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# CHAPTER 16

## MARGINAL COSTING AND CVP ANALYSIS

SOLUTIONS TO BUSINESS APPLICATION CASES
Case 1. Vimalnath : Fixed and Variable Costs
1.

## 2006 graphics rate Rs.12,000/(2,000 + 2,000) = Rs.3.00/hour

2007 graphics rate Rs.14,000/(2,000 + 2,000 + 1,000) = Rs.2.80/hour

2.

## Total charge to the Nonprofit Organ. Dept. = Rs.2.80 1,000 = Rs.2,800

Mahavir is no doubt angry. The amount charged was Rs.800 above the
indicated charge of Rs.2,000.

3.

## Graphics Department charges did increase by Rs.2,000 (Rs.14,000

Rs.12,000). However, the charging rate changed as well. Thus, Tangible
Goods and Public Relations saw a decrease in their graphics charges of
Rs.400 each. It is this Rs.400 decrease (times 2) which showed up as an
Rs.800 increase in Mahavirs bill.

1.

## Allocation ratios for fixed costs (uses normal levels):

Hrs. of flight time
No. of passengers

Bangalore
0.2500
0.3333

Ahmedabad
0.5000
0.5000

Delhi
0.2500
0.1667

Variable rates:
Maintenance: Rs.30,000/8,000 = Rs.3.75 per flight hour
Baggage:
Rs.64,000/30,000 = Rs.2.1333 per passenger
Bangalore
Maintenancefixed:
(0.25 Rs.240,000)
(0.50 Rs.240,000)
(0.25 Rs.240,000)
Maintenancevariable:
(Rs.3.75 2,000)
(Rs.3.75 4,000)

Ahmedabad

Delhi

Rs.60,000
Rs.120,000
Rs.60,000
7,500
15,000

(Rs.3.75 2,000)
Baggagefixed:
(0.3333 Rs.150,000)
(0.5000 Rs.150,000)
(0.1667 Rs.150,000)
Baggagevariable:
(Rs.2.1333 10,000)
(Rs.2.1333 15,000)
(Rs.2.1333 5,000)

7,500
49,995
75,000
25,005
21,333
32,000
Rs.138,828

2.

Rs.242,000

10,667
Rs.103,172

The allocations are the same as in Requirement 1, except variable costs are
assigned using actual instead of budgeted activity.

Maintenancefixed
Maintenancevariable:
(Rs.3.75 1,800)
(Rs.3.75 4,200)
(Rs.3.75 2,500)
Baggagefixed
Baggagevariable:
(Rs.2.1333 8,000)
(Rs.2.1333 16,000)
(Rs.2.1333 6,000)

Bangalore
Rs.60,000

Ahmedabad
Rs.120,000

Delhi
Rs.60,000

6,750
15,750
49,995

9,375
25,005

75,000

17,066
34,133
Rs.133,811

Rs.244,883

12,800
Rs.107,180

## Yes, maintenance actually cost Rs.315,000, but only Rs.271,875 was

allocated. Baggage actually cost Rs.189,000, but Rs.213,999 was allocated (no
costs remain). Actual costs are not allocated so that inefficiencies or
efficiencies are not passed on.

## Case 3 Chain of Hotels

1.

Hyderabad
Bangalore
Kanoor
Faridabad
Delhi

(Rs.431,800/Rs.2,540,000)(Rs.182,500)*
(Rs.508,000/Rs.2,540,000)(Rs.182,500)
(Rs.381,000/Rs.2,540,000)(Rs.182,500)
(Rs.635,000/Rs.2,540,000)(Rs.182,500)
(Rs.584,200/Rs.2,540,000)(Rs.182,500)

= Rs.31,025
= Rs.36,500
= Rs.27,375
= Rs.45,625
= Rs.41,975

2.

3.

## Share of Accounting Department fixed costs based on 2003 sales:

H
B
K
F
D

(Rs.337,500/Rs.2,250,000)(Rs.85,000) = Rs.12,750
(Rs.450,000/Rs.2,250,000)(Rs.85,000) = Rs.17,000
(Rs.360,000/Rs.2,250,000)(Rs.85,000) = Rs.13,600
(Rs.540,000/Rs.2,250,000)(Rs.85,000) = Rs.20,400
(Rs.562,500/Rs.2,250,000)(Rs.85,000) = Rs.21,250

H
B
K
F
D

Variable Cost
(Rs.26)(1,475)=Rs.38,350
(Rs.26)(400) =Rs.10,400
(Rs.26)(938) =Rs.24,388
(Rs.26)(562) =Rs.14,612
(Rs.26)(375) = Rs.9,750

+
+
+
+
+
+

Fixed Cost
Rs.12,750
Rs.17,000
Rs.13,600
Rs.20,400
Rs.21,250

=
=
=
=
=
=

Total
Rs.51,100
Rs.27,400
Rs.37,988
Rs.35,012
Rs.31,000

The method in Requirement 2 ties cost allocated to the driver that causes the
cost. Thus, motels would be more likely to use Accounting Department time
efficiently. The method in Requirement 1 assigns accounting costs on the
basis of a variable which may not be causally related. Also, a motel with
stable sales from year to year may still experience wild fluctuations in
allocated cost due to changing sales patterns of other motels.

1.

2.

## First, convert after-tax profit to before-tax profit.

Before-tax profit = Rs.240,000/(1 0.4) = Rs.400,000
Let X equal the number of units which must be sold to yield before-tax profit
of Rs.400,000.
Rs.400,000
= Rs.400X Rs.200X Rs.100,000
X = 2,500

3.

## Alternative A is best, as shown below.

Alternative A:
Revenue = Rs.400(350) + Rs.360(2,700) = Rs.1,112,000
Variable costs = Rs.200(3,050) = Rs.610,000
Operating income = Rs.1,112,000 Rs.610,000 Rs.100,000 = Rs.402,000
After-tax profit = Rs.402,000(1 0.4) = Rs.241,200

Alternative B:
Revenue = Rs.400(350) + Rs.370(2,200) = Rs.954,000
Variable costs = Rs.200(350) + Rs.175(2,200) = Rs.455,000
Operating income = Rs.954,000 Rs.455,000 Rs.100,000 = Rs.399,000
After-tax profit = Rs.399,000(1 0.4) = Rs.239,400
Alternative C:
Revenue = Rs.400(350) + Rs.380(2,000) = Rs.900,000
Variable costs = Rs.200(2,350) = Rs.470,000
Operating income = Rs.900,000 Rs.470,000 Rs.90,000 = Rs.340,000
After-tax profit = Rs.340,000(1 0.4) = Rs.204,000
4.

## Four assumptions underlying CVP analysis are as follows:

All costs can be divided into fixed and variable elements.
Total variable costs are directly proportional to volume over the relevant
range.
Selling prices are to be unchanged.
Volume is the only relevant factor affecting cost.

1.

## Break-even calculations for the first year of operations:

Fixed expenses:
Advertising
Rent (6,000 Rs.28)
Property insurance
Utilities
Malpractice insurance
Depreciation (Rs.60,000/4)
Wages and fringe benefits:
Regular wages*
Overtime wages**
Fringe benefits (@ 40%)
Total fixed expenses

Rs.500,000
168,000
22,000
32,000
180,000
15,000
403,200
7,500
164,280
Rs.1,491,980

## *(Rs.25 + Rs.20 + Rs.15 + Rs.10)(16 hours)(360 days) = Rs.403,200

**(200 Rs.15 1.5) + (200 Rs.10 1.5) = Rs.7,500
Break-even point = Revenue Variable costs Fixed costs
= Rs.30X + (Rs.2,000)(0.2X)(0.3) Rs.4X Rs.1,491,980
= Rs.30X + Rs.120X Rs.4X Rs.1,491,980
Rs.146X = Rs.1,491,980

## X = 10,219.04 or 10,220 clients

2.

Based on the report of the marketing consultant, the expected number of new
clients during the first year is 18,000. Therefore, it is feasible for the law office
to break even during the first year of operations as the break-even point is
10,220 clients (as shown above).
Expected value = (20 0.10) + (30 0.30) + (55 0.40) + (85 0.20)
= 50 clients per day
Annual clients = 50 360 days
= 18,000 clients per year

## Case 6 Pharmaceutical Products

1.

Current profit:
Sales
Variable expenses
Contribution margin
Fixed expenses
Operating income

Rs.400,000
250,000
Rs.150,000
60,000
Rs.90,000

(Rs.90,000)(1.50)
= (Rs.0.40 Rs.0.25)2,000,000 Rs.60,000 Advertising
Rs.135,000 = Rs.300,000 Rs.60,000 Advertising
Advertising = Rs.105,000
2.

## a. The per-unit contribution margin needs to be the same:

Let P* = New price and V* = New unit variable cost.
(P V) = (P* V*)
Rs.0.40 Rs.0.25
= P* Rs.0.30
Rs.0.15 = P* Rs.0.30
P* = Rs.0.45
The selling price should be increased by Rs.0.05.
b.

## 1.5(P V)/P = (P* V*)/P*

1.5(Rs.0.40 Rs.0.25)/Rs.0.40
Rs.0.5625P* = P* Rs.0.30
Rs.0.4375P* = Rs.0.30
P*
= Rs.0.686

= (P* Rs.0.30)/P*

3.

## Projected contribution margin (800,000 Rs.0.25)Rs.200,000

Present contribution margin
150,000

## Increase in operating income

Rs.50,000
The decision was good as operating income increased by Rs.50,000.
Quantity at new price to earn previous years profit = (Rs.60,000 + Rs.90,000)/
(Rs.0.50 Rs.0.25) = 600,000 units.
4.

## 1.5(Rs.90,000) = (P Rs.0.30)2,000,000 Rs.160,000

2,000,000P Rs.600,000 = Rs.160,000 + Rs.135,000
2,000,000P = Rs.895,000
P = Rs.0.4475
The managers plan is feasible if projections are accurate as the new price is
less than 20% above the old price. The price could be increased to Rs.0.48
without affecting the sales volume adversely (and it should be as this would
maximize profits).

## Case 7 Krishna Optics : Absorption Costing and Variable Costing

1.
Krishan Optics
Variable-Costing Income Statement
For the Year Ended December 31, 2007
Net sales................................................................
Variable costs:
Finished goods inventory, January 1...........
WIP inventory, January 1...............................
Manufacturing costs.......................................
Total available............................................
Finished goods inventory, December 31......
WIP inventory, December 31..........................
Variable manufacturing costs..................
Variable selling expenses..............................
Total variable costs...................................
Contribution margin.............................................
Fixed costs:
Manufacturing overhead................................
Selling expenses.............................................
Administrative expenses................................
Total fixed costs........................................
Operating income.................................................

Rs.1,520,000
Rs.20,680
28,400
834,000
Rs.883,080
(11,800)
(50,000)
Rs.821,280
121,600
942,880
Rs.577,120

## Finished goods inventory, January 1:

Inventory using full cost
Rs.25,000
Less: Fixed overhead (1,080 hrs. Rs.4)
4,320
Rs.20,680
Fixed overhead rate:
2003: Rs.130,000/32,500 = Rs.4 per hour

Rs.175,000
68,400
187,000
430,400
Rs.146,720

## 2004: Rs.176,000/44,000 = Rs.4 per hour

WIP inventory, January 1:
Inventory using full cost
Rs.34,000
Less: Fixed overhead (1,400 hrs. Rs.4)
5,600
Rs.28,400
Manufacturing costs:
Materials
Rs.210,000
Direct Labour
435,000
Variable overhead (42,000 hrs. Rs.4.50) 189,000
Rs.834,000
Variable overhead rate = Rs.198,000/44,000 = Rs.4.50 per hour
Finished goods inventory, December 31:
Inventory using full cost
Rs.14,000
Less: Fixed overhead (550 hrs. Rs.4)
2,200
Rs.11,800
WIP inventory, December 31:
Inventory using full cost
Rs.60,000
Less: Fixed overhead (2,500 hrs. Rs.4)
10,000
Rs.50,000
Variable selling expenses:
Net sales Commission rate = Rs.1,520,000 0.08 = Rs.121,600
Fixed selling expenses:
Total selling expenses
Less: Variable selling expenses

2.

Rs.190,000
121,600
Rs.68,400

## One advantage is that variable-costing financial statements are more easily

understood, since they show that profits move in the same direction as sales.
Absorption-costing profit, on the other hand, is affected by changes in
inventory. A second advantage is that variable costing facilitates the analysis
of cost-volume-profit relationships by separating fixed and variable costs on
the income statement.