CHAPTER 11

11.25- Product mix, relevant costs. (N.Meluman, adapted) Reliable Precision

Tolls make cutting tools for metalworking operations. It makes 2 types of tools:
A6, a regular cutting tool, and EX4, a high-precision tool. A6 is manufactured on
regular machine, but EX4 must be manufactured on both regular machine & a
high-precision machine. The following information are available:
Particulars A6 (Rs.) EX4 (Rs.)
Selling price 200 300
Variable manufacturing cost per unit 120 200
Variable marketing cost per unit 30 70
Budgeted total fixed overhead costs 7,00,000 11,00,000
Hours required to produce one unit on regular 1.0 0.5
machine.

Additional information includes the following:

a) Company faces a capacity constraint on the regular machine of 50,000
hours per year.
b) The capacity of the high-precision machine is not a constraint.
c) Of the Rs.11,00,000 budgeted fixed overhead costs of EX4, Rs.6,00,000
are lease payments for the high-precision machine. The cost is charged
entirely to EX4 because Reliable uses the machine exclusively to produce
EX4.The company can cancel the lease agreement for the high-precision
machine at any time without penalties.
All other overhead costs are fixed and cannot be changed.
Required to:
1. What product mix-that is how many units of A6 & E- will maximize
companys operating income?

2. Suppose company can increase the annual capacity of its regular machines
by 15000 machine-hours at a cost of Rs. 3,00,000. Should company
increase the capacity of the regular machines by 15000 machine-hours By
how much will companys operating income increases or decreases?

3. Suppose that the capacity of the regular machines has been increased to
65,000 hours. Company has been approached to supply 20,000 units of
 another cutting tool, V2 for Rs.240 per unit. Company must either accept
the order for all 20,000 units or reject it totally. V1 is exactly like A6 except
that its variable manufacturing cost is Rs. 140 per unit. (it takes 1 hour to
produce one unit of V2 on the regular machine, and variable marketing cost
equals to Rs. 30 per unit). What product mix should the company choose
to maximize operating income?

11-30: Closing down divisions: Vivek industries has four following operating
divisions. The budgeted revenues & expenses for each division for 2016 are as
follows:

Particulars A (Rs.) B (Rs.) C (Rs.) D (Rs.)

Sales 5,04,000 9,48,000 9,60,000 12,40,000
Cost of Goods sold 4,40,000 9,30,000 7,65,000 9,25,000
Selling, general & 96,000 2,02,500 1,44,000 2,10,000
Administrative expenses
Operating Income /loss (32,000) (1,84,500) (51,000) (1,05,000)

Further analysis of costs reveals the following percentages of variables costs in

each division:
Particulars A B C D
Cost of Goods sold 90% 80% 90% 85%
Selling, general & 50% 50% 60% 60%
administrative expenses

Closing down any division would result in savings of 40% of the fixed costs of
that division. Top management is very concerned about the unprofitable divisions
(A & B) and is considering closing them for the year.
1. Calculate the increase or decrease in operating income if Vivek closes
division A.
2. Calculate the increase or decrease in operating income if Vivek closes
down division B.
3. What other factors should the top MANAGEMENT of Vivek consider
before making a decision?
11-32: Multiple choice. (CPA) Choose the best answer
1. The Beta Company manufactures slippers and sells them at Rs. 100 a pair.
Variable manufacturing cost is Rs.45 a pair, and allocated fixed
manufacturing cost is Rs.15 a pair. It has enough idle capacity available to
accept a one-time-only special order of 20,000 pairs of slippers at a cost of
Rs.60 a pair. Bata will not incur any, marketing costs as a result of the
special order. What would be the effect on the operating income be if the
special order could be accepted without affecting normal sales? (a) Rs.0,
(b) Rs.3,00,000 increase, (c) Rs.9,00,000 increase, or (d) Rs.12,00,000
increase.
2. The Sona Steering Manufactures Part No. 498 for use in kits production
line. The manufacturing cost per unit for 20,000 units of Part No. 498 is as
follows:
Rupees (Rs.)
Direct Materials 6.00
Direct manufacturing labour 30.00
Variable manufacturing overhead 12.00
Fixed manufacturing overhead allocated 16
TOTAL MANUFACTURING COST PER UNIT 64

The Sundaram Fastners Company has offered to sell 20,000 units of Part No. 498
to Sona Steering for Rs.60 per unit. Sona steering will make a decision to buy the
part from Sundaram Fastners if there is overall savings of at least Rs.25,000 for
Sona Steering. If Sona Steering accepts Sundaram fastners offer, Rs.9 per unit
of the fixed overhead allocated would be eliminated. Furthermore, Sona Steering
has determined that the released facilities could be used to save relevant costs in
the manufacture of Part No. 575. For Sona Steering to achieve an overall savings
of Rs. 25,000, the amount of relevant cost that would have to be saved by using
the released facilities in the manufacture of Part No.575 would be (a) Rs. 80,000
(b) Rs. 85,000 (c)Rs. 1,25,000 or (d)Rs. 1,40,000.

11-37: Opportunity Costs. (H.Scaefer) The Bajaj is working at full production

capacity producing 10,000 units of a unique product, Rosebo. Manufacturing cost
per unit for Rosebo is as follows:
 Particulars Amount
(Rs)
Direct Materials 20
Direct manufacturing Labour 30
Manufacturing Overhead 50
TOTAL MANUFACTURING COST 100

Manufacturing overhead cost per unit is based on variable cost per unit of Rs. 20
and fixed cost of Rs. 30,000 (at full capacity of 10,000 units). Marketing cost, all
variable, is Rs. 40 per unit, and the selling price is Rs. 200.
A customer, Royal Company, has asked Bajaj to produce 2,000 units of
Orangebo, a modification of Rosebo. Orangebo would require the same
manufacturing processes as Rosebo. Royal has offered to pay Bajaj Rs. 150 for a
unit of Orangebo and half the marketing cost per unit.
Required: -
1. What is the opportunity Cost to Bajaj of producing the 2,000 units of
Orangebo? (Assume that no overtime is worked.)
2. The Reliable Corporation has offered to produce 2,000 of Rosebo for Bajaj
so that Bajaj may accept the Royal offer. That is, if Bajaj accepts the
Reliable offer, Bajaj would manufacture 8,000 units of Rosebo from
Reliable. Reliable would charge Bajaj Rs.140 per unit to manufacture
Rosebo. On the basis of financial considerations alone, should Bajaj accept
the Reliable offer? Show calculations.
3. Suppose that Bajaj had been working at less than full capacity, producing
8,000 units of Rosebo at the time the Royal offer was made. Calculate the
minimum price Bajaj should accept Rosebo at the time the Royal offer was
made. Calculate the minimum price Bajaj should accept for Orangebo
under these circumstances. (Ignore the previous Rs.150 selling price.)

11-40 Multiple choice, comprehensive problem on relevant costs. The

following are the Parkar Companys unit cost of manufacturing and, marketing a
high-style pen at an output level of 20,000 units per month:
Manufacturing Costs Rs.
Direct Materials 10
Derect manufacturing labour 12
 Variable manufacturing indirect cost 8
Fixed manufacturing indirect cost 5
Marketing cost
-Variable 15
-Fixed 9

The following data refer only to the preceding data: there is no connection
between the situations. Unless stated otherwise, assume a regular selling price of
Rs.60 per unit. Choose the best answer to each question. Show the calculations.
1. In an inventory of 10,000 units of the high-style pen presented in the
balance sheet, the appropriate unit cost to use is (a) Rs.30 (b) Rs.35 (c)
Rs.50 (d) Rs.22 or (e) Rs.59.

2. The pen is usually produced and sale at the rate of 2,40,000 units per year
(an average of 20,000 per month). The selling price is Rs.60 per unit, which
yields total annual revenues of Rs.1,4400,000. Total costs are
Rs.1,41,60,000, and operating income is Rs.2,40,000, or Rs.1 per unit.
market Research estimates that unit sales could be increased by 10% if
prices were cut to Rs.58. Assuming the implied cost-behaviour patterns
continue, this action, if taken, would

a. Decrease operating income by Rs. 72,000.

b. Decrease operating income by Rs.2 per unit (Rs.4,80,000) but increase
operating income but 10% of revenues (Rs.14,40,000), for net increase of
Rs.9,60,000.
c. Decease fixed cost per unit by 10%, or Rs.1.4 per unit, and thus decrease
operating income by Rs.0.6 (Rs.0.2-Rs.1.4) per unit.
d. Increase unit sales to 2,64,000 units, which at the Rs.58 price would give
total revenues of Rs.1,53,12,000 and leads to costs of Rs.59 per unit for
2,64,000 units, which would equal Rs.1,55,76,000, and result in an
operating loss of Rs.2,64,000.
e. None of these.

3. A contract with the government for 5,000 units of the pens calls for the
reinvestment of all manufacturing costs plus a fixed fee of Rs. 10,000. No
variable marketing costs are incurred on the government contract. You are
asked to compare the following into alternatives:
 SALE EACH MONTH TO ALTERNATIVE A ALTERNATIVE B
Regular customers 15000 units 15,000 units
Government 0 units 5,000 units

Operating income under alternative B is greater than that under alternative A by

(a) Rs. 10,000 (b) Rs.25,000 (c) Rs.35,000 (d) Rs.3,000 or (e) none of these.

4. Assume the same data with respect to the government contract as in

requirement 3 except that the two alternatives to be compared are:
SALES EACH MONTH TO ALTERNATIVE A ALTERNATIVE B

Regular customers 20,000 units 15,000 units

Government 0 units 5,000 units

Operating income under alternative B relative to that under alternative A is (a)

Rs.40,000 (b) Rs.30,000 (c) Rs.65,000 less, (d) Rs.5,000 greater, or (e) none of
these.
5. The company wants to enter a foreign market in which price competition
is keen. The company seeks a one-time-only special order for 10,000 units
on a minimum unit-price. It expects that shipping costs for this order will
amount to only Rs.7.5 per unit, but the fixed costs of obtaining the contract
will be Rs.40,000. The company incurs no variable marketing costs other
than shipping costs. Domestic business will be unaffected. The selling to
break-even is (a) Rs.35 (b) Rs.41.5 (c) Rs. 42.5 (d) Rs. 30 or (e) Rs.50.

6. The company has an inventory of 1,000 units of pens that must be sold
immediately at reduced prices. Otherwise, the inventory will be worthless.
The unit cost that is relevant for establishing the minimum selling price is
(a) Rs.45 (b) Rs.40 (c) Rs.30 (d) Rs.59 or (e) Rs.15.

7. A proposal is received from an outside supplier who will make and

transport these high-style pens directly to the Parkar Companys customers
as sales orders are forwarded from Parkars sales staff. Parakars fixed
marketing costs will be unaffected, but its variable marketing costs will be
slashed by 20%. Parkers plant will be idle, but its fixed manufacturing
overhead will continue at 50% of the present levels. How much per unit
would the company be able to pay the supplier without decreasing the
operating income? (a) Rs.47. (b) Rs39.5 (c) Rs.29.5 (d) Rs.53.5 or (e ) none
of these.