The Hindu Business Line : A probe into profit fall

The company wants a detailed investigation into the fall in profits. During your investigation, you find that prices of materials and wage rates have increased by 10 per cent and 15 per cent respectively. There was also an upward revision of selling prices by 10 per cent. Analyse the variation in profits and reconcile the same.

WN1: Sales at budgeted price = 396 x 100/110 = 360

Budgeted sales = 400

Sales volume reduction = Rs 40 lakh (A)

That is, 10 per cent on budgeted sales.

Sales increase due to price increase = 396 - 360

= Rs 36 lakh (F) (that is, 10 per cent increase on Rs 360 lakh)

WN2: Materials — 209

Less: at Budgeted prices (209 x 100 / 110) = 190

Price increase (10 per cent on 190) — 19 A

Usage variance: 200 - 190 = 10 F

WN3: Labour 69

Less: At budgeted rates (69 x 100) / 115 = 60

Rates increase (15 per cent on 60) 9 A

Labour efficiency variance = 60 - 60 = Nil

WN4: Variable overheads cost variance = 40 - 44 = 4 A

WN5: Fixed overhead variance = 50 - 57 = 7 A

Solution: Analysis of variation in profit is shown in Table 13.

Investment decision under NPV method

A COMPANY is considering modernisation of its process of manufacture by either upgrading its existing machinery or purchasing a latest model of new machine. Its existing machine is operational and can be operated for another five years. The present machinery was purchased five years back for Rs 75,000 and has been fully depreciated during this period. It has a realisable value of Rs 30,000. The cost of upgradation has been worked out at Rs 2 lakh, while the new machine will cost Rs 3.50 lakh, including installation charges.

The projected PAT under the three options for the next five years and the estimated salvage value at the end of this period are given in Table 14.

The company uses straight-line method of depreciation and this is accepted by the tax authority. The company's tax rate is 40 per cent and its cost of capital is 12 per cent. Advise whether the company should buy the new machine or upgrade the existing one.

Note: PV factor at 12 per cent value: year 1: 0.893; year 2: 0.797; year 3: 0.712; year 4: 0.636, year 5: 0.567.

The statement of NPV of existing machine is shown in Table 15.

The statement of NPV of upgraded machine (Rs 2 lakh / 5 years = 0.40 depreciation) is shown in Table 16.

The statement of NPV of new machine (Rs 3.50 lakh / 5 years = 0.70 depreciation) is shown in Table 17.

Advice: The company should buy the new machine.

(Concluded)

(Suggested answers to the December 2002 ICWA (Stage II) paper on cost and management accounting.)

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