Professional Documents
Culture Documents
MODULE-V
Advanced Management
Accounting
ICPAP
Institute of Certified Public Accountants of
Pakistan
ICPAP
Theory
Explain how technological change, globalization, and customer needs can affect
an organization and its management accounting system.
Technological change offers opportunities for new products and services and
more efficient methods of operations. Globalization forces organizations to be
more concerned about their customers and operating efficiently. Customer needs
continually change. Organization and their management accounting systems
must adapt to these changes.
Identify strategies for achieving customer value.
Customer value can be achieved through innovative product/service design,
quality, and low cost.
Describe features of organizations that promote decisions to achieve their
goals.
To achieve their goals, organizations must assign responsibilities, measure
performance, and compensate their numbers.
Explain the critical role played by management accounting in making planning
and control decisions to help managers create organizational value.
Management accounting improves planning decisions by providing decision
makers with more information to make better decisions. Management accounting
also supports control decisions by assisting in the assignment of responsibilities
and establishing performance measures to motivate individuals.
Identify the trade-offs that exist in using information for making planning and
control decisions and for external reporting.
Using the same accounting system for making planning and control decisions and
for external reporting leads to trade-offs. Employees will bias information used
for planning purposes if the information is also used as a benchmark for
measuring performance. External report will similarly be affected if also used to
evaluate performance.
Identify the roles of different types of management accountants.
Controllers are responsible for the accounting systems within the organization.
Internal auditors monitor members of the organization to determine whether
prescribed procedures are being followed.
Recognize the role of judgement and ethics in making management accounting
choices.
The management accountant must use judgement in resolving trade-offs arising
from different uses of accounting information. This judgement should recognize
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the effect of decisions on all involved parties. A code of ethics assists the
management accountant in making decisions.
Use differential costs and benefits to assist in cost/benefit analysis.
Differential analysis identifies the costs and benefits that very across alternative
decisions. Only differential costs and benefits are relevant for decisions because
all other factors are the same for each possible decision.
Identify and measure opportunity costs for making planning decisions.
Opportunity cost is defined in terms of alternative uses of a resource. The size of
the forgone opportunity of using the resource is the measure of the opportunity
cost.
Ignore sunk costs for making planning decision.
Sunk costs are costs that have already been incurred and are not relevant for
planning decisions.
Use cost/benefit analysis to make information choices.
Additional information should be gathered if the benefit of improved decision
making is greater than the cost of the information.
Determine how activity costs vary with the rate of output.
The cost of the first few units of an activitys output tends to be quite high. At
normal production levels, the cost of additional units of ac5tivity tends to be
lower. When the activity nears capacity, the cost of additional units of activity
output tends to be higher.
Calculate marginal and average costs.
The marginal cost is the cost of one more unit of output, which is the slope of the
total cost curve. The average cost is the total cost of the activity divided by the
number of units of output.
Approximate activity costs using variable and fixed costs.
Approximating costs by fixed and variable costs assumes that initiating the
activity has a cost, which is the fixed cost. Subsequent units of the activity output
are assumed to cost the same amount per unit, which is the variable cost per unit.
Use the account classification and high/low methods to estimate variable and
fixed costs.
The account classification method identifies fixed and variable costs by
categorizing different cost accounts. The high/low method uses the past highest
and lowest output data points to estimate fixed and variable costs.
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are chosen to reflect these differences. Activity-based costing does not adjust for
fixed opportunity costs and presumes that indirect costs vary with the usage of
the cost driver.
Use product costs for financial reporting.
Product costs in financial reports are dictated by generally accepted accounting
principles (GAAP). Whether a cost is a period or a product cost for financial
reporting purposes potentially influences shareholder wealth, management
compensation, and taxes.
Select a competitive strategy for an organization.
The critical success factors to compete and to increase customer value include
offering innovative products and services, high-quality products and services,
and low costs.
Use activity-based management to reduce an organizations costs without
affecting customer value.
Activity-based management identifies the non-value-added activities as areas for
potential cost reduction.
Make trade-offs in the product life cycle to reduce overall product costs.
Most costs of a product are predetermined by its design. Improved design can
reduce the cost of manufacturing, delivering, maintaining, and disposing of the
product.
Use target costing to select viable products and reduce product cost.
Target costing identifies the product opportunity first. Then a multifunctional
team determines whether and how the organization can offer the product and still
make a profit.
Estimate the costs of using different suppliers.
The cost of a supplier includes the costs of the late delivery, inspections,
unpacking, warehousing, purchasing, and quality.
Use supply chain management to operate more efficiently and reduce costs.
Supply chain management focus on relations with both suppliers and customers.
Cooperating and sharing information with both of these groups can reduce costs
for all parties.
Estimate customer profitability.
The cost of a customer includes the cost of the product or service sold plus the
cost of customer service, fright charges, and collection. These costs should be
compared with the revenues from that customer to determine customer
profitability.
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based
on
performance
measures
and
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the sales level in units at which zero profit is achieved. Using variable and fixed
costs to approximate product costs, the equation solves for the number of units at
which profit equals zero:
0=(P-VC)(Q) FC
FC = (P-VC)(Q)
FC/(P-VC) = Q
The break-even quantity is simply the fixed costs divided by the contribution
margin per unit.
Achieving a Specified Profit
The profit equation also can be sued to determine the necessary amount of a
product or service that must be produced and sold to achieve a specified target
profit. Instead of setting the profit equal to zero, the profit can be set at a specified
amount and the profit equation can be used to solve for the required number of
units produced and sold:
Profit = (P-VC)(Q) FC
Profit + FC = (P VC) (Q)
(Profit + FC)/(P-VC) = Q
The necessary number to achieve a certain profit is the sum of the profit and fixed
costs divided by the contribution margin per unit.
Most firms are interested in the cash flow available after paying income taxes. An
extension of CVP analysis provides the number of units that must be sold to
achieve a specified after-tax profit.
Numerical Example:
Suppose that Laura Gonzalez, the Chicken vendor who pays $100 per day to rent
her cart, wants to make a $60 profit per day. She sells Chickens for $1 and the
variable costs of making the Chicken are $0.20 per Chicken. How many Chickens
must Laura sell per day to have a profit of $60?
Solution:The necessary quantity to have a profit of $60 is as follows:
(Profit + FC)/(P-VC) = ($60 + $100)/($1 - $0.20) = 200 Chickens
Graph of CVP Analysis:CVP analysis can be represented easily by a graph. Below figure demonstrates
Chicken vendor Laura Gonzalezs CVP problem. The total cost line is in the
same form as the variable and fixed cost approximation of opportunity costs. The
chicken vendors fixed cost of $100 is the intercept of the vertical axis. The
variable cost of $0.20 per chicken is the slope of the total cost line. The total
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revenue line is a straight line that extends from the origin. The slope of the total
revenue line is equal to the sales price of $1 per unit.
The break-even point occurs when total costs equal total revenues, which occurs
where the two lines intersect. The shaded area to the left of the break-even
number represent the expected loss if fewer chickens are produced and sold. The
shaded area to the right of the break-even number represents the expected profit
if more chickens are produced and sold. From previous Numerical Example, we
see that producing and selling 200 hot dogs a day achieves a $60 profit.
CVP Analysis and Opportunity Costs:CVP analysis is used for planning purposes; therefore, the opportunity costs are
the appropriate costs to measure. The cost of using noncash resources to make the
product should reflect the alternative use of that resource. Also, if the investment
being considered involves the long-term use of cash, the planning decision should
recognize that there is an opportunity cost of using cash. If cash is borrowed, the
interest expense should be included in the analysis as a fixed cost of the product.
If the organization has available cash for a long-term investment in a product, the
investment prevents the organization from receiving interest on the cash. That
forgone interest expense of borrowed cash plus the foregone interest of available
cash used to make the investment.
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Numerical Example:Paul McDonald is thinking about buying a farm that costs $400,000. He can
borrow $300,000 for the purchase at 10% interest but must use $100,000 of this
own cash for the remainder. What is the annual cost of financing the investment
in the farm?
Solution:External financial reports in the form of an income statement would recognize
only the 10% interest on the loan (0.10)($300,000), or $30,000, annually. For CVP
analysis, however, there is a foregone opportunity of using the $100,000 cash buy
the farm. If the cash had earned 10%, the cost of financing for CVP analysis is
(0.10)($400,000), or $40,000, annually.
Problem with CVP Analysis:CVP analysis is simple to use. It approximates activity costs using fixed and
variable costs while the sales price and variable cost per unit are assumed
constant over all levels of output. These simplifications allow us to estimate profit
by looking at the difference between two straight lines. Most likely, however, cost
and revenue estimates are only reasonable approximations within a small range
of output levels.
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Solution:To solve this problem, a basket of both goods must be established. The products
are made and sold in a 2-to-1 proportion; therefore, the basket should contain two
personal computers and one laser printer. The sales revenue of this basket is
(2)($1,000/personal computer) + (1)($800/laser printer), or $2,800. The variable
cost of this basket is (2)($400/personal computer) + (1)($300/laser printer), or
$1,100. The break-even quantity of this basket is calculated as follows:
($20,000,000)/($2,800 - $1,100)= 11,765 baskets
The 11,765 baskets are equivalent to 23,530 personal computers and 11,765 laser
printers.
The limitation of CVP analysis described in this section indicates that it should be
used with care. CVP analysis has the advantage of being simple but should be
used only as a rough planning tool. It provides a manager with a low-cost
approximation of the profit effect of an investment. Whether a manager wants to
analyze the investment further depends on the cost of the analysis and the
potential benefits of more accurate information.
Explain how short-term decisions differ from strategic decisions.
Strategic decisions involve long-term planning with the opportunity to change the
existing resources of the organization; short term decisions assume that most of
the organizations resources cannot be changed.
Estimate profit and break-even quantities using cost volume-profit analysis.
The break-even quantity is the level of output that generates zero profit and can
be estimated by dividing the fixed costs by the contribution margin per unit. The
output level necessary to achieve a specified profit is the sum of the profit and
fixed costs divided by the contribution margin per unit.
Identify limitations of cost-volume-profit analysis.
Cost-volume-profit analysis assumes that costs can be approximated with fixed
and variable costs, and assume a constant sales price. It cannot be used to
determine optimal levels of output and price, nor does it consider the time value
of money.
Make short-term pricing decisions considering variable cost and capacity.
If an organization is operating below capacity, the marginal cost is approximated
by the variable cost. Therefore, in the short term, the variable cost should be
considered as the lower boundary in making a pricing decision.
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Identify the conflicts that exist between planning and control in the budgeting
process.
The flow of information in the budgeting process might be inhibited or biased
because the information used for planning is often the same information used for
performance evaluation.
Describe the benefits of having both short-term and long-term budgets.
Long-term budgets are used for long-term planning. Short-term budgets are used
for both planning and control.
Explain the responsibilities implications of a line-item budget.
Line-item budgets constrain responsibilities by limiting managers ability to shift
resources from one use to another.
Identify the costs and benefits of budget lapsing.
Budget lapsing constrains the manager to expend resources in the budget period.
This policy provides increased control; however, managers are not able to use
their specialized information to make more efficient decisions are frequently are
motivated to consume excess resources during the budgeted period.
Develop flexible budgets and identify when flexible budgeting should be used
instead of static budgeting.
Flexible budgeting adjusts for volume effects. If the manager cannot control
volume, the flexible budget provides more appropriate numbers for evaluating
the manager.
Explain the cost benefits of using zero-base budgeting.
Zero-base budgeting (ZBB) is costly because each line item in total must be
justified. The benefit of ZBB is the additional flow of information that might be
useful to new managers and might lead to more efficient use of resources.
Create a master budget for an organization including sales, production,
administration, capital investment, and financial budgets.
The master budget is a plan for a certain period that includes expected sales,
operating costs (production and administration), major investments and methods
to finance those investments.
Create pro forma financial statement based on data from the sales, production,
administration, capital investment, and financial budgets.
The pro forma statements include the budgeted income statement, the budgeted
cash flow statement, and the budgeted balance sheet.
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demand. JIT has no job order costs. Accounting Performance measures should be
selected to encourage faster throughput time and to discourage increased
inventory.
Create balanced scorecard to articulate the strategy of the organization.
A balanced scorecard describes objective in a cause-and-effect sequence to achieve
the organizations strategy. Performance measures and targets are identified for
each objective.
Identify when management accounting within an organization should change.
Management accounting must continually adapt to dynamic environments and
organizations. Warning signals within the management accounting system are
dysfunctional behavior by managers and poor planning decisions.
Describe the steps of the capital budgeting process.
The steps of the capital budgeting process include initiation, ratification,
implementation, and monitoring.
Identify the opportunity cost of capital.
The opportunity cost of capital is the forgone opportunity of using cash, which is
the interest rate on borrowing money to replace the cash.
Estimate the payback period of an investment and identify its weaknesses in
making investment choices.
The payback period is the time required for the investment to generate cash flows
equal to the initial investment. The payback method does not consider the time
value of money or cash flows beyond the payback period.
Calculate the accounting rate of return (ROI) and identify its weaknesses in
making investment choices.
The accounting rate of return, or ROI, is the average income from a project
divided by the average investment cost. The ROI is an accounting measure and
does not consider the time value of money.
Calculate the net present value (NPV) of cash flows.
The NPV of cash flows is calculated by discounting all future cash flows to the
present and comparing the present value of the cash inflows with the present
value of the cash outflows.
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Problem No 1:The B & O Company has one production process which yields three different
products: P, R, and T. A process cost system is used. Specific allocation of costs is
impossible for these products until the end of Department 1 where split-off
occurs. Joint products, P, R, and T are further processed in Department 2, 3 and 4,
respectively. At the split-off point the company could sell P at $4.50 at $2.75, and
T $3.20. Department 1 completed and transferred to the other departments a total
of 75,000 units at a total cost of $225,000. The ratio of units produced in
Department 1 for P, R, and T is 2:5:3, respectively.
Required: Allocate the joint costs among the three joint products based on the:
a) Market value at split-off method.
b) Physical output method.
Round all answers to two decimal places.
Solution:a) Joint cost allocation to each product =
costs
Product
P
R
T
Ratio
$67,500
$242, 625
$103,125
$242, 625
$72, 000
$242, 625
Total
Joint cost
$225,000
$225,000
95,633.69
$225,000
66,769.71
$225,000.00
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75,00050%
75,00030%
b) Joint cost allocation to each product =
2
$225, 000 $45, 000
10*
5
Product R
$225, 000 $112,500
10*
3
Product T
$225, 000 $67,500
10*
Total
$225, 000
Product P
*2:5:3=10
Problem No 2:The Three Stooges Production Company uses a process cost system to account for
the production of three different products: M, L, and C. The products are
considered joint products in the first department (Department 1). The products
are split off at the end of processing in Department 1. Product M needs no further
processing after the split-off point while products L and C are sent to
Departments 2A and 2B, respectively, for further processing.
The following revenue and cost information is available:
PRODUCT
M
L
C
UNITS
MARKET VALUE PER UNIT
PRODUCED AT END OF PROCESSING
80,000
$20
70,000
$30
90,000
$25
Product
M
L
C
Total
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Units produced
80,000
70,000
90,000
240,000
Ratio
Joint cost
=
$2,880,000
Allocation of joint
cost
$ 950,103
$2,880,000
914,474
$2,880,000
1,015,423
Total
Product
M
L
C
Total
$2,880,000
Market
Unit
Value of
Produced
Of each Product Costs of each product
(80,000
(70,000
(90,000
$20)
$30)
$25)
Additional
processing
costs
of
each
product
=
$0
560,000
540,000
$1,100,000
Total
Hypothetical
market value
of
each
product
$1,600,000 (1)
1,540,000 (2)
1,710,000 (3)
$4,850,000 (4)
Problem No 3:The Huffy Manufacturing Corporation uses a process cost system and presents
you with the following information:
Main products:
Units sold
20,000
Units produced
25,000
Selling price per unit
$10
Marketing and administrative expenses
$60,000
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$150,000
900
1,200
$3
$300
$800
30%
The main products and by-product split off at the end of Department 1. The byproduct is transferred to Department 2 for additional processing. The main
products need no additional processing. No beginning or ending work-in-process
inventories exist. Ignore income taxes.
Required: Prepare income statements for the Huffy Manufacturing Corporation
under the following assumptions:
a) Net by-product income treated as other income
b) Net by-product income treated as a deduction from cost of goods sold of
the main products sold.
c) Expected value of the by-product treated as a deduction from the total
production costs using the:
1. Net realizable method
2. Reversal cost method
Solution:a) Net by-product income treated as other income:
Sales (main products) (20,000$10)
Cost of main products sold:
Total production costs
Less: Ending inventory (5,0006.00*)
Total cost of main product sold
Gross profit
Marketing and administrative expenses of main
products
Income from operations
Other income:
Net by-product income [$2,700 - ($300+$800)]
Net income
$200,000
$150,000
30,000
120,000
$80,000
60,000
$20,000
1,600
$21,600
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By-product[($2,5201,200)300]
Gross profit
Marketing and administrative expenses:
Main product
By-product
Net income
Schedule A: Production Costs of Main Product
Total production costs of Department 1
Less joint costs applicable to by-product
produced:
Estimated revenue from by-product sales (1,200
units produced $3 per unit)
Less: Expected additional processing costs
(Department 2)
Expected gross profit by-product (30% $3,600)
Production cost of main product
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630
30,286
$60,000
300
120,514
$82,186
60,300
$21,886
$150,000
$3,600
$800
1,080
1,880
1,720
$148,280
$1,720
800
$2,520
Problem No 4:Bates Corporation has decided to accumulate standard costs, in addition to actual
costs, for the next accounting period, 19X5. The following data have been
collected:
Projected production for 19X5
Direct materials required to produce one unit
Price per ton of direct materials based on annual order of:
1 25,000 tones
25,001 50,000 tones
50,001 75,000 tons
Direct labor requirements
Shaping time per ton
Welding time per unit
Average wage rate per hour for:
Shapers
Welders
Factory overhead is applied based on direct labor hours
30,000 units
2 tones
$200 per ton
$190 per ton
$185 per ton
3 hours
10 hours
$11
$15
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required
Per unit price on the basis of an annual order $185 per ton
of 60,000 tons
2) Direct materials efficiency standard per unit:
Direct materials required to produce one unit----------- 2 tons
3) Direct labor price per hour standard:
Type of
Total annual Hourly
Total Annual Direct
work
Hours
X
Rate =
Labor cost
Shaping
180,000*
S11
$1,980,000
Welding
300,000
15
4,500,000
Total
480,000
$6,480,000
*3 hours per ton 60,000 tons
10 hours per unit 30,000 units
Average direct labor price per hour:
$6,480,000 480,000 = $13.50
4) Direct labor efficiency standard (hours) per unit:
Shaping per unit (3 hours 2 tons)..6 hours
Welding .10 hours
16
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$370.00
216.00
4.00
1.92
$591.92
Cumulative
average per
unit (hours)
5.00
4.75
4.513
4.287
4.073
3.869
Output
per direct
labor hour
.20
.21
.22
.23
.25
.26
(Computations)
(15)
(29.5)
(418.052)
(834.296)
(1665.168)
(32123.808)
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b)
Cumulative
Direct labor (Computations) Direct labor
units
of cost
cost per unit
production
1
$26.26
(5$5.25)
$26.25
2
$49.88
(9.5$5.25)
$24.94
4
$94.77
(18.052$5.25)
$23.69
8
$180.05
(34.296$5.25)
$22.51
16
$342.13
(65.168$5.25)
$21.38
32
$649.99 (123.808$5.25)
$20.31
($26.261)
($49.882)
($94.774)
($180.058)
($342.1316)
($6499932)
Problem No 6:The following information for 19X1 was given for the Ken-Glo Company, which
manufactures fluorescent light bulbs
Units of finished product produced
Direct materials quantity standards
15,000 units
3 units of direct materials
per unit of finished
product
50,000 units
60,000 units
$1.25 each
$1.10 each
2 direct labor hours per
unit
30,250 hours
$4.20 per hour
$4.50 per hour
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b)
c)
d)
e)
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Lot
Units in lot
Material used
(Dozens)
(Yards)
22
1,000
24,100
23
1,700
40,440
24
1,200
28,825
The following information is also available:
Hours Worked
2,980
5,130
2,890
Quantity (Dozens)
22
1,000
23
1,700
24
1,200
Total standard cost of production
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$26.40
11.76
9.60
$47.76
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Lot 24
Standard hours allowed
3 hours per dozen 960* equivalent dozen = 2,880
$49 = (2,890 2,880) $4.90
Unfavorable
*1,200 80%
3. Direct labor price (rate) variance
Lot 22
$298 = ($5.00 - $4.90) 2,980
Unfavorable
Lot 23
$513 = ($5.00 - $4.90) 5,130
Unfavorable
Lot 24
$289 = ($5.00 - $4.90) 2,890
Unfavorable
d) Factory overhead variances
Total factory overhead application rate = $4.00
Variable 60% $4.00 = $2.40
Fixed 40% $4.00 = $1.60
Budget at 11,000* Actual Hours
Variable ($2.40 11,000)
Fixed ($576,000/12 40%)
Total for June
*2.980 + 5,130+2,890
1. Price variance
$0 = $45,600 - $46,600
$26,400
19,200
$45,600
2. Efficiency variance
$48 Unfavorable = (11,000 actual direct labor hours 10,980*
standard direct labor hours) $2.40 per direct hour
*3,000 + 5,100 + 2,880
3. Production volume
Expected hours for June:
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Problem No 8:Stacey manufacturing Co. is interested in comparing net earnings for two periods.
The companys operating data are as follows:
Standard production (units)
Actual production (units)
Sales (units)
Selling price per unit
Variable manufacturing costs per unit:
Direct materials
Direct labor
Variable factory
Total variable factory manufacturing unit cost
Fixed factory overhead ($4 per unit)
Selling and administrative expenses (all fixed)
Period1
30,000
30,000
25,000
$15.00
Period 2
30,000
25,000
30,000
$15.00
$6.00
$120,000
$50,000
$6.00
$120,000
$60,000
$1.50
$2.50
$2.00
$375,000
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$375,000
$180,000
30,000
$150,000
$225,000
120,000
$105,000
50,000
$55,000
Absorption Costing
Sales (30,000 $15)
Cost of goods sold:
Beginning inventory (5,000 $10)
Current manufacturing costs (25,000 $10)
Less ending inventory
Cost of goods
Gross profit
Less under absorbed fixed factory overhead*
Less selling and administrative expenses
Net income
*Budgeted fixed factory overhead
Applied fixed factory overhead (25,000 $4)
Under absorbed fixed factory overhead
$450,000
$50,000
250,000
0
$300,000
$150,000
20,000
$130,000
60,000
$70,000
$120,000
100,000
$20,000
Direct Costing
Sales (30,000 $15)
Cost of goods sold:
$450,000
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$30,000
150,000
0
$180,000
$270,000
120,000
$150,000
60,000
$90,000
$500,000
400,000
100,000
$1,200,000
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Required:
a.
What are the variable, fixed, and total costs per unit if the normal
production of 10,000 units per year is achieved?
b. What are the variable, fixed and total costs per unit if only 8,000 units are
produced per year?
c. What is the implication of producing less units (8,000 units) than normal
capacity (10,000 units) for managerial decision making?
d. Which costs are relevant and which costs are irrelevant to a decision to
expend production from normal capacity (10,000 units) to maximum
capacity (12,000 units)?
e. Suppose a second cutting machine, identical in every respect to the first
one, is under consideration for possible purchase. Total production for the
year is still expected to be equal to normal capacity (10,000 units) with the
first cutting machine accounting for 6,000 units and the second cutting
machine accounting for 4,000 units.
1. What are the total costs of operating each of the two machines?
2. What are the variable, fixed, and total costs per unit for each
machine?
3. What costs are relevant and what costs are irrelevant to the
decision to acquire a second cutting machine?
f. Under what condition would both the variable costs and fixed costs be
relevant
in a decision to acquire a second cutting machine?
Solution:-
b) Variable cost per unit = $70 per unit because, by definition, a variable
cost remains constant on a per unit basis within the relevant range.
$400, 000 $100, 000
Fixed cost / unit
$62.50 / unit
8, 000 units
Total cost/unit = $70/unit + $62.50/unit = $132.50/unit
c) While variable cost per unit remains constant whether 8,000 or 10,000
units are produced, the fixed cost per unit increases from $50 per unit to
$62.50 per unit. For purposes of managerial decision making, a higher
fixed cost per unit will necessitate a higher a selling price per unit if, in
the long run, all costs are to be covered and a reasonable profit earned
from each unit produced and sold. If it is not possible to increase the
Page | 37
ICPAP
selling price per unit is in response to the increased fixed cost per unit,
the company will not be able to maximize its operating performance.
As a sound generalization (all other factors held constant), whenever a
company is confronted by a fixed cost, it must expand its production
and sales as much as possible so that the fixed costs can be spread over
as many units as is possible.
d) The electricity and repair and maintenance costs are relevant. They
currently equal $500,000 and $200,000, respectively, at the 10,000-unit
level. They will increase to $600,000 for electricity (12,000 units 10 MH
$5/MH) and $240,000 for repairs and maintenance (12,000 units 10
MH/unit $2/MH). The depreciation and insurance costs are equal to
$400,000 and $100,000, respectively, at 10,000 units and will not change
at 12,000 units. Therefore, the usual relationship between cost behavior
and relevance was applicable. That is, the variable costs were relevant
and the fixed costs were irrelevant.
e) 1.
Machine 1
Machine 2
Electricity
6,000 units 10MH/unit $5/MH
$300,000
4,000 units 10MH/unit $5/MH
$200,000
Repair and maintenance:
6,000 units 10MH/unit $2/MH
120,000
4,000 units 10MH/unit $2/MH
$80,000
Depreciation
400,000
400,000
Insurance
100,000
100,000
Total variable and fixed costs
$920,000
$780,000
2.
Variable cost per unit:
$420,000/6,000
$70.00
$280,000/4,000 units
$70.00
Fixed cost per unit:
$500,000/6,000 units
83.33
$500,000/4,000 units
125.00
Total cost per unit
$153.33
$195.00
3. The total variable cost of $700,000 consisting of $500,000 of electricity
and $200,000 of repairs and maintenance is an irrelevant cost. It will be
incurred whether the first cutting machine produces 10,000 units by
itself or both cutting machines produce a combined total of 10,000 units.
The total fixed cost of $500,000 consisting of $400,000 of depreciation
and $100,000 of insurance is a relevant cost. If the second cutting
machine is not purchased the $500,000 will not be incurred. It is clearly
a future cost that differs between alternative courses of action. Here is a
Page | 38
ICPAP
Page | 39
ICPAP
Page | 40
PRODUCT
Hamburger
Steak
Roast beef
ICPAP
TOTAL
SALES
VALUE AT
SPLIT-OFF
TOTAL
ADDITIONAL
PROCESSING COSTS
$10,000
14,000
13,000
$2,000
3,000
6,000
TOTAL
FINAL
SALES
VALUE
$14,000
20,000
17,000
$120,000
90,000
$30,000
Buy
$(600,000)
90,000
$(480,000)
(100,000)
$(580,000)
70,000
$(510,000)
$(510,000)
$(510,000)
$260
100
120
$480
The only relevant fixed factory overhead cost is the $100,000 that the
problem specifically tells us will be eliminated if part 347 is no longer
manufactured.
Page | 41
ICPAP
$300,000
$200,000
70,000
270,000
$30,000
Page | 42
ICPAP
Hamburger and steak should be processed further while roast beef should
be sold at the split-off point.
b) From part a, The Mighty Meat Company will earn revenue equal to $14,000
from hamburger and $20,000 from steak, both of which will be subject to
additional processing, and $13,000 from roast beef, which will be sold at
the split-off point. The total revenue equals $47,000. The additional
processing costs equal $2,000 for hamburger and $3,000 for steak for a total
of $5,000. However, when the $5,000 of additional processing costs are
added to the $43,000 of joint cost, the total manufacturing costs of $48,000
exceed the total revenues by $1,000. If The Mighty Meat Company cannot
either increase its revenues or decrease its costs, it should no longer be nit
he meat processing business.
Problem No 11:Maur-Shei Bakery sells only chocolate chip cookies. Each cookie sells for $ .20.
variable costs are
Flour and sugar
Butter and eggs
Chocolate chips
$.02
.02
.04
$50
100
$150
Required: Compute the level of sales in units necessary per week (1) to break even
and (2) to earn a profit of $250 under the following independent assumptions.
(Ignore income taxes.)
a)
b)
c)
d)
e)
f)
Page | 43
ICPAP
Page | 44
ICPAP
Problem No 12:The Fong Construction Company projects it will need to replace certain
equipment 5 years from now. The current cost of the equipment desired is
$100,000. Studies of historical price changes for the equipment suggests to Fond
Constructions management that the cost of the equipment will rise by
approximately 9% per year. The firm has excess cast at this time and wants to
place money aside in order to assure it will have enough money to purchase the
equipment 5 year from now.
Required: Assuming that the Fong Construction Company can earn 7%
compounded annually after taxes on any sum it invests today, how much must be
set aside today in order to generate enough funds to purchase the equipment in 5
years?
Solution:The first step is to determine how much will be needed 5 years from now in order
to replace equipment that currently costs $100,000. Since Fong Constructions
management expects the cost of the equipment of $100,000 to rise by 9% per year
compounded annually, the future value is found as follows:
FV = P(FV of $1 for 5 years at 9%)
= $100,000 (1.5386)
= $153,860
The next step is to determine how much must be set aside today in order to
generate $153,860 five years from now. The amount that must be set aside is the
present value of $153,860. Since 7% compounded annually after taxes is assumed
to be earned on any sum invested today, the amount that must be set aside today
is
PV = FV(PV of $1 five years from now at 7%)
= $153,860(.7130)
= $109,702
Thus, $107,702 must be set aside today in order to generate the funds to purchase
the equipment 5 years from now.
Page | 45
ICPAP
Depreciation
$7,125
10,450
9,975
9,975
9,975
$47,500
If the machine is acquired, the firm is entitled to get a 10% tax credit [which
reduces the depreciation base of the asset by half of the $5,000 tax credit, that is,
by $2,500 ($50,000 - $2,500 = $47,500)].
Required: Compute the cash flow consequences that the Tucciarone Macaroni
Company would use to determine whether to acquire the machine. (Assume that
all cash sales and cash operating expenses are recognized for tax purposes in the
year received or paid.)
Solution:Tucciarone Macaroni Companys initial net cash outlay is equal to the cash outlay
for the machine reduced by the tax credit. Since the tax credit is assumed to be
10% of the cost of the equipment, then
Tax credit = .10($50,000)
= $5,000
Therefore, the initial net cash outlay is $45,000 ($50,000 - $5,000).
Page | 46
ICPAP
The cash flow from operations can be found by using the format.
1
$60,000
(20,000)
2
$60,000
(22,000)
Year
3
$60,000
(24,200)
(6,575)
(5,510)
(11,621)
(10,532)
(10,234)
$33,425
$32,490
$24,179
$22,848
$22,484
2
$60,000
Year
3
$60,000
4
5
$60,000 $62,000
4
$60,000
(26,620)
5
$62,000
(29,282)
Additional
revenue
recognized for tax purpose
Less: Additional operating (20,000) (22,000) (24,200) (26,620) (29,282)
expenses recognized for tax
purposes
Additional depreciation for
(7,125) (10,450)
(9,975)
(9,975)
(9,975)
tax purposes*
Additional taxable income
$32,875
$27,550 $25,825 $23,405 $22,743
.20
Marginal tax rate
.20
.45
.45
.45
Additional income taxes
$6,575
$5,510 $11,621 $10,532 $10,234
*information given:
The $2,000 gain is fully taxable because the assets net book value is $0.
Summary:
Initial net cash outlay
Cash flow from operation in
Year 1
Year 2
Year 3
Year 4
Year 5
$45,000
$33,425
$32,490
$24,179
22,848
22,484
Page | 47
ICPAP
Problem No 14:The local florist sells carnations in bunches of six. The following costs are related
to one flower:
Fertilizer
$.15
Utilities
.50
Miscellaneous
.10
The selling price of each bunch is $7.50. If the flowers are not sold at the end of
each day, they are given to the local hospital.
The probability of selling the following number of bunches was determined to be:
Number Probability
0
.03
1
.05
2
.08
3
.12
4
.15
5
.20
6
.17
7
.10
8
.08
9
.02
Required: Determine the expected value of profits.
Solution:Total costs per bunch are
Fertilizer
Utilities
Miscellaneous
$.15
.50
.10
$.75 6 flowers = $4.50 per bunch
Probability
Of Demand
.03
.05
.08
Probability
Profit
profit
$0.00
$0.00
3.00
.15
6.00
.48
Page | 48
3
4
5
6
7
8
9
.12
9.00
.15
12.00
.20
15.00
.17
18.00
.10
21.00
.08
24.00
.02
27.00
1.00
Expected value of profit = $14.13
ICPAP
1.08
1.80
3.00
3.06
2.10
1.92
.54
$14.13
Problem No 15:a) The following results for 19X5 were reported by Case Companys two
investment
Investment center 1
Investment center 2
Controllable income
$200, 000
$450, 000
Controllable assets
$1, 000, 000
$3, 000, 000
15%
ROI
20%
The Case Company has a required rate of return equal to 12%. Upper-level
management is considering an investment proposal which should earn
$90,000 of income on $500,000 of assets. The investment proposals ROI
equals 18% ($90,000/$500,000). Upper level management is in the process
of choosing which of its two investment centers will be asked to initiate the
investment proposal. As far as upper-level management is concerned, it is
very excited about the projects anticipated 18% return, which is well in
excess of the companys 12% required rate of return. Upper-level
management would expect that both of tis investment center managers
would be equally excited. You are required to determine, first for
investment center 1 and second for investment center 2, what course of
action their mangers would take if they were confronted by upper-level
managements proposed investment. Provide whatever data you believe to
be necessary to support each investment center mangers position.
b) The Spacedout Company has a required rate of return equal to 10%. One of
its investment centers, a foreign subsidiary located on the moon, has been
doing very poorly and reported the following results in the year 2525:
Controllable income
$4, 000
Controllable assets
$100, 000
ROI
4%
Page | 49
ICPAP
Controllable income
Controllable assets
ROI
ROI
before Investment ROI after accepting
accepting
proposal
proposal
proposal
$450, 000
$90, 000
$540, 000
$500, 000
$3, 000, 000
$3,500, 000
15%
18%
15.43%
ICPAP
company as a whole, but only because it increased his ROI from 15% to
15.43%.
The intent of part a of this problem is to demonstrate that a lack of goal
congruence can readily occur when ROI is used to evaluate the
performance of investment center managers. Investment center 1 rejected a
desirable project that would have, had it been accepted, been in the best
interest of the company as a whole.
b) The manager of the lunar investment center would, to the surprise of
upper-level management, accept the proposal on the basis of the following
comparative analysis:
ROI
before Investment ROI after accepting
accepting
proposal
proposal
proposal
Controllable income
$4, 000
$600
$4, 600
Controllable assets
$100, 000
$110, 000
$10, 000
ROI
4%
6%
4.18%
Once again, an investment center manager accepts a projects a project only
because it increases his ROI from 4% to 4.18%, despite the obvious fact that
upper-level management would like nothing better than to see the project
rejected.
The intent of part b of this problem is to demonstrate once again that a lack
of goal congruence can readily occur when ROI is used to evaluate the
performance of investment center mangers. An investment center manager
accepted an undesirable project that will not be in the best interests of the
company as a whole.
Problem No 16:Shahid Limited is engaged in manufacturing and sale of footwear. The company
sells its products through company operated retail outlets as well as through
distributors. The management is in the process of preparing the budget for the
year 2010-11 on the basis of following information:
i.
ii.
iii.
iv.
v.
vi.
ICPAP
The previous pattern of sales indicates that 60% of units are sold at the
minimum price; 10% units are sold at the maximum price and remaining
30% at a price of Rs. 2,000 and Rs. 1,200 per footwear for men and women
respectively.
It has been estimated that 30% of the units would be sold through
distributors who are offered 20% commission on retail price. The
remaining 70% will be sold through company operated retail outlets.
The company operates 22 outlets all over the country. The fixed costs per
outlet are Rs. 1.2 million per month and include rent, electricity,
maintenance, salaries etc.
Sales through company outlets include sales of cut size footwears which
are sold at 40% below the normal retail price and represent 5% of the total
sales of the retail outlets.
The company keeps a profit margin of 120% on variable cost (excluding
distributors commission) while calculating the retail price.
Fixed costs of the factory and head office are Rs. 45 million and Rs. 15
million per month respectively.
Required:
Prepare budgeted profit and loss account for the year 2010 2011.
Solution:-
Minimum
Maximum
Average
Total
Price
Men Women
1,000
800
4,000
2,500
2,000
1,200
Units
Men
Women
720,000 300,000
120,000
50,000
360,000 150,000
1,200,000 500,000
2,465,000
147,900
34,510
182,410
Page | 52
ICPAP
Sales net
2,282,590
Variable cost
1,120,455
1,162,135
12 45m
540,000
Gross profit
622,135
12 15m
180,000
12 22 1.2m
316,800
496,800
Net profit
125,335
Problem No 17:Buraq Motors manufactures two types of cars i.e. X and Y. The production of each
type of car involves two departments. Details of production time are as follows:
Production hours per unit
Departments
Car type Assembly
Finishing
X
120
80
Y
80
50
Contribution margin per unit of X is Rs. 150,000 and per unit of Y is Rs. 100,000.
Total capacity of assembly and finishing departments is 18,200 and 12,000 hours
per month respectively.
Required:
Calculate the shadow price per hour of capacity if 200 hours are added to the
capacity of assembly department, assuming that the capacity of finishing
department is not altered.
Solution:Objective function:
Current constraints:
120x + 80y =
18200
Eq 1
80x + 50y=
12000
Eq 2
ICPAP
600x + 400y=
91000
Eq 3
Eq 15
640x + 400y
96000
Eq 4
Eq 28
40x=
5000
x=
125
80x +50y=
12000
10000 +50y=
12000
50y=
2000
y=
40
Eq 2
Revised constraints
120x + 80y =
18400
80x + 50y=
12000
Eq 2
600x + 400y=
92000
Eq 3
Eq 15
640x + 400y
96000
Eq4
Eq2 8
40x=
4000
x=
100
80x +50y=
12000
8000+50y=
12000
50y=
4000
y=
80
Eq 2
Current Options:
A
B
C
Production
x
y
150
0
125
40
0
227
Contributions
22,500,000
22,750,000
22,700,000
Page | 54
ICPAP
Required Options:
Production
Contributions
x
y
A
150
0
22,500,000
B
100
80
23,000,000
C
0
230
23,000,000
Shadow price for additional capacity: (23,000,000 - 22,750,000) = 250,000/200
= Rs.1, 250 per hour
Problem No 18:During the year ending June 30, 2011 Abdul Habib Company Limited has
planned to launch a new product which is expected to generate a profit of Rs. 9.3
million as shown below:
Sales revenue (24,000 units)
Less: cost of goods sold
Gross profit
Less: operating expenses
Net profit before tax
The following additional information is available:
i.
ii.
iii.
iv.
v.
vi.
Rs. in 000
51,600
37,500
14,100
4,800
9,300
75% of the units would be sold on 30 days credit. Credit prices would be
10% higher than the cash price. It is estimated that 70% of the customers
will settle their account within the credit term while rest of the customers
would pay within 60 days. Bad debts have been estimated @ 2% of credit
sales. All cash and credit receipts are subject to withholding tax @ 6%.
80% of the expenses forming part of cost of goods sold are variable. These
are to be paid one month in arrears.
The production will require additional machinery which will be purchased
on July 1, 2010 at a cost of Rs. 60 million. The machine is expected to have a
useful life of 15 years and salvage value of Rs. 7.5 million. The company
has a policy to charge depreciation on straight line basis. The depreciation
on the machinery is included in the cost of goods sold as shown above.
Variable operating expenses excluding bad debts are Rs. 105 per unit.
These are to be paid in the same month in which the sale is made.
50% of the fixed costs would be paid immediately when incurred while the
remaining 50% would be paid 15 days in arrears.
The management has decided to maintain finished goods stock of 1,000
units.
Page | 55
ICPAP
Required:
Calculate the cash requirements for the first two quarters.
Solution:Cash Management
Total sales
Cash sales 25%
Credit sales 75%
Units
6,000
18,000
24,000
51,600
2,000
2,200
1
Working for credit sales
Credit sales
18,000122,200)
Settlement 70%
28%
Gross receipts
Tax @ 6%
Receipts net of tax
3,300
Month
2
Qtr. 1
Qtr. 2
--- Rs. in 000 --(60,000)
2,820
2,820
5,211
9,120
(5,000)
(7,500)
(1,250)
(630)
(630)
(1,143)
(1 ,372)
(59,992)
2,438
1st
Month
Qtr.
3
4
5
---------- Rs. in 000 ----------
3,300 3,300
3,300
3,300
3,300
2,310 2,310
924
2,310 3,234
2,310
924
3,234
2,310
924
3,234
2,310
924
3,234
5,544
(333)
5,211
Page | 56
2nd
Qtr.
9,702
(582)
9,120
ICPAP
Operating expenses
Total operating expenses given
4,800
(2,520)
(792)
1,488
Fixed cost
Fixed factory overheads
7,500
(3,500)
1,488
5,488
457
Problem No 19:Noureen Industries Limited produces and sells sports goods. The management
accountant has developed the following budget for the year ending June 30, 2011.
Budgeted Income Statement
Sales
Variable costs
Fixed overheads
Gross profit
Selling and admin expenses:
Sales commission
Depreciation on assets
Fixed administrative costs
Net operating income
Rs. in 000
80,000
44,800
6,500
51,300
28,700
8,000
700
2,200
10,900
17,800
Page | 57
ICPAP
Sales
Less: Variable expenses
Manufacturing costs
Sales commission
Finance cost
Contribution margin
Contribution margin as % of sales
Fixed expenses
Fixed overheads
Increased
Own sales
commission 20% department
------------Rs. in 000s----------80,000
80,000
44,800
16,000
150
60,950
19,050
23.8
44,800
4,000
150
48,950
31,050
38.8
6,500
6,500
Page | 58
Depreciation
Fixed admin costs
Finance cost
Fixed marketing costs
ICPAP
700
2,200
600
10,000
700
2,200
600
7,000
17,000
ICPAP
iv.
Fixed overheads
These are estimated at Rs. 45 million per annum at 100% capacity. Some of
the facilities can be relieved, if the company does not want to work at more
than 70% capacity. As a result of relieving these facilities, the annual fixed
costs would reduce to Rs. 33.75 million. If the excess production capacity is
used to produce material C, the company can earn a contribution margin of
Rs. 200,000 per month for each 10% capacity utilization.
Required:
Compute the manufacturing cost of product M using the relevant cost approach.
Solution:Manufacturing cost of product B
Material A
(105,000 250)
Material B
(120,000 60)
(90,000 70)
Labour (W-1)
[60 200 6 448 (W-1)]
Variable factory overhead
[2006448(W-1)
hours8]
Fixed factory overhead (W2)
Manufacturing
cost
of
product B
26,250,000
7,200,000
6,300,000
4,425,000
80,731,800
W-1: Labour
Total working hours per labour (200 6)
Units produced in first 300 hours (300/6)
Units produced in remaining 900 hours (900/5)
No. of units produced per worker
No. of full units
Normal loss (5,000 60%)
1,200
50
180
230
100,000
3,000
103,000
448
13,500,000
32,256,000
4,300,800
A
B
5,625,000
1,200,000
6,825,000
4,800,000
6,825,000
2,400,000
4,425,000
Page | 60
ICPAP
Problem No 21:ABC Limited deals in a single product called HGV. It had prepared a budget for
the year ending December 31, 2009 which was based on the following key
assumptions:
Sales
504,000 units @ Rs. 430
Variable cost (40% is direct labour)
Rs. 300 per unit
Fixed cost for the year (including depreciation @ 10%) Rs. 25,000,000
Cost of raw material per kg
Rs. 56.25
Raw material consumption per unit of finished 2 kgs
product
However, the position as shown by the management accounts prepared up to
May 31, 2009 is not very encouraging and depicts the following actual results:
105,000 units were sold @ Rs. 350 per unit.
Average cost of raw material used amounted to Rs. 90/- per unit of
finished product.
Other variable costs were as per the budget.
The marketing department advised the management that the failure to achieve
targeted sale is because a competitor has introduced another product which has
been very popular in the low income areas.
After due deliberations, the management has prepared a revised plan for the
remaining period of the financial year. The plan involves launching of a low
grade version of the existing product named LGV, to capture the low income
market. Salient features of the plan are as under:
i. Sales mix of HGV and LGV is expected to be in the ratio of 1:2. Sale price of
HGV would be increased to Rs. 385, whereas sale price of LGV would be
Rs. 270.
ii. A new machine will have to be purchased for Rs. 1.2 million.
iii. For LGV two different types of raw materials i.e. A and B will be used in
the ratio of 5:3. However, the total weight of raw material used shall be the
same in case of both products. Presently A is available at the rate of Rs. 25
per kg whereas B is available at the rate of Rs 45 per kg. The raw material
consumption per unit of HGV shall continue to be Rs. 90 per unit.
iv.
Production of HGV is carried out by skilled workers. However, only
unskilled workers would be required for the production of LGV. The
wages of unskilled workers would be 40% lower but labour hours per unit
would be 10% higher than HGV.
v. Variable factory overhead cost per unit of LGV would be 10% lower than
HGV.
vi. Additional marketing cost would be Rs. 3 million.
Required:
Compute the sales amount and quantities for the remaining period, to achieve a
break even in 2009.
Page | 61
ICPAP
Solution:ABC Limited
Actual Jan-May 2009
Sales
Variable costs:
Raw materials
Direct labor
Other variable costs
Contribution margin
Rupees
36,750,000
(105,000x350)
(105,000x90)
(300 0.4) x 105,000
(300-112.50-120) x 105,000
Revised Plan Jun-Dec 2009
LGV
270
(31.25)
(33.75)
(65.00)
(9,450,000)
(12,600,000)
(7,087,500)
7,612,500
HGV
385.00
Total
(90.00)
(120.00)
(79.20)
(67.50)
(60.75)
(204.95)
65.05
2
130.10
(277.50)
107.50
1
107.50
3
237.60
25,000,000
3,000,000
70,000
28,070,000
(7,612,500)
20,457,500
79,643,425
Page | 62
ICPAP
ICPAP
OF
BUDGETED
Budgeted profit
Sales volume margin variance
Sale price variance
Material price variance
Material quantity (usage) variance
Labour rate variance
Labour efficiency variance
CONTRIBUTION
AND
ACTUAL
Rupees
7,125,000
213,750
(515,000)
(478,950)
(257,500)
675,937.50
(482,812.50)
Page | 64
ICPAP
(154,500)
270,375
6,396,300
Problem No 23:Clifton Hospital is interested in an analysis of the fixed and variable cost of
supplies related to patient days of occupancy. The following actual data has been
accumulated by the management:
Month
Cost of supplies Occupancy
(Rs. 000)
ratio (%)
December 2008
1,665
90
January 2009
1,804
93
February 2009
1,717
98
March 2009
1,735
94
April 2009
1,597
86
May 2009
1,802
99
Required:
Compute the variable cost of supplies per bed per day using the method of least
square, if the total number of beds in the hospital is 300.
Solution:Patient days
of
occupancy
Dec
Jan
Feb
Mar
Apr
May
Total
Average
1
*8,370
8,649
8,232
8,742
7,740
9,207
50,940
8,490
Diff from
Average (y)
4
-55.0
84.0
-3.0
15.0
-123.0
82.0
Col 2 sqrd
x2
5
14,400
25,281
66,564
63,504
562,500
514,089
1,246,338
(2) x (4)
Rs. 000
xy
6
6,600
13,356
774
3,780
92,250
58,794
175,554
ICPAP
years as it has been regularly increasing the price of its only product i.e. PDT.
However, since the cost of production has been rising, the company is unable to
reduce the price. The companys budget for the next year contains the following
projections:
i. Two types of raw materials i.e. A and B will be used in the ratio of 70:30.
ii. The cost of raw materials would be Rs. 32 and Rs. 10 per kg respectively.
iii. Wastage is projected at 8% of input quantity.
iv.
Labour rate has been projected at Rs. 400 for 8 working hours / day.
v. One labour hour is estimated to be consumed for 4 kgs of finished
products.
vi. Variable overheads have been budgeted at Rs. 5 per kg of input.
vii. Fixed overheads are estimated at Rs. 4,000,000 per annum.
A consultant hired by the company has carried out a detailed study and
recommended the following measures:
Hire a firm of Quality Assurance who would depute its expert staff to
control the ratio of wastage. The company will have to pay Re 0.5 per kg
for the inspection of material. It is expected that overall wastage would
decrease by 80%.
It has been identified that factory workers are spending 25% more time as
compared to other manufacturing units of the industry. An incentive plan
has therefore been suggested, according to which the workers would be
entitled to share 40% of the time saved. It is expected that by implementing
the incentive plan, the workers will achieve the industry average.
Certain improvements have been suggested in the production process and
this will result in reduction in variable overheads by 20%.
It has been ascertained that staff performing various support functions is
underutilized. The company should therefore discontinue the services of
some members of the staff and allocate their work between the remaining
staff. As a result, fixed overheads will decrease by 25%.
Required:
Compute the amount of savings that the revised plan is expected to generate if the
required production is 2 million kgs of PDT.
Solution:Computation of budgeted gross profit based on:
Existing
budget
Rupees
Material A
(2 M kgs x 70%
32) / 0.92
Budget based on
recommended
plan Rupees
45,528,455
Page | 66
Material B
Inspection cost
Labour Cost
Variable
overhead
Fixed Overhead
ICPAP
Savings
(Note) Savings in Labour Cost:
Average labour time for industry (15 minutes /1.25)
Benefits of time saving
[(15 minutes 12 minutes) /60] 2 M 400/8
Workers share (Rs. 5 million 40%)
Savings
6,097,561
1,016,260.00
22,000,000.00
8,130,081.30
3,000,000.00
85,772,357.30
9,314,599.20
12 Minutes
Rs. 5,000,000
Rs. 2,000,000
Rs. 3,000,000
Problem No 25:Ahmed Sons (Pvt.) Ltd., a small sized manufacturer, is experiencing a short term
liquidity crisis. It needs Rs. 10 million by the end of next month and expects to
repay it within 6 months of the date of receipt.
The company is considering the following three alternatives:
i. Obtain short term loan at an interest of 18 percent per annum,
compounded monthly.
ii. Forego cash discount of 2% on some of its purchases. The total purchases
are approximately Rs. 12 million per month. The discount is offered for
payment within 30 days. However, if the payment is delayed beyond 90
days, it could endanger the companys relationship with the supplier.
iii. Make arrangement with a factor who is ready to advance 75 per cent of the
value of the invoices after deduction of all factoring charges, immediately
upon receipt of the invoices. The balance shall be paid within the normal
credit period presently being availed by the customers.
The average sales are Rs. 25 million per month of which 60% are credit
sales. The company's customers pay at the end of the month following the
month in which the sales took place. This level is expected to remain
steady over the next year.
The factor shall charge interest @ 15 percent per annum on the amount of
money advanced. He shall also charge factoring fee of 2 percent.
Page | 67
ICPAP
Rupees
15,000,000
210,938
300,000
510,938
200,000
63,641*
(263,641)
247,297
16,875,000
(210,938)
(300,000)
16,364,062
(10,000,000)
6,364,062
63,641
Less: requirement
Overdraft reduction
Interest at 1% per month
Conclusion:
Option II is the cheapest option. The company should forego the cash discount
of 2% and avail credit for further 60 days.
Problem No 26:XYZ Ltd presently uses a single plant wide factory overhead rate for allocating
factory overheads to products, based on direct labour hours. A break-up of
factory overheads is as follows:
Factory overheads
Production Support
1,225,000
Page | 68
ICPAP
Others
175,000
Total cost (Rs.)
1,400,000
It now plans to use activity-based costing to determine costs of its products. The
company performs four major activities in the Production Support Department.
These activities and related costs are as follows:
Production Support Activities
Rupees
Set up costs
428,750
Production control
245,000
Quality control
183,750
Materials management
367,500
Total
1,225,000
The planning department has gathered the relevant information which is given
below:
Direct
Machine Inspections
No. of
Production
labour
Batch
hours
hours per
Material
Products
in units
hours per
size
per unit
unit
requisitions
unit
(units)
raised
Product X
10,000
2.5
125
7.50
0.2
320
Product Y
2,000
5.0
50
10.00
0.5
400
Product Z
50,000
2.8
10,000
3.00
0.1
30
The quality control department follows a policy of inspecting 5% of all production
in case of X and Y and 2% of all units of Z.
Required:
Determine the factory overhead cost per unit for Products X, Y and Z under:
a) Single factory overhead rate method.
b) Activity Based Costing.
Solution:a) .
Number of units
C
D
E
X
10,000
2.5
25,000
20
Y
2,000
Z
50,000
5.0
2.8
10,000 140,000
40
Total
175,000
1,400,000
Rs. 8
22.40
Page | 69
ICPAP
b) .
Activity based costing
Set-up costs
Batch size
G
Set-ups (A G)
H
Set-up costs
J
Production control
Machine hours per unit
K
Total machine hours (A K)
L
Production control
M
Quality control Allocation
No. of inspections
N
Units inspected (A N)
P
Hours per unit inspected
Q
Total inspection hours (P Q)
R
Quality control costs
S
Materials management
No. of requisitions
T
Material management costs
U
Factory overheads General
Allocated on the basis of direct labour hours V
Total cost (J+M+S+U+V)
W
Factory overhead cost per unit activity based
costing (W A)
Rs.
125
50
80
40
274,400 137,200
10,000
5
17,150
125
428,750
7.5
75,000
75,000
10.0
3.0
20,000 150,000
20,000 150,000
245,000
245,000
5%
500
0.2
100
73,500
5%
100
0.5
50
36,750
2%
1,000
0.1
100
73,500
250
183,750
320
400
156,800 196,000
30
14,700
750
367,500
175,000
1,400,000
Problem No 27:A division of Electronic Appliances Limited sold 6,000 units of refrigerators
during the year ended September 30, 2008, the sale price being Rs. 24,000 per unit.
The opening work in progress comprised of 500 units which were complete as
regards material but only 40% complete as to labour and overheads. The closing
work in progress comprised of 1200 units which were also complete as regards
material but only 50% complete as to labour and overheads. The finished goods
inventory was 800 units at the beginning of the year and 1000 units at the year
end.
The work in progress account had been debited during the year with the
following costs:
Rs. in 000
Direct material
83,490
Direct labour
14,256
Variable overheads
10,890
Fixed overheads
17,490
Page | 70
ICPAP
As compared to the previous year, the costs per units have increased as follows:
Direct material
10%
Direct labour
8%
Variable overheads
10%
Fixed overheads
6%
The selling and administration costs for the year were:
Rupees
Variable cost per unit sold
1,600
Fixed costs
12,000,000
Required:
a) Compute the cost per unit, by element of cost and in total, assuming FIFO
basis.
b) Prepare profit statements on the basis of:
i.
Absorption costing
ii.
Marginal costing.
Solution:a).
Material
Equivalent units
Completed units
6,200
(6,000 + 1,000
800)
Closing work-in- 1,200
progress
Opening work-inprogress
Total equivalent
units
Total cost (Rs.)
Cost per unit (Rs.)
b).
i.
Labour
Variable
Overheads
Total
Variable
Cost
Fixed
Overheads
6,200
6,200
6,200
600
600
600
(500)
(200)
(200)
(200)
6,900
6,600
6,600
6,600
83,490,000
12,100
14,256,000
2,160
10,890,000
1,650
108,636,000
15,910
17,490,000
2,650
Total Cost
126,126,000
18,560
Rupees
144,000,000
6,700,000
13,600,000
126,126,000
(18,396,000)
(18,560,000)
109,470,000
Page | 71
ICPAP
Gross profit
Less: variable selling and administration costs
(1,600 6,000)
Fixed selling and administration costs
34,530,000
9,600,000
12,000,000
21,600,000
12,930,000
Net profit
ii.
Contribution
Less: Fixed costs (17,490 + 12,000)
Net profit
Working
Closing work-in- 14,520,000 1,296,000
progress (Rs.)
Cost per unit last 11,000
2,000
year
Opening work-in- 5,500,000
400,000
progress (Rs.)
Rupees
144,000,000
103,320,000
40,680,000
29,490,000
11,190,000
990,000
16,806,000
1,590,000
18,396,000
1,500
14,500
2,500
17,000
300,000
6,200,000
500,000
6,700,000
Problem No 28:RF Ltd. has established a new division. The total cost of the property, plant and
equipment of the division is Rs. 500 million. The working capital requirements are
expected to average Rs. 100 million. The company plans to finance the division
maintaining a debt equity ratio of 70:30. The cost of debt is 10%.
Other relevant information is as under:
Annual profit before depreciation and financial charges
Rs. 150 million
Life of the assets
10 years
Deprecation method
Straight line
Page | 72
ICPAP
The residual value of the property, plant and equipment is estimated at Rs. 20
million. The division will start functioning from 1st January, 2009.
Required:
a) Compute the return on investment (ROI) on the basis of average net assets
employed by the division for the years 2009 and 2015.
b) Based on the results obtained above, discuss the limitations of ROI as a
measure of performance.
Solution:a) ROI = net profit / total assets (investment)
Computation of net profit
Rs. in million
Annual profit before depreciation and financial charges
150
Depreciation [(Rs. 500 M - 20 M) / 10 years]
(48)
Financial Charges (Rs. 600 70% 10%)
(42)
60
Computation of net capital employed (mid-year) for year 2009
Rs. in million
Net Book Value at 1st January, 2009
500
Net Book Value at 31st December, 2009 [(480 9/10) + 20]
452
Mid-Year Value for year 2009 [(500 + 452) /2]
476
Working Capital
100
Average net capital employed
576
ROI for the year 2009 [(Rs. 60M / Rs. 576M) 100]
10.42%
Computation of average net capital employed (mid-year) for year
2015
Rs. in million
Net Book Value at 1st January, 2015 [(480 4/10) + 20]
212
Net Book Value at 31st December, 2015 [(480 3/10) + 20]
164
Mid-Year Value for year 2015 [(212 + 164) /2]
188
Working Capital
100
Average net capital employed
288
ROI for the year 2015 [(Rs. 60 / Rs. 288) 100]
20.83%
b) Comments on appropriateness of the result
1) ROI method focuses on short term performance whereas investment
decision should be evaluated on the life of the project.
2) Although the net profit for the years 2009 & 2015 are same but the
ROI is much higher in 2015 as compared to 2009 which shows that it
is not an appropriate ratio for comparing the performance on year to
year basis.
Page | 73
ICPAP
Page | 74
ICPAP
Kgs
600,000
750,000
Total Cost
Rupees
282,354,000
24,000,000
14,400,000
6,000,000
33,000,000
30,000,000
60,000,000
449,754,000
Total Cost
Rupees
300,000,000
24,000,000
13,500,000
6,000,000
37,500,000
41,250,000
80,500,000
502,750,000
55,860,000
558,610,000
Rupees
28,000,000
52,500,000
80,500,000
27,000,000
22,500,000
49,500,000
Page | 75
ICPAP
Rs. in million
Rs. in million
660.000
108.000
768.000
460.800
55.296
750.000
135.000
885.000
531.000
63.720
Model Z
Rupees
675,000,000
(558,610,000)
116,390,000
(49,500,000)
(63,720,000)
3,170,000
(951,000)
2,219,000
354,000,000
0.63%
Problem No 30:a) XYZ Ltd. produces a single product which has a large market. It sells an
average of 360,000 units per month at a price of Rs.160 per unit. The
variable cost is Rs.120 per unit.
All sales are made on credit. Debtors are allowed one month to clear off the
dues. The company is thinking of extending the credit term to two months
which will help increase the sale by 25%.
Other information is as follows:
i.
Raw materials constitute 60% of the variable cost.
ii.
The company has a policy of maintaining 60 days stock of finished
goods and 30 days stock of raw materials. The suppliers of raw
materials allow a credit of 20 days.
iii.
The companys cost of funds is 16%.
Required:
Calculate the effect of the proposed credit policy on the profitability of the
company.
b) FGH Ltd. needs financing for its short term requirements. A factor has
offered to advance 80% of the credit bills for a fee of 2% per month plus a
Page | 76
ICPAP
Rupees
128,000
480,000
608,000
(50,000)
(120,000)
438,000
Page | 77
ICPAP
Page | 78
ICPAP
= 2312 / 3,200
= 0.85
Batches
1
2
4
8
16
Cumulative quantity
40
80
160
320
640
Cumulative average
hours per unit
20
17
14.45
12.28
10.44
Cumulative hours
800
1,360
2,312
3,930
6,682
Hence, additional hours for 480 units = 6,682 2,312 = 4,370 hours
Labour hour rate:
600 normal hours + 200 overtime hours
600 + 200 x 2
1,000 hours
Hourly rate
Direct labour:
Rupees
800,000
800,000
800,000
800
Hours
8 workers for 10 weeks for 40 hours
2 workers for 4 weeks for 40 hours
Overtime
Direct
labour cost
Rupees
2,560,000
256,000
592,000
3,408,000
Amount in Rs
4,800,000
3,408,000
Page | 79
ICPAP
2,185,000
10,393,000
21,652
2,310,000
777,600
630,000
A
5400
5
Rupees
5,522,400
3,717,600
1,804,800
800,000
1,004,800
B
3600
6
ii.
20% of B was sold to a corporate buyer who was given a discount of 10%.
The buyer has agreed to double the purchases in 2009 and Mr. Rameez has
agreed to increase the discount to 15%.
In view of better margins in B, Mr. Rameez has decided to promote its sale
at a cost of Rs. 250,000. As a result, its sales to customers other than the
corporate customer, are expected to increase by 30%. However, the
production capacity is limited. He intends to reduce the production/sale of
A if necessary. Mr. Rameez has ascertained that 90% capacity was utilized
Page | 80
iii.
iv.
v.
vi.
vii.
ICPAP
during the year ended November 30, 2008 whereas the time required to
produce one unit of B is 20% more than the time required to produce a unit
of A.
2.4 kgs of the same raw material is used for both brands but the process of
manufacturing B is slightly complex and 10% of all raw material is wasted
in the process. Wastage in processing A is 4%.
The price of raw material have remained the same for the past many years.
However, the supplier has indicated that the price will be increased by 10%
with effect from March 1, 2009.
Direct labour per hour is expected to increase by 15%.
40% of production overheads are fixed. These are expected to increase by
5%. Variable overheads per unit of B are twice the variable overheads per
unit of A. For 2009, the effect of inflation on variable overheads is
estimated at 10%.
Selling and administration expenses (excluding the cost of promotional
campaign on B) are expected to increase by 10%.
Required:
Prepare a profit forecast statement for the year ending November 30, 2009.
Solution:Computation of Sales for 2008
A
Ratio of sale price
Actual sale Qty
Ratio of sale value
Sales value
1.00
5,400.00
5,400.00
2,700,000.00
B
B
Normal
Corporate
1.60
1.44
2,880.00
720.00
4,608.00
1,036.80
2,304,000.00 518,400.00
A
5,400.00
6,000.00
Total
11,044.80
5,522,400.00
B
3,600.00
4,000.00
If only B is produced the company can produce 9,000 units (4,000 + 6,000 / 1.2).
Required production of B in the next year = (2,880 x 1.3) + (2 x 720) = 3744 + 1440
= 5,184 units Remaining capacity can be utilised to produce 4,579 units of A
[(9,000 - 5,184) x 1.2].
Computation of Sales for 2009
Rupees
Sales of A (4,579 x 500)
2,289,500
Page | 81
ICPAP
4,147,200
6,436,700
172,800
6,263,900
Kgs
13,500.00
9,600.00
23,100.00
Rupees
100.00
11,447.50
13,824.00
25,271.50
107.50
2,716,686.25
Hours
27,000
21,600
48,600
22,895
31,104
53,999
5,399
Rs. 993,582
Rupees
252,000.00
378,000.00
A
1.00
5,400.00
5,400.00
162,000.00
30.00
Total
2.00
3,600.00
7,200.00 12,600.00
216,000.00 378,000.00
60.00
Page | 82
ICPAP
Total
264,600.00
1,130,000.00
665,780.75
Problem No 33:Zain Limited operates a production unit which produces a chemical which is
commonly used in various industries. Following information has been collected to
ascertain the companys working capital requirement:
i.
ii.
iii.
iv.
Designed capacity of the plant is 150 tons per hour. However, as in the
past, it is expected that the plant will operate at 70% of the designed
capacity.
The variable cost per ton of finished product would be Rs. 2,500 made up
as under:
Raw materials
62.4%
Consumables and spares
12.0%
Other processing costs
25.6%
Raw material is imported on FOB basis. The supplier allows 45 days credit
from the date of shipment. However, overseas and inland transportation
and port and customs formalities take 30 days.
Because of the nature of the cargo, only one ship is available in a month,
for transporting the raw material.
Page | 83
v.
vi.
vii.
viii.
ix.
x.
xi.
xii.
ICPAP
Required:
Determine the working capital requirement for the year. (Assume 30 days in each
month)
Page | 84
ICPAP
Solution:Budgeted production
Budget production is 70% of the designed capacity
(150 tons 70% 24 hours 30 days 12 months)
(A) Raw material
Quantity of raw material required
(1.25 tons 907,200 tons of finished product)
Quantity of raw material for each shipment
(1,134,000 tons 12 of finished product)
Total cost of purchases including transportation and other variable
purchase cost for each ton of product
(Rs. 2,500 62.4%)
Per ton FOB price of raw material (Rs. 1,560 100 130) 1.25
Total amount to be paid to supplier for each shipment
(Rs. 960 94,500 tons)
Credit period (45-30 days)
Trade credit: Average amount of liability (Rs. 90.72 million 15/30)
Cost of consumables, spares and processing per ton (2,500 37.6%)
(B) Inventory
Raw Material (94,500 tons 2 Rs. 960 1.3)
Work in progress (1,000 Rs. 960 1.3) + (1,000 940 50%)
Finished products (907,200 15 30 12) Rs. 2,500
Spares & consumables
(C) Debtors
Corporate clients
907,200 tons
1,134,000 tons
94,500 tons
Rs. 1,560/ton
Rs. 960
Rs. 90.72 mln
15 days
Rs. 45.36 mln
Rs. 940
Rs. in 000
58,968
1,718
94,500
20,000
175,186
Rupees
35,343,000
(5,197,500)
13,643,438
43,788,938
Tons
907,200
75,600
(37,800)
945,000
2,500
Page | 85
ICPAP
140
2,640
660
3,300
Other credit
5,292,000
35,532,000
40,824,000
43,788,938
175,186,000
(45,360,000)
(40,824,000)
132,790,938
Average
time
40.00
Cumulative
time
40
Page | 86
2
4
8
16
32
64
No. of
workers
40
7
153
153
Available
hours*
522
992
1,882
206
ICPAP
38.00
36.10
34.30
32.58
30.95
29.40
76
144
274
521
990
1,882
Average time
per unit
32.58
30.95
29.40
28.00
Production
per worker
16
32
64
7
Total
production
640
224
9,792
1,071
11,727
No. of
Hours
20,880
6,944
287,946
31,518
347,288
174 x 3
522
Up to June 21
174 x 5.7
992
Up to December 31
174 x 12
[1,882+206] 2,088
Cost of production
Units
Materials
Labour
Overheads
Rate
Total cost
11,727
10,000
117,270,000
347,288
110
38,201,680
11,727
4,000
46,908,000
202,379,680
Production (units)
11,727
17,258
21,573
Page | 87
ICPAP
Given
Given
kgs
%
A
1,014,200
11
B
754,000
13
C
228,000
8
A/B
A+C
kgs
kgs
9,220,000
10,234,200
5,800,000
6,554,000
2,850,000
3,078,000
D/2
D/2
Given
kgs
kgs
Rs.
5,117,100
5,117,100
6,744,430
3,277,000
3,277,000
3,883,100
1,539,000
1,539,000
1,390,800
Page | 88
H
J
K
L
M
N
P
Oct-Mar
Apr-Sept
Average price Oct-Sept
F/A
G/1.1
(G+H)
/2
Purchases during year
J*D
Material consumed at actual K-F
price
Standard price
Given
Standard cost
CxM
Price
variance L N
favourable/(unfavourable)
Total price variance
Favourable
Mix variance:
Raw
Actual
material quantity used
(kgs)
9,220,000
5,800,000
2,850,000
17,870,000
Yield Variance:
Raw
Standard mix
material
of actual
quantity used
A
8,935,000
B
5,956,667
C
2,978,333
17,870,000
Rs.
Rs.
Rs.
6.65
6.05
6.35
5.15
4.68
4.92
6.10
5.55
5.83
Rs.
Rs.
64,987,170
58,242,740
32,245,680
28,362,580
17,944,740
16,553,940
kg
Rs.
Rs.
6.40
59,008,000
765,260
4.85
28,130,000
(232,580)
5.90
16,815,000
261,060
793,740
Standard mix of
actual quantity used
Ratio
A
B
C
ICPAP
3/6
2/6
1/6
Actual
Variances
(kgs)
Standard
price per
kg
(285,000)
156,667
128,333
NIL
6.40
4.85
5.90
Variances
(rupees)
kgs
8,935,000
5,956,667
2,978,333
17,870,000
Standard usage
for actual output
(kgs)
8,910,000
5,940,000
2,970,000
*17,820,000
Variances
(kgs)
(25,000)
(16,667)
(8,333)
(50,000)
Standard
price per
kg
6.40
4.85
5.90
(1,824,000)
759,835
757,165
(307,000)
Variances
Rs.
(160,000)
(80,835)
(49,165)
(290,000)
{Output 1.32 million units x standard input per unit 13.50 kgs(6.75 + 4.50 + 2.25kgs)}
Material usage variance
(597,000)
Problem No 36:Sajid Industries Limited purchases a component C from two different suppliers,
Y and Z. The price quoted by them is Rs. 90 and Rs. 87 per component
respectively. However 7% of the components supplied by Y are defective whereas
in case of Z, 11% of the components are defective. The use of such defective
Page | 89
ICPAP
components results in rejection of the final product. However, the final products
to be rejected are identified when the product is 60 % complete. Such units are
sold at a price of Rs. 200.
The average cost of the final product excluding the cost of component C is as
follows:
Rupees
Material (excluding the cost of the component C)
420
Labour (3 hours @ Rs 60 per hour)
180
Overheads (Rs. 40 per hour based on labour hours)
120
720
50% of the material (including the component C) is added at the start of the
production whereas the remaining material is added evenly over the production
process.
The company intends to introduce a system of inspection of the components, at
the time of purchase. The inspection would cost Rs. 20 per component. However,
even then, only 90% of the defective components would be detected at the time of
purchase whereas 10% will still go unnoticed. No payments will be made for
components which are found to be defective on inspection. The total requirement
of the components is 10,000 units.
Required:
Analyze the above data to determine which supplier should be selected and
whether the inspection should be carried out or not.
Solution:Cost of components without inspection:
Total good components required (A)
Defectives expected (7/93 and 11/89 of 10,000) (B)
Total components to be purchased A + B = (C)
COSTS:
Purchase price of components @ 90 x (C) and 87 x (C)
Production cost of defective units:
Material cost at start - 50% of 420 (B)
Balance processing costs {B*60% of (720-210)}
Sale proceeds of defectives (B) x 200
Total cost of components (including defective components and
defective units produced)
Y
10,000
753
10,753
Z
10,000
1,236
11,236
967,770
977,532
158,130
230,418
(150,600)
1,205,718
259,560
378,216
(247,200)
1,368,108
Z
Page | 90
(D)
Total good components required
(E)
Defectives expected B 10
(F)
Total components required D + E
COSTS:
Purchase price of components @ 90 x (F) and 87 x (F)
Production cost of defective units:
Material cost at start - 50% of 420 x (E)
Balance processing costs (E) * 60% of (720 -210)
Sale proceeds of defectives (E) x 200
Inspection cost @ Rs. 20 per component {20 x (C)}
Total cost of components (including defective components and
defective units produced)
ICPAP
10,000
75
10,075
10,000
124
10,124
906,750
880,788
15,750
26,040
22,950
37,944
(15,000)
(24,800)
215,060
224,720
1,145,510 1,144,692
Conclusion: The best option is that company should buy component Z and
should carry out the inspection.
Problem No 37:Aftab Limited manufactures CNG kits for certain automobiles. The management
of the company foresees sudden rise in the demand of CNG kits in the next year
and they are trying to work out a strategy to meet the rising demand.
Following further information has been gathered by the management:
i. The current market demand is 650,000 units while the companys share is
40%. The demand for the next year is projected at 1,000,000 units while the
company expects to maintain its current market share.
ii. The production capacity of the company while working 8 hours per day is
350,000 units.
iii. The selling price and average cost of production per unit for the current
year, are as follows:
Rupees
Selling Price
Less: Cost of production
Material
Labour (34 hours per unit)
Overheads (60% variable)
Gross Profit
iv.
v.
40,000
24,000
3,400
2,800
30,200
9,800
Since the company was working below capacity, 15% of the labour
remained idle and were paid at 10% below the normal wages. These wages
are included in fixed overheads.
To increase the production beyond the normal capacity, overtime will have
to be worked which is paid at twice the normal rate. Also, the fixed
overheads, other than the labour idle time, would increase by 10%.
Page | 91
ICPAP
vi.
The management has negotiated with certain vendors and received the
following offers:
A present supplier of raw material has offered bulk purchasing
discount @ 2.5%, if the total purchases during the year exceeds Rs.
9.0 billion.
A manufacturer of CNG kits in Italy has offered to supply any
number of finished CNG kits at US$200 per unit. The landed cost of
these units in Pakistan would be Rs. 29,000 per unit.
Required:
Determine the best course of action available to the company.
Solution:Option 1: Manufacturing all units at own factory
350,000 units
Rate
Material units
Labour
Overheads
Existing fixed cost (260,000 x
1,120)
Less: Cost of idle labour (260,000 x
3,400 x 0.15/0.85 x 90%)
24,000
3,400
1,680
Amount
Rs. in
000
8,400,000
1,190,000
588,000
10,178,000
291,200
50,000 units
Rate
24,000
6,800
1,680
Amount
Rs. in
000
1,200,000
340,000
84,000
1,624,000
400,000
units
Amount
Rs. in
000
(140,400)
150,800
15,080
(240,000)
10,328,800
1,399,080
11,728,880
Option 2 Produce 350,000 units locally and import 50,000 units from Italy
Rs. in 000
Production of 350,000 units
10,328,800
Purchase of 50,000 units from outside @ 29,000
1,450,000
Total cost for 400,000 units
11,778,800
Option 3 Impact all (400,000) units from Italy
Purchase of 4000,000 units from outside @ 29,000
11,600,000
Page | 92
ICPAP
150,800
11,750,800
Decision
The company should produce 400,000 units at its own manufacturing facility.
Problem No 38:Rafiq Industries specializes in production of food and personal care products.
During the year 2010, the company intends to launch a new product called PQR.
The relevant details are as follows:
i. The product would be sold in 3 pack sizes and the sales have been
projected as follows:
Pack size
Units
500 grams
200,000
1 kg
120,000
2 kg
90,000
ii. For producing 1 kg of output, following materials would be required:
0.5 kg of material A which costs Rs. 300 per kg.
1 kg of material B. Current stock of material B is 250,000 kgs and it was
purchased @ Rs. 100 per kg. Its current purchase price is Rs. 125 per kg.
The expiry date of the current stock is December 31, 2010. Before the expiry
date, it could be disposed of at the rate of Rs. 110 per kg.
100,000 kgs of material B could be used in producing another product
called UVW with additional cost of Rs. 4,000,000 which could then be sold
at the rate of Rs. 160 per kg. However, both PQR & UVW are produced on
the same machine. The machine has to be worked at 100% capacity for
producing the required quantity of PQR.
iii. Cost of packing materials have been projected as under:
Pack size
Cost per unit
500 grams
30
1 kg
40
2 kg
55
iv.
100 kgs of product would require 5 hours of skilled labour and 10 hours of
unskilled labour. Skilled labour is paid at Rs. 70 per hour and unskilled
labour at Rs. 45 per hour. Currently, the company has 5,000 idle hours of
skilled labour and has a policy to pay 50% for idle hours.
v. The production capacity of the factory is 2 million kgs but currently the
factory is operating at 50% capacity. Fixed overheads at 100% capacity are
Rs. 25 million. However, if the factory operates below capacity, the fixed
overheads are reduced as follows:
by 10% at below 80% of the capacity
by 25% at below 60% of the capacity
Page | 93
ICPAP
Required:
Calculate the sale price for each pack size of the new product assuming that the
company wants to earn a profit of 25% on the cost of the product which shall
include relevant costs only.
Solution:PRICING OF NEW PRODUCTS
Calculation of expected sale
Pack size
(a)
Units
(b)
Total production (Kgs.)
Percentage of total production
Consumption of Material A (c)
(Kgs)
(d)
Cost of Material A {300 (c)}
(e)
Material B {118.125(W-1) (a)}
Packaging cost {(a) x 30, 40; 55} (f)
Labour {7.5625 (W-3) (b)}
Fixed overheads {9.375 (W-4) x (b)}
Total cost
Sales (cost + 25%)
Sale price / unit
Total
500 grams
200,000
400,000
100,000
100%
25%
200,000
50,000
60,000,000
47,250,000
15,750,000
3,025,000
3,750,000
129,775,000
162,218,750
15,000,000
11,812,500
6,000,000
756,250
937,500
34,506,250
43,132,813
216
W-1
Material B
Qty
Opportunity cost of 100,000 kgs (W-2)
100,000
Current disposal price of remaining 150,000
available material
Purchase price of additional requirement
150,000
400,000
W-2
Opportunity cost of 100,000 kgs
Sale Price
Less: additional cost
Sale price if sold without processing
Higher of the above
100,000
1 kg
120,000
120,000
30%
60,000
2 kg
90,000
180,000
45%
90,000
18,000,000
14,175,000
4,800,000
907,500
1,125,000
39,007,500
48,759,375
406
27,000,000
21,262,500
4,950,000
1,361,250
1,687,500
56,261,250
70,326,563
781
Rate
110
Amount
12,000,000
16,500,000
125
118.125
18,750,000
47,250,000
160
16,000,000
(4,000,000)
12,000,000
11,000,000
12,000,000
Page | 94
W-3 Labour
Skilled Labour [(400,000 / 100 5) 70
Unskilled Labour (400,000 / 100 10) 45
Less: Skilled Labour - Idle hours now saved (5,000 70 /2)
Cost per Kg
W-4
Current fixed expenses 25,000,000 (100-25)% =
Production including new product (2,000,00050%)kgs + 400,000 kgs =
Capacity utilization after introduction of new product =
Fixed expenses (25,000,00090%) =
Additional fixed expenses on a/c of new product
Cost per Kg (for allocation purpose)
ICPAP
1,400,000
1,800,000
(175,000)
3,025,000
7.5625
Rs. 18,750,000
1,400,000 Kgs.
70%
22,500,000
Rs. 3,750,000
Rs. 9.375
Problem No 39:Azmat Industries is engaged in manufacturing two products, X and Y. Both the
products have a high demand but the company is facing a liquidity crunch. In
view of the liberal credit policy being followed by the company the Finance
Director is of the opinion that sales of only Rs. 200 million can be financed
through the present resources. However, a credit facility of Rs. 25 million can be
obtained from local market at a mark-up of 16%. If this facility is obtained for the
whole year, the company will be in a position to increase its sale to Rs. 260
million.
The following data is available for the year ended June 30, 2008:
X
Y
Direct materials per unit Rs
300
700
Direct labour per unit Rs.
180
150
Variable overheads per unit Rs.
160
180
Selling price per unit Rs.
900
1,200
Production per machine hour
8
6
The Marketing Director has informed that he has already made commitments for
the supply of 40,000 units of X and 96,000 units of Y. Total available machine
hours are 34,000.
Required:
a) Calculate the maximum profit the company can achieve if the sale is
restricted to Rs. 200 million.
Page | 95
ICPAP
Unit
Rate
Rs.
40,000
900
36,000,000
96,000
1,200
115,200,000
151,200,000
48,800,000
260
170
2,080
1,020
29
14
Units
Hours
X (40,000+ 54,222 )
94,222
11,778
96,000
16,000
27,778
Page | 96
ICPAP
Sales in unit
(b)
Total - Rs.
94,222
96,000
260
170
24,497,720
16,320,000
40,817,720
66,667 units
49,776 units
Rs. 12,941,760
4,000,000
8,941,760
*(34,000 27,778)
Problem No 40:Yousuf Aziz & Company has achieved significant growth over the years. The
Company is negotiating a working capital loan to finance its fast growing
operations. For determining the working capital requirement, the finance
manager has collected the following data for the current financial year which has
just commenced:
i. The sales will increase by 25% over the previous years sales of Rs. 1.0
billion. Local sales were 60% of total sales last year. The volume of local
sales will increase by 10% whereas prices will increase by 15% on the
average. The remaining growth will come from exports, all of which will
be volume driven.
ii. Cash sales to local customers will be approximately Rs. 100 million. Credit
terms for local sales are 2/10 and 1/20. It is estimated that total discounts
to the customers will amount to Rs. 6 million. The value of sales on which
Page | 97
iii.
iv.
v.
vi.
vii.
ICPAP
Required:
Assuming that all transactions are evenly distributed over the year (360 days),
determine the working capital at the end of the year.
Solution:Computation of working capital
Rupees
Debtors:
Exports
(D*30/360)
(Working 1)
40,916,667
(F*0.98*10/360)
(Working 2)
6,533,333
(E*0.99*20/360)
(Working 2)
6,600,000
(C-100,000,000-E-F-13180000)/12
(N x 15/360x0.5)
(Working 3)
23,818,333
2,043,215
Page | 98
ICPAP
Closing Stock
Raw material (H)
(Working 3)
48,342,000
(Working 4)
77,508,667
(L x 30/360)
(24,518,583)
(M x 45/360)
(24,518,583)
(B x 0.38 x 15/360)
(19,791,667)
136,933,382
Working 1
Sales in Previous year
1,000,000,000
1,250,000,000
Local sales
( A x 60%x1.1x1.15 )
759,000,000
Exports
(B-C)
491,000,000
120,000,000
240,000,000
Working 2
Assume sale with 1% discount = X
Sale with 2% discount will be = 2X
Working 3
Page | 99
ICPAP
660,000,000
Exports as above
491,000,000
1,151,000,000
(G*0.48*1.05/12)
48,342,000
(G*0.48*1.05)
580,104,000
(A*0.48/12)
(40,000,000)
588,446,000
Purchases of A (K*3/6)
294,223,000
Purchases of B (K*2/6)
196,148,667
Purchases of C (K*1/6)
98,074,333
Working 4
48,342,000
29,166,667
77,508,667
Page | 100
ICPAP
Problem No 41:Nihal Limited manufactures a single product and uses a standard costing system.
Due to a technical fault, some of the accounting data has been lost and it will take
sometime before the issue is resolved. The management needs certain information
urgently. It has been able to collect the following data from the available records,
relating to the year ended March 31, 2008:
(i) The following variances have been ascertained:
Rs.
Adverse selling price variance
24,250,000
Favourable sales volume variance
2,000,000
Adverse material price variance X
2,295,000
Favourable material price variance Y
2,703,000
Favourable material price variance Z
3,799,500
The overall material yield variance is nil but consumption of X is 10%
below the budgeted quantity whereas consumption of Y is 6% in excess of
the budgeted quantity
Labour rate variance is nil.
(ii) The budgeted sale price of Rs. 100 was 5.26% higher than actual sale price.
(iii) The standard cost data per unit of finished product is as follows:
No. of kgs
Standard Cost
Total Cost
X
5
3.00
15.00
Y
10
2.00
20.00
Z
15
1.80
27.00
(iv) During the year, the finished goods inventory increased by 230,000 units
whereas there was no change in the inventory levels of the raw materials.
(v) Labour costs are related to the consumption of raw materials and the standard
rates are as follows:
Skilled labour for handling material X
Semi-skilled labour for handling material Y
Unskilled labour for handling material Z
Required:
(a) Total actual cost of each raw material consumed
(b) Material mix variance.
(c) Labour Cost Variance.
Page | 101
ICPAP
Rupees
95
(A)
(B)
24,250,000
B/A
4,850,000
(a)
Units Sold
4.85
0.23
Units Manufactured
5.08
Standard cost
Price variance
Mix
variance*
X (5.08*15)
76.2000
2.2950
(7.6200)
70.8750
Y (5.08*20)
101.6000
(2.7030)
6.0960
104.9930
Z (5.08*27)
137.1600
(3.7995)
(0.9140)
132.4465
314.9600
(4.2075)
(2.4380)
308.3145
Actual cost
(b)
Page | 102
(c)
ICPAP
Standard mix
Actual mix
Difference
Variance
(millions Kgs)
(million Kgs)
(million Kgs)
(million Rs.)
X (5.08*5)
25.40
22.860
2.540
7.620
Y (5.08*10)
50.80
53.848
-3.048
-6.096
Z (5.08*15)
76.20
75.692
0.508
0.914
152.40
152.400
2.438
Quantity
consumed
million Kgs
Actual
labour at
standard
cost
Standard
labour cost
Labour cost
variance
million Rs.
skilled
22.860
22.860
25.400
2.540
Fav
semi-skilled
53.848
40.386
38.100
-2.286
Adv
unskilled
75.692
7.569
7.620
0.051
Fav
152.400
71.094
71.400
0.306
Problem No 42:Ibrahim Industrial Company produces custom made machine tools for various
industries. The prices are quoted by adding 50% mark-up on the cost of
production which includes direct material, direct labour and variable factory
overheads. The mark-up is intended to cover the non-manufacturing overheads
and earn a profit. Factory overheads are allocated on the basis of direct labour
hours.
The management has been using this system for many years but recent
experiences have shown that some customers have been dissatisfied with the
prices quoted by the company and have moved to other manufacturers. The CEO
was seriously concerned when KSL, a major client showed its concerns on the
prices quoted by the company and has asked the management accountant to carry
out a critical evaluation of the costing and pricing system.
The management accountant has devised an activity based costing system
consisting of four activity centres. The related information is as follows:
Page | 103
ICPAP
Activity Centre
Basis of Allocation
Activity 1
Activity 2
Manufacturing
Customer Service
Activity 3
Activity 4
Order Processing
Warehousing
Budgeted Activity
Level
72,000 hours
120 order days
20 orders
Direct materials usage
of Rs. 40 million
60%
10%
NIL
40%
70%
NIL
NIL
NIL
20%
NIL
20%
25%
NIL
NIL
55%
100%
100%
100%
Page | 104
ICPAP
Solution:1
(a)
Activity
Manufacturing
Customer
Warehousing
Unallocated
Total
service
Order
processing
Indirect labour
4,320,000
1,440,000
1,440,000
7,200,000
Other manufacturing
overheads
8,550,000
450,000
9,000,000
1,500,000
Quality Control
900,000
600,000
Transportation
126,000
882,000
252,000
1,260,000
1,650,000
3,000,000
600,000
750,000
13,896,000
2,922,000
600,000
2,892,000
Budgeted activity
level
72,000
120
193.00
24,350.00 30,000.00
0.0723
per labour
hour
per Re. of
material
usage
Admin salaries
(b)
1,650,000 21,960,000
20 40,000,000
Order by KSL
Costs under present method
3,000,000
Direct labour
1,500,000
1,350,000
5,850,000
Page | 105
ICPAP
Mark-up - 50%
Sale price
2,925,000
(A)
8,775,000
3,000,000
Direct labour
1,500,000
1,158,000
243,500
30,000
216,900
6,148,400
1,537,100
(B)
7,685,500
(A-B)
1,089,500
Problem No 43:Kamran Limited (KL) produces a variety of electrical appliances for industrial as
well as domestic use. The average life of the equipments is six years. According to
the terms of sale, the company has to provide free after sales service, including
parts, during the warranty period of one year. Thereafter, the services are
provided at market rates. The company has hired Ahmed Hasan Associates
(AHA) to provide these services on the following terms and conditions:
The material required for repairs carried out during the warranty period is
provided by KL. For customers whose warranty period has expired, the
material supplied to AHA is billed at cost plus a mark-up of 15%.
Labour and overheads incurred by AHA on services provided during the
warranty period are billed to KL at cost plus 30%.
KL gets a share in all amounts billed to the customers after the warranty
period. 10% share is received in respect of amounts billed to industrial
customers and 15% in case of domestic customers.
Page | 106
ICPAP
9,000,000
2,400,000
4,180,000
Salary of Supervisor
480,000
720,000
7,780,000
1,220,000
Page | 107
ICPAP
360,000
990,000
1,350,000
988,000
362,000
Net savings
858,000
Working 1
Domestic
Industrial
Total
Customers Customers
Ratio of services provided by AHA
20
80
100
Share of KL in %
15.00%
10.00%
N/A
C (A*B)
11
270,000
720,000
990,000
E (D/B)
1,800,000
7,200,000
9,000,000
F (E-D)
1,530,000
6,480,000
8,010,000
3,450,000
H (F-G)
4,560,000
Working 2
J (H*100/150)
3,040,000
Page | 108
ICPAP
K (J*20/80)
L(J + K)
760,000
3,800,000
Working 3
Mark-up charged by KL on material billed to AHA
360,000
2,400,000
2,760,000
690,000
3,450,000
690,000
L (K*0.3)
(working 2)
228,000
M (H-J)
(working 2)
1,520,000
Total
2,438,000
N ((J+K)*0.1)
(working 2)
380,000
480,000
Page | 109
ICPAP
720,000
1,580,000
Net savings
858,000
Working 1
Mark-up charged by KL on material billed to AHA
360,000
2,400,000
2,760,000
690,000
3,450,000
Working 2
Domestic
Industrial
Customers
Customers
Total
Ratio of services provided by AHA
20
80
100
Share of KL in %
15.00%
10.00%
N/A
C (A*B)
11
270,000
720,000
990,000
E (D/B)
1,800,000
7,200,000
9,000,000
F (E-D)
1,530,000
6,480,000
8,010,000
G (see working 1)
3,450,000
H (F-G)
4,560,000
J (H*100/150)
3,040,000
Page | 110
ICPAP
Page | 111
ICPAP
Page | 112
ICPAP
Page | 113
ICPAP
Page | 114
ICPAP
(b)
(i)
(ii)
(iii)
(iv)
(v)
K (J*20/80)
760,000
L(J + K)
3,800,000
It might be beneficial for Kamran Limited (KL) to focus on core business rather
than on non-core areas like after-sale service.
Ahmed Hasan Associates (AHA) might be technically more competent at
providing these services.
KL should also consider the reliability of AHA as an outside supplier of these
services. If after-sale service is a critical component of KLs business, it might be
better to do it in-house.
There is a potential for KL to be inefficient in terms of cost control during parts
production since the company charges a cost-plus margin to AHA. There is not
much incentive for KL to control costs.
The numbers provided by the cost accountant might be misleading since these
are predominantly direct costs of providing the service and possible effects on
other overheads may not have been considered.
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Glossary
By-product A product of limited sales value produced simultaneously with a
product of greater value, known as main product.
Common costs: Those costs incurred to produce products simultaneously, but
each of the products could have been produced separately.
Joint costs: Costs incurred up to the point in a given process where individual
products can be identified.
Joint product costs: Common cost factors shared by joint products which are
incurred prior to separation into individual joint products.
Joint products: Individual products of significant sales value which are produced
simultaneously and which are results of a common raw material and/or a
common manufacturing process.
Split-off point: The point in the production process wherein separate products,
either joint products or by-products, emerge.
Cost of quality: The cost associated with nonconformance to quality standards. It
consists of prevention costs, appraisal costs, internal failure costs, and external
failure costs.
Direct labor efficiency standard: Predetermined performance standards in terms
of the direct labor hours that should go into the production of one finished unit.
Direct labor price (rate) standards: Predetermined wage rate per hour
Direct material efficiency (usage) standards: Predetermined specifications of the
quality of direct materials that should go into the production of one finished unit.
Direct materials price standards: Predetermined amount of factory overhead, per
hour, for example, that should go into the production of one finished unit:
Flexible budget: A form of budgeting that shows anticipated costs at different
activity levels.
Inspection time: The time spent to inspect the product to make sure it conforms
to production standards as it moves from one production department to the next
and before it is shipped to customers. Inspection time also includes the time it
takes to rework products that are found not to conform to specifications.
Just-in-time philosophy: Manufacturing and purchasing strategies that seek to
reduce throughput time.
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Moving time: The time it takes to move the product from one production
department to the next and the time to move it to and from storage.
Nonvalue-added time: This time includes inspection time, moving time, waiting
time, and storage time. It is also referred to as waste time.
Processing time: The actual time that a product is being worked on
Quality control: A continuous system of feedback necessary for decision making
to ensure optimum product quality.
Standard costing: Costing that is concerned with cost per unit that should be
incurred; standard costing serves basically the same purpose as a budget.
Standard costs: Costs that are expected to be achieved in a particular production
process under normal conditions.
Static budget: A form of planning that shows anticipated costs at one level of
activity.
Storage time: The time that raw material and work in process remain in storage
before they are used by production department and finished products before they
are shipped to customers.
Throughput time: The time between the beginning of the production department
and finished products before they are shipped to customers.
Value-added time: Same as processing time.
Waiting or queue time: The time that the product remains in a production
department before it is worked on.
Waste time: Same as nonvalue-added time.
Zero defects: A program designed to eliminate defects in production.
Budget (controllable) variance: Difference between actual factory overhead and
budgeted factory overhead based on standard direct labor hours allowed.
Combined price-efficiency variance: Direct material price variance per unit
multiplied by the difference between the actual quantities purchased and the
standard quantity allowed.
Direct labor efficiency variance: Difference between the actual direct labor hours
worked and the standard direct labor hours allowed multiplied by the standard
direct labor hour wage rate.
Direct labor price variance: Difference between the actual wage and the standard
wage per direct labor hour multiplied by the actual direct labor hours worked.
Direct materials efficiency variance: Difference between actual quantity of direct
materials used and standard quantity allowed multiplied by the standard unit
price.
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Direct materials price variance: Difference between actual unit price and
standard unit price of direct materials purchased multiplied by the actual
quantity purchased.
Factory overhead efficiency variance: Difference between actual direct labor
hours worked and standard direct labor hours allowed multiplied by the
standard variable factory overhead application rate.
Factory overhead price (spending) variance: Difference between actual factory
overhead and budgeted factory overhead based on actual direct labor hours
worked.
Favorable variance: The result when actual costs are less than standard costs.
Production volume (denominator or idle capacity) variance: Difference between
the activity level used in the denominator for establishing the factory overhead
standard application rate and standard application rate and standard direct labor
hours allowed multiplied by the standard fixed factory overhead application rate.
Pure direct materials price variance: Difference between the direct materials price
variance per unit and the standard quantity allowed.
Unfavorable variance: The result when actual costs are greater than standard
costs.
Variance: Difference arising when actual results do not equal standards, because
of either external or internal factors.
Disposition of variances: The end-of-period treatment of variance that results
from a standard cost system.
Immaterial or insignificant variances: Variances which don not have to be
prorated and which may be treated as period costs.
Proration of variances: Allocation of variances to the specific accounts affected.
Absorption costing: The costing method under which all direct and indirect
production costs, including fixed factory overhead, are charged to product costs.
Contribution margin:
administrative costs.
Sales
less
variable
manufacturing,
selling,
and
Direct costing: The costing method under which only production costs which
tend to vary with the volume of production are treated as product costs.
External reports: Formal financial statements, such as the income statement,
balance sheet, and statement of cash flows, filed with government regulatory
agencies as required, or issued to stockholders.
Fixed factory overhead: The fixed costs, such as rent, insurance, and taxes,
required to provide or maintain facilities for manufacturing.
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Contribution margin per unit: Selling price per unit minus variable cost per unit.
Contribution margin ratio: Contribution margin per unit as a percentage of the
selling price.
Fixed costs: Costs which are not directly associated with production and which
remain constant for a relevant range of productive activity.
Margin of safety: The maximum percentage by which expected sales can decline
and profit can still be realized.
Mixed cost: Costs that are fixed up to a certain level of output but will vary
within certain ranges of output.
Regression analysis: A statistical technique that can be used to estimate the
relationship between cost and output.
Relevant range: The range of output over which the amount of total fixed costs
and unit variable costs remains constant.
Variable costs: Costs which are directly associated with producing a product and
which vary with the level of output.
Annuity: When the same dollar amount is to be paid or received in the future.
Annuity due: An annuity in which the first amount to be paid or received begins
immediately.
Capital budgeting decision: Decisions that involve the long-term commitment of
a firms resources.
Cash flow for a period: For a given period, the difference between additional
dollars received and additional dollars paid out if an investment project is
undertaken.
Cash flow from operations: As used in this chapter, a projects cash flow for all
years except year 0. In some textbooks, cash flow from operations may mean the
cash flow for all years including year 0.
Compound interest: An investment situation in which interest is earned not only
on the principal invested but also on the previous interest earned.
Contingent projects: A project which can only be accepted if some other project is
accepted.
Dependent projects: Same as contingent projects.
Discount rate: The interest rate used to determine the present value.
Discounted value: Same as present value.
Discounting: The process of obtaining the present value of a future value.
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Controllable assets
Controllable revenues
(Investment turnover Earnings ratio)
THE END
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