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P. V. Ratnam

FAMILY Store wants information about the profitability of individual product lines — soft drinks, fresh produce and packaged food.

Family Store provides the data presented in Table 1 for the year 2002-03 for each product line.

Family Store also provides the information shown in Table 2 for the year 2002-03:

Required: i) The store currently allocates support cost (all costs other than cost of goods sold) to product lines on the basis of cost of goods sold of each product line.

Calculate the operating income and operating income as a percentage of revenues for each product line.

ii) If the store allocates support costs (all costs other than cost of goods sold) to product lines using an activity-based costing system, calculate the operating income and operating income as a percentage of revenues for each product line.

iii) Give comments in the answers to (i) and (ii).

Solution: The statement of operating income is presented in Table 3.

The allocation of support costs on the basis of activity-based costing (ABC) is presented in Table 4.

Apportionment of support costs on the basis of ABC will always be better, as costs will be apportioned on the basis of activities. If the activities are more, the costs also will be higher. In case of fresh produce, the activities will be more and, hence, support costs too will be higher.

Accordingly, operating income will be lower. Activities are lower in case of soft drinks and packaged food and so also are the support costs.

Hence, operating income will be higher reflecting, thereby, the correct position.

Joint products

ABC Ltd operates a simple chemical process to convert a single material into three separate items — X, Y and Z. All three end-products are separated simultaneously at a single split-off point.

Products X and Y are ready for sale immediately upon split-off without further processing or any other additional costs. Product Z, however, is processed further before being sold. There is no available market price for Z at the split-off point.

The selling prices quoted here are expected to remain the same in the coming year. During 2002-03, the selling prices of the items and the total amounts sold were:

X — 186 tonnes sold at Rs 1,500 a tonne; Y - 527 tonnes at Rs 1,125 a tonne; and Z — 736 tonnes at Rs 750 a tonne.

The total joint manufacturing costs for the year were Rs 6,25,000. An additional Rs 3,10,000 was spent to finish product Z.

There were no opening inventories of X, Y or Z. At the end of the year, the following inventories of complete units were on hand: X — 180 tonnes; Y — 60 tonnes; and Z — 25 tonnes.

There was no opening or closing work-in-progress.

Required: i) Compute the cost of inventories of X, Y and Z for balance-sheet purposes and cost of goods sold for income statement purpose as of March 31, 2003, using: a) net realisable value (NRV) method of joint cost allocation; b) constant gross-margin percentage NRV method of joint-cost allocation.

ii) Compare the gross-margin percentages for X, Y and Z using two methods given in requirement (i).

Working note (WN) 1 is presented in Table 5.

Solution: Joint cost allocation on the basis of NRV is presented in Table 6.

The cost of inventory and the cost of goods sold (in rupees lakh) are shown in Tables 7 and 8 respectively.

Joint cost (Rs 6.25 lakh + additional cost) = Rs 3.10 lakh = a total of Rs 9.35 lakh.

Cost of goods sold = Rs 7.777 lakh

Cost of inventory = Rs 1.573 lakh

Total = Rs 9.350 lakh (reconciled)

The calculation of gross-margin percentage is presented in Table 9.

Note: At this stage, the question is not clear.

Cost allocation

PQR Ltd has its own power plant, which has two users — the cutting department and the welding department.

When the plans were prepared for the power plant, the top management decided that its practical capacity should be 1,50,000 machine hours.

The annual budgeted practical capacity fixed cost is Rs 9,00,000 and the budgeted variable cost, Rs 4 per machine hour.

The following data given in Table 10 are available:

Required: i) allocate the power plant's cost to the cutting and welding departments using a single rate method in which the budgeted rate is calculated using practical capacity and costs are allocated based on actual usage;

ii) allocate the power plant's cost to the cutting and welding departments, using the dual-rate method in which fixed costs are allocated based on practical capacity and variable costs are allocated based on actual usage; ii) allocate the power plant's cost to the cutting and welding departments using the dual-rate method in which the fixed cost rate is calculated using practical capacity, but fixed costs are allocated to the cutting and welding department based on actual usage.

Comment on your results in requirements (i), (ii) and (iii).

Solution: i) The annual budgeted fixed cost = Rs 9,00,000

Add: Budgeted variable cost (Rs 1,50,000 x 4) = Rs 6,00,000

Total cost = Rs 15,00,000

Single rate = Rs 15,00,000/1,50,000 machine hours (MH) = Rs 10

Allocation of costs on the basis of actual usage:

Cutting department: Rs 15 lakh x 60,000 MH / 1,00,000 MH = Rs 9 lakh

Welding department: Rs 15 lakhs x 40,000 MH / 1,00,000 MH = Rs 6 lakh

Total = Rs 15 lakh

ii) Cutting department: Fixed cost (Rs 9 lakh x 90,000 MH /1,50,000 MH) = Rs 5.40 lakh

Variable cost: 60,000 MH at Rs 4 = Rs 2.40 lakh

Sub-total = Rs 7.80 lakh

Welding department: Fixed cost (Rs 9 lakh x 60,000 MH /1,50,000 MH) = Rs 3.60 lakh

Variable cost: 40,000 MH at Rs 4 = Rs 1.60 lakh

Sub-total = Rs 5.20 lakh

Grand total (7.80 + 5.20) = Rs 13 lakh

iii) Fixed rate: Rs 9 lakh / 1,50,000 MH = Rs 6 per machine hour

Allocation of costs: Cutting department

Fixed cost (Rs 9 lakh x 60,000 MH/1,00,000 MH) = Rs 5.40 lakh

Variable cost: 60,000 MH at Rs 4 = 2.40 lakhs = Rs 7.80 lakh

Welding department: Fixed cost (Rs 9 lakh x 40,000 MH/1,00,000 MH) = Rs 3.60 lakh

Variable cost: 40,000 MH at Rs 4 = Rs 1.60 lakh = Rs 5.20 lakh

Grand total (7.80 + 5.20) = Rs 13.00 lakh

Practical capacity is 1,50,000 MH — 60 per cent in cutting department and 40 per cent in welding department. Actual usage is 1,00,000 MH — 60 per cent in cutting department and 40 per cent in welding department.

Hence, the results in (ii) and (iii) are the same.

The difference between (i) and (ii) or between (i) and (iii) is due to under-utilisation of practical capacity.

(To be concluded)

(Suggested answers to the May 2003 CA (PE II) paper on cost accounting and financial management.)

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