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Question: - PUMBA Que. Paper -302 MCS CASE IV Pike Enterprises has three operating divisions. The managers of these divisions are evaluated on their divisional operating income, a figure that includes an allocation of corporate overhead proportional to the revenues of each division. The operating income statement ($ in thousands) for the quarter of 1998 is as follows – A Division O Division T Division Total Revenues 2000 1200 1600 4800 Cost of Goods Sold 1050 540 640 2230 Gross Margin 950 660 960 2570 Divisional Overheads 250 125 160 535 Corporate Overheads 400 240 320 960 Divisional Operating Income 300 295 480 1075 The manager of A division is unhappy that his profitability is about the same as the O Division’s and is much less than the T Division’s , even though his revenues are much higher than either of these other two divisions. The manager knows that he is carrying one line of products with very low profitability. He was going to replace this line of business as soon as more profitable product
opportunities became available, but he has kept it because the line is marginally profitable and uses facilities that would otherwise be idle. That manager now realizes, however, that the sales from this product line are attracting a fair amount of corporate overheads because of the allocation procedure, and maybe the line is already unprofitable for him. This low-margin line of products had the following characteristics for the most recent quarter ($ in thousand): Revenues 800 Cost of Goods Sold 600 Avoidable Divisional Overhead 100 Required – 1. Prepare the operating income statement for Pike Enterprises for the second quarter of 1998. Assume that revenues and operating results are identical to the first quarter except that the manager of A Division has dropped the low margin product line from his product group. 2. Is Pike Enterprises is better off from this action? 3. Is the A Division manager better off from this action? 4. Suggest changes for Pike’s system of division reporting and evaluation that will motivate division managers to make decisions that are in the best interest of Pike Enterprises as a whole. Discuss any potential disadvantages of your proposal. Solution – 1. A Division O Division T Division Total Revenues 1200(2000-800) 1200 1600 4000 Cost of Goods Sold 450(1050-600) 540 640 1630 Gross Margin 750 660 960 2370 Divisional Overheads 150(250-100) 125 160 435 Corporate Overheads 288[(1200/4000)*960] 288 384 960 Divisional Operating 312 247 416 975 Income 2. From the Pike Enterprises’s point of view dropping of a product by A Division is not an appropriate decision. Because this options reduces the company’s profitability from 1075 to 975. Therefore the company should be better off from this decision. 3. Though it is apparent from the financial results of the A Division that the procedure of allocating the corporate overheads is really taxing on its performance. But in view of company’s overall profitability its decision to drop a product line is not a better decision. Therefore A Division should be better off from this action. 4. A Division to continue with the unprofitable product some relief should be provided to this division. As regards the reporting and evaluation of divisional performance the present system is quite good however to pave out a way for the exceptional situation it is suggested that the corporate overhead should be charged in proportion to the controllable profits of the divisions, which appears to be a reasonable option of corporate overhead allocation. A Division Revenues Cost of Goods Sold Gross Margin 2000 1050 950 O Division 1200 540 660 T Division 1600 640 960 Total 4800 2230 2570
Divisional Overheads Controllable Profit Corporate Overheads Divisional Operating Income
250 700 330 370
125 535 252 283
160 800 377 423
535 2035 960 1075
=================================== File name - Practical Problems on RC.xls 21.1. XYZ Co. Ltd. Is a multidivisional company. One of its divisions has suffered losses in the first half of the year. The sales and cost data for the said division is given as under. You are required to prepare a performance report for the said division. Also advise the management whether to allow the division to continue Amount in Rs. Sales 825000 Controllable Variable Costs 420000 Controllable Fixed Costs 255000 Attributable Segment Costs 75000 Common firm wide cost 95000 allocated to division Profit/Loss -20000 Solution – Performance Report Particulars Amount in Rs. Sales 825000 Less Controllable Variable Costs 420000 Controllable Contribution margin 405000 Less Controllable Fixed Costs 255000 Controllable Segment Margin 150000 Less Attributable Segment Costs 75000 Segment profit contribution 75000 Less Common firm wide cost 95000 Profit/Loss -20000 21.2 The Himalaya Chem. Ltd. has the following operating results for the current year Sales Revenue Less Variable Costs Contribution Less fixed Costs Net Income 5150000 3565000 1585000 800000 785000
Following additional information is available about the proportional results of Himalaya - of the three divisions Divisions X Y Z 205000 Sales Revenue 0 1625000 1475000 146500 Variable Costs 0 1150000 950000 Direct fixed Costs 250000 190000 175000 Find the relative profitability of the three divisions and rank them accordingly. There is a proposal to increase the advertisement expenses by Rs. 100000, which is expected to give additional sales of 10% in all three divisions in that year. Compute the effect of this proposal on individual divisions as also on firm as a whole. The firm's practice as regards expenses is allocation of advertisement is in the proportion of the addition in sale of the divisions and allocated to the divisions as attributable fixed costs. Advice whether the company should go for this advertisement campaign. In case this advertisement campaign gives similar benefits for next three years, what will be your decision? Solution – Performance Evaluation report – X Y Z Firm 2,050,00 1,625,00 1,475,00 Sales Revenue 0 0 0 5,150,000 1,465,00 1,150,00 Less Controllable Variable Costs 0 0 950,000 3,565,000 Controllable Contribution margin 585,000 475,000 525,000 1,585,000 Less Controllable Fixed Costs 250,000 190,000 175,000 615,000 Segment Profit Contribution 335,000 285,000 350,000 970,000 Less Firm Wide Costs 185000 Net Income 785,000 Segment Profit as % of sales 16.3 17.5 23.7 Performance Evaluation report - After Considering Advertisement proposal - Advertisement expenses Rs. 1,00,000 X Y Z Firm 2,050,00 1,625,00 1,475,00 Sales Revenue - Existing 0 0 0 5,150,000 Add Additional Sales 205000 162500 147500 515000 2,255,00 1,787,50 1,622,50 Total sales 0 0 0 5,665,000 1,265,00 1,045,00 Less Controllable Variable Costs 1,611,500 0 0 3,921,500 Controllable Contribution margin 643,500 522,500 577,500 1,743,500 Less Controllable Fixed Costs 250,000 190,000 175,000 615,000
Advt. Cost Segment Profit Contribution Firm Wide Costs Net Income Segment Profit as % of sales Rankings
28,641 100,000 373,859 1,028,500 185,000 843,500 23.0 1
Though the added advertisement expenditure does not improve the Segments profit performance in comparison with the sales but in total there is growth in the profit of the firm by 58,500 which is more than the advertisement expenses hence not acceptable. In case this campaign is going go give benefits for three years the proposal is acceptable. 21.6 In M/s Bitman Tiles Ltd. The sales manager’s performance is judged by the sales he generates. The Performance is compared with the budgeted sales for evaluation purpose. The sales targeted and actual are given as under for the current year Products 3 Color Vitrified Total 890000 1475000 2875000 420000 650000 1395000 470000 825000 1480000 1200000 600000 3300000
Budgeted Sales Variable Costs Contribution Actual Sales
2 Color 510000 325000 185000 1500000
There is no change in actual and budgeted prices as well variable costs per unit. Find how do you rate sales manager's performance? Support with computations. Suggest better performance measure for the firm in this regard. Products 2 Color 3 Color Vitrified Total 1385000 1190000 575000 3150000 882598 502402 36.27 561573 628427 52.81 253390 321610 55.93 1697561 1452439 46.11
Actual Sales Less Variable Costs
(In proportion of Budgeted sales to Variable Costs with Actual sales)
Contribution Contribution Margin Ratio
Though there is increase in the sales volume from rs. 2875000 to 3150000, there is decline in the contribution margin from Rs1480000 to Rs. 1452439; the main reason behind this deviation is unexpected cahnges in the sales mix. Budgeted profitable mix has changed to relatively less profitable actual mix. This has lead to change in weighted average contribution margin from51.48 % to 46.11 %. In real terms the sales manager did not perform well as planned. This obviously spells that mere reliance on sales data may prove misleading. Therefore sales manager may be judged against Sales minus Budgeted Variable Costs and Actual Selling Costs. This will ensure that
charging the actual variables against sales may pass on the inefficiency of the production function to sales function, and thereby it may undermine sales manager's performance. Illustration 1 – MCS Book -Incremental Analysis Illustration 12 – MCS Book - PUMBA May 2005 Illustration – 9 - MCS Book - Profitability - Diamond Co Ltd.
21.9 Budgeted revenue and costs and actual of Bombay Co. Ltd's three products Prod1, Prod2 & Prod3 for the current year ending March 31, given as under – Budgeted Particular Sales Controllable variable Cost Controllable Contribution Margin Common Fixed Cost Profit Actual Particular Sales Less Discount Net Sales Controllable Variable Cost (Manufacturing and sales) Controllable Contribution Margin Common Fixed Cost Profit (Amount Rs. In Lakhs) Prod1 Prod2 Prod3 Company 1,000 600 400 2,000 500 360 280 1,140 500 240 120 860 660 200
Prod1 660 20 640 332
Prod2 660 0 660 400
Prod3 Company 880 2,200 0 20 880 2,180 620 1,352 0 260 828 670 158
During the initiatives have been undertaken to enhance the sales of Prod1 by granting special discounts on bulk orders and additional allocation is made for advertisement and sales promotion expenses of Rs. Based on the above data prepare the analytical report on changes in income so as to help the management to cats the responsibility using contribution approach. Note there is no change in selling price. Solution – Statement Showing Changes in Income I) Effect on Contribution due to Increase in sales (2200-2000)*(860/2000)
II) Effect of Special Discount III) Effect of Sales Mix Variance on Income (Computed as under) Budegted Contribution 2200* (860/2000) Less Actual Contribution Prod1 660 * (500/1000) Prod1 660 * (240/600) Prod1 880 * (120/400) Sales Mix Variance (Adverse) IV) Effect of Variable Cost Variance Actual Variable Cost Budgeted Variable Cost Prod1 660*( 500/1000) Prod2 660*(360/600) Prod3 880*(280/400) Variable Cost Variance (Adverse) Net Change in Income (Decrease) Decrease in Contribution Net Increase in Advertisement Costs Increase in Common Fixed Costs Decrease in Net Inome PGDBM Paper May 2007
20 88 946 330 264 264 858 88 10 1,35 2 330 396 616 1342 10 86 118 32
32 0 10 42
Case 2 – Du Pont & Company has two divisions. South division manufactures an intermediate product for which there is no external market. North division incorporates this intermediate product into a final product which it sells. One unit of intermediate product is used for each unit of final product. The expected units of final product, which north division estimates it can sell at various selling prices are as follows – Unit Selling Price 100 90 80 70 Sales Quantity(Units) 1000 2000 3000 4000
The cost of each division is as follows – South North Variable Cost p.u. Rs. 11 7 Fixed Cost per annum Rs. 60000 90000 The transfer price of the intermediate product determined on cost plus basis is Rs. 35 p.u. You are required to: a. Prepare profit statement for each division as well as for the total company for the various selling prices. b. State which selling price maximizes the profit of the North division and the Company as whole.
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