The Hindu Business Line : Profit hopes behind ad-spend

AUTO India Company Ltd (AICL) is engaged in manufacturing automobile parts. For 2002-2003, the particulars shown in Table 13 are available from the records of AICL.

Additional information concerning the performance of the three departments is given in Table 14.

i) Rank the three departments on the basis of their proportionate measure of relative profitability.

ii) The corporate marketing department of AICL proposes to increase advertisement expenses by Rs 1,25,000 with an expectation of 10 per cent increase in sales in all the three departments.

Analyse the effect of this proposal on the company as a whole and on each department and give a suitable recommendation.

The rankings of the three departments and the effect of advertisement are given in Tables 15 and 16 respectively.

Analysis: The profitability of the departments will improve by increasing the sales quantity. But there is no difference in ranking. For the company as a whole, there will be a profit increase of Rs 42,500.

Recommendation: The proposal to increase advertisement expenses by Rs 1,25,000 should be accepted by the company because (see Table 17) the proposal will result in an additional profit of Rs 42,500 (that is, 34 per cent on Rs 1,25,000).

Transfer pricing

AKASH Industries Ltd has two divisions — P (Production) and S (Selling). P-Division produces an intermediate for which there is no external market. Using this intermediate, S-Division turns it to a finished product FM and sells in the market. Each unit of finished product consumes one unit of intermediate.

The sales quantity is sensitive to the price charged and S-Division has developed the following sales schedule:

Selling price per unit (Rs): 500; 450; 400; 350; 300; and 250

Sales units (number): 1,000; 2,000; 3,000; 4,000; 5,000; and 6,000

The cost details are as shown in Table 18.

The transfer price is Rs 175 based on the full-cost.

Required: i) prepare a profit statement showing the profits of both the departments separately and the company as a whole; and ii) determine the selling price that will maximise the S-Division's profit and the price that will maximise the company's profit.

i) The profit statements of S-Division and P-Division are presented in Tables 19 and 20.

ii) The selling price of Rs 400 per unit will maximise S-Division's profit at Rs 1,20,000 (3,000 units at Rs 400 per unit). At this stage, the company's profit will be Rs 1,80,000 only.

The price that will maximise the company's profit:

Sale — 5,000 units

Selling price — Rs 300 per unit

Transfer price from P to S — Rs 145 per unit.

These three points will improve S-Division's profit and maximise the company's profit as worked out in Table 21.

Variance analysis

JUMBO Food Products Ltd operates a system of standard costing, and, in respect to one of its products which is manufactured within a single cost centre, data for one week have been analysed as shown in Table 22.

Other overheads may be ignored. Profit margin is 20 per cent of sale price and budgeted sales are Rs 60,000 per week. The actual data is shown in Table 23 and the analysis of variances in Table 24.

The production and sales achieved resulted in no changes of stock. Compute: i) the actual output; ii) actual profit; iii) actual price per kg of material; iv) actual rate per labour hour; v) amount of production overhead incurred; vi) amount of production overhead absorbed; vii) production overhead efficiency variance; viii) selling price variance; ix) sales-volume-profit variance.

i) The actual output is shown in Table 25.

Note: AQ x SR = 1,1700

AQ x 1.50 = 11,700

AQ = 11,700/1.50 = 7,800 kg

ii) Actual output: 830 units. 830 x 10 = 8,300 kg should have been consumed. But 7,800 kg only was consumed actually. Hence, usage variance became favourable.

MUV = SR (SQ - AQ )

1.50 (8,300 - 7,800) = Rs 750 F (as given in question)

Hence, actual output was 830 units.

The actual profit is presented in Table 26.

iii) The actual price per kg of material can be ascertained by means of price variance.

MPV = AQ (SR - AR)

1,170 A = 7,800 (1.50 - AR)

-1,170 = 1,1700 - 7,800 AR

7,800 AR = 11,700 + 1,170

AR = 12,870/7,800 = Rs 1.65 per kg

iv) The actual rate per labour hour can be ascertained by means of rate variance.

SC = 830 units x 5 hours = 4,150 hours at Rs 4 = Rs 16,600

AC = Rs 16,324

Efficiency variance = SR (SH - AHP)

360 A = 4 (4,150 - AHP)

-360 = 16,600 - 4 AHP

4 AHP = 16,600 + 360

AHP = 16,960/4 = 4240

Rate variance = AHP (SR - AR)

636 F = 4,240 (4 - AR)

+636 = 16,960 - 4,240 AR

4,240 AR = 16,960 - 636

AR = 16,324/4,240 = Rs 3.85

v) The production overhead is presented in Table 27.

Note: BFO 800 x 25 = Rs 20,000; AFO = Rs 19,600. Expenditure variance is Rs 400 F as given in the question.

vi) Amount of production overhead absorbed: 830 units at Rs 25 = Rs 20,750

vii) Production overhead efficiency variance:

Standard cost per unit — Rs 60

Add: Profit margin (20 per cent of sale price), that is, 25 per cent on cost — Rs 15

Budgeted selling price per unit — Rs 75

Budgeted sales quantity Rs 60,000/75 = 800 units per week.

Note 1: Production and sales achieved resulted in no changes of stock.

Hence, budgeted sales quantity of 800 units is budgeted quantity of production (BQ = 800 units).

This is also taken as SQ 800 units (for one week) — AQ 830 units

Production overhead efficiency variance = SR (AQ - SQ)

25 (830 - 800) = Rs 750 F

Note: There is no capacity variance. Budget is for one week. Actual data also is for one week.

viii) Actual selling price = Rs 59,760/830 units = Rs 72 per unit. Budgeted selling price is Rs 75 per unit (it is taken as standard selling price).

Selling price variance = AQ (AR - SR)

830 (72 - 75) = Rs 2490 A

ix) Sales-volume-profit variance = Standard rate of profit (AQ - BQ)

SP 75 - 60 SC = 15 (830 - 800) = Rs 450 F

Reconciliation of production overhead:

BFO = 800 x 25 = Rs 25,000

AFO = 19,600

SFO = 830 x 25 = 20,750

Total variance = SFO - AFO = 20,750 - 19,600 = Rs 1,150 F

Volume variance = SR (AQ - BQ)

25 (830 - 800) = Rs 750 F (given)

(To be concluded)

(Suggested answers to the December 2003 ICWA (Stage II) paper on management accounting.)

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