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QUESTION NO.1.
BRING ABOUT THE POINTS OF DISTINCTION
BETWEEN
most
available
Computerized
Accounting
Systems
are
Integrated
Systems.Here we take the example of an Integrated Accounting System (our own product by
the name: Soft Accounting System) and explain how its functionality differs with NonIntegrated manual Accounting system.Whereas in manual Financial Accounting, you enter
Cash/Bank transactions in Cash Book and enter all other transactions in General Journal; in
Soft Accounting System, you record Sale/Purchase transactions in Sale Invoice or Purchase
Invoice. In the case of cash purchase/sale, that entry shall automatically be recorded in Cash
Book. And in the case of credit purchase/sale, there will be no need to record it in General
Journal. With a simple entry in sale or purchase invoice, you will not only get all the
Financial Accounting Ledgers and Trial Balance, you will also automatically get your
inventory and cost registers. If yours is a trading Business, then with a simple entry in sales
invoice form, you will also automatically get Cost of that particular Sale calculated on the
basis of both Weighted Average Costing and LIFO Costing methods.If yours is a
manufacturing business, then there is another simple Production Entry Form. You will enter
in it only the basic ongoing production data but as a result, not only you will get detailed
Production Reports, you will also get updated inventory registers of raw-materials and semifinished items with a proper breakup of location/process where those semi-finished items
have reached so far. When final production process on semi-finished items have been
performed, then automatically those semi-finished items are removed from semi-finished
inventory registers and go to Finished Goods Inventory Register. And when you will enter
new sale invoice, then finished goods stock shall be automatically reduced from the Finished
Goods Inventory Register. Not only this, you will also get detailed automated Direct Labor
Payroll Reports. In addition, you will also get automated costing reports like Batch Cost
Report and like etc. And since Soft Accounting System is an Integrated System, so you will
also get automatically updated information in your Financial Accounting Ledgers and Trial
Balance as well.To record daily expenditure and transactions other than Sale/Purchase (or
Sale/Purchase Returns which are to be recorded in Debit/Credit Notes), there are also Cash
Book and General Journal entry forms. So this is the way an Integrated Accounting System
works.
BENEFITS FROM INTEGRATED ACCOUNTING SYSTEM
The benets of integrated accounting system are as follows:
A. As only one set of accounting records is kept, the need for reconciliation between the
prots shown by the two records is eliminated.
B. The duplication of work is eliminated, thus the cost of operating this system is reduced.
C. This method is simple to understand and easy to operate. Unnecessary complications are
eliminated.
D. Cost data can be available promptly and regularly.
E. There is a cross checking of various gures in cost as well as nancial accounts. This
ensures accuracy of gures of cost and nancial data.
F. Use of mechanized accounting methods can be made.
EXAMPLE
PROBLEMS AND SOLUTIONS
1. Journalize the following transactions in the integrated books of account in the books of
XYZ Ltd.
Credit purchases Rs.12, 00, 000
Production wages paid Rs. 7, 00, 000
Stocks issued to production orders Rs. 8, 00, 000
Work expenses charged to production Rs. 4, 50, 000
Finished goods transferred from production orders Rs. 18, 00, 000
Administration expenses charged to production Rs. 1,50, 000
Work expenses outstanding Rs. 1, 20, 000
Work expenses paid Rs. 4, 60, 00
2
JOURNAL ENTRIE
DATE PARTICULARS
1
CREDIT Rs.
1200000
1200000
700000
To Cash/Bank A/c
700000
800000
800000
450000
450000
1800000
during the
1800000
year
150000
150000
120000
outstanding production
120000
overheads
460000
460000
2. Journalize the following transactions assuming that the cost and nancial accounts
are integrated.
Raw materials purchased: Rs.40, 000
Direct materials issued to production: Rs.30, 000
Wages paid [30% direct]: Rs.24, 000
Direct wages charged to production: Rs.16, 800
Manufacturing expenses incurred: Rs.19, 000
Manufacturing overheads charged to production: Rs.18, 400
Selling and distribution costs: Rs.4, 000
Finished products [At cost] : Rs.40, 000
Sales: Rs.58, 000
Closing stock: Nil
Receipts from debtors: Rs.13, 800
Payment to creditors: Rs.22, 000
JOURNAL ENTRIES
DATE
1
PARTICULARS
Stores Ledger Control A/c Dr.
L/F
DEBIT
Rs.
40000
Credit Rs.
40000
30000
30000
24000
To Bank A/c
24000
7200
7200
16800
16800
19000
To Bank A/c
19000
18400
To Bank A/c
18400
4000
To Bank A/c
4000
40000
40000
44000
44000
58000
58000
Bank A/c Dr
13800
13800
2200
2200
creditors]
MAINTENANCE OF ACCOUNTS
As maintained above, the nance department is responsible for maintaining the nancial
ledgers. Thisdepartment maintains the following ledgers.
_ General ledger: It includes all real, nominal and personal accounts except debtors and
creditorsaccounts.
_ Debtors Ledger: It contains the personal accounts of trade debtors.
_ Creditors Ledger: It contains the personal accounts of trade creditors.On the other hand,
the cost accounting department maintains the following cost ledgers.
_ Stores ledger for recording all stores transactions
_ Work-in-progress ledger: Cost of materials, labour and overheads of all jobs, which are in
progress, are posted to this account.
_ Finished goods/stock ledger: This ledger has the record of nished goods/stock.
_ Cost ledger: This ledger maintains the accounts relating to income and expenditure. The
following accounts are maintained in this ledger.
A. Cost control accounts: These accounts are maintained to exercise control over the three
subsidiary ledgers maintained above and also to complete the double entry in cost accounts.
The importantcost control accounts are as follows.
I. Stores ledger control a/c
II. Work-in-progress ledger control a/c
III. Finished goods ledger control a/c
IV. General ledger adjustment a/c
B. Other accounts: They include all other impersonal accounts [real as well as nominal]
whicheffect costs, e.g. wages control account, factory overhead accounts, administration
overheadaccount, selling and distribution overhead account, cost of sales account etc.
Depending uponthe requirement, the following additional accounts may also be maintained.
_ Overhead suspense account
_ Capital orders account
_ Service orders account.
Treatment of Elements of Cost
The following treatment is given to the various elements of cost.
_ Materials: Certain transactions relating to material are recorded in the nancial accounts
also.
10
and difference of credit and debit side will be net profit which will be transfer to general
ledger adjustment account's credit side.
TRANSACTION
DIFFERENCE BETWEEN INTEGRATED AND NON-INTEGRATED ACCOUNTIN
SYSTEM
The journal entries under integral and non-integral accounting systems are given in the
following table.
ITEMS
NON-
NON-
INTEGRATED
INTEGRATED
INTEGRATED
SYSTEM
SYSTEM OF
SYSTEM OF
FINANCIAL
COST BOOKS
BOOK
Purchase ofMaterials
Purchase A/c Dr
To Purchase Ledger
To Purchase Ledger
Control A/c [or
creditors]
Stores Ledger
Control A/c
Dr.
To General Ledger
Adjustment A/c
Stores Ledger
Control A/c
To Creditors A/c
No entry
Work-in-progress
Ledger
Control A/c Dr
To Stores Ledger
Control A/c
Work-in-progress
A/c Dr
To Stores Ledger
Control A/c
Payment ofwages
Wages A/c Dr
To Cash/bank A/c
Paymentfor indirect
Expenses A/c Dr
To Cash A/c
To Creditors A/c
Factory/Adm/S & D
Overhead A/c Dr
To General Ledger
Adjustment A/c
Factory/Adm/S & D
Overhead A/c Dr
To Cash A/c
To Creditors A/c
No entry
Work-in-progress
Control
A/c Dr
To Factory
Overheads
Control A/c
Work-in-progress
Control
A/c Dr
To Factory
Overheads
Control A/c
FactoryOverheadsover No entry
Factory Overhead
Control
A/c Dr
Factory Overhead
Control
A/c Dr
Production
Expenseslike power,
repairs etc.
Recordingof Factory
Overheadsat pre determined rates
absorbed
11
Jobscompleted
No entry
Stock Ledger
Control A/c
Dr
To work-in-progress
Ledger Control A/c
Stock Ledger
Control A/c
Dr
To work-in-progress
Ledger Control A/c
Interest paid
Interest A/c Dr
No entry
Interest A/c Dr
To Cash A/c
To Cash A/c
Rent of ownpremises
Rent of own
premises
Sales [Credit]
12
EXAMPLE
NON-INTEGRATED ACCOUNTING SYSTEM
Pass the journal entries in the cost books non-integrated system for the following transaction.
i)
ii)
Gross total wages paid Rs. 48000. Employer contribute to P.F. and State insurance
Amounts to Rs. 2000/-. Wages analysis book detailed Rs.20000/-. Towards directs
labour ,Rs. 12000/- towards indirect factory labour Rs.10000/- towards salaries
etc.To office staff and Rs. 8000/- for salaries, etc.To selling and distribution staff.
Date
1
Particulars
Debit Rs.
Dr.
Credit Rs.
25000
25000
Dr.
50000
50000
Dr.
20000
Dr.
12000
Dr.
10000
8000
Account
And
Indirect
50000
Expenses
13
Problem . 2
a) Issue of material
Direct
550000
Indirect
150000
200000
Indirect
40000
150000
Administration
50000
Selling
30000
d) Under/absorbed overheads
Factory (over)
20000
Administration (under)
10000
JOURNAL ENTRIES
NO
PARTICULARS
DEBIT Rs.
550000
CREDIT Rs.
150000
700000
200000
40000
240000
150000
150000
14
50000
Dr.
To Administration Overheads Control A/C
Cost
Of
Sale
50000
A/C 30000
Dr.
30000
Dr. 20000
20000
Dr. 10000
10000
A/C
15
CHAPTER- II
Question No.2.
Explain the following concept with the help of graphical
presentation ?
1. Angle of incident
2. Break-Even chart
3. Margin of Safety
4. Profit volume Graph
ANGLE OF INCIDENT
This is the angle between sales line and total cost line. This angle is formed by the
intersection of the total cost line and the sales line (at the BEP). This angle is an indicator of
profit-earning capacity over BEP. Large angle indicates the earning of high margin of profit.
Small angle indicates a low margin of profit which, in turn, suggests that variable costs
constitute a major chunk of cost of sales.
In general, a small angle of incidence indicates that firms are highly stablewith narrow
profit margin, low BEP, high margin of safety, low fixed cost and high variable cost, whereas
a large angle of incidence indicates that firms are highly riskywith high BEP, high fixed
cost, low variable cost and low margin of safety.
It is an angle that is created when the entire sales line intercepts the entire cost line from
below in the breakeven chart. It is inferred that higher the angle, higher is the profit, and
lower the angle lower the profit.
Angle of incidence (0) is the angle between the total cost line and the total sales line. If the
angle is large, the firm is said to make profits at a high rate and vice-versa.
A high angle of incidence and a high margin of safety indicate sound business conditions.
16
BREAK-EVEN CHART
Break Even Point
The concept of Break Even Point is extremely important for decision making in various
areas. This concept is based on the behaviour of costs, i.e. xed cost and variable costs. As
discussed earlier, xedcosts are those costs that remain constant irrespective of the changes in
the volume of production. On theother hand, variable costs are the costs that vary with the
level of production. While xed cost per unit isalways variable, variable cost per units is
always xed. In addition to these two types of costs, there aresemi variable costs that are
partially xed and partially variable. Semi variable costs thus have the featuresof both types
of costs. They remain xed up to a certain level of production and after crossing that level,
they become variable.The Break Even Point is a level of production where the total costs are
equal to the total revenue, i.e. sales. Thus at the break even level, there is neither prot nor
loss. Production level below the break-even-pointwill result into loss while production above
break-even point will result in prots. This concept can be better understood with the help of
the following table.Break-even analysis is a technique widely used by production
management and management accountants. It is based on categorising production costs
between 1those which are "variable" (costs that change when the production output changes)
and those that are "fixed" (costs not directly related to the volume of production).Total
variable and fixed costs are compared with sales revenue in order to determine the level of
sales volume, sales value or production at which the business makes neither a profit nor a loss
(the "break-even point").
Break even level can also be worked out with the help of the following formulae.
Break even point [in units] = Fixed Cost / Contribution per Unit
Break even point [in Rs.] = Fixed Cost / Prot Volume [P/V] Ratio
Break even point can also be shown on the graph paper as follows:
17
Total Revenu
Revenue Cost
Total Cost
BEP
Total Fixed Cost
Margin of Safety
Production / sales Volume
Explanation: On horizontal axis, production and sales volume is shown while on the vertical
axis, salesand costs in amount are shown.
Assumptions of Break Even Point: The concept of break even point is based on the
followingassumptions.
1. Production and sales are the same, which means that as much as is produced is sold out in
the market.
Thus there is no inventory remaining at the end.
2. Fixed cost remains same irrespective of the production volume.
3. Variable cost varies with the production. It changes in the same proportion that of the
production.
Hence it has a linear relationship with the production. In other words, variable cost per unit
remainsthe same.
4. Selling price per unit remains same irrespective of the quantity sold.
Margin of Safety: Margin of Safety is the difference between the actual sales and the break
even sales. As we have discussed, at the break even point there is neither any pro t nor loss.
Hence any rm will alwaysbe interested in being as much above the break even level as
possible. Margin of safety explains precisely
18
this thing and the higher the safety margin the better it is. Margin of safety is computed as
follows.
In the diagram above, the line OA represents the variation of income at varying levels of
production activity ("output"). OB represents the total fixed costs in the business. As output
increases, variable costs are incurred, meaning that total costs (fixed + variable) also increase.
At low levels of output, Costs are greater than Income. At the point of intersection, P, costs
are exactly equal to income, and hence neither profit nor loss is made.
Fixed Costs
Fixed costs are those business costs that are not directly related to the level of production or
output. In other words, even if the business has a zero output or high output, the level of fixed
19
costs will remain broadly the same. In the long term fixed costs can alter - perhaps as a result
of investment in production capacity (e.g. adding a new factory unit) or through the growth in
overheads required to support a larger, more complex business.
Examples of fixed costs:
- Rent and rates
- Depreciation
- Research and development
- Marketing costs (non- revenue related)
- Administration costs
Variable Costs
Variable costs are those costs which vary directly with the level of output. They represent
payment output-related inputs such as raw materials, direct labour, fuel and revenue-related
costs such as commission.
A distinction is often made between "Direct" variable costs and "Indirect" variable costs.
Direct variable costs are those which can be directly attributable to the production of a
particular product or service and allocated to a particular cost centre. Raw materials and the
wages those working on the production line are good examples.
Indirect variable costs cannot be directly attributable to production but they do vary with
output. These include depreciation (where it is calculated related to output - e.g. machine
hours), maintenance and certain labour costs.
Semi-Variable Costs
Whilst the distinction between fixed and variable costs is a convenient way of categorising
business costs, in reality there are some costs which are fixed in nature but which increase
when output reaches certain levels. These are largely related to the overall "scale" and/or
complexity of the business. For example, when a business has relatively low levels of output
or sales, it may not require costs associated with functions such as human resource
management or a fully-resourced finance department. However, as the scale of the business
grows (e.g. output, number people employed, number and complexity of transactions) then
more resources are required. If production rises suddenly then some short-term increase in
20
warehousing and/or transport may be required. In these circumstances, we say that part of the
cost is variable and part fixed.
Limitations of Break even Point: Break Even point is extremely useful in decision- making
regarding the production level. It indicates the level of production where there is neither any
pro t nor loss. Howeverthis is based on the assumption that the variable cost per unit, sales
price per unit and the xed remains the same. If there is any change in these variables, the
break even point will give misleadingresults.
Problems and Solutions:
1. From the following gures, nd the Break Even Volume
Solution:
Break Even Point: [units] = Fixed Cost / Contribution Per Unit =
Rs.40, 00, 000/Rs.200 = 20 000 number of shirts
_ Note: Contribution per units is selling price variable cost per unit Rs.800 Rs.600 =
Rs.200
22
MARGIN OF SAFETY
Margin of safety (MOS) is the excess of budgeted or actual sales over the break evenvolume
of sales. It stats the amount by which sales can drop before losses begin to be incurred. The
higher the margin of safety, the lower the risk of not breaking even.
The margin of safety is the reduction in sales that can occur before the breakeven point of a
business is reached. The amount of this buffer is expressed as a percentage.
The margin of safety concept is especially useful when a significant proportion of sales are at
risk of decline or elimination, as may be the case when a sales contract is coming to an end.
By knowing the amount of the margin of safety, management can gain a better understanding
of the risk of loss to which a business is subjected by changes in sales. The opposite situation
may also arise, where the margin of safety is so large that a business is well-protected from
sales variations.
23
The margin of safety concept does not work well when sales are strongly seasonal, since
some months will yield catastrophically low results. In such cases, annualize the information
in order to integrate all seasonal fluctuations into the outcome.
To calculate the margin of safety, subtract the current breakeven point from sales, and divide
by sales. The formula is:
Current Sales Level Breakeven Point
Current Sales Level
Margin of Safety: Margin of Safety is the difference between the actual sales and the break
even sales. As we have discussed, at the break even point there is neither any pro t nor loss.
Hence any rm will alwaysbe interested in being as much above the break even level as
possible. Margin of safety explains preciselythis thing and the higher the safety margin the
better it is. Margin of safety is computed as follows.
Here are two alternative versions of the margin of safety:
1. Budget based. A company may want to project its margin of safety under a budget for
a future period. If so, replace the current sales level in the formula with the budgeted
sales level.
2. Unit based. If you want to translate the margin of safety into the number of units sold,
then use the following formula instead (though note that this version works best if a
company only sells one product.
3. For example, Lowry Locomotion is considering the purchase of new equipment to
expand the production capacity of its toy tractor product line. The addition will
increase Lowry's operating costs by Rs.100,000 per year, though sales will also be
increased. Relevant information is noted in the following table:
Sales
Gross margin percentage
Fixed expenses
Rs.4,000,000
Rs.4,200,000
48%
48%
Rs.1,800,000
Rs.1,900,000
24
Breakeven point
Rs.3,750,000
Rs.3,958,000
Rs.120,000
Rs.116,000
6.3%
5.8%
Profits
Margin of safety
The table reveals that both the margin of safety and profits worsen slightly as a result of the
equipment purchase, so expanding production capacity is probably not a good idea.
The margin of safety concept is also applied to investing, where it refers to the difference
between the intrinsic value of a company's share price and its current market value. An
investor wants to see a large variance between the two figures (which is the margin of safety)
before buying stock. This implies that there is substantial upside potential for the stock price or at least, it means any error in deriving the intrinsic value must be a big one in order to
erase the margin of safety.
the
breakeven
point
lies.
Companies use PV charts in cost-volume-profit analysis along with breakeven charts and
contribution
charts.
25
CHAPTER- III
Question No. 3.
With the help of suitable example explain how the management
takes the following decision?
1. Accept or Rejects special order decision.
2. Make or Buy decision.
3. Keep or Replace decision.
4. Reduces or Maintain the price the decision.
5. Add or Drop the products decision.
6. Operate or Shut-down decision.
7. Expand or Reduce the capacity decision.
8. Sales or Process decision.
9. Key factor and products mix decision
ACCEPT OR REJECTS SPECIAL ORDER DECISION.
When Should Special Orders Be Accepted?
Special orders should be accepted only if:
Special orders which do not meet these criteria should generally not be accepted. Of course,
soft-benefits should be considered as well.
Accept or Reject?
If incremental revenues are less than incremental costs, reject the order, unless qualitative
characteristics overwhelmingly impact the decision.
If incremental revenues are greater than incremental costs, accept the order unless qualitative
characteristics overwhelmingly impact the decision.
26
An Example
Flowers Inc. manufactures silk roses. Bud Company has approached Flowers with a proposal
to buy 2,000 silk roses for 8,000. Flowers has the necessary capacity. The following costs are
associated annually with silk roses when 10,000 units are produced:
Direct material
21,000
Direct labor
13,000
Manufacturing overhead
Total
9,000
43,000
Forty percent of the overhead is variable. All fixed overhead is allocated equally to all
products produced. In good form, prepare an incremental analysis to analyze whether Flowers
should accept the order from Bud Company.
Forty percent of the overhead is variable. All fixed overhead is allocated equally to all
products produced. In good form, prepare an incremental analysis to analyze whether Flowers
should accept the order from Bud Company.
Step 1: Decide what is not relevant. Allocated fixed overhead is not relevant. The total fixed
overhead of 5,400 (60%*9,000) is the same no matter what decision is made, so it is not part
of the analysis.
Step 2: Determine incremental revenue. The amount of 8,000 is given for this problem.
Step 3: Determine incremental costs. The variable material cost must be determined:
21,000/10,000 = 2.10 per unit
You must then multiply unit cost by the total units in the special order:
2.10 * 2,000 = 4,200
Because variable costs are increased by $4,200, profit will decrease by $4,200, so the amount
is shown as a negative in the incremental analysis.
27
Step 4: Direct labor is another incremental variable cost. The variable cost per unit is:
13,000/10,000 units = 1.30 per unit
The labor cost of all 2,000 units = 2,000*1.30 = $2.600
Because variable costs are increased by 2,600, profit will decrease by 2,600, so this amount is
Step 5: Only the variable portion of the fixed shown as a negative in the incremental
analysis. overhead is relevant. First you must determine the variable overhead per unit which
is 9,000/10,000, or 0.90 per unit. Of this amount, 40% is variable amounting to 0.36 per unit.
The cost of the variable overhead for the 2,000 units in the special order equal 2,000*0.36 =
720. This is an increase cost which causes profit to decrease so the amount is shown as a
negative in the analysis.
The analysis should appear in the following format with respective labels as follows:
Incremental revenue
8,000
Incremental costs:
Direct materials
(4,200)
Direct labor
(2,600)
Variable overhead
Incremental increase in profit if the order is accepted
(720)
480
Because profit increases by 480 if the order is accepted, managers should follow through and
accept the order unless qualitative issues warrant otherwise.
THE MAKE OR BUY DECISION
Marginal costing can be applied in the area of fixation of selling price. The next important
area is whether to make or buy decision. When a company has unused capacity and wants to
manufacture some components, it has two alternatives:
(A) to make within the organization or
(B) to buy from the market.
Often, firms face the question whether to outsource production of a component or continue to
make it in the factory. Comparison of the relevant costs of both the alternatives in such cases
will show whether to continue the existing arrangement or change to buying it, discontinuing
28
the current production. The answer depends upon whether the firm has the option to use the
freed capacity, profitably, or not.
Illustration No. 1
Suresh Ltd. is producing a part at a cost of Rs. 11 per unit. The composition of the cost is as
follows:
Materials
3.00
Wages
4.00
OverheadsVariable2.50
- Fixed
1.50
11.00
Presently, the firm has been incurring a total fixed cost of Rs. 15,000 for manufacturing the
current production of 10,000 units. An outsider is offering the same component, in all aspects
identical in features, for Rs. 10 per unit. On enquiry, it is found from the firm that the
machinethat is manufacturing the parts would remain idle as the machinery cannot be
utilized elsewhere.
(A) Should the offer be accepted?
(B) Would your answer would be different, if the outside firm reduces the price to Rs. 9,
after negotiation. What is the impact of the fixed costs in the decision-making process?
Solution:
The variable cost of the product is as under:
(Rs.)
Materials
Wages
3.00
4.00
OverheadsVariable 2.50
Total Variable Cost
9.50
(A) Here, the additional costs (variable costs) for making are Rs. 9.50. The outside market
priceis Rs. 10. The outside offer is on a higher side by Rs. 0.50 per unit, so the offer is to be
rejected. For every unit bought outside, it results in a loss of Rs. 0.50 per unit.
(B) Now, the outside firm is willing to reduce the price to Rs. 9, while the variable cost is
Rs. 9.50. The offer is to be accepted.
29
So far as the fixed costs Rs. 15,000 is concerned, the firm would incur, whether the firm
makes the product itself or buys it outside. In other words, the existing fixed costs are not to
beconsidered, while taking a decision.
KEEP OR REPLACEMENT DECISION
A company is considering replacing an old machine with a new one. Details about the old m
achine and the new machine are as follows:
Old Machine
Original Cost
1,000,000
Depreciated amount
800,000
10,000
Nil
New Machine
Current purchase cost
300,000
Useful life
3 years
60,000
The new machine can reduce operating costs by 80,000 per annum.
Solution
CostBenefit Analysis for Replacement
Incremental Benefits of Replacement
Total costs saving (3 x $80,000)
240,000
60,000
10,000
310,000
(300,000)
10,000
Conclusion: Since replacement would make a net incremental benefit, it should be replaced.
ADD OR DROP DECISION
30
A decision whether or not to continue an oldproduct line or department, or to start a new one
is called an add-or-drop decision. An add-or-drop decision must be based only on relevant
information.Relevant information includes the revenues and costs which are directly related
to a product line or department. Examples of relevant information aresales revenue, direct
costs, variable overhead and direct fixed overhead. Such decision must not be based on
irrelevant information such as allocated fixed overhead because allocated fixed overhead will
not be eliminated if the product line or department is dropped.
The following example illustrates an add-or-drop decision:
Example
A company has three products: Product A, Product B and Product C. Income statements of
the three product lines for the latest month are given below:
Product Line
Sales
Variable Cost
Contribution Margin
91,000
86,000 112,000
93,000
62,000 120,000
Net Income
42,000
3,000
45,000
169,000
86,000
255,000
314,000
59,000
31
B
30
28
2
35
6
12
18
36
-1
2) Evaluation Of
Alternative
32
PARTICULARS
Contribution of A
Less: Contribution Of B
Total Contribution
Less: Fixed Overheads
Profit / (Loss)
A
250 Units of A &
250Units of B
500
-250
250
750
-500
B
400Units
of B
-400
-400
750
-1150
C
400 Units of A
& 100 units Of
B
800
-100
700
750
-50
D
150 Units of A
& 350 Units of
B.
300
-350
-50
750
-800
500
500
2000
Particulars
Product A
Product B
Units Budgeted to be produced and
sold
1800
3000
1200
selling price per units Rs
60
55
50
Requirement per units
Direct Material
5kg
3 Kg
4 Kg
Direct Labour
4 Hrs.
3 Hrs.
2 Hrs.
Variable Overheads
Rs 7
Rs. 13
Rs.8
Fixed Overheads
Rs.10
Rs.10
Rs.10
Cost of direct Material Per (K.G)
Rs.4
Rs.4
Rs.4
Direct labour hr. Rate
Rs.2
Rs.2
Rs.2
Maximum possibale units of Sales
4000
5000 Rs.1500
All the three products are poroduced from the same direct material using the
same type of machine and labour.Direct Materil Which is the Key Factor Iimited
to 18600Hrs.
34
Solution
Statement of Most Profitable Product Mix
Particulars
A Rs.
B Rs.
Selling Price per Units (i)
60
Variable Cost
Direct Material
20
Direct Labour
8
Variable overheads
7
totla veriable cost (ii)
35
Contribution Per Unit (I - ii)
25
Contribution Per hrs.( WN 1)
6.25
Ranking of most profitable Product
Mix
III
55
C Rs.
50
12
6
13
31
24
8
16
4
8
28
22
11
II
Products
B
A
1.Contribution Per Units Rs.
2. Direct Labour Hours Per Units
3.Contribution per hrs.(Rs) (1/2)
25
4
6.25
24
3
8
C
22
2
11
WN 2
35
Here direct labour hrs. is the key factor and only 18600 hrs. are avaliable to
produced the three products. The available 18000 hrs. are utilised hrs are in order
of the ranking assigned i.e. first of all products see then [products B and lastly
product A will be produced. the number of which products to be Produced will
be depend upon the maximum possible od sale each products the details of the
products to be produced keeoping in view of avalibale hrs. and their ranking are
as below.
Total
hrs.Utilised
(Rs)
Products
C
B
A
Total Hrs.
1500 Units x 2
hrs.
5000 units x
3000
150 units X 4
Hrs
WN 3
PARTICULARS
A
1. Budgeted units to be produced
sold :
2. Fixed Overheads (Rs) Per unit
3. Total fixed Overheads (Rs) (1 X
2)
3000
15000
600
18600
PRODUCTS
B
TOTAL
C
1800
10
3000
10
1200
10
18000
30000
12000
60000
36
BIBILIOGRAPHY
WWW.ICAI.ORG.IN
WWW.ACCOUNTING TOOLS.COM
WWW.CACLUBINDIA.COM
ADVANCE COST ACCOUNTING BOOKS AUTHOER NAME :
DR. VARSHA M. AINAPURE
37