 ✓ ✓ ✓
C 11. Sub Contracting 292 – 306 ✓ ✓ ✓
12. Other Areas of Decision Making & Service 307 – 333 ✓ ✓ ✓
Sector
13. Total Quality Management and Innovation 334 – 361 ✓ ✓ ✓ ✓
D 14. Theory of Constraints 362 – 368 ✓ ✓ ✓
15. Just in Time and Lean System 369 – 393 ✓ ✓ ✓
16. Activity Based Costing 394 – 413 ✓ ✓ ✓ ✓
17. Strategic Analysis of Operating Income 414 – 423 ✓ ✓ ✓ ✓
18. Target Costing 424 – 437 ✓ ✓ ✓ ✓
E 19. Life Cycle Costing 438 – 448 ✓ ✓ ✓
20. Pricing Strategies 449 – 472 ✓ ✓ ✓ ✓
21. Budgeting and Budgetary Control 473 – 506 ✓ ✓
22. Supply Chain Management 507 – 521 ✓ ✓ ✓
23. Environmental Management Accounting 522 – 529 ✓
F 24. Cost Management for Specific Sector 530 – 535 ✓
25. Case Studies 536 – 596 ✓
QT CHAPTERS
26. Simplex 597 – 613 ✓
27. Assignment 614 – 628 ✓ ✓
G 28. Linear Programming : Transportation 629 – 648 ✓ ✓
29. Project Management : CPM & PERT 649 – 672 ✓ ✓
30. Simulation 673 – 687 ✓ ✓
H Recap Theory Questions 688 – 786 ✓ ✓ ✓
Z Table 812
Contents for Recap Theory Questions
Sl. No. Chapter Page No

1. Basic Cost Concepts 688
2. Activity Based Costing 695
3. Budgeting, Performance Measurement and Theory of Constraints 704
4. Relevant Costing, Marginal Costing and Decision Making 711
5. TQM, Value Chain Analysis and Business Process Reengineering 721
6. Pricing 729
7. Service Sector 731
8. Standard Costing 733
9. Target and Life Cycle Costing 737
10. Transfer Pricing 747
11. MRP, MRP-II, ERP and JIT 752
12. Uniform Costing and Inter Firm Comparison 760
13. Learning Curve 763
14. Linear Programming 770
15. Simplex 772
16. Assignment 775
17. Transportation 778
18. CPM and PERT 781
19. Simulation 786
CVP Analysis
Class
WORK
Chapter 8
CVP Analysis
Techniques 1. Absorption Costing
of Costing 2. Marginal Costing
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Uses of Marginal 1. Pricing - in Competition
Costing 2. CVP Analysis
3. Management Decision Making
Comparative Income Under Marginal Costing and Absorption

Statement Costing
CVP Analysis 1. Basics

Calculations a. Contribution
b. Break up ofTotal Cost
c. Prot Volume Ratio
2. Break Even Analysis
a. Break Even Point and Cash Break Even
Point
b. Margin of Safety
c. Break Even Point and Prot Volume
Chart
d. Jugalbandi Jodi
e. Break Even Point of Multiple Products
f. Break Even Point in Case of Merger
g. Break Even Point of Perishable
Products and Potential Break Even
Point
h. Break Even with Opportunity Cost
i. Break Even Point with Step Fixed Costs
or Multiple BEP
j. BEP with Probability
k. CVP under uncertainty
3. Indifference Analysis
a. Indifferent Point Analysis
b. Shutdown Point Analysis
| 237
Advanced Strategic
Cost Management
CVP Analysis
Class
WORK
COST – VOLUME – PROFIT ANALYSIS

CVP Analysis is a systematic way of examining the relationship between changes in activity or volume
and changes in total sales revenue, expenses and profit. The analysis is applicable in the short – run
being a period of one year or less, in which the output of a firm is restricted to that available from the
current operating capacity. The objective of the analysis is to establish what will happen to the finan-
cial results if a specified level of activity or volume fluctuates.
The assumptions made are:
(a) All other variable remain constant.
(b) A single product or multi – products with constraint sales mix.
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(c) Fixed costs do not change.

(d) Profits are calculated on a variable costing basis.
(e) Total costs and total revenues are linear functions of output.
(f) The analysis applies to the relevant range of output only.
(g) Cost can be accurately divided into fixed and variable elements.
(h) The analysis applies only to the short term horizon.
CURVILINEAR CVP ANALYSIS

In CVP analysis, the usual assumption is that the total sales line and variable cost line will have linear
relationship, that is, these lines will be straight lines, and however, in actual practice it is unlikely to
have a linear relationship for two reasons, namely:
(a) After the saturation point of existing demand the sales value may show a downward trend.
(b) The average unit variable cost declines initially, reflecting the fact that, as output increases the
firm will be able to obtain bulk discounts on the purchase of raw materials and can also benefit
from division of labour. When the plant is operated at further higher levels of output, due to
bottlenecks and breakdowns the variable costs per unit will tend to increase. Thus the law of in-
creasing costs may operate and the variable cost per unit may increase after reaching a particular
level of output.
In such cases, the contribution will not increase in linear proportion on the phenomenon of diminish-
ing marginal productivity, the total cost line will not be straight, as assumed but will be of curvilinear
shape. This situation will give rise to two break even points. The optimum profit profits is earned at the
point where the distance between sales and total cost is the greatest.
238 |Advanced Strategic

Cost Management
CVP Analysis
Class
WORK
Q 1 Ex. Book No. Pg. No.
The following details are given for a company:
Margin of Safety – ` 1,87,500 (7,500 units)

Total Cost – ` 1,93,750
Break Even Sales – 2,500 units
Find:
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(a) Profit
(b) Profit Volume Ratio
(c) Break Even Sales (`)
(d) Fixed Cost
Reference What’s New
Break Even Analysis

November, 2010
Titan Engineering is operating at 70% capacity and presents the following information:
Break Even Point ` 200 Crores

PV Ratio 40 %
Margin of Safety ` 50 Crores
Management has decided to increase production to 95% capacity level with the following modifica-
tions. The selling price will be reduced by 8 %. The variable cost will be reduced by 5% on sales. The
fixed cost will increase by ` 20 crores , including depreciation on additions, but excluding interest on
additional capital. Additional capital of ` 50 crores will be needed for capital expenditure and working
capital. The management will be needed to earn ` 10 crores over and above the present profit and
also meet 20 per cent interest on the additional capital. What will be the revised Break-even point, P/V
Ratio, and Margin of safety?
Break Even Analysis Variable Cost Calculation
Advanced Strategic
Cost Management | 239
CVP Analysis
Class
WORK
The comparative profit statement of two quarters of a firm is as under:
Particulars Quarter I Quarter II

Units sold 2,500 3,750
Direct materials 87,500 ?
Direct wages 62,500 ?
Fixed and variable factory OH 75,000 96,000
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Sales 2,75,000 ?
Profit 50,000 65,250
In the second quarter, the direct material price has increased by 20%. These was a saving of ` 4,000 in
fixed overheads in the second quarter. The other costs and selling price remained the same.
Determine the quantity that should have been sold in the second quarter to maintain the same
amount of profit per unit as in the first quarter.
Break Even Analysis Breakup of total Overheads
A company makes 1,500 units of a product for which the profitability statement is given below:
`
Sales 1,20,000
Direct materials 30,000
Direct labour 36,000
Variable overhead 15,000
Subtotal variable cost 81,000
Fixed cost 16,800
Total cost 97,800
Profit 22,200
After the first 500 units of production, the company has to pay a premium of ` 6 per unit towards over-
time labour. The premium so paid has been included in the direct labour cost of ` 36,000 given above.
You are required to compute the Break – even point.

Cost Management
CVP Analysis
Class
WORK
Break Even Analysis Varying Level of Cost

May, 2007
C Block
A ltd makes and sells a single product. The company’s trading results for the year 2009 are:
` in ‘000
Sales 3,000
Direct materials 900
Direct labour 600
Overheads 900
2,400
Profits 600
For the year 2010, the following are expected:

1. Reduction in selling price by 10 %
2. Increase in quantity sold by 50 %
3. Inflation of direct material cost by 8 %
4. Price inflation in variable overhead by 6 %
5. Reduction of fixed overhead expenses by 25 %
It is also known that:
(a) In 2008, overhead expenditure totalled to ` 8,00,000.
(b) Total overhead cost inflation for 2009 has been 5 % more than 2008.
(c) Production and sales volumes have been 25 % higher in 2009 than in 2008.
The high – low method is used by the company to estimate overhead expenditure.
(a) Prepare a statement showing the estimated trading results for 2010.
(b) Calculate the break - even point for 2009 and 2010.
(c) Comment on the BEP and profits of the years 2009 and 2010.
Break Even Analysis Breakup of Total Overheads

May, 2008
Advanced Strategic
CVP Analysis
Class
WORK
SP ` 20
VC ` 12
Fixed Cost ` 2,00,000
Sales forecasts Pb
15,000 10%
20,000 10%
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25,000 10%
30,000 20%
35,000 30%
40,000 10%
45,000 10%
(a) What is the probability that the firm can Break even?
(b) What is the probabilities of achieving sales (i) To earn a profit of ` 60,000 (ii) To incur a loss of `
50,000
Break Even Analysis with Probability

Effect
The selling price of a product for the next accounting period is 110, and the variable cost is estimated
to be 70 per unit. The budgeted fixed costs for the period are 1,63,500. Estimated sales for the period
are 5,000 units, and it is assumed that the probability distribution for the estimated sales quantity is
normal with a standard deviation of 125 units. The selling price, variable cost and total fixed cost are
assumed to be certain. What is the probability of profits being greater than 40,000? (Area to the left of
z = 0.7 = 0.7580)
Break Even Analysis under uncertainty

Cost Management
CVP Analysis
Class
WORK
Two manufacturing companies which have the following operating details decide to merge:-
PARTICULARS Company I Company II

Capacity utilization 90 % 60 %
Sales (` in lakhs) 540 300
Variable cost (` in lakhs) 396 225
Fixed cost (` in lakhs) 80 50
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In the merged company, it was decided to incur additional fixed cost of ` 15 lacs. Expenses incurred
on merger against formation of new company was ` 2 lacs.
Assuming that the proposal is implemented, Calculate:-
a. Break even sales of the merged plant and the capacity utilization at that stage.
b. Profitability of the merged plant at 80 % capacity utilization.
c. Sales turnover of the merged plant to earn a profit of ` 75 lakhs.
Break Even Analysis in case of Merger Merged PV Ratio
The budgeted results of a company are given below. The total sales are ` 12,50,000 and the fixed over-
heads for the period are ` 5,02,200.
Product % Sales Mix PV Ratio

X 20 50
Y 32 40
Z 48 30
Required:
1. Find overall break even sales.
2. Prepare a statement showing the amount of loss being incurred at present.
3. Recommend a change in the total sales value and the sales of all products required to eliminate
loss and earn a profit of ` 10,000 at the same sales mix.
4. Recommend the additional sales in any one individual product to eliminate loss and earn a profit
of ` 10,000.
Advanced Strategic
CVP Analysis
Class
WORK
Break Even Analysis with Multiple Combined PV Ratio

Products

C Block
Anuradha Enterprises manufactures and sells black phenyl worth ` 20,000, white phenyl worth `
25,000, scented phenyl worth ` 10,000 and naphthalene balls worth ` 5,000 every month. The firm’s
total fixed costs per month are ` 14,700. The variable costs are: on black phenyl 60%, on white phenyl
68%, on scented phenyl 80% and on naphthalene balls 40%.
The proprietor, Ms Anuradha Shah, being casually a science graduate, wonders at what combined
sales volume she will really start earning profit. Please help her in arriving at such a sales volume.
Break Even Analysis with multiple Combined PV Ratio

Products
May, 1999
Jayveeru Ltd makes and sells two products – Veeru and Jay. The budgeted selling price of Veeru is `
1,800 and that of Jay is ` 2,160. Variable costs associated with producing and selling of the Veeru are `
900 and with Jay ` 1,800. Annual fixed production and selling costs of Jayveeru Ltd. are ` 88,000.
The company has two production and sales options. The Veeru and Jay can be sold either in the ratio
of two Veerus to three Jays or in the ratio of one Veeru to two Jays.
What will be the optimal mix and why?
Break Even Analysis with Multiple Evaluation of Product Mix

Products
November, 1999

Cost Management
CVP Analysis
Class
WORK
Entertain U Ltd. hires an air conditioned theatre to stage plays on weekend evenings. One play is
staged per evening. The following are the seating arrangements:
VIP rows: the first 3 rows of 30 seats per row, priced at ` 320 per seat.
Middle Level – the next 18 rows of 20 seats per row, priced at ` 220 per seat.
Last level – 6 rows of 30 seats per row, priced at ` 120 per seat.
For each evening, a drama troupe has to be hired at ` 71,000. Rent has to be paid for the theatre at
` 14,000 per evening and air conditioning and other stage arrangement charges work out to ` 7,400
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per evening. Every time a play is staged, the drama troupe’s friends and guests occupy the first row
of the VIP class, free of charge, by virtue of passes granted to these guests. The troupe ensures that
50% of the remaining seats of VIP class and 50% of the seats of other two classes are sold to outsid-
ers in advance and the money is passed on to Entertain U. The troupe also finds for every evening, a
sponsor who puts up his advertisement banner near the stage and pays Entertain U a sum of ` 9,000
per evening. Entertain U supplies snacks during the interval, free of charge to all the guests in the
hall, including the VIP free guests. The snacks cost Entertain U ` 20 per person. Entertain U sells the
remaining tickets and observes that for every one seat demanded from the last level, there are 3 seats
demanded from the middle level and 1 seat demanded from the VIP level. You may assume that in
case any level is filled, the visitor buys the next higher or lower level, subject to availability.
(a) You are required to calculate the number of seats that Entertain U has to sell in order to break
even and give the category wise total seat occupancy at BEP.
(b) Instead of the given pattern of demand, if Entertain U finds that the demand for VIP, Middle and
Last Level is in the ratio 2:2:5, how many seats in each category will Entertain U have to sell in
order to break even?
Break Even Analysis with Multiple Application in Theatre

Products
May, 2011
A newspaper company presently sells 1,00,000 copies of its morning daily. It wants to publish evening
daily. The following particulars are given:
Actuals for Morning Estimates for Evening

Sale Price ` 2 per paper ` 0.50 per paper
Variable cost ` 1.20 per paper ` 0.22 per paper
Fixed cost ` 2,40,000 per week ` 10,000 per week
Advanced Strategic
CVP Analysis
Class
WORK
Sale of morning daily will fall @ 1 copy for-every 10 copies sold of evening daily. Calculate break-even
sales for evening daily. What should be the minimum price for evening daily if the demand is 80,000
units per week.
Break Even Analysis with Opportunity

Cost
November, 2005
C Block
A pharma company produces formulations having a shelf life of one year. The company has an open-
ing stock of 30,000 boxes on 1st January 2010 and expected to produce 1,30,000 boxes as was in the
just year ended of 2009. Expected sale would be 1,50,000 boxes. Costing department has worked out
escalation in cost by 25 % on variable cost and 10 % on fixed cost. Fixed cost for year 2009 was ` 40 per
box. New price announced for 2010 is ` 100 per box. Variable cost on opening stock is ` 40 per box. You
are required to compute the Break – even volume for year 2010. Also find Potential Break – even point.
Break Even Analysis for Perishable

Products and Potential Break Even Point
The following information is given:

Fixed Cost ` 30
SP per unit ` 80
VC per unit ` 20
Slab cost ` 20 for every 3 units
Show Break Even point for first 3 slabs and comment.
Break Even Analysis with Step Fixed Cost Columnar Method, Real and
Imaginary Break Even

Cost Management
CVP Analysis
Class
WORK
The following information is given:

Fixed Cost ` 200
SP per unit ` 100
VC per unit ` 70
Show Break Even point for first 8 slabs and comment.
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Break Even Analysis with Step Fixed Cost Columnar Method
From the following calculate Break Even Point:
SP per unit ` 100

VC per unit ` 60
Fixed cost ` 2,48,000
Break Even Analysis with Step Fixed Cost Algebric Method
Advanced Strategic
CVP Analysis
Class
WORK
X ltd manufactures a semiconductor for which the cost and price structure is given below:
` per unit
Selling price 500
Direct material 150
Direct labour 100
Variable overhead 50
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Total Fixed cost 2,00,000
The product is manufactured by a machine, whose spare part costing ` 2,000 needs replacement after
every 100 pieces of output. This is in addition to the above costs. Assume that no defectives are pro-
duced and that the spare part is readily available in the market at all times at ` 2,000.
(a) Prepare the profitability statement for production levels of 2,000 units and 3,000 units when
fixed cost is ` 1 lac.
(b) What is the break - even point for the above data i.e. when fixed cost is ` 1 lac and ` 2 lac?
(c) Comment on the BEP, if the fixed cost can be reduced to ` 1,80,000 from the existing level of ` 2
lacs.
Break Even Analysis with Step Fixed Cost

November 2006
Kalyan University conducts a special course on “Computer Application” for a month during summer.
For this purpose, it invites applications from graduates. An entrance test is given to the candidates
and based on the same, a final selection of a hundred candidates is made. The Entrance Test consists
of four objective type examinations and is spread over four days, one examination per day. Each can-
didate is charged a fee of ` 500 for taking up the entrance test. The following data was gathered for
the past two years:
Statement of Net Revenue from the Entrance Test For the Course of “Computer Application”
2008 (`) 2009 (`)

1. Gross revenue (Fees collected) 10,00,000 15,00,000
2. Costs: Valuation 4,00,000 6,00,000
Question Booklets 2,00,000 3,00,000

Cost Management
CVP Analysis
Class
WORK
Hall rent at ` 20,000 per day 80,000 80,000

Salary 60,000 60,000
Supervision Charges 40,000 60,000
(1 supervisor for every 100 candidates at ` 500 per day)
General Administration expenses 60,000 60,000
Total cost 8,40,000 11,60,000
3. Net revenue 1,60,000 3,40,000
You are required to compute:

(a) The budgeted net revenue if 4,000 candidates take up the entrance test in 2010.
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(b) The break-even number of candidates.
(c) The number of candidates to be enrolled if the net income desired is ` 2,00,000
Break Even Analysis with Step Fixed Cost Profit with Step Fixed Cost
Vivek Elementary School has a total of 300 students consisting of 5 sections with 60 students per sec-
tion. The school plans for a picnic around the city during the week – end to places such as the zoo, the
Nicco Park, the planetarium, etc. A private transport operator has come forward to lease out the buses
for taking the students. Each bus will have a maximum capacity of 50 (excluding 2 seats reserved for
teachers accompanying the students). The school will employ two teachers for each bus, paying them
an allowance of ` 50 per teacher. It will also lease out the required number of buses. The following
are the other cost estimates:
PARTICULARS COST
Breakfast `5
Lunch ` 10
Tea `3
Entrance Fee at Zoo `2
Rent per bus ` 650
Special permit fee per bus ` 50
Block Entrance fee at planetarium:
No. of students Amount (`)

Upto 100 200
101-200 300
201 & above 450
Advanced Strategic
CVP Analysis
Class
WORK
Prizes to students for games is as below:
No. of students Cost of prizes (`)

Upto 50 900
51 – 125 1,050
126 – 150 1,200
151 – 200 1,300
201 – 250 1,400
251 & above 1,500
No costs are incurred in respect of the accompanying teachers (except the allowance of ` 50 per
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teacher).
To meet the above costs the school collects ` 40 from each student who wish to join the trip. The
School releases subsidy of ` 5 per student in the trip towards it.
You are required to:
(a) Prepare a tabulated statement showing total costs at the levels of 60, 120, 180, 240 and 300 stu-
dents indicating each item of cost.
(b) Compute average cost per student at each of the above levels.
(c) Calculate the number of students to break even for the trip as the school suffered loss during the
previous year despite 72% of the students having joined the trip.
Break Even Analysis with Step Fixed Cost Columnar Method, Real and
Imaginary Break Even
M company is evaluating two new machines to replace the firm’s current machine, which is worn out.
The analysis of alternative machines has been narrowed to A and B and the estimated costs of oper-
ating them are shown below:
Machine A Machine B
Material Costs per unit ` 60 ` 40
Labour Costs per unit ` 80 ` 30
Estimated Fixed Costs ` 30,000 ` 58,000
The current selling price per unit is ` 340 and the company expects a sale of 800 units in the next year
after the machine is replaced.

Cost Management
CVP Analysis
Class
WORK
Required:
1. Compute the cost indifference points for the two machines and suggest which one to buy.
2. Assuming the company buys the machine it selects and after some time it realises that the new
machine has improved the quality of the product. Hence the management feels justified to hike
the selling price to ` 470. The management is aware that this may bring down the sales. To coun-
ter this, it wishes to spend ` 10,000 on advertising highlighting the improved quality of the prod-
uct. If the management does not want to lose out on expected profits, find the price indifference
point and comment.
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Indifference Point Analysis Price Indifference
The following are cost data for three alternative ways of processing the clerical work for cases brought
before the management :
A B C
Manual Semi – Automatic Fully Automatic
Monthly Fixed Costs (`)
Occupancy 15,000 15,000 15,000
Maintenance contract 0 5,000 10,000
Equipment lease 0 25,000 1,00,000
Total 15,000 45,000 1,25,000
Unit Variable Cost
Supplies (`) 40 80 20
Labour 5 hr @ ` 40 1 hr @ ` 60 0.25 hr @ ` 80
Required:
(a) Calculate cost indifference points. Interpret your results.
(b) If the present load is 600 cases and it is expected to go up to 850 cases in near future, which
method is most appropriate on cost considerations?
Indifference Point Analysis Three Options
Advanced Strategic
CVP Analysis
Class
WORK
Standard Pumps Ltd. is manufacturing Petrol and Diesel operated pumps. The company wants to have
a customer survey before marketing the pumps. You are asked to workout the economics of choice
between the two types of pumps. The company provides you the following:
Petrol Operated Diesel Operated

Pump X Pump Y
Selling Price (`) 80,000 1,24,000
Cost of fuel per litre (`) 40 25
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Operating Hours per litre 20 40
Using above data answer following questions:-

a. How many hours the pumps should run so that the customer willing to buy is indifferent in choice
between X and Y? Assume that fuel cost has linear function with respect to time. 32000 Hrs.
b. Assuming the price of X remains unchanged, and the customer wants to run the pump for 12,800
hours, how much he will be willing to pay for Y ?
c. If Standard Pump Ltd. offers to convert a Petrol operated Pump to Diesel operated one after
18,000 hrs of operation of the former, how much customer will be willing to pay for this modifi-
cation of the pump?
d. If there is a saving of ` 33,500 in operating cost of Y over its life, how many hours the customer
should expect to run the pumps so as to be indifferent in choice?
e. If there is a restriction on the fuel supply to the extent of 750 litres for both Petrol & Diesel what
will be customer’s preference either for Petrol operated or Diesel operated one?
f. Do you suggest any other point that should be considered for choice between alternatives apart
from above?
Indifference Point Analysis Case Study

Cost Management
CVP Analysis
Class
WORK
Paints ltd manufactures 2,00,000 tins of paint at normal capacity per annum. It incurs the following
manufacturing costs per unit:
`
Direct material 7.80
Direct labour 2.10
Variable overhead 2.50
Fixed overhead 4.00
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Each unit is sold for ` 21 with an additional variable selling overhead incurred at ` 0.60 per unit.
During the next quarter, only 10,000 units can be produced and sold. Management plans to shut down
the plant estimating that the fixed manufacturing cost can be reduced to ` 74,000 for the quarter.
When the plant is operating, the fixed overheads are incurred at a uniform rate throughout the year.
Additional costs of plant shut down for the quarter are estimated at ` 14,000.
You are required:
(a) To advise whether it is more economical to shut down the plant during the quarter rather than
operate the plant.
(b) Calculate the shut down point for the quarter in terms of units.
Shutdown Point Analysis

November 2008
G ltd. Produces and sells 95,000 units of X in a year at its 80% production capacity. The selling price
of product is ` 8 per unit. The variable cost is 75 % of sales price per unit. The fixed cost is ` 3,50,000.
The company is continuously incurring losses and the management plans to shut down the plant. The
fixed cost is expected to be reduced to ` 1,30,000. Additional cost of plant shut down are expected at
` 15,000.
Should the plant be shut down? What is the capacity level of production at shut down point?

November 2010
Advanced Strategic
CVP Analysis
Class
WORK
Alfa Engineering Works Ltd. had the following annual budget for the year ending on 30th June:
` in lakhs 60% 80%

Production capacity costs:
Direct materials 9.60 12.80
Direct labour 7.20 9.60
Factory expenses 7.56 8.04
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Administrative expenses 3.72 3.88

Selling and distribution expenses 4.08 4.32
Total cost 32.16 38.64
Profit 4.86 10.72
Sales 37.02 49.36
Owing to adverse trading conditions, the company has been operating during July/September at 40%
capacity, realizing budgeted selling prices.
Owing to acute competition, it has become inevitable to reduce prices by 35% even to maintain the
sales at the existing level. The directors are considering whether or not their factory should be closed
down until the trade recession has passed.
A market research consultant has advised that in about a year’s time there is every indication that sales
will increase to 75% of normal capacity and that the revenues to be produced for the full year at that
volume could be expected to ` 40 lakhs
If the directors decide to close down the factory for a year it is estimated that:
a. The present fixed costs would be reduced to ` 6 lakhs p.a.
b. Closing down costs (redundancy payments, etc.) would amount to ` 2 lakhs.
c. Necessary maintenance of plant would cost ` 50,000 p.a.; and
d. On re-opening the factory, the cost of overhauling the plant, training and engagement of new
personal would amount to ` 80,000.
Prepare a report for the directors, making your recommendations.

Cost Management
CVP Analysis
Class
WORK
Solution
REPORT TO DIRECTORS
As discussed, we have analysed the cost implications of the decision of temporary closure of the fac-
tory due to trade recession. We find that if the factory is run at 40% capacity and with the reduced
selling prices, the loss likely to be incurred in one full year (the estimated period of recession) would
be around ` 9.64 lakhs as detailed below:
Particulars ` in lakhs
Direct materials 6.40
Direct labour 4.80
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Factory expenses 7.08
Administrative expenses 3.56
Selling and distribution expenses 3.84
Total cost 25.68
Sales (37.02 x 40/60 x 65%) 16.04
Loss 9.64
If the factory is closed, the following costs will be incurred:
Particulars ` in lakhs
Fixed costs 6.0
Closing down costs 2.0
Maintenance costs 0.5
Cost of overhauling 0.8
Loss 9.3
The loss will be minimum if factory is closed down.

In our views, even if running the factory entailed a somewhat bigger loss as compared to the loss
incurred by closing it down temporarily, it may be better to keep the factory in operation. This is
because a closure, even if temporary, results in the loss of regular and old customers, suppliers and
skilled personnel. This, coupled with a loss of goodwill in the market, may give rise to substantial loss-
es at the time of restarting the factory.
We trust that the above analysis would be helpful to you in reaching an appropriate decision in the
matter. We shall be glad to be of any further assistance that may be required in this regard.
Working Note:
Factory expense Administrative expense Selling expense

At 60% 7.56 3.72 4.08
At 80% 8.04 3.88 4.32
Change for 20% 0.48 0.16 0.24
VC at 100% 2.40 0.80 1.20
VC at 60% 1.44 0.48 0.72
FC 7.56 - 1.44 = 6.12 3.72 - 0.48 = 3.24 4.08 - 0.72 =3.36
Total cost at 40% 7.08 3.56 3.84
| 255
Advanced Strategic
Cost Management
CVP Analysis
Home
A Block
WORK
Yash Raj Films operates in the entertainment industry and one of its activities is to promote concerts
at locations throughout India. Yash Raj is examining the viability of a concert in Kolkata. Estimated
Fixed costs are ` 60,00,000. These include the fees paid to performers, the hire charges of the venue
and advertising costs. The variable costs consist of the cost of a pre – packed buffet which will be pro-
vided by a firm of caterers at a price, which is currently being negotiated, but it is likely to be ` 1500
per ticket sold. The proposed price per ticket is ` 3,000.
Required:
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1. How many tickets must be sold to break – even?

2. How many tickets must be sold to earn a profit of ` 30,00,000?
3. What profit would result if 8,000 tickets are sold?
4. What selling price would have to be charged to give a profit of ` 30,00,000 on sale of 7,000 tickets?
Break Even Analysis
The following data are provided for an output of 10,000 units.
Selling Price ` 5 per unit

Variable cost ` 3 per unit
Fixed expenses ` 10,000
Output volume 10,000 units
Profit ` 10,000
Required:
Calculate the impact of changes in profit, Break Even Units and Break Even Sales under the following
situations:
1. Increase of 10 % in volume of sales.
2. Increase of 10 % in variable costs.
3. Increase of ` 2,000 in fixed expenses.
4. A fall of 50 paisa in selling price.
Break Even Analysis

Cost Management
CVP Analysis
Home
WORK
A single product company furnishes the following data:
Year 1 Year 2
Sales ` 24,00,000 ?
PV Ratio 33 %1
3 30 %
Margin of Safety 25 % 40 %
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While there was no change in the volume of sales & variable cost in year 2, the selling price & fixed cost
was reduced. Calculate the sales, fixed costs and profit for year 2.
Break Even Analysis
Your company manufacturing only a single product sells it at a price of ` 80 per unit. The variable cost
per unit is ` 48 and the annual fixed cost amounts to ` 18 lakh. Based on these data, you are required
to work out the following:
a. Present PV ratio and Break even sales
b. Increase in the volume of sales required if the profit is sought to be increased by ` 3.6 lakh.
c. Percentage increase or decrease in sales volume:
-- to offset an increase of ` 4 per unit in variable cost
-- to offset an increase in selling price by 10 % without affecting the quantum of existing profit.
Break Even Analysis Offset Effect
Advanced Strategic
CVP Analysis
Home
A Block
WORK
Design Pens Ltd manufactures only pens where the marginal cost of each pen is ` 3. It has fixed costs
of ` 25,000 per annum. Present production and sales of pens is 50,000 units and selling price per pen
is ` 5. Any sale beyond 50,000 pens is possible only if the company reduces 20 % of its current selling
price.
However, the reduced price applies only to the additional units. The company wants a target profit
after tax of ` 50,000. How many pens the company must produce and sell if the target profit is to be
achieved if tax rate is 50 %?
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Break Even Analysis Varying Level of Cost
The following information of a company is available for the year 2009:
`
Sales 40,000
Raw materials 20,000
Direct wages 6,000
Variable and fixed OH 10,000
Profit 4,000
Units sold 200 nos.
In the year 2010, wage rate will increase by 50 % and fixed cost will decrease by ` 600. If 300 units are
sold in 2010, the total fixed and variable OH will be ` 11,400. How many units should be sold in 2010
so that the same amount of profit per unit as in year 2009 may be earned?
Break Even Analysis Breakup of Total Overheads

May, 2007

Cost Management
CVP Analysis
Home
WORK
The financial controller of ACE ltd. has prepared the following estimates of working results for the year
ending 31st March 2009:
Year ended 31.3.2009

Direct material ` 16 per unit
Direct wages ` 40 per unit
Variable overheads ` 12 per unit
Selling price ` 125 per unit
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Fixed expenses ` 6,75,000 per annum
Sales ` 25,00,000 per annum
During the year 2009 – 2010, it is expected that the material prices and variable overheads will go up
by 10 % and 5 % respectively. As a result of reengineering of business processes, the overall direct la-
bour efficiency will increase by 12 % but the wage rate will go up by 5 %. The fixed overheads are also
expected to increase by ` 1,25,000.
The Vice President – Manufacturing states that the same level of output as obtained in 2008 – 2009
should be maintained in 2009 -2010 also and efforts should be made to maintain the same level of
profit by suitably increasing the selling price.
The Vice President – Marketing states that the market will not absorb any increase in the selling price.
On the other hand, he proposes that publicity involving advertisement expenses as given below will
increase the quantity of sales as under:
Advertisement expenses (`) 80,000 1,94,000 3,20,000 4,60,000

Additional unit of sales 2,000 4,000 6,000 8,000
Required:
(a) Present an income statement for 2009 – 2010.
(b) Find the revised price and the percentage of increase in the price for 2009 – 2010, if the views of
the Vice President – Manufacturing are accepted.
(c) Evaluate the four alternative proposals put forth by the Vice President – Marketing. Determine
the best output level to be budgeted and prepare an overall income statement for 2009 – 2010
at that level of output.
Evaluation of Proposals Labour Cost Calculation
Advanced Strategic
CVP Analysis
Home
A Block
WORK
A Co. manufactures three products – X, Y and Z. The unit-selling price is ` 100, ` 80 and ` 50 respec-
tively. The corresponding unit variable cost are ` 50, ` 40 and ` 20 respectively. The quantity wise
proportions in which these products are manufactured and sold are 20 %, 30 % and 50 % respectively.
The total fixed cost are ` 14,80,000.
Work out the overall break–even quantity and the product-wise break–up of each quantity.

C Block
Break Even Analysis with Multiple

Products
A Co. manufactures and sales 4 types of products under the brand names, Ace, Utility, luxury and
Supreme. The sales – mix in value comprises the following :-
Ace – 33-1/3 %, Utility – 41-2/3 %, Luxury – 16-2/3 %, Supreme – 8 -1/3 %
The total budgeted sales (100 %) are ` 6 lakhs per month. The operating costs are :-
Ace – 60% of S.P.; Utility- 68% of S.P.; Luxury-80% of S.P.; Supreme- 40% of S.P.
The fixed cost is ` 1,59,000.
a) Calculate the overall break-even point.
b) It has been proposed to change the sales mix as below:- (the total sales remaining at ` 6 lakh per
month)
Ace – 25%; Utility – 40%; Luxury-30%; Supreme-5 %
Assuming this proposal is implemented; calculate the overall new break-even point.
Break Even Analysis with Multiple

Products

Cost Management
Make or Buy Decisions
Class
WORK
Chapter 9
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DECISION MAKING
Tools for Decision Application of Tools for

Making Decision Making
1 Relevant Costing
2 CVP Analysis
3 Linier Programming
4 Theory of Constraints
One Time Decision Regular

or or
Non-Repititive Decisions Operational Decisions
1 Evaluation of one time offers

2 Make / Buy Decisions 1 Key Factors or Constraints
3 Subcontracting Decisions Optimisation
4 Export Offers
5 Utilisation of Spare Capacity
Use - CVP Analysis
- Linear Programming
- Theory of Constraints
Use Relevant Costing
= Incremental Analysis
| 261
Advanced Strategic
Cost Management
Class
WORK
MAKE OR BUY DECISIONS

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Cost Factors
1. Capacity Available for Quantity

Required
1. Applicability Step 1 : Relevant Cost of Manufacture
(a) On Raw Materials Step 2 : Purchase Cost
(b) On Components Step 3 : Compare and Decide
2. Capacity Required is more than

2. Factors Inuencing Decisions Capacity Available
(a) Cost Factors Step 1 : Compare Relevant Cost of
(b) Non Cost Factors Manufacture and Purchase and
Decide
Step 2 : For Components to be
3. Non Cost Factors manufactured, Find savings in
manufacturing per unit
(a) Quality and Secrecy
Step 3 : Find Hours / Unit of Manufacture
(b) Quantity
Step 4 : Find Savings in Manufacturing
(c) Time per Hour
(d) Peer Co-operation Step 5 : Rank for Manufacture
(e) Focus Step 6 : Allocate the available Capacity to
(f) Capacity manufacture
(g) Investment Step 7 : Purchase what quantity could

not be purchased
(h) Skills
3. Indifference Point Analysis

Cost Management
Class
WORK
Auto Parts Ltd has an annual production of 90,000 units for a motor component. The component cost
structure is as below:
Material ` 270 per unit

Labour (25 % fixed) ` 180 per unit
Variable OH ` 90 per unit
Fixed OH ` 135 per unit
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Total ` 675 per unit
(a) The purchase manager has an offer from a supplier who is willing to supply the component at `
540. Should the component be purchased?
(b) Assume the resources now used for this component’s manufacture are to be used to produce
another new product for which the selling price is ` 485. The material cost for this product is ` 200
per unit. 90,000 units of this product can be produced at the same cost basis as above for labour
and expenses.
Discuss whether it would be advisable to divert the resources to manufacture the new product
on the footing that the component presently being produced is purchased from the market.
Make or Buy Decision Comparison of Relevant Cost

and Purchase Cost
You are the management auditor of XYZ ltd. The Managing Director of the company seeks your advice
on the following problem:
The XYZ Ltd produces a variety of products each having a number of component parts. Product B
takes 5 hours to produce on a machine no. 99 working at full capacity. Product B has a selling price of `
50 and a marginal cost of ` 30 per unit. A – 10 a component part could be made on the same machine
in 2 hours for a marginal cost of ` 5 per unit. The supplier’s price is ` 12.50 per unit.
(a) Should the company make or buy A -10? Assume that machine hour is available in limited supply.
(b) Would your answer differ if there is a spare capacity?
Make or Buy Decision Comparison of Relevant Cost

May 1995
and Purchase Cost
Advanced Strategic
Class
WORK
A company is considering the possibility of purchasing components from a supplier which it now
makes. The supplier will provide the components in the necessary quantities at a unit price of ` 9.
Transportation and storage costs would be negligible.
The company produces the components from a single raw material bought in economic lots of 2,000
units at a cost of ` 2 per unit. Average annual demand is 20,000 units. The annual holding cost is ` 0.25
per unit and the minimum stock level is set at 400 units. Direct labour costs for the component are ` 6
per unit, fixed manufacturing overhead is charged at a rate of ` 3 per unit based on a normal activity
of 20,000 units. The company hires the machine on which the components are produced at a rate of `
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200 per month and if component is not produced, such hire charges can be avoided.
Should the company make the component or purchase?
Make or Buy Decision EOQ Concepts
A firm needs a component in an assembly operation. If it wants to do the manufacturing itself, it

would need to buy a machine for ` 4 lakhs which will last for 4 years with no salvage value. Manufac-
turing costs in each of the 4 years would be ` 6 lakhs, ` 7 lakhs, ` 8 lakhs, and ` 10 lakhs respectively. If
the firm had to buy the components from a supplier, the cost would be ` 9 lakhs, ` 10 lakhs, ` 11 lakhs,
and ` 14 lakhs respectively in each of the four years. However, the machine would occupy floor space
which would have been used for another machine. This latter machine would be hired at no cost to
manufacture an item, the sale of which would produce net cash flows in each of the four years of ` 2
lakhs. It is impossible to find room for both the machines and there are no other external effects. The
cost of capital is 10 % and the present value factor for each of the four years is 0.909, 0.826, 0.751 and
0.683 respectively.
Should the firm make the components or buy from outside?
Make or Buy Decision Present Value Based

Cost Management
Class
WORK
On a farm of 200 acres, a farmer plans to use 100 acres for raising crops, 20 acres for growing fodder
and the balance of 80 acres for grazing milk cattle. For raising the crop the seed will cost ` 50 per acre
and the fertilisers ` 70 per acre. The yield will be 30 tonne per acre, which would be sold at ` 50 per
tonne.
The fodder will cost ` 20 per acre for seed and ` 50 per acre for fertilisers. The fodder produced will be
fed to the cows. On the 80 acres, 40 milking cows will be kept. In addition to the fodder, other feeding
stuffs will cost ` 20,000 in all for the year. It is expected that each cow would produce one calf which
will be sold at ` 100 each together with an annual milk yield sold at ` 1,200. The resale value of the
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cows would be diminishing at the rate of ` 100 per annum. Other farm costs per annum (which are
unlikely to change) are:
Farm workers wages ` 36,000

Rates and taxes ` 24,000
General garages ` 30,000
A suggestion is made that fodder should be purchased instead of growing it. If this is done, it is esti-
mated that fodder will cost ` 250 per cow per annum.
Prepare statements to indicate to the farmer, whether the fodder should be purchased or grown and
released land may be utilised either for raising the crop or grazing milk cattle.
Make or Buy Decision Contribution Lost
Panchwati Cement Ltd produces ’43 grade’ cement for which the company has an assured market.
The output for 2010 has been budgeted at 1,80,000 units at 90% capacity utilisation. The cost sheet
based on output (per unit) is as follows:
`
Selling price 130.00
Direct material 30.00
Component EH 9.40
Direct wages @ ` 7 per hour 28.00
Factory overhead (50 % fixed) 24.00
Selling and distribution overheads (75 % variable) 16.00
Administrative overhead (fixed) 5.00
Advanced Strategic
Class
WORK
The factory overheads are applied on the basis of direct labour hours.
To utilise the idle capacity and to improve the profitability of the company, the following proposals
were put up before the Board of Directors for consideration:
a. An order has been received from abroad for 500 units of product 53 grade cement per month at
` 175 per unit. The cost data are:
Direct material - ` 56 per unit, direct labour – 10 hours per unit, selling and distribution overhead
applicable to this product order is ` 14 per unit and variable factory overheads are chargeable on
the basis of direct labour hours.
b. The company at present manufacture component EH one unit of which is required for each unit
of product 43 grade. The cost details for 15,000 units of component EH are as follows:
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`
Variable overheads 25,500
Fixed overheads 33,000
Total 1,41,000
The component EH however is available for purchase at the market at ` 7.90 per unit.
c. In the event of company deciding to purchase the component EH from market, the company has
two alternatives for the use of the capacity so released, which are as under:
I. Rent out the released capacity at ` 1 per hour
II. Manufacture component GYP which can be sold at ` 8 per unit.
The cost data of this component for 15,000 units are:
`
Factory variable overheads 13,500
Other variable overheads 25,500
Total 1,12,500
Required:
(i) Prepare a statement showing profitability of the company envisaged in the budget.
(ii) Evaluate the export order and state whether it is acceptable or not.
(iii) Make an appraisal of the proposal to manufacture component EH and state whether component
EH should be manufactured in the factory or purchased from the market. Assume that no alter-
native use of spare capacity is available.
(iv) Evaluate the alternative use of the spare capacity and state whether to manufacture or buy the
component EH and if your decision is to buy component EH, which of the two alternatives for the
use of spare capacity will you prefer?

Cost Management
Class
WORK
Make or Buy Decision Unique Variety

November 2004
A company manufacturing a highly successful line of cosmetics intends to diversify the product line to
C Block
achieve fuller utilisation of its plant capacity. As a result of considerable research made the company
has been able to develop a new product called “EMO”.
EMO is packed in tubes of 50 gram capacity and is sold to the wholesalers in cartons of 24 tubes at `
240 per carton. Since the company uses its spare capacity for the manufacture of EMO, no additional
fixed expenses will be incurred.
Share of fixed allocated overhead ` 4,50,000 per month. The company estimates the production and
sale of EMO at 3,00,000 tubes per month and on the basis the following cost estimates have been
developed:
` per carton
Direct wages 72
Overheads 54
Total costs 234
After a detailed market survey the company is confident that the production and sales of EMO can be
increased to 3,50,000 tubes per month and ultimately to 4,50,000 tubes per month.
The company at present has a capacity for the manufacture of 3,00,000 empty tubes and the cost of
the empty tubes if purchased from outside will result in a saving of 20% in material and 10% in direct
wages and variable overhead costs of EMO. The price at which the outside firm is willing to supply the
empty tubes is ` 1.35 per empty tube.
If the company desires to manufacture empty tubes in excess of 3,00,000 tubes, a new machine in-
volving an additional fixed overheads of ` 30,000 per month will have to be installed.
Required:
a. State by showing your workings whether the company should make or buy the empty tubes at
each of the three volumes of production of EMO namely, 3,00,000; 3,50,000 and 4,50,000 tubes.
b. At which volume of sales will it be economical for the company to install the additional equip-
ment for the manufacture of empty tubes?
c. Evaluate the profitability on the sale of EMO at each of the aforesaid three levels of output based
on your decision and showing the cost of empty tubes as a separate element of cost.
Advanced Strategic
Class
WORK
Make or Buy Decision Unique Variety

C Block
B Ltd. makes industrial power drills, which is made by the use of two components A (electrical and me-
chanical components) and B (plastic housing). The following table shows the cost of plastic housing
separately and the cost of the electrical and mechanical components:
A B A&B
` ` `
Sales 1,00,000 units @` 100 1,00,00,000
Variable Costs:
Direct materials 44,00,000 5,00,000 49,00,000
Direct labour 4,00,000 3,00,000 7,00,000
Variable factory overhead 1,00,000 2,00,000 3,00,000
Other variable costs 1,00,000 - 1,00,000
Sales commission @10% of sales – - 10,00,000
Total variable costs 50,00,000 10,00,000 70,00,000
Contribution - - 30,00,000
Total fixed costs 22,20,000 4,80,000 27,00,000
Operating income 3,00,000
Answer the following questions independently:

(i) During the year, a prospective customer offered ` 82,000 for 1,000 drills. The drills would be man-
ufactured in addition to the 1,00,000 units sold. B Ltd. would pay the regular sales commission
rate on the 1,000 drills. The Chairman rejected the order because “it was below our costs”. Calcu-
late operating income if B Ltd. accepts the offer.
(ii) A supplier offers to manufacture the yearly supply of 1,00,000 units plastic housing components
for ` 13.50 each. Assume that B Ltd. would avoid ` 3,50,000 of the costs assigned to plastic hous-
ing if it purchases. Calculate operating income if B Ltd. decides to purchase the plastic housing
from the supplier.
(iii) Assuming that B Ltd. could purchase 1,20,000 units (plastic housing components) for ` 13.50
each and use the vacated plant capacity for the manufacture of deluxe version of drill of 20,000
units (and sell them for ` 130 each in addition to the sales of the 1,00,000 regular units) at a var-
iable cost of ` 90 each, exclusive of housings and exclusive of the 10% sales commission. All the
fixed costs pertaining to the plastic housing would continue, because these costs are related to
the manufacturing facilities primarily used. Calculate operating income of B Ltd if it purchases
the plastic housings and manufacture the deluxe version of drills.

Cost Management
Class
WORK
Make or Buy Decision Profit Computation

November 2009
C Block
A Company manufacturing agricultural machinery is preparing its budget for the year 2010. An initial
review shows that it will not be possible to manufacture all requirements for components A, B, C and
D because the normal metal pressing capacity of 20,000 hours would be exceeded. The company can
choose between the alternative courses of action given below to obtain the products in excess of
normal production capacity:
(i) To buy entirely from outside suppliers.
(ii) To buy from outside suppliers and / or use a partial second shift.
The data given below are for the year 2010:
Standard production cost per unit:
Components A B C D
Variable costs:
Direct materials 18.50 13.50 12.50 22.00
Direct wages 5.00 4.00 11.00 20.00
Direct expenses 5.00 10.00 5.00 30.00
Fixed overhead 2.50 2.00 5.50 10.00
Total production cost 31.00 29.50 34.00 82.00
Requirements, in units 2,000 3,500 1,500 2,800
Direct expenses relate to the use of the metal presses, which cost ` 5 per machine hour to operate.
Fixed overhead is absorbed as a percentage of direct wages.
Quotations obtained from outside suppliers indicate a willingness to manufacture all or any part of
the total requirements at the following prices, each delivered to the factory:
Components `
A 30.00
B 29.50
C 26.00
D 84.00
Second shift operations would increase direct wages costs by 25 % over the normal shift, and fixed
overhead by ` 250 for each 1,000 (or part thereof ) second shift hours worked.
Advanced Strategic
Class
WORK
You are required, using the information given above and showing your supporting calculations, to
state:
(a) Which components and in what quantities should be manufactured in the 20,000 hours of press
time available?
(b) Whether it would be profitable to make any of the balance of components required on a second
shift basis instead of buying them from outside suppliers?
Make or Buy Decision Key Factor Effect

C Block
A company manufactures three components. These components pass through two of the company’s
departments P and Q. The machine hour capacity of each department is limited to 6,000 hours in a
month. The monthly demand for components and cost data are as under:
Components A B C
Demand (units) 900 900 1350
Direct Materials/ unit ` 45 ` 56 ` 14
Direct Labour/ unit ` 36 ` 38 ` 24
Variable OH/ unit ` 18 ` 20 ` 12
Fixed OH: P @ ` 8 per hour ` 16 ` 16 ` 12
Q @ ` 10 per hour ` 30 ` 30 ` 10
Total ` 145 ` 160 ` 72
Components A and C can be purchased from market at ` 129 each and ` 70 each respectively.
You are required to prepare a statement to show which of the components in what quantities should
be purchased to minimise cost.
Make or Buy Decision Multiple Key Factors

November 2002

Cost Management
Class
WORK
Priya Gadgets Ltd specialising in household gadgets, has just perfected and test marketed a modified
version of a popular gadget. It has three components X, Y and Z, one of each is required per gadget.
All these requirements are made and assembled in its own factory and capacity utilisation of the ma-
chines is full.
The modification (Assembly Division) essentially involves a special machining and fixing a new attach-
ment for which the company has provided for double the existing production capacity to take care of
possible increased demand.
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The cost structure of the modified gadget is as under:
Fixed cost
Machine hours Variable cost
Components allocated per Total cost
per unit per unit
unit
X 16 50 15 65
Y 24 56 20 76
Z 32 54 30 84
Special machinery and assembly -- 60 45 105
Total cost -- 220 110 330
Selling price 500
Since the response to the modified gadget is very good the company would like to capture the market
in the ensuing year itself by increasing sales. While all the existing machines in the factory are capable
of making all the components X, Y and Z, increase of machine capacity cannot be achieved or made
during the budget year. However, the special machining process and capacity permits one of the com-
ponents either, X, Y or Z to be bought from outside. The following offers have been received:
Component Price per unit

X ` 66
Y ` 78
Z ` 94
The marketing manager feels that sales can be increased at least by 50% during the year and with a
little advertisement support even 75%.
You are required to give your recommendation as to which component should be bought from out-
side if production is to be increased by 50% and 75% respectively.
Make or Buy Decision Key Factor with Condition of

Purchase of One Component
only
Advanced Strategic
Class
WORK
GG Ltd manufactures and sells an equipment called water purifier. The cost data for each batch of ten
numbers of water purifiers is as follows:
Components A B C D E
Machine hours 20 28 24 - -
Labour hours - - - 4 2
Variable costs (`) 64 108 116 24 8
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Fixed costs as apportioned 36 52 64 26 22
Assembly costs (all variable) – ` 50 per batch

Selling price – ` 800 per batch
Maximum available machine capacity for making components A, B and C is 10,800 hours and it can-
not be increased further. Labour is available for making components D and E and for assembling the
product.
Estimated increase in demand next year is 50 % and fixed costs in general may increase by ` 10,000.
In order to release production capacity to meet increased market demand, the company decided to
purchase one of the machine made components.
Quote Ltd is the only supplier of Components A, B and C. Because of incomplete records, it is unable
to quote single figure prices. Its quotation is as follows:
Pessimistic Most Likely Optimistic

Component Probability Probability Probability
View (`) View (`) View (`)
A 120 0.25 110 0.5 80 0.25
B 200 0.25 130 0.5 140 0.25
C 160 0.25 140 0.5 120 0.25
It is agreed between the companies that the price of each of the components will be determined on
an overall basis based on information found in the quotation.
(a) Indicate, in the context of key factor, the maximum number of batches that could be produced,
if each of the three alternatives namely buying A or B or C is considered.
(b) Analyse the financial implication of purchase and advise which component is to be bought keep-
ing in view the fact that production capacity will be limited to a 50 % increase.
(c) Prepare a profit statement for the period assuming that the component chosen by you is bought
out and extra production is made and sold.
Make or Buy Decision Key Factor with Condition of

May 2000
Purchase of One Component
only

Cost Management
Home
WORK
A machine manufactures 10,000 units of a part at a total cost of ` 21 of which ` 18 is variable. This part
is readily available in the market at ` 19 per unit. If the part is purchased from the market then the
machine can either be utilised to manufacture a component in the same quantity contributing ` 2 per
component or it can be hired out at ` 21,000.
Recommend which of the alternative is profitable?
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Make or Buy Decision
May 1997
B ltd. produces and sells bicycles. It also manufactures the chains for its bicycles. It expects to produce
and sell 24,000 bicycles during 2009-2010. It is considering an offer from an outside vendor to supply
the number of chains at ` 12 per chain.
The accountant of B ltd reports the following costs for producing 24,000 chains:
Cost per
Particulars Total cost (`)
units (`)
Direct material 5.00 1,20,000
Direct labour 4.00 96,000
Variable manufacturing overhead 2.00 48,000
Inspection, set up, etc 1.00 24,000
Machine rent 1.00 24,000
Allocated fixed overhead 1.25 30,000
14.25 3,42,000
The following additional information is available:

(1) Inspection, set up, etc varies with the number of batches in which the chains are produced. Cur-
rently chains are being produced in the batch size of 2,000 units.
(2) Direct labour cost represents wages to four workers who are exclusively engaged in the manu-
facturing of chains. These workers are in permanent capacity and cannot be retrenched.
(3) If B ltd procures all its chains from outside vendor, it will not require the machine which it has
hired for manufacturing chains.
Advanced Strategic
Home
WORK
Required:
(a) Assume that if B ltd purchases chains from outside vendor, the facility (including workers) where
the chains are currently manufactured will remain idle. Should B Ltd accept the offer from out-
side vendor at the anticipated production and sales volume of 24,000 units?
(b) Whether your decision in (a) will change if facilities can be used to upgrade the bicycle which will
result in incremental revenue of ` 22 per bicycle. The variable cost for upgrading would be ` 18
per bicycle and tooling cost would be ` 16,000.
(c) Assume that facilities will be as stated in (b) above. Further assume that with better planning B
Ltd will be able to manufacture chains in the batch size of 4,000 units (instead of 2,000 units) if it
decides to produce chains inside.
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Make or Buy Decision
Jolly Fabrics manufactures quality napkins at its unit in Tirupur. The unit has a capacity of 60,000 nap-
kins per month. Present monthly production for April is 40,000 napkins. Cost incurred for production
are as below:
Particulars ` per unit Remarks

Direct material 6 No fixed cost
Direct labour 2 Fixed cost 75 %
Manufacturing overhead 4 Variable 25 %
Total 12
The marketing costs per unit is ` 7 (` 5 is variable). Marketing costs include distribution costs and cus-
tomer service costs. Present selling price is ` 22.50 per unit.
Due to a strike at its existing napkin supplier, a hotel group has offered to buy 10,000 napkins from Jol-
ly Fabrics @ ` 11 per napkin for the month of June. No further sales to the hotel are anticipated. Fixed
manufacturing costs and marketing costs are tied to the 60,000 napkins. The acceptance of the special
order is not expected to affect the selling price to regular customers. No marketing costs involved in
special order. Prepare:
(i) Budgeted income statement for April.
(ii) Actual income statement under absorption costing for April.
(iii) Should Jolly Fabrics accept the special order from the hotel or not?

Cost Management
Home
WORK
Profit Computation
November 2003
C Block
A company has the following option to avail 18000 units of a component required in a product :
Manufacture by Manufacture by
Purchase
Method A Method B
Fixed Cost p.a. ` 10,000 ` 20,000 –
Variable Cost p.a. 1.50 0.80 2.80
Decide.
Make or Buy Decision Indifference Point Analysis
Advanced Strategic
Key Factors
Class
WORK
Chapter 10
Key Factors
What is a Key Factor ?

C Block
Ways to deal with Key Factor

1. Traditional Approach
2. Modern Approach
Different situations to deal with Key Factor

No. of Products No. of Key Factors How to deal with it
ONE Muitiple Theory of Bottleneck
Utilise the available for best products

Step 1 : Ranking of Products based on
Muitiple ONE Contribution per unit of Key Factor
Step 2 : Allocation Based on Rank
Use Combinations
Use Simultaneous Equations
Muitiple Muitiple
Use Linear Programming
Use Throughput Accounting
Special Effects
1. Different basis of Ranking
2. Tie between two ranks
3. Fractional Allocation Reasoning
4. Minimum or Specic Commitment
5. Incremental Ranking for Varying level of Selling Prices or Fixed Costs

Cost Management
Key Factors
Class
WORK
A company produces three products from an imported raw material. The cost structure per unit of the
products is as under:
Product
A B C
Sales value 200 300 250
Direct material 50 80 60
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Direct wages @ ` 6 per hour 60 120 108
Variable overheads 30 60 54
Out of Direct materials, 80 % is of the imported raw material purchased at ` 10 per kg.
Prepare a statement showing comparative profitability of three products under the following scenar-
ios:
(i) Imported raw material is in restricted supply.
(ii) Production capacity is limiting factor.
(iii) When maximum sales potential of products A and B are 1,000 units each and that of product C is
500 units for specific requirement, availability of imported material is restricted to 10,000 kgs per
month, how the profit could be maximised?
Multiple Products and One Key Factor Specific Commitment
Akshara Ltd manufactures 3 Products X, Y and Z which are made up from 3 parts A, B and C in the
following proportion:
Product Parts
X 1 A and 1 B
Y 2 A, 2 B and 1 C
Z 3 A, 1 B and 2 C
Advanced Strategic
Key Factors
Class
WORK
These parts are made on the premises. Further information is as follows:
A (`) B (`) C (`)

Selling Price 6 14 24
Direct materials 2 2 5
Time cost 2 9 12
Time cost covers the cost of Direct labour and Overheads and is valued at ` 6 per hour. All parts can
be sold individually at the above selling price but the market demand, which it is hoped, will be satis-
fied from the expansion will be for the products. The further expansion would provide an additional
58,000 hours and the additional market demand for the products would be 5,000 units each. Addi-
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tional fixed expenses related to the expansion are expected to be ` 15,000.

Prepare a statement showing how the additional capacity available should be used to generate max-
imum additional profit.
Multiple Products and One Key Factor Parts to Products
The operating results of BM Ltd for the year 2009 were as under:
SALES MIX PRODUCT SALES MIX % PV RATIO %

A 40 20
B 10 6
C 30 12
D 20 10
Total sales value of all the products was ` 80 lacs. Total fixed overheads amounted to ` 10 lacs. Raw
material content of each product represented 50 % of the respective variable cost. The forecast for the
year 2010 is as under:
(a) The raw material costs will go up by 10 %.
(b) The company has been able to obtain import quota of raw material of the value of ` 35 lacs at
new price.
(c) The maximum sale potential of any of the above four products is 40 % of the total 2009 potential
sales value.
(d) The company expects to secure an increase of 5 % in the selling prices of all the products uni-
formly.

Cost Management
Key Factors
Class
WORK
Required:
(a) Prepare a statement showing profitability of 2009.
(b) Set a product mix to maximise profit in 2010.
(c) Prepare a statement showing profitability of 2010.
Multiple Products and One Key Factor Ranking After adjustment of

Price Index
C Block
E Ltd manufactures and sells four types of products under the brand names A, B, C and D. On a turno-
ver of ` 30 crores in 2009, company earned a profit of 10% before interest and depreciation which are
fixed. The details of product mix and other information are as follows:
Raw Material as % on
Products Mix % to total sales P/V Ratio (%)
sales value
A 30 20 35
B 10 30 40
C 20 40 50
D 40 10 60
Interest and depreciation amounted to ` 225 lakhs and ` 115.50 lakhs respectively. Due to increase in
prices in the international market, the company anticipates that the cost of raw materials which are
imported will increase by 10% during 2010. The company has been able to secure a license for the
import of raw materials of a value of ` 1,535 lakhs at 2010 prices. In order to counteract the increase
in costs of raw materials, the company is contemplating to revise its product mix. The market survey
report indicates that the sales potential of each of the products: A, B and C can be increased upto 30%
of total sales value of 2009. There was no inventory of finished goods or work in progress in both the
year.
You are required to set an optimal product mix for 2010 and find the profitability.
Multiple Products and One Key Factor Ranking After adjustment of

Price Index
Advanced Strategic
Key Factors
Class
WORK
Dolls & Company are specialists in the manufacture of dolls for children. They manufacture and mar-
ket four types of dolls patented under the names ; Dolly , Molly , Jolly , Polly and a doll-dress sewing kit
. They required your assistance as a Cost Accountant for determining the appropriate sales and prod-
uct mix of their products for the coming year . From the production standards established , market
forecasts and pricing policies , you get the following data : -
Estimated demand Standard material Standard labour cost Estimated SP per

Doll’s name
for next year (units) cost per unit (`) per unit (`) unit (`)
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Dolly 50,000 1.40 0.80 5.20

Molly 42,000 0.70 0.50 2.40
Jolly 35,000 2.70 1.40 8.50
Polly 40,000 1.00 1.00 4.00
Sewing Kit 3,25,000 0.60 0.40 3.00
To promote sales of the dolls, there is a 15% discount offered in the established price of a kit, pur-
chased at the same time along with a doll & it is expected that all customers will avail this benefit.
The labour rate of ` 2.00 per hour is expected to continue without change in the next year. The plant
has an effective capacity of 1,30,000 labour hours on a single shift basis. Present equipment can pro-
duce all of the products . Overtime worked is paid at double the normal rate.
Next year’s Fixed Cost is estimated at ` 30,000 in the factory , ` 20,000 in Administration and ` 50,250
in Selling and Distribution. Other variable costs will be equivalent to 50% of Standard Direct Labour
Cost. The Co. has a very small inventory of the products that can be ignored .
You are required to draw a conservative estimate for next year of the total contribution that would be
made by each product line and the net income that would be earned by the company.
The Company is at present having some industrial relations problem and if this continues in the next
year, it would not then possible to arrange for overtime work. Anticipating that eventuality, you are
required to suggest a product-mix that would absolutely minimize the drop in the income already
envisaged. With that product – mix work out product wise contribution and the new net income that
would be earned as a result.
Multiple Products and One Key Factor Unique Variety

Cost Management
Key Factors
Class
WORK
The following four products are prepared by an agricultural company-
Potatoes Turnips Parsnips Carrots

Area occupied (acres) 25 20 30 25
Yield per acre (tonnes) 10 8 9 12
SP per tonne (`) 100 125 150 135
Variable cost per acre (`):
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Fertilisers 30 25 45 40
Seeds 15 20 30 25
Pesticides 25 15 20 25
Direct wages 400 450 500 570
Fixed overhead per annum: ` 54,000.

The land which is being used for the production of carrots and parsnips can be used for either crop,
but not for potatoes or turnips. The land being used for potatoes and turnips can be used for either
crop, but not for carrots or parsnips. In order to provide an adequate market service, the gardener
must produce each year at least 40 tonnes each of potatoes and turnip and 36 tonnes each of parsnips
and carrots.
a) You are required to present a statement to show:
i. the profit for the current year;
ii. the profit for the production mix which you would recommend.
b) It is possible to make the land presently suitable for Potatoes & Turnips, viable for growing all
products if certain land development work is undertaken. This work will involve a capital expend-
iture of ` 6,000 per acre which a Bank is prepared to finance at the rate of interest of 5% p.a. The
Fertilisers cost of the entire crop of carrots will decrease on an average by ` 2.60 per tonne.
Assuming that the other constraints continue, advise the grower whether the land development
scheme should be undertaken and if so the maximum total profit that would be achieved after
the said development scheme is undertaken.
c) If maximum production of any product is 960 tons, find the most profitable product mix in ques-
tion (b).
Multiple Products and One Key Factor Unique Variety
Advanced Strategic
Key Factors
Class
WORK
SRK Ltd. manufactures 3 Products A, B and C. The details for a unit are as under:
A B C
Direct materials (`) 15 19 25
Direct Labour (`) 7 5 11
Variable overhead (`) 3 6 4
Selling Price 30 38 50
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Output per day (units) 110 Or 60 Or 50
If sale of Product A exceeds 50 units a day, the selling price is expected to fall to ` 29 a unit for each
additional unit, if sale of C exceeds 20 units a day, the selling price is expected to fall to ` 49 a unit and
if sales of B exceeds 15 units a day, the price is expected to fall to ` 37 a unit.
The company works on eight hour day and on average 40 minutes daily are taken up by machine set-
ting up time. The constraint is the machine capacity.
Work out the optimum level of production that would yield maximum profits for the company.
Multiple Products and One Key Factor Incremental Ranking
Apex Limited manufacturer two products, P and Q, using the same production facility.
The following information is available for a production period:
Particulars Product P Product Q

Demand (units) 2,20,000 1,75,000
Contribution (` / unit) 10 12
Machine hours required per 100 units 15 25
P and Q can be produced only in batches of 100 units, and whatever is produced has to be sold or
discarded. Inventory build-up is not possible from one production period to another. The total fixed
costs for each level of production and directly attributable to P and Q are given below:

Cost Management
Key Factors
Class
WORK
Level of output Total Fixed Costs (`)

Product P Product Q
Upto 1,00,000 units 6,00,000 5,50,000
1,00,001 to 2,00,000 units 13,50,000 12,20,000
2,00,001 to 3,00,000 units (maximum possible level) 18,70,000 15,50,000
75,000 machine hours are available in the production period.

(i) Calculate the quantities of P and Q in the best product mix to achieve the maximum profit and
compute the maximum profit.
(ii) What will be the opportunity cost of meeting P’s demand fully?
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Zilmil ltd makes two products ‘Brightly’ and ‘Lightly’. Both the products use the same labour force, the
size of which is restricted to 78,000 hours per month. Brightly needs 2 hours per unit to make whereas
Lightly needs one hour. The estimated production and sales, manufacturing and selling expenses per
month are as follows:
Brightly Lightly
Production and sales (units) 12,000 16,000 40,000 48,000
Cost per month (`) 34,00,000 38,00,000 62,00,000 66,80,000
The company is considering pricing option in a highly competitive market. It has estimated sales de-
mand at various selling prices.
Brightly
Selling price per unit (`) 276 272 268 264 260 254
Sales demand per month 12,000 14,000 16,000 18,000 20,000 22,000
Lightly
Sales demand per month 40,000 42,000 44,000 46,000 48,000 50,000
You are required to compute profit maximising price and quantity for each product if labour hours are
limited.
Advanced Strategic
Key Factors
Class
WORK

C Block
Sellaway Ltd manufactures and markets two products A and B, the demand in the market of which
fluctuates with the prices quoted. As a result of the deliberations of its recent sales conference, the
following data were agreed upon as a working basis:
Product A Product B
Expected demand per month (units) 900 1,000 1,500 1,600 2,000 3,000
8 labour hours are required to produce Product A and 4 labour hours to produce Product B and the
maximum capacity of the factory is restricted to 20,000 labour hours per month.
The cost structure is as under for one unit of production:
Particulars Product A (`) Product B (`)

Direct material 4 3
Direct labour 6 5
Variable overheads 10 6
20 14
Fixed overheads are ` 32,400 per quarter.

You are required to compute the possible combinations and arrive at a proper price mix for maximum
profitability.
Multiple Products and One Key Factor Incremental Ranking and

Combinations

Cost Management
Key Factors
Class
WORK
Bloom Ltd makes 3 products A, B and C. the following information is available for a unit:
A (`) B (`) C (`)

Selling price (peak – season) 550 630 690
Selling price (off – season) 550 604 690
Material cost 230 260 290
Labour (peak season) 110 120 150
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Labour (off season) 100 99 149
Variable production overhead 100 120 130
Variable selling overhead (only for peak season) 10 20 15
Labour hours required per unit (hrs) 8 11 7
Material cost and variable production overheads are the same for the peak season and off season.
Variable selling overheads are not incurred in the off season. Fixed costs amount to ` 26,780 for each
season, of which ` 2,000 is towards salary for special technician, incurred only for product B, and `
4,780 is the amount that will be incurred on after-sales warranty and free maintenance of only product
C, to match competition.
Labour force can be interchangeably used for all the products. During peak season, there is labour
shortage and the maximum labour hours available are 1,617 hours. During off – season, labour is free-
ly available, but demand is limited to 215 units for A, B and C put together, for A demand is limited to
100 units, for B it is 115 units and for C it is 135 units.
a. Advise the company about the best product mix during peak season for maximum profit.
b. What will be the maximum profit for the off season?
Multiple Products and One Key Factor Specific Fixed Cost
Advanced Strategic
Key Factors
Class
WORK
A company manufactures single product ‘A’. It requires 3 hrs in Department A, 4 hrs in Department B, 7
hrs in Department C and 10 hrs in Department D. The maximum hour available in each of the depart-
ment is 15,000 hours. Find the maximum possible production of Product A.
One Product and Multiple Key Factors Theory of Bottleneck

C Block
A company manufactures two products A and B using imported raw materials. The selling prices of
these products are: A – ` 144, B – ` 216. The standard cost data are as under:
Product A Product B
(`) (`)
Raw material:
P 15 20
Q 5 20
Direct wages at ` 4 per hour:
Department 1 24 36
Department 2 12 24
Department 3 36 -
Department 4 - 48
Variable overheads 16 14
Fixed overheads are ` 50,000 per annum. The company operates a 8 hour shift for 300 days in a year
and the number of worker engaged are 45, 24, 27 and 36 in departments 1, 2, 3 and 4 respectively. The
number of workers cannot be increased or transferred from one department to another.
Required:
(a) The product mix to yield maximum profit.
(b) The most profitable mix if only one product is to be manufactured by the company. Whether
your answer will differ if the availability of both the imported raw materials in totals is limited to
` 1,80,000.
Multiple Products and Multiple Key Combinations

Factors

Cost Management
Key Factors
Class
WORK
Find the optimum mix:
Product A Product B
Materials per unit (Kg) 2 5
Labour Hour per unit (Hrs) 4 6
The maximum amount of materials available is 40,000 kgs and the labour hour available is 50,000 hrs.
C Block
Multiple Products and Multiple Key Simultaneous Equations

Factors
P, Q, R and S are the four types of products that appear in the price list of a company with a note that a
particular item or items may not be available on demand. The demand for the products is more than
what the company can supply and non supply of any of them will have no effect on the demand for
the rest.
For the year 2010, the company has made the following tentative budget that will use up all the avail-
able supplies of material and labour in that year.
A linear programming was made by the company’s accountant who stated that the opportunity costs
or the shadow prices came to ` 2.50 per labour hour and ` 16.25 per kg of material. He also suggested
the product mix, which has since been forgotten. The accountant has left the company. The company
now asks you as their management consultant to give your opinion about the budgeted program.
Data from tentative budget:
Product P Q R S
Production and sales units 1,000 1,200 1,600 800
Selling price per unit (`) 100 130 120 150
Variable cost per unit (`) 60 80 50 70
Labour hour per unit 3 4 2 5
Material usage per unit (kg) 2 3 4 5
(a) Determine the optimal sales mix for the company.

(b) What difference the sales mix in (a) will make that in the tentative budget in respect of contribu-
tion?
Advanced Strategic
Key Factors
Class
WORK
Multiple Products and Multiple Key Shadow Price and

Factors Simultaneous Equations

C Block
A company is producing three products P, Q & R. Relevant information is given below:
Product P Q R
Raw material per unit (kg) 20 12 30
Machine hours per unit (hours) 3 5 4
Selling price per unit (Rs.) 500 400 800
Maximum limit of production Unit 1,500 1,500 750
Only 9,200 hours are available for production at a cost of Rs.20 per hour and maximum 50,000 kgs. of
material @ Rs. 20 per kg., can be obtained.
(Only product mix quantities are to be shown, calculation of total profit at that product mix not re-
quired to be shown)
Required
On the basis of the above information determine the product-mix to give the highest profit if at least
two products are produced.
Multiple Products and Multiple Key Ranking and Simultaneous

Factors Equations

Cost Management
Key Factors
Home
WORK
The following particulars are extracted from the records of a company:
Product A per Product B per

unit unit
Sales ` 200 ` 240
Consumption of material 4 kgs 6 kgs
Material cost ` 20 ` 30
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Direct wages cost ` 30 ` 20
Direct expenses ` 20 ` 30
Machine hours used 6 hrs 4 hrs
Overhead Expenses:
Fixed ` 10 ` 20
Variable ` 34 ` 40
Direct wage per hour is ` 5.

(a) Comment on the profitability of each product (both use the same raw materials) when:
(i) Total sales potential in units is limited.
(ii) Total sales potential in value is limited.
(iii) Raw material is in short supply.
(iv) Production capacity is the limiting factor (in terms of man hours).
(b) Assuming raw material as the key factor, the availability of which is 20,000 kg and the maximum
sales potential of each product is 3,500 units, find out the product mix which will yield the maxi-
mum profit.
Multiple Products and One Key Factor
An engineering company is engaged in producing four products through operations at welding and
pressing departments. Products W1 & W2 are produced by welders in the welding department where-
as products P1 & P2 are produced by press-operators in the pressing department. Due to specific skill
requirements, the welders and press-operators can only work in their own department. The following
relevant data are available in respect of the products:
Advanced Strategic
Key Factors
Home
WORK
Products
W1 W2 P1 P2
Hours required per unit 4 4 5 2
Direct materials cost per unit (`) 18 22 32 44
Direct labour Hourly Rate (`/ hr) 4 4 4 4
Variable Overhead per unit (`) 2 2 3 3
The company incurs ` 50,000 per annum towards fixed costs. The maximum available hours are 20,000
and 16,000 for welding and pressing departments respectively. The demands keep on fluctuating
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but the minimum demands which are to be met as per management’s decision are 2,000 units of W1,
2,500 units of W2, 1,800 units of P1 and 2,200 units of P2 . The production manager suggests that the
welders and press-operators can be trained to perform both welding and pressing jobs so that excess
demand of any of the products can be met. This decision is going to increase the burden of fixed costs
by ` 5,000 per annum.
Prepare the profitability statement for optimum product-mix and recommend with reasons and ap-
propriate workings whether it is advisable to train the welders and press – operators as suggested by
the production manager.
Multiple Products and One Key Factor

Without Training Profit = ` 93,600; With Training
Profit = ` 96,600
A company manufactures two products. Each product passes through two departments A and B be-
fore it becomes a finished product. The data for a year are as under:
Products Aristocrat Deluxe

Maximum sales potential (units) 7,400 10,000
Product unit data:
Selling Price per unit (`) 90 80
Machine hours per unit:
Department A (hrs) 0.50 0.30
Department B (hrs) 0.40 0.45
Maximum capacity of Department A is 3,400 hours and of Department B is 3,840 hours.

Maximum quantity of direct materials available is 17,000 kg. Each product requires 2 kg. of direct ma-
terials. The purchase price of the direct materials is ` 5 per kg.

Cost Management
Key Factors
Home
WORK
Variable costs are budgeted at ` 50 per hour for Department A and ` 60 per hour for Department B.
In view of the aforesaid production capacity constraints, the company has decided to produce only
one of the two products during the year under review.
Required:
(i) Which of the two products should be produced and sold in the year under review to maximise
the profit? State the number of units of that product and the resultant contribution.
(ii) The surplus capacity available in Department A or Department B after manufacture of either Aris-
tocrat or Deluxe is proposed to be hired out to earn a contribution of ` 40 per hour in the case of
Department A and ` 60 per hour in the case of Department B.
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Prepare a statement to show whether Aristocrat or Deluxe should now be produced to maximise
the total contribution. Calculate such total contribution.
(iii) The company has been advised to produce 4,250 units of each product and also to hire out the
surplus capacity of Department A and/ or Department B. You are required to examine the fea-
sibility of this proposal and to prepare a budget analysis showing the total contribution for the
year.
(iv) Find the optimum product mix using a LP model when both of the products should be manufac-
tured and the maximum contribution if no hiring facility is available.
One Product and Multiple Key Factors Linear Programming
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Advanced Strategic
Cost Management
Sub Contracting
Class
WORK
Chapter 11
Sub Contracting
Cost Factors
C Block
1. Capacity Available for Quantity

Required
1. Applicability Step 1 : Relevant Cost of Manufacture
Step 2 : Purchase Cost
On Finished Goods or a part of Finished
Goods Production Step 3 : Compare and Decide
2. Capacity Required is more than

2. Factors Inuencing Decisions Capacity Available
(a) Cost Factors Step 1 : Compare Relevant Cost of

Manufacture and Purchase and
(b) Non Cost Factors Decide
Step 2 : For Components to be
manufactured, Find savings in
3. Non Cost Factors manufacturing per unit
(a) Quality and Secrecy Step 3 : Find Hours / Unit of Manufacture

Step 4 : Find Savings in Manufacturing
(b) Quantity
per Hour
(c) Time Step 5 : Rank for Manufacture
(d) Peer Co-operation Step 6 : Allocate the available Capacity to
(e) Focus manufacture
Step 7 : Purchase what quantity could
(f) Capacity
not be purchased
(g) Investment
(h) Skills 3. Difference between Key Factor &
Subcontracting Approach
(a) Key Factor - First Produce & Purchase

remaining
(b) Subcontracting - Compare Produce and
Purchase and then decide

Cost Management
Sub Contracting
Class
WORK
4. Subcontracting with Varying Fixed

Costs Levels
5. Sub Contracting A Part of

Production
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6. Subcontracting of Dependent
Products - e.g. Dinner Set or Furniture
Set
7. Indifference Point Analysis
| 293
Advanced Strategic
Cost Management
Sub Contracting
Class
WORK
The following data is given for four products:
A B C D
Selling Price per unit (`) 150 80 105 90
Variable cost per unit (`) 100 50 60 70
Purchase price per unit (`) 120 60 100 50
Hours required per unit 2 5 10 1
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Maximum demand (units) 1,000 1,000 1,000 1,000
Hours available are 14,500 hours

State which of the product should be manufactured or purchased under:
(a) Key Factor Approach
(b) Sub Contracting Approach
Key Factor vs Sub Contracting
Hazy Ltd are manufacturers for products P, Q, R and S. The direct cost of production are estimated as:
P (`) Q (`) R (`) S (`)

Material 36 38 42 24
Labour:
Assembly @ ` 4 per hour 8 12 16 16
Machining @ ` 6 per hour 12 24 18 36
Total fixed cost is dependent on output level as follows:
Production (units) Total Fixed Costs (`)

Upto 50,000 4,00,000
50,001 to 75,000 5,00,000
75,001 to 1,00,000 6,00,000

Cost Management
Sub Contracting
Class
WORK
The Sales Director estimates that demand for their products in the next year will be as follows:
P Q R S
Units 18,000 30,000 27,000 15,000
The Production Manager states that the capacity of existing machines is 2,10,000 hours per annum,
though this will be increased to 3,00,000 hours in two years time when new plant which is currently
on order will be delivered.
Meanwhile a local firm has offered to manufacture any of the products on a sub – contract basis at the
following prices:
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P Q R S
Price per unit 63 80 72 82
Required:
(a) Advise the management to what extent the services of sub – contractor should be utilised in
order to meet the expected demand of P, Q, R and S.
(b) Prepare a statement showing profit.
Sub Contracting Incremental Fixed Cost Effect

on units
Lee Electronic manufactures four types of electronic products, A,B,C and D. All these products have a
good demand in the market. The following figures are given to you:
A B C D
Material cost (`/units) 64 72 45 56
Machining Cost (`/unit @ ` 8 per hour) 48 32 64 24
Other Variable costs (` / unit) 32 36 44 20
Selling Price (`/unit) 162 156 173 118
Market Demand (units) 52,000 48,500 26,500 30,000
Advanced Strategic
Sub Contracting
Class
WORK
Fixed Overhead at different levels of operation are:
Level of operation (in production hours) Total Fixed Cost (`)

Upto 1,50,000 10,00,000
1,50,000 – 3,00,000 10,50,000
3,00,000 – 4,50,000 11,00,000
4,50,000 – 6,00,000 11,50,000
At present, the available production capacity in the company is 4,98,000 machine hours. This capacity
is not enough to meet the entire market demand and hence the production manager wants to in-
crease the capacity. The company wants to retain the customers by meeting their demands through
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alternative ways. One alternative is to sub-contract a part of its production. The sub-contract offer
received as under :
A B C D
Sub Contract Price (` per unit) 146 126 155 108
The company seeks your advice in terms of products and quantities to be produced and/or sub-con-
tracted, so as to achieve the maximum possible profit. You are required to also compute the profit
expected from your suggestion.
Sub Contracting Incremental Fixed Cost Effect

on Hours
K Ltd manufactures and sells a range of sports goods. Management is considering a proposal for ad-
vertising programme which would cost the company ` 3,00,000. The marketing department has put
forward the following two alternative sales budgets for the following year:
Products (‘000 units)

A B C D
Budget 1: without advertising 216 336 213 180
Budget 2: with advertising 240 373 342 198

Cost Management
Sub Contracting
Class
WORK
Selling price and variable production costs are budgeted as follows:
Products (` per unit)

A B C D
Selling prices 11.94 14.34 27.54 23.94
Variable production costs:
Direct material 5.04 6.60 15.24 12.48
Direct labour 2.04 2.04 3.36 3.18
Variable overheads 0.72 0.72 1.20 1.08
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Other data:
(a) The variable overheads are absorbed on a machine hour basis at a rate of ` 1.20 per machine
hour.
(b) Fixed overheads total ` 30,84,000 per annum
(c) Production capacity during the budget period 8,15,000 machine hours.
(d) Products A and C could be bought in at ` 10.68 and ` 24 per unit respectively.
Determine whether investment in the advertising campaign would be worthwhile and how produc-
tion facilities would be best utilised.
Sub Contracting Two in one
XYZ Ltd. is currently manufacturing 5,000 units of the product ‘XY 100’ annually, making full use of its
machine capacity. The selling price & total cost p. u. associated with ‘XY 100’ are as follows:
` `
Selling price per unit 900
Costs per unit:
Variable machine operating costs @ ` 100 per machine hr 150
Manufacturing overhead costs 180
Marketing and administrative costs 200
730
Operating income per unit of XY 100 170
Advanced Strategic
Sub Contracting
Class
WORK
XYZ Limited can sell additional 3,000 units of ‘XY 100’, if it can outsource those additional units.
ABC Limited, a suppliers of quality products, has agreed to supply upto 6,000 units of ‘XY 100’ per year
at a price of ` 650 per unit delivered at XYZ’s factory.
XYZ Limited can use its facility to produce an alternative product ‘XY 200’. It can sell up to 12,000 units
of ‘XY 200’ annually. Estimated selling price and total costs per unit to manufacture and sell 12,000
units of ‘XY 200’ are as follows:
` `
Selling price per unit 600
Costs per unit:
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Variable machine operating costs @ ` 100 per machine hr 50
Manufacturing overhead costs 60
Marketing and administrative costs 110
420
Operating income per unit of XY 200 180
Other information pertaining to the operating of XYZ Limited is as follows:

(a) XYZ Limited use machine hours as the basis for assigning fixed manufacturing overhead. The
fixed manufacturing overhead for the current year is ` 3,00,000. These costs will not be affected
by the product-mix decision.
(b) Variable marketing and administrative costs per unit for various products are as follows:
Manufactured ‘XY 100’ ` 80
Purchased ‘XY 100’ ` 40
Manufactured ‘XY 200’ ` 60
Fixed marketing and administrative costs for the current year is ` 6,00,000. These costs will not be
affected by the product-mix decision.
Calculate the quantity of each product that XYZ Limited should manufacture and / or purchase to
maximize operating income. Show your calculations.
Sub Contracting Unique Variety

Ranking on Contribution

Cost Management
Sub Contracting
Class
WORK
The opportunities afforded by the European Union have created a pleasant problem for CD ltd which
is considering concentrating its production on one of two products: Robroy or Trigger – both of which
are currently made and sold. With the expansion in sales possible, either product can be sold in quan-
tities which exceed the capacity of the present production facilities. Therefore, the use of sub – con-
tractor is being considered.
Sub – contractor Jason can produce upto a maximum of 10,000 units of Robroy or 8,000 units of Trig-
ger in a year for the type of work done by Department 1. Jason’s prices would be ` 110 for Robroy and
` 170 for Trigger, both prices being inclusive of the raw materials.
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Sub – contractor Nadira can produce upto a maximum of 6,400 units of Robroy or 4,000units of Trigger
in a year for the type of work done by Department 2. Nadira’s prices would be ` 120 for Robroy and `
154 for Trigger, both prices being inclusive of the raw materials.
If more than 18,000 units of Trigger are to be sold in a year, the price of the total quantity sold would
need to be reduced to ` 390 each.
CD Ltd has stated that its standard selling prices and standard prime costs for each product for the
forth coming year is:
Robroy Trigger
Hours ` Hours `
Selling prices 300 430
Costs:
Department 1
Direct materials 45 75
Direct wages 5 40 7.5 60
Department 2
Direct materials 15 20
Direct wages 7.5 75 10 100
Production overheads are to be absorbed on a direct labour hour basis and the budgeted overheads
for the forthcoming year are:
Department 1 Department 2
Fixed ` 4,00,000 ` 8,00,000
Variable per direct labour hour ` 2.00 ` 2.40
Budgeted maximum labour hours available 1,00,000 1,60,000
You are required to state, with supporting calculations and estimated profit figures, whether CD Lim-
ited should concentrate its resources on Robroy or Trigger if:
i. It does not use sub contractor.
ii. It uses sub contractor and restricts its sales to either 22,000 units of Robroy or 18,000 units of
Trigger.
Advanced Strategic
Sub Contracting
Class
WORK
Sub Contracting Partial Sub Contracting

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S. M Ltd. is engaged in the manufacture of Plastic bottles of standard size. The factory has eight ma-
chines of identical size each, capable of producing 50 bottles per hour. The variable cost per bottle is
` 0.40 and the selling price is ` 1.00 each.
The Co. has received an offer from another firm for manufacture of 50,000 units of a plastic moulded
toy. The price per toy is ` 6.00 & the variable cost is ` 4.80 each. In the case the company takes up the
job, it has to meet the expenses of making a special mould required for the manufacture of the toy.
The cost of the mould is ` 20,000. The company’s time study analysis shows that the machines can
produce only 20 toys per hour.
The company has a total capacity of 10,000 machine hours during the period in which the toy is re-
quired to be manufactured. The fixed costs excluding the cost of construction of the mould during
the period will be ` 21,000. The Co. has an order for the supply of 3,75,000 bottles during the period.
Required:
a. Do you advice the company to take up the order for manufacturing plastic moulded toys during
the time it has an order in its books for the supply of 3,75,000 bottles.
b. If the orders for the supply of bottles increase to 5,00,000 bottles, will you advise the company to
accept the order for the supply of plastic moulded toys ? State the reasons.
c. An associate company of S M Ltd. has idle capacity and is willing to take up the whole or part of
the manufacturing of the plastic moulded toys on subcontracting basis. The subcontract price
inclusive of the cost of construction of mould is ` 5.60 per toy.
Determine the minimum expected excess machines hour capacity needed to justify producing
any portion of the toy order by the company itself rather than subcontracting.
d. The company expected that it would be left with an excess capacity of 1,600 machine hours dur-
ing the period. Consequently, it accepted the toy order and subcontracted the balance require-
ments of the toys to meet the order. Later, the demand for bottles increased to 4,50,000 units for
the period. Since the company had accepted the toy order to fill 1,600 machines hours, it could
meet the demand for bottles only to the extent of 8,400 machines hours. Work out the loss which
the company suffered not being able to predict the demand for bottles accurately.
Sub Contracting Profit Computation

Cost Management
Sub Contracting
Class
WORK
X ltd. has incurred losses during past five years. Its projection for the year 2010 is also not very encour-
aging. The management is seriously considering the closure of the only manufacturing unit. However,
it is quite open to get the products on a sub – contracting basis and to continue its administrative
and marketing functions. Currently, four products are being manufactured and sold by catering to
different markets. The management is also willing to sacrifice any of these products to ensure survival.
` in crores
A B C D
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Sales 72.0 54.0 84.0 60.0
Costs:
Material 48.0 30.0 54.0 36.0
Labour 18.0 12.0 30.0 30.0
Allocated overheads:
Manufacturing 6.0 4.8 7.2 4.8
Admin & selling 2.4 1.2 3.6 2.4
Total cost 74.4 48.0 94.8 73.2
Profit/ (Loss) (2.4) 6.0 (10.8) (13.2)
The projected volume and sub contracting charges are:
A B C D
Volume (‘000 nos.) 2,000 1,500 3,000 2,000
Sub – contracting charges per unit (`) 80 70 90 130
Manufacturing, administrative and selling overheads consists of staff salaries, rent, essential mainte-
nance and tax – payable to the local authorities.
In case the management decides to discontinue the manufacturing operations a minimum notice pe-
riod of 3 months will be required to be given to staff as well as to the landlords of the manufacturing
unit and offices.
You may assume that both the manufacturing as well as the administrative and selling overheads is
fixed in nature, and that in the notice period mentioned above, these expenses would continue to be
incurred.
Assume that labour costs are related to the volume of operations and do not involve any notice period
for discontinuance,
Assume that the costs are incurred and revenue are earned evenly in each of the calendar months.
Based on the above, you are required to advise the management in the best option out of the options
under its considerations, viz:
(i) Issue notices to the staff, the landlords of manufacturing unit and offices on the first day of the
year and discontinue all the operations that very day.
Advanced Strategic
Sub Contracting
Class
WORK
(ii) Issue notices as above on the first day of the year and continue the operations till the end of the
notice period (only profitable products need to be continued).
(iii) Issue notices to the staff and the landlord, only in the manufacturing unit, resort to sub contract-
ing and to continue the administrative and marketing functions, (Sub – contracting is to be done
of profitable products only).
Sub Contracting Subcontracting charges

instead of Sub contracting
price.
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Fancy Furnishers Ltd manufactures one type of sofa set exclusively. The set contains the following
seven components: One sofa, two centre table and four chairs.
These components can be either manufactured by the company or sub – contracted and the follow-
ing are the relevant data:
Sofa Table Chair

Direct material cost per unit (`) 1,000 500 550
Direct labour hours per unit 100 50 10
Sub – contract price per unit (`) 2,500 1,000 750
Sales of sofa sets are currently 8,000 per period, each set selling per ` 7,500. A capacity constraint of
5,00,000 direct labour hours obligates the company to sub – contract the components. The variable
overheads vary with direct labour hours worked and are incurred at a rate of ` 2 per hour. Fixed costs
are ` 17,50,000 per period and labour costs ` 5.50 per hour.
(a) Which components and how many should be manufactured by the company for current sales?
(b) What is the maximum profit that could be earned at current selling price, if sales were unlimited?
(c) If the selling price has to be reduced to ` 6,950 per sofa set what is the maximum profit that the
company can obtain, if sales are unlimited.
Sub Contracting Dependent Products

Cost Management
Sub Contracting
Class
WORK
Aditya Ltd. manufactures four products A-1, B-2, C-3 and D-4 in Gurgaon and one product F-1 in Farid-
abad. Aditya Ltd. operates under Just-in-time (JIT) principle and does not hold any inventory of either
finished goods or raw materials.
Company has entered into an agreement with M Ltd. to supply 10,000 units per month of each prod-
uct produced from Gurgaon unit at a contracted price. Aditya Ltd. is bound to supply these contracted
units to M Ltd. without any fail. Following are the details related with non contracted units of Gurgaon
unit.
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A-1 B-2 C-3 D-4
Selling Price per unit 360.00 285.00 290.00 210.00
Direct Labour @ ` 45 per hour 112.50 67.50 135.00 67.50
Direct Material M-1 @ ` 50 per kg. 50.00 100.00 --- 75.00
Direct Material M-2 @ ` 30 per litre. 90.00 45.00 60.00 ---
Variable Overhead (varies with labour hrs) 12.50 7.50 15.00 7.50
Variable Overhead (varies with machine hrs) 9.00 12.00 9.00 15.00
Total Variable Cost 274.00 232.00 219.00 165.00
Machine Hours per unit 3 hours 4 hours 3 hours 5 hours
Maximum Demand per month (units) 90,000 95,000 80,000 75,000
The products manufactured in Gurgaon unit use direct material M-1 and M-2 but product F-1 pro-
duced in Faridabad unit is made by a distinct raw material Z. Material Z is purchased from the outside
market at ` 200.00 per unit. One unit of F-1 requires one unit of material Z.
Material Z can also be manufactured at Gurgaon unit but for this 2 hours of direct labour, 3 hours of
machine time and 2.5 litres of material M-2 will be required.
The Purchase manager has reported to the production manager that material M-1 and M-2 are in
short supply in the market and only 6,50,000 Kg. of M-1 and 6,00,000 litre of M-2 can be purchased in
a month.
Required
(i) CALCULATE whether Aditya Ltd. should manufacture material Z in Gurgoan unit or continue to
purchase it from the market and manufacture it in Faridabad unit.
(ii) CALCULATE the optimum monthly usage of Gurgaon unit’s available resources and make deci-
sion accordingly.
(iii) CALCULATE the purchase price of material Z at which your decision in (i) can be sustained.
Advanced Strategic
Sub Contracting
Home
WORK
A company manufactures two products EXE and WYE, which pass through two of its departments
exclusively used for them. A market research study conducted by the company reveals that the com-
pany can sale either 38,500 units of EXE or 31,500 units of WYE in a year. The manufacturing cost and
selling price details are as under:
EXE WYE
Selling price per unit ` 375 ` 540
Costs:
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DEPARTMENT 1:
Direct materials ` 58 ` 100
Direct labour ` 50 (5 hrs) ` 75 (7.5 hrs)
DEPARTMENT 2:
Direct materials ` 21 ` 26
Direct labour ` 90 (7.5 hrs) ` 120 (10 hrs)
OVERHEADS DEPARTMENT 1 DEPARTMENT 2
Variable Overhead rate per direct labour hour ` 2.40 ` 3.60
Fixed overheads ` 5,00,000 ` 10,00,000
Budgeted direct labour hours 1,75,000 2,80,000
Since the quantity which can be sold exceeded the production capacity, the company has been con-
sidering the use of sub-contracting production facilities. Accordingly, when tenders were floated, two
contractors responded as under:
Contractor DS offers to produce up to a maximum of 17,500 units of EXE or 14,000 units of WYE in
a year for the type of work done by department 1 of the company. The price charged by DS is ` 138
per unit of EXE and ` 212 per unit of WYE. These prices included the cost of direct materials used in
department 1 of the company.
Contractor DW can produce up to a maximum of 11,200 units of EXE and 7,000 units of WYE in a year
for the type of work done by department 2 of the company. The price charged by DW is ` 150 per unit
of EXE and ` 192 per unit of WYE. These prices included the cost of direct materials used in department
2 of the company.
Required:
(a) If the company does not wish to use the sub-contracting facility, which of the two product and
in what quantity should be produced and sold by the company by using its own manufacturing
capacity to earn maximum profit? Calculate the resultant maximum profit.
(b) If the company wishes to produce either 38,500 units of EXE or 31,500 units of WYE by using
sub-contracting facility, state which of the two products should be produced to maximise the
profits. Calculate the resultant maximum profit.

Cost Management
Sub Contracting
Home
WORK
Sub Contracting Partial Sub Contracting
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New ltd. Plans to completely manufacture a single product Z, whose selling price and variable man-
ufacturing costs will be ` 100 per unit and ` 80 per unit respectively. If the complete production is
done at its own factory, fixed machining costs will be ` 3,62,000 and fixed administration and selling
overheads will be ` 30,000 for the production period.
Alternatively, the product can be finished outside by sub contracting the machine operations at ` 10
per unit, but this will entail an increase in the fixed administration overheads by ` 1,20,000, while fully
avoiding the machining cost of ` 3,62,000.
Based on the above figures and assuming a production capacity of 30,000 units for the production
period, advise with relevant supporting figures, from a financial perspective, for what volumes of mar-
ket demand will:
(a) A manufacture be recommended at all?
(b) A fully in house production be recommended?
(c) The sub contracting option be recommended?
Sub Contracting Indifference Point Analysis
A furniture company sell one type of furniture set. This set contains following items: One table, two
arm chairs and four armless chairs. These items can either be manufactured or purchased and the
relevant data are as follows:
Armless
Table Arm Chair
Chair
Material cost per unit ` 20 ` 10 ` 11
Labour Hr per unit 10 hrs 5 hrs 1 hr
Purchase price per unit ` 50 ` 20 ` 15
Advanced Strategic
Sub Contracting
Home
WORK
At present, selling price is ` 150 per set and demand are for 8,000 sets. Only 50,000 Labour hrs are
available, labour cost is ` 1.1 per hour and variable overhead is ` 0.40 per labour hour Fixed Costs are
` 35,000 p.a.
(i) Which items and how many should be manufactured to maximise profit?
(ii) What maximum profit can be earned, if the demand is infinite?
(iii) What would be the maximum profit if selling price has to be reduced to ` 139 per set?
Sub Contracting Dependent Products

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Cost Management
Other Areas of Decision Making & Service Sector
Class
WORK
Chapter 12
Other Areas of Decision Making
& Service Sector
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1. Export Offers 1. Evaluation of Offers
2. Minimum Solution of Offer
3. Incremental Revenue and Differential Cost of
Offer at Different Levels
4. Evaluating Multiple Export Offers to be
accepted together
Joint Product
2. Evaluation of Further Processing of Products
Decisions
Service Sector 1. Break Even Analysis

3.
Decision 2. Protability Analysis
1. Spare Capacity Utilization

4. Other Decisions
2. Introduction of Own sales force
3. Miscellaneous
Advanced Strategic
Other Areas of Decision Making& Service Sector
Class
WORK
A firm furnishes the following information:
Capacity in units 2,000 3,000 4,000 5,000 6,000

Unit cost (`) 40 35 34 32 31
Unit price (`) 100 95 94 - -
At present the company is operating at 4,000 units capacity and has received an order for 2,000 units
from an export market at ` 28 per unit.
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Should the order be accepted?
Export Offers Incremental Profit
At present the firm is operating at 50,000 level of output, capacity of plant is 1,00,000 units.
Level Fixed Cost (`) Variable cost per unit (`) Total cost (`)
0 1,50,000 -- 1,50,000
10,000 1,50,000 5.00 2,00,000
20,000 1,50,000 5.00 2,50,000
50,000 1,50,000 5.00 4,00,000
60,000 1,60,000 5.00 4,60,000
(a) An offer received from abroad for the supply of 10,000 unit, what should be the lowest price?
(b) If supplier also provides the discount @ 10 % per unit on variable cost for all the unit, when total
purchase is above 50,000 unit then what should be the minimum price for such 10,000 unit.
Export Offers Minimum Price

Cost Management
Class
WORK
A Company has a capacity of producing 1,00,000 units of a certain product in a month. The Sales De-
partment reports that the following schedule of sales prices is possible.
Volume of production 60% 70% 80% 90% 100%

SP per unit ` 0.90 ` 0.80 ` 0.75 ` 0.69 ` 0.63
The variable cost of mfg. between these levels is ` 0.15 per unit. Fixed cost ` 40,000.
(a) Prepare a statement showing incremental revenue and differential cost at each stage. At which
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volume of production will the profit be maximum?
(b) If there is a bulk offer at ` 0.50 per unit for the balance capacity over the maximum profit volume
for export and price quoted will not affect the internal sale, will you advise accepting this bid and
why?
(c) What should be the minimum price for an offer of 20,000 units & capacity cannot be increased?
Export Offers Minimum Price using Different

Levels of Incremental Cost
Sports Specialists Ltd is famous for specialised manufacture of quality chess boards sets. Presently the
company is working below its normal capacity of 1,000 units per month. The company sells its chess
board sets in the national market at ` 150 per unit. During April 2009, 600 units were sold which is the
regular sales volume for each month all through the year.
The unit cost of production is –
Direct material ` 60
Direct Labour ` 30
Factory OH ` 30
Selling and Administration OH ` 15
The company has received an export order on 20th April for supply of 600 units to be despatched by
end of June. However, the order stipulates the price per unit as ` 100 only. The cost analysis indicated
that the cost of direct material and direct labour that are to be incurred on the export order would be
same amount per unit as the regular line of production. However, an amount of ` 2,000 will have to be
incurred on special packing. No additional factory, selling or administrative overhead costs would be
incurred in executing the export since the firm is operating below its normal capacity.
Advanced Strategic
Class
WORK
Using Differential cost analysis method, prepare the income statement to show whether the accept-
ance of the export order would be profitable to the company.
Export Offers Incremental Profit
Q 5
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Ex. Book No. Pg. No.
X ltd having an installed capacity of 1,00,000 units of a product is currently operating at 70 % utili-
sation. At current levels of input prices, the FOB unit costs (after taking credit for applicable export
incentives) work out as follows:
Capacity utilisation percent FOB unit costs (`)

70 % 97
80 % 92
90 % 87
100 % 82
The company has received three foreign offers from different sources as under:
Source A: 5,000 units at ` 55 per unit FOB
Source B: 10,000 units at ` 52 per unit FOB
Source C: 10,000 units at ` 51 per unit FOB
Advise the company as to whether any or all export orders should be accepted or not.
Export Offers Multiple Offers together

Cost Management
Class
WORK
A company manufactures and markets its product Rosin. The company which is presently operating
at a capacity of 75% sells 6,000 tonnes of Rosin in the domestic market. The cost structure based on
the current production is :
` per tonne
Selling Price 45,000
Raw materials 100% variable 30,000
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Wages and salary 60% variable 7,000
Stores and spares 66 2/3% variable 300
Packing materials 100% variable 300
Repairs and maintenance 50% variable 400
Power and fuel 80% variable 2,500
Depreciation 100% fixed 1,000
Other overheads 20% variable 500
Total costs 42,000
Profit 3,000
One-sixth of the requirement of raw materials is imported. The company until recently experienced
no difficulty in importing its requirements of raw materials at cost. In view of the present policy of the
Government, the company has now to export its product to earn its requirements of foreign exchange
for importing raw materials. In case the company decides to export its products, it will be eligible to
obtain foreign exchange entitlements to the extent of 40% of the export sales value.
Alternatively, the company can go in for purchase of foreign exchange in the open market at a premi-
um of 50% and consequently the imported raw material cost will increase to that extent. The company
has therefore under its consideration a proposal for utilisation of the balance capacity of its plant for
export at a price of ` 35,000 per tonne. The special export expenses are estimated at ` 200 per tonne.
(i) Present a statement of overall profitability broken into profitability under domestic sales and
export sales.
(ii) Advise whether the company should go in for export business or not.
(iii) What price adjustment is required in the domestic sales to achieve the overall average profit of `
3,000 per tonne as per the cost sheet.
Export Offers Export for Import
Advanced Strategic
Class
WORK
Pigments ltd. Is a chemical factory producing joint products J,K and L at a joint cost of production of
` 9,60,000. The sales are:
J: 60,000 units at ` 5 per unit

K: 20,000 units at ` 20 per unit
L: 40,000 units at ` 10 per unit
The company seeks your advice regarding the following options available:
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Option 1: After the joint process, all of L can be further processed to make 36,000 units of M, at an
additional processing cost of ` 1,80,000 and M can be sold at ` 18 per unit.
Option 2: the facilities used to convert L to M may be used to make 7,000 units of an additional prod-
uct A, with a different raw material input. Product A can be made at an additional variable manufac-
turing cost of ` 12 per unit and will fetch ` 30 as the selling price, but the company will have to offer
one unit of J as a free gift for each unit of A sold.
Evaluate the proposals using the incremental cost approach.
Joint Products Decisions
Expert Roadways Services Pvt. Ltd. is planning to run a fleet of 15 buses in Birpur City on a fixed route.
Company has estimated a total of 2,51,85,000 passenger kilometers per annum. It is estimated buses
to have 100% load factor. Buses are purchased at a price of ` 44,00,000 per unit whose scrap value at
the end of 5 years life is ` 5,50,000. Seating capacity of a bus excluding a Driver’s seat is 42. Each bus
can give a mileage of 5 kmpl. Average cost of fuel is ` 66 per liter. Cost of Lubricants & Sundries per
1,000 km would be ` 3,300. Company will pay ` 27,500 per month to Driver and two attendants for
each bus.
Other annual charges per bus: Insurance ` 55,000, Garage Charges ` 33,000, Repairs & Maintenance `
55,000. Route Permit Charges upto 20,000 km is ` 5,500 and ` 2,200 for every additional 5,000 km or
part thereof.
Required
(i) CALCULATE a suggested fare per passenger/km taking into account markup on cost @20% to
cover general overheads and sufficient profit.

Cost Management
Class
WORK
(ii) The Transport Sector of Birpur is highly regulated. The Government has fixed the fare @ ` 1.35 for
next 2 years. COMMENT on the two year’s profitability taking into consideration the inflation rate
of 8%.
Note: Route permit charges is not subject to Inflation.
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A hospital operates a 40 bed capacity special health care department. The said department levies a
charge of ` 425 per bed day from the patient using its services. The data relating to fees collected and
costs for the year 2008 are as under :
`
Fees collected during the year 34,95,625
Variable costs based on patient days 13,57,125
Department fixed costs 6,22,500
Apportioned costs of the hospital administration charges10,00,000. Besides the above, nursing staff
were employed as per the following scale at ` 48,000 per annum per nurse.
Annual Patient Days No. of nurses required

Less than 5000 3
5000 – 7000 4
7000 – 9000 6
Above 9000 8
The projections for the year 2009 are as under; --

1. The costs other than apportioned overheads will go up by 10%.
2. The apportioned overheads will increase by ` 2,50,000 per annum.
3. The salary of the nursing staff will increase to ` 54,000 per annum per nurse.
The occupancy of the bed capacity is not likely to increase in 2009 and consequently the manage-
ment is actively considering a proposal to close down the department. In that event, the departmen-
tal fixed costs can be avoided.
Advanced Strategic
Class
WORK
Required:
(a) Present statement to show the profitability of the department for the years 2008 and 2009.
(b) Calculate the
a. break-even bed capacity for the year 2009
b. increase in fee per bed day required to justify continuance of the department.
Hospital Industry Profitability and Break Even

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Kangana Resorts operates a lodging house with attached facilities of a shopping arcade and restau-
rant on a National Highway. The following details are available:
(a) The lodging house has 40 twin – bedded rooms, which are to be rented for ` 200 per night on
double occupancy basis. The occupancy ratio is expected at 85 % and always both the beds in
the room will be occupied. The lodging facilities are operated for 200 days in the year during
foreign tourists season time only.
(b) As per past record the spending pattern of each tourist staying in the lodge will be as under:
` 50 per day in the shopping arcade and ` 80 per day in the restaurant.
(c) Ratios of variable cost to respective sales volume are:
Shops – 50 % ; Restaurant – 60 %.
(d) For the lodging house the variable cost on house – keeping and electricity will amount ` 30 per
day per occupied room.
(e) Annual fixed overhead for the entire complex is estimated at ` 10,00,000.
Required:
(i) Prepare an income statement for the next year.
(ii) The Lodging House Manager suggests a proposal of reducing room rent at ` 150 per day on
double occupancy basis, which will increase occupancy level to 95 %. Should the proposal be
accepted or not?
Hotel Industries Meaning of Double Occupancy

Cost Management
Class
WORK
Happy Holidays Company contracts to take children on excursion trips. Relevant information for a
proposed excursion trip is given below:
`
Revenue per trip per child 4,000
Expenses that have to be incurred:
Train fare per child per trip 1,700
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Meals per child per trip 300
Craft materials per child per trip 600
Room rent per trip (4 children per room) 760
Local Vehicle (6 children per vehicle) 1200 (per vehicle)
Fixed costs that are required to be covered 5,18,130
Find the minimum number of children to cross the break - even point and start earning profit.
Travel Industry Break Even
The management of New Hotel has prepared the budget, which shows the following room occupancy:
Average %
January-March 45
April-June 60
July-September 90
October-December 55
Revenue for the year is estimated to be ` 30,00,000 and arises from three profit centres:
Accommodation 45%
Restaurant 35%
Bar 20%
Total 100%
The accommodation revenue is earned from several different categories of guest, each of which pays
a different rate per room. The three profit centres have the following percentage gross margins:
Advanced Strategic
Class
WORK
Accomodation Restaurant Bar

% % % % % %
Revenue 100 100 100
Wages 20 30 15
Cost of Sales -- 40 50
Direct costs 10 10 5
30 80 70
Profit 70 20 30
Fixed costs for the year are estimated to be ` 5,65,000. Capital Employed is ` 70,00,000. To improve the
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Return on Capital Employed (ROCE) two suggestions have been made:

a) To Offer Special Two-Night Holidays at a reduced price of ` 25 per night. It is expected that
those accepting the offer would spend an amount equal to 40% of the accommodation charge
in the restaurant, and 20% in the bar. The gross margin percentages for the three profit centres
would remain same as above.
b) To Increase Prices: Management is confident that there will be no drop in volume of sales if
restaurant prices are increased by 10% and bar prices by 5%. Accommodation prices would also
need to be increased.
Required:
a. Calculate the budgeted return on capital employed before tax ; and
b. Calculate
i) how many two-night holidays would need to be sold each week in the three off-peak
quarters to improve the return on capital employed by a further 4% above the percent-
age calculated in a) above.
ii) by what percentage the prices of accommodation would need to be increased to achieve
the desired increase in ROCE shown in b) i) above.
Hotel Industry Profitability and Evaluation

based on ROCE
Mr. Philips owns a gift shop, a restaurant and a lodge in Shimla. Typically he operates these only dur-
ing the season period of four months in a year. For the past season the occupancy rate in the lodge
was 90% and level of activity in case of gift-shop and restaurant at 80%. The relevant data for the past
season were as under:

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Gift Shop Restaurant Lodge

` in ‘00
Amt % Amt % Amt %
Receipts / sales 48,000 100 64,000 100 1,80,000 100
Expenditure:
Cost of Sales 26,400 55 35,200 55 -- --
Supplies 2,400 5 6,400 10 14,400 8
Insurance & taxes 1,920 4 6,400 10 36,000 20
Depreciation 2,880 6 8,000 12.5 39,600 22
Salaries 4,800 10 4,800 7.5 25,200 14
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Electricity charges 960 2 3,200 5 13,500 7.5
Total 39,360 82 64,000 100 1,28,700 71.5
Profit 8,640 18 -- -- 51,300 28.5
Additional information:
(a) Cost of sales and supplies vary directly with the occupancy rate in case of lodge and level of ac-
tivity in case of gift shop and restaurant.
(b) Insurances and Taxes and depreciation are for the entire period of twelve months.
(c) Salaries paid are for the season period except a Chowkidar for the lodge who is paid for the full
year at ` 40,000 per month.
(d) Electricity charges include fixed charges of ` 64,000, ` 1,92,000 and ` 9,90,000 for gift-shop, res-
taurant and lodge respectively. The balance amount varies directly with occupancy rate in case
of lodge and level of activity in case of gift- shop and restaurant. Fixed electric charges are for
the season except in case of lodge where ` 6,90,000 is for the season and ` 3,00,000 for the entire
period of twelve months.
Mr. Philips is interested in increasing his net income. The following two options are under his consid-
erations:
(a) To continue the operations during the season period only by inserting advertisement in newspa-
pers thereby occupancy rate to reach 100% in case of lodge and 90% level of activity in respect
of gift shop and restaurant. The costs of advertisement are estimated at ` 12,00,000.
(b) To continue operations throughout the entire period of twelve months comprising season peri-
od of four months and off-season period of eight months.
The occupancy rate is expected at 90% and 40% during season period and off-season period
respectively in case of the lodge.
The room rents are bound to be reduced to 60% of the original rates during off-season period.
The level of activity of gift-shop and restaurant is expected at 80% and 30% during season &
off-season period respectively but 5% discount on the original rates will have to be offered dur-
ing off-season period.
Which option is profitable? As a Chartered Accountant would you like to suggest him any other alter-
native based upon the above figures, which can be adopted to earn more net profit? (Use incremental
revenue and cost approach).
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Hotel Industry Incremental Profit under

different proposals

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A City Health Centre provides health and other related services to the citizens who are covered under
insurance plan. The health centre receives a payment from the Insurance company each time any pa-
tient attends the centre for consultation as under:
Consultation Involving Payment from Insurance Co. (`)

No treatment 60
Minor treatment 250
Major treatment 500
In addition, the adult patients will have to make a co payment which is equivalent to the amount of
payment for the respective category of treatment made by the Insurance company. However, children
and senior citizens are not required to make any such co payment.
The Health Centre will remain open for 6 day in a week for 52 weeks in a year. Each physician treated
20 patients per day although the maximum number of patients that could have been treated by a
physician on any working day is 24 patients.
the health centre receives a fixed income of ` 2,25,280 p.a. for promotion of health products from the
manufacturer. The annual expenditure of health centre is as under:
(a) Materials and consumables (100% variable): ` 22,32,000
(b) Staff salaries p.a. per employee (Fixed)
Physician 4,50,000
Assistants 1,50,000
Administrative Staff 90,000
` 6,90,000
(c) Establishment and other operating costs (Fixed) ` 16,00,000
The non financial informations are:

a. Staff:
No. of Physicians – 6
No. of Assistants – 7
No. of Administrative staffs - 2

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b. Patient Mix:
Adults: 50%, Children: 40%, Senior Citizen: 10%
c. Mix of patient Appointments:
Consultation – requiring no treatment – 70%

Minor treatment – 20%
Major treatment – 10%
1. Calculate the net income of City Health Centre for next year.
2. Determine the percentage of maximum capacity required to be utilised next year in order to
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Break Even.
Hospital Industry Profitability and Break Even
Flyway Ltd. has hired an aircraft to specially operate between cities A and B. All the seats are economy
class.
The following information is available:
Seating capacity of the aircraft 260 passengers

Average number of passengers per flight 240 passengers
Average one-way fare from A to B ` 5,000 per passenger
Fuel costs per flight from A to B ` 90,000
Food cost (A to B sector) (no charge to passenger) ` 300 per passenger
Commission to travel agents (All tickets are through agents) 10% of the fare
Annual lease costs allocated to each flight ` 2,00,000
Ground services, baggage handling/checking in Service costs per flight A ` 40,000
to B
Flight crew salaries per flight A to B ` 48,000
There is an offer from another airlines operator, Haltgo Ltd. for a stop-over at destination D, which is on
the way from A to B. Due to this, the flight will operate from A to D, then from D to B.
The following terms are considered for the stop-over:
50 seats from D to B will be booked by Haltgo at ` 2,700 per ticket, whether or not Haltgo is able to
sell them to its customers. No agents’ commission is payable on these tickets. However Snacks must
be provided to these passengers also by Flyway Ltd. at no further charge to Haltgo of the passengers.
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A maximum of 60 tickets can be sold by Flyway’s travel agents for the A to D sector at a fare of ` 3,000
per passenger.
Since the stop-over wastes more time, 25 of Flyway’s original passengers in the A to B sector will vol-
untarily drop out in favour of other airlines offering direct flights between A and B.
Due to the stop-over, fuel costs will increase from ` 90,000 to ` 1,35,000. Additional airport landing/
baggage handling charges of ` 19,000 per stop-over will have to be incurred by Flyway Ltd.
Flyway Ltd will have to serve snacks to all the passengers in the D to B sector at no charge to passen-
gers. Each snack will cost Flyway ` 200. This will be in addition to the original food at ` 300 served in
the A to D sector.
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You may assume that fuel costs are not affected by the actual number of passengers in the flight,
ignore non-financial considerations, additional wear and tear to aircraft due to extra landing/take-off.
Without considering Haltgo’s offer,
(i) What is the profit earned by Flyway Ltd. per flight from A to B?
(ii) What is the Break-even number of passengers for each flight from A to B?
(iii) Considering the effects of Haltgo’s offer, evaluate whether Flyway should accept the offer.
(A detailed profitable statement is not essential. Only figures relevant for the cost-revenue analysis are
required).
Airlines Industries Profitability and Evaluation

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A company manufactures two products ‘AB’ and ‘CD’ by utilising 25% and 40% of its total capacity
respectively. The cost data per unit for 2008–09 are as under:
AB CD
Production and sales (units) 5,000 10,000
Selling price ` 80 ` 100
Direct material ` 10 ` 30
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Direct labour @ ` 5 per hour ` 25 ` 20
Variable overheads are 100% on wages. Fixed overheads for 2007–08 amounted to ` 2,25,000.
During 2009-10 the company expects that the direct material costs will rise by 5%, the labour hourly
rate will rise by 25 paisa and variable overheads will continue to maintain same relationship with
wages as was in 2008– 09. For the same volume of output as was in 2007– 08, the selling price is to be
enhanced by 5% in case of ‘AB’ and 4% in case of ‘CD’.
The company has the following proposals for consideration of the management for 2009-10 to im-
prove profitability:
(a) Utilise the balance capacity to produce ‘AB’ and to sell this increased production at the existing
selling price of ` 80.
(b) Utilise the balance capacity to produce ’CD’. While doing so the efficiency will down by 16% on
account of newly recruited labour in respect of this increased production. Fixed selling & distri-
bution expenses of ` 50,000 will have to be spent to sell this additional output.
(c) Introduce new product ‘EF’ to utilize the balance capacity. One unit of ‘EF’ can be manufactured
in 7 labour hours. Direct material will cost ` 40 p.u.. Its selling price p.u. will be ` 145. variable
overheads will maintain same ratio to wages as for other two products. To boost the sales of ‘EF’
special advertising expenses of ` 30,000 will be spent.
The present allocation of 25% and 40% capacity for ‘AB’ and ‘CD’ cannot be changed and only the spare
capacity is required to be used for production under the aforesaid proposals:
Required:
(i) Present a statement of Profit for 2008– 09.
(ii) Using incremental revenue and differential cost approach, find out which proposal is more prof-
itable for 2009-10.
(iii) Present a statement of profit for 2009-10 based on above recommendation.
Spare Capacity
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Solution
Note 1: Computation of Variable Cost per unit
AB CD
Material 10 30
Labour 25 20
Variable OH 25 20
Total 60 70
Note 2: Computation of contribution per unit at present

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AB CD
SP 80 100
VC 60 70
Contribution 20 30
Note 3: Computation of Revised Contribution for 2009 – 2010:
AB CD
Revised SP 80 x 105 % = 84 100 x 104% = 104
Less: Direct material 10 x 105% = 10.5 30 x 105 % = 31.5
Direct Labour 5.25 x 5 hr = 26.25 5.25 x 4 hr = 21
Variable OH 26.25 x 100% = 26.25 21 x 100% = 21
Revised Contribution 21 30.5
Note 4: Computation of Idle Capacity:
AB (25 %) CD (40 %)
Hrs utilized at present 5000 x 5 = 25,000 hrs 10,000 x 4 = 40,000
Hours available = 25,000/25% or 40,000/40% = 1,00,000 hrs

Total hrs utilized = 25,000 hrs + 40,000 hrs = 65,000 hrs
Therefore, hours unutilized = 1,00,000 – 65,000 = 35,000 hrs
Solution to part (i)
Statement showing profit for year 2008 – 2009

Particulars AB CD Total
Units sold 5,000 10,000
Contribution per unit (N 2) 20 30
Total contribution 1,00,000 3,00,000 4,00,000
Less: Fixed cost 2,25,000
Profit 1,75,000

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Solution to part (ii)
Statement Showing Evaluation of Proposals for 2009 – 2010

Particulars Amount
Proposal I
Additional Production of AB (35,000 / 5 ) 7,000 units
Incremental contribution from sale of additional AB (80 – 63) x 7000 ` 1,19,000
Incremental contribution from sale of old AB (21 – 20) x 5000 ` 5,000
Incremental contribution from sale of old CD (30.5 – 30) x 10000 ` 5,000
Total Incremental contribution ` 1,29,000
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Proposal II
Incremental Contribution from sale of additional CD (N 5) ` 1,15,375
Incremental Contribution from sale of old AB `5,000
Incremental Contribution from sale of old CD ` 5,000
Total Incremental Contribution ` 1,25,375
Proposal III
Incremental Contribution from EF (N 6) ` 1,27,500
Incremental Contribution from sale of old AB `5,000
Incremental Contribution from sale of old CD ` 5,000
Total Incremental Contribution ` 1,37,500
Therefore, Proposal III is best.

Note 5: Incremental Contribution from additional CD (Proposal II):
Hour per unit for CD at reduced efficiency [4/ 84%] 4.7619 hr

Additional production of CD (35,000 /4.7619) 7,350 units
Sales Revenue 7350 x 104 7,64,400
Less: Materials 7350 x 31.5 2,31,525
Labour 35,000 x 5.25 1,83,750
Variable OH 35,000 x 5.25 1,83,750
Contribution 1,65,375
Less: Discretionary Fixed Costs 50,000
Profit 1,15,375
Note 6: Incremental Contribution from New EF (Proposal III):
Production of EF (35,000 / 7 hrs) 5,000 units

Sales revenue (5,000 x 145) ` 7,25,000
Less: Materials (5,000 x 40) ` 2,00,000
Labour (5,000 x 5.25 x 7 hr) ` 1,83,750
Variable OH (100 % of wages) ` 1,83,750
Contribution ` 1,57,500
Less: Fixed Cost ` 30,000
Profit ` 1,27,500
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Solution to part (iii):

The profit for year 2009 – 2010 based on recommendation of Proposal III will be (` 1,75,000 + `
1,37,500) = ` 3,12,500.
R ltd has spare capacity in two of its manufacturing departments – Department 4 and Department 5. A
five day week of 40 hours is worked, but there is only enough internal work for 3 days per week so that
2 days per week (16 hours) could be available in each department. R ltd has sold this time to another
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manufacturer, but there is some concern about the profitability of this work.
The accountant has prepared a table giving the hourly operating cost in each department. The sum-
marised figures are as follows:
Department 4 Department 5
(`) (`)
Power costs 40 60
Labour costs 40 20
Overhead costs 40 40
120 120
The labour is paid on a time basis and there is no charge in the weekly wage bill whether or not the
plant is working at full capacity. The overhead figures are based on firm’s current overhead absorption
rates (fixed and variable) when the departments are operating at 90% of full capacity (assume 50
weeks a year). The budgeted fixed overhead attributed to Department 4 is ` 36,000 p.a. and that for
Department 5 ` 50,400 p.a.
As a short term measure the company has been selling processing time to another manufacturer @ `
70 per hour in either departments. The customer is willing to continue this arrangement and to pur-
chase any spare time available, but R ltd is considering the introduction of a new product on a minor
scale to absorb the spare capacity.
Each unit of the new product would require 45 minutes in Department 4 and 20 minutes in Depart-
ment 5. The variable cost of the required input material is ` 10 per unit. The market study indicated as
follows:
(1) With a selling price of ` 100, the demand would be 1,500 units p.a.
(2) With a selling price of ` 110, the demand would be 1,000 units p.a.
(3) With a selling price of ` 120. The demand would be 500 units p.a.
You are required to calculate the best weekly programme for the spare time in the two manufacturing
department, to determine the best price to charge for the new product and to quantify the weekly
gain that this programme and price should yield.
Spare Capacity

Cost Management
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SOLUTION
Note 1: Analysis of OH Recovery Rates of Departments and benefit from sub contracting
Particulars Department 4 Department 5

Normal hours for the period (50 weeks x 40 hrs x 1800 hrs 1800 hrs
90%)
Fixed OH per hr (` 36000 and ` 50400) / 1800 hrs ` 20 per hr ` 28 per hr
Total OH per hr (given) ` 40 per hr ` 40 per hr
Variable OH per hr (Total OH – Fixed OH) ` 20 per hr ` 12 per hr
Power costs per hr (given) ` 40 per hr ` 60 per hr
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Total Variable costs per hr (Power + VOH) ` 60 per hr ` 72 per hr
Sub contracting rate per hr ` 70 per hr ` 70 per hr
Contribution per hr in sub contracting ` 10 per hr ` (2) per hr
Relevant cost for production instead of subcon- `(60+10)=` 70 per hr ` 72 per hr
tracting
Note 2: It is given that there is no change in the weekly wage bill whether or not the plant is working
at full capacity. Hence, Labour cost is committed and fixed in nature.
Note 3: Sub contracting is not desirable in Department 5, since there is a loss of ` 2 per hour. Sub con-
tracting is feasible only for Department 4, resulting in a contribution of ` 10 per hour.
Statement showing Evaluation of Spare capacity and possible production quantity

Spare capacity available during the period [(5-3)days x 50 weeks x 8 hr] 800 hours
Time required in Department 4 for every unit of the new product 45/60 hrs
Maximum possible production based on Department 4 spare capacity 1,067 units
Time required in Department 5 for every unit of new product 20/60 hrs
Maximum possible production based on Department 5 spare capacity 2,400 units
Thus, possible production from both department 1,067 units
Statement showing optimum production plan

Particulars Option 1 Option 2 Option 3
Production and Sales (Restricted to maximum) 1,067 1,000 500 units
units units
Selling price per unit ` 100 ` 110 ` 120
Variable costs:
Material ` 10 ` 10 ` 10
Department 4 @` 70 per hr for 45 min ` 52.50 ` 52.50 ` 52.50
Department 5 @ ` 72 per hr for 20 min ` 24 ` 24 ` 24
Contribution per unit ` 13.50 ` 23.50 ` 33.50
Total contribution earned ` 14,405 ` 23,500 ` 16,750
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Decision:
1. The company should choose Option 2 i.e. Production and sale of 1,000 units of the product at a
selling price of ` 110.
2. The additional gain over and above the present gain from sub contracting (since relevant cost
has been considered for departments) = ` 23,500 / 50 weeks = ` 470 per week.
3. The Final Decision can be concluded as below:
Particulars Department 4 Department 5

Spare capacity at present 800 hrs or 16 hrs per week 800 hrs or 16 hrs per week
Capacity utilized by production 1,000 units × 45/60 hrs = 750 1,000 units × 20/60 hrs = 333 hrs
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of 1,000 units of new product hours or 15 hrs per week or 6.7 hrs per week
Balance unutilized capacity 50 hrs or 1 hour per week 467 hours or 9.3 hrs per week
Utilization of balance capacity Hire out at ` 70 per hr Not hired out, still spare capacity
SM Ltd. is engaged in the manufacture of a range of consumer products. The sales are made through
its own authorised agents who are paid a commission of 20% on the selling price of the products. The
company has prepared the following budget:
` (in lakhs)
Sales 225.00
Production costs:
Prime costs and variable overheads 78.75
Fixed overheads 36.25
Selling costs:
Agents commission 45.00
Sales office expenses (fixed) 2.00
Administration costs (fixed) 30.00
Total costs 192.00
Profit 33.00
The company, after the finalisation of the above budget, is faced with a demand from its agents for an
increase in their commission to 22% of selling price. The company is therefore contemplating to dis-
pense with the services of agents and instead employ its own sales force. In that event the company
expects to incur the following costs:
` (in lakhs)
Sales Manager’s Salary and expenses 7.50
Salesmen’ expenses, including travelling expenses 2.00
Sales office costs (in addition to the present costs) 5.00
Interest and depreciation on sales department vehicles 3.50
18.00

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In addition to the above it will be necessary to hire 40 salesmen at a salary of ` 40,000 per annum each
plus a commission of 5% on sales plus car allowance of ` 1 per kilometres to cover vehicle costs except
interest and depreciation which has already been considered above.
Assuming that the company decides in favour of employing its own sale force, you are required to
answer the following questions:
(a) For the same volume of sales as envisaged in the budget, what is the maximum average kilo-
metre per annum that the salesmen could travel if the company is to achieve the same budgeted
profit as it would have obtained by retaining the agents and granting them the increased com-
mission which they had demanded.
(b) At what level of sales would the original budgeted profit be achieved if each salesman were to
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travel an average of 14,000 km per annum. Assume all other assumptions inherent in the budget
are maintained.
(c) What is the maximum level of commission on sales that the company could afford to pay if it
wished to achieve a 16% increase in its original budgeted profit and expected a 16% increase in
sales at the budgeted selling prices and an average of 16,000 km per annum of travel by each
salesman?
Introduction of own Sales Force
Solution
Solution to part (a)
Particulars Agent Salesmen

Sales 225.00 225.00
Prime cost and VOH 78.75 78.75
Fixed OH 36.25 36.25
Selling Costs:
Agent commission (225 x 22%) 49.50 --
Salesmen commission (225 x 5%) -- 11.25
Sales office expense 2.00 2.00
Salesmen salary (40,000 x 40) -- 16.00
Other sales expense -- 18.00
Car allowance -- 4.25 (b/f )
Administration costs 30.00 30.00
Profit 28.50 28.50
Hence, for same level of profit, maximum average expense for travel which can be given as Car allow-
ance = ` 4.25 lakh.
Kilometres per annum per salesman = ` 4,25,000 ÷ ` 1 per km ÷ 40 salesmen = 10,625 kms.
Advanced Strategic
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Solution to part (b)

1. Variable cost on sales ratio:
Total Variable expense = 78.75 + 11.25 = ` 90 lakh
Variable cost on sales ratio = ` 90 ÷ ` 225 = 40%
2. Additional profit required:
Required Profit = ` 33 lakh
Less: Current profit = ` 28.5 lakh
Additional profit ` 4.5 lakh
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New Travelling expense = ` 14,000 × 40 salesmen = ` 5,60,000

Additional Travelling expense = ` 5,60,000 – ` 4,25,000 = ` 1,35,000.
Therefore, Additional profit required will now be ` 4.5 lakh + ` 1.35 lakh = ` 5.85 lakh.
3 Additional Sales Value to generate additional profit of ` 5.85 lakh = ` 5.85 / 60% = ` 9.75
lakh.
Solution to part (c)
Original profit = ` 33 lakh
Now, the company want a profit of ` 33 lakh x 116 % = ` 38.28 lakh
Sales Value = ` 225 lakh x 116 % = ` 261 lakh
Statement of profit
Sales 261
Variable cost (78.75 × 116 %) 91.35
Fixed OH 36.25
Sales office expense (18 +16+2) 36.00
Car allowance (16,000 km × 40 salesmen × ` 1) 6.40
Administration cost 30
Agents commission 22.72 (b/f )
Profit 38.28
Therefore, percentage of commission that can be paid on sales = 22.72 ÷ 261 = 8.70 %
The ‘Bade Sahab Masti Club’ of a large public sector undertaking has a cinema theatre for the exclusive
use of themselves and their families. It is a bit difficult to get good motion pictures for show and so
pictures are booked as and when available.
The theatre has been showing the picture “Khoon ki Pyaas” for the past two weeks. This picture which
is strictly for adults only has been a great hit and the manager of the theatre is convinced that the
attendance will continue to be above normal for another two weeks, if the show of “Khoon ki Pyaas”

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is extended. However, another popular movie, eagerly looked forward to bu both adults and children
alike, - “ Appu on Udan Khatola” is booked for the next two weeks. Even if “Khoon ki Pyaas’ is extended,
the theatre has to pay the regular rental on “Appu on Udan Khatola” as well.
Normal attendance at the theatre is 2,000 patrons per week, approximately one – fourth of whom are
children under the age of 12. Attendance for “Khoon ki Pyaas” has been 50% greater than the normal
total. The manger believes that this would taper off during a second two weeks, 25% below that of the
first two weeks during the third week and 33.1/3 % below that of the first two weeks during the fourth
week. Attendance for “ Appu on Udan Khatola” would be expected to be normal throughout its run,
regardless of the duration.
All runs at the theatre are shown at the regular price of ` 2 for adults and ` 1.20 for children under 12.
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The rental charge for “Khoon ki Pyaas” os ` 900 for one week or ` 1,500 for two weeks. For “Appu on
Udan Khatola” it is ` 750 for one week or ` 1,200 for two weeks. All other operating costs are fixed at
` 4,200 per week, except for the cost of potato wafers and cakes which average 60% of their selling
price. Sales of potato wafers and cakes regularly average ` 1.20 per patron, regardless of age.
The manager can arrange to show “Khoon Ki Pyaas” for one week and “Appu on Udan Khatola” for the
following week or he can extend the show of “Khoon Ki Pyaas” for two weeks, or else he can show “
Appu on Udan Khatola” for two weeks, as originally booked.
Show by computation, the most profitable course of action he has to pursue.
Evaluation of Alternatives
Solution
STATEMENT SHOWING COMPARATIVE PROFIT
Show “Khoon Ki Pyaas”

For a week and “Appu Show “Khoon Ki Pyaas” Show “Appu On Udan
Particulars
On Udan Khatola” for for two weeks Khatola” for two weeks
the following week
Attendance:
Adults:
First week 2250 2250* 1500
Second week 1500 2000* 1500
Total 3750 4250 3000
Children:
First week - - 500
Second week 500 - 500
Total including adults 4250 4250 4000
Revenue (`)
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Adults @ ` 2 7500 8500 6000

Children @ ` 1.20 600 - 1200
Sale of potato & wafers @ ` 1.20 5100 5100 4800
per patron
Total Revenue 13,200 13,600 12,000
Costs (Relevant):
Hire charges of “Khoon Ki 900 1500 -
Pyaas”
Cost of Potato, Wafers (60% of 3060 3060 2880
their sales)
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Total relevant costs 3,960 4,560 2,880

Profit 9,240 9,040 9,120
Hence the best option is to show “Khoon Ki Pyaas” for a week and “Appu On Udan Khatola” for
the following week.
NOTE: The hire charges for ‘Appu On Udan Khatola’ and the fixed operating costs of ` 4,200 per week
are irrelevant as it is committed fixed cost.
* The attendance for Khoon Ki Pyaas is given 50% above normal for first two weeks. It is assumed that
Normal implies 2,000 patrons, although it is known that the movie is only for adults. Thus, attendance
in 3rd week will be = 2,000 × 150% × 75% = 2,250 and in fourth week will be = 2,000 × 150% × 66.666%
= 2,000
Go to Hell Hospital Ltd runs only an Intensive Care Unit (ICU). For this purpose, it has hired a building
at a rent of ` 10,000 per month. The ICU has undertaken to bear the cost of repairs and maintenance
charges.
The ICU consisted of 50 beds and 5 more beds can be safely accommodated, when the situation de-
mands at a charge of ` 5 per bed per day.
During a financial year, it was ascertained that only for 120 days in the year, the ICU had full capacity
of 50 patients per day and for another 80 days, it had on an average 40 beds only occupied per day.
The total hire charges for the extra beds incurred for the whole year amount to ` 4,000. Expert Doctors
from various places and outstations were engaged and the fees were paid on the basis of the number
of patients attended and the time spent by them and on an average, it worked out to ` 20,000 per
month during that financial year. The other expenses for the year were as under:
PARTICULARS AMOUNT
4 Supervisors, each at a salary of ` 500 per month
8 nurses, each at a salary of ` 300 per month
4 ward boys each at a salary of ` 150 per month
Repairs and maintenance ` 7,200
Cost of food supplied to patients ` 88,000

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Laundry Charges ` 56,000

Medicines Supplied ` 70,000
Cost of Oxygen, X – Ray, etc ` 1,08,000
Janitor and other services ` 25,000
Administrative charges for ICU ` 99,100
The ICU has recovered an overall amount of ` 100 per day on an average from each patient. The cost
of Janitor and other services is variable as it is related to number of patient – days.
Prepare a Revenue statement for the above financial year and indicate the profit per patient day
made by the ICU. Find Break – Even units.
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Hospital Industries Break Even
Solution
Working Note:
Total Revenue Generated: = No. of Days x No. of Patients x Collection Per Day
Full Capacity = 120 x 50 x 100 = 6,00,000

Partial Capacity = 40 x 80 x 100 = 3,20,000
Hire of Beds (Total Hire Charges ÷ Hire charge per bed) = (4,000 ÷ 5) x 100 = 80,000
10,00,000
REVENUE STATEMENT OF ICU OF GO TO HELL HOSPITAL FOR THE YEAR ENDED ………
PARTICULARS COMPUTATION ` `
REVENUE RECEIVED WN 10,00,000
LESS: Variable Expenses
Hire Charges 4,000
Cost of food 88,000
Laundry charges 56,000
Medicines 70,000
Janitor 25,000
Cost of Oxygen 1,08,000
Doctor’s Fees 20,000 x 12 2,40,000 5,91,000
CONTRIBUTION INCOME – VARIABLE 4,09,000
EXPENSES
LESS: Fixed Expenses
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Rent 10,000 x 12 1,20,000

Supervisor’s Salary 4 x 500 x 12 24,000
Nurse’s Salary 8 x 300 x 12 28,800
Ward Boy’s Salary 4 X 150 X 12 7,200
Repairs and Maintenance 7,200
Administration charges 99,100 2,86,300
PROFIT CONTRIBUTION – FIXED EX- 1,22,700
PENSES
PROFIT PER PATIENT DAY 1,22,700 ÷ 1,000 ` 12.27
C Block
CONTRIBUTION PER PATIENT DAY: Total Contribution ÷ Patient Days

= ` 4,09,000 ÷ 10,000 = ` 40.90
BREAK – EVEN POINT = Fixed Cost ÷ Contribution per patient
= ` 2,86,300 ÷ ` 40.90 = 7,000 patients.
Enjoy Well Club runs a library for its members. As part of club policy, an annual subsidy of upto ` 5 per
member including cost of books may be given from the general funds of the club. The management
of the club has provided the following figures for its Library Department.
Number of Club members 5,000

Number of Library members 1,000
Library fee per member per month ` 100
Fine for late return of books ` 1 per book per day
Average number of books returned late per month 500
Average number of days each book is returned late 5 days
Number of available old books 50,000 books
Cost of new books ` 300 per book
Number of books purchased per year 1,200 books
Cost of maintenance per old book per year ` 10
Staff Details Per Employee Salary per month

1 Librarian ` 10,000
3 Assistant Librarian ` 7,000
Clerk ` 4,000
1. Calculate:
(a) The cost of maintaining the library per year excluding the cost of new books
(b) The cost incurred per member per month on the library excluding cost of new books, and
(c) The net income from the library per year.

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2. If the club follows a policy that all the new books must be purchased out of Library revenue–
(a) What is the maximum number of books that can be purchased per year, and
(b) How many excess books are being purchased by the library per year.
Library Profitability
C Block
Solution
1(a) STATEMENT SHOWING COST OF MAINTAINING THE LIBRARY PER YEAR
PARTICULARS WORKINGS AMOUNT (`)

Cost of maintaining the old books ` (10 x 50,000) 5,00,000
Librarian’s Salary ` (10,000 x 12 x 1) 1,20,000
Assistant Librarian’s Salary ` (7,000 x 3 x 12) 2,52,000
Clerk’s Salary ` (4,000 x 1 x 12) 48,000
TOTAL COST 9,20,000
1(b) Cost incurred per month = ` (9,20,000 ÷12) ÷ 1,000 members = ` 76.67
1(c) STATEMENT SHOWING NET INCOME OF THE LIBRARY PER ANNUM
PARTICULARS WORKINGS AMOUNT (`)
(A) Revenues:
Library Fee 100 x 1,000 members x 12 months 12,00,000
Fine 500 books x 12 months x 5 days x ` 1 30,000
Subsidy from club ` 5 x 5,000 members 25,000
Total Revenue 12,55,000
(B) Costs:
Cost of maintaining per Computed as above
year excl new books 9,20,000
Cost of new books ` 300 x 1,200 books 3,60,000
Total Costs 12,80,000
Net Income or Loss (A) – (B) (25,000)
2. If the policy is that all new books must be purchased out of library Revenue:
(a) Maximum number of books that can be purchased =
Revenue − Total costs excluding cost of new books 12,55,000 − 9 , 20 , 000
= = 1,166 books
Cost of new books 300
(b) Excess books that are purchased by the library per year = 1,200 – 1,116 = 84 books
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Chapter 13
1. Quality
Basics
2. Total Quality
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Models & Theories 1. Six Sigma

2. DMAIC, DMADV
3. BPR
4. Deming’s 14 Points Methodology
5. PDCA Cycle
6. Four P’s of Quality
7. Six C’s of Quality
8. The Business Excellence Models
9. Eight Dimension’s of Quality
10. Quality Control Cost
Calculations 1. Justication or Incremental Analysis of

Incurring Quality Control Costs
2. Indifferent Point Analysis

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CIMA defines ‘Total Quality Management’ as “Integrated and comprehensive system of planning
and controlling all business functions so that products or services are produced which meet or ex-
ceed customer expectations. TQM is a philosophy of business behaviour, embracing principles such
as employee involvement, continuous improvement at all levels and customer focus, as well as be-
ing a collection of related techniques aimed at improving quality such as full documentation of
activities, clear goal-setting and performance measurement from the customer perspective.”
SIX SIGMA QUALITY

Six Sigma refers to the philosophy and methods which the companies such as Motorola and General
Electric had used to eliminate defects in their products and processes.
Six Sigma is a business management strategy, originally developed by Motorola, USA in 1986, that
is widely used in many sectors of industry. The core of Six Sigma was “born” at Motorola in the 1970s
out of senior executive Art Sundry’s criticism of Motorola’s bad quality. As a result of this criticism, the
company discovered a connection between increases in quality and decreases in costs of production.
At that time, the prevailing view was that quality costs extra money. In fact, it reduced total costs by
driving down the costs for repair or control. Six Sigma was heavily inspired by the quality improve-
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ment methodologies of the six preceding decades, such as quality control, Total Quality Management
(TQM), and Zero Defects. Originally, it referred to the ability of manufacturing processes to produce
a very high proportion of output within specification. Processes that operate with “six sigma quality”
over the short term are assumed to produce long-term defect levels below 3.4 defects per million
opportunities (DPMO). Six Sigma’s implicit goal is to improve all processes to that level of quality or
better.
Six Sigma is a registered service mark and trademark of Motorola Inc. As of 2006 Motorola reported
over US$17 billion in savings from Six Sigma.
Representation of Six Sigma Process through Normal Distribution
defects defects
Numerical Concept of Six Sigma
‘Sigma’ is a statistical term that measures how far a process deviates from perfection. The higher the
sigma number, the closer the process is to perfection.
The values of Defect Percentage
Six Sigma is 3.4 defects per million opportunities or getting things right 99.99966% of the time. It is
possible to develop ways of reducing defects by measuring the level of defects in a process and dis-
covering the causes.
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The Value of the Defect Percentage Under Various Sigma Levels
Defects per Million

Percentage Percentage
Sigma Level Opportunities Quality/ Profitability
Defective (%) Yield (%)
(DPMO)
1σ 6,91,462 69 31Loss
2σ 3,08,538 31 69Non-Competitive
3σ 66,807 6.7 93.3Average Industries
4σ 6,210 0.62 99.38Above Average
5σ 233 0.023 99.977Below Maximum
Productivity
6σ 3.4 0.0034 99.99966 Near Perfection
The second last column (in above table) indicates the percentage of values that lie within the control
limits. The more popular measure, the number of defects per million opportunities, is indicated in
second column.
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It may not be possible to achieve ‘perfect Six Sigma’ but relevant benefits can be achieved from a rise
from one Sigma Level to another.
Limitations of Six Sigma

• Six Sigma focuses on quality only.
• Six Sigma does not work well with intangible results.
• Substantial infrastructure investment is required.
• Six Sigma is complicated for some tasks.
• Not all products need to meet Six Sigma standards.
• Six Sigma focuses on specific type of process only.
• There are lot to real time barriers which needs to be resolved while translating the theoretical
concepts into practical applications.
Lean Six Sigma
Lean Six Sigma is the combination of Lean and Six Sigma which help to achieve greater results that
had not been achieved if Lean or Six Sigma would have been used individually. It increases the speed
and effectiveness of any process within any organization. By using lean Six Sigma, organisations will
be able to Maximize Profits, Build Better Teams, Minimize Costs, and Satisfy Customers.
DMAIC
While Six sigma methods include many of the statistical tools that were employed in other quality
movements, here they are employed in a systematic project oriented fashion through the define(D),
measure(M), analyze(A), improve(I) and control(C) cycle. This cycle was developed by General Elec-
tric.

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The focus of methodology, however, is understanding and achieving what the customer wants, since
that is seen as the key to profitability of a production process. In fact, to get across this point, some use
of the DMAIC as an acronym for “Dumb Managers Always Ignore Customers”.
This method is very robust. It is used to improve existing business process. To produce dramatic im-
provement in business process, many entities have used it successfully. It has five phases:
DMAIC is used under the following circumstances:
• A product or process exists.
• The project is part of ongoing continuous improvement process.
• Only a single process needs to be altered.
• Competitor’s actions are stable.
• Customer’s behaviour is unchanging.
• Technology is stable.
Illustration
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Application of DMAIC in the Banking Sector
In banking sector, DMAIC may be used as follows:
• Define: Customer satisfaction & loyalty have significant impact on financial performance of a
bank. Six Sigma involves defining objectives and opportunities to improve (based on customer’s
feedback or complaints) in discussion with staff.
• Measure: In this phase, Six Sigma experts deploy quantitative procedures to collect statistical
data. Then the statistical data is used for measuring the impact of the various processes on cus-
tomer satisfaction. Different processes may have different impact on customer satisfaction. The
measurement of impact of the individual processes helps the banks to concentrate on improving
the processes that have the maximum impact on customer satisfaction. In the banking industry,
wait times are said to have the maximum impact on customer satisfaction.
• Analyse: In this phase, Six Sigma experts analyse the data collected in accordance with the pa-
rameters set for improvement. So that, the processes (that directly affects customer’s satisfac-
tion) can be improved at minimum cost.
• Improve: In this phase, experts take corrective measures to improve processes in consultation
with staff based on facts and statistics. Advanced statistical tools can also be used to study the
impact of the proposed improvement initiative on business processes.
• Control: Control systems should be put in place to monitor the impact of the improvement ini-
tiatives through periodical review performance. If still a business process is not performing well
in accordance with the desired Six Sigma levels, the process is referred back to the ‘define’ phase.
However, if a small problem is impacting the performance, then corrective measures are taken
and the whole process is not referred back.
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DMADV
The application of these methods is aimed at creating a high-quality product keeping in mind cus-
tomer requirements at every stage of the product. It is an improvement system which is used to devel-
op new processes or products at Six Sigma quality levels. Phases are described in diagram:
Define the project goals and customer deliverables.
Measure and determine customer needs and specifications.
Analyze the process options to meet the customer needs.
Design (detailed) the process to meet customer needs.
Verify the design performance and ability to meet customer needs.
DMDAV is used under the following circumstances:
• A product or process is not in existence
• Existing process has been optimised using either DMAIC or some other process.
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• Project have strategic importance.

• Multiple process need to be altered.
• Competitor’s performance is changing.
• Customer’s behaviour is changing.
• Technology is growing.
Similarities between DMADV and DMAIC
• Both of these six sigma methodologies are based on defects per million opportunities (DPMO).
• Both DMADV and DMAIC use the same kind of six sigma quality management tools.
• Customer’s needs are the basic parameter for both six sigma methodologies.
Both DMADV and DMAIC are fundamental six sigma methodologies for improving quality of product/
process. Broadly, DMAIC deals with improving some existing process to make it align with customer’s
needs while DMADV deals with new design or redesign.
Differences between DMAIC and DMADV
DMAIC DMADV
Review the existing processes and fixes prob- Emphases on the design of the product and pro-
lem(s) cesses.
More reactive process. Proactive process.
Increase the capability. Increase the capacity.
Rupee benefits quantified rather quickly. Rupee benefits more difficult to quantify and
tend to be much more long term.

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Examples of DMAIC problem-solving methods: Examples of procedures that the DMADV devel-
opment method is designed to address:
• Reduce the cycle time to process a patent.
• Add a new service
• Reduce the number of errors in sales list.
• Create a real-time system.
• Improve search time for critical information.
• Create a multiple-source lead tracking sys-
tem
BUSINESS PROCESS REENGINEERING

In 1989, Michael Hammer, an ex-MIT computer professor turned consultant, published an article in the
Harvard Business Review titled, “Reengineering Work: Don’t Automate, Obliterate”. Although sev-
eral major companies had been experimenting with reengineering principles prior to that time, Ham-
mer generally is credited with first using the term “reengineering”. Hammer defines Business Process
Reengineering (BPR) (or simply reengineering) as “the fundamental rethinking and radical redesign of
business processes to achieve dramatic improvements in critical contemporary measures of perfor-
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mance, such as cost, quality, service, and speed.” Thus, the four key components of BPR are as follows:
Business Process
Reengineering
Fundamental Radical Dramatic End to End

Rethinking Redesign Improvements Business Process
• Fundamental rethinking of business processes requires management to challenge the very ba-
sic assumptions under which it operates and to ask such rudimentary questions as “Why do we
do what we do?” and “Why do we do it the way we do it?”
• Radical redesign relies on a fresh-start, clean-slate approach to examining an organization’s
business processes. This approach focuses on answers to the question, “If we were a brandnew
business, how would we operate our company?” The goal is to reinvent what is done and how it is
done rather than to tinker with the present system by making marginal, incremental, superficial
improvements to what’s already being done.
• Achieving dramatic improvements in performance measurements is related to the preceding
two elements. The fundamental rethinking and radical redesign of business processes are aimed
toward making quantum leaps in performance, however measured. BPR is not about improve-
ment in quality, speed, and the like that is on the order of 10%. Improvement of that order of
magnitude often can be accomplished with marginal, incremental changes to existing process-
es. Reengineering, on the other hand, has much loftier objectives. For example, the reengineer-
ing of Ford’s procurement process reduced the number of persons employed in the process by
75%.
• Reengineering focuses on end-to-end business processes rather than on the individual activi-
ties that comprise the processes. Michael Hammer contends that the fragmented business pro-
cesses and bureaucratic, hierarchical organization structures evident in most businesses today
have their origins in the Industrial Revolution, when specialization of labour and economies of
scale were the promised keys to success. He argues that managers lose sight of their real objec-
tives when processes are segmented into individual tasks, each task is assigned to a specialist,
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and elaborate mechanisms are established to track and control the performance of those tasks.
Instead, BPR takes a holistic view of a business process as comprising a string of activities that
cuts across traditional departmental or functional lines. BPR is concerned with the results of the
process (i.e., with those activities that add value to the process). This crossfunctional focus has
been used for many years by manufacturing companies. Reengineering would apply that view to
all business processes.
For example, consider the activities such as receiving a customer’s order, checking the customer’s
credit, verifying inventory availability, accepting the order, picking the goods in the warehouse,
and shipping the goods to the customer, as discrete activities. Reengineering would change our
emphasis by breaking down the walls among the separate functions and departments. Instead
of order taking, picking, shipping, and so forth, the entire process of “order fulfilment” would be
examined and would concentrate on those activities that add value for the customer. The cus-
tomer is not concerned with the individual tasks that an organisation undertakes to fill an order
nor is the customer concerned with how the company organizes itself to carry out those jobs.
The customer is concerned only with getting the right goods, in the proper quantities, in satisfac-
tory condition, and at the agreed-upon time and price.
Principles of BPR
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The principles of successful BPR are as follows:

1. Organize around outcomes
2. Have those who need the results of a process perform the process
3. Integrate the processing of information into the work process that produces the information
4. Treat geographically dispersed resources as though they were centralized
5. Line parallel activities instead of integrating their results
6. Put the decision point where the work is performed, and build controls into the process
7. Capture information once and at the source
DEMING’S 14 POINTS METHODOLOGY:

1. Create constancy of purpose for improving products and services.
2. Adopt the new philosophy.
3. Cease dependence on inspection to achieve quality.
4. End the practice of awarding business on price alone; instead, minimize total cost by working
with a single supplier.
5. Improve constantly and forever every process for planning, production and service.
6. Institute training on the job.
7. Adopt and institute leadership.
8. Drive out fear.
9. Break down barriers between staff areas.
10. Eliminate slogans, exhortations and targets for the workforce.

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11. Eliminate numerical quotas for the workforce and numerical goals for management.
12. Remove barriers that rob people of pride of workmanship, and eliminate the annual rating or
merit system.
13. Institute a vigorous program of education and self-improvement for everyone.
14. Put everybody in the company to work accomplishing the transformation.
PDCA Cycle of Mr. Deming

It is a detailed version of DMAIC cycle above consisting of four steps – Plan (P), Do (D), Check (C) and
Act (A).
ACT PLAN
D Block
DEMING
Circle
CHECK DO
FOUR P’s OF QUALITY CONTROL

People, Process, Problem, Preparation
SIX C’s OF QUALITY CONTROL

• Commitment: If a TQM culture is to be developed, so that quality improvement becomes a nor-
mal part of everyone’s job, a clear commitment, from the top must be provided. Without this all
else fails. It is not sufficient to delegate ‘quality’ issues to a single person since this will not provide
an environment for changing attitudes and breaking down the barriers to quality improvement.
Such expectations must be made clear, together with the support and training necessary to their
achievement.
• Culture: Training lies at the centre of effecting a change in culture and attitudes. Management
accountants, too often associate ‘creativity’ with ‘creative accounting’ and associated negative
perceptions. This must be changed to encourage individual contributions and to make ‘quality’ a
normal part of everyone’s job.
• Continuous Improvement: Recognition that TQM is a ‘process’ not a ‘programme’ necessitates
that we are committed in the long term to the never-ending search for ways to do the job better.
There will always be room for improvement, however small.
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• Co-operation: The application of Total Employee Involvement (TEI) principles is paramount. The
on-the-job experience of all employees must be fully utilised and their involvement and cooper-
ation sought in the development of improvement strategies and associated performance meas-
ures.
• Customer Focus: The needs of the customer are the major driving thrust; not just the external
customer (in receipt of the final product or service) but the internal customer’s (colleagues who
receive and supply goods, services or information). Perfect service with zero defects in all that is
acceptable at either internal or external levels. Too frequently, in practice, TQM implementations
focus entirely on the external customer to the exclusion of internal relationships; they will not
survive in the short term unless they foster the mutual respect necessary to preserve morale and
employee participation.
• Control: Documentation, procedures and awareness of current best practice are essential if TQM
implementation is to function appropriately. The need for control mechanisms is frequently
overlooked, in practice, in the euphoria of customer service and employee empowerment. Un-
less procedures are in place improvements cannot be monitored and measured nor deficiencies
corrected.
D Block
THE BUSINESS EXCELLENCE MODELS

Business Excellence (BE) is a philosophy for developing and strengthening the management systems
and processes of an organization to improve performance and create value for stakeholders.
The essence of this approach is to
(a) Develop quality management principles that increase the overall efficiency of the operation,
(b) Minimize waste in the production of goods and services, and
(c) help to increase employee loyalty as a means of maintaining high standards throughout the
business by achieving excellence in everything that an organization does (including leadership,
strategy, customer focus, information management, people and processes).
Business excellence principles emerged because of development of quality drive into traditional busi-
ness management. Business excellence considers various management thoughts as core concepts
and structures quality management in a manner that can be adapted by any enterprise. Several busi-
ness excellence models exist world-wide. While variations exist, these models are all remarkably simi-
lar. The most common include;
• EFQM (European Foundation for Quality Management) Excellence Model
• Baldrige Criteria for Performance Excellence
• Singapore BE Framework
• Japan Quality Award Model
• Australian Business Excellence Framework
• EFQM (European Foundation for Quality Management) Excellence Model – The EFQM Excel-
lence Model provides an all-round view of the organisation and it can be used to determine how
different methods fit together and complement each other. Based on the needs of the organisa-
tion, this model can be used with other tools of improvement to attain sustainable excellence.
The EFQM conceptual model helps organizations to realize in practice the fundamental concepts

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and to understand the cause- and-effect relationships between what the organization does and
the results it achieves. The EFQM Excellence Model is also a self-assessment model for an organi-
zation that wants to assess its level of excellence. It is based on nine criteria.
There are five ‘Enablers’ and four ‘Results’. The ‘Enabler’ criteria cover what an organisation
does. The ‘Results’ criteria cover what an organisation achieves. ‘Results’ are caused by ‘Enablers’.
Enablers Results
People
People
Results
Processes,
Customer Business
Leadership Strategy Products & Results Results
Services
Partnerships Society
& Resources Results
Learning, Creativity and Innovation

The dynamic nature of the model is emphasised by the arrows as shown in the diagram. The
model helps the enablers by innovation and learning leading to improved results. The Model’s
D Block
nine boxes, shown above, represent the criteria against which to assess an organisation’s pro-
gress towards excellence. Each criterion consists of a number of sub-criterion, including the ele-
ments that need to be considered for the organization to achieve excellence in its business, and
which are indicative of what can be considered good practice; these are further evaluated using
the RADAR logic assessment framework.
The last component is the RADAR (results-approaches-deploy-assess-refine) logic, which is a
management and evaluation tool for analysing the performance of an organization.
R = Results
A and R Approaches
A=
Assess and Rene Plan and Develop
Deploy
D=
Approaches
Baldrige Criteria for Performance Excellence
This model provides the foundation for most of the business excellence models adopted around the
world. The framework is build around the seven categories i.e.,
• Leadership,
• Strategic planning,
• Customer and market focus,
• Measurement analysis and knowledge management,
• Workforce,
• Process management and
• Business results.
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Business Excellence Model and Organizational Culture
Business Excellence approach focuses on strengthening the internal function and communication,
looks towards the cultivation of strong ties with consumers and can be incorporated into the culture.
Excellence cannot be attained if the staffs are forced to conform to certain norms. They have to be
critically managed and motivated. A wisdom is required to be developed among employees that by
pursuing the goal of their organization they are meeting their own objectives. Employees feel accredit
when they are considered important elements in pursuit of excellence as they learn new skills.
A feeling of association is developed and employees start believing in the management philosophies
when the organization tries to achieve excellence. For achieving business excellence effective leader-
ship is equally important to manage all the resources efficiently.
A strong and empathetic leader, effective communication system, employee empowerment, employ-
ee motivation, innovative and creative culture are some of the strategies to make the employees feel
connected to the management philosophy of the organization.
A robust culture arises as a result of implementation of business excellence model, which can make
the organization a world class performer.
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EIGHT DIMENSIONS OF QUALITY

1. Performance: Performance refers to a product’s primary operating characteristics. This dimen-
sion of quality involves measurable attributes; brands can usually be ranked objectively on indi-
vidual aspects of performance.
2. Features: Features are additional characteristics that enhance the appeal of the product or ser-
vice to the user.
3. Reliability: Reliability is the likelihood that a product will not fail within a specific time period.
This is a key element for users who need the product to work without fail.
4. Conformance: Conformance is the precision with which the product or service meets the speci-
fied standards.
5. Durability: Durability measures the length of a product’s life. When the product can be
repaired, estimating durability is more complicated. The item will be used until it is no longer
economical to operate it. This happens when the repair rate and the associated costs increase
significantly.
6. Serviceability: Serviceability is the speed with which the product can be put into service when
it breaks down, as well as the competence and the behavior of the serviceperson.
7. Aesthetics: Aesthetics is the subjective dimension indicating the kind of response a user has to
a product. It represents the individual’s personal preference.
8. Perceived Quality: Perceived Quality is the quality attributed to a good or service based on indi-
rect measures.

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QUALITY CONTROL COSTS - By Joseph Juran and Philip Crosby

Cost of Quality
Cost of Poor Quality Cost of Good Quality

or or
Price of Non Conformance Price of Conformance
or or
Cost of Failure of Control Cost of Control
Internal Failure External Failure Appraisal Prevention

Cost Cost Cost Cost
Costs associated with delivering Quality are:

(a) Appraisal Costs: - These are connected with measuring conformity with requirements and in-
D Block
clude –
1. Cost of incoming inspections (note that if suppliers adopt a total quality approach, this cost
can be eliminated)
2. Cost of set up inspections
3. Cost of acquiring and operating the process control and measuring equipment.
(b) Prevention Costs: - These are the costs of ensuring that defects do not occur in the first place.
These may be –
1. Routine preventive repairs and maintenance to equipment
2. Quality training for operatives to improve skills and efficiency. Training employees works
provided the employee also understand and accept the benefits of such training. Training
can occur both inside and outside the workplace. Internal training may include the ideas of
team working and quality discussion groups, which are known as QUALITY CIRCLES.
3. Building of quality into the design and manufacturing process. When a product is designed,
its specification should consider factors that will minimise future rectification costs. Produc-
tion methods should be as simple as possible and use the skills and resource existing within
the sphere of knowledge of the organisation and its employees.
(c) Internal Failure Costs:- These costs are:
1. Costs of scrap
2. Reworking costs
3. Manufacturing and process engineering required to correct the failed process.
It is contended that, in many companies, the costs of internal failure are so great that a
total quality programme can be financed entirely from the savings that are made from
it – hence the expression ‘quality is free’.
(d) External Failure Costs:- These costs are:
1. Marketing costs associated with failed products and loss of customer goodwill.
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2. Manufacturing or process engineering costs relating to failed products externally.

3. Compensation or replacement for units returned by customers.
4. Repair costs (after sales)
5. Travel costs to visit sites with faulty products
Optimal COQ
It is generally accepted that an increased expenditure in prevention and appraisal is likely to result in
a substantial reduction in failure costs. Because of the trade off, there may be an optimum operating
level in which the combined costs are at a minimum.
Hence it is further argued that striving for zero defects through a program of continuous improve-
ments is not good for the economic interest of the company.
Total Costs
Cost of
Non-conformance
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Cost of
conformance
0 1 2 3 4 % defects
Steps of Application of PAF Model
The prevention, a`ppraisal, and failure (PAF) model is the most widely accepted method for measur-
ing and classifying quality costs. Follow this five-step process.
1. Gather some basic information about the number of failures in the system
2. Apply some assumptions to that data in order to quantify the data
3. Chart the data based on the four elements listed above and study it
4. Allocate resources to combat the weak-spots.
5. Do this study on a regular basis and evaluate your performance

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The Iceberg Model
Many of the costs of quality are hidden and thus making it difficult to identify by formal measurement
systems. The iceberg model is very often used to illustrate this matter:
Waste
Customer
Rejects Returns Inspection
Costs
Rework Testing Costs Recalls
Excessive Overtime Excessive Field Incorrectly

Service Expenses Late Completed Sales Order
Pricing or Paperwork
Billing Errors
Planning Delays Unused Capacity
Excessive Access Inventory
Employee Development Complaint
Fluctuation Cost of Failed Handling
Product
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Time with
Dissatised Customer
Excessive IT
System Costs
Only a minority of the costs of poor and good quality is obvious – appear above the surface of the
water. The reduction of cost under water has a huge scope. If we identify and improve these costs, the
costs of doing business will significantly reduce.
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Quality products can be determined by using a few of the dimensions of quality. Identify the follow-
ing under the appropriate dimension:
(i) Consistency of performance over time.
(ii) Primary product characteristics.
(iii) Exterior finish of a product
(iv) Useful life of a product.
Solution
Quality of Products with Appropriate Dimension
Sl. Quality of Products (Examples) Dimension

(i) Consistency of performance over time Reliability
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(ii) Primary product characteristics Performance

(iii) Exterior finish of a product Aesthetics
(iv) Useful like of a product Durability
Eight Dimensions of Quality
Classify the following items under the appropriate category of quality costs viz. Prevention cost, ap-
praisal cost, internal failure cost and external failure cost:
(a) Rework
(b) Disposal of scrap
(c) Warranty repairs
(d) Revenue loss
(e) Repairs to manufacturing equipment
(f) Discount on defective sale
(g) Raw material inspection
(h) Finished product inspection
(i) Establishment of quality circles
(j) Packaging inspection

Cost Management
Class
WORK
(k) Quality Consultant Cost

(l) Re-purchase of components to create replacement
(m) Customer survey for feed back on quality
(n) Employee time spend on reviewing and assessing the quality of output.
(o) Testing of material of special nature from outside laboratory.
Quality Control Cost
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TQM ltd. implemented a quality improvement programme and had the following results:
2010 2011
(` in ‘000) (` in ‘000)
Sales 6,000 6,000
Scrap 600 300
Rework 500 400
Production inspection 200 240
Product warranty 300 150
Quality training 75 150
Material inspection 80 60

(a) Classify the quality costs as prevention, appraisal, internal failure and external failure and express
each class as a percentage of sales.
(b) Compute the amount of increase in profits due to quality improvement.
Quality Control Cost
Advanced Strategic
Class
WORK
Carlon Ltd makes and sells a single product, the unit specification are as follows:
Direct Materials X 8 sq mt at ` 40 per square metre

Machine time 0.6 Running hours
Machine cost per gross hour ` 400
Selling price ` 1,000
Carlon ltd requires to fulfil orders for 5,000 product units per period. There are no stocks of product
units at the beginning or end of the period under review. The stock level of Material X remains un-
changed throughout the period.
Carlon ltd is planning to implement a Quality Management Programme (QMP). The following addi-
tional information regarding costs and revenues are given as of now and after implementation of
Quality Management Programme.
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Before the implementation of QMP After the implementation
5% of incoming material from suppliers scrapped due to Reduced to 3%

poor receipt and storage organisation.
4% of material X input to the machine process is wasted due Reduced to 2.5%

to processing problems.
Inspection and Storage of Material X costs ` 1 per sq mt. No change in the unit rate
Purchased
Inspection during the production cycle, calibration checks Reduction of 40% of the existing
on inspection equipment, vendor rating and other checks cost
cost ` 2,50,000 per period.
Production quantity is increased to allow for the downgrad- Reduction to 7.5%

ing of 12.5% of the production units at the final inspection
stage. Downgraded units are sold as ‘seconds’ at a discount
of 30% of the standard selling price.
Production quantity is increased to allow for return from Reduction to 2.5%

customers (these are replaced free of charge) due to specifi-
cation failure and account for 5% of units actually delivered
to customers.
Product liability and other claims by customers is estimated Reduction to 1%

at 3 % of sales revenue from standard product sale.
Machine idle time is 20% of gross machine hours used (i.e. Reduction to 12.5%
Running hours = 80% of Gross Hours)

Cost Management
Class
WORK
Sundry costs of administration, selling and distribution total Reduction by 10% of the existing
– ` 6,00,000 per period.
Prevention programme costs ` 2,00,000 Increase to ` 6,00,000
The QMP will have a reduction in Machine run time required per product unit to 0.5 hour.
Required:
1. Prepare summaries showing the calculation of (i) Total production unit (pre – inspection). (ii)
Purchase of Materials X (square metres), (iii) Gross Machine Hours. In each case, the figures are
required for the situation both before and after the implementation of the QMP so that orders for
5,000 product units can be fulfilled.
2. Prepare Profit and Loss Account for Carlon Ltd for the period showing the profit earned both
before and after the implementation of the Total Quality Programme.
Comparative Profitability before and
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after TQM
The budget estimates of a company using sophisticated high speed machines based on a normal
working of 50,000 machine hours are as under:
` in lakhs
Sales (1,00,000 units) 100
Raw materials 20
Direct wages 20
Factory overheads – variable 10
Fixed 10
Selling and distribution overheads – variable 5
Fixed 5
Administrative overhead – Fixed 10
Total costs 80
Profit 20
Since the demand for the company product is high the possibilities of increasing the production are
explored by the budget committee. The Technical Director stated that maintenance has not been giv-
en due importance in the budget and that if preventive maintenance is introduced, the breakdown
repair costs and the hours lost due to breakdown can be reduced and consequently production can
be increased.
Advanced Strategic
Class
WORK
In support of this, he presented the following data, showing how injection of more and more funds
on preventive maintenance will bring down the break – down repair costs and reduce or eliminate
stoppages due to breakdown: -
Proposed expenditure on preventive Expenditure estimated to be

Machine hours saved
maintenance (`) incurred on breakdown (`)
19,200 1,92,000 Nil
38,400 1,53,600 800
76,800 1,15,200 1,600
1,53,600 76,800 2,400
3,07,200 57,600 3,200
6,14,400 - 4,000
Using the differential cost and contribution concept, advise the management upto what level break-
down hours can be reduced to increase production and maximise profits of the company consistent
with minimum costs.
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Incremental analysis of Preventive

Maintenance Cost
A company manufactures a single product, which requires two components. The company purchases
one of the components from two suppliers: X Ltd and Y Ltd. The price quoted by X Ltd. is ` 180 per
hundred units of the component and it is found that on an average 3 % of the total receipt from this
supplier is defective. The corresponding quotation from Y ltd is ` 174 per hundred units, but the de-
fective would go up to 5%. If the defectives are not detected, they are utilised in production causing a
damage of ` 180 per 100 units of the components.
The company intends to introduce a system of inspection for the components on receipt. The inspec-
tion cost is estimated at ` 24 per 100 units of the component. Such an inspection will be able to detect
only 90% of the defective components received. No payment will be made for components found to
be defective in inspection.
(a) Advise whether inspection at the point of receipt is justified?
(b) Which of the two suppliers should be asked to supply? Assume total requirement is 10,000 units
of the component.
Implementation of Inspection Program

Cost Management
Class
WORK
A company has a normal manufacturing capacity of 1,50,000 units of a product per annum. The actual
costs based on this output achieved during the last year were as under:
`
Direct material 36
Direct labour 20
Variable overheads 20
Fixed overheads 20
The budget for the next year envisages the following increases:
Direct materials 33 1/3 %

Direct labour 10 %
Variable overheads 5%
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Fixed overheads 15 %
In view of the substantial increase in material costs, the company explored the possibilities of using a
substitute material. The company has been able to identify a cheaper source of direct materials which
will cost ` 40 per unit of output.
The tests reveal that the use of cheaper direct material as above will make the following impact on
the costs:
(i) The direct labour cost will increase by ` 1 per unit of output.
(ii) It will lead to 5% rejection in output.
(iii) It will result in a final quality testing programme evaluating an additional fixed cost of ` 4,00,000.
The selling prices are estimated as under for different levels of sales volume for the next year:
Selling price per unit (`) 128 136 144 152 160 168 176
Demand (‘000 units) 190 170 150 140 125 110 95
Required:
(i) Advise whether the company should use the regular direct materials or cheaper direct materials
to maximise its profitability by producing the normal volume of output.
(ii) Considering the range of selling prices estimated at different volumes of output, determine the
selling price which will maximise the profit if (A) regular direct materials are used and (B) Cheaper
direct materials are used.
(iii) Calculate for the price selected by you in (ii) above, the amount of additional fixed cost at which
the company will be indifferent in choice of direct materials.
(iv) Find Indifference point of the additional quality cost if selling price is ` 160 per unit
Advanced Strategic
Class
WORK
Comparative Study of using regular and

cheaper substitute material
A Ltd. produces and markets a range of consumer durable appliances. It ensures after sales service
through X ltd. The big appliances are serviced at customer’s residence while small appliances are ser-
viced at workshop of X ltd.
The material supplied to X ltd is charged at cost + 10 %. X ltd charges customers at 25 % over the
above price. For labour, the company receives 10 % of the rate fixed for work done under the after
sales service agreement and 15 % of the rate fixed in case jobs not covered under the agreement from
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X Ltd. 60 % by value of the total work undertaken by X Ltd was for big appliances and rest accounted
for small appliances during the previous year.
The company decides to carry out all or some of the work itself and has chosen one area in the first
instance. During the previous year the company earned a profit of ` 2,16,000 as detailed below from
X Ltd. for the area chosen:
Particulars Materials (`) Labour (`)

Under after sales service agreement 60,000 1,00,000
For jobs not covered under the agreement 20,000 36,000
The company forecasts same value of work in that area for the ensuing period.
The following three options are under consideration of the management:
(1) To set up a local service centre to provide service for small appliances only. The existing system is
to continue for big appliances.
(2) To set up a local services centre to provide service for big appliances only. The existing system is
to continue for small appliances.
(3) To set up a local service centre to provide service to all appliances. The existing system then
stands withdrawn.
The relevant costs for carrying out jobs under the above options are as under:
Particulars (` ‘000) Option 1 Option 2 Option 3

Heat, rent, light, etc 125 50 150
Management costs 108 83 150
Service staff costs 230 440 750
Transport costs 25 220 230
You are required to find out the most profitable option.

Cost Management
Class
WORK
Evaluation of After sale service

implementation
A company makes a single product which sells at ` 800 per unit and whose variable cost of production
is ` 500 per unit. Production and sales are 1,000 units per month. Production is running to full capacity
and there is market enough to absorb an additional 20% of output each month.
The company has two options:
Option 1: Inspect finished goods at ` 10,000 per month. 4% of production is detected as defectives
and scrapped at no value. There will be no warranty replacement, since every defect is detected. A
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small spare part which wears out due to defective material is required to be replaced at ` 2,000 per
spare for every 20 units of scrap generated. This repair cost is not included in the manufacturing cost
mentioned above.
Option 2: Shift the finished goods inspection at no extra cost to raw material inspection, (since defec-
tive raw materials are entitled to free replacement by the supplier), take up the machine set up tuning
and machine inspection at an additional cost of ` 8,000 per month, so that scrap of finished goods is
completely eliminated. However, delivery of uninspected finished products may result in 1 % of the
quantity sold to be replaced under free warranty due to minor variation in dimensions, which does
not result in the wearing out of the spare as stated in Option 1.
(i) Using monthly figures relevant for decision making, advise which option is more beneficial to the
company from a financial perspective.
(ii) Identify the quality costs that can be classified as
a. Appraisal costs and
b. External failure costs.
Incremental analysis of Quality Control

Cost
Burdoy Ltd has a dedicated set of production facilities for component X. A just in time system is in
place such that no stocks of materials, work in progress or finished goods are held.
Advanced Strategic
Class
WORK
At the beginning of period 1, the planned information relating to the production of component X
through the dedicated facilities is as follows:
(i) Each unit of component X has input materials: 3 units of material A at ` 18 per unit and 2 units of
material B at ` 9 per unit.
(ii) Variable cost per unit of component X (excluding materials) is ` 15 per unit worked on.
(iii) Fixed costs of the dedicated facilities for the period is ` 1,62,000.
(iv) It is anticipated that 10 % of the units of X worked on in the process will be defective and will be
scrapped.
It is estimated that customers will require replacement (free of charge) of faulty units of compo-
nent X at the rate of 2 % of the quantity invoiced to them in fulfilment of orders.
Burdoy Ltd is pursuing a total quality management philosophy. Consequently all losses will be
treated as abnormal in recognition of a zero defect policy and will be valued at variable cost of
production.
Actual statistics for each period 1 to 3 for component X are shown in Appendix below. No chang-
es have occurred from the planned price levels from materials, variable overhead or fixed over-
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head costs.
Required:
(a) Prepare an analysis of the relevant figures provided in Appendix to show that the period 1 actual
results were achieved at the planned level in respect of (i) quantities and losses and (ii) unit cost
levels for material and variable costs.
(b) Use your analysis from (a) in order to calculate the value of the planned level of each of internal
and external failure costs for period 1.
(c) Actual free replacements of components to customers were 170 units and 40 units in periods 2
and 3 respectively. Other data relating to period 2 and 3 is shown in Appendix.
Burdoy Ltd authorized additional expenditure during period 2 and 3 as follows:
Period 2: Equipment accuracy checks of ` 10,000 and staff training of ` 5,000.
Period 3: Equipment accuracy checks of ` 10,000 plus ` 5,000 of inspection costs, also staff train-
ing costs of ` 3,000 on extra planned maintenance of equipment.
Required:
i. Prepare an analysis for each of periods 2 and 3 which reconciles the number of compo-
nents invoiced to customers with those worked on in the production process. The analysis
should show the change from the planned quantity of process losses and changes from
the planned quantity of replacement of faulty components in customer hands. (All relevant
working notes should be shown).
ii. Prepare a cost analysis for each of periods 2 and 3 which shows actual internal failure costs,
external failure costs, appraisal costs and prevention costs.
iii. Prepare a report, which explains the meaning and inter relationship of figures in Appendix
and in analysis (a), (b) and (c) (i)/ (ii). The report should also give examples of each cost type
and comment on their use in the monitoring and progressing of the TQM policy being pur-
sued by Burdoy Ltd.

Cost Management
Class
WORK
Appendix
Actual statistics for Component X

Period 1 Period 2 Period 3
Invoiced to customers (units) 5,400 5,500 5,450
Worked on in process (units) 6,120 6,200 5,780
Total cost:
Material A and B (`) 4,40,640 4,46,400 4,16,160
Variable costs of production (excluding material costs) (`) 91,800 93,000 86,700
Fixed Costs (`) 1,62,000 1,77,000 1,85,000
Comparative Profitability before and

after TQM
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Solution
(a) (i)
Components worked on in the process (units) 6,120

Less: Planned defective units 612
Replacements to customers (2 % of 5,400) 108
Components invoiced to customers 5,400
(ii) Planned component cost = (3 × ` 18 for material A) + (2 × ` 9 for material B) + ` 15 variable cost
= ` 87
Comparing with data in the appendix:
Materials = ` 4,40,640 / 6,120 = ` 72
Variable overhead = ` 91,800/ 6,120 = ` 15
(b) Internal failure cost = ` 53,244 (612 units × ` 87)
External failure cost = ` 9,396 (108 units × ` 87)
(c) (i)
Period 2 Period 3
Particulars
Actual Planned Diff. Actual Planned Diff.
Worked on in process 6,200 6,200 5,780 5,780
Less: Defects 530 620 90 290 578 288
Components Delivered 5,670 – 5,490 –
Less: Free Replacements 170 110 (60) 40 109 69
Components Invoiced 5,500 5,500 5,450 5,450
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Advanced Strategic
Cost Management
Class
WORK
(ii)
Particulars Period 2 Period 3
Internal Failure costs – Defects 46,110 (530 x 87) 25,350 (290 x 87)
External failure cost – Warranty 14,790 (170 x 87) 3,480 (40 x 87)
Appraisal costs – Equipment accuracy checks 10,000 15,000
Prevention costs – Stuff training 5,000 8,000
(iii) The following points should be included in the report:

1. In sufficient detail is provided in the statistics shown in the appendix thus resulting in the
need for an improvement in reporting.
2. The information presented in (c) (i) indicates that free replacement to customers were 60
greater than planned in period 2 but approximately 70 less than planned in period 3. In
contrast, the in process defects were 90 less than planned (approximately 15 %) in period 2
and 288 less than plan (approximately 50 %) in period 3.
3. Internal failure costs show a downward trend from periods 1-3 with a substantial decline in
period 3. External failure costs increased in period 2 but declined significantly in period 3.
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4. The cost savings arising in period 2 and 3 are as follows:
Particulars Period 2 (`) Period 3 (`)

Increase/ Decrease from previous
period:
Internal failure costs -7,134 (53,244 – 46,110) -20,880 (46,110 – 25,230)
External failure costs + 5,394 (9,396 – 14,790) -11,310 (14,790 – 3.480)
Total Decrease -1.740 -32,190
The above savings should be compared against the investment of ` 10,000 appraisal costs and ` 5,000
prevention costs for period 2 and ` 15,000 appraisal cost and ` 8,000 prevention cost in period 3. It can
be seen that the costs exceed the savings in period 2 but the savings exceeded the costs in period 3.
There has also been an increase in the external failure costs from period 1 to period 2. Investigations
should be made relating to the likely time lag from incurring prevention pr appraisal costs and their
subsequent benefits.
5. The impact on customer goodwill from the reduction in replacements should also be examined.

Cost Management
Home
WORK
A company using a continuous manufacturing operation achieves an output of 3 kg per hour. The
selling price is ` 450 per kg. The raw material cost is ` 125 per kg of output and the direct labour and
variable overheads amount to ` 316 per kg of output. The company has provided an expenditure of
` 640 on maintenance and ` 6,400 on breakdown repairs per month in its budget. Breakdowns aver-
aging 300 hours per month occur due to mechanical faults. These could be reduced or eliminated, if
additional maintenance on the following scale were undertaken:
Breakdown hours 0 60 120 180 240 300

Maintenance costs (`) 20,480 10,240 5,120 2,560 1,280 640
Repair costs (`) 0 1,920 2,560 3,840 5,120 6,400
Using the incremental cost and incremental revenue concept, you are required to:
(a) Determine the optimum level up to which breakdown can be reduced to increase production.
(b) Calculate the additional profits obtainable at that level as compared to the present situation.
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Incremental analysis of Preventive

Maintenance Cost
Asha Road Carriers is a transporting company that transports goods from one place to another. It
measures quality of service in terms of: (i) Time required to transport goods, (ii) On – time delivery, (iii)
Number of lost or damaged cartons.
To improve its business prospects and performance, the company is seriously considering to install a
scheduling and tracking system, which involves an outlay of ` 1,50,000, besides equipments costing
` 2,00,000 needed for installation of the system. The company proposes to utilise the proceeds of
the fixed deposit maturing next month to purchase the equipment. The rate of interest at present
on deposit is 10 %. The company furnishes the following about its present and anticipated future
performance –
On time delivery (%)

Expected at
Current at 85 %
95 %
Variable costs per carton lost or damaged ` 50 ` 50
Fixed costs per carton lost ` 30 ` 30
Number of cartons lost or damaged 3,000 1,000
Advanced Strategic
Home
WORK
The company expects that each percent point increase in on – time performance will result in revenue
increase of ` 18,000 per annum. Contribution margin of 45 % is required. Should Asha Road Carriers
acquire and install the system?
Incremental analysis of Quality Control

Cost
A company produces and sells a single product. The cost data per unit for the year 2017 is predicted
as below:
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` per unit
Direct Material 35
Direct Labour 25
Variable Overheads 15
Selling Price 90
The company has forecast that demand for the product during the year 2017 will be 28,000 units.
However, to satisfy this level of demand, production quantity will be increased?
There are no opening stock and closing stock of the product.
The stock level of material remains unchanged throughout the period.
The following additional information regarding costs and revenue are given:
• 12.5% of the items delivered to customers will be rejected due to specification failure and will
require free replacement. The cost of delivering the replacement item is 5 per unit.
• 20% of the items produced will be discovered faulty at the inspection stage before they are de-
livered to customers.
• 10% of the direct material will be scrapped due to damage while in storage.
Due to above, total quality costs for the year is expected to be 10,75,556.
The company is now considering the following proposal:
1. To introduce training programmes for the workers which, the management of the company
believes, will reduce the level of faulty production to 10%. This training programme will cost
4,50,000 per annum.
2. To avail the services of quality control consultant at an annual charges of 50,000 which would
reduce the percentage of faulty items delivered to customers to 9.5%.

Cost Management
Home
WORK
Required
(i) PREPARE a statement of expected quality costs the company would incur if it accepts the propos-
al. Costs are to be calculated using the four recognised quality costs heads.
(ii) Would you RECOMMEND the proposal? Give financial and non-financial reasons.
Total Cost of Quality
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Advanced Strategic
Cost Management
Theory of Constraints
Class
WORK
Chapter 14
Theory of
1. Theory of Constraints or Theory of
Constraints Bottleneck
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2. Goldralt’s Rule of Synchronous

Manufacturing to deal with Bottleneck
Throughput
1. Throughput meaning
Accounting
2. Three Measures of Performance
3. Prot Statement in Throughput
Accounting
4. Dealing with Constraints using
Throughput Accounting Ratios
(a) From multiple constraints to one Constraint
(b) From multiple products to lesser number of
products

Cost Management
Class
WORK
THEORY OF CONSTRAINTS
As advocated by Goldratt and Cox in 1980s in their novel called ‘THE GOAL’ published in USA, TOC
focuses its attention on constraints and bottlenecks within the firm that hinder speedy production.
The main concept is to maximize the rate of manufacturing output i.e. production or throughput of
the firm by removing the constraints through synchronous manufacturing or harmonisation of pro-
duction process.
GOLDRATT’S RULE OF PRODUCTION SCHEDULING:
- Synchronous Manufacturing
1. Do not balance the capacity – balance the flow.
2. The level of utilisation of a non bottleneck resource is determined not by its own potential but by
some other constraint in the system.
3. Utilisation and activation of the resource are not the same.
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4. An hour lost at a bottleneck is an hour lost for the entire system.
5. An hour saved at a non bottleneck is a mirage.
6. Bottlenecks govern both throughput and inventory in the system.
7. The transfer batch may not and many times should not be equal to the process batch.
8. A process batch should be variable both along its route and time.
9. Priorities can be set only by examining the system constraints.
Goldratt’s Five-Step Method for Improving Performance

1. Identifying the System Bottlenecks: This step involves identification of constraints which re-
strict output from being expanded.
2. Describe How to Exploit the Bottlenecks: Having identified the bottlenecks it becomes the
focus of attention since only the bottleneck can restrict or enhance the flow of products. It is
therefore essential to ensure that the bottleneck activity is fully utilised. Decision regarding the
optimum-mix of products to be produced by the bottleneck activity must be made.
3. Subordinate Everything Else to the Decision in Step-2: This step requires that the optimum
production of bottleneck activity should determine the production schedule of the nonbottle-
neck activities.
Let us consider an organisation dealing with a product which requires multiple parts and pro-
cessed on different machines. With multiple parts in a product, dependencies arise among op-
erations; some operations cannot be started until parts from previous operations are available.
Waiting time appear for two reasons:
- Parts that require processing at a bottleneck machine must wait in line until the bottleneck
machine is free, and
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Advanced Strategic
Cost Management
Class
WORK
- Parts made on non-bottleneck machines must wait until parts coming off the bottleneck
machines arrive.
Therefore, the workers of non-bottleneck machines should not be motivated to improve their
productivity if the additional output cannot be processed by bottleneck machine. Producing
more non-bottleneck output results in increase in WIP inventories and no increase in sales vol-
ume. Therefore, the preferred course of action is that bottleneck machine should setup pace for
non-bottleneck machine.
4. Elevate the System Bottlenecks or Increase Bottleneck Efficiency and Capacity: This step
involves taking action to remove (that is elevate) the constraint. This might involve replacing a
bottleneck machine with a faster one or providing additional training for a slow worker or chang-
ing of the design of the product to reduce the processing time required by a bottleneck activity.
5. Repeat the Process as a New Constraint Emerges: If the bottleneck activity has been elevated
and replaced by a new bottleneck activity it is necessary to return to step 1 and repeat the pro-
cess.
D Block

Cost Management
Class
WORK
Classify the following items under three measures used in the theory of constraints:
(i) Research and Development Cost
(ii) Rent / utilities
(iii) Raw materials used for production
(iv) Depreciation
(v) Labour cost
(vi) Stock of raw materials
(vii) Sales
(viii) Cost of equipments and buildings
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Three Measures Classification
A company produces 3 products A, B and C. The following information is available for period:
Particulars A B C
Contribution (Sales – Direct Materials) ` 24 ` 20 ` 12
Machine hours required per unit:
Machine 1 12 4 2
Machine 2 18 6 3
Machine 3 6 2 1
Estimated Sales demand (units) 200 200 200
It is given that machine capacity is limited to 3,200 hours for each machine, you are required to ana-
lyze the above information and apply TOC process to remove the constraint.
Throughput Accounting Ratios of Removing Multiple Constraints

Machines
Advanced Strategic
Class
WORK
H ltd. Manufactures three products. The material cost, selling price and bottleneck resource details per
unit are as follows:
X Y Z
Selling Price (`) 66 75 90
Material and other variable cost (`) 24 30 40
Bottleneck resource time (minutes) 15 15 20
Budegted Factory Costs for the period are ` 2,21,600. The bottleneck resource time available for the
period is 75,120 minutes.
Required:
(i) Company adopted Throughput Accounting and products are ranked according to Product Re-
turn Per Minute. Select the highest ranked product
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(ii) Calculate throughput accounting ratio and comment on it.
Throughput Accounting Ratios of

Products
A co. manufactures four products. The unit cost, selling price and bottleneck resource details per unit
are as follows:
Particulars A B C D
Selling Price (`) 56 67 89 96
Materials (`) 22 31 38 46
Labour (`) 15 20 18 24
Variable Overhead (`) 12 15 18 15
Fixed Overhead (`) 4 2 8 7
Bottleneck Resource time (minutes) 10 10 15 15
(a) Assuming the labour is a unit variable cost, if the products are ranked according to their contri-
bution, which is the most profitable product?
(b) Assuming that labour is a unit variable cost, if budgeted unit sales are in the ratio 2:3:3:4 and
monthly fixed costs are budgeted to be ` 15,000, what will be the number of units of A that
would be sold at the budgeted breakeven point?

Cost Management
Class
WORK
(c) If the company adopted throughput accounting and the products were ranked according to
‘product return per minute’, which is the highest ranked product?
Throughput Accounting Ratio of Ranking

Products
Flop sum Ltd. make and sell two products A and B, each of which passes through the same automated
production operations. The following estimated information is available for a period:
Product unit data A B
D Block
Direct material cost (`) 2 40
Variable Production overhead cost (`) 28 4
Overall hours per product unit (hrs) 0.25 0.15
Production/ sales of products A and B are 1,20,000 units and 45,000 units respectively. The selling
prices per unit for A & B are ` 60 and ` 70 respectively.
Maximum demand for each product is 20% above the estimated sales levels.
Total fixed production overhead cost is ` 14,70,000. This is absorbed by products A and B at an average
rate per hour based on the estimated production levels.
One of the production operations has a maximum capacity of 3,075 hours which has been identified
as a bottleneck which limits the overall production/ sales of products A & B. The bottleneck hours re-
quired per product unit for product A & B are 0.02 & 0.015 respectively.
Required:
a) Calculate the mix (units) of products A and B which will maximize net profit and the value (`) of
the maximum net profit.
b) The co. has decided to determine the profit maximizing mix of products A and B based on the
throughput Accounting principle. Calculate the mix (units) of products A and B which will maxi-
mize net profit and the value of that net profit.
Comparative Study of Marginal

Costing and Throughput Accounting
Optimisation
Advanced Strategic
Class
WORK
Write short notes on Drum – Buffer –Rope – Theory of Constraints

Solution
When there is an internal constraint, there are very few resources (people, machines, equipment, ma-
terials) dictating the output of the system. The most limiting resource is referred to as the ‘Drum’ as it
determines the pace or ‘beat’ of the entire system. The constraint resource cannot be allowed to waste
one moment of its capacity. This means that it should never be stopped waiting for parts and should
not use capacity producing anything other than the parts required to fulfill sales orders. To ensure this
we finitely schedule the Drum creating a Drum Schedule. The Drum schedule should maximise the
Throughput of the Constraint and provide a detailed plan for just this one area. The Drum Schedule
must be derived from the Shipping Schedule.
Subordinate everything else to the above decisions, there are a number of actions that have to be
met by the non-constraints in the system in order to meet the Drum Schedule and ultimately the
shipping schedule. The Constraint buffer is a pre-determined length of time; we must release the
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order into the system before the order is due on the Drum Schedule. As all other resources have more
capacity than the constraint (by definition), the effect of introducing parts a buffer time before they
are due at the constraint is that work builds up in front of the constraint and protects it from break-
downs on preceding operations.
To ensure that too much inventory is not introduced into the system, it is important to start a new
order only as the constraint finishes one. To ensure this, a Rope is tied to the first (gating) operation
of the system. This is calculated by the date the order appears on the Drum Schedule minus the Con-
straint Buffer time giving a schedule for material release into the system. We have now “choked” the
release of work into the system.
To ensure the Shipping Schedule is met after meeting the Drum Schedule a rope is tied from the Drum
to the Shipping Schedule. The rope length is a buffer of time to ensure the shipping schedule is always
met; this is called the shipping buffer.
This “choking” of release results in excess capacity being revealed in the non-constraints in front of
and behind the Drum. This can have negative ramifications and must be properly handled in imple-
mentation; otherwise non-constraint resources will slow down to protect themselves from perceived
negative consequences of not being busy all the time. This will of course impact Throughput and
delivery performance.

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Chapter 15
D Block
1. Lean System and 7 wastes
Basics
2. JIT
3. Kaizen Costing
4. 5S of JIT
5. Cellular Manufacturing
6. Total Productive Maintenance
Varieties 1. Time Analysis under JIT

2. JIT Purchasing
3. JIT Production
Back ush Accounting

Accounting Under JIT
(a) Variant 1
(b) Variant 2
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LEAN SYSTEM
Lean System is an organized method for waste minimization without sacrificing productivity within
a manufacturing system. Lean implementation emphasizes the importance of optimizing work flow
through strategic operational procedures while minimizing waste and being adaptable.
Waste is any step or action in a process that is not required to complete a process successfully (called
“Non-Value Adding”). When Waste is removed, only the steps that are required (called “Value-Adding”)
to deliver a satisfactory product or service to the customer remain in the process.
There are generally 7 type of wastes:
1. Overproduction: Producing ahead of demand.
2. Inventory: Having more inventory than is minimally required at any point in the process, includ-
ing end-product.
3. Waiting: Waiting includes products waiting on the next production step.
4. Motion: People or equipment moving or walking more than is required to perform the process.
5. Transportation: Moving products that is not actually required to perform the process.
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6. Rework from defects: Non-right first time.

7. Over Processing: Unnecessary work elements (non-value added activities).
Many large manufacturing companies like General Motors and Toyota are into lean manufacturing.
Lean manufacturing involves a shift in traditional thinking, from batch and queue to product-aligned
pull production. Instead of producing a lot of parts, the focus is on different types of operations con-
ducted adjacent to each other in a continuous flow.
Some of the techniques are:
(a) Just-in-Time (JIT)
(b) Kaizen Costing
(c) 5 S
(d) Total Productive Maintenance (TPM)
(e) Cellular Manufacturing/ One-Piece Flow Production Systems
(f) Six Sigma (SS)
Most of these applications are based on following principles:
• Perfect first-time quality
• Waste minimization
• Continuous improvement
• Flexibility
The characteristics of lean manufacturing:
• Zero waiting time
• Zero inventory
• Pull processing
• Continuous flow of production
• Continuous finding ways of reducing process time.

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JUST-IN-TIME (JIT) – The Pull System

A just in time approach is a collection of ideas that streamline a company’s production process ac-
tivities to such an extent that wastage of all kinds viz., of time, material, and labour is systematically
driven out of the process. JIT has a decisive, positive impact on product costs.
CIMA defines:
“Just-in-time (JIT): System whose objective is to produce or to procure products or components as
they are required by a customer or for use, rather than for stock. just-in-time system Pull system, which
responds to demand, in contrast to a push system, in which stocks act as buffers between the different
elements of the system such as purchasing, production and sales”.
“Just-in-time production: Production system which is driven by demand for finished products,
whereby each component on a production line is produced only when needed for the next stage”.
“Just-in-time purchasing: Purchasing system in which material purchases are contracted so that the
receipt and usage of material, to the maximum extent possible, coincide”.
A complete JIT system begins with production, includes deliveries to a company’s production facil-
D Block
ities, continues through the manufacturing plant, and even includes the types of transactions pro-
cessed by the accounting system.
“Process that vastly reduces the amount of raw materials inventory and improves the quality of
received parts”
• To begin with, a company must ensure that it receives products/spare parts/materials from its
suppliers on the exact date and at the exact time when they are needed. For this reason the
purchasing staff must investigate and evaluate every supplier, eliminate those which could not
keep up with the delivery dates.
• In addition, deliveries should be sent straight to the production floor for immediate use in man-
ufactured products, so that there is no time to inspect incoming parts for defects.
• Instead, the engineering staff must visit supplier sites and examine their processes, not only to
see if they can reliably ship high-quality parts but also to provide them with engineering assis-
tance to bring them up to a higher standard of product.
• As soon as suppliers certify for their delivery and quality, the concern must install a system, which
may be as simplistic as a fax machine or as advanced as an electronic data interchange system or
linked computer systems, that tells suppliers exactly how much of which parts are to be sent to
the company.
• Drivers then bring small deliveries of product to the company, possibly going to the extreme of
dropping them off at the specific machines that will use them first.
“Process in which a company reduces the amount of work-in-process, while also shrinking the
number of products that can be produced before defects are identified and fixed, thereby re-
ducing scrap costs”
• Next, we shorten the setup times for concern’s machinery. In most of the factories equipment is
changed over to new configurations as rarely as possible because the conversion is both lengthy
and expensive. When setups take a long time, company management authorises long produc-
tion runs, which spreads the cost of the setup over far more units, thereby reducing the setup
cost on a per-unit basis. However, with this approach too many products are frequently made
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at one time, resulting in product obsolescence, inventory carrying costs, and many defective
products (because problems may not be discovered until a large number of items have already
been completed). ‘But under JIT system a different approach to the setup issue is followed which
focuses on making a video tape of a typical set up, instead of reducing the length of equipments
setups and thereby eliminating the need for long production runs to reduce per unit costs. A
team of industrial engineers and machine users examines this tape, spotting and gradually elim-
inating steps that contribute to a lengthy setup’ . It is not unusual, after a number of iterations, to
achieve setup times of minutes or seconds when the previous setup times were well into hours.
• It is not sufficient to reduce machine setup times because there are still problems with machines
not being coordinated properly so that there is a smooth, streamlined flow of parts from ma-
chine to machine. In most of the companies there is such a large difference between the operat-
ing speeds of different machines that work-in-process inventory builds up in front of the slowest
ones. Not only does this create an excessive quantity of work-in-process inventory, but defective
parts produced by an upstream machine may not be discovered until the next downstream ma-
chine operator works his way through a pile of work-in-process and finds them. By the time this
happens the upstream machine may have created more defective parts, all of which must now
be destroyed or reworked. There are two ways to resolve both problems.
(a) The first involves a “kanban card,” which is a notification card that a downstream machine
D Block
sends to each machine that feeds it parts, authorizing the production of just enough com-
ponents to fulfill the production requirements being authorized in turn by the next ma-
chine further downstream. This is also known as a “pull” system, since kanbans are initiated
at the end of the production process, pulling work authorizations through the production
system. With this approach, there is no way for work-in-process inventory to build up in the
production system, since it can be created only with a kanban authorization.
(b) The second way to reduce excessive work-in-process inventory and defective parts, is to,
group machines into working cells. A working cell is a small cluster of machines which can
be run by a single machine operator. This individual machine operator takes each output
part from machine to machine within the cell; and thus there is no way for work-in-pro-
cess to build up between machines. Also, this operator can immediately identify defective
output which otherwise is difficult for each machine of the cell. This configuration has the
additional benefit of lower maintenance costs since the smaller machines used in a machine
cell are generally much simpler than the large, automated machinery they replace. Also, be-
cause the new machines are so small, it is much easier to reconfigure the production facility
when it is necessary to produce different products, avoiding the large expense of carefully
repositioning and aligning equipment.
Both kanbans and machine cells should be used together—they are not mutually exclusive.
By doing so a company can achieve extremely low product defect rates, as well as vanish-
ingly small investments in work-in-process inventory.
• Before the preceding steps are completed, it becomes apparent that a major change must also
be made in the work force. The traditional approach is to have one employee maintaining one
machine, which is so monotonous that workers quickly lapse into apathy and develop a complete
disregard for the quality of their work. Now, with full responsibility for a number of machines, as
well as product quality, workers become much more interested in what they are doing. To en-
hance this situation the human resource development department of organisation must prepare
and organise training classes to teach to employees how to operate a multitude of differ-
ent machines, perform limited maintenance on the machines without having to call in the
maintenance staff, spot product errors, understand how the entire system flows, and when

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to halt the production process to fix problems. In short, the workforce must be completely
retrained and focused on a wide range of activities. This usually results in a reconfiguration of
the compensation system as well, because the focus of attention shifts away from performance
based to high production volumes and in the direction of performance based to high product
quality.
• A major result of having an empowered workforce is that employees are allowed to stop their
machines when they see a problem, and either fix it on the spot or immediately call in a repair
team. In either case the result is immediate resolution of the bulk of performance problems. This
one step has a profound impact on much of the manufacturing variance analysis. Historically,
management accountants compile all kinds of variance information at the end of each month, in-
vestigate problems in detail, and then present a formal problem analysis report to management
a few weeks after the end of the month. However, because the production staff resolved the
underlying issues within a few minutes of their occurence, the variance report becomes a com-
plete waste of time. Management no longer cares what happened a month in the past because
it is presently dealing with current problems that will not appear on management accountant
reports for weeks to come. In short, the quick response capabilities of a JIT system allows the
management accountant to omit a large amount of the variance reporting that was previously
an important central job function.
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“Processes in which company alters in supporting accounting system”
• Finally, the massive changes caused by a JIT system also requires several alterations in the sup-
porting accounting systems. Because of the large number of daily supplier shipments, the ac-
counting staff faces the prospect of going through a large pile of accounts payable paperwork.
To make the problem worse there is no receiving paperwork, because the suppliers deliver parts
directly to the production operation, so there is no way to determine if deliveries have been
made. To avoid the first problem, accountants can switch to making a single consolidated
monthly payment to each supplier. The second problem requires a more advanced solution.
To prove that a supplier has delivered the part quantities which it claims it has, the accounting
system that can determine the amount of finished products created during the period and then
multiply these quantities by the parts listed on the bill of materials for each product, obtaining
a total quantity for each part used. The accountants then pay suppliers based on this theoretical
production quantity, which is also adjusted for scrap during the production process (otherwise
suppliers—unfairly—will not be paid for their parts that are scrapped during the company’s pro-
duction process). This approach also means that there is no need for suppliers to send invoices,
since the company relies solely on its internal production records to complete payments.
Clearly, the changes imposed by a JIT system are profound and can greatly improve company oper-
ations when installed and operated correctly. They can also have a profound effect on product costs.
So, JIT system aims at:
• Meeting customer demand in a timely manner
• Providing high quality products and
• Providing products at the lowest possible total cost.
The five main features of JIT production system:
• Organise production in manufacturing cells, a grouping of all the different types of equipment
used to make a given product. Materials move from one machine to another where various oper-
ations are performed in sequence. Material – handling cost are reduced.
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• Hire and retain workers who are multi-skilled so that they are capable of performing a variety of
operations, including repairs and maintenance tasks. Thus, labour idle time gets reduced.
• Apply TQM to eliminate defects. As, there are tight link stages in the production line, and min-
imum inventories at each stage, defect arising in one stage can hamper the other stages. JIT
creates urgency for eliminating defects as quickly as possible.
• Place emphasis on reducing set-up time which makes production in smaller batches economical
and reducing inventory levels. Thus, company can respond to customer demand faster.
• Carefully selected suppliers capable of delivering high quality materials in a timely manner di-
rectly at the shop – floor, reducing the material receipt time.
Essential Pre-requisites of a JIT system
• Low variety of goods
• Vendor reliability
• Good communication
• Demand stability
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• TQM
• Defect free materials
• Preventive maintenance
Performance Measurements in JIT

(a) Small machines small investment laser need to justify
(b) Rewarding employees on quality or improvements
(c) Eliminating labour efficiency variance altogether
(d) High inventory turnover ratio (Toyota achieved 70 times)
(e) Concern for Customer Complaints
(f ) Reduction of scrap
(g) Keeping track of cost of quality
(h) Customer Service – On time delivery, shipping full orders and no returns
(i) Ideas generated by employees
KAIZEN COSTING
Lean manufacturing is founded on the idea of kaizen, or continual improvement. Continuous im-
provement is the continual examination and improvement of existing processes and is very different
from approaches such as business process re-engineering (BPR), which seeks to make radical one-off
changes to improve an organization’s operations and processes. This philosophy implies that small,
incremental changes routinely applied and sustained over a long period result in significant improve-
ments. The kaizen strategy aims to involve workers from multiple functions and levels in the organiza-
tion in working together to address a problem or improve a particular process.

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Some of the activities in the kaizen costing methodology include the elimination of waste in the pro-
duction, assembly, and distribution processes, as well as the elimination of work steps in any of these
areas. Though these points are also covered in the value engineering phase of target costing, the
initial value engineering may not uncover all possible cost savings. Thus, kaizen costing is really de-
signed to repeat many of the value engineering steps for as long as a product is produced, constantly
refining the process and thereby stripping out extra costs. The cost reductions resulting from kaizen
costing are much smaller than those achieved with value engineering but are still worth the effort
since competitive pressures are likely to force down the price of a product over time, and any possible
cost savings allow a company to still attain its targeted profit margins while continuing to reduce cost.
Kaizen Costing Principles

• The system seeks gradual improvements in the existing situation, at an acceptable cost.
• It encourages collective decision making and application of knowledge.
• There are no limits to the level of improvements that can be implemented.
• Kaizen involves setting standards and then continually improving these standards to achieve
long-term sustainable improvements.
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• The focus is on eliminating waste, improving systems, and improving productivity.
• Involves all employees and all areas of the business.
Kaizen Costing vs Standard Costing
Kaizen Costing Standard Costing

1. Focus on Cost reduction 1. Focus on cost control
2. Sets small standards and reduce continuously 2. Sets long term stable standards
3. Employee participation in setting standards 3. No employee participation
Illustration
M. India Ltd. (MIL) is an automobile manufacturer in India and a subsidiary of Japanese automobile
and motorcycle manufacturer Leon. It manufactures and sells a complete range of cars from the entry
level to the hatchback to sedans and has a present market share of 22% of the Indian passenger car
markets. MIL uses a system of standard costing to set its budgets. Budgets are set semi-annually by
the Finance department after the approval of the Board of Directors at MIL. The Finance department
prepares variance reports each month for review in the Board of Directors meeting, where actual per-
formance is compared with the budgeted figures. Mr. Suzuki, group CEO of the Leon is of the opinion
that Kaizen costing method should be implemented as a system of planning and control in the MIL.
Required
RECOMMEND key changes vital to MIL’s planning and control system to support the adoption of
‘Kaizen Costing Concepts’.
Solution
Kaizen Costing emphasizes on small but continuous improvement. Targets once set at the beginning
of the year or activities are updated continuously to reflect the improvement that has already been
achieved and that are yet to be achieved.
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The suggestive changes which are required to be adopted Kaizen Costing concepts in MIL are as
follows:
(a) Standard Cost Control System to Cost Reduction System: Traditionally Standard Costing sys-
tem assumes stability in the current manufacturing process and standards are set keeping the
normal manufacturing process into account thus the whole effort is on to meet performance
cost standard.
On the other hand Kaizen Costing believes in continuous improvements in manufacturing pro-
cesses and hence, the goal is to achieve cost reduction target. The first change required is the
standard setting methodology i.e. from earlier Cost Control System to Cost Reduction System.
(b) Reduction in the periodicity of setting Standards and Variance Analysis: Under the existing
planning and control system followed by the MIL, standards are set semi-annually and based on
these standards monthly variance reports are generated for analysis. But under Kaizen Costing
system cost reduction targets are set for small periods say for a week or a month. So the period
covered under a standard should be reduced from semi-annually to monthly and the current
practice of generating variance reports may be continued or may be reduced to a week.
(c) Participation of Executives or Workers in standard setting: Under the Kaizen Costing system
participation of workers or executives who are actually involved in the manufacturing process
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are highly appreciated while setting standards. So the current system of setting budgets and
standards by the Finance department with the mere consent of Board of Directors required to be
changed..
5 S of JIT
5S is the name of a workplace organization method that uses a list of five Japanese words: seiri, seiton,
seiso, seiketsu, and shitsuke.Transliterated into Roman script, they all start with the letter “S”. The list
describes how to organize a work space for efficiency and effectiveness by identifying and storing
the items used, maintaining the area and items, and sustaining the new order. The decision-making
process usually comes from a dialogue about standardization, which builds understanding among
employees of how they should do the work.
In some cases, 5S has become 6S, the sixth element being safety.
The 5 S
There are five 5S phases: They can be translated from the Japanese as “sort”, “set in order”, “shine”,
“standardize”, and “sustain”. Other translations are possible.
Sort
• Remove unnecessary items and dispose of them properly.
• Make work easier by eliminating obstacles.
• Reduce chances of being disturbed with unnecessary items.
• Prevent accumulation of unnecessary items.
• Evaluate necessary items with regard to cost or other factors.
• Remove all parts or tools that are not in use.
• Segregate unwanted material from the workplace.

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• Need fully skilled supervisor for checking on regular basis.

• Don’t put unnecessary items at the workplace & define a red-tagged area to keep those unnec-
essary items.
• Waste removal.
Set In Order
• Arrange all necessary items so that they can be easily selected for use.
• Prevent loss and waste of time by arranging work station in such a way that all tooling / equip-
ment is in close proximity
• Make it easy to find and pick up necessary items
• Ensure first-in-first-out FIFO basis
• Make workflow smooth and easy
• All of the above work should be done on regular basis
Shine
D Block
• Clean your workplace completely
• Use cleaning as inspection
• Prevent machinery and equipment deterioration
• Keep workplace safe and easy to work
• Keep workplace clean and pleasing to work in
• When in place, anyone not familiar to the environment must be able to detect any problems
within 50 feet in 5 secs.
Standardize
• Standardize the best practices in the work area.
• Maintain high standards in workplace organization at all times.
• Maintain orderliness. Maintain everything in order and according to its standard.
• Everything in its right place.
• Every process has a standard.
Sustain
• To keep in proper working order.
• Also translates as “do without being told”.
• Perform regular audits.
• Training and discipline.
• Training is goal-oriented process. Its resulting feedback is necessary monthly.
The Origins of 5 S
5S was developed in Japan and was identified as one of the techniques that enabled Just in Time
manufacturing.
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Two major frameworks for understanding and applying 5S to business environments have arisen, one
proposed by Osada, the other by Hirano, Hirano provided a structure for improvement programs with
a series of identifiable steps, each building on its predecessor. As noted by John Bicheno, Toyota’s
adoption of the Hirano approach was ‘4S’, with Seiton and Seiso combined.
Variety of 5 S Applications
5S methodology has expanded from manufacturing and is now being applied to a wide variety of
industries including health care, education, and government. Visual management and 5S can be par-
ticularly beneficial in health care because a frantic search for supplies to treat an in-trouble patient (a
chronic problem in health care) can have dire consequences.
5 S in Lean Product & Process Development
The output of engineering and design in a lean enterprise is information, the theory behind using
5S here is “Dirty, cluttered, or damaged surfaces attract the eye, which spends a fraction of a second
trying to pull useful information from them every time we glance past. Old equipment hides the new
equipment from the eye and forces people to ask which to use.
Illustration
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Application in Web Based App that Needs a Screen Interface

• Seri (sort)- Seri can be thought as a sorting through features, interface elements, and screens to
minimize an application or a single screen to its most essential parts.
• Seiton (set in order)- Seiton is about designing for uniformity so that users can derive meaning
from a page’s content based on how it is laid out.
• Seiso (shine)- Seiso can relate to improving or updating the look of graphical elements, devot-
ing attention to more perfect alignment and distribution amount page elements, and devising
colour palettes that contribute to the overall mood and personality of the application.
• Seiketsu (standardize)- Online, adhering to standards means using proper semantic mark up in
webpages and keeping the code used for presentation and content clearly separated.
• Shitsuke (sustain)- Improvement should not come in smart waves and then fade away. It should
be kept on permanent basis. The repeated process of reduction to retain only what’s needed in
a screen application, the arrangement of elements into most effective forms, the polishing of
what’s left and the standardisation of screen are the processes that should be maintained.
CELLULAR MANUFACTURING/ ONE PIECE FLOW PRODUCTION

SYSTEM
A Sub Section of JIT and Lean System is Cellular Manufacturing. It encompasses a group technology.
The goals of cellular manufacturing are:
• To move as quickly as possible,
• Make a wide variety of similar products,
• Making as little waste as possible.

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In the assembly line multiple cells are used. Each cell comprises of one or more machines which ac-
complish a certain task. The product moves from one cell to the next, each station completing part of
the manufacturing process. U-shaped design is given to these cells because this allows for the super-
visor to move less and have the ability to more readily watch over the entire process.
Flexibility in operations is its biggest advantage. Changes are easy to make as the machines are au-
tomatic. Variety, of product scaling is possible and minor changes to the overall design are made
possible changing the overall design. Although boring the changes can be done precisely and quickly.
A cell is created by consolidating the processes required to create a specific output, such as a part
or a set of instructions. Reduction is the extra steps are done in the process of creating the specific
output, and facilitate quick identification of problems and encourage communication of employees
within the cell in order to resolve issues that arise quickly. It gives massive Gains on implementation
in productivity and quality while simultaneously reducing the amount of inventory, space and lead
time required to create a product. It is for this reason that the one-piece-flow cell has been called “the
ultimate in lean production”.
Implementation Process
D Block
Step 1 : First, the parts to be made must be grouped by similarity (in design or manufacturing require-
ments) into families.
Step 2 : A systematic analysis of each family must be performed; typically in the form of production
flow analysis (PFA) for manufacturing families, or in the examination of design/product data for design
families. This analysis can be time consuming and costly, but is important because a cell needs to be
created for each family of parts.
Step 3 : There are also a number of mathematical models and algorithms to aid in planning a cellu-
lar manufacturing center, which take into account a variety of important variables such as, “multiple
plant locations, multi-market allocations with production planning and various part mix.”
Step 4 : Once these variables are determined with a given level of uncertainty, optimizations can be
performed to minimize factors such as, “total cost of holding, inter-cell material handling, external
transportation, fixed cost for producing each part in each plant, machine and labor salaries.”
Difficulties in Creating Flow
Following difficulties need to be considered and addressed to create efficient flow in cellular manu-
facturing:
• Exceptional Elements
• Machine Distances
• Bottleneck Machines and Parts
• Machine Location and Relocation
• Part Routing
• Cell Load Variation
• Inter and Intracellular Material Transferring
• Cell Reconfiguring
• Dynamic Part Demands and
• Operation and Completion Times
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Benefits and Costs
Scattered processes are merged to form short focused paths in concentrated places. So constructed,
by logic a cell reduces flow time, flow distance, floor space, inventory, handling, scheduling transac-
tions, and scrap and rework (the latter because of quick discovery of nonconformities). Moreover, cells
lead to simplified, higher validity costing, since the costs of producing items are contained within the
cell rather scattered in distance and the passage of reporting time.
Production and quality controls are facilitated. Cells that are underperforming in either volume or
quality can be easily isolated and targeted for improvement. The segmentation of the production pro-
cess allows problems to be easily located and it is more clear which parts are affected by the problem.
There are also a number of benefits for employees working in cellular manufacturing. The small cell
structure improves group cohesiveness and scales the manufacturing process down to a more man-
ageable level for the workers.
Workers can more easily see problems or possible improvements within their own cells and tend to
be more self-motivated to propose changes. Additionally, these improvements that are instigated by
the workers themselves cause less and less need for management, so over time overhead costs can
be reduced.
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There are a number of possible limitations to implementing cellular manufacturing. Some argue that
cellular manufacturing can lead to a decrease in production flexibility. Cells are typically designed to
maintain a specific flow volume of parts being produced. Should the demand or necessary quantity
decrease, the cells may have to be realigned to match the new requirements, which is a costly opera-
tion, and one not typically required in other manufacturing setups.
TOTAL PRODUCTIVE MAINTENANCE (TPM)

Total Productive Maintenance (TPM) is a system of maintaining and improving the integrity of produc-
tion and quality systems. This is done through the machines, equipment, processes, and employees
that add to the value in Business Organisation. This concept was first introduced by M/s Nippon Denso
Co. Ltd. of Japan, a supplier of M/s Toyota Motor Company.
TPM helps in keeping all equipment in top working condition so as to avoid breakdowns and delays
in manufacturing processes.
How TPM can be introduced in the organization?
The introduction of TPM follows four main phases:
• Preparation Stage: Establish a suitable environment and conducting programme awareness.
• Introduction Stage: Initialization of TPM, information to suppliers, customers, and other stake-
holders.
• Implementation Stage: This is done with the help of eight activities referred as eight pillars of
TPM.
• Institutionalizing stage: This is the stage of getting TPM awards.
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Foundation & Pillars About Techniques

Foundation: 5S TPM starts with 5S. It deals with or- Seiri (sort), Seiton (set in order) Sei-
ganizing a workplace which helps so, (shine), Seiketsu (standardize),
to recognize the uncover problems. Shitsuke, (sustain).
P-1: Autonomous Operation of equipment without Cleaning, Lubricating, Visual Inspec-
Maintenance breakdown and eliminating the de- tion, Tightening of Loosened Bolts
fects at source through active em- etc.
ployee participation.
P-2: Focussed This pillar is about the minor im- Kaizen Register, Kaizen Summary
Improvement (Kaizen) provements made on continuous Sheet, Why-Why Analysis, Summary
basis. This pillar aims to reduce loss- of Losses.
es in the workplace that affect effi-
ciencies.
P-3: Planned This is proper maintenance system Preventive Maintenance, Break-
Maintenance adopted for improvement in relia- down Maintenance, Corrective
bility and maintainability of equip- Maintenance, and Maintenance Pre-
ment. It aims to have zero break- vention.
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down and optimum maintenance
cost.
P-4: Early Management This focuses on shortening the time Engineering and Re-engineering
required for product and equip- Processes.
ment development.
P-5: Quality This is towards achieving custom- Root Cause Analysis, Customer Data
Maintenance er satisfaction through delivery of Analysis.
highest quality product.
P-6: Education & It aims to improve knowledge/skills Training Calendar, Policies for Edu-
Training and enhance morale of employees. cation and Training, On-site Training
etc.
P-7: Office TPM This refers to application of TPM Analyzing processes and procedure
techniques in administration to im- towards increased Office Automa-
prove productivity and efficiency tion.
in the functions with elimination of
losses.
P-8: Safety, Health, and Above all the safety of worker is ut- Drama, Safety Slogans, Quizzes,
Environment most importance. It aims to have Posters Making to create awareness
zero accidents and zero health dam- related to safety.
ages.
Performance Measurement in TPM
The most important approach to the measurement of TPM performance is known as Overall Equip-
ment Effectiveness (OEE) measure. The calculation of OEE measure requires the identification of “six
big losses”
1. Equipment Failure/ Breakdown
2. Set-up/ Adjustments
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3. Idling and Minor Stoppages

4. Reduced Speed
5. Reduced Yield and
6. Quality Defects and Rework
The first two losses refer to time losses and are used to calculate the availability of equipment. The
third and fourth losses are speed losses that determine performance efficiency of equipment. The last
two losses are regarded as quality losses.
Performance × Availability × Quality = OEE %
OEE may be applied to any individual assets or to a process. It is unlikely that any manufacturing pro-
cess can run at 100% OEE. According to Dal et al (2000), Nakajima (1998) suggested that ideal values
for the OEE component measures are:
Availability > 90%

Performance > 95%
Quality > 99%
D Block
Accordingly, OEE at World Class Performance would be approximately 85%. Kotze (1993) contradict-
ed, that an OEE figure greater than 50% is more realistic and therefore more useful as an acceptable
target.
Illustration
Gold Coast Company Ltd. manufactures spare parts. It works in two shifts of 8 hours for 6 days in a
week. Lunch break is 45 mins and other miscellaneous breaks add up to 25 minutes. The following
details are collected for the last 4 weeks by the TPM team for one of their important equipment
Hours for Planned Preventive Maintenance = 15 minutes per shift
For Breakdown Maintenance = 6 hours total
Set up Changes = 15 hours total
Power Failure = 4 hours total
Standard Cycle Time per piece = 3 minutes
No of Parts Produced per shift = 120
Parts Accepted per shift = 115
Required
CALCULATE ‘OEE’.

Cost Management
Class
WORK
Solution
Calculation of Shifts
Days per week …(A) 6

Shifts per week …(B) 2
Total Working Shifts per week …(C = A × B) 12
Total Weeks …(D) 4
Total Shifts …(E = C × D) 48
Calculation of Loss of Time per shift
Breakdown Maintenance ( in mins) 360

Set up Changes (in mins) 900
Power Failure (in mins) 240
Total …(A) 1,500
Loss of Minutes per shift …(A/ 48) 31.25
D Block
Add: Lunch Breaks per shift 45
Add: Other Breaks 25
Add: Preventive Maintenance 15
Total Time Loss (in Minutes) per shift 116.25
 480 min s. − 116.25 min s. 

Availability Ratio per shift =   × 100%
 480 min s. 
= 75.78%
Actual Production = 120 units per shift

Standard time = 3 minutes
Standard Time Required = 120 units × 3 minutes = 360 minutes
Actual Time Taken = 480 mins. – 116.25 mins. = 363.75 minutes
Performance Ratio =
 360 min s. 
Performance Ratio =   × 100%
 363.75 min s. 
= 98.96%
 115 parts 
Quality Ratio =   × 100% = 95.83%
120 parts 
Thus, OEE = 0.7578 × .9896 × .9583 = 71.86%
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Connection Between TQM and TPM
The connection between TQM and TPM are summarized below:

• TQM and TPM make company more competitive by reducing costs, improving customer satisfac-
tions and slashing lead times.
• Involvement of the workers into all phases of TQM and TPM is necessary.
• Both processes need fundamental training and education of participants.
• TPM and TQM take long time to notice sustained tangible benefits.
• Commitment from top managements are necessary for success of the implementation.
ACCOUNTING FOR PULL SYSTEM – BACK FLUSH COSTING

Back-flushing requires no data entry of any kind until a finished product is completed. At that time
the total amount finished is entered into the computer system, which multiplies it by all the compo-
nents listed in the bill of materials for each item produced. This yields a lengthy list of components
D Block
that should have been used in the production process and which are subtracted from the beginning
inventory balance to arrive at the amount of inventory that should now be left on hand.
Given the large transaction volumes associated with JIT, this is an ideal solution to the problem.
However, there are some serious problems with back-flushing that must be corrected before it will
work properly. They are:
• Production reporting: The total production figure entered into the system must be absolutely
correct, or else the wrong component types and quantities will be subtracted from stock. This is
a particular problem when there is high turnover or a low level of training to the production staff
that records this information, which leads to errors.
• Scrap reporting: All abnormal scrap must be diligently tracked and recorded; otherwise these
materials will fall outside the black-flushing system and will not be charged to inventory. Since
scrap can occur anywhere in a production process, a lack of attention by any of the production
staff can result in an inaccurate inventory. Once again, high production turnover or a low level of
employee training increases this problem.
• Lot tracing: Lot tracing is impossible under the back-flushing system. It is required when a man-
ufacturer need to keep records of which production lots were used to create a product in case all
the items in a lot must be recalled. Only a picking system can adequately record this information.
Some computer system allows picking and back-flushing system to coexist, so that pick trans-
actions for lot tracing purpose can still be entered in the computer. Lot tracing may then still be
possible if the right software is available; however, this feature is generally present only on high-
end systems.
• Inventory accuracy: The inventory balance may be too high at all times because the backflush-
ing transaction that relieves inventory usually does so only once a day, during which time other
inventory is sent to the production process; this makes it difficult to maintain an accurate set of
inventory records in the warehouse.

Cost Management
Class
WORK
Of all the issues noted here, the worst is a situation where the production staff is clearly incapable of
providing sufficiently accurate scrap or production reporting for the back-flushing system. If there is
an easily traceable cause, such as less capable workers on a particular shift, moving a few reliable em-
ployees into these positions can provide immediate relief from the problem. It may even be possible
to have an experienced shift supervisor to collect this information. However, where this is not possi-
ble for whatever reason, computer system users experience back-flushing garbage in, garbage out
(GIGO)—entering inaccurate information rapidly eliminates any degree of accuracy in the inventory
records, requiring many physical inventory counts to correct the problem. Consequently, the success
of a back-flushing system is directly related to a company’s willingness to invest in a well-paid, experi-
enced well-educated production staff that undergoes little turnover.
Back Flush Costing has two variants according to which accounting are done
Variant 1 :
This is the less radical variant.
There are two inventory accounts - raw materials and finished goods, i.e. No WIP account. There are
two trigger points:
D Block
1. Purchase of raw materials - Dr Materials account Cr Creditors
2. The cost of labour and other manufacturing expenses - are debited to a conversion cost account
and credited to cash or creditors. The conversion cost account can be thought of as a suspense
account where amounts are placed temporarily.
3. On completion of units - Dr Finished goods account with the standard cost of goods produced
Cr Materials account with the standard cost of materials Cr Conversion cost account with the
standard cost of conversion.
4. Goods Sold is recorded
5. Variance in Conversion Cost is accounted in Conversion Cost Account
Variant 2
This is more radical.
No records are kept of work-in-progress raw materials, so if this method is to be used, stocks of both
raw materials and work-in-progress must be negligible. Also assumed that all costs are equal to stand-
ard cost. It has only one trigger point.
1. As before, the cost of labour and other manufacturing expenses are initially debited to a conver-
sion cost account and credited to cash or creditors.
2. Entries into the finished goods inventory account are made only when goods are completed, and
the journal entries will be: Dr Finished goods account with the standard cost of goods produced
Cr Creditors with the standard cost of material used in goods produced Cr Conversion cost ac-
count with the standard cost of conversion.
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TIME ANALYSIS UNDER JIT

In many Western organizations in the past it took several months to make a product from start to fin-
ish, despite the fact that if worked on continuously it could be made in say, two days. The difference
in time is largely due to non value adding time like set up time, movement time, waiting time and
inspection time. It is apparent that value is only added to the product during the actual processing
time. These have been estimated to represent as little as 10% of the total manufacturing lead time in
many companies and thus up to 90% of production time adds costs and no value.
The objective of JIT is to organize the production system in such a way that the manufacturing lead
time becomes equal to process time.
Manufacturing Lead time = Setup time + Movement Time + Process Time + Waiting Time +
Inspection Time.
D Block

Cost Management
Class
WORK
ABC Ltd. is planning to introduce Kaizen Costing approach in its manufacturing plant. State whether
and why the following are Valid or Not in respect of Kaizen Costing.
(i) VP (Finance) is of the view that company has to make a huge initial investment to bring a large
scale modification in production process.
(ii) Head (Personnel) has made a point that introduction of Kaizen Costing does not eliminate the
training requirement of employees.
(iii) General Manager (Manufacturing) firmly believes that only shop floor employees and workers’
involvement is prerequisite of Kaizen Costing approach.
(iv) Manager (Operations) has concerns about creation of confusion among employees and workers
regarding their roles and degradation in quality of production.
Solution
(i) Invalid: Kaizen Costing is the system of cost reduction procedures which involves making small
and continuous improvements to the production processes rather than innovations or large-
D Block
scale investment.
(ii) Valid: The training of employees is very much a long-term and ongoing process in the Kaizen
costing approach. Training enhances the abilities of employees.
(iii) Invalid: Kaizen costing approach involves everyone from top management level to the shop
floor employees. Every employee’s active participation is a must requirement.
(iv) Invalid: Though the aim of Kaizen Costing is to reduce the cost but at the same time it also aims
to maintain the quality. Kaizen costing also aims to bring the clarity in roles and responsibilities
for all employees.
Give Back flush Costing Journal Entries in respect of the following transaction –
i. Raw material purchased – ` 3,20,000
ii. Materials placed into production
iii. Actual Direct Labour Cost – ` 50,000
iv. Actual Overhead Cost – ` 4,50,000
v. Conversion Cost Applied – ` 4,70,000
vi. All units were completed and sold
vii. Variance is recognized
Accounting under Back Flush
Advanced Strategic
Class
WORK
Napier Company uses a backflush costing system with three trigger points:
(a) Purchase of Direct Materials
(b) Completion of Good Finished Units of Product
(c) Sales of Finished Goods
You are provided with the following information for July 2016.
Direct Materials Purchased `2,64,000 Conversion Costs Allocated `1,20,000

Direct Materials Used `2,55,000 Costs Transferred to Finished `3,75,000
Goods
Conversion Costs Incurred `1,26,600 Cost of Goods Sold `3,57,000
Required
D Block
(i) Prepare journal entries for July (without disposing of under allocated/ over allocated conversion
costs).
(ii) Under an ideal JIT production system, how would the amounts in your journal entries change
from the journal entries in requirement (i)?
Accounting under Back Flush

RTP
Queenstown Furniture (QF) manufactures high-quality wooden doors within the forests of Queens-
town since 1952. Management is having emphasize on creativity, engineering, innovation and expe-
rience to provide customers with the door they desire, whether it is a standard design or a one-of-a-
kind custom door. The following information pertains to operations during April:
Processing time 9.0 hrs.* Waiting time 6.0 hrs.*

Inspection time 1.5 hr.* Move time 7.5 hrs.*
Units per batch 60 units
(*) average time per batch

Required
Compute the following operational measures:
(i) Average non-value-added time per batch

Cost Management
Class
WORK
(ii) Average value added time per batch

(iii) Manufacturing cycle efficiency
(iv) Manufacturing cycle time
Time analysis under JIT

RTP
Kumar Enterprises has decided to adopt JIT policy for materials. The following effects of JIT are iden-
tified:
D Block
• To implement JIT, the company has to modify its production and material receipt facilities at a
capital cost of ` 6,00,000. The new facilities will require a cash operating cost of ` 48,000 p.a.
• Raw material stock holding will be reduced from ` 28,00,000 to ` 8,00,000.
• The company can earn 15 % on its long term investments.
• The company can avoid rental expenditure on storage facilities amounting to ` 30,000 p.a. Prop-
erty taxes and insurance amounting to ` 12,000 will be saved due to JIT programme.
• Presently there are 7 workers in the stores department at a salary of ` 3,000 each per month. After
implementing JIT scheme, only 2 workers will be required in this department. Of the balance 5
workers, 3 will be transferred to other departments, while 2 workers’ employment will be termi-
nated.
• Due to receipt of smaller lots of raw materials, there will be some disruption of production. The
costs of stock – out will be ` 3,40,000 in the first year only. This Stock – out costs can be brought
down from the second year onwards.
Determine the financial impact of the JIT policy. Is it advisable for the company to implement the JIT
policy.
JIT Purchase System
Advanced Strategic
Class
WORK
Solution
COST BENEFIT ANALYSIS OF JIT POLICY:
COSTS `
Interest on capital for modifying production facilities (` 6,00,000 x 15%) 90,000
Operating Costs of new production facilities 48,000
Stock – out Costs (first year only)
Total 3,40,000
4,78,000
BENEFITS `
Interest on investments for released funds
( ` 28,00,000 – ` 8,00,000 )x 15% 3,00,000
Savings in salary of 2 workers terminated
(` 3,000 x 12 months x 2) 72,000
Savings in Rental Expenditure 30,000
D Block
Savings In Property Tax and Insurance 12,000

Net Loss due to JIT policy ( first year) 64,000
Total 4,78,000
Therefore, JIT Policy should not be implemented in first year
X Video Company sells package of blank video tapes to its customer. It purchases video tapes from
Y Tape Company @ ` 140 a packet. Y Tape Company pays all freight to X Video Company. No incom-
ing inspection is necessary because Y Tape Company has a superb reputation for delivery of quality
merchandise. Annual demand of X Video Company is 13,000 packages. X Video Co. requires 15% an-
nual return on investment. The purchase order lead time is two weeks. The purchase order is passed
through Internet and it costs ` 2 per order. The relevant insurance, material handling etc ` 3.10 per
package per year. X Video Company has to decide whether or not to shift to JIT purchasing. Y Tape
Company agrees to deliver 100 packages of video tapes 130 times per year (5 times every two weeks)
instead of existing delivery system of 1,000 packages 13 times a year with additional amount of ` 0.02
per package. X Video Co. incurs no stock out under its current purchasing policy. It is estimated X Vid-
eo Co. incurs stock out cost on 50 video tape packages under a JIT purchasing policy. In the event of a
stock out, X Video Co. has to rush order tape packages which costs ` 4 per package.
Comment whether X Video Company should implement JIT purchasing system.
Z Co. also supplies video tapes. It agrees to supply @ ` 136 per package under JIT delivery system. If
video tape purchased from Z Co., relevant carrying cost would be ` 3 per package against ` 3.10 in
case of purchasing from Y Tape Co. However Z Co. doesn’t enjoy so sterling a reputation for quality. X
Video Co. anticipates following negative aspects of purchasing tapes from Z Co. :

Cost Management
Class
WORK
(a) To incur additional inspection cost of 5 paisa per package.

(b) Average stock out of 360 tapes packages per year would occur, largely resulting from late deliv-
eries. Z Co. cannot rush order at short notice. X Video Co. anticipates lost contribution margin per
package of ` 8 from stock out.
(c) Customer would likely return 2% of all packages due to poor quality of the tape and to handle
this return an additional cost of ` 25 per package.
Comment whether X Video Co places order to Z Co
JIT Purchase System
Solution
D Block
Comparative Statement of cost for purchasing from Y Co Ltd under current policy & JIT
Particulars Current policy JIT

Purchasing cost (13,000 x 140) = 18,20,000 (13,000 x 140.02) = 18,20,260
Ordering cost (2 x 13 orders) = 26 (2 x 130 orders) = 260
Opportunity (1,000/2 x140x15%) = 10,500 (100/2 x 140.02x15%) =1,050
carrying cost
Other carrying cost (1,000/2 x 3.10) = 1,550 (100/2 x 3.10) = 155
Stock out cost (4 x 50) = 200
Total relevant cost 18,32,076 18,21,925
Comments: As may be seen from above, the relevant cost under the JIT purchasing policy is lower
than the cost incurred under the existing system. Hence, a JIT purchasing policy should be adopted
by the company.
Statement of cost for purchasing from Z Co Ltd.
Particulars `
Purchasing cost (13,000 x 136) 17,68,000
Ordering cost (2 x 130 orders) 260
Opportunity carrying cost (100/2 x 136 x 15%) 1020
Other carrying cost (100/2 x 3) 150
Stock out cost (8 x 360) 2,880
Inspection cost (13,000 x 0.05) 650
Customer return cost (13,000 x 2% x 25) 6,500
Total Relevant cost 17,79,460
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Comments: The comparative costs are as follows,

Under current policy ` 18,32,076.00
Under purchase under JIT ` 18,21,925.10
Under purchase from Z Co Ltd ` 17,79,460
Packages should be bought from Z Co as it is the cheapest.
Innovation Ltd. has entered into a contract to supply a component to a company which manufactures
electronic equipments.
Expected demand for the component will be 70 ,000 units totally for all the periods. Expected sales
and production cost will be -
D Block
Period 1 2 3 4
Sales (units) 9,500 17,000 18,500 25,000
Variable cost per unit 30 30 32.50 35
Total fixed overheads are expected to be `14 lakhs for all the periods. The production manager has to
decide about the production plan.
The choices are:
Plan 1: Produce at a constant rate of 17,500 units per period. Inventory holding costs will be ` 6.50 per
unit of average inventory per period.
Plan 2:Use a just-in-Time (JIT) system
Maximum capacity per period normally - 18,000 units
It can produce further up to 10 ,000 units per period in overtime.
Each unit produced in overtime would incur additional cost equal to 30% of the expected variable
cost per unit of that period.
Assume zero opening inventory.
(i) Calculate the incremental production cost and the savings in inventory holding cost by JIT pro-
duction system.
(ii) Advise the company on the choice of a plan.
JIT Production System

Cost Management
Class
WORK
KP Ltd. (KPL) manufactures and sells one product called “KEIA”. Managing Director is not happy with its
current purchasing and production system. There has been considerable discussion at the corporate
level as to use of ‘Just in Time’ system for “KEIA”. As per the opinion of managing director of KPL Ltd. –
“Just-in-time system is a pull system, which responds to demand, in contrast to a push system, in
which stocks act as buffers between the different elements of the system such as purchasing, pro-
duction and sales. By using Just in Time system, it is possible to reduce carrying cost as well as other
overheads”.
KPL is dependent on contractual labour which has efficiency of 95%, for its production. The labour has
to be paid for minimum of 4,000 hours per month to which they produce 3,800 standard hours.
For availing services of labour above 4,000 hours in a month, KPL has to pay overtime rate which is
45% premium to the normal hourly rate of `110 per hour. For avoiding this overtime payment, KPL
in its current production and purchase plan utilizes full available normal working hours so that the
higher inventory levels in the month of lower demand would be able to meet sales of month with
D Block
higher demand level. KPL has determined that the cost of holding inventory is `70 per month for each
standard hour of output that is held in inventory.
KPL has forecast the demand for its products for the first six months of year 2018 as follows:
Month Demand (Std. Hrs.)

Jan’18 3,150
Feb’18 3,760
Mar’18 4,060
Apr’18 3,350
May’18 3,650
Jun’18 4,830
Following other information is given:

(i) All other production costs are either fixed or are not driven by labour hours worked.
(ii) Production and sales occur evenly during each month and at present there is no stock at the end
of Dec’17.
(iii) The labour are to be paid for their minimum contracted hours in each month irrespective of any
purchase and production system.
Required
As a chief accountant you are requested to COMMENT on managing director’s view.
JIT Production System
Advanced Strategic
Activity Based Costing
Class
WORK
Chapter 16
Product Costing
Using Absorption Costing

Basics
Using Activity Based Costing
Costing Branches
Management Accounting Branches Applicability and Non Applicability of ABC
(with Limitations and Justications)
E Block
Comparative Study
Activity Based Budgeting
Traditional Environment
Modern Environment Variance Analysis with ABC
Steps for ABC

Break Even Analysis with ABC
Cost Pool
Cost Driver
Rate / driver
Apportionment
Different Categories of Activities
Unit Level
Batch Level
Product Level
Facility Level

Cost Management
Class
WORK
ACTIVITY BASED COST MANAGEMENT (ABM)

The term Activity based management (ABM) is used to describe the Cost Management application of
ABC. The use of ABC as a costing tool to manage costs at activity level is known as Activity Based Cost
Management (ABM). ABM is a discipline that focuses on the efficient and effective management of
activities as the route to continuously improving the value received by customers. ABM utilizes cost
information gathered through ABC. Through various different types of analysis, ABM manages activi-
ties rather than resources. It determines what drives the activities of the organisation and how these
activities can be improved to increase the profitability.
Implementing ABM
Step 1 : Decide what are the organisation’s most important issues and what types of information
would be required to address those issues.
Step 2 : Top Management support is cited to identify critical information needs.
Step 3 : Incorporate ABC methods into organization’s financial reporting process.
Step 4 : If integrating ABC into the main cost reporting system is not feasible, consider developing a
separate ABC system.
Step 5 : The existing information system should easily support input requirements.
Step 6 : Implementation team should be represented by the people who will be actual users of the
ABM information.
E Block
Step 7 : Implement ABM at a high level in order to get concepts across.
Benefits of Activity Based Cost Management
• Provision of excellent basis and focus for cost reduction.
• Provides operational management with a clear view of HOW to implement an Activity Based
Budget?
• Provision of clear understanding of the underlying causes of business processing costs.
• Provision of excellent basis for effectiveness of management decision making.
• Identification of key process waste elements, permit management prioritisation and leverage of
key resources.
Difference between ABC and ABM
The ABC refers to the technique for determining the cost of activities and the output that those ac-
tivities produce. It is the logical distribution of overhead i.e. overhead should be distributed on the
consumption of resources consumed by goods and services. The aim of ABC is to generate improved
cost data for use in managing a company’s activities.
The ABM is a much broader concept. It refers to the management philosophy that focuses on the plan-
ning, execution and measurement of activities as the key to competitive advantage.
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Activity Based Budgeting (ABB)

ABB analyse the resource input or cost for each activity. It provides a framework for estimating the
amount of resources required in accordance with the budgeted level of activity. Actual results can be
compared with budgeted results to highlight both in financial and non-financial terms those activities
with major discrepancies from budget for potential reduction in supply of resources. It is a planning
and control system which seeks to support the objectives of continuous improvement. It means plan-
ning and controlling the expected activities of the organization to derive a cost-effective budget that
meet forecast workload and agreed strategic goals. The three key elements of activity based budget-
ing are as follows:
- Type of work to be done
- Quantity of work to be done
- Cost of work to be done
E Block

Cost Management
Class
WORK
State with a brief reason whether you would recommend an activity based system of costing in each
of the following situation:
(i) Company K Produces one product. The overhead cost mainly consists of depreciation
(ii) Company L produces 5 different products using different production facilities
(iii) A Consultancy firm consisting of lawyers, accountants and computer engineers provides man-
agement consultancy service to clients.
(iv) Company S produces two different labour intensive products. The contribution per unit in both
products is very high. The BEP is very low. All the work is carried on efficiently to meet target
costs.
Justification for ABC

May 2012
E Block
PQ ltd makes two products P and Q, which are similar products with slight difference in dimensions,
but use the same manufacturing processes and facilities. Production may be made interchangeably
after altering machine set up. Production time is the same for both the products. The cost structure is
as follows:
` per unit P Q
Selling price 100 120
Variable manufacturing cost 45 50
(directly linked to units produced)
Contribution 55 70
Fixed manufacturing cost 10 10
Profit 45 60
Fixed cost per unit has been calculated based on the total practical capacity of 20,000 units per annum
(which is either P or Q or both put together). Market demand is expected to be the deciding factor re-
garding the product mix for the next 2 years. The company does not stock inventory of finished goods.
The company wishes to know whether ABC system is to be set up at a cost of ` 10,000 per month for
the purpose of tracking and recording the fixed overhead costs for allocation to products.
Support your advice with appropriate reasons.
Advanced Strategic
Class
WORK
Independent of above, if you are told to assume that fixed costs stated above, consist of non cash
component of depreciation to plant at ` 90,000 for the year, will your advice change? Explain.
Justification for ABC
A company produces two products P and Q and the details is as follows:
P Q
Units produced 10,000 20,000
Materials cost per unit (`) 4 2.50
Labour cost per unit (`) 3 1.50
No. of runs 200 500
Machine hrs per 100 units 3 2.50
No. of units per order 400 1,000
E Block
Packing of Finished goods units per container 10 40
The following costs have been analysed:
Amount (`)
Machine setup cost 21,000
Machine running cost 32,800
Processing and handling cost 9,000
Packing and distribution cost 18,000
You are required to compute cost per unit under Traditional and Activity Based Costing system. Under
traditional method, processing cost and packing cost are observed as a percentage of material cost
whereas setup and running cost are observed on the basis of machine hours.
Product Cost Statement Cost Driver Computation

Cost Management
Class
WORK
During the last twenty years, KL’s manufacturing operation has become increasingly automated, with
computer-controlled robots replacing operatives. KL currently manufactures over 100 products of
varying levels of design and complexity. A single, plant-wide overhead absorption rate, based on di-
rect labour hours, is used to absorb overhead costs.
In the quarter ended March 2009 , KL’s manufacturing overhead costs were :
` ‘ 000.
Equipment operation expenses 125
Equipment maintenance expenses 25
Wages paid to technicians 85
Wages paid to store men 35
Wages paid to dispatch staff 40
Total 310
During the quarter, Rapier Management Consultants were engaged to conduct a review of KL’s cost
accounting systems. Rapier’s report includes the following statement:
‘In KL’s circumstances, absorbing overhead cost in individual products on a labour-hour absorption
basis is meaningless. Overhead costs should be attributed to products using an activity-based costs
(ABC) system. We have identified the following most significant activities:
E Block
(a) Receiving component consignment from suppliers;
(b) Setting up equipment for production runs;
(c) Quality inspections;
(d) Dispatching goods orders to customers.
Our research has indicated that, in the short term, KL’s overhead are 40% fixed and 60 percent variable.
Approximately half the variable overheads vary in relation to direct labour hours worked and half vary
in relation to the number of quality inspections. This model applies only to relatively small changes in
the level of output during a period of two years or less’.
Equipment operation and maintenance expenses are apportioned as follows:
Components stores (15%), manufacturing (70%) and goods dispatch (15%)
Technician wages are apportioned as follows:
Equipment maintenance (30%) setting up equipment for production runs (40%) and quality inspec-
tions (30%).
During the quarter:
(a) A total of 2,000 direct labour hours were worked (paid at ` 12 per hour);
(b) 980 component consignment were received from suppliers;
(c) 1,020 production runs were set up;
Advanced Strategic
Class
WORK
(d) 640 quality inspection were carried out; and

(e) 420 goods orders dispatched to customers.
KL’s production during the quarter included a component R for which direct labour hours worked
25. Direct materials cost ` 1,200. Component consignment received 42. Production runs 16. Quality
inspections 10. Goods orders dispatched 22. Quantity produced 560.
In April 2009 a potential customer asked KL to quote for the supply of a new component Z to a given
specification. 1,000 units of Z are to be supplied each quarter for a two-year period. They will be paid
for in equal instalments on the last day of each quarter. The job will involve an initial design cost of
` 40,000 and production will involve 80 direct labour hours, ` 2,000 materials, 20 component consign-
ments, 15 production runs, 30 quality inspections and 4 goods dispatches per quarter.
KL’s sales director comments: ‘Now we have a modern ABC system, we can quote selling prices with
confidence. The quarterly charges we quote should be the forecast ABC production cost of the units
plus the design cost of the Z depreciated on a straight-line basis over the two years of the job- to
which we should add a 25 per cent mark-up for profit. We can base our forecast on costs experience
in the quarter ended March 2009. KL’s cost of capital is 3 % per quarter. The annual value @3% in 8
quarters = 7.0197
Requirements:
(a) Calculate the unit cost of component R using KL’s existing cost accounting system.
(b) Calculate the unit cost of components R. using this ABC system.
(c) Calculate the charge per quarter that should be quoted for supply of component Z in a manner
consistent with the sales director’s comments.
E Block
Advise KL’s management on the merits of this selling price, having regard to factors you consider rel-
evant.
Product Cost Statement Cost Pool Computation

May 2011

Cost Management
Class
WORK
Biskoot Ltd manufactures three types of biscuits, A, B and C in a fully mechanised factory. The compa-
ny has been following conventional method of costing and wishes to shift to Activity Based Costing
System and therefore wishes to have the following data presented under both the system for the
month:
Particulars `
Inspection cost 73,000
Machine repairs and maintenance 1,42,000
Dye cost 10,250
Selling overheads 1,62,000
A B C
Prime cost (` per unit) 12 9 8
SP (` per unit) 18 14 12
Gross production (unit per production run) 2,520 2,810 3,010
No. of defective units per run 20 10 10
Inspection hrs per production run 3 4 4
Dye cost per production run (`) 200 300 250
No. of Machine hrs per production run 20 12 30
E Block
Sales units per month 25,000 56,000 27,000
The following additional information is given:

(i) No accumulation of inventory is considered. All good units produced are sold.
(ii) All manufacturing and selling overheads are conventionally allocated on the basis of units sold.
(iii) Product A needs no advertisement. Due to its nutritive value, it is readily consumed by diabetic
patients of a hospital. Advertisement costs included in the total selling overhead is ` 83,000.
(iv) Product B needs to be specially packed before being sold, so that it meets competition. ` 54,000
was the amount spent for the month in specially packing B and this has been included in the
total selling overhead cost given.
You are required to present product - wise profitability statements under the conventional system and
the ABC system and accordingly rank the products.
Profitability Statement Selling Cost

May 2008
Advanced Strategic
Class
WORK
ABC electronics make audio player model ‘AB 100”. It has 80 components. ABC sells 10,000 units each
month at ` 3,000 per unit. The cost of manufacturing is ` 2,000 per unit or ` 200 lakhs per month for
the production of 10,000 units. Monthly manufacturing costs incurred are as follows:
` in lakhs
Direct material costs 100.00
Direct manufacturing labour costs 20.00
Machining costs 20.00
Testing costs 25.00
Rework costs 15.00
Ordering costs 0.20
Engineering costs 19.80
200.00
Labour is paid on piece rate basis. Therefore, ABC considers direct manufacturing labour costs as var-
iable cost.
The following additional information is available for ‘AB 100’:
(i) Testing and inspection time per unit is 2 hours
(ii) 10 percent of ‘AB 100’ manufactured are reworked.
E Block
(iii) It currently takes 1 hour to manufacture each unit of ‘AB 100’.

(iv) ABC places two orders per month for each component. Each component is supplied by a differ-
ent supplier.
ABC has identified activity cost pools and cost drivers for each activity. The cost per unit of the cost
driver for each activity cost pool is as follows:
Manufacturing Cost per unit of cost

Description of activity Cost driver
activity driver
Machining costs Machining components Machine hours of ` 200 per machine
capacity hour
Testing costs Testing components and finished Testing hours ` 125 per machine
products (Each unit of ‘AB 100’ is hour
tested individually)
Rework costs Correcting and fixing errors and Units of ‘AB 100’ ` 1,500 per unit
defects reworked
Ordering costs Ordering of components Number of orders ` 125 per order
Engineering costs Designing and managing of prod- Engineering hours ` 1,980 per engi-
ucts and processes neering hour
Over a long – run horizon, each of the overhead costs described above vary with chosen cost drivers.
In response to competitive pressure ABC must reduce the price of its product to ` 2,600 and to reduce
the cost by at least ` 400 per unit. ABC does not anticipate increase in sales due to price reduction.

Cost Management
Class
WORK
However, if it does not reduce the price it will not be able to maintain the current sales level.
Cost reduction on the existing model is almost impossible. Therefore, ABC has decided to replace
‘AB 100’ by a new model ‘AB 200’, which is modified version of ‘AB 100’. The expected effect of design
modifications are as follows:
(i) The number of components will be reduced to 50.
(ii) Direct material costs to be lower by ` 200 per unit.
(iii) Direct manufacturing labour costs to be lower by ` 20 per unit.
(iv) Machining time required to be lower by 20 percent.
(v) Testing time required to be lower by 20 percent.
(vi) Rework to decline to 5 percent.
(vii) Machining capacity and engineering hours capacity to remain same.
ABC currently outsources the rework on defectives.
Required:
(i) Compare the manufacturing cost per unit of AB 100 and AB 200.
(ii) Determine the immediate effect of design change and pricing decision on the operating income
of ABC. Ignore income tax. Assume that the cost per unit of each cost driver for AB 100 continues
to apply AB 200.
E Block
Product Cost Statement
May 2002
A manufacturing company produces Ball Pens that are printed with the logos of various companies.
Each pen is priced at ` 5. Costs are as follows:
Unit Variable Level of Cost

Cost Driver
Cost Driver
Unit Sold 2.5 -
Setups 225 40
Engineering Hours 10 250
Other data: Total Fixed Costs (Conventional) - ` 48,000 Total Fixed Costs (ABC) - ` 36500 Required:
1. Compute Break Even Point in units using Activity Based Analysis
2. Suppose that company could reduce the setup cost by ` 75/setup and could reduce the number
of engineering hours needed to 215. How many units must be sold to break even in this cost?
Advanced Strategic
Class
WORK
Break Even with ABC
Catalyst Ltd. Makes a single product with the following details:
Current Situ-
Description Proposed Change
ation
Selling Price (`/unit) 10
Direct Costs (`/unit) 5
Present number of setups per production period, (before each pro- 42
duction run, setup is done)
Cost per set up (`) 450 Decrease by ` 90
Production units per run 960 1,008
Engineering hours for production period 500 422
Cost per engineering hour (`) 10
E Block
The company has begun Activity Based Costing of fixed costs and has presently identified two cost
drivers, viz. production runs and engineering hours. Of the total fixed costs presently at Rs. 96,000,
after the above, ` 72,100 remains to be analyzed. There are changes as proposed above for the next
production period for the same volume of output.
Required
(i) How many units and in how many production runs should Catalyst Ltd. produce in the changed
scenario in order to break-even?
(ii) Should Catalyst Ltd. continue to break up the remaining fixed costs into activity based costs?
Why?
Break Even with ABC

Cost Management
Class
WORK
Following are the information available regarding data on traditional cost and ABC system. Find Var-
iances.
Traditional Costing system:
Standard overhead rate ` 11 per labour hr

Standard time 2 hrs per unit
Actual amount spent ` 20,000
Actual output 2,000 uts
Activity based costing system:
Standard cost driver rates:

Set up cost ` 90 per set up
Inspection cost ` 4 per inspection
Material movement cost ` 6 per material movement
Actual cost driver numbers:
No. of Set up 120
No. of inspections 1,000
No. of material movement 800
E Block
Actual amount spent: `
Set up 11,000
Inspection 5,000
Material handling 4,000
Variance Analysis under ABC
N & S Co. (NSC) is a multiple product manufacturer. NSC produces the unit and all overheads are asso-
ciated with the delivery of units to its customers.
Particulars Budget Actual
Overheads (`) 4,000 3,900
Output (units) 2,000 2,100
Customer Deliveries (no.’s) 20 19
Advanced Strategic
Class
WORK
Required
Calculate Efficiency Variance and Expenditure Variance by adopting ABC approach.
Variance analysis under ABC
Catalyst Ltd. Makes a single product with the following details:
Description Current Situation Proposed Change

Selling Price (`/unit) 10
Direct Costs (`/unit) 5
Present number of setups per production period, (before each 42
production run, setup is done)
Cost per set up (`) 450 Decrease by ` 90
Production units per run 960 1,008
E Block
Engineering hours for production period 500 422

Cost per engineering hour (`) 10
The company has begun Activity Based Costing of fixed costs and has presently identified two cost
drivers, viz. production runs and engineering hours. Of the total fixed costs presently at ` 96,000, after
the above, ` 72,100 remains to be analyzed. There are changes as proposed above for the next produc-
tion period for the same volume of output.
Required
(i) How many units and in how many production runs should Catalyst Ltd. produce in the changed
scenario in order to break-even?
(ii) Should Catalyst Ltd. continue to break up the remaining fixed costs into activity based costs?
Why?

Cost Management
Class
WORK
6-Twelve is an Indian – Japanese international chain of convenience stores for food, snacks, hot and
cold beverages is formulating its activity-based budget for January 2018. 6-Twelve has only three
product types: Soft Drinks, Fresh Drinks, and Ready to Eat Food. The budgeted data relating to three
products are as under:
Activity and Driver Cost Driver Rates Jan 2018 Budgeted

2017 Jan 2018 Amount of Driver Used
Actual Rate Budgeted Ready to Eat
Soft Drinks Fresh Drinks
(`) Rate (`) Food
Ordering (per purchase order) 5,000 4,500 16 20 16
Delivery (per delivery) 4,000 4,100 13 60 20
Shelf-Stocking (per hour) 1,000 1,050 15 170 93
Customer Support (per item sold) 10 9 4,500 34,600 10,500
6-Twelve has a continuous improvement system to budgeting monthly activity costs for each month
of 2018. February’s budgeted cost-driver rate is 0.996 times the budgeted January 2018 rate. March’s
budgeted cost-driver rate is 0.996 times the budgeted February 2018 rate and so on.
Required
(i) What is the total budgeted cost for each activity in January 2018.
E Block
(ii) What advantages might 6-Twelve gain by using an activity-based budgeting approach over, say,
an approach that allocates the cost of these activities to products as a percentage of the cost of
goods sold?
(iii) What is the total budgeted cost for each activity in March 2018 if March 2018 has the same budg-
eted amount of cost-driver usage as January 2018.
(iv) What are the benefits of 6-Tweleve adopting a kaizen budgeting approach? What are the limita-
tions?
Activity Based Budgeting
Advanced Strategic
Home
WORK
The following are Product Nova Shaft’s data for next year budget:
Activity Cost driver Cost driver volume per year Cost pool
Purchasing Purchase orders 1,500 ` 75,000
Setting Batches produced 2,800 ` 1,12,000
Materials handling Material movement 8,000 ` 96,000
Inspection Batches produced 2,800 ` 70,000
Machining costs Machine hours 50,000 ` 1,50,000
Purchase orders 25
Output 15000 units
Production batch size 100 units
Materials movements per batch 6
Machine hours per unit 0.1
Required:
(a) Calculate the budgeted overhead costs using activity based costing principles.
(b) Calculate the budgeted overhead costs using absorption costing (absorb overhead using ma-
chine hours).
E Block
(c) How can the company reduce the ABC for Product Nova Shaft?
Product Cost Statement How to reduce ABC
The following information provides details of costs, volume and cost drivers for a particular period:
Particulars X Y Z Total
Production and sales (units) 30,000 20,000 8,000
Direct material cost (` per unit) 25 20 11 12,38,000
Direct labour hours (Hours/ unit) 4/3 2 1 88,000
Machine hours (Hours / unit) 4/3 1 2 76,000
Direct labour cost (` / unit) 8 12 6

Cost Management
Home
WORK
No. of production runs 3 7 20 30

No. of deliveries 9 3 20 32
No. of receipts 15 35 220 270
No. of production orders 15 10 25 50
Overhead costs of ` 18,48,000 are split up as:
Particulars Amount (`)

Set up 30,000
Machining 7,60,000
Receiving 4,35,000
Packing 2,50,000
Engineering 3,73,000
Past system:
In the past, the company has allocated overheads to products on the basis of direct labour hours.
However, the majority of overheads are related to machine hours rather than direct labour hours.
Redesigned system:
The company has recently redesigned its cost system by which overheads of the receiving depart-
ment are recovered by a materials handling overhead rate based on direct material costs and the
remaining overheads are recovered using a machine hour rate.
E Block
Both the current and the previous cost system reported low profit margins for product X, which is the
company’s highest selling product. The management accountant has recently attended a conference
on activity based costing, and the overhead costs for the last period have been analysed by the major
activities in order to compute activity based costs.
Required:
(a) Compute the product costs using a traditional volume – related costing system assuming:
(i) All overheads are recovered on the basis of direct labour hours as used in the past.
(ii) Overheads are recovered by the redesigned system.
(b) Compute product costs using an activity – based costing system.
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Advanced Strategic
Cost Management
Home
WORK
Howzzat co. manufactures several products of varying levels or design and models. It uses a single
overhead recovery rate based on direct labour hours. The company’s overheads in the first half of the
year are as under:
`
Machine operation expenses 10,12,500
Machine maintenance expenses 1,87,500
Salaries of technical staff 6,37,500
Wages and salaries of stores staff 2,62,500
During this period, the company introduced Activity Based Costing system and the following signif-
icant activities were identified – (a) Receiving materials and components (b) Set up of machines for
production runs, and (c) Quality inspection. It is also determined that –
The machine operation and machine maintenance expenses should be apportioned between Stores
and Production activity in 20:80 ratio.
The technical staff salaries should be apportioned between Machine maintenance, Set –up and Qual-
ity inspection in 30:40:30 ratio.
The consumption of activities during the period under review is as under:
E Block
Amount
Direct labour hours worked 40,000
Direct wage rate ` 6 per hour
Production set – ups 2,040
Material and component consignment received from suppliers 1,960
Number of quality inspections carried out 1,280
The data relating to two products manufactured by the company during the period are as under:-
Particulars PRODUCT P PRODUCT Q

Direct material costs ` 6,000 ` 4,000
Direct labour hours 960 100
Direct material consignments received 48 52
Production runs 36 24
Number of quality inspections done 30 10
Quantity produced 15,000 5,000
A potential customer has approached the company for the supply of 24,000 units of a component K
to be delivered in lots of 3,000 units per quarter. The job will involve an initial design cost of ` 60,000
and the manufacture will involve the following per quarter:

Cost Management
Home
WORK
Direct material cost ` 12,000

Direct labour hours 300
Production runs 6
Inspections 24
Number of consignments of direct material to be received 20
The company desires a mark – up of 25% on cost.
Required:
(a) Calculate the cost of Products P and Q based on existing system of single overhead recovery rate.
(b) Determine the cost of Products P and Q using Activity based costing system.
(c) Compute the sales value of Component K using Activity based costing system.
Product Cost Statement Cost Pool Computation

May 2003
E Block
Fruitolay has decided to increase the size of the store. It wants the information about the profitability
of the individual product lines: Lemon, grapes and papaya. It provides the following data for 2009 for
each product line:
Lemon Grapes Papaya

Revenues ` 79,350 ` 2,10,060 ` 1,20,990
Cost of goods sold ` 60,000 ` 1,50,000 ` 90,000
Cost of bottles returned ` 1,200 -- --
Number of purchase orders placed 36 84 36
Number of deliveries received 30 219 66
Hours of shelf stocking time 54 540 270
Items sold 12600 110400 30600
Fruitolay also provides the following information for the year 2009:
Total costs
Activity Description Cost allocation Basis
(`)
1. Bottle returns Returning of empty bottles to the 1,200 Direct tracing to the
store product line
2. Ordering Placing of orders of 15,600 156 purchase
purchases orders
Advanced Strategic
Home
WORK
Total costs
Activity Description Cost allocation Basis
(`)
3. Delivery Physical delivery and the receipts 25,200 315 deliveries
of merchandise
4. Shelf stocking Stocking of merchandise on store 17,280 864 hours of time
shelves and ongoing restocking.
5. Customer Sup- Assistance provided to customers 30,720 153600 items sold
port including bagging and check out
Required:
(i) Fruitolay currently allocates store support costs (all costs other than the cost of goods sold) to the
product line on the basis of the cost of goods sold of each product line. Calculate the operating
income and operating income as a percentage of revenue of each product line.
(ii) If Fruitolay allocates store support costs (all costs other than the cost of goods sold) to the prod-
uct lines on the basis of ABC system, calculate the operating income and operating income as a
percentage of revenue of each product line.
(iii) Compare both the systems.
Profitability Statement
November 2010
E Block
A bank offers three products viz., deposits, Loans and Credit Cards. The bank has selected 4 activities
for a detailed budgeting exercise, following activity based costing methods.
The bank wants to know the product wise total cost per unit for the selected activities, so that prices
may be fixed accordingly.
The following information is made available to formulate the budget:
ACTIVITY PRESENT (`) ESTIMATION FOR THE BUDGET PERIOD

(i) ATM Services
(a) Machine Maintenance 4,00,000 All fixed, no change
(b) Rents 2,00,000 Fully fixed, no change
(c) Currency Replenish- 1,00,000 Expected to double during budget period
ment cost
7,00,000 This activity is driven by no. of ATM transactions.
(ii) Computer Processing 5,00,000 (Half of this amount is fixed and no change is
expected)

Cost Management
Home
WORK
ACTIVITY PRESENT (`) ESTIMATION FOR THE BUDGET PERIOD

(the variable portion is expected to increase to
three times the current level)
This activity is driven by no. of computer transac-
tions.
(iii) Issuing statements 18,00,000 Presently, 3 lac statements are made. In the
budget period, 5 lac statements are expected.
For every increase of one lakh statements, one
lakh rupees is the budgeted increase
This activity is driven by the number of state-
ments.
(iv) Customer Inquiries 2,00,000 Estimated to increase by 80% during the budget
period.
This activity is driven by telephone minutes
DEPOSITS LOANS CREDIT CARDS

No. of ATM transactions 1,50,000 -- 50,000
No. of computer processing transactions 15,00,000 2,00,000 3,00,000
No. of statements to be issued 3,50,000 50,000 1,00,000
Telephone minutes 3,60,000 1,80,000 1,80,000
The bank budgets a volume of 58,600 deposit accounts, 13,000 loan accounts, and 14,000 Credit card
E Block
accounts.
(i) Calculate the budgeted rate for each activity;
(ii) Prepare the budgeted cost statement activity wise.
(iii) Find the budgeted product cost per account for each product using (i) and (ii) above.

November 2009
Advanced Strategic
Strategic Analysis of Operating Income
Class
WORK
Chapter 17
E Block
Strategic Analysis 1. Strategic Protability Analysis

of (a) Type 1
Operating Income (b) Type 2
2. Direct Product Protability
(DPP)
3. Customers Protability Analysis

Cost Management
Class
WORK
STRATEGIC PROFITABILITY ANALYSIS

Type 1
a. Growth effect i.e. Revenue and Cost effect of growth. i.e. volume
b. Price effect i.e. Revenue and cost effect of price.
c. Productivity i.e. efficiency effect of cost.
Balanced Score Card (Financial Perspective)

Particulars LY Profit Growth Effect Price Effect Productivity CY Profit
Revenue *** ***(N 1) *** (N 4) -- ***
Less:
Materials *** *** (N 2) *** (N 5) *** (N 6) ***
Conv. Cost (Fixed) *** -- *** (N 7) -- ***
Ad & S/D OH (Fixed) *** -- *** (N 7) -- ***
Profit *** *** (N 3) ***
Note 1:
Sales Volume Variance: Excess Revenue received due to excess quantity sold = (AO – BO) Budgeted SP
Note 2:
Excess cost incurred due to excess quantity sold = (BO – AO) × Budgeted MC per unit
E Block
Note 3:
Sales Margin Volume Variance (Marginal Approach):
Adding Note 1 and Note 2 we get,
= (AO – BO) × (Budgeted SP – Budgeted Material Cost per unit)
= (AO – BO) × (Budgeted Margin or contribution per unit) = Sales Margin Volume Variance.
[Assumed Material cost is the only variable cost].
Note 4:
Sales Price Variance: Excess revenue generated due to excess price = (ASP – BSP) × AO
Note 5:
Material Price Variance: Excess cost incurred due to excess price in resource used = (Std Price p.u. –
Actual price p.u.) x AQ
Note 6:
Material Usage Variance = (SQ – AQ) x Std price
Note 7:
Expenditure Variance: For Fixed Cost only expenditure variance is shown i.e. Budgeted Cost – Actual Cost
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Advanced Strategic
Cost Management
Class
WORK
TYPE 2 - PORTER’S THREE GENERIC STRATEGIES FOR GROWTH

PRODUCT DIFFERENTIATION STRATEGY EFFECT ON PROFITABILITY ANALYSIS
If the market size grows, then definitely, the quantity sold by the company will increase.
By reducing its selling price, the company may capture competitor’s market i.e. its Market Share would
increase. This strategy is known as Product Differentiation Strategy whereby the loss due to decrease
in selling price would be covered by increase in quantity sold.
PRODUCT DIFFERENTIATION = Price Effect + Market Share
In such a case, changes in operating income in a Balanced Score Card are shown as below:
Balanced Score Card (Product Differentiation)

Particulars Amount
1. Market Size Variance ****
2. Product Differentiation
Market Share Variance ******
Price Effect on revenue and cost ******
****
3. Cost Leadership or Productivity Effect ****
Change in Profit (Yr 2 – Yr 1) ****
Direct Product Profitability (DPP)

E Block
CIMA describe DPP “used primarily within the retail sector, DPP involves the attribution of both the
purchase price and other indirect costs (for example distribution, warehousing and retailing) to each
product line. Thus, a net profit, as opposed to a gross profit, can be identified for each product. The
cost attribution process utilizes a variety of measures (for example warehousing space and transport
time) to reflect the resource consumption of individual products.”
Benefits of DPP
• Better cost analysis.
• Better pricing decisions.
• Better management of stores and warehouse space.
• The rationalisation of product ranges.
Direct Product Profitability Statement
Retail organisations traditionally deducted the bought in cost of goods from the selling price to give
a gross margin. The gross margin is useless measure for controlling the costs of the organisation itself
or making decisions about the profitability of the different products. This is because none of the costs
generated by the retail organisation itself are included in its calculation. For example, it does not in-
clude the storage costs of the different goods and these costs vary considerably from one goods to
another. A method was needed which relates the indirect costs to the goods according to the way the
goods uses or creates these costs.

Cost Management
Class
WORK
Indirect costs, for DPP may be analysed into basic cost categories as follows:
(i) Overhead Cost: This is incurred through an activity that is not directly linked to a particular
product.
(ii) Volume Related Cost: The cost is incurred in relation to the space occupied by products. This in-
cludes storage and transport costs.
(iii) Product Batch Cost: This cost is often a time-based cost. If product items (that is a number of
identical products which are handled together as a batch) are stocked on shelves a labour time
cost is incurred.
(iv) Inventory Financing Costs: This is the cost of tying up money in stock and is the cost of the prod-
uct multiplied by interest rate per day or per week.
Direct Product Profit can be derived as shown below:
Sales ✓
Less : Cost of Goods Sold ✓
Gross Margin ✓
Less : Direct Product Costs ✓
(Warehouse, Transportation, Store etc.)
Direct Product Profit ✓
Customers Profitability Analysis
E Block
Most firms today understand the source of their revenues but unfortunately, do not understand the
source of profits. Often, attempts to measure profitability center on either product costs alone or on
profitability at the business unit or enterprise level. These attempts can be severely misleading. What
firms fail to do is measure profit at the most meaningful and controllable level, the customer level. Un-
derstanding the underlying components of cost and addressing specific causes of poor profitability
associated with specific customers will significantly improve bottom-line performance. Undertaking a
customer account profitability improvement initiative is a five-step process:
Analyse the Calculate the Re-engineer/

Calculate the
customer annual Identify and eliminate the
annual costs
base and split revenues retain quality unprotable
of serving the
it into the earned from customers segments
segment
segments the customer
Customer Profitability Analysis is best conducted with a technique known as Activity Based Costing or
ABC analysis. The net profit coming from each customer which can be calculated by revenue less costs
done by this tool. These costs are not only manufacturing and distribution costs but also sales costs,
marketing costs, services cost and any other related costs which have to be undertaken to service the
customer.
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Advanced Strategic
Cost Management
Class
WORK
Platinum customers
Gold customers
Iron customers
Lead customers
Prot tires Marketing

Investment
Pyramid
After finalisation of cost customers are divided into different profit tiers. This principle is best observed
in the banking industry with credit card as a product. Customers are basically classified into four types
• Platinum Customers – Most Profitable
• Gold Customers – Profitable
• Iron Customers – Low Profit but Desirable
• Lead Customers – Unprofitable and Undesirable
A credit card company would always give the best service as well financial and other benefits to the
top two customers. It will at the same time try to attract iron customers and try to convert these iron
customers to platinum or gold customers. Finally, these companies will have systems in place so as to
avoid lead customers completely.
E Block
It is found that with customer profitability analysis, the firm can correctly classify customers and also
find out which of the customers it needs to hold on to and acquire more of the same type, and which
customers it needs to let go of. Several times, firms find out that there are customers which they
should have left altogether as the profitability from these customers is minimum and expenses are
more.
Cost calculation is one of the major problem in CPA. Calculating cost per customer becomes difficult
especially in a service environment where manpower as well as time also has a cost factor associated
with it. Time spent with each customer is different and therefore the cost is different. Furthermore,
there are several non-customer related costs too. If these costs are ignored, then right figures would
be difficult to check. The customers will be shown more profitable than they are.

Cost Management
Class
WORK
Following a strategy of product differentiation, Westwood corporation makes a high end kitchen
range hood, KE8. Here’s Westwood’s data for 2010 and 2011:
Particulars 2010 2011

1. Units of KE8 produced and sold 40,000 42,000
2. Selling price per unit ` 100 ` 110
3. Direct Materials (square feet) 120,000 123,000
4. Direct Material Cost per square feet ` 10 ` 11
5. Manufacturing capacity for KE8 50,000 units 50,000 units
6. Conversion costs ` 10,00,000 ` 11,00,000
7. Conversion cost per unit of capacity (6÷5) ` 20 ` 22
8. Selling and customer service capacity 30 customers 29 customers
9. Selling and customer service costs ` 7,20,000 ` 7,25,000
10. Cost per customer of selling and customer service capacity 24,000 25,000
(9÷8)
Westwood produced no defective units and reduced direct material usage per unit of KE8 in 2011.
Conversion costs in each year are tied to manufacturing capacity. Selling and customer service costs
are related to number of customers that the selling and service functions are designed to support.
Required:
E Block
1. Calculate the growth, price – recovery and productivity component that explain the change in
operating income from 2010 to 2011.
2. Suppose during 2011 the market for high end kitchen range hoods grew at 3 % in terms of num-
ber of units and all increases in market share (that is increase in number of units sold greater than
3 %) are due to Westwood’s product differentiation strategy. Calculate how much of the change
in operating income from 2010 to 2011 is due to the industry market size factor, cost leadership
and product differentiation.
Profitability Analysis Growth Price and Productivity

Effect with Product
Differentiation
Oceano T- shirt company sells a variety of T – shirts. Oceano presents the following data for its first
two years of operations 2003 and 2004. For simplicity, assume that all purchasing and selling costs are
included in the average cost per T – shirt and that each customer buys one T - shirt.
Advanced Strategic
Class
WORK
Particulars 2003 2004

Number of T – shirts purchased 20,000 30,000
Number of T –shirts lost 400 300
Number of T – shirts sold 19,600 29,700
Average selling price ` 15 ` 14
Average cost per T – Shirt ` 10 `9
Administrative capacity ( No of customers that can be served) 40,000 36,000
Administrative costs ` 80,000 ` 68,400
Administrative cost per customer `2 ` 1.90
Administrative cost depends on the number of customers capacity that Oceano has created to sup-
port and not the actual number of customers served.
Calculate the growth, price – recovery and productivity components of changes in operating income
between 2003 and 2004.
Profitability Analysis Trader’s Effect

E Block
Aditya Decors Ltd. (ADL) is a leading manufacturer of luxury sanitary products and has divided its
whole business into different product segments. At the Last year the management of ADL has decided
to make some changes in its one of product-line ‘AADee’ the improved version was made available for
sale from 1st of April 2014. At the end of the financial year 2014-15, the finance and accounts depart-
ment has extracted some relevant data for the product line ‘AADee’ to analyse the decision taken last
year. The data related with AADee for the financial year 2013-14 and 2014-15 are as follows:
2013-14 2014-15
No. of Units Sold 4,00,000 4,30,000
Selling Price per unit 4,175 4,325
Direct Materials Consumed 24,00,000 kg. 25,10,000 kg.
Cost per kg. Of Direct Materials 470 485
Direct Labour Used 32,00,000 hrs. 34,80,000 hrs.
Rate per labour hour 30 31
Fixed Costs 1,60,00,000 1,76,00,000
ADL has the capacity to produce 5,00,000 units of AADee a year. Show RECONCILIATION of Operating
Profit from 2013-14 to 2014-15.

Cost Management
Class
WORK
Also show the reconciliation due to cost leadership, product differentiation and market size impact if
the increase in sales volume due to market growth is 5% and the rest are due to the company’ s prod-
uct differentiation strategy.
Profitability Analysis Growth Price and Productivity

Effect with Product
Differentiation
Jigyasa India Ltd. (JIL) has 30 retail stores of uniform sizes “Fruity and Sweety Retails” across the coun-
try. Mainly three products namely ‘Butter Jelly’, ‘Fruits and Nuts’ and ‘Icy Cool’ are sold through these
retail stores. JIL maintains stocks for all retail stores in a centralized warehouse. Goods are released
from the warehouse to the retail stores as per requisition raised by the stores. Goods are transported
to the stores through two types of vans i.e. normal and refrigerated. These vans are to be hired by the
JIL. Costs per month of JIL are as follows:
Amount in `
Warehouse Costs:
Labour and Staff Costs 27,000
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Refrigeration Costs 1,52,000
Material Handling Costs 28,000
Total 2,07,000
Head Office Costs:
Salary and Wages to Head Office Staff 50,000
Office Administration Costs 1,27,000
Total 1,77,000
Retail Stores Costs:
Labour Related Costs 33,000
Refrigeration Costs 1,09,000
Other Costs 47,000
Total 1,89,000
Average transportation cost of JIL per trip to any retail stores are as follows:
Normal Van ` 3,200

Refrigerated Van ` 4,900
The Chief Financial Manager asked his Finance Managers to calculate profitability based on three
products sold through Fruity and Sweety retail stores rather than traditional method of calculating
profitability.
Advanced Strategic
Class
WORK
The following information regarding retail stores are gathered:
Fruit and
Butter Jelly Icy Cool
Nuts
No. of Cartons per cubic metre 42 28 40
No. of items per cartons (units) 300 144 72
Sales per month (units) 18,000 4,608 1,152
Time in warehouse (in months) 1 1.5 0.5
Time in retail stores (in months) 1 2 1
Selling Price per unit (`) 84 42 26
Purchase Price Per unit (`) 76 34 22
Butter Jelly and Icy Cool are required to be kept under refrigerated conditions.
Additional Information:
Total Volume of all goods sold per month 40,000 cubic metres
Total Volume of all Refrigerated Goods sold per month 25,000 cubic metres
Carrying Volume of Each van 64 cubic metres
Required:
Calculate the profit per unit using Direct Product Profitability Method

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Direct Product Profitability
A and B are two customers of XYZ Electronics Ltd, a manufacturer of audio players. Selling Price per
unit is ` 5,400. Its cost of production per unit is ` 4,420.
Additional costs are:
Order processing cost ` 2,000 per order

Delivery Costs ` 3,500 per delivery
Details of customers A and B for the period are given below:
Customer A Customer B
Audio Players Purchased (nos.) 350 500
No. of orders 5 (each of 70 units) 10 (each of 50 units)
No. of deliveries 5 0

Cost Management
Class
WORK
The company’s policy is to give a discount of 5% on the selling price on orders for 50 units or more,
and to further give 8% discount on the undiscounted selling price if a customer uses his own transport
of collect the order. Assume that production levels are not altered by these orders.
Required:
(i) Analyse the profitability by comparing profit per unit for each customer
(ii) Comment on the discount policy on delivery
Customer Profitability Analysis
Oxford Medical Care (OMCC) is a pharmaceutical firm, operating its entire business through its four
customers OX1, OX2, OX3, and OX4. OX1 and OX2 are small pharmaceutical stores while OX3 and OX4
are large discount stores with attached pharmacies. OMCC uses discount pricing strategy and prices
its products at variable cost plus 25%.
Item Small Pharmaceuticals Large Pharmaceuticals Activity rate
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OX1 OX2 OX3 OX4
No. of orders 4 9 6 3 ` 750
Order Size ` 40,000 ` 20,000 ` 4,25,000 ` 4,00,000 -
Average Discount 4.5% 9.5% 17.5% 11.5% -
Regular Deliveries 4 9 6 3 ` 375
Expedite Deliveries 2 0 2 0 ` 1,250
General Administration Cost ` 20,250 ` 48,375
Required:
(i) Prepare a Customer profitability statement that shows the profit from each customer and each
customer channel.
(ii) Recommend some points to improve OMCC’s profit.
Customer Profitability Analysis
Advanced Strategic
Target Costing
Class
WORK
Chapter 18
Target Costing
Steps in 1. Identify the market requirements – need

1.
Target Costing for a new product or improvement in
existing.
2. Set Target Selling Price based on customer
expectations and sales forecasts.
3. Set Target Production Volume based on
demand and supply.
4. Establish Target Pro t Margin for products
based on Company's long term pro t
objectives, goals, etc.
5. Set Target cost or Allowable Cost for each
product
Target Cost = Target SP – Target Pro t
6. Determine Current Cost of producing new
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product, based on available resource and

condition.
7. Set Cost reduction target in order to
match the current cost with the target
cost.
8. Identify Cost reduction opportunities by
using Value Engineering and Value
Analysis.
9. Achieve Cost Reduction and target pro t
by effective implementation of cost
Value analysis & reduction decision.
2.
Value Engineering
10. Focus on further cost reduction
possibilities i.e. continuous improvement
Target Costing program.
3.
Control Point
4. Implementing 1. Target Costing System
Value Chain
5.
Analysis

Cost Management
Target Costing
Class
WORK
VALUE ENGINEERING AND VALUE ANALYSIS

Value Engineering means searching for opportunities to modify the design of each component or
part of a product to reduce cost but without reducing the functionality or quality of the product.
Value Analysis means studying the activities that are involved in producing the product to detect
non value adding activities that may be eliminated or minimised to save cost but without reducing
the functionality or quality of the product. It helps to identify –
(a) Value added Cost :- the cost if eliminated, would reduce the utility of the product.
(b) Non Value added Cost :- the cost if eliminated would not reduce the utility of the product.
Illustration 1
Identify Value Adding / Non-value Adding activities.
(a) Polishing furniture used by a system engineer in a software firm.
(b) Maintenance by a software Co. of receivable management software for a banking company.
(c) Painting of Pencils manufactured by a Pencil Co.
(d) Customer’s Computer keyboard cleaning by a Computer Repair Centre.
(e) Providing brake adjustments in cars for repairs by a Car Service Station.
Dealing with Value Analysis / Value Engineering
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• Can we eliminate functions from the production process?
• Can we eliminate some durability or reliability?
• Can we minimize the design?
• Can we design the product better for the manufacturing process?
• Can we substitute parts?
• Can we combine steps?
• Can we take supplier’s assistance?
• Is there a better way?
The initial value engineering may not uncover all possible cost savings. Thus, Kaizen Costing is de-
signed to repeat many of the value engineering steps for as long as a product is produced, constantly
refining the process and thereby stripping out extra costs. The cost reductions resulting from kaizen
costing are much smaller than those achieved with value engineering but are still worth the effort
since competitive pressures are likely to force down the price of a product over time, and any possible
cost savings allow a company to still attain its targeted profit margins while continuing to reduce cost.
It is also called as Continuous Cost Control.
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Advanced Strategic
Cost Management
Target Costing
Class
WORK
Illustration 2
Classify the following items under the more appropriate category: Category (CC) – Cost Control Or
Category (CR) – Cost Reduction:
(i) Costs exceeding budgets or standards are investigated.
(ii) Preventive function
(iii) Corrective function
(iv) Measures to standardize for increasing productivity
(v) Provision of proper storage facilities for materials.
(vi) Continuous comparison of actual with the standards set.
(vii) Challenges the standards set
(viii) Value analysis
Solution
Classification of Items under Cost Reduction (CR)/ Cost Control (CC)
Sl.
Item Category CC/ CR
No.
(i) Costs exceeding budgets or standards are investigated CC
(ii) Preventive function CC
(iii) Corrective function CR
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(iv) Measures to standardize for increasing productivity CR

(v) Provision of proper storage facilities for materials CC
(vi) Continuous comparison of actual with the standards set CC
(vii) Challenges the standards set CR
(viii) Value analysis CR
Target Costing Control Points

Control Points which should be taken care of in all target costing projects:
• Identification of Principal Control Point: Experience shows that there always comes a point,
where the cost of maintaining the design team exceeds the savings gardened from additional
iterations. It is also necessary that most products should be launched within a reasonably short
time or they will miss the appropriate market, where they will beat the delivery of competing
products to the market. This emphasis that the principal control points over the course of target
costing programme should be properly taken care of.
• Point of Go/No Go Decision: If target costing is not reached, management retains power to
abandon the design project. There comes a point, when actual performance is very close to ex-
pected performance in matter of cost incurrence.
• Milestone can be in terms of Timer or Points: A milestone can be in terms of time, say one
month. It can also be on the points in design process, at which specific activities are completed.

Cost Management
Target Costing
Class
WORK
Implementing a Target Costing System

A target costing initiative requires the participation of several departments. Because there are so
many participants in the process from so many departments, some of whom have different agendas
in regard to what they want the program to produce. Design projects can be delayed by squabbling
or by an inability to drive down design or production costs in a reasonably efficient manner. This delay
may lead to serious cost overruns in the cost of the design team itself, which can lead to abrupt termi-
nation of the entire targets costing system by the management team. However, these problems can
be mitigated or completely eliminated by ensuring that the steps listed here are completed when the
target costing system is first installed:
Step 1 : Create a Project Charter:
Step 2 : Obtain a Management Sponsor:
Step 3 : Obtain a Budget:
Step 4 : Assign a Strong Team Manager:
Step 5 : Enroll Full-Time Participants:
Step 6 : Use Project Management Tools:
Value Chain Analysis - Porter’s Value Chain
Firm Infrastructure
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Support Human Resource Management
Ma
Activities
rg
Technology Development
in
Procurement
Ma
Inbound Operations Outbound Marketing Service

rg
Logistic Logistic & Sales

n i
Primary Activities
Each activity should have a cost driver.

Two types of Cost Drivers
Structural or Executional
as per underlying economic structure such as as per execution requirement such as capacity
sale, complexity of production etc. utilisation, plant layout work etc.
Porter’s Five Forces

(1) Bargaining Power of Customers
(2) Bargaining Power of Suppliers
Advanced Strategic
Target Costing
Class
WORK
(3) Threat of New Entrants

(4) Threat of Substitutes
(5) Threat of Competitive Rivalry
Illustration 3
ABC Ltd. is engaged in business of manufacturing branded readymade garments. It has a single man-
ufacturing facility at Ludhiana. Raw material is supplied by various suppliers.
Majority of its revenue comes from export to Euro Zone and US. To strengthen its position further in
the Global Market, it is planning to enhance quality and provide assurance through long term war-
ranty.
For the coming years company has set objective to reduce the quality costs in each of the primary
activities in its value chain.
Required
State the primary activities as per Porter’s Value Chain Analysis in the value chain of ABC Ltd with brief
description.
Solution
Primary activities are the activities that are directly involved in transforming inputs into outputs and
delivery and after-sales support to output. Following are the primary activities in the value chain of
ABC Ltd.:-
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1. Inbound Logistics: These activities are related to the material handling and warehousing. It also
covers transporting raw material from the supplier to the place of processing inside the factory.
2. Operations: These activities are directly responsible for the transformation of raw material into
final product for the delivery to the consumers.
3. Outbound Logistics: These activities are involved in movement of finished goods to the point of
sales. Order processing and distribution are major part of these activities.
4. Marketing and Sales: These activities are performed for demand creation and customer solici-
tation. Communication, pricing and channel management are major part of these activities.
5. Service: These activities are performed after selling the goods to the consumers. Installation,
repair and parts replacement are some examples of these activities.
Illustration 4
Examine the Validity of following statements along with the reasons:

(i) The concepts, tools and techniques of value chain analysis apply only to all those organizations
which produce and sell a product.
(ii) Procurement activities are included in the Primary activities as classified by Porter under value
chain analysis concept.
(iii) As per Porter’s five forces model, bargaining power of buyers does influence the
(iv) profitability of an industry or market.
(v) Value chain analysis in the strategic framework consists of single cost driver concept.

Cost Management
Target Costing
Class
WORK
Solution
(i) Invalid
The concepts, tools and techniques of value chain analysis apply to organizations which produce and
sell a product and also to organizations which provide a service.
(ii) Invalid
Procurement activities are included in the support activities rather than primary activities.
(iii) Valid
Bargaining power of buyers is one of the factor or force that influences the profitability of a market or
industry. More the bargaining power buyers have, more the pressure on the industry to not increase
the price of product or service. They may even have to reduce the price sometimes.
(iv) Invalid
Value chain analysis in the strategic framework consists of multiple cost drivers concept. In value chain
analysis, a set of unique cost drivers is identified for each value activity instead of single cost driver
application at the overall firm level. Multiple cost drivers may be classified into Structural drivers and
Executional drivers.
Illustration 5
Classify the following business activities into primary and support activities under value chain analy-
sis.
(i) Material Handling and warehousing – Primary
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(ii) Purchasing of raw materials, supplies and other consumables – Support
(iii) Order Processing and distribution - Primary
(iv) Selection, placement and promotion of employees - Support
(v) Installation, repair and parts replacement – Primary
(vi) Transforming input into final products – Primary
(vii) General Management, Planning, finance, accounting - Support
(viii) Communication, pricing and channel management - Primary
Advanced Strategic
Target Costing
Class
WORK
A company has the capacity of production of 80,000 units and presently sells 20,000 units at ` 100
each. The demand is sensitive to selling price and it has been observed that with every reduction of
` 10 in selling price, the demand is doubled. What should be the target cost at full capacity if profit
margin on sale is taken at 25%?
What should be the cost reduction scheme by applying value engineering, if at present 40% of cost is
variable with same % of profit?
If Rate of Return is 15% on investment, what will be maximum investment at full capacity?
Target Cost Maximum Investment
Kowloon Toy Company (KTC) expects to successfully launch Toy “H” based on a Disney character. KTC
must may 15% royalty on the selling price to the Disneyland. KTC targets a selling price of ` 100 per
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toy and profit of 25% on selling price.

The following are the cost data forecast:
`/ toy
Component H1 8.50
Component H2 7.00
Labour: 0.40 hr. @ ` 60 per hr. 24.00
Product Specific Overheads 13.50
In addition, each toy requires 0.6 kg of other materials, which are supplied at a cost of `16 per kg. with
a normal 4% substandard quality which is not usable in the manufacture.
Required
DETERMINE if the above cost structure is within the target cost. If not, what should be the extent of
cost reduction?
Target Cost

Cost Management
Target Costing
Class
WORK
Bee manufacturing company sells its product at ` 1,000 per unit. Due to competition its competitors
are likely to reduce price by 15%. Bee wants to respond aggressively by cutting price by 20% and ex-
pects that the present volume of 1,50,000 units p.a. will increase to 2,00,000. Bee wants to earn a 10%
target profit on sales. Based on a detailed value engineering the comparative position is given below:
Particulars Existing Target

Direct material cost per unit ` 400 ` 385
Direct manufacturing labour per unit ` 55 ` 50
Direct machinery cost per unit ` 70 ` 60
Total ` 525 ` 495
Manufacturing overhead: Existing Target

No. of orders (` 80 per order) 22,500 21,250
Testing hours (` 2 per hour) 4,500,000 3,000,000
Units reworked (` 100 per unit) 12,000 13,000
Manufacturing overheads are allocated using relevant cost drivers. Other operating costs per unit for
the expected volume are estimated as follows:
Research and Development ` 20
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Design and Processing ` 30
Marketing ` 100
Customer service ` 15
Calculate target costs per unit and target costs for the proposed volume showing breakup of different
elements.
Target Cost
RTP
Computo ltd. manufactures two parts P and Q for Computer industry:

P : Annual production and sales of 1,00,000 units at a selling price of ` 100.05 per unit.
Q : Annual production and sales of 50,000 units at a selling price of ` 150 per unit.
Direct and indirect costs incurred on these two parts are as follows:
Advanced Strategic
Target Costing
Class
WORK
Particulars P (` ‘000) Q (`’ 000) Total (` ‘000)

Direct material cost (variable) 4,200 3,000 7,200
Labour cost (variable) 1,500 1,000 2,500
Direct machining cost (see note) 700 550 1,250
Indirect costs:
Machine set up cost 462
Testing cost 2,375
Engineering cost 2,250
16,037
Note: Direct machining costs represent the cost of machine capacity dedicated to the production of
each product. These costs are fixed and are not expected to vary over the long run horizon.
Additional information is as follows:
Particulars P Q
Production batch size 1,000 units 500 units
Set up time per batch 30 hours 36 hours
Testing time per unit 5 hours 9 hours
Engineering cost incurred on each product ` 8.40 lakh ` 14.10 lakh
A foreign competitor has introduced product very similar to ‘P’. To maintain the company’s share and
profit, Computo Ltd. has to reduce the price to ` 86.25.
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The company calls for a meeting and comes up with a proposal to change design of Product P. The
expected effect of new design is as follows:
(i) Direct material cost is expected to decrease by ` 5 per unit.
(ii) Labour cost is expected to decrease by ` 2 per unit.
(iii) Machine time is expected to decrease by 15 minutes; previously it took 3 hours to produce 1 unit
of ‘P’. The machine will be dedicated to the production of new design.
(iv) Set up time will be 28 hours for each set up.
(v) Time required for testing each unit will be reduced by 1 hour.
(vi) Engineering cost and batch size will be unchanged.
Required:
(a) Company management identifies that cost driver for Machine set up is set up hours used in batch
setting and for testing hours is testing time. Engineering costs are assigned to products by spe-
cial study. Calculate the full cost per unit for P and Q using Activity based costing.
(b) What is the mark – up on full cost per unit of P?
(c) What is the Target cost per unit for new design to maintain the same mark – up percentage on
full cost per unit as it had earlier?
(d) Will the new design achieve the cost reduction target? (Assume cost per unit of cost drivers for
the new design remains unchanged).

Cost Management
Target Costing
Class
WORK
(e) List four possible management actions that the Computo Ltd. should take regarding new design.
Target Cost
May 2006
You are a manager of XYZ Paper Mills and have recently come across a particular type of paper which
is being sold at a substantially lower rate by another company, ABC Ltd than the price charged by your
own mill. The value chain for use of one tonne of such paper for ABC Ltd is :
ABC Ltd sells this particular paper to merchant @ ` 1466 per ton. ABC Ltd pays for the freight which
amounts to ` 30 per ton. Average returns and allowances amount to 4% of sales and approximately
equals to ` 60 per ton.
The value chain of your company, through which the paper reaches the ultimate customer is similar
to that of ABC ltd. However, your mill does not sell directly to the merchant, the latter receiving the
paper from huge distribution centre maintained by your company at Haryana. Shipment Costs from
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the Mill to the Distribution Centre is ` 11 per ton while the operating costs in the Distribution Centre
are estimated at ` 25 per ton. The return on investments required by the Distribution Centre for the
investments made, amount to an estimate of ` 58 per ton.
Calculate the Mill Manufacturing Target Cost for this particular paper for XYZ ltd. Assume that the
return on investment expected by XYZ Ltd is ` 120 per ton of paper.
Target Cost Supply Chain and Value Chain

RTP
Two identical companies, A and B manufacture and sell an identical product with the same cost struc-
ture. The selling price is ` 10 per unit and the variable cost is ` 6 per unit – same in both cases. The
capacity is 25,000 units in both companies and the Fixed Overhead for both A and B are ` 35,000. Both
the companies are aiming at a year end profit of ` 15,000.
The year is almost coming to close. Company A has already sold 10,000 units and can make and sell
additional 15,000 unit while Company B has already made and sold 20,000 units. Fortunately at this
Advanced Strategic
Target Costing
Class
WORK
junction, Company C wants 5,000 units of the same product. It invites competitive quotations from
Co. A and Co. B
Both Company A and B are keen to get the order from C.
Which Company, in your opinion, has the better chance of getting the offer from Company C?
Impact of Target on Future Business

RTP
E Block

Cost Management
Target Costing
Home
WORK
Sterling Enterprises has prepared a draft budget for the next year as follows:
Quantity 10,000 units

Sales price per unit ` 30
Less: Variable cost per unit:
Direct material `8
Direct labour `6
Variable overhead (2 hrs x ` 0.50) `1
Contribution per unit ` 15
Budgeted Contribution ` 1,50,000
Budgeted Fixed costs ` 1,40,000
Budgeted Profit ` 10,000
The Board of Directors is dissatisfied with this budget, and asks a working party to come up with an
alternate budget with higher target profit figures.
The working party reports back with the following suggestions that will lead to a budgeted profit of
` 25,000. The company should spend ` 28,500 on advertising, but the target sales price up to ` 32 p. u.
It is expected that the sales volume will also rise, inspite of the price rise, to 12,000 units.
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In order to achieve the extra production capacity, however, the work force must be able to reduce
the time taken to make each unit of the product. It is proposed to offer a pay and productivity deal in
which the wage rate per hour is increased to ` 4. The hourly rate for variable overhead will be unaf-
fected.
Ascertain the target labour time required to achieve the target profit.
Target Labour Time
You-Scream Ltd. is engaged in production of three types of ice cream products: Chiku, Seetafal and
Cherry. The company presently sells 50,000 units of Chiku @ ` 25 per unit, Seetafal 20,000 @ ` 20 per
unit and Cherry 60,000 units @ ` 15 per unit. The demand is sensitive to selling price and it has been
observed that every reduction of ` 1 per unit in selling price, increases the demand for each prod-
uct by 10% to the previous level. The company has the production capacity of 60,500 units of Chiku,
24,200 units of Seetafal and 72,600 units of Cherry. The company marks up 25% on cost of the product.
Advanced Strategic
Target Costing
Home
WORK
The company management decides to apply ABC analysis. For this purpose it identifies four activities
and the rates as follows:
Activity Cost Rate

Ordering ` 800 per purchase order
Delivery ` 700 per delivery
Shelf stocking ` 199 per hour
Customer support and assistance ` 1.10 per unit sold
The other relevant information for the products are as follows:
Chiku Seetafal Cherry

Direct material per unit (`) 8 5 6
Direct Labour per unit (`) 5 4 3
No. of purchase orders 35 30 15
No. of deliveries 112 66 48
Shelf stocking hours 130 150 160
Under the traditional costing system, store support costs are charged @30% of prime cost. In ABC
these costs are coming under customer support and assistance.
Required:
(a) Calculate target cost for each product after a reduction of selling price required to achieve the
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sales equal to the production capacity.

(b) Calculate the total cost and unit cost of each product at the maximum level using traditional
costing.
(c) Calculate the total cost and unit cost of each product at the maximum level using activity based
costing.
(d) Compare the cost of each product calculated in (a) and (b) with (c) and comment on it.
Target Cost Computation

Cost Management
Target Costing
Home
WORK
6,000 pen drives of 2 GB are to be sold in a perfectly competitive market to earn ` 1,06,000 profit,
whereas in monopoly market only 1,200 units are required to be sold to earn the same profit. The fixed
costs for the period are ` 74,000. The contribution per unit in the monopoly market is as high as three
fourths its variable cost. Determine the target selling price per unit under each market condition.
Target Selling Price

May 2011
E Block
Advanced Strategic
Life Cycle Costing
Class
WORK
Chapter 19
Life Cycle Costing
Basics 1. Product Life Cycle

2. Phase in Product Life Cycle
Strategies during 1. Cost Strategies

Life Cycle 2. Price Strategies
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3. Marketing Strategies
Calculations 1. Life Cycle Protability

2. Life Cycle Investment
3. Life Cycle Net Present Value
4. Learnng Curve Effect in
Product Lie Cycle

Cost Management
Life Cycle Costing
Class
WORK
PRODUCT LIFE CYCLE

Product life cycle represents the period commencing from the initiation of product development,
passes through various stages – preliminary work test manufacture and marketing, improvement
of market leading to “boom” (the peak point) and if it cannot be sustained recession follows up to
the point of decline, obsolescence and eventual withdrawal from the market. It does not necessarily
means that product - life is limited. It could have a sustained life.
Characteristics of phenomenon :
Initial storage – Cash outflow
Prime period – Net cash inflow
Decline – Gradual increase in net cash outflow
Reasons : new products need product – familiarisation exercises to create gradual development of
demand. In such initial stages, production and sales, being below break-even level, net cash outflow
will result.
During prime periods, production and sales being at/or above break-even point, there could be net
cash inflow.
During initial stage of decline, production and sales being expected at/above break-even point, the
could be net cash inflow.
During initial stage of decline, production and sales will fall resulting in gradual decrease in cash in-
flow, resulting eventually in cash outflow.
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Above phenomenon depends on various factors, consisting of both controllable and uncontrollable
Global context : with the globalization and liberalisation policy in India, product life cycle will also de-
pend on global condition. Stiffer competition in place and quality, faster development of technology
in other parts of the world, marketing capabilities, export and import restrictions, shifting of demand
pattern, availability of subtitles are the factors which will have effect on the product life cycle.
Phases in Product Life Cycle

Factors Introduction Growth Maturity Decline
Sales Low Sales Rapidly Rising Peak Sales Declining Sales
Sales
Costs High Cost per Average cost per Low cost per Low cost per
customer customer customer customer
Profit Negative Profit Rising profit High profit Declining profit
Customer Early Innovators Middle Adopters Majority Laggards
Competitors Growing Few Stable Number Declining Num- Numbers begin-
to decline ber ning
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Advanced Strategic
Cost Management
Life Cycle Costing
Class
WORK
Stages Product life cycle curve
Introduction Growth Maturity Decline
Time
Use of the product life cycle :

(i) as a Planning tool, it characteristics the marketing challenges in each stage and posses major
alternative marketing strategies.
(ii) as a control tool, the launched PCL concept allows the company to measure product perfor-
mance against similar products launched in the post.
(iii) as a Forecasting tool, it is less useful because sales histories exhibit diverse patterns and the
stages vary in duration
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Cost Management
Life Cycle Costing
Class
WORK
Rapid Heal Tech Ltd. (RHTL) is a leading IT security solutions and ISO 9001 certified company. The solu-
tions are well integrated systems that simplify IT security management across the length and depth of
devices and on multiple platforms. RHTL has recently developed an Antivirus Software and company
expects to have life cycle of less than one year. It was decided that it would be appropriate to adopt a
market skimming pricing policy for the launch of the product. This Software is currently in the Intro-
duction stage of its life cycle and is generating significant unit profits.
Required
(i) Explain, with reasons, the changes, if any, to the unit selling price that could occur when the Soft-
ware moves from the Introduction stageto Growth stage of its life cycle.
(ii) Also suggest necessary strategies at this stage.
Solution
Following acceptance by early innovators, conventional consumers start following their lead. New
competitors are likely to now enter the market attracted by the opportunities for large scale produc-
tion and profit. RHTL may wish to discourage competitors from entering the market by lowering the
price and thereby lowering the unit profitability. The price needs to be lowered so that the product
becomes attractive to different market segments thus increasing demand to achieve the growth in
sales volume.
Strategies at this stage may include the following
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(i) Improving quality and adding new features such as Data Theft Protection, Parental Control, Web
Protection, Improved Scan Engine, Anti Spyware, Anti Malware etc.
(ii) Sourcing new market segments/ distribution channels.
(iii) Changing marketing strategy to increase demand.
(iv) Lowering price to attract price-sensitive buyers.
Strategies during Life Cycle
Examine the Validity of following statements:

(i) In the introduction stage, usual marketing strategy is to strengthen the supply chain relation-
ships to make the product easily accessible by target customers.
Advanced Strategic
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(ii) In the introduction stage, competitors will purchase the product to carry out reverse engineering
and understand how the product works, so that they can develop their own similar, but different
product.
(iii) In the introduction phase, the firm will seek to avoid this competition by maintaining its selling
price at the end of the introduction stage.
(iv) In the growth stage, if the product cannot be differentiated in other ways, the firm may need
further reductions in selling price to maintain growth.
(v) In the maturity stage, firms are tempted to engage in costly promotional price wars to wean
away market share from competitors.
(vi) In the decline stage, failing sales may induce firms to slash marketing expenditure. Brand loyalty
will be exploited to create profits.
P & G International Ltd. (PGIL) has developed a new product “K” which is about to be launched into the
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market and anticipates to sell 80,000 of these units at a sales price of `300 over the product’s life cycle
of four years. Data pertaining to product “K” are as follows:
Costs of Design and Development of Moulds, ` 8,25,000

Dies, and Other Tools
Manufacturing Costs `125 per unit
Selling Costs `12,500 per year + `100 per unit
Administration Costs `50,000 per year
Warranty Expenses 5 Replacement Parts per 25 units at `10 per part ;
1 Visit per 500 units (Cost ` 500 per visit)
Required
i. Compute the product “K”’s ‘Life Cycle Cost’.
ii. Suppose PGIL can increase sales volume by 25% through 10% reduction in selling price. Should
PGIL choose the lower price?
Life Cycle Profitability

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Y-Connections, China based firm, has just developed ultra-thin tablet S-5 with few features like the
ability to open two apps at the same time. This tablet cost ` 5,00,000 to develop; it has undergone
extensive research and is ready for production. Currently, the firm is deciding on plant capacity, which
could cost either ` 35,00,000 or ` 52,00,000. The additional outlay would allow the plant to increase
capacity from 500 units to 750 units. The relevant data for the life cycle of the tablet at different capac-
ity level are as under:
Expected Sales 500 units 750 units

Sale Price `79,600 per unit `69,600 per unit
Variable Selling Costs 10% of Selling Price 10% of Selling Price
Salvage Value - Plant ` 6,25,000 ` 9,00,000
Profit Volume Ratio 40%
Required:
Advise Y – Connections, regarding the optimal plant capacity to install. The tablet’s life cycle is two
years. Ignore time value of money.
Life Cycle Profitability
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A public company responsible for the supply of domestic gas has been approached by several pro-
spective customers in a rural area adjacent to a high-pressure main. As a condition of its license to op-
erate as a utility, the company is obliged to respond positively to current needs provided the financial
viability of the company is not put at risk. New customers are charged ` 250 each for connection to
the system.
Once a meter is installed, a standing charge of ` 10 per quarter is billed. Charges for gas are levied at
` 400 per 1,000 metered units.
A postal survey of the area containing, according to the rating authority, 5,000 domestic units, elicited
a 40% response rate. 95% of those who responded confirmed that they wished to become gas users
and expressed their willingness to pay the connection charge.
Although it is recognized that a small percentage of those willing to pay for connection may not
actually choose to use gas, it is expected that the average household will burn 50 metered units per
month. There will be some seasonal differences.
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The company’s marginal cost of capital is 17% pa and supplies of bulk gas cost the company ` 0.065
per metered unit.
Determine what the maximum capital project cost can be to allow the company to provide the service
required if wastage of 15% has to be allowed.
Life Cycle Investment
Web Security Ltd. (WSL) is a leading IT security solutions and ISO 9001 certified company. The solu-
tions are well integrated systems that simplify IT security management across the length and depth of
devices and on multiple platforms. WSL has recently developed an Antivirus Software and company
expects to have life cycle of less than one year. It was decided that it would be appropriate to adopt a
market skimming pricing policy for the launch of the product. This Software is currently in the Intro-
duction stage of its life cycle and is generating significant unit profits.
Required
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Explain, with reasons, the changes, if any, to the unit selling price that could occur when the Software
moves from the Introduction stage to Growth stage of its life cycle.
Also suggest necessary strategies at this stage.
Blue Mountains Ltd. (BML) has developed a new product ‘K-2’which is about to be launched into the
market. Company has spent ` 30,00,000 on R&D of product ‘K-2’. It has also bought a machine to pro-
duce the product ‘K-2’ costing ` 11,25,000 with a capacity of producing 1,100 units per week. Machine
has no residual value.

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The company has decided to charge price that will change with the cumulative numbers of units sold:
Cumulative Sales (units) Selling Price ` per unit

0 to 2,200 750
2,201 to 7,700 600
7,701 to 15,950 525
15,951 to 59,950 450
59,951 and above 300
Based on these selling prices, it is expected that sales demand will be as shown below:
Sales Demand per week

Weeks
(units)
1-10 220
11-20 550
21-30 825
31-70 1,100
71-80 880
81-90 660
91-100 440
101-110 220
Thereafter NIL
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Unit variable costs are expected to be as follows:
` per unit
First 2,200 units 375
Next 13,750 units 300
Thereafter 225
BML uses just-in-time production system. Following is the total contribution statement of the product
‘K-2’ for its Introduction and Growth phase:
Introduction Growth
Weeks 1 - 10 11 - 30
Number of units Produced and Sold 2,200 5,500 8,250
Selling Price per unit (Rs.) 750 600 525
Variable Cost per unit (Rs.) 375 300 300
Contribution per unit (Rs.) 375 300 225
Total Contribution (Rs.) 8,25,000 16,50,000 18,56,250
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Required
(i) Prepare the total contribution statement for each of the remaining two phases of the product’s
life cycle.
(ii) Discuss Pricing Strategy of the product ‘K-2’.
(iii) Find possible reasons for the changes in cost during the life cycle of the product ‘K-2’.
Profitability during Life Cycle Unique Variety

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Great Eastern Appliances Ltd. (GEAL) manufactures consumer durable products in a very highly
competitive market. GEAL is considering launching a new product ‘Kitchen Care’ into the market
and gathered the following data:
Expected Market Price ` 5000 per unit

Direct Material Cost ` 1850 per unit
Direct Labour Cost ` 80 per hour
Variable Overhead Cost ` 1000 per unit
Packing Machine Cost (specially to be purchased ` 5,00,000
for this product)
GEAL expects the selling price for the new product will continue throughout the product’s life and
a total of 1,000 units can be sold over the entire lifetime of the product.
Required
(i) Calculate the expected total labour hours over the life time of the product ‘Kitchen Care’.
(ii) Profitability of product ‘Kitchen Care’ that GEAL will earn over the life time of the prod-
uct.
(iii) Average target labour cost per unit over the life time of the product if GEAL requires average
profit of ` 800 per unit, to achieve its long term objectives.
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NOTE
250 –0.3219 = 0.1691, 249 –0.3219 =0.1693
Profitability during Life Cycle Learning Curve Effect
In WM Ltd. the ‘OB’ equipment is about to be replaced either by ‘CF’ system or by an ‘OF’ system. Fi-
nance costs 12% a year and the other estimated costs are as follows:
CF OF
(`) (`)
Initial Cost 28,000 40,000
Annual Operating Costs 24,000 p.a. 18,000 p.a.
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Required
If the company expected the new system (either CF or OF) to last at least for 12 years, which system
should be chosen?
Profitability during Life Cycle Present Value Computation
Netcom Ltd. manufactures and sells a number of products. All of its products have a life cycle of less
than one year. Netcom Ltd. uses a four stage life cycle model (Introduction, Growth, Maturity and
Decline).
Netcom Ltd. has recently developed an innovative product. It was decided that it would be appropri-
ate to adopt a market skimming pricing policy for the launch of the product.
However, Netcom Ltd. expects that other companies will try to join the market very soon.
This product is currently in the Introduction stage of its life cycle and is generating significant unit
profits. However, there are concerns that these current unit profits will not continue during the other
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stages of the product’s life cycle.

Required
EXPLAIN, with reasons, the changes, if any, to the unit selling price and the unit production cost that
could occur when the products move from the previous stage into each of the following stages of its
life cycle:
(i) Growth
(ii) Maturity

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Chapter 20
Pricing Strategies
Pricing 1. Techniques Of Pricing

Strategies 2. Pricing Under Different Market
Structures
3. Pricing Strategies
(a) Skimming Pricing Policy
(b) Penetration Pricing Policy
(c) Competitive Pricing
(d) Loss Leader
(e) Strategic Pricing Of New
Products
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(f) Marketing Strategies To Create
Value
4. Pricing In Periods Of Recession
5. Pricing Below Marginal Cost
6. Principles Of Product Pricing
(a) Price Customization
(b) Price Sensitivity
7. Price Adjustment Polices
8. Value- Based Pricing Method
9. Structured Approach To Pricing
Decisions
10. Pricing Of Services: Issues
11. Pareto Analysis
(a) Usefulness Of Pareto Analysis
(b) Applicability Of Pareto Analysis
To Business Situations
(c) Limitations Of Pareto Analysis
12. Prot Maximization Model
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TECHNIQUES OF PRICING
(a) Absorption Costing or Traditional Pricing technique for establish product :
S.P = prime cost (actual) + overhead recovered + mark up
(b) Conversion cost method :
S.P = total conversion cost + mark up on conversion cost
(c) Standard Cost Method:
S.P = Standard Cost + mark up
(d) Marginal Cost Method :
S.P = total variable cost + mark up on variable cost
(e) Differential Cost Method:
S.P = Differential Cost + mark up.
(f) Relevant cost technique:
Minimum sale price = variable cost + discretionary cost + opportunity cost.
(g) Learning Curve Method or Experience curve method:
S.P = Static cost + Reducible cost + Mark up
(h) Return on investment method: (ROCE or ROI)
S.P = total cost + mark up on capital employed
(i) Activity Based Costing.
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S.P = Prime cost + overhead on cost driver + mark up

(j) Life Cycle Costing :
S.P = total cost on estimated life + mark up
(k) Target Costing:
Target SP = Target Cost + Target Profit
PRICING UNDER DIFFERENT MARKET STRUCTURES

The determination of optimal price can be considered under the following market structures:
Perfect Competition
Under perfect competitive market, there are large numbers of sellers selling a homogeneous prod-
uct using identical production process and all of them have perfect information about the market and
price. Perfect market allows free entry and exit of firms into and out of the industry.
Under this type of market, firm has no pricing policy of its own as the sellers are price takers (i.e. it
has to accept the price determined by the market) and sell as much as they are capable of selling at
the prevailing market price. Since each firm produces and sells a homogeneous product, it cannot
increase its price beyond the market price. If it does so then it has to lose all of its market demand to
the competitors.

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There is no control over market price which will equate the quantities available with the quantities
which the buyers are willing to buy. The firm has to take a decision in favour of the quantity to sell.
The firm can continue to produce so long as its marginal cost is less than or equal to its selling price,
upto the point at which the marginal cost is equal to price, increase in output will add to revenue and
thereafter the increase will add to cost.
Monopoly
Monopoly is a market condition where there is only one supplier or producer of a homogeneous
product for which there is no close substitute but has many buyers. Under the monopoly, a firm is a
price setter i.e. it can fix any price but here also the pricing is done taking elasticity of demand for the
product into consideration. That means though the seller/ producer can fix any price but it will go for
the price where demand for the product and consequent profit will be maximum.
Monopolistic Competition
The monopolistically competitive market is one in which there are large number of firms producing
similar but not identical products. Since there is limit to the growth of competitors the excess profits
earned by monopolistic situation attracts new competition. This will have a long-run effect on the
excess profits which will tend to diminish because of the price competition with close substitutes.
The company will, however, have to compare marginal cost and marginal revenue in maximising its
profits.
Under monopolistic condition, consumers may buy more at a lower price than at higher price. The
profit can be maximised by equating marginal revenue with marginal cost.
Oligopoly
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A market structure where there are few firms producing or selling homogenous or identical product.
In this type of market structure the firms are aware of the mutual interdependence of investment,
production process, advertising and sales plan of its rival firm. Hence, any change in any variable by a
firm is likely to have an equal reaction on the part of other competing firms. It is therefore, clear that
the oligopolistic firm, while determining the price for its product, consider not only the demand
for the product but also the reactions of the other firms in the industry to any action or decision
it may take.
If a firm does not follow or adapt its pricing policy in consonance with its competitor, the shift in the
sales will be sensitive. That means demand will shift towards the lower price. Thus, each firm will study
the potential reaction before increasing or decreasing the selling price. The firms in oligopolistic mar-
ket maintain the price of the product either by close analysis of each other’s behavior or by means of
cooperation and collusion.
Pricing Strategies of Oligopolies
Oligopolies may pursue the following pricing strategies:
• Predatory Pricing: Keeping price artificially low, and often below the full cost of production.
• They may also operate a Limit-Pricing Strategy to discourage entrants, which is also called entry
forestalling price.
• Oligopolists may collude with rivals and raise price together, but this may attract new entrants.
• Cost-Plus Pricing: A straightforward pricing method, where a firm sets a price by calculating
average production costs and then adding a fixed mark-up to achieve a desired profit level. There are
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different versions of cost-plus pricing, including full cost pricing, where all costs - that is, fixed and
variable costs - are calculated, plus a mark-up for profits, and contribution pricing, where only variable
costs are calculated with precision and the mark-up is a contribution to both fixed costs and profits.
Non-Price Strategies
Non-price competition is the favoured strategy for oligopolists because price competition can lead to
destructive price wars – examples include:
• Trying to improve Quality & After Sales Servicing, such as offering extended guarantees.
• Spending on Advertising, Sponsorship, and Product Placement.
• Sales Promotion, such as buy-one-get-one-free, is associated with the large supermarkets, which
is a highly oligopolistic market, dominated by three or four large chains.
• Loyalty Schemes, which are common in the supermarket sector, such as Reliance’s One Card.
PRICING STRATEGIES
1. Skimming Pricing Policy.
It is a policy of high price during the early period of a product’s existence. This can be synchro-
nized with high promotional expenditure and in the later years the prices can be gradually re-
duced.
The reasons for following such a policy are:
Inelastic Demand: The demand is likely to be inelastic in the earlier stages till the product till the
product is established in the market.
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High Profit at initial stage: The charging of high price in the initial periods, serves to skim the
cream of the market that is relatively insensitive to price. The gradual reduction in price in the
later year will tend to increase the sales.
Demand not known: This method is preferred in the beginning because in the initial periods
when the demand for the product is not known the price covers the initial cost of production.
Financing High Cost of Capital: High initial capital outlays, needed for manufacture, result in
high cost of production. Added to this, the manufacturer has to incur huge promotional activi-
ties resulting in increased costs. High initial prices will be able to finance the cost of production
particularly when uncertainties block the usual sources of capital.
2. PENETRATION PRICING POLICY

The circumstances in which penetration policy should be adopted are as follows:
(i) When the demand of the product is elastic to price, In other words, the demand of the prod-
uct increases when price is low.
(ii) When there are substantial saving on large-scale production. Here increase in demand is
sustained by the adoption of low pricing policy.
(iii) When there is threat of competition. The prices fixed at a low level act as an entry barrier to
prospective competitors.
(iv) This is only an entry strategy. The prices are regularised by companies after gaining a market
share.

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3. COMPETITIVE PRICING
Where a company sets its price mainly on the consideration of what its competitors are charging,
its pricing under such situation is called competitive pricing. Two types of competitive pricing
are:
a. Going rate pricing: Under this method, the firm tries to keep its price at the average level
charged by the industry. Such pricing is useful where it is difficult to measure costs. Adop-
tion of such pricing will not only yield fair return but would be least disruptive for industry’s
harmony. Under highly competitive conditions in homogeneous product market (such as
food; raw materials and textiles) the company has no pricing decision to make.
b. Sealed bid pricing: competitive pricing is adopted in situations where firms compete for
jobs on the basis of bids. The bid is the firms offer price, and it is a prime example of pric-
ing based on the expectations of how competitors will price rather than on a rigid relation
based on the concerns own costs or demand. The objective of the firm in bidding situation
is to get the contract and therefore it tries to set its prices lower than the other bidding firms.
c. Cost plus pricing : favourable to get a better quality job in the competitive market situation
e.g. Government contract for infrastructure
4. Loss Leader: Where a product can be enriched by a series of optional extras, which a customers
of the main product are at liberty to add on for additional advantages, the main product may be
offered at a relatively low price. If the price is set below cost, the product becomes a loss leader.
It leads the customers to buy the extras or optional advantageous spare parts which are highly
priced.
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When a product range consists of one or more main products and a series of related optional
‘extract’, which the customer can ‘add on’ to the main product, the supplier can set a relatively
low price for the main product and a high one for the ‘extras’. Obviously, the aim is to stimulate
sufficient demand for the former to ensure the target return from sales of the latter. The strategy
has been used successfully by aircraft engine, gas turbine manufacturers, who win an order with
a very competitively priced main product that can only be serviced by their own, highly priced
spare parts.
Gillette did not invent the safety razor but the market strategy Gillette adopted helped to build
market share. Gillette razors were sold at 1/5 of the cost to manufacture them but only Gillette
blades fitted and these were sold at a price of 5 cents. The blades cost only 1 cent to manufacture
and so Gillette made large profits once it had captured the customer.
5. STRATEGIC PRICING OF NEW PRODUCTS

The pricing of new product poses a bigger problem because of the uncertainty involved in the
estimation of their demand. In order to overcome this difficulty experimental sales are conduct-
ed in different markets using different prices to see which price is suitable. A company may, for
example, choose three different markets and by using the same amount of sales promotional ac-
tivities, ascertain what the right price is. In such circumstances, it may even prove that the high-
est price yielding the largest unit contributory margin need not necessarily maximise the profits.
A lower price may well go to maximise the profits. But at the same time if a product is priced very
low to attract more demand, it may be difficult in the future to raise the price as it may not be
acceptable to the consumers. So, pricing of a new product is very critical issue which should be
decided after a thorough market study and consumer behavior analysis.
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A new product is analysed into three categories for the purpose of pricing:
Revolutionary Product: A product is said to be revolutionary when it is new for the market
and has the potential to create its own value. This type of product has revolutionary impact on
the market and consumer behaviour. It replaces the existing method or technology and the ap-
proach to doing a work is quite different and unique. These products enjoy the benefit of product
differentials and have the potential of being market leader.
Revolutionary product may enjoy the premium price as a reward for its innovation and taking
first initiative.
Evolutionary Product: A product introduces upgraded version with few additional characteris-
tics of the product is known as evolutionary product.
The evolutionary products may be priced taking cost-benefit, competitor, and demand for the
product into account.
Me-too Product: A product is said to be me-too product when its emergence is a result of the
success of a revolutionary product. These types of products are very similar (in ordinary language
imitation) to revolutionary and/ or evolutionary products of other firms. The firm while produc-
ing me-too products, generally follows the similar production process and technology that is
used by the other firms. These are known as market followers.
The me-too products are price takers as the price is determined by the market mainly by the
competitive forces.
6. Marketing Strategies to Create Value

Creating value for the customers is one of the important objectives of a firm. A firm makes all the
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efforts to create value and to achieve this it formulates its marketing strategy in that direction.
Understanding customers’ wants and needs is foundation for building this value. To create value,
a firm makes the following marketing strategies:
• First it develops a product that satisfy the wants and needs of the customers,
• After identification and development, it designs a promotion program to convey the value
of the products to the customers.
• It chooses the right distribution channel through which its product will reach to the custom-
ers
• At last it has to design a pricing strategy that creates incentive to purchaser to buy the prod-
uct and to seller to sell the product.
PRICING IN PERIODS OF RECESSION

In periods of recession, a firm may sell its articles at a price less than the total cost but above the
marginal cost for a limited period.
The advantages of this practice are:
• The firm can continue to produce and use the services of skilled employees who are well trained
and will be difficult to re-employ later if discharged.

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• Plant and machinery can be prevented from deterioration through idleness.

• The business would be ready to take advantage of improved business conditions later.
• This avoids the competition of securing the business of the firm.
One thing to remember here is that a situation like this should not lead to a drastic price cutting and
the orders accepted should not cover a long period extending over the production facilities of a peri-
od when business conditions improve.
PRICING BELOW MARGINAL COST

Firm may also be justifiable to sell the product at a price below marginal cost for a limited period
provided the following conditions prevail:
• Where materials are of perishable nature.
• Where stocks have been accumulated in large quantities and the market prices have fallen. This
will save the carrying cost of stocks.
• To popularize a new product.
• Where such reduction enables the firm to boost the sales of other products having larger profit
margin.
PRINCIPLES OF PRODUCT PRICING
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As already stated, cost should not be considered as an important determinant of price. The tendency
should be to lower the price in such a way so as to choose a right combination of price and output to
maximise profits. The important determinants of price, therefore, are competitive situations prevail-
ing in the market and elasticities.
Taking the standard products into consideration, the pricing principles are much the same whether
the product is a new one or the one already well established in the market. However, the environmen-
tal situation and information base are different.
To arrive at a right price, the following important points to be kept in the mind:
(a) Price Customization
Pricing of a product is some time customised keeping taste, preference and perceived value of a
consumer into consideration. Price customisation is done in various ways:
• Based on product line: Based on the requirement of the consumer products can be custom-
ized and accordingly the prices. For example, some may like to have a smartphone with 16
GB over 32 GB. In this case pricing for the product can be based on memory specification.
• Based on customer’s past behaviour: A customer with good payment record may be given
more discounts then the others.
• Based on demographics: Different pricing may be adopted based on age or social status. For
example, railway fare concession for senior citizen and concessional price tickets for military
personnel.
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• Based on time differential: Pricing for a product or service is also done on the basis of time
differential i.e. different price for different time period. For example, discounted price for
data usage provided by a broadband service provider if subscription paid for six months at
a time.
Apart from above pricing principles, other macro economic and legal factors should also be giv-
en due importance while chalking out a pricing strategies.
(b) Price Sensitivity
It measures the customer’s behaviour to the change in price of a product. Nagle1 has identified
nine factors that contribute to price sensitivity. These factors are:
• Unique Value Effect- More unique the product, lower is the price sensitivity.
• Substitute Awareness Effect- If the buyers are aware of substitutes and these perform the
same function, then the buyer’s price sensitivity will be high.
• Difficult Comparison Effect- Price sensitivity will be low if the buyer has difficulty comparing
two alternatives.
• Total Expenditure Effect- If then expenditure on the product represents a low proportion of
the consumer income, the price sensitivity will be less visible for such a product.
• End- Benefit Effect- Buyers are less price sensitive where the expenditure on the product is
low compared to the total cost of the end product.
• Shared Cost Effect- If the cost of the product is shared by another party, the buyer will have
less prone to price sensitivity.
• Sunk Investment Effect- Price sensitivity is low in products which are used along with assets
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previously bought.
• Price Quality Effect- Higher the perceived quality of the product, lower the price sensitivity.
• Inventory Effect- If the product cannot be stored, the buyer will be less price sensitive.
One of the methods more commonly used for measuring price sensitivity is controlled exper-
imentation. In this method, customers are offered different brands at different prices and cus-
tomer’s responses are obtained. Then the company’s brand prices are changed and customer’s
response at each price level is recorded. The price at which demand for the product starts declin-
ing is the level where price sensitivity begins and based on the response level, sensitivity can be
measured. It depends on the nature of the product and buyer characteristics.
Price Adjustment Polices –

(i) Distributor’s Discounts – It means price deductions that systematically make the net price vary
according to buyer’s position in the chain of distribution.
(ii) Quantity discounts are price reductions related to the quantities purchased.
(iii) Cash discounts are price reductions based on promptness of payment.
(iv) Price Discrimination – charging different prices and it takes various forms according to whether
the basis is customer, product, place or time.
(v) Geographic Pricing – Pricing policies may be established whereby the buyer pays all the freight
expense, the seller bears the entire cost, or the seller and buyer share this expense. The strategy

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chosen can influence the geographic limits of a firm’s market, locations of its production facilities,
sources of its raw materials, and its competitive strength in various geographic markets.
(a) Point of production pricing: Price not including freight charges.
(b) Uniform delivered pricing: Uniform price at all locations including delivery charges.
(c) Zone delivered pricing: Different prices for different geographical zones depending on
uniform fright charges to that zone.
(d) Freight absorption pricing: Prices are inclusive of freight that a competitor located near
the client would charge.
Value- Based Pricing Method

There is an increasing trend to price the product on the basis of customer’s perception of its value.
This method helps the firm in reducing the threat of price wars. Marketing research is important for
this method. It is based on:
Objective Value or True Economic Value (TEV)
This is a measure of benefits that a product is intended to deliver to the consumers relative to the
other products without giving any regard whether the consumer can recognize these benefits or not.
True economic value for a consumer is calculated taking two differentials into consideration:
TEV = Cost of the Next Best Alternative + Value of Performance Differential
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Cost of the next best alternative is the cost of a comparable product offered by some other company.
Value of performance differential is the value of additional features provided by the seller of a product.
A firm’s product may be superior to the next best alternative in some dimensions but inferior in others.
STRUCTURED APPROACH TO PRICING DECISIONS

Logical and acceptable way of structuring the process:
Step 1 : Company and Marketing Objectives
Step 2 : Set Pricing Objectives and Policy
Step 3 : Assess Target Markets Assess Costs/ Cost Structure
Step 4 : Assess Customer’s Demand
Step 5 : Assess Competitors Select Pricing Method
Step 6 : Select Specific Pricing
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PRICING OF SERVICES: ISSUES

• When services are uniquely tailored to each customer’s needs, the pricing cannot be easy. Each
service transaction is likely to have distinct pricing structure.
• In certain services customer’s participation is essential. The customer may have to incur certain
intangible costs over and above monetary cost while making use of a service. The pricing deci-
sion in such services should accommodate the intangible costs that a customer may have to bear
with.
• Some of the services like health care, education, communication, transport, etc. fall within the
larger domain of government. Therefore, price of those services tends to be regulated.
• Some services pricing is determined in a collective manner. Trade association, professional bod-
ies, or other institutions may impose broad guidelines for fixing the price.
PARETO ANALYSIS
Pareto analysis: Pareto analysis is based on the 80.20 rule that was a phenomenon observed by Vil-
fred Pareto, an Italian Economist. According to him 80% of wealth of Milan in Italy was owned by 20%
of its citizens. The phenomenon can be observed in many different business situations & the man-
agement can follow it in various circumstances to direct management attention to the key control
mechanism or planning aspects.
USEFULNESS OF PARETO ANALYSIS
It helps to establish top priorities & to identify both profitable and unprofitable targets it helps to:
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a. Prioritize problems, goals and objectives

b. Identify root causes
c. Select and define key quality improvement programs
d. Select key customer relations and service programs
e. Select key employee relations improvement programs
f. Select and define key performance improvement programs
g. Maximize research and product development time
h. Verify operating procedures and manufacturing processes
i. Product or services sales and distribution
APPLICABILITY OF PARETO ANALYSIS TO BUSINESS SITUATIONS
The Pareto analysis is generally applicable to the following business situation.
(i) Pricing of a product: In practice, it has been observed that 20% of products of a firm may ac-
count for 80% of total sales revenue. Under such circumstances the firm can adopt more sophis-
ticated pricing method for small portion of products that jointly accounts for approximately 80%
of total sales revenue. For the remaining 80% of the products the firm may use cost bases pricing
method.
(ii) Customer profitability: Customers can also be analyzed instead of products, for their relative
profitability It has been often found that 20% of customers may generate 80% of sales revenue
profit. Such an analysis is useful for the evaluation of portfolio of customer profile.

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(iii) Stock control: Approximately 20% of the total investment in quantity of stock may account for
about 80% of its investment. Since the number of items is small therefore the management of a
firm may be able to control most of the monetary investment in them.
(iv) Applicability in activity based costing: In ABC it is often said that 20% of an organisation cost
drivers are responsible for 80% of the total overhead cost. By analyzing, monitoring and con-
trolling those cost drivers that cause most cost a better control and understanding of overheads
may be obtained.
(v) Quality control: Pareto analysis seeks to discover from an analysis of defect report or customer
complaints which “vital few” causes are responsible for most of the reported problems. Often
80% of underlying problems can usual be traced to 20% of the various underlying causes.
LIMITATIONS OF PARETO ANALYSIS

Potential cost is involved and Product & customer of low rank is neglected.
ILLUSTRATION ON PARETO ANALYSIS
ABC Ltd manufactures and sells seven products. The following data relates to the latest period:
Product Contribution (` in ‘000)

P 96
Q 36
R 720
S 240
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T 12
U 60
V 24
Analyse which product requires most control as per Pareto.

Solution
The first step is to rearrange the products in descending order of contribution and calculate the cu-
mulative contribution.
Contribution Cumulative contribution

Product Cumulative %
(` ‘000) (`’000)
R 720 720 61
S 240 960 81
P 96 1056 89
U 60 1,116 94
Q 36 1,152 97
V 24 1,176 99
T 12 1,188 100
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It shows that more than 80 percent of the total contribution is earned by two products: R and S. The
position of these products needs protecting, perhaps through careful attention to branding and pro-
motion. The other products require investigation to see whether their contribution can be improved
through increased prices, reduced costs or increased volumes.
PROFIT MAXIMIZATION MODEL

Pricing model is a mathematical model which uses economic theory of pricing.
(i) As per economic theory of pricing, Profit is Maximum at a level of output where Marginal Reve-
nue (MR) is equal to Marginal Cost (MC) i.e.
Marginal Revenue (MR) = Marginal Cost (MC)
This model determines the level of production up to which production can be continued.
(ii) The Basic Price equation, which is used to determine the Price where Profit is Maximum. The
equation is written as:
P = a – bQ
(iii) The Marginal Revenue equation is written as
Marginal Revenue (MR) = P = a – 2bQ
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Cost Management
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Class
WORK
State the pricing policy most suitable in each of the following independent situations:
(i) The company makes original equipment and does defence contract work. There are other com-
panies which also undertake such projects.
(ii) The product made by a company is new to the market. It is expected to enjoy a long term de-
mand. Competition is expected very soon, since the product will be desirable to most customers.
(iii) Stock of processed ready to eat products, whose shelf life will soon be over in the next 2 months.
The product is going to be discontinued.
(iv) A company sells a homogeneous product in a highly competitive market.
(v) ‘A’ is a new product for the company and the market and meant for large scale production and
long term survival in the market. Demand is expected to be elastic.
(vi) ‘B’ is a new product for the company, but not for the market. B’s success is crucial for the compa-
ny’s survival in the long term.
(vii) ‘C’ is a new product to the company and the market. It has an inelastic market. There needs to
be as assured profit to cover high initial costs and the usual sources of capital have uncertainties
blocking them.
(viii) ‘D’ is a perishable item, with more than 80% of its shelf life over.
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Pricing Strategies Case Study
The share of production and the cost based selling price computed separately for a common product
for each of the four companies in the same industry are as follows :
Company
A B C D
Share of production (%) 40 25 20 15
Costs :
Direct Material (`/Unit) 75 90 85 95
Direct Labour (`/Unit) 50 60 70 80
Depreciation (`/Unit) 150 100 80 50
Other Overheads (`/Unit) 150 150 140 120
Total (`/Unit) 425 400 375 345
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Company
A B C D
Fair Price (`/Unit) 740 615 550 460
Capital Employed per Unit :
(a) Net Fixed Assets (`/Unit) 1,500 1,000 800 500
(b) Working Capital (`/Unit) 70 75 75 75
Total (`/Unit) 1,570 1,075 875 575
Required :
What should be the uniform price that should be fixed for the common product?
Uniform Pricing
Generation 2050 Technologies Ltd. develops cutting-edge innovations that are powering the next
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revolution in mobility and has nine tablet smart phone models currently in the market whose previ-
ous year financial data is given below:
Profit-Volume (PV)
Model Sales (`’000)
Ratio
Tab - A001 5,100 3.53%
Tab - B002 3,000 23.00%
Tab - C003 2,100 14.29%
Tab - D004 1,800 14.17%
Tab - E005 1,050 41.43%
Tab - F006 750 26.00%
Tab - G007 450 26.67%
Tab - H008 225 6.67%
Tab - I009 75 60.00%
Required
(i) Using the financial data, carry out a Pareto ANALYSIS (80/20 rule) of Sales and Contribution.
(ii) DISCUSS your findings with appropriate RECOMMENDATIONS.

Cost Management
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Pareto Analysis
An organisation manufactures a product, particulars of which are detailed below:
Annual Production 20,000 units

Material cost ` 60,000
Other variable cost ` 1,20,000
Fixed cost ` 40,000
Apportioned Investment ` 2,00,000
Determine the unit selling price under each of the following strategies. Assume that the organization’s
tax rate is 25%.
(a) 20% return on investment;
(b) 30% mark-up based on total cost;
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(c) 20% profit on sales price;
(d) 15% profit on list sales when trade discount is 35%;
(e) 40% mark-up based on incremental cost;
(f) 50% mark-up based on value added by manufacturer.
Pricing Techniques
Metal Products Ltd. have received an enquiry for the supply of 2,00,000 numbers of a special type of
machine screw. Capacity exists for manufacture of the screws in the company’s unit no.3, but a fixed
investments of ` 60,000 and working capital to the extent of 25% of sales value will be required if the
job is undertaken. The costs are estimated as follows:-
Raw materials 20,000 lbs @ ` 2.30 per lb
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Labour hours 18,000 hrs of which 2,000 would be overtime

hours payable at double the labour rate.
Labour rate ` 1 per hour
Factory overhead ` 1 per labour hour
Selling and distribution cost ` 23,000
Material recovered as scrap at end of operation ` 2,000
Expected rate of return 25 percent on capital employed
Prepare a cost and price statement indicating the price which should be quoted to the customer.
Pricing on ROCE
A small scale unit has a capacity to make 10,000 units of a product. The actual cost in 2009 is given
below:
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Direct material ` 50 per unit

Direct labour ` 12 per unit
Variable overheads ` 4.5 per unit
Fixed factory overheads ` 25,000
The company’s budget for the next year was to be prepared for the following data:
(a) A wage agreement is entered into where the wage will be linked to an index. The labour rate
presently comprises of 50 % basic pay and balance as D.A. The formula is to link the existing D.A.
to price index.
(b) The sale is estimated to touch 80 % capacity.
(c) The average fixed assets (net) will be ` 2,25,000 and working capital would be 25 % of value of
sales.
(d) Company expects a return of 15 % on capital employed.
(e) The price indices for the base period 2009 and for 2010 are as follows:
2009 2010
Cost of living index for D.A. 420 525
Copper 450 600
Aluminium 400 480
(f) The material used is 60 % copper and 40 % aluminium.

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Determine the price at which product will be sold in 2010.
Pricing on ROCE CLI
The profit for the year of Push On Ltd. works out to 12.5% of the capital employed and the relevant
figures are as under:-
Sales ` 5,00,000
Direct Materials ` 2,50,000
Direct Labour ` 1,00,000
Variable Overheads ` 40,000
Capital Employed ` 4,00,000
The new Sales Manager who has joined the company recently estimates for next year a profit of about
23% on capital employed, provided the volume of sales is increased by 10% and simultaneously there
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is an increase in selling price of 4% and an overall cost reduction in all the elements of cost by 2%.
Find out by computing in details the cost and profit for next year, whether the proposal of Sales Man-
ager can be adopted.
Evaluation based on ROCE FC as as a balancing figure
What’s my Price Ltd, manufactures Product ‘S’ in departments A and B which also manufactures other
products using the same machines. The particulars per unit of the Product ‘S’ are as under:
Particulars Dept A Dept B

Direct Materials 8 kg @ ` 3 per kg 4 kg @ ` 5 per kg
Direct Labour 2 hrs @ ` 2 per hr 3 hrs @ ` 10 per hr
Overheads DLHr DLHr
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Overhead Rates
Fixed ` 6 per hr ` 3 per hr
Variable ` 5 per hr ` 2 per hr
Value of Plant ` 16 lakh ` 8 lakh
Variable selling and distribution overheads relating to Product ‘S’ amount to ` 20,000 per month. The
product requires a Working Capital of ` 3,00,000 at the target volume of 1,000 units per month occu-
pying 25% of the practical capacity.
Required:
(a) Using the return on investment pricing formula, find the price of Product ‘S’ to yield a contribu-
tion to cover 24% p.a. rate of return on investment.
(b) If product ‘S’ is a well established product in the market, what should be the basis of fixation of
Price. Set the minimum price on that basis.
(c) If product ‘S’ is a new product about to be launched in the market, what should be the basis of
fixation of price. Set the minimum price on that basis.
Pricing on ROCE ROCE = Contribution

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ABC Ltd. has developed a new product which is about to be launched into the market. The variable
cost of selling the product is ` 17 per unit. The marketing department has estimated that at a sale
price of ` 25, annual demand would be 10,000 units. However, if the sale price is set above ` 25, sales
demand would fall by 500 units for each ` 0.50 increase above ` 25. Similarly, if the price is below ` 25,
demand would increase by 500 units for each ` 0.50 stepped reduction in price below ` 25.
Determine the price which would maximise ABC Ltd’s profit in the next year.
Calculus Based Pricing

Cost Management
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A manufacturing company has an installed capacity of 1,50,000 units per annum. Its cost structure is
given below:
Material costs ` 10 per unit

Labour (Minimum ` 1,00,000 per month) ` 10 per unit
Variable Overheads ` 4 per unit
Fixed overheads: ` 1,92,300 per annum.
Semi – variable overheads ` 60,000 per annum at 75 % capacity, which increases by ` 4,000 per annum
for every 5 % increase in capacity utilisation for the year as a whole. The capacity utilisation for the
next year is estimated at 75 % for three months, 80 % for next six months and 90 % for the remaining
part of the year. If the company is planning to have a profit of 20 % on the selling price, calculate the
selling price per unit?
Pricing Techniques Semi-variable Overheads
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A Company manufacturing agricultural Tractors has a capacity to produce 6,000 tractors annually. The
capital employed in the project as on date is ` 20 crores.
With increasing cost of production and reducing margins the company is fast narrowing its margin of
safety. The return on capital employed fell from 10% in the previous year to 6% in the current year, i.e.,
the current year profit is ` 1.20 crores. The company wants to maintain the original cut off rate of 12%
and various possibilities have been examined for this purpose.
The company is at present manufacturing and marketing 6,000 tractors annually though there is im-
balance in the plant. The company has the following major production departments with percentage
capacity utilisation for the present production:
Capacity
Production Department
Utilised
Machine Shop 75 %
Assembly Shop 100 %
Heat Treatment Shop 75 %
Induction hardening 50 %
Advanced Strategic
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The Company operates a single shift of 8 hours per day on an average for 300 days in a year. For tech-
nical reason the plant will have to operate on single shift basis only. The two alternatives which have
emerged after a detailed study are:
(a) To hire out the surplus capacity in the productions shops for which constant demand exists. The
following income and expenditure projections are drawn out:
Hire Charges per hr (`) Incremental cost per hr (`)

Machine shop 10,000 2,000
Heat Treatment shop 7,500 1,500
Induction hardening 5,000 1,000
(b) To increase the installed capacity to 8,000 tractors by spending ` 2 crores on additional machin-
ery for the assembly shop. The incremental revenue from the additional sale will be ` 5,000 per
tractor. The cost of additional finance will be 12% being the cost of existing capital employed. In
addition tax benefits on an average will work out to 1% of additional investment
Decide.
Evaluation based on ROCE

May, 2000
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C ltd, an Indian company, has entered into an agreement of strategic alliance with Z inc of United
States of America for the manufacture of personal computers in India. Broadly, the terms of agree-
ment are:
(a) Z will provide C with kits in a dismantled condition. These will be used in the manufacture of the
personal computer in India. On a value basis, the supply, in terms of the FOB price will be 50 %
thereof.
(b) C will procure the balance of materials in India.
(c) Z will provide to C with designs and drawings in regard to the materials and supplies to be pro-
cured in India. For this C will pay Z a technology fee of ` 3 crores.
(d) Z will also be entitled to a royalty at 10 % of the selling price of the computers fixed for sales in
India as also reduced by cost of standard items procured in India and also the cost of imported
kits from Z.
(e) C will furnish to Z detailed quarterly returns:

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Other informations available are:

i. FOB price agreed $ 510.
ii. Exchange rate to be adopted $ 1 = ` 47.059
[Note: In making the calculations, the final sum may be rounded to the next rupee]
iii. Insurance and Freight ` 500 per kit.
iv. Customs duty leviable is 150 % of the CIF prices, but as a concession, the actual rate leviable has
been fixed at 30 % of CIF.
v. The technology agreement expires with the production of 2,00,000 computers.
vi. The quoted price on kits includes a 20 % margin of profits on cost to Z.
vii. The estimated cost of materials and supplies to be obtained in India will be 140 % of the cost of
supplies made by Z.
viii. 48 % of the value in rupees of the locally procured goods represents cost of the standard items.
ix. Cost of assembly and other overheads in India will be ` 2,000 per personal computer.
Required:
Calculate the selling price of a personal computer in India bearing in mind that C has targeted a profit
of 20 % to itself on the selling price.
Pricing Technique Royalty Calculation
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November, 2001
Value- Based Pricing Method

There is an increasing trend to price the product on the basis of customer’s perception of its value.
This method helps the firm in reducing the threat of price wars. Marketing research is important for
this method. It is based on:
Objective Value or True Economic Value (TEV)
This is a measure of benefits that a product is intended to deliver to the consumers relative to the
other products without giving any regard whether the consumer can recognize these benefits or not.
True economic value for a consumer is calculated taking two differentials into consideration:
TEV = Cost of the Next Best Alternative + Value of Performance Differential
Cost of the next best alternative is the cost of a comparable product offered by some other company.
Value of performance differential is the value of additional features provided by the seller of a product.
A firm’s product may be superior to the next best alternative in some dimensions but inferior in others.
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A company has furnished the following cost data:
Direct materials ` 11.20 per unit

Direct wages ` 3.00 per unit
Variable overheads ` 0.80 per unit
Fixed factory overhead ` 6,60,000 p.a.
Fixed selling and administration overhead ` 3,60,000 p.a.
Annual sales 4,00,000 units
Capital employed on fixed assets ` 9,00,000
Capital employed on current assets 50 % of sales
Determine the selling price per unit to yield 20 % return on capital employed.
Pricing based on ROCE

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An organisation manufactures a product, particulars of which are detailed below:
Annual production 20,000 units

Cost per annum (`)
Material 50,000
Other variable cost 60,000
Fixed cost 40,000
Apportioned investment 1,50,000
Determine the unit selling price under two strategies mentioned below. Assume that the organisa-
tion’s tax rate is 40 %.
(a) 20 % return on investment.
(b) 6 % profit on list sales, when trade discount is 40 %.

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Pricing based on ROCE

May, 2006
Universe ltd. manufactures two products X and Y. It is facing severe competition in the market. The
monthly sales potential in units at different selling prices as anticipated by the sales manager are as
under:
Product X Product Y
SP per unit (`) Sales Potential (Units) SP per unit (`) Sales Potential (Units)
110 5,000 78 30,000
108 7,500 77 32,000
107 8,000 75 35,000
103 8,400 72 40,000
96 9,000 69 45,000
The total costs as disclosed by the budgets of the company are as follows:
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Particulars Product X Product Y
Output and sales per month (units) 5,000 9,000 30,000 45,000
Total costs per month (` in lakhs) 5 6.6 18 25.5
Labour hours needed per month 20,000 36,000 60,000 90,000
You are required to find out the selling price and units to be sold to earn maximum profit where labour
hours are available without any restriction.
Best Selling Price
Advanced Strategic
Pricing Strategies
Home
WORK
Aditya Heavy Engineering Ltd. (AHEL) produces its only product A7. To manufacture a unit of A7, vari-
able cost of `2,20,000 is incurred. Market research has indicated that at a selling price of ` 5,10,000 no
order will be received, but the demand for A7 will be increased by two units with every `5,000 reduc-
tion in the unit selling price below `5,10,000.
You are required determine the unit selling price for A7 that will maximize the profit of AHEL.
Best Selling Price

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Cost Management
Budgeting and Budgetary Control
Class
WORK
Chapter 21
Calculations
Basics
1. Budgetary Control Ratios
1. Budget (a) Activity Ratio
(a) What is Budget (b) Capacity Ratio
(b) Difference between Budget and (c) Efficiency Ratio
Forecast
(d) Calendar Ratio
(c) Difference between Budget and
Standard (e) Standard Capacity Usage Ratio
(f) Maximum Capacity
(g) Practical Capacity
2. Budgeting
(h) Normal Capacity
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(a) What is Budgeting
(i) Idle Capacity
(b) Approaches of Budgeting
(i) Expost and Exante
(ii) Traditional and Zero Based 2. Preparation of Fixed Budget
(iii) Rolling Budget
3. Preparation of Flexible Budgets

(with variance)
3. Budgetary Control
(a) Feed Back and Feed Forward Control 4. Preparation of Functional Budgets
(b) Behavioural aspects (a) Sale Budget
(c) Beyond Budgeting (b) Production Budget
(c) Raw material Budget
(d) Wages Budget
(e) Cash Budget
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BUDGETARY CONTROL
Budgetary Control is “Systematic control of an organization’s operations through establishment of
standards and targets regarding income and expenditure, and a continuous monitoring and adjust-
ment of performance against them.”
Brown and Howard defines Budgetary Control is “a system of controlling costs which includes the
preparation of budgets, co-ordinating the departments and establishing responsibilities, comparing
actual performance with the budgeted and acting upon results to achieve maximum profitability.”
Budget is an estimation of revenues and expenses over a specified future period of time which needs
to be compiled and re-evaluated on a periodic basis based on the needs of the organisation. Budget-
ary Control is the process by which budgets are prepared for the future period and are compared with
the actual performance for finding out variances, if any. In other words, Budgetary Control is a process
with the help of which, managers set financial and performance goals, compare the actual results with
the budgets, and adjust performance, as it is needed.
Atrill and McLaney identify a number of characteristics that are common to businesses with effective
budgetary control:
Prerequisites of Effective Budgetary Control
• A serious attitude to the system is required
• Clear demarcation between areas of managerial responsibility
• Reasonable budget targets
• Established data collection, analysis and reporting techniques
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• Reports aimed at individual managers, rather than general

• Fairly short reporting periods, typically a month
• Timely variance reports
• Action being taken to get operations back under control if they are shown to be out of control
FEEDBACK AND FEED-FORWARD CONTROL

Feedback and Feed-forward are two types of control schemes for systems that react automatically to
changing environmental dynamics. Each utilizes sensors to measure important factors and a set of
rules to react to changes in those factors. Feedback and Feedforward Controls may coexist in the same
system, but the two designs function in very different ways.
Feedback Control
Feedback as the name suggests is a reaction after an action has taken place. So, there has to be an
error if we want to take corrective actions.
According to the CIMA’s Official Terminology, It is defined as: ‘Measurement of differences between
planned outputs and actual outputs achieved, and the modification of subsequent action and/or
plans to achieve future required results. Feedback control is an integral part of budgetary control and
standard costing systems.’
A feedback system would simply compare the actual historical results with the budgeted results.

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Types of Feedback
Feedback
Primary Could be reported to line management in the form of control reports, comparing
actual and budgeted results.
If the variances are small or can be corrected easily then the information may not be
feedback to anyone higher in the organisation.
Secondary Where feedback is sent to a higher level in an organisation and can lead to a plan
being reviewed and possibly changed.
For example, the revision of a budget after large variances were discovered due to
price changes over time.
Negative Feedback taken to reverse a deviation from standard.
This could be by amending the inputs or process so that the system reverts to a
steady state.
For example, a machine may need to be reset over time to its original settings.
Positive Taken to reinforce a deviation from standard.
The inputs or process would not be altered.
Control Reports
Control reports are feedback devices, but they are only part of the feedback system. A control report
does not by itself cause a change in performance. A change results only when managers take actions
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that lead to change1. Norton Bedford suggested the following five guidelines for feedback manage-
ment control reports:
1. Feedback report should disclose both accomplishment and responsibility
2. Feedback reports should be extracted promptly
3. Feedback reports should disclose trends and relationships
4. Feedback reports should disclose variations from standards
5. Feedback reports should be in standardized format
John C. Camillus suggested six broad approaches to implementing Preventive Management Control:
1. Indicator, both leading’ and “early warning”
2. Contingency plans
3. Trend Analysis
4. Adaptive Mechanisms
5. Congruent System Design
6. Policy Directives
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Limitations
Feedback control system does have some operational limitations. First, it depends heavily on success
of the error detection system. Second, there may be a time lag between the error detection, error con-
firmation, and error revision during which actual results may change again2.
Feed-forward Control
In certain cases, we may be able to measure the amount of error before it has actually taken place. We
may thus be able to place a control mechanism before the error takes place. Feed-forward Control is
one such Controlling system.
According to the CIMA’s Official Terminology, It is defined as the ‘forecasting of differences between
actual and planned outcomes and the implementation of actions before the event, to avoid such
differences.’
A feed-forward control system operates by comparing budgeted results against a forecast. Control
action is triggered by differences between budgeted and forecasted results.
Example
Information on Industrial Dispute in a state which was a major supplier of an important raw material
would cause smart buyers to buy before prices went up and their own inventory were exhausted (in
contrast a pure feedback system would not react until inventory had actually fallen).
Any manager who ignores feed-forward control will contribute to the downfall of a company.
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Implementation of Feed-forward Control
Guidelines to be followed before implementation of Feed-forward Control

• Thorough planning and analysis are required
• Careful discrimination must be applied in selecting input variables
• The feed-forward system must be kept dynamic
• A model of control system should be developed
• Data on Input Variables must be regularly collected
• Data on Input Variables must be regularly assessed
• Feedforward control requires action
Limitations
Akira Ishiwkawa observed the following limitations of the feed-forward control system:
• The feed-forward process is an evaluation process and is concerned with the estimates of uncer-
tain future. This problem of uncertainty is likely to limit application of the concept.
• Study of future is not well developed; neither are the tools that have potential for overcoming
the problem of uncertainty2.

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Illustration 1
Real Petroleum Corporation manufactures lubricant oils for motor vehicles (two wheelers, four wheel-
ers and heavy vehicles). The company offers lubricant oils in various packages ranging from a 100 ml
pouch to a 200 litres drum. About 70% of lubricant sales comprise are made in the form of 900 ml
‘cans’. The process of manufacturing and packaging lubricant oils are given below:
− Base oil of required grade are imported from middle east.
− The base oil are blended with additives at the manufacturing plants at specified temperatures to
produce lubricant oils.
− The oil is stored for a day to bring the temperature to normal.
− The plant has an automated bottling facility. The operator is required to preset the quantity and
number of ‘cans’ to be filled in a computerised system. No manual intervention is required there-
after.
− The product is filled in ‘cans’ at the first stage of packaging with 900 ml of product.
− Caps are fixed on the ‘cans’ and sealed at the second stage of packaging.
− The product is weighed at third stage of packaging (a conversion factor is used to cover volume
into weight) before the ‘cans’ are packed into a carton.
Any ‘can’ having lesser quantity of oil is removed before the ‘cans’ are packed into the cartons. The
‘cans’ which are short filled cannot be reused. Once the seal is broken, the ‘can’ is of no use. There is no
process by which the oil in short filled ‘can’ could be reused. Hence the product is wasted.
The company is considering a proposal to add a component in its packaging unit to avoid losses
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arising out of quantity issues in packaging. The component will be installed after the first stage of
packaging. The component will measure the volume of product and will forward the ‘can’ for capping
and sealing only if the quantity in ‘cans’ is correct. In case the ‘can’ does not have required volume of
product, the ‘can’ will be topped up with balance product before the capping and sealing process. The
company will be able to achieve 0% wastage due to short filling after implementation of new system.
Required
Using the context of control systems, IDENTIFY and EXPLAIN the type of control which is existing in
the company and the type of control which is proposed.
Solution
What is Control?
Control is a management function of establishing benchmarks and comparing actual performance
against the benchmarks and taking corrective actions. Control is required at all levels of organisation
to ensure that the organisation achieves its intended objective. There are two types of control systems
- Feedback Control and Feed-forward Control.
Feedback Control
Feedback Control is a control activity that takes place after a process is complete. It is also known as
post action control. If any problem is identified after a process is complete, a corrective action is taken
to rectify the problem. Feedback control provides information only after the process is complete and
sometimes a significant time is lost to take corrective action. Feedback-based systems have the ad-
vantage of being simple and easy to implement.
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Real Petroleum currently has a feedback control mechanism in place. The actual volume of the prod-
uct is measured at the end of the packaging process. The current control process is that any ‘can‘
which is short filled is not packed in the carton. This ensures that a lower quantity of product is not
supplied into the market. The current control system, however leads to product losses as identifica-
tion of short-filled ‘cans’ at the end of process is not useful to the production process. In case, there
is a huge variation in the final packaging, the packaging system can be reviewed to ensure that such
problems do not acquire in the future.
Feed-forward Control
Feed-forward Control is also referred to as a preventive control. The rationale behind feedforward
control is to foresee potential problems and take corrective action to ensure that the final output is as
expected. Feed-forward controls are desirable because they allow management to prevent problems
rather than having to cure them later. Feed-forward control are costly to implement as it requires ad-
ditional investment and resources. These are designed to detect deviation some standard or goal to
allow correction to be made before a particular sequence of actions is completed
The proposed system in Real Petroleum is a Feed-forward control. In this case, any short filling is iden-
tified in the packaging process itself and corrective action is taken to ensure that the final packed ‘can’
has proper quantity of product. The new process is beneficial to the company as the wastage arising
out of the packaging process can be avoided. The savings must be compared with the cost required to
modify the packaging process before finalising on whether the new system should be implemented
or not.
Behavioural Aspects of Budgetary Control

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Behavioural aspects elucidate that many of the goals of budgeting are contradictory. On the one side,
we want to be able to fairly evaluate the performance of managers. But we also want to motivate
managers and therefore, even if managers are not involved in the process, managers may find the
budget too challenging and therefore reduce their effort. That in turn would distort any evaluation.
The participation of managers in setting targets for themselves tends to improve motivation and per-
formance. If, we want budgets to act as a way of communicating organisational goals. But the budget
themselves may distort the goals as they will be very short term, be focused on cost reduction rather
than, say, quality aspects, and they will solely focus on financial aspects of the organisation’s goals.
There is therefore a conflict between aiming to achieve financial control and communicating the or-
ganisation’s goals.
Moreover, the budget is framed to act as a plan for a manager, section, or division. The manager may
therefore pursue this plan at the cost of other critical success factors that emerge in the internal or ex-
ternal environment of the firm. For example, a production manager may continue to use the planned
materials mix even if the sales department are indicating that customers would desire a different
product design and the purchasing department have accommodated their purchases accordingly.
The production manager then has to choose between the plan and inter departmental coordination.
Many of the conflicts arise due to the human nature of a budgetary control system. Managers do not
always follow organisational goals, they do not always think long term, they may be cautious of mov-
ing away from the plan etc. This provides a conflict between many of the goals of a budgetary control
system which needs to be considered at a strategic level when implementing such a system.

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Budget Slack
Budget affects the approach and behaviour of managers and used to motivate the managers. Unre-
alistic demanding targets tend to affect manager’s performance adversely. Allowing managers to set
their own targets will introduce slack targets. Managers working in an environment where they are
expected to meet the budget targets often try to introduce slack into budget. But, where there is more
relaxed attitude, or when other factors are considered alongside the analysis of variances, managers
are general less inclined to introduce slack. But it can have a detrimental impact on the evaluation
of actual performance if managers incorporate ‘slack’ into the budget in order to make it easier to
achieve.
Effect of the Budget Difficulty on Performance
Once budgets have been set as performance targets, surely performance will be evaluated. This can
be simply a comparison of actual with budgeted performance or alternatively can be a more detailed
comparison of actual performance with flexed budget performance, as is found in variance analysis
and operating statements. The evaluation step is often one of the most argumentative as it is here
that performance is likely to be criticised and employees will be sensitive. There are many potential
difficulties: Hofstede (1968)
• Budgets have no motivational effect unless they are accepted by the managers involved as their
own personal targets.
• Up to the point where the budget is no longer accepted, the more demanding the target the
better the results achieved.
• Demanding budgets are seen as more relevant than less difficult targets, but negative attitudes
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result if they are seen as too difficult.
• Acceptance of budgets is facilitated when good upward communication exists. The use of de-
partmental meeting was found helpful in encouraging managers to accept budget targets.
• Managers’ reactions to budget targets were found affected both by their own personality and by
more general cultural and organizational norms.
The relationship between budget difficulty and the ensuring level of performance can be shown
graphically and is illustrated as under:
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The Effect Budget Difficulty on Performance

Optimal
Performance Budget
Expectations Budget
Budget Level
Adverse Budget
variance
Performance
Actual
Performance
Easy Budget Difficulty Difficult
“Budget level that motivates the best level of performance may not be achievable. In contrast, the
budget that is expected to be achieved motivates a lower level of performance as managers no longer
aspire to meet the budget target.” The balanced scorecard approach of Kaplan and Norton, and the
building block approach of Fitzgerald and Norton can be a great help in ensuring that objectives (or
targets), or budgets are set for a very wide range of factors, both financial and nonfinancial.
Illustration 2
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“It’s frustrating working with Denial. He’s very dominant and expects everything to be done his way.
We have done more and better work to get up to budget, and the minute we make it he tightens the
budget on us. We can’t work any faster and still maintain quality. We always seem to be interrupting
the big jobs for all those small rush orders. The accountants seem to know everything that’s happen-
ing in my department, sometimes even before I do. I thought all that budget and accounting stuff was
supposed to help, but it just gets me into trouble. I’m trying to put out quality work; they’re trying to
save money. This is a dead end job. I don’t see much of a future here.”
– said Mr. Singh, manager of the machine shop of Global Mfg. Ltd. a UK based Company.
Mr. Singh had just attended the monthly performance evaluation meeting for plant department
heads. These meetings had been held on the third Friday of each month since Mr. Denial, MBA from
Manchester University, had joined the Indian operations a year earlier. Mr. Singh had just been given
the worst evaluation he had ever received in his long career with Global Mfg. Ltd. He was the most
respected of the experienced machinists in the company. Old Plant Manager had often stated that
the company’s success was due to the high quality of the work of machinists like Mr. Singh. He had
been with Global Mfg. Ltd. for many years and was promoted to supervisor of the machine shop when
the company expanded and moved to its present location. As supervisor, Mr. Singh stressed the im-
portance of craftsmanship and told his workers that he wanted no careless work coming from his
department.
When Mr. Denial became the plant manager, he directed that monthly performance comparisons
be made between actual and budgeted costs for each department. The departmental budgets were
intended to encourage the supervisors to reduce inefficiencies and to seek cost reduction opportuni-
ties. The company controller was instructed to have his staff ‘tighten’ the budget slightly whenever a

Cost Management
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department attained its budget in a given month; this was done to reinforce the plant supervisor’s de-
sire to reduce costs. Mr. Denial often stressed the importance of continued progress toward attaining
the budget; he also made it know that he kept a file of these performance reports for future reference.
Required
IDENTIFY the problems which appear to exist in budgetary control system and explain how budgetary
control system could be revised to improve the effectiveness.
Solution
The budgetary control system appears to have several very important shortcomings which reduce its
effectiveness and may in fact cause it to interfere with good performance. Some of the shortcomings
are explained below.
Lack of Coordinated Goals: Mr. Singh had been led to believe high quality output is the goal; it now
appears low cost is the goal. He does not know what the goals are and thus cannot make decisions
which lead toward reaching the goals.
Influences of Uncontrollable Factors: The actual performance relative to budget is greatly influenced
by uncontrollable factors i.e. rush orders. Thus, the variance reports serve little purpose for evaluation
of performance.
The Short-Run Perspectives: The monthly evaluation and the budget tightening on a monthly basis
result in a very short-run perspective. This will result in inappropriate decisions.
The improvements in the budgetary control system must correct the deficiencies described above.
Accordingly:
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− Budgetary control system must more clearly define the company’s objectives.
− Budgetary control system must develop an accounting reporting system which better matches
controllable factors with supervisor responsibility and authority.
− Establish budget values for appropriate time periods which do not change monthly simply as a
result of a change in the prior month’s performance.
The entire company from top management down must be educated in sound budgetary procedures
so that all parties will understand the total process and recognize the benefit to be gained.
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Participation in Budget Setting Process
There are two main approaches to budgeting, the top down approach and bottom up approach.
Budgets can be prepared centrally and subordinates have little influence on the target setting. This
called top down budget or imposed style approach. The benefit of top down approach is that it can
be produced quickly and involve less management time than other options. However, there are signif-
icant risk of inaccurate budgets being set that are also not acceptable to the subordinate managers.
An alternative to top-down approach is for the subordinate managers to participate in the prepa-
ration of their own budgets and then these budgets to be reviewed by senior management. This is
called bottom up approach or participative approach.
Many researchers have recommended that the bottom up approach involving participation is a pref-
erable method of preparing a budget. Other studies have suggested that participation is not a solu-
tion that will solve all problem. Following table highlights factors that have been suggested in differ-
ent studies as influencing the effectiveness of participation:
Factors Influencing the Effectiveness of Participation is Less Effective and Rele-

Study
Participation vant
Vroom (1960) Personality With managers who are more highly
authoritarian.
Hopwood (1978) Work Situation In a highly programmed and tech-
nologically constrained environ-
ment.
Brownell (1981) Locus of Control For those individuals who feel they
have a low degree of control over
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their destiny.
Mia (1989) Job Difficulty Where job difficulty is low.
Bruns and Waterhouse Types of Organizational Structure In a centralized organization.
(1975)
The testimony from the various research proposed that participative styles of management will not
necessarily more effective than other styles, and that participative methods should be used with care.
Accordingly, it is essential to identify those circumstances where there is testimony that participative
methods are effective, rather than to introduce universal application into firms. Participation must
be used selectively; but if it is used in the right circumstances, it has an outstanding potential for en-
couraging the assurance to organisational goals, enlightening attitudes towards budgeting system,
and increasing subsequent performance. However, there are some limitations on the positive effects
of participation in standard setting and circumstances where topdown budget setting is preferable1.
They are as follows:
Circumstances Where Top-Down Budget Setting is Preferable
1. Where personality characteristics of the participation may limit the benefits of participation
2. Where participation by itself is not adequate in ensuring commitment to standards and
managers can significantly influence the results
3. Where a process is highly programmable and clear, stable input-output relationships
4. Where a firm has large number of homogeneous units and operating in a stable environment

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Use of Accounting Information in Performance Evaluation1
Some dysfunctional consequences that arise with accounting measures of performance may not be
due to the insufficiency of the performance measures, but rather may outcome from the way in which
the accounting measures are used. The accounting information provided by an accounting system
must be interpreted and used with care.
Hofstede (1968) found that stress on the actual results in performance evaluation led to more exten-
sive use of budgetary information, and this made the budget more relevant. However, this stress was
associated with a feeling that the performance appraisal was unjust. To overcome this problem, the
correct balance must be established when the budgeted performance is evaluated.
Hopwood (1976) observed three distinct styles of using budget and actual cost information in per-
formance evaluation in manufacturing division of a large US company:
• Budget Constrained Style: The evaluation is based upon the Cost centre head’s ability continu-
ally to meet the budget on short term basis.
• Profit Conscious Style: Performance of the Cost Centre’s head is linked to ability in increase the
general effectiveness of his unit’s operations in relation to the long- term goals of the organisa-
tion.
• Non- Accounting Style: Accounting data plays a relatively unimportant part in the supervisor’s
evaluation of the cost centre head’s performance.
Beyond Budgeting (BB)
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Limitations of Traditional Budgets
• Time-consuming and costly to put together
• Constrain responsiveness and flexibility
• Often a barrier to change
• Rarely strategically focused and are often contradictory
• Add little value, especially given the time required to prepare
• Concentrate on cost reduction and not on value creation
• Developed and updated too infrequently, usually annually
• Are based on unsupported assumptions and guesswork
• Reinforce departmental barriers rather than encourage knowledge sharing
• Make people feel undervalued.
To overcome these limitations a tool came into force known as Beyond Budgeting. Beyond Budgeting
is a leadership philosophy that relates to an alternative approach to budgeting which should be used
instead of traditional annual budgeting.
According to CIMA’s Official Terminology- ‘An idea that companies need to move beyond budgeting
because of the inherent flaws in budgeting especially when used to set contracts. It is argued that a
range of techniques, such as rolling forecasts and market related targets, can take the place of tradi-
tional budgeting.’
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BB identifies its two main advantages.

• It is a more adaptive process than traditional budgeting.
• It is a decentralised process, unlike traditional budgeting where leaders plan and control organi-
sations centrally.
Characteristics of Beyond Budgeting
(a) The rolling budgets may incorporate KPIs.
(b) Benchmarking can be incorporated in budgets.
(c) Here the focus of the managers shift to improving future results.
(d) Allow operational managers to react to the environment.
(e) Encourage a culture of innovation.
(f ) More timely allocation of resources.
Suitability
(a) Industries where there is rapid change in the business environment –

Flexible targets will be responsive to change.
(b) Industries using management methods such as TQM –
Continuous improvement will be the key.
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(c) Industries undergoing radical change, e.g. using BPR –

Budgets may be hard to achieve in such circumstances.
Benefits of the ‘Beyond Budgeting’ Model

• Beyond budgeting helps managers to work in coordination to beat the competition. Internal
rivalry between managers is reduced as target shifts to competitors.
• Helps in motivating individuals by defining clear responsibilities and challenges.
• It eliminates some behavioural issues by making rewards team-based.
• Proper delegation of authority to operational managers who are close to the concerned action
and can react quickly.
• Operational managers do not restrict themselves to budget limits and focus on achieving key
ratios.
• It establishes customer-orientated teams.
• It creates information systems which provide fast and open information throughout the organi-
sation.

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Beyond Budgeting – Principles for Adaptive Performance Management
Goals Set aspirational goals aimed at continuous improvement, not fixed annual targets.
Rewards Reward shared success based on relative performance, not on meeting fixed annual
targets.
Planning Make planning a continuous and inclusive process, not an annual event.
Controls Base controls on relative key performance indicators (KPIs) and performance trends,
not variances against a plan.
Resources Make resources available as needed, not through annual budget allocations.
Co-ordination Co-ordinate cross-company interactions dynamically, not through annual planning
cycles.
Leadership Principles
Customer Focus everyone on improving customer outcomes, not on meeting internal tar-
gets.
Accountability Create a network of teams accountable for results, not centralised hierarchies.
Performance Champion success as winning in the marketplace, not on meeting internal tar-
gets.
Freedom to Act Give teams the freedom and capability to act, don’t merely require adherence to
plan.
Governance Base governance on clear values and boundaries, not detailed rules and budgets.
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Information Promote open and shared information, don’t restrict it to those who ‘need to
know’.
Implementation of Beyond Budgeting
There are nine steps that Hope and Fraser consider to be essential to implementing the Beyond Budg-
eting approach.
1. Define the Case for Change and Provide an Outline Vision
2. Be Prepared to Convince the Board
3. Get Started
4. Design and Implement New Processes
5. Train and Educate People
6. Rethink the Role of Finance
7. Change Behaviour – New Processes, Not Management Orders
8. Evaluate the Benefits
9. Consolidate the Gains
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Outlined by Jeremy Hope – Traditional vs Beyond Budgeting
Traditional Budgeting Management Beyond Budgeting Management

Model Model
Targets and Rewards • Incremental targets • Stretch goals
• Fixed incentives • Relative targets and re-
wards
Planning and Controls • Fixed annual plans • Continuous planning
• Variance controls • KPI’s & rolling forecasts
Resource and Coordination • Pre-allocated resources Central • Resources on demand Dy-
coordination namic Coordination
Organizational Culture • Central control • Local control of goals/
plans
• Focus on managing numbers
• Focus on value creation
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History of the Company

Great Bus Tours Co. Ltd. (GBTCL) is an open top double-decker bus sightseeing company, particularly
identified with its special red and cream-colored buses. It commenced operating in small town of
Meghalaya in June 2013 with four buses and as of 2017 operated over 44 buses in north east region of
India. GBTCL operates five routes with stops at tourist destinations. The company runs hopon, hop-off
bus tours of various hills, with one 24-hour ticket valid for unlimited journeys on the route.
Budget Process/ Incentive Plan
As a part of management performance control and incentive scheme it has been following participa-
tive budgeting approach. In GBTCL, budgeting is a joint process in which functional divisions develop
their plans in conformity with corporate goals for the next financial year. Based on these plans, divi-
sions prepare functional budgets and send to the appropriate management for review and approval.
The budgets after the incorporation of the feedback and suggestions received from the said manage-
ment, are finalised for the implementation. Then, finalised budgets are used as yardstick for perfor-
mance measurement. Comparing the actual performance with the yardstick, bonus and other per-
formance related incentives are considered. The higher management believe that this performance
control and incentive scheme is very helpful to measure the performance and fixing responsibilities
for the responsibility centres.
Budgeted Income Statement ( ` ‘000)
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Revenue 1,13,800
Less:
Variable Costs-
Direct Material (Fuel, Lubricants and Sundries) 13,600
Direct Labour 40,500
Variable Overheads 7,700
Fixed Costs-
Operating Overheads (Buses, Garage, Salaries) 18,100
Marketing and Administration 10,700
Profit/ (Loss) before taxes 23,200
Tabel-1
Current Year’s Income Statement( ` ’000)
Revenue 93,500
Less:
Variable Costs:
Direct Material (Fuel, Lubricants and Sundries) 19,600
Advanced Strategic
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Fixed Costs:
Profit/ (Loss) before taxes (250)
Table-2
Other Information
Surprisingly above given current year’s actual results were not up to the mark. Actual results were
clearly showing adverse performance in comparison with budgeted figures.
Managers of GBTCL were upset because they did not receive the bonus. Ms. Maggie, Tour Manager of
Route No. 3, said –
“We lost 2 months revenue and fuel prices are almost doubled. We did our best but these circumstanc-
es were beyond our control and we should not penalize at all.”
In support of her statement, Ms. Meggie provided following additional information –
(a) Rain is common in Northern Region. But, the past year set a record in numbers. In July the expect-
ed average was 1,577 mm and received was 1,810 mm, In August the expected average rain was
990 mm and actual received was 1,535 mm. Heavy rain in these two months disrupted normal
life of the region.
(b) The fuel prices has risen almost continuously since last year due to surge in global crude prices.
(c) Additional operational expenses 22,00,000 also incurred to remove the milky appearance and
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give the stainless a nice new look effected by heavy rain.

She claimed that –
“Revised budget with consideration of the above factors would give different results and lead to dif-
ferent conclusions”
Required
ANALYSE the tour manager’s view.
Solution
Analysis of Issue
It appears that GBTCL has been badly hit by the weather – high rain in July and August have led to a
slump in business. Revenue have seen a fall of 18% over the budgeted figure. Direct Material (most
of the fuel) is 21% of the Sales (compared to 12% of budgeted level) because of hike in fuel price.
Variable Overheads are almost same. However, interestingly, there is a saving of 1,50,000 in Operating
Overheads as compared to the budgeted figure after catering additional Operational Expenses of
22,00,000 (for removal of milky appearance etc.). Furthermore, there is reduction in Marketing & Ad-
ministration Cost. The ratio of Salary to Sales rose to 40% in 2017from 36% (as budgeted). This appears
to be atypical. Instead, there should be a cut in this ratio due to slump in business.
Award of bonus in case of losses is not justified and managers should be held accountable for their
operations. However, they should not be held accountable for the events beyond their control. A man-
ager cannot control movements in fuel price, yet he/ she is supposed to have the most information

Cost Management
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and he/ she is expected to correctly forecast movements in the prices of fuel. Managers shouldn’t be
penalized for the uncontrollable events.
Accordingly, in GBTCL, there should be revision in the budget to account uncontrollable events.
Refer Table-3.
Revised Budgeted Income Statement ( ` ’000)
Revenue* 94,833
Less:
Variable Costs-
Direct Material** (Fuel, Lubricants and Sundries) 19,879
Fixed Costs-
Profit/ (Loss) before taxes 3,787
Tabel-3
*10 months revenue; ** at actual price levels
The Revised Profit Margin has come down to 4% as against the Target Profit Margin of 20%. This clearly
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indicates that the performance was benchmarked against the higher target. If original budget figure
is used to measure the performance, it will punish employees for the reason which are beyond their
control.
GBTCL is not too far away from Revised Profit Margin. Therefore, at least some bonus may be consid-
ered to be awarded to the employees which may create more employee loyalty and may be beneficial
for long term.
Further, continuous monitoring of Budget Performance (achievement/ failure) in GBTCL is essential to
overcome this situation. This helps to identify where revisions are required in the budget to account
changing conditions, errors, modification to company’s plan etc. Monitoring of Budget Performance
should be the responsibility of the managers in GBTCL. The essence of the effective monitoring of
Budget Performance is that the managers should provide accurate, relevant, actionable information
on time to the appropriate management level so that budget can give a realistic target to measure
the performance.
It is also important to note that at the time of revising the budget, the primary budget as well as past
information should not be ignored as they are the basis for preparing all budgets.
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A company is engaged in manufacturing of several products. The following data have been obtained
from the record of a machine shop for an average month:
Budgeted:
No. of working days 24
Working hours per day 8
No. of direct workers 150
Efficiency One standard hour per clock hour
Downtime 10%
Actual for August 2010:
Net operator hours worked 20,500
Standard hours produced 22,550
There was a special holiday in August
Required:
Calculate Efficiency, Activity and Standard capacity usage ratio, Calendar Ratio.
Budgetary Control Ratios Standard Hours and Standard

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November, 2010
Capacity usage
The following are the details of the budgeted and the actual cost in a factory for six months from
January to June 2009. From the figures given below you are required to prepare the production cost
budget for the period from January to June 2010:
Particulars Budget Actual

Production (units) 20,000 18,000
Qty of materials used 2,000 MT 1,900 MT
Labour Hours used 8,00,000 hrs 7,99,920 hrs
Materials Cost (`) 40,00,000 39,90,000
Labour Cost (` per hour) 20 22
Variable Overhead (`) 2,40,000 2,16,000
Fixed Overhead (`) 4,00,000 4,20,000

Cost Management
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In the first half of 2010, production is budgeted for 25,000 units. Material cost per metric tonne will
increase from last year’s actual by ` 300 but is proposed to maintain the consumption efficiency of
2010 as budgeted. Labour efficiency will be lower by another 1 % and labour rates will be ` 22 per
hour. Variable and Fixed overheads will go up by 20 % over 2009 actual.
Fixed Budget Sales Efficiency Ratio

November, 2008
A company prepared the following budget for a year:
Variable Fixed Variable Fixed Sales

Item R/M Labour Profit
Factory OH Factory OH Selling OH Selling OH Price
Percent 40% 20% 10% 10% 5% 12% 3% 100%
After evaluating the half – yearly performance, it was observed that the company would be able to
achieve only 80% of the original budgeted sales. The revised budgeted sales as envisaged above was
estimated at ` 1,080 lakhs after taking into account a reduction in the selling price by 10%.
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Prepare a statement showing the break – up of the original and revised budget for the year.
The Co. has received an export order. The estimated prime cost and special export expenses for fulfill-
ing the export order are ` 12 lac and ` 40,000 respectively.
Find the lowest quotation.
Fixed Budget Revised Budget and Lowest

Quotation - Relevant Cost
Advanced Strategic
Class
WORK
V Ltd. manufactures a single product. The selling price of the product is ` 150 per unit. The following
are the result obtained by the company during the last two quarters:
Particulars Quarter 1 Quarter 2

Sales (units) 5,100 4,800
Production (units) 5,500 4,500
Direct Materials – A (`) 66,000 54,000
Direct Materials – B (`) 55,000 45,000
Manufacturing wages (`) 1,56,750 1,38,000
Factory Overheads (`) 86,000 83,000
Selling Overheads (`) 79,000 73,000
The company estimates its sales for the next quarter to range between 5,500 units and 6,500 units,
the most likely volume being 6,000 units. The manufacturing programme will match with the sales
quantity such that no increase in inventory of finished goods is contemplated in the next quarter. The
following price and cost changes will, however, apply to the next quarter:
1. The price of direct material B will increase by 10%. There will be no change in the price of direct
material A.
2. The wage rates will go up by 8%. If the production volume increases beyond 5,500 units overtime
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premium of 50% is payable on the increased volume due to overtime working to be done by the
variable labour complement.
3. The fixed factory and selling expenses will increase by 20% and 25% respectively.
4. A discount in the selling price of 2% is allowed on all sales made at 6,500 units level of output. The
selling price, however, will remain unaltered, if the volume of output is below 6,500 units.
5. While operating at a volume of output of 6,500 units in the next quarter, the company intends
to quote for an additional volume of 2,000 units to be supplied to a Government department
for its captive consumption. The working capital requirement of this order is estimated at 80%
of the sales value of the Government order. The company desires a return of 20% on the capital
employed in respect of this order.
Required:
a. Prepare a flexible budget for the next quarter at 5,500, 6,000 and 6,500 unit levels and determine
the profit at the respective volumes.
b. Calculate the lowest price p.u. to be quoted in respect of the GOVT. order for 2,000 units.
Flexible Budget
May, 2003

Cost Management
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JBC Limited, a manufacturing company having a capacity of 60,000 units has prepared a following
cost sheet:
Direct Material (per unit) ` 12.50

Direct Wages (per unit) ` 5.00
Semi – variable cost ` 30,000 fixed plus 0.50 per unit
Factory overhead (per unit) ` 10.00 (50 % fixed)
Selling and administration overhead (per unit) ` 8.00 (25 % variable)
Selling price (per unit) ` 40
During the year 2008, the sales volume achieved by the company was 50,000 units. The company has
launched an expansion program as under:
a. The capacity will be increased to 1,00,000 units.
b. The cost of investment on expansion is ` 5 lakhs which is proposed to be financed through finan-
cial institution at 12 per cent per annum.
c. The depreciation rate on new investment is 10 per cent based on straight line.
d. The additional fixed overheads will amount to ` 2.00 lakhs up to 80,000 units and will increase by
` 80,000 more beyond 80,000 units.
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After the expansion, the company has two alternatives for operating the expanded plant as under:
(i) Sales can be increased up to 80,000 units by spending ` 50,000 on special advertisement cam-
paign to explore new market.
(ii) Sales can be increased up to 1,00,000 units subject to the following:
(a) Reduction of selling price by ` 4 per unit on all the units sold.
(b) The direct material cost would go down by 4 per cent due to discount on bulk buying.
(c) By increasing the variable selling and administration expenses by 4 per cent.
Required:
(i) Construct a flexible budget at the level 50,000 units, 80,000 units and 1,00,000 units of produc-
tion and select best profitable level of operation.
(ii) Calculate break- even point both before and after expansion.
Flexible Budget Break Even Point

May, 2009
Advanced Strategic
Class
WORK
Nesley Ltd. has prepared the following sales budget for the first five months of 2008:
Month Sales Budget (units)

Jan 20,800
Feb 25,600
Mar 22,200
Apr 20,800
May 18,800
Inventory of finished goods at the end of every month is to be equal to 25 % of sales estimate for the
next month. On 1st January, 2008 there were 5,500 units of product on hand. There is no work – in –
progress at the end of any month.
Every unit of product requires two types of materials in the following quantities:
Material A: 2 kg
Material B: 5 kg
Materials equal to one half of the requirement of next month’s production are to be in hand at the end
of every month. This requirement was met on 1st January, 2008.
Prepare the following budgets for the quarter ending 31st March 2008:
E Block
(a) Production Budget and

(b) Material Purchase Budget.
Functional Budget
A single product company estimated its sales for the next year quarter - wise as under:
QUARTER SALES (UNITS)

I 30,000
II 37,500
III 41,250
IV 45,000

Cost Management
Class
WORK
The opening stock of finished goods is 10,000 units and the company expects to maintain the closing
stock of finished goods at 16,250 units at the end of the year. The production pattern in each quarter
is based on 80% of the sales of the current quarter and 20% of the sales of the next quarter.
The opening stock of raw materials in the beginning of the year is 10,000 kg. and the closing stock at
the end of the year is required to be maintained at 5,000 kg. Each unit of finished output requires 2 kg.
of raw materials.
The company proposes to purchase the entire annual requirement of raw materials in the first three
quarters in the proportion and at the prices given below:
Quarter Purchase of raw material % to annual requirement (kg) Price per kg (`)
I 30 % 2
II 50 % 3
III 20 % 4
The value of the opening stock of raw materials in the beginning of the year is ` 20,000. You are re-
quired to present the following for the next year, quarter wise:
(i) Production budget (in units).
(ii) Raw material consumption budget (in quantity).
(iii) Raw material purchase budget (in quantity and value).
Functional Budget Store Ledger Card
E Block
Solo products Ltd. manufactures and sells a single product and has estimated a sales revenue of ` 126
lakhs this year based on a 20% profit on selling price. Each unit of the product requires 3 Ibs of ma-
terial P and 1 and 1/2 Ibs of material Q for manufacture as well as a processing time of 7 hours in the
Machine Shop and 2 and 1/2 hours in the Assembly Section. Overheads are absorbed at a blanket rate
of 33-1/3% on Direct Labour. The factory works 5 days of 8 hours a week in a normal 52 weeks a year.
On an average statutory holidays, leave and absenteeism and idle time amount to 96 hours, 80 hours
and 64 hours respectively, in a year.
The other details are as under:
Purchase Price Material P ` 6 per lb

Material Q ` 4 per lb
Comprehensive Labour Rate Machine Shop ` 4 per hour
Assembly Shop ` 3.20 per hour
Advanced Strategic
Class
WORK
No. of employees Machine Shop 600

Assembly Shop 180
FINISHED GOODS: Material P Material Q
Opening Stock (20,000 units) 54,000 lbs 33,000 lbs
Closing Stock (Estimated) ? units 30,000 lbs 66,000 lbs
The past performances of factory in last three years are:
Year Machine Shop (hrs) Assembly Shop (hrs)

2007 11,00,000 3,45,000
2008 10,30,000 3,20,000
2009 10,80,000 3,40,000
You are required to calculate:

(a) The number of units of the product proposed to be sold and the closing finished goods stock.
(b) Purchases to be made of materials P and Q during the year in Rupees.
(c) Capacity utilization of machine shop and Assembly section, along with your Comments.
Functional Budget Based on Bottle Neck and

Capacity Utilisation
E Block
P. Ltd. manufactures two products using one type of material and one grade of labour. Shown below
is an extract from the company’s working papers for the next period’s budget:
PARTICULARS PRODUCT A PRODUCT B
Budgeted Sales (units) 3,600 4,800
Budgeted material consumption per product (Kg) 5 3
Budgeted material cost ` 12 per kg
Standard hours allowed per product 5 4
Budgeted wage rate ` 8 per hour
INFORMATION:
1. Overtime premium is 50% and is payable, if a worker works for more than 40 hours a week. There
are 90 direct workers.
2. The target productivity ratio (or efficiency ratio) for the productive hours worked by the direct
workers in actually manufacturing the products is 80%; in addition the non-productive down
time is budgeted at 20% of the productive hours worked.

Cost Management
Class
WORK
3. There are twelve 5 day weeks in the budget period and it is anticipated that sales and production
will occur evenly throughout the whole period.
4. It is anticipated that stock at the beginning of the period will be:
Product A: 1,020 units; Product B: 2,400 units; Raw material 4,300 kgs.
5. The target closing stock, expressed in terms of anticipated activity during the budget period are:
Product A: 15 days sales; Product B: 20 days sales; Raw material: 10 days consumption.
Required:
(a) Material Purchases Budget showing the quantities and values, for the next period.
(b) Wages budget for the direct workers
(c) Would your answer change in (a) above if raw materials stock on closing date is kept according to
the requirement of stock of finished goods, if yes, then prepare new material purchase budget.
Functional Budget Wages Budget

November, 2014
E Block
A company is engaged in the manufacture of specialised sub-assemblies required for certain electron-
ic equipments. The company envisages that in the forthcoming month, December, 2010, the sales will
take a pattern in the ratio of 3:4:2 respectively of sub-assemblies, X, Y and Z.
The following is the schedule of components required for manufacture:
Component Requirements Per Unit

Sub – Assembly SP ` / Unit
A B C D
X 520 1 8 4 2
Y 500 1 2 10 6
Z 350 1 2 4 8
Purchase Price (`/ Unit) 60 20 12 8
Advanced Strategic
Class
WORK
The direct labour time and variable overheads required for each of the sub-assemblies are:
Labour Hour Per

Assembly Variable Overheads
per sub assembly (`)
Grade I Grade II
X 8 16 36
Y 6 12 24
Z 4 8 24
Direct Wage Rate per hour `5 `4 --
The labourers work 8 hours a day for 25 days a month.

The opening stocks of sub-assemblies and components for December, 2010 are as under:
SUB ASSEMBLIES (Units)

X 800
Y 1,200
Z 2,800
Fixed overheads amount to ` 7,57,200 for the month and a monthly profit target of ` 12 lacs has been
set.
The company is eager for a reduction of closing inventories for December, 2010 of sub assemblies by
E Block
10% of quantity as compared to the opening stock.

Prepare Sales budget in quantity and value for December 2010:
Functional Budget Sales Budget
Solution
Working Note 1: Desired Contribution:
Particulars Amount (`)

Fixed Cost
Desired Profit
Desired Contribution

Cost Management
Class
WORK
Working Note 2: Contribution Per Unit:
Particulars X Y Z
Selling Price
Less: Variable Costs per unit
Components cost
A
B
C
D
Labour cost
Grade I
Grade II
Variable OH
Contribution per unit 96 130 62
Working Note 3: Units to be Sold: x = 6300 units y = 8400 units z = 4200 units
E Block
Sales Budget (in Qty and Value)
Particulars X Y Z
Units to be Sold (WN – 3)
Selling Price Per unit
Estimated Sales (`)
| 499
Advanced Strategic
Cost Management
Class
WORK
Bintan-Indo Manufacturers Ltd. (BIML) is specialist in the manufacturing of Industrial Products. They
manufacture and market two types of products under the name ‘X’ and ‘Y’. Company produces two
products from three basic raw materials ‘A’, ‘B’, and ‘C’. Company follows a 13- period reporting cycle
for budgeting purpose. Each period is four weeks long and has 20 working days. Data relating to the
purchase of raw materials are presented below:
Purchase Price Standard Pur- Reorder Point Projected Inventory Status at Lead Time in
Raw Material
(Per Kg) chase Lot (Kg) (Kg) the end of 5th period (Kg) Working Days
On Hand On Order
A ` 1.00 90,000 72,000 96,000 90,000 10
B ` 2.00 30,000 45,000 54,000 - 25
C ` 1.00 60,000 60,000 84,000 60,000 20
Past experience has shown that adequate inventory levels for ‘X’ and ‘Y’ can be maintained if 40 per-
cent of the next period’s projected sales are on hand at the end of a reporting period. Other relevant
information is as follows:
Projected
Product Raw Material Specifications Inventory Projected Sales
Levels
At the end of
E Block
A B C current (5th) 6th Period 7th Period 8th Period

period
Kg Kg Kg Units Units Units Units
X 1.25 0.50 - 18,000 45,000 52,500 57,000
Y 2.00 - 1.50 16,800 42,000 27,000 24,000
The sales of ‘X’ and ‘Y’ do not vary significantly from month to month. Consequently, the safety stock
incorporated into the reorder point for each of the raw materials is adequate to compensate for varia-
tions in the sales of the finished products.
Raw materials orders are placed the day the quantity on hand falls below the reorder point. BIML’s
suppliers are very trustworthy so that the given lead times are reliable.
The outstanding orders for raw materials ‘A’ and ‘C’ are due to arrive on the 10th and 4th working day
of the 6th period, respectively. Payments for all raw material orders are remitted by the 10th day of
the delivery.
Required
Determine the following items for raw materials ‘A’, ‘B’, and ‘C’ for inclusion in the 6th period report to
management:
(i) Projected quantities (in Kg) to be issued to production.
(ii) Projected quantities (in Kg) ordered and the date (in terms of working days) the order is to be
placed.

Cost Management
Class
WORK
(iii) The projected inventory balance (in Kg) at the end of the period.
(iv) The payments for purchases with due date.
Functional Budget Inventory Control Techniques
E Block
| 501
Advanced Strategic
Cost Management
Home
WORK
A Co. manufactures two products X and Y. Product X requires 8 hrs to produce while Product Y requires
12 hrs. In April, of 22 effective working days of 8 hours a day, 1,200 units of X and 800 units of Y were
produced. The Co. employs 100 workers in production department to produce X and Y. The budgeted
hours are 1,86,000 for the year.
Calculate Capacity, Efficiency and Activity Ratio.
Budgetary Control Ratios

November, 2004
In a company, factory overheads are applied on the basis of direct labour hours. The following infor-
mation is given:
Department A Department B
E Block
Fixed Factory Overheads (`) 3,36,000 1,26,000

Variable Overheads per labour hour (` per hour) 0.50 1.50
Direct labour hours required as per direct labour hour budget
For product X 1,40,000 70,000
For Product Y 28,000 56,000
Prepare the product-wise budget for fixed and variable overhead costs.
Fixed Budget
May 2011

Cost Management
Home
WORK
The budgets for XYZ Ltd. for the first three quarters of operation are shown below :
Budget period
(` in ‘000)
Q-I Q-II Q-III
Activity:
Sales (units) 9 17 15
Production (units) 10 20 15
Costs:
Direct Material
A 60 120 90
B 50 100 75
Production Labour 180 285 230
Manufacturing Overheads (excluding depreciation) 90 120 105
Depreciation of Production Machinery 20 20 20
Administration Expenses 25 25 25
Selling & Distribution Expenses 38 54 50
The figures shown above represent the costs structure of XYZ Ltd., which have the following major
E Block
features. Fixed element of any cost is completely independent of activity levels:
(a) Any variable element of each cost displays a linear relationship with activity level, except that the
variable labour cost become 50% higher for activity in excess of 19,000 units per quarter due to
the necessity for overtime working.
(b) The variable element of selling and distribution expenses is a function of sales. All other costs
with a variable element are a function of production volume.
Activity for each quarter is spread evenly throughout that quarter. In Quarter IV Production level will
be set equal to sales level. Production and sales in this quarter is expected to range between 15,000
units and 21,000 units. The most likely volume is 18,000 units. In month 9 it will be possible to accu-
rately estimate the sales for Quarter IV.
Cost structure will remain the same as in Quarters I to III except the following:
a. Variable wage rate will rise by 12½%.
b. Variable labour input per unit of output will decrease, due to learning curve effect, such that 80%
of the previous labour input per unit of output will be required in Quarter IV. The threshold for
overtime working remains at 19,000 units per quarter.
c. Fixed factory overheads and the fixed element of selling and distribution costs will each rise by
20% (The variable element of selling and distribution costs will be unaltered).
Advanced Strategic
Home
WORK
Required:
(i) Prepare a Statement to show, under each cost classification given in the budgets, the variable
cost per unit and fixed costs which will be effective in Quarter IV.
(ii) Prepare a flexible budget of production costs for the Quarter IV.
Flexible Budget
Alpha Mills prepared the following budget for its department for 2010 - 11 for 12,000 unit of produc-
tion.
`
Raw material @` 3 per unit 36,000
Labour 2 hours/ unit @` 2.5 per hour 60,000
Production Overheads:
Power(variable) 3,000
E Block
Repairs (variable) 1,500

Indirect labour (80% variable) 2,400
Factory rent (fixed) 3,600
Factory insurance (fixed) 1,800
Other manufacturing expenses (50% variable) 600
Total production cost 1,08,900
You are required to present the flexible budget classified under fixed and variable costs for:
(a) Production of 10,000 units.
(b) Production of 15,000 units, for which raw material price increases by 10% for the entire quantity
and labour rate increases by ` 0.5 per hour for the full direct labour hours.
Flexible Budget
November, 2011

Cost Management
Home
WORK
A company is engaged in manufacturing two products M and N. Product M uses one unit of compo-
nent P and two units of component Q. Product N uses two units of component P, one unit of compo-
nent Q and two units of component R. Component R which is assembled in the factory uses one unit
of component Q. Components P and Q are purchased from the market. The company has prepared
the following forecast of sales and inventory for the next year:
Product M Product N
Sales (in units) 80,000 1,50,000
At the end of the year 10,000 20,000
At the beginning of the year 30,000 50,000
The production of both the products and the assembling of the component R will be spread out
uniformly throughout the year. The company at present orders its inventory of P and Q in quantities
equivalent to 3 months production. The company has compiled the following data related to two
components:
P Q
Price per unit (`) 20 8
Order placing cost per order (`) 1,500 1,500
Carrying cost per annum 20% 20%
E Block
Required:
(i) Prepare a Budget of production and requirements of components for next year.
(ii) Suggest the optimal order quantity of components P and Q.
Functional Budget Inventory Control

May, 2016
Solution
(i) Production Budget for Products / Budgeted Requirements of Components
Production Budget for Product M & N
Particulars ‘M’ Units ‘N’ Units

Inventory at the end of the year 10,000 20,000
Sales Forecast 80,000 1,50,000
Total Requirements 90,000 1,70,000
Less: Beginning Inventory 30,000 50,000
Production 60,000 1,20,000
Advanced Strategic
Home
WORK
Budgeted Requirements of Components ‘P’, ‘Q’ and ‘R’
Components ‘P’ ‘Q’ ‘R’

For Product ‘M’: Production 60,000 units
‘P’: 60,000 × 1 per unit 60,000 --- ---
‘Q’: 60,000 × 2 per unit --- 1,20,000 ---
For Product ‘N’: Production 1,20,000 units
‘P’: 1,20,000 × 2 per unit 2,40,000 --- ---
‘Q’: 1,20,000 × 1 per unit --- 1,20,000 ---
‘R’: 1,20,000 × 2 per unit --- --- 2,40,000
For comp ‘R’: Production 2,40,000 comp
‘Q’: 2,40,000 × 1 per component ‘R’ --- 2,40,000 ---
Total Requirements 3,00,000 4,80,000
(ii) Optimum Order Quantity

‘P’ ‘Q’
2 × 3, 00 , 000 × 1, 500 2 × 4 , 80 , 000 × 1, 500

EOQ EOQ
20 × 20% 8 × 20%
= 15,000 components = 30,000 components
E Block

Cost Management

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ADVANCED

For CA-CMA - Final Level

Contact No. ............................................................................................................................................................................................

S J C Registration No. : ........................................................................................................................................................................

Helpline: 033 2262 7126

Sl. No. Chapter Page No

Comparative Income Under Marginal Costing and Absorption

CVP Analysis 1. Basics

COST – VOLUME – PROFIT ANALYSIS

(c) Fixed costs do not change.

CURVILINEAR CVP ANALYSIS

238 |Advanced Strategic

Q 1 Ex. Book No. Pg. No.

The following details are given for a company:

Margin of Safety – ` 1,87,500 (7,500 units)

Reference What’s New

Break Even Analysis

Q 2 Ex. Book No. Pg. No.

Break Even Point ` 200 Crores

Reference What’s New

Break Even Analysis Variable Cost Calculation

Q 3 Ex. Book No. Pg. No.

The comparative profit statement of two quarters of a firm is as under:

Particulars Quarter I Quarter II

Reference What’s New

Break Even Analysis Breakup of total Overheads

Q 4 Ex. Book No. Pg. No.

240 |Advanced Strategic

Reference What’s New

Break Even Analysis Varying Level of Cost

Q 5 Ex. Book No. Pg. No.

For the year 2010, the following are expected:

Reference What’s New

Break Even Analysis Breakup of Total Overheads

Q 6 Ex. Book No. Pg. No.

Reference What’s New

Break Even Analysis with Probability

Q 7 Ex. Book No. Pg. No.

Reference What’s New

Break Even Analysis under uncertainty

242 |Advanced Strategic

Q 8 Ex. Book No. Pg. No.

PARTICULARS Company I Company II

Reference What’s New

Break Even Analysis in case of Merger Merged PV Ratio

Q 9 Ex. Book No. Pg. No.

Product % Sales Mix PV Ratio

Reference What’s New

Break Even Analysis with Multiple Combined PV Ratio

Q 10 Ex. Book No. Pg. No.

Reference What’s New

Break Even Analysis with multiple Combined PV Ratio

Q 11 Ex. Book No. Pg. No.

Reference What’s New

Break Even Analysis with Multiple Evaluation of Product Mix

244 |Advanced Strategic

Q 12 Ex. Book No. Pg. No.

Reference What’s New

Break Even Analysis with Multiple Application in Theatre

Q 13 Ex. Book No. Pg. No.

Actuals for Morning Estimates for Evening

Reference What’s New

Break Even Analysis with Opportunity