STRATERGIC COST

MANAGEMENT

ANSWER: 1

We will use the given data and apply the appropriate formulas to calculate the required
informa on for the watch showroom. Let's start the calcula ons:

a) Allowance: Allowance refers to the amount that remains a er deduc ng variable costs
from sales revenue. It represents the amount available to cover fixed costs and generate
profit. The formula for the post is:
Contribu on = Sales – Variable Costs
Given: Selling price per unit = Rs. 9800 Variable cost per unit = Rs. 4905
Contribu on per unit = Selling price per unit - Variable cost per unit = Rs. 9800 - Rs.4905 =
Rs. 4895

b) Profit-Volume Ra!o (PV): Profit-Volume Ra o (PV) is the ra o of contribu on to

sales and represents the percentage of each rupee of sales contribu ng to cover fixed costs
and generate profit. The formula for the PV ra o is:
PV ra o = (contribu on / sales) × 100
Given: Contribu on per unit = Rs. 4895 Selling price per unit = Rs. 9800
PV Ra o = (Unit Contribu on / Unit Selling Price) × 100 = (Rs 4,895 / Rs 9,800) × 100 ≈ 50%
c) BE Ra!o (Break-even Ra!o): Break-even Ra o (BE) is the ra o of break-even sales to
total sales and represents the percentage of sales required to cover all costs, resul ng in
zero profit or loss. The formula for the BE ra o is:
BE ra o = (breakeven sales / total sales) × 100
To calculate the BE ra o in units, we need to determine the breakeven point. The formula for
the breakeven point in units is:
Breakeven point (in units) = fixed cost / contribu on per unit
Given: Fixed costs:
• Rent per month = Rs. 100,000
• Wages per month = Rs. 120,000
Fixed expenses = rent per month + salaries per month = Rs. 100,000 + Rs.120,000 = Rs.
220,000
Breakeven point (in units) = Rs. 220,000 / Rs. 4895 ≈ 45 units (rounded to nearest whole
number)
To calculate the BE ra o in value terms, we divide break-even sales by total sales:
Breakeven sales (in value) = Breakeven point (in units) × Selling price per unit = 45 units × Rs.
9800 = Rs. 441,000
BE Ra o (in Value) = (Breakeven Sales / Total Sales) × 100 = (Rs 441,000 / Rs 600,000) × 100 ≈
73.5%

d) Margin of Safety (MOS) on actual sales of Rs. 600,000: Margin of safety (MOS)
is the amount by which actual sales exceed turnover sales. It refers to the cushion that is
available before the business starts to incur a loss. The formula for MOS is:
MOS = Actual Sales - Break-even Sales
Given: Actual Sales = Rs. 600,000 Breakeven Sales = Rs. 441,000
MOS = Rs. 600,000 - Rs.441,000 = Rs. 159,000

e) Number of watches to be sold to earn a profit of Rs. 20,000: To calculate the

number of watches needed to achieve the target profit, we need to consider both fixed and
variable costs. The formula for calcula ng the required number of units is:
Required number of units = (target profit + fixed costs) / contribu on per unit
Given: Target profit = Rs. 20,000 Fixed Cost = Rs. 220,000 contribu on per unit = Rs. 4895
Number of units required = (Rs.20,000 + Rs.220,000) / Rs. 4895 ≈ 49 units (rounded to
nearest whole number)

In conclusion:
Based on the given data and calcula ons for the watch showroom, we have established the
following informa on: a) Contribu on per unit: Rs. 4895 b) PV ra o: 50% c) BE ra o (in
units): 45 units BE ra o (in value): 73.5% d) MOS on actual sales Rs. 600,000: Rs 159,000 e)
Number of watches to be sold to earn a profit of Rs. 20,000: 49 units
 ANSWER: 2

In order to allocate costs to the three types of footwear (A, B, and C) using tradi onal cos ng
methods and ac vity-based cos ng, we must analyze the cost drivers associated with each
ac vity and determine the alloca on base for each cost. Let's con nue the calcula ons and
comparisons:

Tradi!onal cos!ng method: The tradi onal cos ng method allocates costs based
on a predetermined alloca on base, such as direct labor hours or machine hours. In this
case, we allocate costs based on the number of switches for shi costs, machine hours for
plant overhead, and number of receipts/packages for packaging costs. Engineering costs and
supervision costs will be allocated on the basis of direct labor hours for simplicity.

a) Shi3 cost: Total shi cost = Rs. 50,000 Alloca on base = Number of switches
Cost allocated to A = (3/9) * Rs. 50,000 = Rs. 16,667 Cost allocated to B = (4/9) * Rs. 50,000 =
Rs. 22,222 Cost allocated to C = (2/9) * Rs. 50,000 = Rs. 11,111

b) Factory overhead: Total factory overhead = Rs. 100,000 alloca on base = machine
hours
Cost allocated to A = (20/53) * Rs. 100,000 = Rs. 37,736 Cost allocated to B = (18/53) * Rs.
100,000 = Rs. 33,962 Cost allocated to C = (15/53) * Rs. 100,000 = Rs. 28,302

c) Packing cost: Total packing cost = Rs. 20,000 Alloca on base = Number of
receipts/packages
Cost allocated to A = (4/17) * Rs. 20,000 = Rs. 4,706 Cost allocated to B = (5/17) * Rs. 20,000
= Rs. 5,882 Cost allocated to C = (8/17) * Rs. 20,000 = Rs. 9,412

d) Engineering Cost: Total Engineering Cost = Rs. 30,000 alloca on base = technical hours
Cost allocated to A = (30/120) * Rs. 30,000 = Rs. 7,500 Cost allocated to B = (40/120) * Rs.
30,000 = Rs. 10,000 Cost allocated to C = (50/120) * Rs. 30,000 = Rs. 12,500
e) Cost of Supervision: Total cost of supervision = Rs. 10,000 alloca on base = hours
spent by supervisor
Cost allocated to A = (10/32) * Rs. 10,000 = Rs. 3,125 Cost allocated to B = (12/32) * Rs.
10,000 = Rs. 3,750 Cost allocated to C = (10/32) * Rs. 10,000 = Rs. 3.125

Ac!vity-Based Cos!ng (ABC): The ac vity-based cos ng method allocates costs

based on the ac vi es that drive the costs, rather than using arbitrary alloca on bases. It
involves iden fying cost drivers and assigning costs to each ac vity based on their
consump on. In this case, we will consider number of switches for shi cost, machine hours
for manufacturing overhead, number of receipts/packages for packaging cost, engineering
hours for engineering cost, and supervisory hours for supervisory cost.

a) Shi3 cost: Total shi cost = Rs. 50,000 Number of switches for A = 3 Number of switches
for B = 4 Number of switches for C = 2
Cost allocated to A = (3/9) * Rs. 50,000 = Rs. 16,667 Cost allocated to B = (4/9) * Rs. 50,000 =
Rs. 22,222 Cost allocated to C = (2/9) * Rs. 50,000 = Rs. 11,111

b) Factory overhead: Total factory overhead = Rs. 100,000 machine hours for A = 20
machine hours for B = 18 machine hours for C = 15
Cost allocated to A = (20/53) * Rs. 100,000 = Rs. 37,736 Cost allocated to B = (18/53) * Rs.
100,000 = Rs. 33,962 Cost allocated to C = (15/53) * Rs. 100,000 = Rs. 28,302

c) Packing cost: Total packing cost = Rs. 20,000 Number of receipts/packages for A = 4
Number of receipts/packages for B = 5 Number of receipts/packages for C = 8
Cost allocated to A = (4/17) * Rs. 20,000 = Rs. 4,706 Cost allocated to B = (5/17) * Rs. 20,000
= Rs. 5,882 Cost allocated to C = (8/17) * Rs. 20,000 = Rs. 9,412

d) Engineering Cost: Total Engineering Cost = Rs. 30,000 engineering hours for A = 30
engineering hours for B = 40 engineering hours for C = 50
Cost allocated to A = (30/120) * Rs. 30,000 = Rs. 7,500 Cost allocated to B = (40/120) * Rs.
30,000 = Rs. 10,000 Cost allocated to C = (50/120) * Rs. 30,000 = Rs. 12,500

e) Cost of Supervision: Total cost of supervision = Rs. 10,000 supervisor hours spent on A
= 10 supervisor hours spent on B = 12 supervisor hours spent on C = 10
Cost allocated to A = (10/32) * Rs. 10,000 = Rs. 3,125 Cost allocated to B = (12/32) * Rs.
10,000 = Rs. 3,750 Cost allocated to C = (10/32) * Rs. 10,000 = Rs. 3.125

Comparison and Discussion: By comparing the results obtained from the

tradi onal cos ng method and the ac vity-based cos ng (ABC) method, we can observe the
following:

1. Tradi!onal cos!ng method: The tradi onal cos ng method allocates costs based on
predetermined alloca on bases such as machine hours and number of receipts/packages.
This method assumes that these alloca on bases directly drive costs. However, it does not
take into account the different cost factors associated with each ac vity.

2. Ac!vity-Based Cos!ng (ABC): The ABC method allocates costs based on the
ac vi es that drive the cost, considering different cost drivers for each ac vity. It provides a
more accurate and detailed cost alloca on because it takes into account the specific
ac vi es that consume resources.

3. Differences in cost alloca!on: By comparing the cost alloca ons between the two
methods, we can see that the ABC method takes into account the specific cost drivers
associated with each ac vity, resul ng in different cost alloca ons compared to the
tradi onal method.

4. Increased cost accuracy: The ABC method provides a more accurate representa on
of the costs incurred for each type of footwear because it takes into account the actual
ac vi es and their respec ve cost drivers. This provides a beLer understanding of the cost
structure and helps iden fy areas where costs can be managed and reduced more
effec vely.

5. Insights into cost management: By u lizing the ABC method, a company can
iden fy ac vi es that contribute significantly to costs and focus on managing these ac vi es
more effec vely. It provides insight into cost drivers and helps make informed decisions
about resource alloca on, process improvement and product pricing.

6. Complexity and implementa!on: Implementa on of the ABC method requires

more effort and resources compared to tradi onal cos ng. It includes ac vity analysis,
iden fica on of cost drivers and crea on of cost groups. However, the benefits of more
accurate cost alloca on and cost management insights jus fy the extra effort.

In conclusion:
A comparison between tradi onal cos ng and ac vity-based cos ng shows that ABC
provides a more accurate and detailed cost alloca on by considering the specific cost factors
associated with each ac vity. It enables beLer visibility into cost management and helps
iden fy areas for improvement. Although ABC can be more complex to implement, the
benefits gained in terms of cost accuracy and strategic cost management make it a valuable
approach for a company.
 ANSWER: 3A

To draw up a cash budget, we need to es mate cash inflows and ouOlows based on the
given informa on. A cash budget helps in managing and planning cash flow and ensures that
the company has enough liquidity to meet its obliga ons and make strategic decisions. Let's
calculate the cash budget based on the data provided:

1. Cash Inflows: We calculate cash flows by mul plying sales units by the sales price of
each product.
Journal Cash Inflow = Sales Units x Sales Price = 8,750 x Rs. 80 = Rs. 700,000 Cash flow from
laptop = units sold x selling price = 12,500 x Rs. 64 = Rs. 800,000 Cash inflow from Spiral
Bound = units sold x selling price = 5,000 x Rs. 100 = Rs. 500,000
Total cash inflow = Rs. 700,000 + Rs. 800,000 + Rs. 500,000 = Rs. 2,000,000

2. Cash ou<lows:
a) Variable costs: We calculate variable costs by mul plying sales units by variable costs
per unit for each product.
Variable cost per journal = Sales units x Variable cost = 8,750 x Rs. 20 = Rs. 175,000 Variable
cost of laptop = units sold x variable cost = 12,500 x Rs. 23 = Rs. 287,500 Variable Cost of
Spiral Binding = Sales Units x Variable Cost = 5,000 x Rs. 35 = Rs. 175,000
Total variable cost = Rs. 175,000 + Rs. 287,500 + Rs. 175,000 = Rs. 637,500

b) Fixed costs: Fixed costs are listed for each product.

Total Fixed Cost = Rs. 65,000 + Rs. 140,000 + Rs. 95,000 = Rs. 300,000

c) General overhead alloca!on: General overhead alloca on is given for each product.
Total General Overheads Alloca on = Rs. 280,000 + Rs. 320,000 + Rs. 200,000 = Rs. 800,000
Total Cash Flows = Total Variable Costs + Total Fixed Costs + Total General Overhead
Alloca on = Rs. 637,500 + Rs. 300,000 + Rs.800,000 = Rs. 1,737,500

3. Net Cash Flow: Net Cash Flow = Total Cash Flow - Total Cash Flow = Rs. 2,000,000 -
Rs.1,737,500 = Rs. 262,500
4. Beginning and Ending Cash Balance: We have to consider the beginning cash
balance (if any) and calculate the ending cash balance.
Opening Cash Balance = Rs. X (Given Opening Cash Balance) Closing Cash Balance = Opening
Cash Balance + Net Cash Flow = Rs. X + Rs. 262,500

In conclusion:
The cash budget shows that the company has es mated a total cash inflow of Rs. 2,00,000
and a total cash ouOlow of Rs. 1,737,500. This results in a net cash flow of Rs. 262,500. The
ending cash balance will be the sum of the opening cash balance (if any) and the net cash
flow. Managing cash flow through a cash budget helps in planning liquidity needs, making
strategic decisions and ensuring the smooth running of the business.
 ANSWER: 3B

When deciding whether to replace a machine, it is crucial to iden fy the relevant

informa on that directly influences the decision-making process. Let's analyze the
informa on provided to determine which is relevant and which is not:

1. Deprecia!on of exis!ng machinery (Rs. 25,000/- p.a.): This informa on is

relevant as it represents the cost associated with the exis ng machinery. Deprecia on
expense reflects the deprecia on of a machine over me and is an important factor to
consider in cost analysis.

2. Cost of new machine (Rs. 45000/-): This informa on is relevant as it represents the
expenditure required to acquire a new machine. The cost of a new machine is essen al to
evaluate the ini al investment and compare it to the benefits and savings of using the new
machine.

3. Increase in energy cost due to new machine (Rs.5000/- p.a.): This informa on
is relevant as it represents the cost that will be incurred if the new machine is used. The
increase in energy costs is an opera ng cost that must be taken into account when
comparing the total cost of running exis ng and new machinery.

4. Rent of factory building (Rs. 60,000/- p.a.): This informa on is irrelevant for
deciding whether to replace the machine. Ren ng a factory building is a fixed price that
remains the same regardless of the machine used. It does not directly affect the decision-
making process for replacement decisions.

5. Scrap value of old machine (Rs. 4000/-): This informa on is relevant as it

represents the es mated value of the exis ng machine at the end of its useful life. Scrap
value is a factor to consider when evalua ng the total cost of replacing a machine, as it
represents the poten al offset of the ini al investment in a new machine.

In conclusion:
The relevant informa on for the decision process of whether to con nue with the exis ng
machine or use a new one includes the deprecia on of the exis ng machine, the cost of the
new machine, the increase in energy costs due to the new machine, and the scrap value of
the old machine. These factors directly affect the costs and benefits associated with the
decision and should be carefully considered in order to make an informed and strategic
decision regarding machine replacement. On the other hand, the rent of the factory building
is irrelevant to this par cular decision because it remains the same regardless of the
machine used.