Question

Champion Industries Limited is a company that has in stock, some units of a partially processed item ExWy.
It has a cost Rs. 75,000 but that is now obsolete and has a scrap value of only Rs. 21,000. Other than selling
ExWy for scrap, there are only two alternative uses:
Alternative A:
Converting entire stock of ExWy into a specialized product Gamma, which would require the following
additional total work and materials.
Material A 600 Kgs
Material B 1,000 Kgs
Direct labor Unskilled 5,000 hours
Semi-skilled 5,000 hours
Highly skilled 5,000 hours
Extra selling and delivery expenses Rs. 27,000
Extra Advertising Rs. 18,000

The conversion would produce 900 units of Gamma, and these could be sold for Rs. 300 per unit.
Material A is already in stock and is widely used within the company.
Material B is also in stock but it is unlikely that any additional supplies can be obtained for some
considerable time because of an industrial dispute. At the present time Material B is normally used in the
production of Product Z which sells at Rs. 390 per unit and incurs total variable cost (excluding material
B) of Rs. 210 per unit. Each unit of Product Z uses four Kgs of Material B.
The detail of Material A and B are as follows:
Material A Material B
(Rs.) (Rs.)
Historic cost at time of purchase 100 per Kg 10 per Kg
Net realizable value 85 per Kg 18 per Kg
Replacement cost 90 per Kg ………

Alternative B:
ExWy can be converted into a component Delta that is regularly used within the company for production
of various industrial products. Details of the extra work and material which would be required for
conversion of ExWy into Delta are as follows.
Material C 1000 Kgs
Direct labor Unskilled 4,000 hours
Semi-skilled 1,000 hours
High skilled 4,000 hours
1200 units of Delta are regularly purchased per quarter at a cost of Rs. 900 per unit. The conversion of
currently available ExWy would reduce the quantity of Delta to be purchased to 900 units for the next
quarter only. However, since the volume purchased would be reduced some discount would be lost, and
the price of those purchased from the outside would increase to Rs 1,050 per unit for that quarter.

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Material C is not available externally but is manufactured by Champion Industries Limited. The standard
cost per Kg of Material C would be as follows.
(Rupees)
Direct labor, 6 hours unskilled labor 18
Raw material 13
Variable overhead, 6 hours at Rs. 1 per hour 6
Fixed overhead, 6 hours at Rs3 18
55
Other general information:
The wage rate and overhead recovery rates are as follows:

Variable overhead Rs. 1 per direct labor hour.

Fixed overhead Rs. 3 per direct labor hour
Unskilled Labor Rs. 3 per direct labor hour
Semi-skilled Rs. 4 per direct labor hour
High skilled Rs. 5 per direct labor hour

The unskilled labor is employed on a casual basis and sufficient labor can be acquired to exactly meet the
production requirements. Semi-skilled labor is part of the permanent labor force but the company has
temporary excess supply of this type of labor at present time.

Highly skilled labor is in short supply and cannot be increased significantly in the short term. This labor is
presently engaged in meeting the demand for Product Y, which requires 4 hours of highly skilled labor.
The contribution from the sale of one unit of Product Y is Rs. 24.
Required
Advise about the best course of action in respect of available stock of ExWy.

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Solution
(i) – Immediate sale
Rs.
Net sale value 21,000

(ii) – Special product Gamma

Rs.
Sales [Rs. 300 x 900] 270,000
Material A [Rs. 90 x 600] (54,000)
Material B (W-1) (45,000)
Direct labor:
Unskilled [Rs. 3 x 5,000] (15,000)
Semi skilled -
Highly skilled (W-2) (55,000)
Variable OH [Rs. 1 x (5,000 + 5,000 + 5,000)] (15,000)
Extra selling and delivery expenses (27,000)
Extra advertising (18,000)
41,000

(iii) – Material Delta conversion

Rs.
Cost saving (W-3) 135,000
Material C (W-4) (37,000)
Direct labor:
Unskilled [Rs. 3 x 4,000] (12,000)
Semi skilled -
Highly skilled [Rs. 11(W-2) x 4,000] (44,000)
Variable OH [Rs. 1 x (4,000 + 1,000 + 4,000)] (9,000)
33,000
Conclusion:
Production of special product is most profitable option

W-1 Since it cannot be purchased for some considerable time and stock in hand must be used,
therefore, its opportunity cost is relevant.
Rs.
Sale alternative 18.00
Contribution lost per unit 45.00
[(Rs. 390 - Rs. 210)/4]
Total relevant cost 45,000
[Rs. 45 x 1,000]

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W-2 Rs.
Contribution lost per hour [Rs. 24/4] 6.00
Wage rate 5.00
11.00
Total relevant cost 55,000
[Rs. 11 x 5,000]

W-3
Rs.
Saving of purchase cost of 300 units [300 x Rs. 900] 270,000
Loss of discount on remaining purchases (135,000)
[(1,200 - 300) x (Rs. 1,050 - Rs. 900)]
135,000

W-4 Rs.
Since material C is internally manufactured, its relevant cost will
be variable manufacturing cost only [Rs. 55 - Rs. 18] 37.00

Total relevant cost [Rs. 37 x 1,000] 37,000

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