and import license for the picture tubes required in the manufacture of
its tvs has been obtained, the corporation is considering an increase in
production to its full installed capacity.
The management requires a statement showing all details of
production costs at 100% level of activity.
Solution:
Marginal Cost Statement
(At 100% Level Of Activity Total Cost Cost Per Unit
With 400 Units)
Rs. Rs.
Materials
20,00,000
5,000
Labour
6,00,000 1,500
Variable Factory Overhead
5,00,000 1,250
Marginal Factory Cost
31,00,000 7,750
Fixed Factory Overhead
2,50,000
625
Total factory cost
33,50,000
8,375
Thus, the marginal factory cost per unit is rs.7,750 and the total
production cost per unit is rs.8,375.
Commentary:
(i) Calculation Of Variable Factory Overheads Per Unit:
Rs.6,00,000 – Rs.5,00,000
= --------------------------------- = Rs.1,250
80 Units
195
(II) Calculation Of Fixed Factory Overheads:
Factory Overheads – (No. Of Units At Certain Level Of Activity X Variable
Factory Overheads Per Unit).
Therefore Rs.5,00,000 – (200 Units X 1,250)
Therefore Rs.5,00,000 – Rs.2,50,000 = Rs.2,50,000
The Amount Can Be Verified By Making Calculation At Any Other Level
Of Activity.
(III) Variable Factory Overheads At 100% Level Of Activity:
400 Units X 1,250 = Rs.5,00,000
4. Key Factor
A concern would produce and sell only those products which offer
maximum profit. This is based on the assumption that it is possible to
produce any quantity without any difficulty and sell likewise. However, in
actual practice, this seems to be unrealistic as several constraints come in
the way of manufacturing as well as selling. Such constraints that come in
the way of management’s efforts to produce and sell in unlimited quantities
are called `key factors’ or `limiting factors’. The limiting factors may be
materials, labour, plant capacity, or demand. Management must ascertain
the extent of the influence of the key factor for ensuring maximisation
of profit. Normally, when contribution and key factors are known, the
relative profitability of different products or processes can be measured
with the help of the following formula:
Contribution
Profitability = -----------------------
Key Factor
Illustration 7: from the following data, which product would you
recommend to be manufactured in a factory, time, being the key factor?
Per
Unit
of
Per
Unit
of
Product
X
Product
Y
Direct Material
24
14
Direct Labour At Re.1 Per Hour 2
3
Variable Overhead At Rs.2 Per Hour 4
6
Selling Price
100
110
Standard Time To Produce
2 Hours
3 Hours
196
Solution:
Per Unit of Per Unit of
Product X
Product Y
Selling Price
100 110
Less: Marginal Cost:
Direct Materials
24
14
Direct Labour
2 3
Variable Overhead
4 30 6 23
-- --- -- ---
Contribution
70
87
Standard Time To Produce
2 Hours
3 Hours
Contribution Per Hour
70/2
87/3
= Rs.35
= Rs.29
Contribution per hour of product x is more than that of product y by
rs.6. Therefore, product x is more profitable and is recommended to be
manufactured.
5. Make Or Buy Decisions
A company might be having unused capacity which may be utilized
for making component parts or similar items instead of buying them
from the market. In arriving at such àmake or buy’ decision, the cost of
manufacturing component parts should be compared with price quoted
in the market. If the variable costs are lower than the purchase price, the
component parts should be manufactured in the factory itself. Fixed costs
are excluded on the assumption that they have been already incurred, and
the manufacturing of components involves only variable cost. However,
if there is an increase in fixed costs and any limiting factor is operating
while producing components etc. That should also be taken into account.
Consider the following illustration, throwing light on these aspects.
Illustrations 8:
You are the management accountant of XYZ CO. Ltd. The
Managing director of the company seeks your advice on the following
problem: the company produces a variety of products each having a number
of computer parts. Product “B” takes 5 hours to produce on machine no.99
197
working at full capacity. “bB” has a selling price of rs.50 and a marginal
cost, Rs.30 per unit. “A-10” a component part could be made on the same
machine in 2 hours for marginal cost of Rs.5 per unit. The supplier’s price
is Rs.12.50 per unit. Should the company make or buy “A10”?
Assume that machine hour is the limiting factor.
Solution:
In this problem the cost of new product plus contribution lost
during the time for manufacturing “A-10” should be compared with the
supplier’s price to arrive at a decision.
Rs.
“B”
–
Selling
Price
50.00
Marginal Cost
30.00
-------
20.00
-------
It takes 5 hours to produce one unit of “B.
Therefore, contribution earned per hour on machine no.99 is Rs.20/5 =
Rs.4. “A-10” takes two hours to be manufactured on machine which is
producing “B”. Real cost of “A-10” to the company = marginal cost of “aA-
10” plus contribution lost for using the machine for “A-10”.
Rs.5 + Rs.8 = Rs.13
This is more than the seller’s price of rs.12.50 and so it is advisable for the
company to buy the product from outside.
Illustration 9:
A t.V. Manufacturing company finds that while it costs Rs.6.25 To
make each component X, the same is available in the market at Rs.4.85
Each, with an assurance of continued supply. The break down of cost is:
Rs.
Materials
2.75
Each
Labour
1.75
Each
Other Variables
0.50 Each
Depreciation And Other Fixed Costs
1.25 Each
6.25
198
Should you make or buy?
Solution:
Variable cost of manufacturing is Rs.5; (Rs.6.25 – Rs.1.25) but the
market price is Rs.4.85. If the fixed cost of Rs.1.25 is also added, it is not
profitable to make the component. Because there is a saving of Rs.0.15
even in variable cost, it is profitable to procure from outside.
6. Suitable Product Mix/Sales Mix
Normally, a business concern will select the product mix which
gives the maximum profit. Product mix is the ratio in which various
products are produced and sold. The marginal costing technique helps
management in taking appropriate decisions regarding the product mix,
i.e., in changing the ratio of product mix so as to maximise profits. The
technique not only helps in dropping unprofitable products from the
mix but also helps in dropping unprofitable departments, activities etc.
Consider the following illustrations:
Illustration 10: (Product Mix)
The following figures are obtained from the accounts of a
departmental store having four departments.
Departments
(Figures
In
Rs.)
Particulars A
B C D Total
Sales
5,000
8,000
6,000 7,000 26,000
Marginal Cost 5,500
6,000
2,000 2,000 15,500
Fixed Cost 500
4,000
1,000
1,000 6,500
(Apportioned)
Total Cost 6,000
10,000
3,000
3,000 22,000
Profit/Loss(-) 1,000 (-) 2,000 3,000 4,000 4,000
On the above basis, it is decided to close down dept. B immediately, as the
loss shown is the maximum. After that dept. A will be discarded. What is
your advice to the management?
199
Statement Of Comparative Profitability
Departments
Particulars A
B
C D Total
Sales
5,000
8,000
6,000 7,000 26,000
Less:
Marginal Cost 5,500
6,000
2,000 2,000 15,500
Contribution (-) 500 2,000
4,000
5,000 10,500
Fixed Cost
6,500
--------
Profit
4,000
--------
Commentary:
From the above, it is clear that the contribution of dept. A is negative
and should be discarded immediately. As dept. B provides rs.2,000 towards
fixed costs and profits, it should not be discarded.
Illustration 11 (Sales Mix):
Present the following information to show to the management:
(a) the marginal product cost and the contribution per unit; (b) the total
contribution and profits resulting from each of the following mixtures:
Product
Per
Unit
(Rs.)
Direct Materials
A
10
B
9
Direct Wages
A
3
B
2
Fixed Expenses Rs.800
Variable Expenses Are Allocated To Products As 100% Of Direct Wages.
Rs.
Sales Price
A
20
B
15
200
Sales Mixtures:
Ֆ 1000 Units Of Product A And 2000 Units Of B
Ֆ 1500 Units Of Product A And 1500 Units Of B
Ֆ 2000 Units Of Product A And 1000 Units Of B
Solution:
(A) Marginal Cost Statement
A
B
Direct
Materials
10
9
Direct Wages
3
2
Variable Overheads (100%)
3
2
---
---
Marginal
Cost
16
13
Sales Price
20
15
Contribution
4
2
1000 A+
1500 A+
2000 A+
(B) Sales Mix
2000 B
1500 B
1000B
Choice
(I)
(II)
(III)
(Rs.)
(Rs.)
(Rs.)
Total Sales
(1000 X 20 + (1500 X 20 +
(2000 X 20 +
2000 X 15) = 1500 X 15) =
1000 X 15) =
50,000
52,500
55,000
(1000 X 16 + (1500 X 16 +
(2000 X 16 +
2000 X 13) = 1500 X 13) =
1000 X 13) =
Less: Marginal Cost 42,000
43,500
45,000
------------------------------------------------------------
Contribution
8,000 9,000
10,000
Less: fixed costs
800
800
800
------------------------------------------------------------
Profit
7,200
8,200
9,200
Therefore sales mixture (iii) will give the highest profit; and as such,
mixture (iii) can be adopted.
201
7. Pricing Decisions
Marginal costing techniques help a firm to decide about the prices
of various products in a fairly easy manner. Let’s examine the following
cases:
(I) Fixation of Selling Price
Illustration 12:
P/V Ratio Is 60% and the marginal cost of the product is Rs.50.
What will be the selling price?
Solution:
S – V
V
C
P/V Ratio = ----------
= 1 - ----- = -----
S
S
S
Variable Cost
40
---------------- = 40%
or ------
Sales
100
50 50 X 100
Selling Price = -------
= -------------- = Rs.125
40%
40
(ii) Reducing Selling Price
Illustration 13:
The Price Structure Of A Cycle Made By The Visu Cycle Co. Ltd. Is
As Follows:
Per Cycle
Materials
60
Labour
20
Variable Overheads
20
-----
Fixed
Overheads
100
Profit
50
Selling Price
50
-----
200
202
This is based on the manufacture of one lakh cycles per annum.
The company expects that due to competition they will have to reduce
selling prices, but they want to keep the total profits intact. What level of
production will have to be reached, i.e., how many cycles will have to be
made to get the same amount of profits, if:
(a) the selling price is reduced by 10%?
(b) the selling price is reduced by 20%?
Solution:
(Rs.)
(Rs.)
Existing profit
= 1,00,000 x 50 =
50,00,000
Total fixed overheads = 1,00,000 x 50 =
50,00,000
(a) Selling price is reduced by 10% and to get the existing profit of rs.50
lakhs.
New Selling Price
=
200 – 10% Of Rs.200
=
200 – 20 =Rs.180
New Contribution
=
180 – 100 =Rs.80 Per Unit
Total Sales (Units)
=
F + P/Contribution Per Unit
5,00,000
+
5,00,000
=
---------------------------
80
=
1,25,000
Cycles
Are to be obtained and sold to earn the existing profit of rs.5,00,000.
(b) Selling price reduced by 20% and to get the existing profit of rs.5,00,000.
New Selling Price
=
200 – 20% Of Rs.200
=
200 – 40 = Rs.160
New Contribution
=
S – V
=
160 – 100 = Rs.80 Per Unit
Total Sales (Units)
=
F + P/Contribution Per Unit
5,00,000
+
5,00,000
= ---------------------------
60
=
1,66,667 cycles are to be produced
and sold to earn the existing profit of rs.50 Lakhs.
203
(iii) Pricing During Recession:
Illustration 14:
SSA company is working well below normal capacity due to
recession. The directors of the company have been approached with an
enquiry for special job. The costing department estimated the following in
respect of the job.
Direct
Materials
Rs.10,000
Direct Labour 500 Hours @
Rs.2 Per Hour
Overhead Costs: Normal Recovery Rates
Variable
Re.0.50
Per
Hour
Fixed
Re.1.00
Per
Hour
The directors ask you to advise them on the minimum price to be charged.
Assume that there are no production difficulties regarding the job.
Solution:
Calculation Of Marginal Cost:
(Rs.)
Direct
Materials
10,000
Direct Labour