Cost Academy

Advanced Management Accounting Time Allowed: 2 hours 1. Attempt all the questions Total Marks: 100

To stimulate interest and provide an atmosphere for intellectual discussion, a finance faculty in a management school decides to hold special seminars on four contemporary topics leasing, portfolio management, private mutual funds, swaps and options. Such seminars should be helping once a week in the afternoons. However, scheduling these seminars (one for each topic, and not more than one seminar per afternoon) has to be done carefully so that the number of students unable to attend is kept to a minimum. A careful study indicates that the number of students who cannot attend a particulars seminar on a specific day is as follows: Leasing Monday Tuesday Wednesday Thursday Friday 50 40 60 30 10 Portfolio Management 40 30 20 30 20 Private mutual funds 60 40 30 20 10 Swaps and options 20 30 20 30 30

Find an optimal schedule of the seminars. Also find out the total numbers of students who will be missing at least one seminar. Solution This is an unbalanced minimization assignment problem. We first of all balance it by adding a dummy topic: Leasing Monday Tuesday Wednesday Thursday Friday 50 40 60 30 10 Portfolio Management 40 30 20 30 20 Private mutual funds 60 40 30 20 10 Swaps and options 20 30 20 30 30 Dummy 0 0 0 0 0

Subtracting the minimum element of each column from all the elements of that column, we get the following matrix: Leasing Monday Tuesday Wednesday Thursday Friday 40 30 50 20 0 Portfolio Management 20 10 0 10 0 Private mutual funds 50 30 20 10 0 Swaps and options 0 10 0 10 10 Dummy 0 0 0 0 0

The minimum number of lines to cover all zeros is 4 which is less than the order of the square matrix (i.e. 5), the above matrix will not give the optimal solution. Subtract the minimum uncovered element (=10) from all uncovered elements and add it to the elements lying on the intersection of two lines, we get the following matrix. Leasing Portfolio Management Private mutual funds Swaps and options Dummy

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Cost Academy

Monday Tuesday Wednesday Thursday Friday

30 20 40 10 0

20 10 0 10 10

40 20 10 0 0

0 10 0 10 20

0 0 0 0 10

Since the minimum number of lines to cover all zeros is 5 which is equal to the order of the matrix, the above matrix will give the optimal solution which is given below: Leasing Monday Tuesday Wednesday Thursday Friday 30 20 40 10 0 Portfolio Management 20 10 0 10 10 Private mutual funds 40 20 10 0 0 Swaps and options 0 10 0 10 20 Dummy 0 0 0 0 10

And the optimal schedule is Monday Tuesday Wednesday Thursday Friday Swaps and options No seminar Portfolio Management Pvt. Mutual funds Leasing No of students missing 20 0 20 20 __10 __70

Thus, the total number of students who will be missing at least one similar = 70 3. The Arcot Machinery Company has been offered a contract to build and deliver nine extruding presses to the home bottling company. The contract price negotiated is contingent upon meeting a specified delivery time, with a bonus offered for early delivery. The marketing department has established the following cost and time information: Activity Normal time (Weeks) Normal cost Rs. Crash time (Weeks) 1 3 2 7 2 4 4 1 Crash cost (Rs.) 9,000 14,000 6,000 6,000 5,000 3,600 14,000 10,600

A B m 1-2 1 5 3 5,000 2-3 1 7 4 8,000 2-4 1 5 3 4,000 2-5 5 11 8 5,000 3-6 2 6 4 3,000 4-6 5 7 6 2,000 5-7 4 6 5 10,000 6-7 1 5 3 7,000 Normal delivery time is 16 weeks for a contract price of Rs. 62,000.

On the basis of the calculated profitability for each delivery time specified in the following table, what delivery schedule do you recommend that the company may implement? Contract delivery time (Weeks) 15 14 13 12 Contract amount Rs. 62,500 65,000 70,000 72,500

(Here a =t0: optimistic time, b =tp: pessimistic time, m =tm: most likely time.)

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Solution Let us first calculate the expect duration of each activity. Activity A 1 1 1 5 2 5 4 1 Normal time (Weeks) B 5 7 5 11 6 7 6 5 m 3 4 3 8 4 6 5 3 Normal cost Rs. 5,000 8,000 4,000 5,000 3,000 2,000 10,000 7,000 Crash time (Weeks) 1 3 2 7 2 4 4 1 Crash cost (Rs.) 9,000 14,000 6,000 6,000 5,000 3,600 14,000 10,600 Cost slope (Rs.) 2,000 6,000 2,000 1,000 1,000 800 4,000 1,800

1-2 2-3 2-4 2-5 3-6 4-6 5-7 6-7

The network for the given problem is drawn below:

3
4 3 3 6 4

2
8

6
3

The critical path is 1-2-5-7 with total duration of 16 weeks. Cost of all activities is Rs. 44,000. contract price is Rs. 62,000 for normal delivery time of 16 weeks. Hence the profit is of Rs. 18,000. For calculating the most profitable delivery schedule, let us start crashing the activities on the critical path. Cost slopes for various activities are given in the above table. Step 1: Now there are two critical paths viz. 1-2-4-6-7 & 1-2-5-7 with duration of 15 weeks. So we crash activity 1-2 by 1 day at crash cost of Rs. 2,000. project duration is 14 weeks. Profit = Rs. 65,000-Rs. (45,000 +2,000) = Rs. 18,000 Step 2: Now there are two critical paths viz. 1-2-4-6-7 & 1-2-5-7 with duration of 15 weeks. So we crash activity 1-2 by 1 day at crash cost of Rs. 2,000. project duration is 14 weeks. Profit = Rs. 62,500- (Rs. 44,000 + Rs. 1,000) = Rs. 62,500 Rs. 45,000 = Rs. 17,500 Step 2: Now there are two critical paths viz. 1-2-4-6-7 and 1-2-5-7 with duration of 15 weeks. So we crash activity 1-2 by 1 day at crash cost of Rs. 2,000. Project duration is 14 weeks. Profit = Rs. 65,000 Rs. (45,000 +2,000) = Rs. 18,000 Step 3: We again crash activity 1-2 by 1 day. So the project duration is 13 weeks

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Cost Academy

Profit = Rs. 70,000 (Rs. 47,000 +Rs. 2,000) = Rs. 70,000 Rs. 49,000 = Rs. 21,000 Step 4: Now we crash activity 4-6 for path 1-2-4-6-7 at crash cost of Rs. 800 and activity 5-7 for path 1-2-5-7 at crash cost of Rs. 4,000. Project duration is now 12 weeks. Profit = Rs. 72,500 (Rs. 49,000 + Rs. 4,000 +Rs. 800) = Rs. 72,500 Rs. 53,800 = Rs. 18,700 No, further crashing is possible. From step 3, it can be seen that the profit is maximum when the project duration is 13 weeks. Hence, the company should implement the delivery schedule of 13 weeks at a contract amount of Rs. 70,000 to gain maximum profit of Rs. 21,000. ______________ 5. Factory A B C Demand 1 5 6 3 75 Destination 2 1 4 2 20 3 7 6 5 50 Supply to be exhausted 10 80 15

Since there is not enough supply, some of the demands at the three destinations may not be satisfied. For the unsatisfied demands, let the penalty costs be rupees 1,2 and 3 for destinations (1), (2) and (3) respectively. Find the optimal allocation that minimizes the transportation and penalty costs. Solution Since demand (= 75+ 20 + 50 = 145) is greater than supply (= 10 + 80 +15 = 105) by 40 units, the given problem is an unbalanced one. We introduce a dummy factory with a supply of 40 units. It is given that for the unsatisfied demands, the penalty cost is rupees 1,2 and 3 for destinations (1), (2) and (3) respectively. Hence, the transportation problem becomes Destination (1) (2) (3) Supply to be exhausted A 5 1 7 10 B 6 4 6 85 C 3 2 5 10 Dummy 1 2 3 40 Demand 75 20 50 The initial solution is obtained below by vogels method Factory A B C Dummy Destination (1) 5 20 6 15 3 40 1 2 3 40/0 112 5 15/0 111 Supply (2) 10 1 10 4 50 6 80/70/50/0 222 7 10/0 4-(3) Difference

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Cost Academy

Demand Difference 2 3

2 0 2

75/35/20/0 1 2 2 1

20/10/0

50/0

The initial solution is given is the table below: Factory Destination Supply (1) (2) (3) A 2 10 5 1 7 10 B 20 10 50 6 4 6 80 C 15 3 2 5 15 Dummy 40 40 1 2 3 Demand 75 20 50 -5 We now apply the optimality test to find whether the initial solution found above is optimal or not. The number of allocations is 6 which is equal to the required m +n 1 (=6) allocations. Also, these allocations are independent. Hence, both the conditions are satisfied. Let us now introduce ui, and vj; I = (1,2,3,4) and j = (1,2,3) such that ij = Cij (ui +vi) for allocated cells. We assume that u2 =0 and remaining uis, vjs and js are calculated Since all ij,s for non basic cells are positive, therefore, the solution obtained above is an optimal one. The allocation of factories to destinations and their cost is given below:Factory A B B B C Dummy 2 1 2 3 1 1 Destination 10 Re. 1 20 Rs. 6 10 Rs. 4 10 Rs. 6 15 Rs. 3 40 Re. 1 _________ 4. Frontier Bakery keeps stock of a popular brand of cake. Daily demand based on past experience is as given below: Experience indicates Daily demand : 0 Probability : 0.01 units Cost Rs. 10 Rs. 120Transportation Rs. 40 Rs. 40 cost Rs. 300 Penalty cost Rs. 40 Rs. 555 Total cost

15 0.15

25 0.20

35 0.50

45 0.12

50 0.02 14, 68, 09

Consider the following sequence of random numbers: R. No. 48, 78, 09, 51, 56, 77,

Using the sequence, simulate the demand for the next 10 days. Find out the stock situation if the owner of the bakery decides to make 35 cakes every day. Also estimate the daily average demand for the cakes on the basis of simulated data.

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Cost Academy

Solution According to the given distribution of demand, the random number coding for various demand levels is shown in Table below: Random Number coding Demand probability Cum. Prob. Random nos. fitted 0 0.01 00 00 15 0.15 0.16 01-15 25 0.20 0.36 16-36 35 0.50 0.86 36-85 45 0.12 0.98 86-97 50 0.02 1.00 98-99 The simulated demand for the cakes for the next 10 days is given in the Table below. Also given in the table is the stock situation for various days in accordance with the bakery decision of making 35 cakes per day. Day 1 2 3 4 5 6 7 8 9 10 Determination of Demand and stock levels Random No. Demand Stock 48 35 78 35 -09 15 20 51 35 20 56 35 20 77 35 20 15 15 40 14 15 60 68 35 60 09 15 80

Expected demand = 270/10 =27 units per day. 4. V Ltd. manufactures a single product. The selling price of the product is Rs. 150 per unit. The following are the result obtained by the company during the last two quarters:

Quarter 1

Quarter 2

Sales units Production units

5,100 5,500

4,800 4,500

Rs. Direct materials A 66,000

Rs. 54,000

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Cost Academy

B Manufacturing wages Factory overheads Selling overheads

55,000 1,56,750 86,000 1,79,000

45,000 1,38,000 83,000 1,73,000

The company estimates its sales for the next quarter to range between 5,500 units and 6,500 units, the most likely volume being 6,000 units. The manufacturing programme will match with the sales quantity such that no increase in inventory of finished goods is contemplated in the next quarter. The following price and cost changes will, however, apply to the next quarter:

The price of direct material B will increase by 10%. There will be no change in the price of direct material A.

The wage rates will go up by 8%. If the production volume increases beyond 5,500 units, overtime premium of 50% is payable on the increased volume due to overtime working to be done by the variable labour complement.

The fixed factory and selling expenses will increase by 20% and 25% respectively.

A discount in the selling price of 2% is allowed on all sales made at 6,500 units level of output. The selling price, however, will remain unaltered, if the volume of output is below 6,500 units.

While operating at a volume of output of 6,500 units in the next quarter, the company intends to quote for an additional volume of 2,000 units to be supplied to a government department for its captive consumption. The working capital requirement of this order is estimated at 80% of the sales value of the government order. The company desires a return of 20% on the capital employed in respect of this order.

Required: (i) Prepare a flexible budget for the next quarter at 5,500, 6,000 and 6,500 unit levels and determine the profit at the respective volumes.

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Cost Academy

(ii) Calculate the lowest price p.u. to be quoted in respect of the govt. order for 2,000 units.

6.

The budgets for XYZ Ltd. for the first three quarters of operation are shown below : Period Covered Activity : Sales (Units 000) Production (Units 000) Costs (Rs.000) Direct Material A B Production Labour Manufacturing Overheads (Excluding Depreciation) Depreciation of Production Machinery Administration Expenses Selling & Distribution Expenses Budgets Quarters I III QI Q II 9 10 17 20 Q III 15 15

60 50 180 90 20 25 38

120 100 285 120 20 25 54

90 75 230 105 20 25 50

The figures shown above represent the costs structure of XYZ Ltd., which have the following major features :Fixed element of any cost is completely independent of activity levels. (i) Any variable element of each cost displays a linear relationship with activity level, except that the variable labour cost become 50% higher for activity in excess of 19,000 units per quarter due to the necessity for overtime working. The variable element of selling and distribution expenses is a function of sales. All other costs with a variable element are a function of production volume. Activity for each quarter is spread evenly throughout that quarter.

(ii) (iii)

In Quarter IV Production level will be set equal to sales level. Production and sales in this quarter is expected to range between 15,000 units and 21,000 units. The most likely volume is 18,000 units. In month 9 it will be possible to accurately estimate the sales for Quarter IV. Cost structure will remain the same as in Quarters I to III except the following : (i) (ii) Variable wage rate will rise by 12%. Variable labour input per unit of output will decrease, due to learning curve effect, such that 80% of the previous labour input per unit of output will be required in Quarter IV. The threshold for overtime working remains at 19,000 units per quarter. Fixed factory overheads and the fixed element of selling and distribution costs will each rise by 20% (The variable element of selling and distribution costs will be unaltered.)

(iii)

Required : (i) Prepare a Statement to show, under each cost classification given in the budgets, the variable cost per unit and fixed costs which will be effective in Quarter IV. (ii) Prepare a flexible budget of production costs for the Quarter IV. (May 95 Q:4b)

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