The Hindu Business Line : Costing in the old mould

XYZ Products produces a gasoline additive, Gas Gain. This product increases engine efficiency and improves gasoline mileage by creating a more complex burn in the combustion process.

Careful controls are required during the production process to ensure that the proper mix of input chemicals is achieved and that evaporation is controlled. If the controls are not effective, there can be loss of output and efficiency.

The standard cost of producing a 500 litre batch of Gas Gain is Rs 6,075. The standard material mix and related standard cost of each chemical used in a 500-litre batch are as shown in Table 11.

The quantities of chemicals purchased and used during the current production period are shown in Table 12. A total of 140 batches of Gas Gain were manufactured during the current production period. XYZ Products determines its cost and chemical usage variations at the end of each production period:

Compute the total material usage variance and then breakdown this variance into its mix and yield components.

Working note (WN)1: Input chemicals — 600 litres; production of Gas Gain — 500 litres in each batch, resulting in 100 litres loss in the process.

WN2: Standard cost (SC) of 140 batches is shown in Table 13.

WN3: Standard yield rate (SYR) = Rs 8,50,500 / 140 batches

= Rs 6,075 per batch or 8,50,500 / 70,000 litres = Rs 12.15 per litre of output.

WN4: SCSM = Rs 8,50,500 (that is,140 batches of Rs 6,075)

WN5: Standard yield for actual input: 140 x 600 = 84,000 litres

Thus, in 140 batches 84,000 litres are produced. So, batches required to produce 84,420 litres would be: 84,420/84,000 x 140 = 140.7 batches.

Actual yield — 140 batches.

Solution: Material usage variance (MUV) = SR (SQ - AQ)

Echol = 9 x (140 x 200 = 28000 - 26600) = 12,600 F

Protex =19.125 x (140 x 100 = 14000 - 12880) = 21420 F

Benz = 6.75 x (140 x 250 = 35000 - 37800) = 18,900 A

CT - 40 = 13.50 x (140 x 50 = 7000 - 7140) = 1890 F

Total — Rs 13,230 F

Material yield variance (MYV) = SYR (AY - SY)

6075 x (140 - 140.7) = Rs 4252.50 A

Material mix variance = SR x (SPPAU - AQ)

Echol = 9 x (84,420/84,000 x 28,000 - 26,600)

= 9 x (28,140 - 26,600) = 13,860 F

Protex = 19.125 x (84,420/84,000 x 14000 - 12880)

19.125 x (14,070 - 12,880) = 22,758.75 F

Benz = 6.75 x (84,420/84,000 x 35000) - 37,800

= 6.75 x (35,175 - 37,800) = 17,718.75A

CT-40 = 13.50 x (84,420/84,000 x 7,000 - 7,140)

= 13.50 x (7,035 - 7,140) = 1,417.50 A

Total — Rs 17,482.50 F

Reconciliation: MUV = MMV + MYV

13,230 F = 17,482.50 F + 4,252.50 A

Under-absorbed OH

IN A FACTORY, the overheads of the production department are absorbed on the basis of Rs 18 per machine hour. The details for October 2002 are as follows: Factory overheads incurred — Rs 16,50,000

Of the Rs 16,50,000, the amount that became payable following a labour court award — Rs 2,50,000

Prior-period expense booked in October 2002 — Rs 1,50,000

Actual machine hours worked — 65,000

Actual production was 2,60,000 units, of which,1,95,000 units were sold. On analysing the reasons, it was found that 40 per cent of the under-absorbed overheads was because of defective planning and the rest was attributed to normal cost increase.

How would you treat under-absorbed overheads in cost accounts?

The accounting treatment in cost accounts is shown in Table 15.

Production — 2,60,000 units

Less: Sold — 1,95,000 (three-fourths of 2,60,000)

Closing stock — 65,000 units (one-fourth of 2,60,000)

Cost of sales is to be debited with Rs 36,000 (three-fourths of 48,000). Closing stock of finished goods is to be debited with Rs 12,000 (one-fourth of 48,000).

Note: The factory overhead control account is given in Table 16.

Profit-hiking option

MNP Ltd produces a chocolate almond bar. Each bar sells for Rs 20. The variable cost for each bar (sugar, chocolate, almonds, wrapper, labour) total Rs 12.50. The total fixed cost is Rs 30,00,000. During the year, 10,00,000 bars were sold. The CEO of MNP, not fully satisfied with the profit performance of the chocolate bar, was considering the following options to increase the bar's profitability: a) increase advertising; b) improve the quality of ingredients and, simultaneously, increase the selling price; c) increase the selling price; d) a combination of the three.

i) The sales manager is confident that an advertising campaign could double sales volume. If the company CEO's goal is to increase this year's profits by 50 per cent over last year's, what is the maximum amount that can be spent on advertising?

ii) Assume that the company improves the quality of its ingredients, thus increasing variable cost to Rs 15. Answer the following questions: a) How much the selling price be increased to maintain the same break-even point? b) What will be the new price, if the company wants to increase the old contribution margin ratio by 50 per cent.

iii) The company has decided to increase its selling price to Rs 25. The sales volume drops from 10,00,000 to 8,00,000 bars. Was the decision to increase the price a good one? Compute the sales volume that would be needed at the new price for the company to earn the same profit as last year.

iv) The sales manager is convinced that by improving the quality of ingredients (increasing variable cost to Rs 15) and by advertising the improved quality (advertisement amount would be increased by Rs 50,00,000), sales volume could be doubled. He has also indicated that a price increase would not affect the ability to double sales volume as long as the price increase is not more than 20 per cent of the current selling price. Compute the selling price that would be needed to achieve the goal of increasing profits by 50 per cent. Is the sales manager plan feasible? What selling price would you choose? Why?

Working note (WN) 1: Last year's profit

Sales (10-lakh bars at Rs 20 each) — Rs 200 lakh

Less: Variable cost (10-lakh bars at Rs 12.50) — Rs 125 lakh

Contribution:10-lakh bars at Rs 7.50 — Rs 75 lakh

Less: Fixed costs — Rs 30 lakh

Profit — Rs 45 lakh

WN2: PV ratio = C/S x 100 = 7.50/20 x 100 = 37.5 per cent

WN3: BEP = F/CPU = 30 lakh / 7.50 = 4,00,000 units

BEP = F/PV ratio = 30 lakh/37.5 per cent = Rs 80 lakh

Solution: The goal is to increase this year's profits by 50 per cent over last years. 45 + 50 per cent = Rs 67.50 lakh profit.

Double the sales (20-lakhs bars at Rs 20) = Rs 400 lakh

Less: Variable cost (Rs 20 lakh x 12.50) = Rs 250 lakh

Contribution — Rs 150 lakh

Less: Fixed costs — Rs 30 lakh

Balance — Rs 120 lakh

Less: Desired profit — Rs 67.50 lakh

Advertisement campaign — Rs 52.50 lakh

Maximum amount that can be spent on advertising will be — Rs 52.50 lakh

Or let A =Amount of advertising

Sales = F + A + P / PV ratio

400 = 30 + A + 67.50 / 37.5 per cent

400 x 37.5 per cent = 30 + A + 67.50

150 = 97.50 + A

A = 150 - 97.50 = Rs 52.50 lakh.

ii)(a) PV ratio was 37.5 per cent, that is, variable cost ratio of 62.5 per cent. Hence, the new selling price = 15/62.5 per cent = Rs 24. Selling price to be increased by Rs 4 per unit (24 - 20).

Note: New CPU 24 - 15 = Rs 9. PV ratio = 9/24 = 0.375, that is, 37.5 per cent.

b) Contribution margin ratio increases by 50 per cent, that is, 37.5 per cent + 50 per cent increase = 56.25 per cent PV ratio. Then, the variable cost ratio will be 43.75 per cent. New selling price = 15/43.75 per cent = Rs 34.29 per unit.

iii) Increase in SP and reduction of sales volume:

Sales (8 lakh x 25) = Rs 200 lakh

VC (8 lakh x 12.50) = Rs 100 lakh

Contribution (8 lakh x 12.50) = Rs 100 lakh

Less: Fixed cost = Rs 30 lakh

Profit = Rs 70 lakh

Last year's profit = Rs 45 lakh

Increase over last year's profit = Rs 25 lakh

Hence the decision to increase selling price is a good one.

Now, the PV ratio =12.50 / 25 = 0.50, that is, 50 per cent

Sales = F + P = 30 + 45 = Rs150 lakh sales

PV ratio of 50 per cent is required to earn the same profit as last year.

iv) Selling price (20 + 20 per cent increase) = Rs 24 x 20 lakh units = 480

Less: Variable cost (20 lakh x 15) = Rs 300 lakh

Contribution (20 lakh x 9) = Rs 180 lakh

Less: Fixed cost, including advertisement = Rs 80 lakh

Profit = Rs 100 lakh

Fixed cost = Rs 30 lakh

Advertisement = Rs 50 lakh

Total fixed cost = Rs 80 lakh

Add: Desired profit (45 + 50 per cent) = Rs 67.50 lakh

Contribution = Rs 147.50 lakh

CPU = 147.50 lakh / 20 lakh = Rs 7.375 lakh

Add: Variable cost = Rs 15 lakh

Selling price per unit = Rs 22.375 lakh

The sales manager's plan is feasible and it will earn a profit of Rs 100 lakh, which is higher than the desired profit of Rs 67.50 lakh.

But the selling price of Rs 22.375 per unit is sufficient to achieve the desired profit of Rs 67.50 lakh.

A selling price of Rs 22.375 per unit will be chosen, as the product is competitive and, hence, the selling price should be as low as possible.

Operating costing

A CEMENT company brings limestone to its factory from a nearby quarry. The rate paid for transportation from the quarry — located 6 km away from the factory — is Rs 45 per tonne.

The company is considering a proposal to buy its own 8-tonne capacity trucks.

The information given in Table 17 is also available. Each truck will make five trips (to and fro) daily on an average of 24 days in a month.

Cost of diesel is Rs 20 per litre.

Salary of drivers — Rs 3,000 per month. Two extra drivers will be employed to work as relievers.

The capacity of the cement plant is 9,600 tonnes per month of limestone crushed.

Required: Prepare a cost statement on the basis of data, showing transport cost per tonne, and recommend whether the company should buy its own 8-tonne capacity trucks.

The operating cost statement (of own 8-tonne truck) is presented in Table 18.

Five trips x 24 days x 8 tonnes = 960 tonnes

Ten trucks are required to transport 9,600 tonnes per month.

Hence the operating cost of 10 trucks will be Rs 3,92,210 (39221 x 10). Cost per tonne will be Rs 40.86 (3,92,210/9,600 tonnes). The present cost is Rs 45 per tonne. Hence, the company should buy its own 8-tonne trucks (10 Nos).

WN1: 6 + 6 = 12 km x 5 trips x 24 days = 1,440 km

That is, 1440 / 3 = 280 litres at Rs 20 = Rs 9,600

6(b)A Pharmaceutical Company purchases a raw material, which is then processed to yield three chemicals: Anarol, Estyl and Betryl. In Oct

(Concluded)

(Suggested answers to the November 2002 CA (Intermediate) paper on cost accounting.)

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