Accounting

Techniques for
decision making
2

(1)Opening stock of raw materials

+ purchase of raw materials
+ expenses on raw materials
closing stock of raw materials

(3)

prime cost
+ factory expenses
+ opening stock of work in

(2) =

raw materials consumed

+ production usages
+ direct expenses viz

electricity

(4) =
(6) =

process
- Closing stock of work in

Factory cost
+ Administrative expenses
Cost of sales
+ Profit
- losses

process

(5) =

Cost of production
+ Selling and distribution
expenses
+ Opening stock of finished
stock
- Closing stock of finished
stock

(7) =

Selling price

 Costing has been defined as the techniques and process of ascertaining

cost of products r cost of services.
Objectives:
i.
ii.
iii.

To find out cost of products and cost of services

To control cost of products and cost of services, so that it will not exceed the
limit laid down.
To reduce cost of products and cost of services.

i.
ii.
iii.
iv.

It facilitates preparation of estimates

It helps in maximization of profit
It helps in eliminating loss making activities
It helps in taking following managerial decisions:

Applications:

a.
b.
c.
d.
e.
f.

Price fixation
Export price fixation
Make or buy decision
Continue or discontinue a product
Replacement of men by machines and machines by better machines
Profit planning
Profit maximization is a key factor

 Marginal costing is the ascertainment of marginal cost by segregating fixed and variable cost
and measurement of the effect of variation in the volume of output or product mix on profit
level.
Only prime cost plus variable overheads are included in finding out cost of production.
Fixed costs are treated as period cost and charged to costing profit and loss account and not
to a product.
Applications:
i.
ii.
iii.
iv.
v.
vi.
vii.
viii.
ix.

Determination of optimum level of production.

Continue or discontinue of a department an activity or a product line.
Pricing of product or jobs.
Export pricing
Make or buy decision
Pricing based on limiting or key factors
Expand or buy decisions
Profit planning
Hire or purchase decision

i.
ii.

The analysis of overheads into fixed or variables items may often present difficulties.
Application of marginal costing is difficult in job costing and in joint products and by-products.
The element of semi-variable cost creates problem.

Limitations:

 It is the level of activity or volume of sales at which company is neither

making profit nor incurring losses. It is a level of activities where there is no
profit no loss. If we go beyond that point there is a profit, if we work less
than that point there is a loss.
Applications: are same as applications of Marginal Costing.

Example: 1

Satish company Ltd. has an unutilized capacity of 66,000 direct labour hours within its existing
unutilized capacity. The company can produce any combination of product X, Y or Z without
increase fixed costs. The company has supplied the following data:-

P R O D U C T S
X

Estimated selling produce for unit

Rs. 30

Rs. 36

Rs. 54

Variable Manufacturing Cost per unit

Rs. 20

Rs. 24

Rs. 36

Fixed Cost (allocated)

Rs. 4

Rs. 6

Rs. 8

Standard hours required to produce unit

4 hours

6 hours

8 hours

Estimated No. of units that cold be sold

7, 000

5, 000

4, 000

Which of the products and how many units of each product should you recommend to be produced
and sold by the company?

Example: 2
A company is, at present, working at 80% of its capacity and producing 8000 units pee annum. It
operates flexible budgetory control system. The following figures are available from its budget:

80%
Rs.

100%
Rs.

1. Sales

8, 00, 000

10, 00, 000

2. 2. Fixed Expenses

1, 50, 000

1, 50, 000

3. Semi- fixed expenses

1, 00, 000

1, 10, 000

4. Variable cost

4, 00, 000

5, 00, 000

5. Units made

8, 000

10, 000

You are required to determine the differential cost of producing 2000 units by increasing capacity to
100 per cent.
What would you recommend for an export price for 2000 units. Taking into account that overseas prices
are much lower than indigenous price?

Example: 3
Following information has been made available from the cost records of united automobiles Ltd.,
manufacturing spare parts:
Direct materials
per unit
X
Rs. 8
Y
Rs. 6
Direct wages
X
24 hours @ 25 paise per hour
Y
16 hours @ 25 paise per hour
Variable overheads
150% of direct wages
Fixed overheads (total)
Rs. 750
Selling price
X
Rs. 25
Y
Rs. 20
The directors want to be acquainted with the desirability of adopting any one of the following
alternative sales mixes in the budget for the next period.
a. 250 units of X and 250 units of Y

400 units of Y only

400 units of X and 100 units of Y

150 units of X and 350 units of Y

State which of the alternative sales mixes you would recommend to the management.

Example: 4

The sales turnover and profit during two years were as follows:Year

Seles

Profit

2010

Rs. 3, 00, 000

Rs. 40, 000

2011

Rs. 3, 40, 000

Rs. 50, 000

You are required to calculate

i. P/V ratio
ii. Break-even point
iii. The sales required to earn a profit of Rs. 80, 000
iv. The profit made when sales are Rs. 5, 00, 000
v. Margin of safety at a profit of Rs. 1, 00, 000

Example: 5
An analysis of Sultan Manufacturing Co. Ld. Led to the following information:
Cost element
Variable Cost
Fixed Costs
(% of sales)
Rs.
Direct material
32.8
Direct labour
28.4
Factory overhead
12.6
1, 89, 900
Distribution overheads
4.1
58, 400
General administration overheads
1.1
66, 700
Budgeted sales are Rs. 18, 50, 000. You are required to determine:
i. The break-even sales volume ;
ii. The profit at the budgeted sales volume; and
iii. The profit if actual sales :
a. Drop by 10% and
b. Increase by 5% from budgeted sales.

Example: 6

From the following particulars you are required to calculate:

i. P/V ratio
ii. Break-even point for sales.
iii. Profit or Loss when sales are Rs. 5, 00, 000/iv. Sales required to earn profit of Rs. 60, 000/-.
v. Safety margin in the year 2011.
Year

Sales

Profit

Rs.

Rs.

2010

4, 00, 000

(-) 20, 000

2011

6, 00, 000

80, 000

Example 7
X chemicals ltd has two factories with similar plant
& machinery for manufacturing soda ash. The
board of directors of the company has
expressed the desire to merge them and to run
them as one integrated unit. Following data are
available in respect of these two factories.
Particulars

Capacity in
operation

60%

100%

Turnover

120 lacs

300 Lacs

Variable cost

90 Lacs

220 Lacs

Fixed cost

25 Lacs

40 Lacs

Find Out:
a.What should be the capacity of the merged
factory to be operated for break even?
b.What is the profitability of working 80% of the
integrated capacity?
c.What turnover will give an overall profit of Rs.
60 lacs?

Solution
to
Example
7
X
Y
Xy merged

Particulars

Xy at 80%

60%

Equivalen
t to 100%

120

200

300

500

400

Less
90
Variable cost

150

220

370

296

Contribution

30

50

80

130

104

Less Fixed
Expenses

25

25

40

65

65

Profit

25

40

65

39

PV Ratio

25%

25%

26.67%

26%

26%

BEP Sales

100

100

150

250

250

Capacity of
merged
plant
capacity at
BEP

50%

Desired
Turnover=
(Fixed cost+
Desired

(65+60)/X100
26

Turnover

480.77
lacs

Example 8
A factory is currently working at 50% capacity and
produces 10000 units. Estimate the profits of the
company when it works at 60% and 80% capacity.
At 60% working raw material cost increases by 2%
and selling price falls by 2%. At 80 % working, raw
material cost increases by 5% and selling price falls
by 5%.At 50% capacity working, the product cost
Rs 180 per unit and is sold at Rs. 200 per unit. The
unit cost of Rs. 180 is made up as under.
Particulars

Amt Rs.

Material

100

Labour

30

Factory Overheads

30 (40% fixed)

Adm. Overheads

20(50% fixed)

Example 9
A multi product company has the following costs and output data for the last year.

Particulars

Sales mix

40%

35%

25%

Selling price

20

25

30

Variable cost

10

15

18

Total fixed
150000
Thecost
company proposes to replace product Z by product S. Estimated cost and output data are
Total sales

500000

Particulars

Sales mix

50%

30%

20%

Selling price

20

25

28

Variable cost

10

15

14

Analyse the proposed changes and suggest what decision the company should take.

Total fixed
cost

150000

Total Sales

500000

Example 10

X ltd having an installed capacity of 100000 units of products is

currently operating at 70% utilisation. At current level of input
prices, The FOB unit cost works as follows.
Capacity utilisation(%)

FOB cost(Rs)

70

97

80

92

90

87

100

82

The company required three foreign offers from different

sources as under.
Source A 5000 units at 55 per unit FOB.
Source B 10000 units at 52 per unit FOB.
Source C 10000 units at 51 per unit FOB.
Advise the company as to whether any or all the export order
should be exported or not.

Solution to example 10
Differential cost at different capacity utilisation
Capacit
y%

Prodn
FOB
@
unit
different cost
level

Total
cost

Diff cost Dcu

70

70000

97

6790000

80

80000

92

7360000

570000

57

90

90000

87

7830000

470000

47

100

100000

82

8200000

370000

37

Gain or loss on various export orders

Export
order

Units

Capacity Dcu
utilisatio
n

Total

Fob
pric
e

Sales
revenue

Gain

5000

75%

57

285000

55

275000

(10000)

10000

85%

5000 @ 57
5000 @ 47

520000

52

520000

Nil

10000

95%

5000 @ 47
5000 @ 37

420000

51

510000

90000

1305000

80000

1225000

Example 11
Calculate from the following data
1. The value of the output at which the business breaks
even
2. The % of capacity at which it breaks out.
Particulars

Budget for the

year 2012 based
on 100% capacity

Estimated Shut
Down expenses

Direct material

300000

Direct Wages

200000

Factory Expenses

300000

100000

Selling & Dist. Exp

100000

50000

Adm Exp

100000

500000

Net Sales

1200000

Example 12
The following data are obtained from the records of xyz ltd.
Particulars

First 6 months

Last 6 months

Sales

45000

50000

Total cost

40000

43000

There is no change in variable cost and that fixed exp are incurred
equally in the two half year products.
Calculate for the year
1. PV ratio
2. Break even sales
3. % of margin of safety
4. If the desired profit is Rs.14000 calculate required sales value
5. If the desired profit is Rs.14000 and the current tax rate is 35%,
calculate required sales value.

Example 13

The accounts of a company are expected to reveal a profit of

1400000 after charging fixed cost of 100000 for the year ended
31st dec 2011. The selling price of the product is Rs. 50 per unit
and variable cost per unit is Rs. 20.
Market investigations suggest the following responses to the price
changes.
Alternatives

Selling price
reduced by %

Qnty sold
increased by %

5%

10%

7%

20%

10%

25%

Evaluate these alternatives and state which of the alternative on

profitability consideration should be adopted for the forth coming
year.

Solution to example 13
Break even units
Break even units with profit=
(Fixed cost + desired profit)/cont per unit.
=(1000000+1400000)/30
=80000 units
Alternati Units
ve

S.P per
unit

V.Cost
per unit

Cont per Total

unit
cont

88000

47.50

20

27.50

2420000

96000

46.50

20

26.50

2544000

100000

45.00

20

25.00

2500000

Alternative 2 should be selected.

Example 14
V ltd budgets to make 100000 units of its product perfect. The
variable cost is Rs.10 per unit while fixed cost is Rs.600000.
The companys finance director has suggested the cost plus
approach should be used for pricing with a mark up of 25%.
The marketing director disagreed and has supplied the following
inf.
Price per unit

Demand

18

84000

20

76000

22

70000

24

64000

26

54000

As management accountant of the company analyse the above

proposal and comment.

Solution to example 14
Since additional qnty can be sold only by reducing the selling price the max cont
and incremental cont will be revealed in decision making.
Qnty

S.P per
unit Rs.

V.C per
unit Rs.

Cont
per unit
Rs.

Total
Increme
cont Rs. ntal
cont.
Rs.

84000

18

10

672000

76000

20

10

10

760000

88000

70000

22

10

12

840000

80000

64000

24

10

14

896000

56000

54000

26

10

16

864000

-32000

1. The optimum level of output is the point at which the total contribution is max.
Beyond the point, incremental cont. Becomes negative.
2. From the above, max cont is at 64000 units.
3. The finance directors suggestion of cost price plus would result in a price of
(10+6)+25%=Rs.20 . At this level contribution is not max , it is still possible to
increase the price.
4. Since fixed cost Rs. 600000 are the same irrespective of the output.