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Relevant Information Historical costs may be helpful in making predictions. Analyzing differences between expected future revenues and costs. Relevant Revenues They are expected future revenues.
Relevant Costs Relevant Costs are expected future costs Production capacity to manufacture components. Qualitative Factors Perception regarding possible future price changes. Nature of the work to be subcontracted
AN ILLUSTRATION
Spare parts Ltd. has an annual production of 50,000 units for component X. The components cost structure is as below: Rs. Materials 250 per unit Labour (25% fixed) 180 per unit Expenses: Variable 90 per unit Fixed 135 per unit Total 675 per unit
The purchase manager has an offer from a supplier who is willing to supply the component at Rs.540. Should the component be purchased and production stopped?
AN ILLUSTRATION
XYZ Ltd. is considering to drop Product B from its line because accounting statements show that product B is being sold at a loss. INCOME STATEMENT
PRODUCT A Sales Revenue 50,000 7500 15,000 7500 30,000 20,000 12,500 PRODUCT B 7500 1000 2000 1000 4000 3500 4500 PRODUCT C 12,500 1500 2500 1250 5250 7250 4000 TOTAL 70,000 10,000 19,500 9750 39,250 30,750 21000
Cost of Sales:
Direct Material Direct Labour Indirect Manufacturing Cost TOTAL COST Gross Margin on sales Selling and administrative
Additional Information: Factory overhead costs : Fixed Costs-Rs.5850 and Variable Costs-Rs.3900. Variable costs by products are: A-Rs.3000,B-Rs.400,C-Rs.500. No change in Fixed Costs and expenses, if product B is eliminated Variable selling and administrative expenses to the extent of Rs.11000.By products: A-Rs.7500,BRs.1500,C-Rs.2000. Fixed selling and administrative expenses are Rs.10,000. No change in sales of Product A and Product C after Product B is dropped.
PARTICULARS Sales Revenue Less: Variable production Costs: Direct Mat. Direct Labour Factory OH
PRODUCT A 50,000
PRODUCT B 7500
PRODUCT C 12,500
TOTAL 70,000
1500
4900 2600
2000
6500 6000
11000
44,400 25,600
Operate Or Shutdown
Need to determine about the short run firms. Management should consider all the investments. Loss incurred if the firm is shut down. Cost incurred while shutting down.
Numerical
A company operating below 50% of its capacity expects that the volume of sales will drop below the present level of 10,000 units per month. Management is concerned that the further drop in sales volume will create a loss and has consideration that the operations will be suspended, until better market conditions prevail and also a better selling price. At which point company should be shutdown? Sales revenue(10,000@Rs 3 ) Rs 30,000 (-) Variable costs@ Rs 2 per unit Rs 20,000 Fixed costs Rs 10,000 Net Income 0
Cont..
Units produced
Shutdown Sales revenue@ Rs 3 0 Variable cost@ Rs 2 0 Contribution
Fixed cost Loss
2000 4000 6000 8000 10,000 6000 12000 18000 24000 30,000 4000 8000 12000 16000 20,000 2000 4000 6000 8000 10,000
0
4000 (4000)
Shutdown is desirable at the point at which the operating losses exceed the shutdown cost..
PRODUCT M Sales (-) Profit Cost of Sales (-) Selling & Dist. Expenses 2,00,000 50,000 1,50,000 6,280
1,43,720 20,000
1,23,720
83,440 15,000
68,440
55,440 10,000
45,440
2) If B1 is not processed further Sales of product B1 (-) Share in joint cost Profit Rs 1,00440 Rs 68,440 32,000
Numerical
Modern & Mills Ltd. Manufactures certain grades of products known as M whose by product are B1 and B2.the joint expense of manufacture amount to Rs 2,37,600.
PRODUCT M SALES COST INCURRED Rs 2,00,000 Rs 20,000 PRODUCT B1 1,20,000 15,0000 PRODUCT B2 80,000 10,0000
PROFIT % ON SALES
25
20
15
Total fixed selling expenses are 10% of total cost of sales which are in ratio of 20:40:40 1) Prepare a statement showing apportionment of joint costs to the product. 2) If the product B1 is not subject to further processing and is sold at the point of separation, for which there is a market of Rs 1,00440 without incurring any selling expenses. Would you advise its disposal at this stage
PRODUCT M Sales (-) Profit Cost of Sales (-) Selling & Dist. Expenses 2,00,000 50,000 1,50,000 6,280
1,43,720 20,000
1,23,720
83,440 15,000
68,440
55,440 10,000
45,440
2) If B1 is not processed further Sales of product B1 (-) Share in joint cost Profit Rs 1,00440 Rs 68,440 32,000
Special Orders
It is made when a company has excess production capacity. Possibility of selling it at lower price. Provided it doesnt affect the sales of the same product. Pricing can be done using the cost analysis technique. Fixed costs are not considered when deciding the pricing of special orders. Only variable costs are considered.
A manufacturing company produces 20,000 units by operating at 60% of the capacity and sells at a price of Rs. 30/unit. The figures for the year 2003 are:Production Raw material@ Rs. 4.25 Direct labour @ Rs. 5.75 Variable factory overhead @ 7.75 Fixed factory overhead Variable selling costs 2.75% of selling price Rs . 85,000 1,15,000 1,55,000 1,25,000
72,500
The company receives a special order for 10,000 units from a firm. The company wants to earn a profit of Re 1.00 per unit and no selling expenses are to be incurred for the special order. The pricing of special order:Variable costs to be incurred: (Rs.)
Raw materials
Direct labour Variable overhead
4.25
5.75 7.75 17.75
Desired profit
Minimum price
1.00
18.75
Income Statement
Without special order Special order
Sales 6,00,000 Raw materials 85,000 1,87,500 42,500
Direct labour
Variable overhead
1,15,000
1,55,000
57,500
77,500
1,72,500
2,32,500
16,500
3,71,500 1,25,000 72,500 1,97,500
1,77,500 -
Total costs
Net Income
5,69,000
31,000
1,77,500
10,000
7,46,500
41,000
An export order has been received that would utilize half the capacity of factory. Order must be executed at 10% below the normal domestic prices. The alternatives available to the management are: 1. Reject the order and continue with the domestic sales only( as at the present); or 2. Accept the order, split capacity between overseas and domestic sales and turn away excess domestic demand i.e. (50% for domestic sales + 50% for export).
Replace or Retain
To replace or retain plant and equipment. Differential costs involved are:1. Change in fixed overhead charges. 2. Loss on sale of old equipment. 3. Related costs such as rate of return and interest. Differential benefits involved are:1. Higher production and increased sales 2. Savings in operating costs 3. Realizable value of old machine.
Suppose a company has purchased a plant for Rs. 1,00,000 five years ago which has a life of 10 years with no salvage value. The present book value is Rs. 50,000. Management is considering the replacement of this plant with new plant costing Rs. 80,000 having a life of 5 years with no scrap value at the end of its life. The costs of operating present plant and the proposed plant are as follows:
Present plant Variable costs: (Rs.) Proposed plant (Rs.)
80,000
48,000
12,000
Depreciation
10,000 1,00,000
16,000 76,000
It appears that new plant would result into savings of Rs. 24,000. But the book value of the present equipment is a sunk cost and not relevant in the decision.
Present plant Variable costs: (Rs.) Proposed plant (Rs.)
80,000
48,000
10,000
12,000
Depreciation
0 90,000
16,000 76,000
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