msc sums solution (mba)

Q Girish Engineering (MCS-2004) Numerical

Responsibility budgeting was introduced in a medium sized organization Girish Engineering.

Monthly report (in part) for an expense centre in factory is: All figures in Rs. Lacs

Actual VarianceDirect Labour 100.13 0.21 (Favourable)Indirect Labour 66.34 8.10 (Unfavourable)Total Controllable Costs 168.47 8.50 (Unfavourable)Department Fixed Costs 38.82 --------Allocated Costs 53.62 --------

Questions:1. Why no variance is shown in two items? Is this correct approach in performance

reporting?2. Should overhead expenses mentioned above be included in Controllable Costs?

Why? Why not?

Solution (a):

Variances between actual and budgeted departmental fixed costs are obtained simply

by subtraction, since these costs are not affected by either the volume of sales or the

volume of production. That’s why no variance is shown for departmental fixed costs.

Allocated costs are a share of the costs of a resource used by a project, where the same

resource is also used by other activities. These are different to the Incurred costs

because these costs are not exclusively related to any individual project. However, the

cost of the resource still needs to be recovered, and making a fair and reasonable charge

to all projects using the resource does this.

The key difference between costs and Allocated costs is that the latter will be charged

based upon an estimate, rather than actual cash values. Thus as it is charged based upon

an estimate the budgeted figure is the same as the actual figure and hence no variances.

Solution (b):

Overhead Expenses mentioned above should not be included in controllable costs

because some costs are uncontrollable like fixed costs. . They don't vary with the change

in short run managerial decisions and output. And some costs are controllable i.e. they

can be managed and changed with the managerial decisions and output.

As the above overhead expenses would have certain portion of fixed expenses this is

hard to control. So, these should not be a part of controllable cost.

Kiran Company (MCS-2004) Numerical

Budget versus Actual comparison for div Z of Kirancompany is as follows:

Budget Actual Actual better

(worse) than budget

Sales and other income 800 740 (60)

Variable expenses 480 436 44

Fixed expenses 120 120 0

Sales promotional expenses 40 28 12

Operating profit 160 156 4

Net working capital 400 412 12

Fixed assets 160 148 (12)

(a) Carry out and overall performance analysis to decide areas needing investigation.

From the given data, we see that there is a certain amount of variance between the

budgeted operating profit and actual operating profit. In order to analyze the variances, we

need to understand the key causal factors that affect profit, namely, revenues and cost

structure. The profit budget has embedded in it certain expectations about the state of total

industry, company’s market share, selling prices and cost structure. Results from variance

computation are actionable if changes in actual results are analyzed against each of this

expectation.

Revenue variances, that is a negative Rs 60 lakhs, could be a result of selling price variance,

mixed variance and/or volume variance. A combination of above three factors must have

been unfavorable that is either the volume of sales must have been below the budgeted

volumes ( this must be particularly true since actual variable expenses are less than

budgeted) and/or the selling price must have been below expectation and/or the proportion

of products sold with a higher contribution must have been less than budgeted.

One more factor could have been the overall industry volume. However, this factor is

beyond the managements control and largely dependent on the state of economy.

Variable expenses are directly proportional to volumes and hence as is evident are less than

budgeted.

Sales promotional expenses also show a negative variance which could be a cause of lower

sales volumes.

A cause of concern is that despite lower sales, the net working capital is more than

budgeted which indicates capital block in higher inventory.

Another issue is that the fixed assets are lower than the budget by Rs 12 lakhs which may

indicate slower capacity expansion then expected or distressed sale of assets to tide over

cash flow.

(b) What are the remedial measures if any would you suggest based on analysis?

The budgeted estimates may be too optimistic and far from reality, one needs to ensure

that estimates the as realistic as possible. Given the estimates are correct, in that case

depending upon the above analysis, the management needs to take corrective action areas

needing improvement, sales volume could be improved by better marketing, quality

standards and promotional efforts, product mix could be improved by selling more of higher

contribution products. Better sales will ensure a higher inventory turnover. Better credit

management to recover receivables, will ensure improve cash flow situation since less

capital will be tied up in working capital.

Q.5ABC ltd. (MCS-2008) Numerical

Particulars Division X (Rs.) Division Y (Rs.)

ROI 28% 26%

Sales 100 Lacs 500 lacs

Investment 25 lacs 100 Lacs

EBIT 7 Lacs 26 lacs

Analyze and comment upon performances of both the divisions

Solution:

Division X

ROI = (Profit / investment)* 100

Profit = (28/100)*25lacs

= 7lacs

Profit margin = (Profit/sales)*100

= (7/100)*100

= 7lacs

Turnover of investments = (Sales/investment)*100

= (100/25)*100

= 4 times

Division Y

ROI = (Profit / investment)* 100

Profit = (26/100)*100lacs

= 26lacs

Profit margin = (Profit/sales)*100

= (26/500)*100

= 5.2lacs

Turnover of investments = (Sales/investment)*100

= (500/100)*100

= 5 times

Profit margin of X is better than profit margin of division Y. Turnover of investment of division Y is better than

Division X.

Hence cost management of Division X is better than Division Y.

MCS 2006 (SUM NO 7)

Q) Soniya Company has two Divisions: A & B. Return on Investment for both divisions is 20%.

Details are given below:-

Particulars Div A Div B

Divisional sales 4000000 9600000

Divisional Investment 2000000 3200000

Profit 400000 640000

Analyse and comment on divisional performance of each.

ANSWER

As Profit Margin = Profit *100

Sales

Profit Margin for Division ‘A’= 4,00,000 /40,00,000 *100 = 10%

Profit Margin for Division ‘B’ = 6,40,000/ 96,00,000 *100 = 6.6%

Turnover of Investment = Sales * 100

Investment

Turnover of Investment for Division ‘A’ = 40,00,000/20,00,000 = 2 times

Turnover of Investment for Division ‘B’ = 96,00,000/32,00,000 = 3 times

As Return on investment for both Divisions A and B is 20%.

COMMENTS:-

Division ‘A’ – Although ‘A’ has more profit margin than Division ‘B’ that is 10% as compared to

6.6% of ‘B’, so it has more profitability but inspite of it, division ‘A’ has lower turnover of

investment that its assets management is bad than Division ‘B’, it can be improved by increased sales

or reducing investment.

Division ‘B’ – Needs to improve profit margin by increasing sales and reduce variable cost and sales

at same price or by reducing salesprice and increase the volume of sales so that its profit would

improve. As it has good assets management shown by its turnoverof Division ‘B’ that is 3 times

which is better than Division ‘A’. So it can become profitable organisation by improving Profit

Margin

Q5: Shandilya Ltd. (MCS-2008) Numerical

Shandilya Ltd. has adopted Economic Value Added (EVA) technique for the appraisal of performance of its

three divisions A,B and C. Company charges 6% for current assets and 8 % for Fixed Assets, while computing

EVA relevant data are given below :-

Particulars Div A Div B Div C Total

Budgeted Actual Budgete

d

Actual Budgeted Actual Budgete

d

Actual

Profit 360 320 220 240 200 200 780 760

Current Assets 400 360 800 760 1200 1400 2400 2520

Fixed Assets 1600 1600 1600 1800 2000 2200 5200 5600

Solution:

Particulars Div A Div B Div C Total

Budgeted Actual Budgete

d

Actual Budgeted Actua

l

Budgete

d

Actual

ROA 18% 16% 9% 9% 6% 6% 10% 9%

EVA 208 170.4 44 50.4 -32 -60 220 160.8

Q 2)Suresh Ltd. (Numerical) (MCS-2007) and same as Ananya Ltd (MCS 2009)

(a) Define profit in this case and prepare a statement for both divisions and overall company.

Solution:

i) Profitability statement of Division A:-

Particulars Amount(Rs.)

Selling price p.u. 35

Variable Cost p.u. 11

Contribution p.u. 24

Contribution p.u. Expected sales

(no. of units)

Total contribution Total Fixed cost

(Rs.)

Net profit (Rs.)

24 2000 48000 60000 (12000)

24 3000 72000 60000 12000

24 6000 144000 60000 84000

ii) Profitability statement of Division B:-

Selling p.u. Total

variable

cost p.u.

Contribution

p.u.

Expected

sales (no. of

units)

Total

contribution

Total Fixed

cost (Rs.)

Net profit

(Rs.)

90 42 48 2000 96000 90000 6000

80 42 38 3000 114000 90000 24000

50 42 8 6000 48000 90000 (42000)

[Note: Total Variable cost p.u. = Variable cost p.u. (Rs.7) + Transfer price of intermediate product

(Rs.35)]

iii) Profitability statement of Company as a whole:-

Expected sales Net profit of division A

(Rs.)

Net profit of Division

B (Rs.)

Total Net profit

2000 (12000) 6000 (6000)

3000 12000 24000 36000

6000 84000 (42000) 42000

(b) State the selling price which maximizes profits for division B and company as a whole.

Comment on why the latter price is unlikely to be selected by division B.

Solution:

As per the calculation in part (a), selling price p.u. of Rs.80 maximizes profit for division B

whereas selling price p.u. of Rs.50 maximizes profit for the Company as a whole. However, if

Division B opts for selling price p.u. of Rs.50 in order to maximize Company’s profit, it would

suffer a loss of Rs.42000. Therefore, Division B would not select Selling price p.u. of Rs.50.

MCS – 2007

Two Divisions A and B of Satyam Enterprises operate as Profit centers. Division A normally

purchases annually 10,000 nos. of required components from Div. B; which has recently

informed Div. A that it will increase selling price per unit to Rs.1,100. Div.A decided to

purchase the components from open market available at Rs. 1000 per unit. Naturally, Div. B is

not happy and justified its decision to increase price due to inflation and added that overall

company profitability will reduce and the decision will lead to excess capacity in Div. B, whose

variable and fixed costs per unit are respectively Rs. 950 and Rs. 1,100.

Assuming that no alternate use exists for excess capacity in Div. B, will company as a whole

benefit if div A buys from the market.

If the market price reduces by Rs. 80 per unit. What would be the effect on the company

(assuming Div. B still has excess capacity) if A buys from the market

If excess capacity of Div. B could be used for alternative sales at yearly cost savings of Rs. 14.5

lacs, should Div. A purchase from outside?

Justify your answers with figures.

Solution

Option A ( Div A buys from outside)

Total Purchase Cost = 10,000 Units * Rs. 1000 = Rs. 1,00,00,000

Total outlay if transferred inside = 10,000 Units * Rs. 950 = Rs. 95,00,000

Since total outlay if transferred inside is lesser than total purchase cost if bought from outside, relevant cost is the lesser one i.e. Rs. 95,00,000 and overall benefit for the company would be Rs. 5,00,000

a) Option B ( if the market price is reduced by Rs. 80 per unit and A buys from the market)Total Purchase Cost = 10,000 Units * Rs. 920 = Rs. 92,00,000Total outlay if transferred inside = 10,000 Units * Rs. 950 = Rs. 95,00,000Since total purchase cost is lesser than the total outlay if transferred inside, relevant cost is the lesser one i.e. 92,00,000 and overall benefit for the company would be Rs. 3,00,000

b) Option C ( if excess capacity of Div B could be used for alternative sales at yearly cost savings of Rs 14.5 lacs, should Div A purchase from outside)Total Purchase Cost = 10,000 Units * Rs. 1,000 = Rs. 1,00,00,000Total outlay if transferred inside = 10,000 Units * Rs. 950 = Rs. 95,00,000Total opportunity cost if transferred inside = Rs. 14,50,000Total relevant cost becomes Rs. 1,00,00,000If Div A purchase from outside, overall benefit for the company would be Rs. 9,50,000. Therefore, Div A should purchase from outside.

Particulars Option A

Amount

Option B

Amount

Option C

Amount Total Purchase Cost 1,00,00,000 92,00,000 1,00,00,000

Total outlay if transferred inside 95,00,000 95,00,000 95,00,000Total opportunity cost if transferred inside - - 14,50,000Total relevant cost 95,00,000 92,00,000 1,00,00,000Net advantage/disadvantage to company as a

whole if it buys from inside

5,00,000 (3,00,000) (9,50,000)

For 20,000 Units For 19,600 Units

(Numerical) MCS – 2004

Division B of Shayanacompany contracted to buy from Div. A, 20,000 units of a

components which goes into the final product made by Div. B. The transfer price for this

internal transaction was set at Rs. 120 per unit by mutual agreement. This comprises of

(per unit) Direct and Variable labour cost of Rs. 20; Material Cost of Rs.60; Fixed

overheads of Rs.20 (lumpsum Rs.4 lacs) and Rs.20 lacs that Div. A would require for this

additional activity. During the year, actual off take of Div. B from Div. A was 19,600

units. Div. A was able to reduce material consumption by 5% but its budgeted

investment overshot by 10%.

a) As Financial controller of Div. A, compare Actual VsBudgetred Performance

b) Its implications for Management Control?

Solution:

a)

Particulars Budgeted

(Rs. Per

Unit)

Budgeted

(Total in Rs.)

Actual

(Rs. Per Unit)

Actual

(Total in Rs.)

Direct and

Variable Labour

Cost

20 4,00,000 20 3,92,000

Material Cost 60 12,00,000 57 11,17,200

Fixed Overheads 20 4,00,000 4,00,000

Total Cost 100 20,00,000 19,09,200

Transfer Price 120 24,00,000 119.86 23,49,200

Profit 20 4,00,000 4,40,000

Investment 20 20,00,000 22,00,000

ROI =

Profit/Investment

20% 20%

Despite of increase in investment by 10%, there is negligible difference in transfer price. Also the

sales have decreased by 400 units. Therefore we can say that additional investment has not achieved

any positive results.

Q) Division of Aparna Company manufactures Product A, which is sold to another division as a component of its product B; which then is sold to third division to be used as part of its Product C (sold to outside market). Intra company transactions rule: standard cost plus a 10 percent return on fixed assets and inventory, to be paid by the buying division.

Standard Cost per Unit Product A Product B Product C

*Purchase of outside material (Rs.) 40 60 20Direct. Labour (Rs.) 20 20 40Variable overhead (Rs.) 20 20 40*Fixed overhead per unit. (Rs.) 60 60 20Average Inventory (Rs.) 14 lacs 3 lacs6 lacsNet Fixed Assets (Rs.) 6 lacs 9 lacs 3.2 lacsStandard Production (Units) 2 lacs 2 lacs 2 lacs

(a) Determine from above data, transfer prices for Products A, B and Standard Cost of Product C.

(b) Product C could become uncompetitive since upstream margins are added. Comment.

Answer(a):Standard Cost of Product A

Outside material (40 * 2 lac units) 80,00,000

Direct Labour (20 * 2 lac units) 40,00,000

Variable O.H. (20 * 2 lac units) 40,00,000

1,60,00,000

+ 10% on (FA + Inventory)

i.e. 10% on 20 lacs 2,00,000

1,62,00,000

Transfer Price for Product A = 1,62,00,000 = 81

2,00,000

Standard Cost of Product B

Outside material (60 * 2 lac units) 1,20,00,000



2,00,00,000

+ 10% on (FA + Inventory)

i.e. 10% on 12 lacs 1,20,000

2,01,20,000

Transfer Price for Product A = 2,01,20,000 = 100.6

2,00,000

Standard Cost of Product C

Outside material (20 * 2 lac units) 40,00,000



Fixed O.H. (20 * 2 lac units) 20,00,000

2,20,00,000

(b): While arriving at the cost of Product C, margins of Product A, which become an input to Product

B, and Product B, which in turn become an input to Product C, are added. So when it is sold to outside

market, it suffers a disadvantage from its competitors as far as pricing is concerned, as its price will

normally be high compared to products of similar category. So it might become uncompetitive.

But in the long run, customers will distinguish between a good product and a bad product and the one

with the best quality will survive. So if the quality of product C is better than its competitors than only

it can survive in this competitive market.

Another strategy for the company is to cut the margins added by Products A and B, and then come out

with Product C with a lower price tag on it. This may do well to the product by making higher

revenues and capturing the market share.

Q) Ananaya& Company comprises of five divisions A, B, C, D and E and the present performance.

metricis return on assets. However, the controller has suggested management to switch over to

economic value added(EVA) as the criterion rather than return on assets. Compute and tabulate

both return on assets and EVA on the basis of following information (Rs. lakhs) and comment on

divisional performance.

Division Profit Fixed Assets Current Assets

--

A 300 800 160

- - ----

B 220 400 1600

C 100 600 1000

________

D 110 400 800

-

E 180 200 800

Controller feels corporate finance rates on current assets and.fixed assets should be 5% and 10%

respectively.

Solution:

Working Note:

Return on Assets = Profit * 100

Total Assets

A = 300/960*100 = 31.25%

B = 220/2000*100 = 11%

C = 100/1600*100 = 6.25%

D = 110/1200*100 = 9.17%

E = 180/1000*100 = 18%

Economic Value Added (EVA) = Profit – (W.A.C.C.* Capital Employed)

In this case,

EVA = Profit – (W.A.C.C. on Fixed Assets * Total Fixed Assets) + (W.A.C.C. on Current Assets * Total

Current Assets)

A = 300 – (0.10*800) + (0.05*160) = 212 lakhs

B = 220 – (0.10*400) + (0.05*1600) = 100 lakhs

C = 100 – (0.10*600) + (0.05*1000) = -10 lakhs

D = 110 – (0.10*400) + (0.05*800) = 30 lakhs

E = 180 – (0.10*200) + (0.05*800) = 120 lakhs

Summary

Division Return on Assets (R.O.A.) Economic Value Added (E.V.A.) (Rs.

lakhs)

A 31.25% 212

B 11.00% 100

C 6.25% -10

D 9.17% 30

E 18.00% 120

Comments:

1. It appears from the above analysis that division A has performed the best among the five divisions.

2. Also, it can be clearly noticed that divisions C and D seem to be in trouble.

3. Division A has performed the best when seen in terms of return on assets and economic value

added.

4. The reason why division A has performed the best is that it has the best working capital

management that can be reflected in the total amount invested in current assets and which is the

least among the five divisions.

5. The above reason holds true for the poor performance of divisions C and D as can be seen that

they have a huge amount invested in current assets which does not indicate good signs about their

operational efficiency.

6. A company which is into an expansion and overall growth mode primarily invests into fixed assets

and this is also one of the major reasons why the performance of division A is the best amongst all.

7. Though division C has also invested a huge amount in fixed assets the advantage is offset due to

the fact that it perhaps has a larger investment in current assets.

8. Division E is the second best both in terms of R.O.A. as well as E.V.A.

9. Though division E has the same amount invested in current assets as that of division D and

perhaps a lesser amount invested in fixed assets its profitability is much better and hence it has

delivered a better performance.

10. Division B is a better performer than divisions C and D in terms of R.O.A. as well as E.V.A. but the

major problem with this division is that it has a terrible working capital management. Its current

assets are the highest and this reflects that it has huge sums of money held up either in debtors or

inventory or rather it is holding a large amount of cash which is not a good sign.

Q: 32 Pritam Engineering manufacturers (MCS-2005) Numerical

Pritam Engineering manufacturing variety of metal product at many factories.Currently. It is

experiencing crisis, Management has, therefore, decided to detailed expense control system

including responsibility budgets for overhead expense items at each factory. From historical data,

Controller developed a standard for each overhead expense item (relating expense to volume of

activity). Summarized expenses for November,2005 given to concerned Production Supervisor for

comments is tabulated. All figures are in Rs. 000.

Item Standard at nominal volume Budgeted at actual volume actual

Management Supervision

720 720 582

Indirect labour 12706 11322 12552Idle time 420 361 711Materials, Tools 3600 3096 3114Maintenance, scrap 14840 13909 17329Allocated expenses 21040 21040 21218Total per ton (Rs.) 2133.04 2103.39 2413.3

(A) Explain with justification which of the two (1) or (2) is more meaningful for expense control.

(B) Can the supervisor be held responsible for all overhead expenses included? Why/why not?

Ans. (A) There is two general types of expense centers: engineered

and discretionary. This label relate to two types of cost. Engineered

costs are those for which the “right” or “proper” amount can be

estimated with reasonable reliability for example, a factory’s costs for

direct labor, direct material, components, supplies, and utilities.

Discretionary costs (also called managed costs) are those for which

not such engineered estimate is feasible. In discretionary expense

centers, the costs incurred depend on managements judgment as to

the appropriate amount under the circumstances.

Engineered expense centers

Engineered expense centers are usually found a manufacturing

operations. Warehousing, distribution, trucking, and similar units

within the marketing organization may also be engineered expense

centers, as may certain responsibility centers within administrative

and support department for instance, accounts receivable,

accounts payable, and payroll sections in the controller

department; personnel records and the cafeteria in the human

resources department; shareholder records in the corporate

secretary department; and the company motor pool. Such units

perform repetitive tasks for which standard costs can be

developed. These engineered expense centers are usually located

within departments that are discretionary expense centers.

In an engineered expense center, output multiplied by the standard

cost of each unit produced measures what the finished product

should have cost. The difference between the theoretical and the

actual cost represents the efficiency of the expense center being

measure.

We emphasize that engineered expense centers have other

important tasks not measured by cost alone; their supervisors are

responsible for the quality of the products and volume of

production as well as for efficiency. Therefore, the type and level

of production are prescribed, and specific quality standards are set.

So that manufacturing costs are not minimized at the expense of

quality. Moreover, managers of engineered expense centers may be

responsible for activities such as training and employee

development that are not related to current production; their

performance reviews should include an appraisal of how well they

carry out these responsibilities.

There are few, if any, responsibility centers in which all cost items

are engineered. Even in highly automated production departments,

the use of indirect labor and various services can vary with

management’s discretion. Thus the term engineered expense

center refers to responsibility centers in which engineered costs

predominate. But it does not imply that valid engineered estimates

can be made for each and every cost item.

Discretionary expense centers

Discretionary expense centers include administrative and support

units (e.g. accounting, legal, industrial relations, public relations,

human resources), research and development operations, and most

marketing activities. The output of these centers cannot be

measured in monetary terms.

The term discretionary does into imply that managements

judgment as to optimum cost is capricious or haphazard. Rather it

reflects management’s decisions regarding certain policies:

whether to match or exceed the marketing efforts of competitors;

the level of services the company should provide to its customers;

and the appropriate amounts to spend for R&D, financial planning,

public relations, and a host of other activities.

One company may have a small headquarters staff, while another

company of similar size and in the same industry may have a staff

10 times as large. The senior managers of each company may each

be convinced that their respective decisions on staff size are

correct, but there is no objective way to judge which (if either) is

right; both decisions may be equally good under the circumstances,

with the differences’ in size reflecting other underlying deference’s

in the two companies.

As far as above stated over heads are concern, we can easily

estimate “proper” or “right” amount with responsible reliability.

There for standard (1) is more meaningful for expenses control.

Ans. (B) A responsibility center is an organization unit that is

headed by a manager who is responsible for its activities. In a

sense, a company is a collection of responsibility centers, each of

which is represented by a box on the organization chart. These

responsibility centers form a hierarchy. At the lowest level are the

centers of the sections, work shift, and other small organization

units. Departments or business units comprising several of these

smaller units are higher in the hierarchy. From the standpoint of

senior management and and the board of directors, the entire

company is a responsibility center, though the term is usually used

to refer to units within the company and there for Supervisor is

responsible for the uses of the Above stated Resources (over heads)

like Indirect labor, idle time, Materials, tools, maintenance, scrape

and Management supervision by proper supervising supervisor can

control the listed overhead expenses.

Q:2005 )A TV dealership Veena Television (VT) is organized into four profit centers.

colour TV, Black and White, spare parts(SP) and servicing (SG) each headed by

manager BTV in addition to BVTV sales; also sells old TV exchanged (under scheme)

by customer while purchasing new TV . in one particular instance a new TV was sold

for 14150(financed by cash rs2000, Bank loan 7350and Rs 4800;exchange price for old

TV agreed by CTV manager )cost of new TV was Rs 11420.Shivangi Manager of BTV,

examined the old TV (valued at Rs 3500 by TV trade magazine) and felt that she could

get Rs 5000 for that TV offer repairing cabinet, resulting and servicing for which she

would use services of SP and SG price chargeable to BTV by SP and SG are at market

rates Rs235 for parts by SP and Rs 470 for services by SG. Market price are arrived at

after marking up cost by 3.5 times SG and 1.4 times SP. BTV pays a service

commission of Rs 250 per TV sold .overhead fixed per sale are CTV Rs 835;BTV Rs

665;SP RS 32 ;SG Rs 114.

Compute the profitability of the transaction assuming sales commission of $250 for the trade in on a selling price of $5000

Compute at market price At cost price Gross and net profit each

SOLUTION:

SP of New TV by CTV = $14150.

Original cost= $11420 ($14150= $2000 cash down payment + $4800

trade in allowance + $7350 bank loan)

Guide Book Value =$3500

Ms. Shivangi of BTV Dept, believed that she could sell the trade in at $5000

Other Cost: Rs235 for parts by SP and Rs 470 for services by SG

When trade-in is recorded @ $4800 4800+470+235=5505; 5000-5505= (-505)

Particulars New TV OLD TV Service PartsSales 14150 5000 470 235

Selling commission 0 250 0 0

Gross profit 2730 -505 470 235

Overhead 835 665 114 32

Servicing 0 470 0 0 Net profit before common exp 1895 -1640 591 123

If the trade-in is recorded @ $3500

Particulars New TV OLD TV Service Parts

Sales 14150 5000 470 235

Selling commission 0 250 0 0

Gross profit 2730 1045 470 235

Overhead 835 665 114 32

Servicing 0 470 0 0

Net profit before common exp 1895 -340 356 123

2006: sum(11)

Two divisions A and B of sonali enterprises operate Profit centers. Div A normally purchases annually 10000 nos. of required components from Div B, which has recently informed Div A that it will increase selling price p.u to Rs. 1100. Div A decided to purchase the components from open market available at Rs.1000 p.uDiv B is not happy and justified its decision to increase price due to inflation and added that the overall company profitability will reduce and decision will lead to excess capacity in Div B, whose V.C and Fixed cost p.u. are Rs. 950 and Rs.1100.

1. Assuming that no alternate use exists for excess capacity in Div B, will company benefit as a whole if Div A buys from the market.

2. If the market price reduces by Rs.80 p.u. What would be the effect on the company (assuming Div B has still excess capacity) if A buys from market.

3. If excess capacity of Div B could be use for alternative sales at yearly costs savings of Rs. 14.5 lacs, should Div A purchase from outside?

Justify your answers with figures

ANSWER

1) Division ‘A’ action

BUY OUTSIDE (Rs.) (Rs.) BUY INSIDE

Total Purchase Cost 10,00,000 Nil

Total Outlay Cost Nil 9,50,000

Net Cash Outflow To The Company As A Whole

10,00,000 9,50,000

The Company as a whole will benefit if Division ‘A’ buys inside from Division ‘B’.

2) If the market price reduces by Rs.80 p.uDivision ‘A’ action





9,20,000 9,50,000

The Company as a whole benefit if ‘A’ buys from outside supplier at Rs. (1000-80) = 920

3) If excess capacity of Div B could be use for alternative sales at yearly costs savings of Rs. 14.5 lakhs

Division ‘A’ action




Revenue From Using These Facilities

1,45,000


8,55,000 9,50,000

1 Girish Engineering Ltd. (Numerical) (MCS-2006)

(1) On the basis of costing, will the manager be interested in accepting the market offer?

Solution:

Particulars Amount (Rs./unit) Amount (Rs./unit)

Cost of critical component for division X

220

Cost of other material 500

Fixed & processing costs 290

Total cost for division X 1010

Selling price of final product 1000

Net loss for division X 10

Desired profit for division X 60

Thus on the basis of full actual cost incurred by division X, it would suffer a loss of Rs.10/unit if it accepts the market offer whereas its target profit margin is Rs.60/unit. So, division X would not accept the market offer.

(2) Is this offer beneficial to the company as a whole? Justify with figures.

Solution:

Particulars Amount (Rs. Lakh) Amount (Rs. Lakh)

Cash inflow (a) 50 (5000 units * Rs.1000/unit)

Cash outlay:

Variable cost for division Y 5 (Working note)

Material bought by division X from outside

25 (5000 units * Rs.500/unit)

Total cash outlay (b) 30

Net cash inflow to Company as a whole [(a)- (b)]

20

Thus, the Company as an entity would receive cash inflow of Rs.20 lakh. So, the offer is beneficial to the company as a whole.

Working notes:-

Variable cost for division Y:

Desired RoI =10% of Rs.2.4 Cr. p.a. = Rs.24 lakh p.a. i.e. Rs.2 lakh per month

Fixed cost assigned to division X = Rs.4 lakh per month

Fixed cost p.u. = 400000/5000 = Rs.80

Contribution per month = Rs.6 lakh

Total sales value for division Y = 220 * 5000 = Rs.11 lakh per month

So, total Variable cost per month for division Y = 11 lakh – 6 lakh = Rs.5 lakh

Variable cost p.u. for division Y = 500000/5000 = Rs.100

An annual investment of Rs2.4 Cr. is assigned by division Y to division X but it does not imply that a special investment of Rs.2.4 Cr. is made by division Y exclusively to produce the component required by division X. Therefore, cash outflow associated with this investment is not relevant for the above concerned decision regarding accept the market offer.

(3) If yes, how should the company organize its transfer pricing mechanism? Illustrate.

Solution:

Currently, Girish Engineering Ltd. is following 2 step transfer pricing method wherein the selling division charges actual variable cost along with profit mark-up & separately allocates a particular amount of fixed costs per month to the buying division. However, in the case of division X (buying division) & division Y (selling division), this method of transfer pricing is not feasible as division X would suffer loss if it accepts the market offer under this scenario. So, divisions X & Y can negotiate a transfer price by taking into account full actual variable cost (Rs.100 p.u.) & half of fixed costs incurred by division Y that is assigned to division X (Rs.40 p.u.) & add a mark-up of say Rs.10/unit. Taking into consideration only half of the fixed costs of selling division i.e. division Y prevents shifting of any operational inefficiencies from selling division to buying division i.e. division X, which would unnecessarily increase the costs for division X and thereby eat up its profit margin. In this case, division X’s total costs would turn out to Rs.940 (500 + 290 + 150) & would earn a profit margin of Rs.60 p.u. (desired profit margin). Also, contribution p.u. for division Y would be Rs.50 (150 – 100). Thus, total contribution for division Y would be Rs.250000 resulting in RoI of 12.5% (250000/2000000) which is more than the desired RoI of 10%.

msc sums solution (mba)

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