Management Accountancy -Final course

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10(f).

LEARNING CURVE THEORY

Leaning objective You will be able to know the behaviour of non-linear cost at the completion of this chapter. For this you have to follow the steps as below 1. 2. 3. 4. 5. Computation of leaning equation Application of learning in time & cost Pricing of product with learning Application of Standard costing Application of learning table.

Definition When the product design remain same, nature of production is manual & production is of continuous nature, than average labour time decreases with the increases in production volume. This is known as Learning curve technique which measures labour-hours per unit ( i.e. average labour hour). It declines with the increase in production because workers are learning and becoming better performer of the jobs as they produce more & more units. Managers use learning curves to predict how labour-hours, or labour costs, will increase as more units of same product are produced continuously. Avg. Labour time

Learning or experience curve Units It was first observed in aircraft assembly industry. In general, as workers become more familiar with their tasks, their efficiency improves. It helps the managers learn to improve their scheduling of work among the shifts in the plant , as a result of efficiency & productivity increases, unit costs decrease on a non-linear cost function basis Now a days concept of learning curve is applied in the business functions, in the value chain, such as marketing, distribution, and customer service. Experience curves Experience curves are very similar to learning curves. Learning curves deal only with labour hours and therefore labour cost reducing by a predetermined percentage. But experience curves cover all costs and yet they are very similar in percentage terms to learning curves. All costs reduce with experience to some extent. Material costs may decrease slightly with quantity discounts better utilisation, etc., but will not decrease by a large amount. Variable overheads in general is a labour base cost and so decrease in a similar way. Fixed overheads will decrease per unit as more units are produced following Absorption costing.

Distinctive features of Learning Curve theory in manufacturing environment:

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The Theory of learning curve was first introduced by T.P. Wright of Curtiss-Wright, Buffalo, USA engaged in production of airframes. As the production quantity of a given item doubled, the cost of that item decrease at a fixed rate. This phenomenon is the basic premise on which the theory of learning curve has been formulated. They key words, doubled and rate are important as the quantity produced doubles, the absolute amount of cost increase will be successively smaller but the rate of decrease will remain fixed. This is essence of the learning curve theory and it occurs due to following distinctive features of manufacturing environment: 1. 2. 3. 4. 5. 6. Better tooling methods are developed and used; More productive equipments are designed and used to make the product; Designed bugs are detected and corrected; Engineering changes decrease over the time. Designed engineering are prompted to achieve better design for reducing material and labour cost. Earlier teething problems are overcome. As the product involves monthly, management is prompted to strive for better planning and better management. Rejections and rework tend to diminish over time.

Applications & Uses of Learning curve. i. ii. iii. iv. L.C. helps in analysing cost-volume profit relationship and is useful for cost estimates and forecasting L.C. helps in budgeting and profit planning L.C. helps in pricing, particularly in a tender when it is known that the tender consists of several repetitive jobs

L.C. helps design engineers in making decision, based upon expected rates of improvement. v. L.C. helps in setting standards in learning phase vi. L.C. knowledge helps in manpower planning for contract of long duration or for repetitive clerical work. vii. LC suggest grate opportunities for cost reduction to be achieved by improving learning. viii. LC concept provides a means of evaluating the effectiveness of training programs Limitations to the usefulness of the learning curve: 1. The learning curve is useful only for new operations where machines do not constitute a major part of the production process. It is not applicable to all productions. E.g. new and experienced workmen. 2. The learning curve assumes that the production will continue without any major interruptions. If for any reason the work in interrupted, the curve may be deflected or assume a new slopes 3. Changes other than learning may effect the learning curve. For example, improvement in facilities, arrangements, and equipment as well as personnel morale and performance may be factors influencing the curve. On the other hand, negative developments in employee attitudes may also affect the curve and reverse or retard the progress of improvement. 4. The characteristic 80 percent learning curve as originally obtaining in the air force industry in U.S. A. has been usually accepted as the percentage applicable to all industries. Studies show that there cannot be a unique percentage which can be universally applied.

Management Accountancy -Final course Factors affecting Learning Curve: 1.

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While pricing for bids, general tendency is to set up a very high initial labour cost so as to show a high learning curve. This should the learning curve useless and sometimes misleading. The method of production, i.e. whether it is labour oriented or machine oriented influences the slop of the learning. When labour turnover rate is high management has to train new workers frequently. In such situations the company may never reach its maximum efficiency potential. One of the important requisites of the learning curve concept is that there should be uninterrupted flow of work. The fewer the interruptions, the grater will be the improvement in efficiency. Changes in a product or in the methods of production, designs, machinery, or the tools/used affect the slope of the learning curve. All these have the effect of starting learning a fresh because of new conditions If the changes are frequent, there may be no learning at all. Also other factors influencing the learning curve are labour strikes, lock outs and shut downs due to other cause also/affect the learning curve. In each such case there is interruption in the progress of learning.

2. 3.

4.

5.

Technique :
1. learning Equation y = axb y = the average time per unit for x units a = the time for the first unit x = the cumulative number of units b = the learning coefficient = log of learning % log 2

So, log y = log a + b log x 2. The learning % is applicable with the time of 1 st unit when production volume is doubled. Total time = x . y = x . axb = a . x 1+ b

3. 4. Example 1

Apply the concept of Static cost & Reducible cost while prepare the Cost Sheet .

If the learning rate is 80% , find the learning co-effitient? at 80% learning b = log 0.8 log 2 -1. +0.9031 ) = --------------------------------0.3010 = - 0.3219 Average time = y = ax 0.3219 at 80% learning rate Example 2

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Find Average Labour time & cost for producing 1,2,3,4 & 8 units when the time for first unit = 300 hours learning rate is at 80%. Wage rate is Rs. 30 per hour.

Ans. Units (x) 1 2 3 4 8 10 Avg. time (hr.) 300 240 210.6 192 153.6 142.95

Statement of Time & Cost Avg. cost (Rs. 30/hr.) 9,000 7,200 6,318 5,760 4,608 4,288.5 Total cost 9,000 14,400 18,954 23,040 36,864 42,885 Different cost -5,400 4,554 4,086 13,824 (5th 8th) 6,021 (9th & 10th )

Note -1 When x = 2. y = 300 & b =- 0.3219 Log y = log 300 0.3219 log 2 Log y = 2.4771 0.3210 3010 = 2.3235 Y = Antilog (2.3235) = 210.6 Note-2 When x = 4, y = 300 & b= - 0.3219 Log y = Log 300 0.3219 Log 4 = 2.4771 0.3219 = 0.6021 = 2.2833 Y = Antilog (2.2833) = 192.0

Remember 1 When the production volume is double, then rate of learning can be applied straight away without the requirement of logarithmic scale. So we can so the above calculation in the following statement Production value 1 2 4 8 Remember 2: Learning Table may be given in the problem Average time 300 300.8 = 240 240.8 = 192 = 300 (0.8) 2 1920.8 = 153.6 = 300 (0.8)3 = 300 0.512 = 300 51.2%

Management Accountancy -Final course X 1 2 4 8 16 y 100% 80% 64% 51.2% 40.96%

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So, if the table is given then Average time = a% Remember 3: We know Average time = Total time No. of units Total time = No. of units Average =x.y = x. ax-b = a. x 1+b Remember 4:: Application of differential cost i.e. TCn-TC (n-1) Cost of 2nd unit = TC2-TC1 = 14,400 9,000 = Rs. 5,400 Cost of 3rd unit = TC3-TC2 = 18,954 14,400 = Rs.4,554

Classification of cost under learning effect

The costs which reduce with learning are known as reducible cost. For e.g. Labour cost, Variable overhead (on the basis of labour), Fixed overhead per unit: The cost which does not vary with learning are known as static cost. For e.g. cost of machine department, Administration overhead (in total)l etc. Cost Sheet under Learning curve technique Static cost Add: Reducible cost Cost of sales Add: Mark up Sales price Example 3 The material cost/unit is Rs.100. Wages rate is Rs. 5/hr. Time required for 1 st unit 200 hrs. Customers 1st order for 4 units then again 4 units in 2nd order. Variable overhead Rs. 8/hr. Fixed overhead 200% of Labour cost. Mark up 15%. Learning rate as demanded by customer & accepted by producer is 80% . Find the price to be quoted for both the order separately. Answer Total units to produce = 4 + 4 =8 Units Avg. time Avg. Labour cost @ Rs 5 per hour Total labour Cost Rs

Management Accountancy -Final course 1 2 4 8 200 160 128 102.4 1,000 800 640 512 1,600 2,560 4,096

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Or Statement of conversion cost ( Reducable) Units 1 2 4 8 Avg. conversion cost @ 5+6 Rs 200 13 = 2,600 160 13 = 2,080 128 13 =1,664 102.4 13 = 1,331 Total conversion cost C Rs 2,600 4,160 6,656 10,645

Cost Sheet under Learning curve technique Order 1 Rs. Static Cost Material: Reducible cost Labour & overhead Fixed overhead (128410) Cost of Sales Add Mark up 15% Sale price Example 4 If the direct labour cost is reduced by 20% with every doubling of output, what will be the average labour cost for the sixteen units produced as an approximate percentage of the cost of the first unit produced? Solution If reducible labour cost falls by 20% then learning create reduces by 80% X 1 2 4 8 16 % (after reduction) 100 80 64 51.2 40.96 3,200 6,656 5,120 14,976 Order 2 Rs. 3,200 (10,645-6,656) 3,992 3,072 10,265

Example 5 A Company developing a new product makes a model for testing, and then a demonstration model and then goes for regular production. The time taken to make the model is 300 hours and from past experience of similar models, it is known that a 90% learning curve applies. The average time for each of the first two production models will be. (1) (3) 270 hours 216 hours (2) (4) 243 hours 219 hours Find the correct one with calculation.

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Solution Type of product Model I unit Demo 1 unit Production 2 units X 1 2 4 Avg. Hrs. required 300 270 243 T0tal time required 300 540 972

Total time required for production units i.e. 3rd & 4th unit = 972-540 = 432 Avg. time = 432/2 = 216 hrs. Example 6 (a) Your Company has been approached by a customer to supply four units of a new product made to the customers individual specification. The company experiences a 90% learning rate. The estimated labour time for the first unit of this product is 150 hours and the Companys direct labour cost is Rs. 25 per hour. Estimate the labour cost for this order. (b) (c) (d) Solution Learning table Units (x) 1 2 4 8 ans. (a) ans. (b) ans. (c) Avg. time 150 hr. 135 hr. 121.5 hr. 109.35 Total time 150 270 486 874.8 48625 = 388.825 = 109.3525 = Difference -120 216 388.8 12,150 9,720 2,733.75 After receiving the first order, it the customer places a repeat orders what will be the labour cost for the second order. If the customer had ordered all eight units at the same time, calculate the labour cost per unit for the combined order. what will be the loss if 8 units are ordered & cancel the order after receiving 4 units ?

Loss = Amount should be received on 4 units learning Amount received as on price fixed by 8 units learning = 121.54 @ 25 109.35425 = 1,215 (12,150 10,935) For 2nd order Total Units Total hours Amount Rs Loss Original 2+6 = 8 874.8-270 = 604.8 (604.8/6)2 @25 = 5,040 Rs. 360 Revised 2+ 2 = 4 216 21625 = 5,400

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Example 7 Z plc experiences difficulty in its budgeting process because it finds it necessary to quality the learning effect as new products are introduced. Substantial product changes occur and result in the need for retraining. An order for 30 units of a new product has been received by z plc. So far, 14 have been competed; the first unit required 40 direct labour hours and a total of 240 direct labour has been recorded for the 14 units. The production manager expects an 80% learning effect for this type of work. The company uses standard absorption costing. The direct costs attributed to the Centre in which the unit is manufactured and its direct materials costs are as follows:

Direct materials Direct labour Variable overhead Fixed overhead

Rs. 30.00 per unit. Rs. 6.00 per hour. Re. 0.50 per direct labour hour Rs. 6,000 per four week operating period.

There are ten direct employees working a five day week, eight, eight hours per day. Personal and other downtime allowances account for 25% of the total available time The company usually quotes a four week delivery period for orders. You are required to (i) Determine whether the assumption of an 80% learning effect is a reasonable one in this case, by using the standard formula Y = axb Where (ii) (iii) Solution (i) Calculate the number of direct labour hours likely to be required for an expected second order of 20 units. use the cost data given to produce an estimated product cost for the initial order, examine the problems which maybe created for budgeting by the presence of the learning effect. Units 1 14 Total hrs. 40 240

At 80% learning When X = 14 Y = 4014 0.3219 = 17.11

(Solve by taking log)

Total time should be 17.1114 = 239.54 hrs. i.e. approx 240 hrs. Assumption of an 80% learning effect is a reasonable.

(ii)

Second order x = 30+20 = 50 y = 4050 -.3219 = 11.36

(Solve by taking log)

Management Accountancy -Final course Hrs. required for 2nd order = 11.3650 401.7 hrs. = 166.3 hrs. x = 30 y = 4030 0.3219 = 13.39 Total turnover for 30 units 13.3930 units = 401.7 hrs. (iii) Normal capacity 105875%4 = 1,200 hrs. Fixed overhead = 6,000/1,200 = Rs. 5/hr. Fixed overhead Recovery rate = Rs. 5/hr. Statement of Cost Units: Material @ 30 Labour @ 6401.7 hrs. Variable overhead 5/LHR Fixed overhead @ 5/hr. Total cost Cost p.u. = Rs. 184 Application of Learning Curve in Batch Costing 30 Rs 900 2,410 201 2,009 5,520

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Here time for 1st Batch will be given instead for time for 1st unit. Apply learning curve on the basis of batch size instead of units where batch size = Total unitsUnits in 1st Batch. Example 8 . Order: Units/order 1 40 2 20 3 12 4 20

Time required by 1st batch =100 hrs. Learning rate 80%. Find the time required for each subsequent order by applying the following table. An 80% learning curve on ordinary graph paper would show the following relationship between the x axis (volume) and y axis (cumulative average price of elements subject to the learning curve) : x y% x y% 1.0 100 2.1 78.9 1.1 96.9 2.2 77.8 1.2 93.3 2.3 76.8 1.3 93.7 2.4 76.0 1.4 89.5 2.5 74.9 1.5 87.6 2.6 74.0 1.6 86.1 2.7 73.2 1.7 84.4 2.8 72.3 1.8 83.0 2.9 71.5 1.9 81.5 3.0 70.7 2.0 80.0 3.1 70.0

Management Accountancy -Final course Answer Units Per order 40 20 12 20 Cumulative Units 40 60 72 92 Batch size/lot size Avg. time per batch 1.0 100 1.5 (60/40) 87.6 10087.6% 1.8 (72/40) 83.0 2.3 (92/40) 76.8

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(Avg. no. of batch) Total Time 100 131.4 149.4 176.6

Example 9 Engine Ltd. manufacture engine mountings for wide-bodied airliners. They have been asked to bid on a prospective contract for 90 engine mountings for the Jumbo jet aircraft. They have just completed an initial run of 30 of these mountings at the following costs :Direct materials Direct labour (6000 hours @ Rs. 4) Tooling Cost (re-usable) Variable Overhead (Rs. 0.50 per labour hour) Fixed Overhead (Re. 1/- per labour hour) Rs.(lacks) 20,000 24,000 3,000 3,000 6,000 56,000

An 80% learning curve is thought to be pertinent in this case. The marketing director believes that the quote is unlikely to be accepted if it exceeds Rs. 1,10,000 and as the Company are short of work, he believes the contract to be vital. You are required to comment whether is it worth accepting at Rs.1,10,000.State your assumptions clearly. Solution Units 30 90

x 30 120

Batch size 1 4

Avg. time 6,000 3,840

Total Time. 6,000 15,360

Difference -9,360

Note 1: 30 units is already being produced 90 units are to be produce if tender is accepted. Total production volume = 120/30 = 4 batches. Required time at 80% learning 6,0000.80.84 6,000 = 9,360 hrs. Note-2: The Company is short of order hence penetration pricing technique should be adopted i.e. Variable cost +discretionary Fixed cost. D.M. (20,0003) D.L. 9,3604 Rs. in lakhs 60,000 37,440

Management Accountancy -Final course V O/h. (50,0009,360) Total Relevant cost Offer price 1,10,000 lakhs Net gain (1,10,000 1,02,120) = 7,880 lakhs Offer is accepted Tooling cost (Sunk cost). Committed Fixed overhead ABS IR cost __4,680 1,02,120

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Assume that there will no production run in between the 1st order of 30 units & tender 2 accept.

Example 10 AB Limited, which has a fairly full order book, is approached by a customer with the offer of a contract for a model that is a variant, in terms of dimensions and materials used, of one of its existing products. Though the customer expects to pay normal price for the model, he wants AB Limited to take account of an 80% learning curve in its price calculations; this level has been shown to be reasonable in AB Limiteds industry for relevant work. The prospective contract is for a total of 464 units made up of an initial order of 160 units, two subsequent orders of 80 units each, and three subsequent orders of 48 units each. AB Limited estimates the following costs for the initial order :

Direct materials : Rs. per unit P .. 8 metres .. .. at 3.50 per metre Q .. 12 kg. .. .. at 1.00 per kg. Direct wages : Department : 1 4 hours .. at Rs. 1.25 per hour 2 50 hours.. at Rs.1.50 per hour 3 15 hours.. at Rs. 1.00 per hour Variable overhead: 20% of direct wages Fixed overhead rates, Department : 1 .. .. 2 .. .. 3 .. .. Rs. per hour 2.00 1.00 0.80

The nature of the work in the three production departments is as follows : Department 1 Uses highly automatic machines. Although the operators on these machines need to be fairly skilled, their efficiency only affects the quality of the work but can have little impact on the quantity of this departments output which is largely machine controlled. Department 2 is partially mechanized, whilst Department 3 is an assembly department.

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In both departments 2 and 3 the skill of operators is a major determinant of the volume of output. The terms of the contract price allow for : Direct materials cost plus Conversion cost plus 2.5 % profit margin 12.5 % profit margin

You are required to calculate the price per unit for : (I) the initial order of 160 units ; (ii) (iii) the second, third and fourth orders, if given successively but without guarantee of further orders ; the whole contract of six orders if given from the start but on the same basis of production and delivery.

NB : An 80% learning curve on ordinary graph paper would show the following relationship between the x axis (volume) and y axis (cumulative average price of elements subject to the learning curve) : x y% x y% 1.0 100 2.1 78.9 1.1 96.9 2.2 77.8 1.2 93.3 2.3 76.8 1.3 93.7 2.4 76.0 1.4 89.5 2.5 74.9 1.5 87.6 2.6 74.0 1.6 86.1 2.7 73.2 1.7 84.4 2.8 72.3 1.8 83.0 2.9 71.5 1.9 81.5 3.0 70.7 2.0 80.0 3.1 70.0 Solution Note-1: Dept. (a) 1 2 3 (a) Statement of Conversion cost Or computation of conversion cost/hour Labour Cost Vari ohd Fixed o/h Per hr. per hr. per hr. (b) (c) (d) 1.25 0.25 2.0 1.5 0.32 1.0 1 0.2 0.8 Conversion cost/hrs. (e) 3.5 2.8 2.0 Rs./unit Static cost: Material P (83.5) Q (121) Conversion cost of Department 1 4 hrs. @ 3.5 Reducable cost: Conversion cost of Dept. 2 50 hrs. @ 2.8 Conversion cost of Dept. 3 15 hrs. @ 2 Total cost 28 _12 Rs./unit

Computation of sales price for 1st order of 160 units

40 14

140 _30

170 224

Management Accountancy -Final course Markup: On material 40@ of 2.5% On conversion cost @ 12.5% of 184 Selling price/unit (b) Order 1 2 3 4 All units unit 160 80 80 48 U 160 240 320 368 464 Batch size 1.0 1.5 2.0 2.3 2.9 Avg. conv. Cost 27,200 23,827.2 21,760.00 20,889.6 19,448 1 23

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24 248 Total cost 27,200 35,741.00 43,520.00 48,046.00 56,399 Diff. Cost -8,541 7,779 4,526

To reduce the volume of calculation we consider the reducable cost @ Rs. 170/unit for a batch size of 160 unit. For the application of learning % & differential cost. Total reducable cost for 1st batch 170160 =27,200 Order Static Cost Reducable cost 2nd 54 8,541/80 = 106.76 160.76 Statement of Selling price/unit 3rd 54 7,779/80 = 97.24 151.24 I 13.91 166.15 4th 54 4,526/48 94.29 148.29 I 13.54 162.83 All 54 5,6399/464 121.55 175.55 I 16.94 193.49

(a) (b)

Total (a+ b) Add: Mark up On material I On conversion cost 15.1 Sales 176.86

If the production capacity is content p.a. and cannot be increased in coming year.
In this case production volume p.a. will increase due to the learning effect. As learning begins from 1st unit in 1st year, production volume of 2nd year = Total production of 2 years Production of year 1. The total production of 2 years should be computed as- time available p.a. 2 = aX 1+b. Example 11 ( with application of DCF) Cosy Comforts Ltd. makes household appliances. It is now examining a three-year old contract to make electrical bread toasters for sale through a departmental store. During the entire contract period, it will receive for its toaster a fixed price of Rs. 40 per piece for whatever quantity it can produce in the 3 years. Skilled labour is the constraint and this cannot be increased above that currently available in the Company for making the toaster. Capital investment required Additional overhead Material Labour (skilled0 Rs. Rs. Rs. Rs. 50,000 payable down cash with nil scrap value 25,000 per annum 30 per toaster 5 per hour.

The production manager envisages a learning curve effect for labour in the form of y = ax 0.3 where y = average labour hours per unit , a = labour hours per first unit and x = cumulative production. He estimates that the first toaster will take 10 hours to produce and the fixed amount of skilled labour available will enable 5000 toasters to be produced in the first year. Assume all cash inflows to arise at year end and the cost of capital is 15%. What is your advice ?

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Solution . Note 1 time for 1st unit 10 hrs. b = -0.3. 1st year estimated production 5,000 units. Total time of year 1 = 1005,000 1-0.3 Log (TT of y1) = Log 10 + 0.7 log 5,000 = 1.0 + 0.73.6990 = 3.5893 Total time of year 1 = 3,885.0 Note-2: Total turnover of 2 years = Time/years2 = ax0.7 3,8852 = 10 X0.7 777 = x 0.7 Log 777 = 0.7 Log X Log x = 2.8904/0.7 = 4.1291 X = 13,460.0 Production of 2nd year 13,460- 5,000 = 8,460 units Note-3: Total time of 3 years 3,8853 = ax 0.7 11,655 = 10 X0.7 Log 11,655 = Log 10 + 0.7 Log x 4.0668 = 1+0.7 log x log x = 3.0668/0.7 = 4.3811 x = 24,050.0 Production of 3rd year 24,050 13,460 = 10,590 units. Statement of NPV 2 8,460 40 30 19,425 25,000 40,175 30,378.07

(a) (b) (c) (d) (e) (f)

Year Units Selling price/unit Material/unit Labour @ 5 3,885 hrs. Discretionary Fixed overhead Cash inflow (p.a.) [a (b-c) d-e] Discounted C.F. @ 15% Total

1 5,000 40 30 19,425 25,000 5,575 4,847.833 75,646.71

3 10,590 40 30 19,425 25,000 6,61,475 40,420.81

Management Accountancy -Final course NPV 25,646.71

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Application of learning curve in standard costing. With the help of the learning curve theory the standard time of any batch or unit can be computed then compare the actual data with the standard and compute the variances. Example 12 A firm has developed a product for which the following standard cost estimates have been made for the first batch to be manufactured in Month 1. Standard costs for the batch Rs. 500 labour hours @ Rs 8 per hour 4,000 55 units of direct materials @ Rs 100 per unit 5,500 Variable overhead 500 hours @ Rs 15 per hour 7,500 17,000 From experience the firm knows that labour will benefit from a learning effect and labour times will be reduced. This is expected to approximate to an 80% learning curve. In addition, the growing expertise of labour is expected to improve the efficiency with which materials are used. The usage of materials is expected to approximate to a 95% learning curve. The actual production for the first six months was as follows : Month 1 Month 2 Month 3 Month 4 Month 5 Month 6 20 batches 30 batches 25 batches 24 batches 33 batches 28 batches Total 160 batches

During Month 6 the following results were recorded for the last batch made : Actual results of last batch Labour hours Direct wages Direct materials (41 units) Variable overhead You are required (a) (b) (c) (d) Solution (a) Learning Co-efficient of material = log 95/log 2 = -1 +0.9777/0.3010 = -0.0741 to calculate the learning coefficient for materials ; to derive the Standard Cost of the last batch in Month 6; to calculate what variance have arisen in connection with the last batch i.e.160th ; to explain what information the variances provide for management. 95 Rs 978 Rs 3,977 Rs 1,685

(b)

Standard for 160th = Total for 160 total for 159

Management Accountancy -Final course Material: Total consumption for 160 batch Total consumption 160 = 55(160) 1-0.0741 = 1.7404 + 0.9259 2.2041 = 3.7812 Total consumption for 160 = Rs. 6,042 For 159 units TC159 = 55(159) 0.9259 = log 55 + 0.9259 log 159 = 1.7404 + 0.9259 2.2014 = 3.7787 Total consumption for 159 = 6,008 Consumption for 160th batch 6,042- 6,008 =34 units

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Labour b = 0.3219 (1-0.3219) Total hour for 160 batch = log 500 + 0.6781 log 160 = 2.6990 +0.6781 2.2041 = 4.1936 Antilog of 4.1936 = 15,620

For 159 batch , total hours log 500 +0.67812.2014 = 4.1918 = 15,550 Labour hour for 160th batch = 15,550 15,620 = 70 hrs. Standard (output 1 unit) Input Rate 34 100 70 8 70 15 Cost Card Actual (output 1 unit) Input Amt in Rs 41 3,977 95 978 1,685 Std.Rate Actual input Amt in Rs 4,100 760 1,425

Mat. Lab. V oh

Amt. 3,400 560 1,050

Mat cost variance = standard cost for actual output actual cost = 3400 3977 = Rs577 @ Mat usage variance = standard cost for actual output Std rate actual input = 3400 4100 = Rs 700 @ Mat price variance = Std rate actual input - actual cost = 4100 3977 = Rs. 123 ( F )

Management Accountancy -Final course Lab cost variance = standard cost for actual output actual cost = 560 978 = Rs 418 @ Lab Efficiency variance = standard cost for actual output Std rate actual input = 560 760 = Rs 200 @ lab rate variance = Std rate actual input - actual cost = 760 978 = Rs. 218 @ Variable overhead Cost variance = standard cost for actual output actual cost = 1050 1685 = Rs 635 @ Efficiency variance = standard cost for actual output Std rate actual input = 1050 1425 = Rs 375 @ Expenditure variance = Std rate actual input - actual cost =1425 1685 = Rs. 260 @

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Points to remember for Examination purpose

1. 2. 3. 4. 5. You are always calculating the average labour time. The nature of work is always manual . When the production volume is double, apply learning rate on time for 1st unit. Apply the concept of Static cost & Reducible cost to find cost of production. Read the problem carefully to find the reducible cost .

Problems for self-assessment

1. DKS manufacturers several production including the U. Production scheduling constraints require that one batch of Us is produced each quarter. The production of a batch of 12,000 U has been scheduled for the quarter ending March 31, 2006. This production will take place and any production surplus to current requirements will be added to stock. Budgeted fixed costs associated with U are Rs. 1,20,000 per quarter. The standard variable cost for U is Rs. 15 at the level of output schedule for the quarter. Most of the variable costs are labour related and it is known that U involves an 80% learning curve. In the past, DKS has operated a full cost plus pricing policy. The selling price for each product is set by calculating its full cost and adding 20% thereto for profit. In December 2005, DKS management term meet to discuss selling price for the coming quarter A market survey on demand for U is presented to the meeting : Price per U (Rs.) Sales of Us per quarter 25 11,750 30 11,500 35 40 45 8,750 7,500 6,000

The financial accountant advocates a selling price of Rs. 45 since this maximises profit. The management advocate retaining the established full cost plus policy since it is common sense

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You are required (a) to explain and discuss the alternative proposals for the selling price of the U in the quarter of March 31, 2006 and to state which proposal you consider that DKS should adopt ; (c) to calculate the optimum batch size for the production of the U and the optimum selling price for the U if this batch size is adopted. Discuss the implications of any differences between your proposal in part (a) and your calculation in part (b). Assume an 80% learning curve for ur answer. Answer a. b. 2. Profit Rs. 60,000 Optimum profit Rs 50,085 at 11,500 units

A company is considering investing in a project with the following characteristics : Equipment is to be purchased costing Rs. 70,000, payable at once and having a life of five years with no residual value. The equipments used to produce one type of product whose sales are budgeted as follows : Year to 30th June 2000 2001 2002 2003 2004 Number of units. 20 40 50 30 10 Total = 150

The selling price of the units is to be Rs.4,000 each. Costs of units are : Direct materials Variable production overhead Variable selling and administration overhead

Rs.1,200 each 50% of direct wages 10% of selling price.

Direct wages are paid at Rs.3 per hour. The first unit to be produced is budgeted to take 1505.3 man-hours of work and an 80% learning curve applies to direct wages. Fixed overhead relating to this project is Rs.12,000 per annum The company requires a 12% DCF return on its investments. calculate whether or not the project meets the companys investment

You are required to criterion, based on : (i) (ii)

the average direct wages rate for the whole quantity of units budgeted to be sold ; the direct labour times expected to be required in each individual year ; Ignore tax.

NB : An 80% learning curve on ordinary graph paper would show the following relationship between the x axis (volume) and y axis (cumulative average cost of elements subject to the learning curve) :

Management Accountancy -Final course X 1 2 10 20 30 40 50 60 Y% 100.00 80.00 47.65 38.13 33.46 30.50 28.39 26.77 X 70 80 90 100 110 120 130 140 150 Y% 25.48 24.40 23.40 22.71 22.03 21.41 20.86 20.38 19.93

Page No. 19

Answer a. b. 3.

Average time 300 hours with NPV Rs. 2,334 NPV Rs. 3,880

A company has designed a prototype Electronic Starter for which the following information are available: Direct labour hour Direct material cost Direct labour rate Variable overhead Fixed overhead = = = = = 260 hours Rs.30,000 Rs. 20 per hour 130% of direct labour 70% of direct labour.

Based on the demonstration of the prototype, the company has received order for 50 unit during first six months and another 75 units during the following six months thereafter. A learning curve effect of 80% is applicable. It is expected that in view of large volume, a 5% discount on material cost will be available in first six months and a 10% discount thereafter. The rates of overhead will remain unchanged and the same percentages would apply. The company sets the selling price with a 40% mark up on costs. Determine the selling price per unit for the first 50 units and the next 75 units. (The index of learning rate of learning curve effect of 80% is 0.3219.) Answer Selling price for order 1 Rs.47,986 & of order 2 Rs. 42,453.