Managerial Accounting and Control

Managerial Accounting and Control 1.Lilac Flour Meal 2.Hospital Supply Inc. 3. Moti Hera Private Ltd.

Introduction to Process costing

Process costing  Process costing is a method of costing used mainly in manufacturing where units are continuously mass-produced through one or more processes.



In process costing, it is the process that is costed (unlike job costing where each job is costed separately). The method used is to take the total cost of the process and average it over the units of production.

 Process costing is adopted when there is mass production through a sequence of several processes. Example include chemical, flour and glass manufacturing

Direct material Direct labour overheads Direct material Direct labour overheads Direct material Direct labour overheads

Process 1

Process 2

Process 3

Finished goods

Cost of goods sold 4

Process Cost Systems

 In a process cost system, costs are tracked through a series of connected manufacturing processes or departments; used for large volume production of uniform products  An accounting system used to apply costs: • To similar products • That are mass-produced • In a continuous fashion • Manufacturing process can be clearly segregated in to clearly identifiable processes or departments.  Process costing is appropriate for industries: chemicals, food processing, breweries, petroleum refining, metal manufacturing, steel making, paper industry etc.  Process costing assumes a sequential flow of costs from one process to another as units of output passes through a specified production process.

Process Cost Accounting System

Accounting for Process Costing • Costs are accumulated by each process • Each process maintains its process account • The process account is debited with the costs incurred and credited with goods completed and transferred to other process account • When the goods are completed, they will be transferred to finished goods account • When the goods are sold, the amount will be transferred to the cost of goods sold account 8

Process A

Material 500 Labour 100 Overhead200 800

Process B

Process B

800

800

Process A800 Material 50 Labour 150 Overhead100

Process C

1100

Process C

Process B 1100 Material 80 Labour 110 Overhead 210 1500

1100

1100

Finished Goods

Finished Gds 1500

Process C 1500

Cost of GDs Sold Bal c/d

1500

1500

1300 200 1500

9

Lilac Flour Meal  Processed Wheat to produce White flour (60%), Suji (10%), Wholemeal Flour (10%) and Bran (20%)  The purchase price of wheat and operating cost up to the point of separation of end products were treated as Joint Costs.  Packing, Selling and distribution cost incurred after the sieving stage was identified with individual products and treated as Separable costs.  At Present: The average unit cost for each product was arrived at by dividing the total joint costs by the combined output of the four products.

Joint Costs Seperable Costs Total Profit Profit margin

1665000 55620 17,20,620 21,780 1.266%

Monthly Wheat Input = 900 tons

Product

White flour Suji Wholemeal flour Bran

Production Production in % in tons

60 10 10 20

Joint Cost allocated on the Joint Cost basis of Per Ton production (Rs.) quantities (Rs.)

540 999000 90 166500 90 166500 180 333000 900 16,65,000

1850 1850 1850 1850 1850

Separable Total Cost Per Costs per Ton (Rs.) Ton (Rs.)

78 84 34 16

1928 1934 1884 1866

Sales Price per Ton (Rs.)

2100 2480 2000 1140

Profit Profit (Loss) for (Loss) per Total ton (Rs.) Output (Rs.)

172 92880 546 49140 116 10440 -726 -130680 21780

Product

Production Production Sales Value Total Sales % of Total Joint Cost Allocated Separable Total Cost Profit Profit (Loss) in % in tons Per ton Value (Rs.) Sales allocated on the Cost Per Costs per Per Ton (Loss) per for Total (Rs.) Value basis of Sales ton Ton (Rs.) ton (Rs.) Output (Rs.) White flour 60 540 2100 1134000 65.08 Value 1083780 2007 78 2005 15 8100 Suji 10 90 2480 223200 12.81 213300 2370 84 2454 26 2340 Wholemeal flour 10 90 2000 180000 10.33 172260 1914 34 1948 52 4680 Bran 20 180 1140 205200 11.78 195660 1087 16 1103 37 6660 900 1742400 100.00 1665000 21780

Methods of allocating the Joint Cost 1. 2. 3. 4. 5.

Net Realisable Value Method Relative Sales Value Method Physical Unit Method Weighted Average Method Profit Method

Net Realisable Value (NRV) Method • It is based on the assumption that the processing costs incurred subsequent to the split-off point contribute nothing to profit i.e., the increase in the products sales value is equal to the separable costs. Joint Costs

1665000

White flour Selling Price per ton (Rs.) Prodn in tons Sales Value (Rs.) Seperable Cost per ton (Rs.) Total Separable Cost NRV (Sales- Separable costs) NRV weight Jt Cost Allocation (NRV Approach) Per Ton Joint Cost

2100 540 1134000 78

Suji 2480 90 223200

42120

84 7560

1091880 0.65 1077781 1996

215640 0.13 212856 2365

WholeMeal 2000 90 180000 34

Bran 1140 180 205200

Total 1742400

16 3060

2880

176940 0.10 174655 1941

202320 0.12 199708 1109

1686780

Relative Sales Value Method • As per this method the joint cost is allocated on the basis of the market value of the products manufactured. • Assumption is: if a product is having higher sales price it costs more to produce and hence market value is the basis to allocate joint cost. Joint Costs

1665000

Selling Price per ton (Rs.) Prodn in tons Sales Value (Rs.) Sales weight Jt Cost on Sales Value (SalesValueWt X Jt Cost) Per Ton Cost

White flour Suji 2100 2480 540 90 1134000 223200 0.65 0.13 1083626 213285 2007 2370

WholeMeal 2000 90 180000 0.10 172004 1911

Bran 1140 180 205200 0.12 196085 1089

Total 1742400

Physical Unit Method • On the basis of units manufactured Joint Costs Prodn in tons Physical Unit Method Output Proportion Joint Cost on PU Per Ton Jt Cost

1665000 White flour 540 0.6 999000 1850

Suji 90 0.1 166500 1850

WholeMeal 90 0.1 166500 1850

Bran 180 0.2 333000 1850

Total 900

Weighted Average Method • When Products are heterogeneous, the weighted average approach can be used. • This method by logic superior to the physical unit method as it assigns weight to each individual product and thus recognises the unique importance of each product. • The weight factor may be the time required to process the units, the production procedure, Sale price, Amount of prime cost ( direct labour and direct material ) used for each product etc. Joint Costs

Assuming Each Product is unique

1665000

Prodn in tons Weighted Average Method Wheat Consumption weight Weighted Output Ratio Joint Cost (Weighted Average)

White flour 540

Suji 90

WholeMeal 90

Bran 180

4

3

2

1

2160 0.77 1289032

270 0.10 161129

180 0.06 107419

180 0.06 107419

Total 900

2790 1665000

Profit Margin Method • This method is based on the assumption that profits are earned on the total cost incurred and not on the joint cost only. White flour Suji WholeMeal Bran Selling Price per ton (Rs.) Prodn in tons Sales Value (Rs.) Sales weight Jt Cost on Sales Value (SalesValueWt X Jt Cost) Per Ton Cost Seperable Cost per ton (Rs.) Total Separable Cost Joint Cost Total Cost

2100 2480 540 90 1134000 223200 0.65 0.13 1083626 213285 2007 2370 78 84 42120 7560

2000 90 180000 0.10 172004 1911 34 3060

1140 180 205200 0.12 196085 1089 16 2880

Profit Profit Margin Profit Margin (Selling price x profit margin) Production Cost (Selling Price- Profit) Joint Cost allocated/ton (Prod Cost - Seperable Cost)

Total 1742400

55620 1665000 1720620 21780 1.25

26.25 2074

31 2449

25 1975

14.25 1126

1996

2365

1941

1110

Example: MMC manufactures memory modules in two step process. Chip fabrication and module assembly. In chip fabrication, each batch of raw silicon wafers yields 500 standard chips and 500 deluxe chips. Chips are classified as standard and deluxe on the basis of their density ( number of memory bits on each chip). Standard chips have 500 memory bits per chip and deluxe chips have 1000 memory bits per chip. Joint costs to process each batch are $24000. In module assembly each batch of standard chips is converted in to standard memory modules at a separately identified cost of $1000 and then sold for $8500. Each batch of deluxe chips is converted into deluxe memory modules at a separately identified cost of $1500 and then sold for $25000. Q1. Allocate joint costs of each batch. Q2. Which method should MMC use? Q3. MMC can further process each batch to 500 standard memory modules to yield 400 DRAM products at an additional costs of $1600. The selling price per DRAM product will be $26.

MMC manufactures Net Realizable Value Step I Sale Value Memory Bits per chip Step 2 Sperable Cost NRV at Split Off Pt Total NRV of Both products at Spilt off Pt Joint Cost

Given Given Given

Standard Delux Total Units Price Value Units Price Value 500 $8,500 $42,50,000 500 $25,000 $125,00,000 $167,50,000 500 1000 $1,000 $5,00,000 $7,500 $37,50,000

$1,500 $7,50,000 $23,500 $117,50,000 $155,00,000 $31,000 $24,000

Given

Weightege Joint Cost allocated Unit Jt Cost Total Cost per Chip

24% $5,806 $11.6 $6,806

76% $18,194 $18.2 $19,694

Net Realizable Value Standard Delux Total Step I Units Price Value Units Price Value Physical Unit Method Sale Value Given 500 $8,500 $42,50,000 500 $25,000 $125,00,000 $167,50,0 Memory Bits per chip Given 500 1000 Physical Meausres of Total Production 500 1000 Step 2 Weightage 33% 67% Sperable Cost Given $1,000 $5,00,000 $1,500 $7,50,000 Joint CostOff Alloted $8,000 $16,000 $155,00,0 NRV at Split Pt $7,500 $37,50,000 $23,500 $117,50,000 Total Cost $9,000 $17,500 Total NRV of Both products Spilt off Pt $31,0 Unit Jtatcost divide/no of units $16.0 $16.0 Joint Cost Given $24,0

Sales Value Method Sales Value Sales Value Proportion Joint Cost Allocaiton Seperable Cost Total Cost Jt Cost per unit

Standard $42,50,000 25.4% $6,089.55 $1,000 $7,089.55 $12.18

Delux $125,00,000 74.6% $17,910.45 $1,500 $19,410.45 $17.91

Hospital Supply Inc

Hospital Supply Inc

Question 1 Question 1 Total fixed costs (TFC) = fixed costs per unit times normal volume =($660 + $770)*3,000 = $4,290,000. Contribution margin per unit = unit price minus unit variable costs = $4,350 - $2,070 = $2,280.

Break  even volu me 

$4,290,000  1,882 units $2,280

 $4,350 - 2,070  Break  even sales  $4,290,000 /    $8,185,461 $4,350   (actually, 1,882 *$4,350 = $8,186,700)

Question 2 Recommendation: Lowering prices reduces income. Other factors, such as the reduction of available capacity and the capacity and the impact on market share, could also affect the decision.

Impact: Price .................................................. Quantity .................................................. Revenue .................................................. Variable mfg. costs .................................................. Variable mktg. costs .................................................. Contribution margin ............................................... Fixed mfg. costs .................................................. Fixed mktg. costs .................................................. Income ............................................

Before Price Reduction $ 4,350

After Price Reduction $ 3,850

Difference $ (500)

3,000

3,500

500

$13,050,000

$13,475,000

$ 425,000

( 5,385,000)

(6,282,500)

(897,500)

(825,000)

(962,500)

(137,500)

6,840,000

6,230,000

(610,000)

(1,980,000)

(1,980,000)

--

(2,310,000)

(2,310,000)

--

$ 2,550,000

$ 1,940,000

$(610,000)

Question 3

Recommendation: Don't accept contract

Government revenue = (500 * $1,795) +.125 ($1,980,000) + $275,000 = $1,420,000, assuming the government's "share" of March fixed manufacturing costs is .125 (500/4,000).

Question 4 Minimum price = variable mfg costs + shipping costs + order costs = $1,795 + $410 + $22,000/1,000 = $2,227 At this price per unit, the $2,227,000 of differential costs caused by the 1,000-unit order will just be uncovered. Some students solve for this price using the break-even formula (UR = unit revenue):

TCF UR  UVC  Q 22,000 UR  2,205  1,000 units $22,000 = 1,000UR - $2,205,000 $2,227,000 = 1,000UR $2,227 = UR

Question 6 Total revenue Total variable manufacturing costs

Total variable marketing costs

Total contribution margin Total fixed manufacturing costs Total fixed marketing costs Payment to contractor

Income

All Production In-house $13,050,000 (5,385,000) (825,000)

6,840,000 (1,980,000) 2,310,000 --

$ 2,550,000

1,000 Units Contracted $13,050,000

$3,590,000 $770,000 8,690,000 1,386,000 2,310,000 2,444,000 2,550,000

$4,994,000 - X = $2,550,000 X = $2,444,000 or $2,444 per unit maximum purchase price

Question 7

Contract 1,000 Regular Hoists and Produce 800 Modified Hoists

All Production In-house Regular (In)

Total revenue Total variable manufacturing costs Total variable marketing costs

Total contribution margin Fixed manufacturing Fixed marketing Contractor Income

$13,050,000 (5,385,000)

(825,000) 6,840,000

Regular (Out)

Modified

Total

$8,700,000 $4,350,000

$3,960,000 $17,010,000

(3,590,000)

(2,420,000) (6,010,000)

(550,000)

(220,000)

(440,000)

(1,210,000)

4,560,000

4,130,000

1,100,000

9,790,000

(1,980,000)

(1,980,000)

2,310,000

(2,310,000)

-$ 2,550,000

$2,950,000 $ 2,550,000

Example: ILAB manufactures design tables. ILAB has a policy of adding a 20% markup to full costs and currently has excess capacity. Assume the cost driver for variable and fixed manufacturing overhead costs is the number of output units. The following information pertains to the company's normal operations per month: Output units = 30,000 tables Machine-hours = 8,000hours Direct manufacturing labor-hours =10,000 hours Direct materials per unit = Rs. 50 Direct manufacturing labor per hour = Rs. 6 Variable manufacturing overhead cos = Rs. 161,250 per month Fixed manufacturing overhead costs = Rs. 600,000 per month Product and process design costs = Rs. 450,000 per month Marketing and distribution costs = Rs. 562,500 per month ILAB is approached by an overseas customer to fill a one-time-only special order for 2,000 units. All cost relationships remain the same except for a one-time setup charge of Rs. 20,000. No additional design, marketing, or distribution costs will be incurred. What is the minimum acceptable bid per unit on this one-time-only special order? For long-run pricing of the coffee tables, what price will most likely be used by the company?

Direct materials Direct manufacturing labor (Rs.6 x 10,000) / 30,000 Variable manufacturing (Rs.161,250 / 30,000) Setup (Rs. 20,000 / 2,000) Minimum acceptable bid

Rs. Rs. 50.00 2 5.375 10 Rs. 67.38

Direct materials Direct manufacturing labor ($6 x 10,000)/30,000 Variable manufacturing ($161,250/30,000) Fixed manufacturing ($600,000/30,000) Product and process design costs ($450,000/30,000) Marketing and distribution ($562,500/30,000) Full cost per unit Markup (20%) Estimated selling price

50.00 2 5.375 20 15 18.75 111.125 22.225 133.35

Moti and Heera (Private) Limited (A) & (B)

Moti and Heera (Private) Limited (A) & (B)

Bombay Poster Plant Rs. B-Po-1

355230.92

Less B-PO-2

107621.19

Equals B-PO-3

247609.73

Less B-PO-4A

96155.16

Less B-PO-4B

89651.49

Equals B-PO-5

61803.08

Bombay Paint Plant Rs. B-PA-1

206261.48

Less B-PA-2

72305.19

Equals B-PA-3

133956.29

Less B-PA-4A

32343.98

Less B-PA-4B

51502.33

Equals B-PA-5

50109.98

Bombay Commercial Department Rs. B-C-1

81361.56

Less B-C-2

54718.73

Equals B-C-3

26642.83

Less B-C-4A

--

Less B-C-4B

2299.83

Equals B-C-5

24343.00

Delhi Poster Plant Rs. D-Po-1

99898.50

Less D-PO-2

40619.18

Equals D-PO-3

59279.32

Less D-PO-4A

13608.73

Less D-PO-4B

15937.68

Equals D-PO-5

29732.91

Delhi Paint Plant Rs. D-PA-1

23318.21

Less D-PA-2

3866.94

Equals D-PA-3

19451.27

Less D-PA-4A

4068.32

Less D-PA-4B

5517.93

Equals D-PA-5

9865.02

Delhi Commercial Department Rs. D-C-1

14514.51

Less D-C-2

9883.79

Equals D-C-3

4630.72

Less D-C-4A

--

Less D-C-4B

591.66

Equals D-C-5

4039.06

Mumbai Location Moti Heera Analysis Alternative Choice Decisions: Differencial Costs

Mumbai Income Variable Cost Contribution to Mumbai Fixed OH Sunk Cost Escapable Fixed Cost Total Fixed Cost Contributin to Local Company OH Mumbai OH Contribution to Company OH and Profits Fixed Cost to Sales Break Even Location Cont./ Sales Ratio Cont to Sales (P/v Ratio)

Poster Paint Commercial Location Total EX 3 EX 4 EX 5 3,55,231 2,06,261 81,363 6,42,855 1,07,621 72,305 54,719 2,34,645 2,47,610 1,33,956 26,644 4,08,210 96,155 32,344 1,28,499 89,651 51,502 2,300 1,43,453 1,85,806 83,846 2,300 2,71,952 61,804 50,110 24,344 1,36,258 89,482 46,776 0.52 2,66,565 0.17 0.70

0.41 1,29,103 0.24 0.65

0.03 7,024 0.30 0.33

0.42 4,28,274 0.21 0.63

Delhi Location Delhi Income Variable Cost Contribution to Delhi Fixed OH Sunk Cost Escapable Fixed Cost Total Fixed Cost Contributin to Local Company OH Delhi OH Contribution to Company OH and Profits

Poster Paint Commercial EX 6 EX 7 EX 8 99,899 23,318 14,516 40,619 3,867 9,884 59,280 19,451 4,632 13,608 4,068 15,938 5,518 592 29,546 9,586 592 29,734 9,865 4,040

1,37,733 54,370 83,363 17,676 22,048 39,724 43,639 31,011 12,628

Company OH Company Profit/Loss Fixed Cost to Sales Break Even Location Cont./ Sales Ratio Cont to Sales (P/v Ratio)

0.30 49,791 0.30 0.59

0.41 11,492 0.42 0.83

0.04 1,855 0.28 0.32

0.29 65,632 0.32 0.61

Moti Heera Analysis Alternative Choice Decisions: Differencial Costs

Mumbai Income Variable Cost Contribution to Mumbai Fixed OH Sunk Cost Escapable Fixed Cost Total Fixed Cost Contributin to Local Company OH Mumbai OH Contribution to Company OH and Profits Fixed Cost to Sales Break Even Location Cont./ Sales Ratio Cont to Sales (P/v Ratio)

Delhi Income Variable Cost Contribution to Delhi Fixed OH Sunk Cost Escapable Fixed Cost Total Fixed Cost Contributin to Local Company OH Delhi OH Contribution to Company OH and Profits

Poster Paint Commercial Location Total Company TOTAL EX 3 EX 4 EX 5 3,55,231 2,06,261 81,363 6,42,855 1,07,621 72,305 54,719 2,34,645 2,47,610 1,33,956 26,644 4,08,210 96,155 32,344 1,28,499 89,651 51,502 2,300 1,43,453 1,85,806 83,846 2,300 2,71,952 61,804 50,110 24,344 1,36,258 89,482 46,776 0.52 2,66,565 0.17 0.70 Poster EX 6 99,899 40,619 59,280 13,608 15,938 29,546 29,734

0.41 1,29,103 0.24 0.65 Paint EX 7 23,318 3,867 19,451 4,068 5,518 9,586 9,865

0.03 7,024 0.30 0.33 Commercial EX 8 14,516 9,884 4,632 592 592 4,040

0.42 4,28,274 0.21 0.63

1,37,733 54,370 83,363 17,676 22,048 39,724 43,639 31,011 12,628

Company OH Company Profit/Loss Fixed Cost to Sales Break Even Location Cont./ Sales Ratio Cont to Sales (P/v Ratio)

7,80,588 2,89,015 4,91,573 1,46,175 1,65,501 1,79,897 1,20,493 59,404 1,00,061 (40,657)

0.30 49,791 0.30 0.59

0.41 11,492 0.42 0.83

0.04 1,855 0.28 0.32

0.29 65,632 0.32 0.61

0.53

Relevant Costing

Relevant cost for Decision Making  A relevant cost is a cost that differs between alternatives. Relevant cost, in cost accounting, refers to the incremental and avoidable cost of implementing a business decision.  An avoidable cost can be eliminated in whole or in part, by choosing one alternative over another.  Avoidable costs are relevant costs. Unavoidable costs are irrelevant costs.  Relevant costs are also known as differential, or incremental costs.

 When making a particular decision-relevant costs are those that may change, depending on the decision taken. Therefore, any increase or decrease in future cash flows as a result of a decision is an indication of relevant cost.

Examples: Types of Non-Relevant (irrelevant) Costs: (i). Sunk Cost: Sunk cost is expenditure which has already been incurred in the past. Sunk Cost do not affect future costs and cannot be changed by any current or future action, hence these costs are irrelevant in decision making. Sunk cost is irrelevant because it does not affect the future cash flows of a business. (ii). Committed Costs: Committed costs are costs that will occur in the future, but that cannot be changed. Future costs that cannot be avoided are not relevant because they will be incurred irrespective of the business decision being considered.

(iii). Non-Cash Expenses: Non-cash expenses such as depreciation and amortisation are not relevant because they do not affect the cash flows of a business. (iv). General Overheads: If any general and administrative overheads which are not affected by the decisions under consideration can be ignored. It depends to the situation and nature of the business operation.

Relevant Costs for Decision Making: Following alternative decision areas can be explored further in the context of Relevant Costing. 1. 2. 3. 4.

Make or buy decision/ To produce or to purchase? Drop or retain a segment. Utilization of constrained resources. Special order.

Southwestern Company needs 1,000 motors in its manufacture of automobiles. It can buy the motors from Jinx Motors for Rs.1,250 each. South western’s plant can manufacture the motors for the following costs per unit: Direct materials Direct manufacturing labor Variable manufacturing overhead Fixed manufacturing overhead Total

Rs 500 Rs 250 Rs 200 Rs 350 Rs 1,300

If Southwestern buys the motors from Jinx, 70% of the fixed manufacturing overhead applied will not be avoided. Required: Should the company make or buy the motors?

Should the production line be dropped? Vulcan swimming cloth pvt. ltd. Is considering to drop one of its product line. A recent product income statement for the product line is as follows:

Revenue Cost of goods sold Gross margin Selling and administrative expenses Net Loss

Rs. 950,760 861840 88920 136800 (47,880)

Factory overhead accounts for 35 percent of cost of goods sold and is one third fixed. These data are believed to reflect conditions in the immediate future.

Contribution Margin Analysis

Revenue Variable costs of goods sold: Total cost of sales

Less: Fixed costs (861,840 x 35% x 1/3 = 100,548) Contribution margin (over variable and fixed costs)

Rs.950,760

861,840

100,548

761,292

Rs.189,468

Tamex Company is presently making a part that is used in one of its products. The unit product cost is: Direct materials ....................................................... Rs. 9 Direct labor 5 Variable manufacturing overhead ........................... 1 Depreciation of special equipment .......................... (The special equipment has no resale value.) 3 Supervisor’s salary .................................................. 2 General factory overhead ........................................ (Common costs allocated on the basis of direct labor-hours) 10 Total unit product cost............................................. Rs. 30 The costs above are based on 20,000 parts produced each year. An outside supplier has offered to provide the 20,000 parts for only Rs. 25 per part. Should this offer be accepted?

Dimond Company needs 10,000 engines for the cars they are producing; they can either buy these engines from outside suppliers or make them themselves. Here are the traditional costs for making the product internally. Per Unit (Rs.) Total (Rs.) Material Labour Applied Variable Costs Total

200 100 100 400

2,000,000 1,000,000 1,000,000 4,000,000

it costs the company Rs. 400 per engine to make, however they could in fact buy the engines from a supplier at a cost of Rs. 420 per unit. Making seems to be the best option. However, if the company buy in the engines it can use the staff and facilities to produce another product which gives us a contribution of Rs.50. Whether the Dimond Company should manufacture the product or should it buy from the outsider.

Due to the declining popularity of digital watches, Sweiz Company’s digital watch line has not reported a profit for several years. An income statement for last year follows: Segment Income Statement—Digital Watches Sales ...................................................................... Less variable expenses: Variable manufacturing costs ............................ Variable shipping costs ...................................... Commissions ..................................................... Contribution margin .............................................. Less fixed expenses: General factory overhead*................................. Salary of product line manager .......................... Depreciation of equipment** ............................ Product line advertising ..................................... Rent—factory space*** .................................... General administrative expense* ....................... Net operating loss ..................................................

Rs. 500,000 Rs. 120,000 5,000 75,000

60,000 90,000 50,000 100,000 70,000 30,000

200,000 300,000

400,000 Rs. (100,000)

* Allocated common costs that would be redistributed to other product lines if digital watches were dropped. ** This equipment has no resale value and does not wear out through use. *** The digital watches are manufactured in their own facility. Should the company retain or drop the digital watch line?

Case 26-1: Import Distributors, Inc.

Import Distributors, Inc. (IDI) imported appliances and distributed them to retail appliance stores in the Rocky Mountain States. IDI carried three broad lines of merchandise: audio equipment , television equipment and kitchen appliances. Each three lines accounted for about one third of total IDI sales revenues. Although each line was referred to by IDI managers as a “department”, until 1994 the company did not prepare departmental income statements. In late 1993, departmental accounts were set-up in anticipation of preparing quarterly income statements by department starting 1994. Although in first quarter of 1994, IDI had earned net income amounting to 4.3 per cent of sales, the television department (TVD) has shown gross margin that is too small to cover the department’s operating expenses:

The TVD’s poor performance prompted the company’s accountant to suggest that perhaps the department should be discontinued. This suggestion led to much discussion among the management group, particularly concerning two issues:

First, was the first quarter of the year representative enough of longer term results to consider discontinuing the TVD? And second, would discontinuing TVD cause a drop in sales in the other two departments? One manager however stated that “ even if the quarter was typical and other sales would not be hurt, I am still not convinced that we would be better off by dropping the TVD.

Impact of Discontinuing Television Department Forgone gross $(189,930) margin Cost savings: Personnel $10,140 Department 12,393 Inventory taxes 37,274 Delivery costs 32,248 Sales commissions 80,621 Interest costs 23,708 Total savings Impact on operating profit

1,96,384 $

6,454

Tipton one stop decorators sells paint and paint supplies, carpets, and wallpapers at a single store location in Mumbai. Al though the company has been very profitable over the years, management has seen a significant decline in wallpaper sales and earnings. Recent figures are presented below. Particulars Sales Variable Costs Fixed Costs Total Costs Operating Income

Paint & Paint Supplies (Rs) 3,80,000 2,28,000 56,000 2,84,000 96,000

Carpets (Rs) 4,60,000 3,22,000 75,000 3,97,000 63,000

Wallpaper (Rs) 1,40,000 1,12,000 45,000 1,57,000 (17,000) Loss

Tipton is studying whether to drop wallpaper business because of the changing market and accompanying loss. If the wallpaper business is dropped, the following changes are expected to occur: a). The vacated space will be remodelled at a cost of Rs 12,400 and will be devoted to an expanded line of highend carpet business. The sales of carpet are expected to increase by Rs 1,20,000, and the line’s overall contribution margin ratio will rise by 5%. b). Tipton can cut wallpaper’s fixed cost by 40%. The remaining fixed cost will continue to be incurred. c). Customers who purchased wallpaper often bought paint and paint supplies; hence sales of paint and paint supplies are expected to fall by 20%. d). The firm will increase advertising expenditure by Rs. 25,000 to promote the expanded carpet business.

the division. But Why? And How?

Sales…………………….. Less: Variable costs…. Existing Contribution margin…. If wallpaper is closed, then:

Paint and Supplies

Carpeting

Wallpaper

Rs 380,000 228,000 Rs 152,000

Rs 460,000 322,000 Rs 138,000

Rs 140,000 112,000 Rs 28,000

Loss of wallpaper contribution margin…... Remodeling……………………………………. Added profitability from carpet sales*…… Fixed cost savings (Rs45,000 x 40%)………. Decreased contribution margin from paint and supplies (Rs152,000 x 20%)…………….. Increased advertising……………………….. Income (loss) from closure…………………

Rs (28,000) (12,400) 65,000 18,000 (30,400) (25,000) Rs (12,800)

* The current contribution margin ratio for carpeting is 30% (Rs138,000 ÷ Rs460,000). This ratio will increase to 35%, producing a new contribution for the line of Rs 203,000 [(Rs 460,000 + Rs 120,000) x 35%]. The end result is that carpeting’s contribution margin will rise by Rs 65,000 (Rs 203,000 - Rs138,000), boosting firm profitability by the same amount.

Jamestown Candle works has just received a request from the Williamsburg Foundation for 800 candles to be used in a special event for major donors. The candles will be used as the only illumination in the reception room and will be given out as gifts to the donors as they leave. The candles will be imprinted with the Williamsburg Foundation logo. This sale will have no effect on the company’s normal sales to retail outlets. The normal selling price of a candle of about the size and weight of the special candles is $3.95 and its unit product cost is $2.30, as shown below: Direct materials Direct labor Manufacturing overhead Unit product cost

$1.35 0.15 0.80 $2.30

The variable portion of the manufacturing overhead is $0.05 per candle; the other $0.75 represents fixed manufacturing costs that would not be affected by this special order. Jamestown Candle works would have to order a special candle mold in which the Williamsburg Foundation logo is inscribed. Such a mold would cost $800. In addition, the Williamsburg Foundation wants a special wick containing gold-like thread that would add $0.20 to the cost of each candle. Because of the large size of the order and the charitable nature of the work, the Williamsburg Foundation has asked to pay only $2.95 each for this candle. If accepted, what effect would this order have on the company’s net operating income?

Incremental revenue ............................................ Incremental costs: Variable costs: Direct materials ........................................... Direct labor.................................................. Variable manufacturing overhead ............... Special wick ................................................ Total variable cost............................................ Fixed cost: Special mold ................................................ Total incremental cost ......................................... Incremental net operating income .......................

Per Unit $2.95

1.35 0.15 0.05 0.20 $1.75

Total for 800 Candles $2,360

1,080 120 40 160 1,400 800 2,200 $ 160

Ensign Company makes two products, X and Y. The current constraint is Machine N34. Selected data on the products follow:

Selling price per unit Less variable expenses per unit Contribution margin Contribution margin ratio Current demand per week (units) Processing time required on Machine N34 per unit

X $60 36 $24 40% 2,000

Y $50 35 $15 30% 2,200

1.0 minute

0.5 minute

Machine N34 is available for 2,400 minutes per week, which is not enough capacity to satisfy demand for both product X and product Y. Should the company focus its efforts on product X or product Y?