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Differential Costing

Differential Costing

Differential cost is the change in cost which may result from adopting an alternative course of action in the level of activity which may change in fixed cost or variable cost.

**Characteristics of Differential Costing
**

Differential cost analysis is not made within the accounting records rather it is made outside the accounting records. Total differential cost are considered in differential cost analysis. Cost per unit is not taken into consideration. Total differential revenues are compared with total differential cost before advocating an alternative course of action. The item of cost which do not change for the alternatives under differential costing. Under differential cost analysis the differential costs are considered and not cost per unit.

**Uses and Applications
**

Accept or reject decision. Sell or further sell decision. Continue or shut down decision. Extend or reduce capacity decision Pricing decision Sales Mix

**A) Accept or Reject decision(Practical)
**

A manufacturer is operating at 50% of its capacity due to competition. The following are the detailsRaw material- Rs 6 per unit. Direct Labour- Rs 4 per unit. Variable overhead- Rs 3 per unit. Fixed overhead- Rs 2 per unit. Total-Rs 15. Output - 15000 units. Total cost - Rs 225000. Sales value - Rs 210000. Loss - Rs 15000.

Contd.

A foreign customer to buy 6000 unit at Rs 13.50 per unit and the company does not know whether to accept or reject as it is suffering losses at the current level. Advise what should be done?

Solution

Existing level (15000) 210000 90000 60000 45000 195000 New Total Order (6000) (21000) 81000 291000 36000 24000 18000 78000 126000 84000 63000 273000

Sales(A) Variable Cost Raw material Labour Variable Overhead Total VC(B)

Contd.

Contribution(A-B) - FC 15000 3000 18000 30000 30000 15000 3000 12000 (loss) (profit) (loss) The offer can be accepted as it is reducing the loss by Rs 3000.

Practical-2

I took the order for 5000 at Rs 50 each because I get more than the cost incurred to produce them said the Works Mgr and produced the following Particulars B4 accepting order After Rs accepting the order VC 250000 400000 FC 750000 851000 Total Cost 1000000 1251000

Contd.

Cost per unit 40 41.70

Analyze the figure and the decision taken.

**Sell or Further process decision(Practical)
**

A manufacturing co. is evaluating two possible processes for the manufacturing of a component. The following data is made availableProcess X Process Y per unit per unit Selling Price 20 20 VC 12 14 Total Fixed cost 3000000 2100000 Output Capacity in units 430000 500000

Contd.

Expected sales in unit in next 2 yrs 400000 400000 You are required to suggest a) Which process should be taken? b) Would you change your answer as given above if you were informed that the capacities of the two process as follows X= 600000 units and Y= 500000 units? Why? Substantiate your answer.

Solution

Comparative Profitability Statement Particulars Process X Process y a)SP per unit 20 20 - VC per unit 12 14 Contrn per unit 8 6 Total C in Rs 3200000 2400000 - Total FC 3000000 2100000 Profit 200000 300000

Contd.

If total capacity Is utilized and sold Contribution 3440000 3000000 - Total FC 3000000 2100000 Profit 440000 900000 Comment a) Process y can be chosen as it gives higher profit (if present capacity is utilized and sold). b) Process X can be chosen if its capacity is increased i.e.

Contd.

Contribution at 600000 Unit for X - Fixed Cost Profit Contribution at 500000 Units - Fixed Cost Profit Process X 4800000 3000000 1800000 Process Y 3000000 2100000 900000

**Continue or Shut Down Decision
**

A manufacturing company has three product line A, B and C. The company management requested an income statement by product line and received the followingsA B C Total Sale 400000 100000 300000 800000 Less- Cost of goods sold 250000 60000 200000 510000 Gross Profit 150000 40000 100000 290000 Operating Exp. 130000 70000 80000 280000 Net Profit/Loss 20000 -30000 20000 10000

Contd.

The Company President and principal shareholder argued that such an analysis is misleading and he requested further information about the company s operating exp. He was given the following detailsA VariableOperating exp. Total Fxd OE 110000 B 30000 C 50000 Total 190000 90000 280000

Contd.

You are requested to prepare an income statement showing the contribution by pdt covering the company s fixed cost. Would you recommend discontinuance of pdt. B Soln-Cost of goods sold is MC or VC.

Particulars Sale(A) Variable/Marginal Cost Variable erating VC/MC(B) Contribution(A-B) Fixed A 400000 250000 110000 360000 40000 B 100000 60000 30000 90000 10000 C 300000 200000 50000 250000 50000 Total 800000 510000 190000 700000 100000 90000 10000

Comment

If pdt B is discontinued then Contribution is Rs(100000-10000)= Rs 90000 and fixed cost is Rs 90000. Therefore there will be no profit or loss. If pdt b is continued it gives a profit of Rs 10000(as per statement). So it is advisable to continue B instead of discontinuance.

**Extend or Reduce Capacity Decision
**

A company engaged in plantation activities has 200 hectares of virgin land, which can be used in growing jointly or individual tea, coffee, and cardamom. The yield per unit hectare of different crops and their selling price per kg are as under:Particulars Yield(kg) Selling Price(Rs) Tea 2000 20 Coffee 500 40 Cardamom 100 250

Contd.

The relevant cost data are given belowVC/kg Tea Coffee Cardamom Labor Chrg 8 10 120 Packing chrgs 2 2 10 Other Cost 4 1 20 Total 14 13 150

Contd.

Fixed Cost Per Annum Cultivation & growing cost Admin. Cost Land Revenue Repairs & Maintenance Other Cost RS 1000000 200000 50000 250000 300000 1800000

Contd.

The policy of the company is to produce and sell all kinds of commodities and the maximum and minimum are to be cultivated per commodity is as followsCommodity Max Min Tea 160 120 Coffee 50 30 Cardamom 30 10 Calculate the most profitable pdt mix and max profit which can be achieved.

Solution

Solno S ont i ution ont i n on i l ot l ont i ution K to t llot ot l i l o

t

Contd.

Total Contribution= Rs 2455000 (Tea+Coffee+Cardamom) - Fixed Cost = Rs 1800000 Profit = Rs 655000

Pricing Decision

A television manufacturing company find that in 1984 it cost them Rs 616000 to manufacture 200 sets of TV which are sold at Rs 4000 eachCost was made up of RS Material 200000 Direct Wages 300000 Factory Overhead 60000 Office Overhead 56000

Contd.

For 1985 they estimated:a) That each TV set will require material Rs 1000 and wages Rs 1500. b) That the factory overhead expenses will bear the same relation to the direct wages as in the previous year. c) The %age of office overhead exp on factory cost will be the same as in the previous yr. Prepare a statement showing the profit they should make per unit if they enhance the price of the TV by Rs 80.

Solution

Soln:Cost Particular 1984 unit cost Material 1000 Direct Wages 1500 Factory Overhead(20% of DW) 300 Office Overhead(10% of Factory Cos 280 Cost of production 3080 Profit 920 Sales 4000 Profitability Statement 200 TV Amt 1985 per unit cost 200000 1000 300000 1500 60000 300 56000 280 616000 3080 184000 1000 800000 4080

Contd.

Selling Price enhanced by Rs 80/-. Therefore Price= Rs(920+80)= Rs 1000. 10% of Factory Cost= 200000+300000+60000= 560000*10/100= 56000. Therefore 56000/200= 280 each.

Sales Mix

Following information has been made available from the cost record of United Automobiles manufacturingDirect Material Rs Per Unit X 8 Y 6 Wages X 24 hrs@ 25p/hr Y 16 hrs@ 25p/hr Variable Overhead X Rs 9 Y Rs 6 Fixed Overhead Rs 750 Selling Price X Rs 25 Y Rs 20

Contd.

The directors want to be acquired with the desirability of adopting any one of the following alternative sales mix in the budget for the next perioda) 250 units of X and 250 units of Y. b) 400 units of Y only. c) 400 units of X & 100 units of Y. d) 150 units of X & 350 units of Y. State which of the alternative sales mix you would recommend to management.

Solution

Marginal Cost Statement Per Unit

Product X Product Y Direct Materials 8 6 Direct Wages 6 4 Variable Overhead 9 6 Marginal Cost 23 16 Contribution 2 4 Selling Price 25 20

Contd.

Selection of Sales Alternative

Particular X Y Total a) 250 units of X & 250 units of Y Contribution 500 1000 1500 Fixed Cost 750 Profit 750 b) 400 units of Y only Contribution Nill 1600 1600 Fixed Cost 750 Profit 850 c) 400 units of X & 100 units of Y Contribution 800 400 1200 Fixed Cost 750 Profit 450 d) 150 units of X & 350 units of Y Contribution 300 1400 1700 Fixed Cost 750 Profit 950

Contd.

As the fourth alternative of manufacturing 150 units of X and 350 units of Y yields max profit, it is the best sales alternative and would therefore be recommended for adoption.

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