SUGGESTED_ANSWER TO QUESTION_SYL2016_JUNE2017_PAPER-15

FINAL EXAMINATION
GROUP - III
(SYLLABUS 2016)

SUGGESTED ANSWERS TO QUESTIONS

JUNE - 2017
Paper-15 : STRATEGIC COST MANAGEMENT – DECISION MAKING
Time Allowed : 3 Hours Full Marks : 100

The figures in the margin on the right side indicate full marks.
Answer Question No. 1 in Section A, which is compulsory, carrying 20 marks.
Further, answer any 5(five) Questions from Section B, each carrying 16 marks.

Section – A (20 Marks)

1. Choose the most appropriate answer to the following questions giving justification. Each
question carries 2 (two) marks. 2x10=20

(i) Stock Control data for Material P are:

Annual usage: 3600 units; Cost per unit: `100/-; Cost of placing an order: `40;
Stockholding Cost: 20% of the overall stock volume; Lead time: One month
The EOQ based on the above data is:
(a) 210 units
(b) 175 units
(c) 90 units
(d) 120 units
(ii) Which of the following would take place if a company is able to reduce its variable
cost?
Contribution Margin Break-Even Point
(a) Increase Increase
(b) Decrease Decrease
(c) Increase Decrease
(d) Decrease Increase
(iii) The following details relate to Product P-1 of a manufacturing company:
Level of activity (units) 1000 2000
Cost per unit (`):
Direct materials 4.00 4.00
Direct labour 3.00 3.00
Production Overheads 3.50 2.50
Selling Overheads 1.00 0.50
11.50 10.00
The total fixed cost and variable cost per unit are:
Total Fixed Cost (`) Variable Cost per unit (`)
(a) 2,000 7.00
(b) 2,000 8.50
(c) 3,000 7.00
(d) 3,000 8.50
(iv) A company makes a single product which it sells at `10 per unit. Fixed costs are `
48,000 per month and the product has a contribution to sales ratio of 40%. In a period
when actual sales were `1,40,000, the company's margin of safety in units was:
(a) 2000
(b) 3000

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(c) 3500
(d) 4000
(v) The following tasks are associated with ABC system:
I. Allocation of costs to products
II. Identification of cost pools
III. Identification of cost drivers
IV. Calculation of pool rates
The proper order of the preceding tasks is:
(a) III, II, IV, I
(b) I, II, III, IV
(c) III, IV, II, I
(d) IV, III, II, I
(vi) A company has the capacity of production of 80000 units and presently it sells 20000
units at ` 100 each. The demand is sensitive to selling price and it has been observed
that every reduction of ` 10 in selling price the demand is doubled. What should be
the target cost at full capacity it profit margin on sales is taken at 25%?
(a) ` 58 lakhs
(b) ` 52 lakhs
(c) ` 48 lakhs
(d) ` 50 lakhs
(vii)The information relating to the direct material cost of a company is as follows:
Standard price per unit ` 7.20
Actual quantity purchased in units 1600
Standard quantity allowed for actual production in units 1450
Material price variance on purchase (Favourable) ` 480
What is the actual purchase price per unit?
(a) `7.50
(b) `6.40
(c) `6.50
(d) `6.90
(viii)Backflush costing is most likely to be used when:
(a) Management desires sequential tracking of costs
(b) A Just-in-Time inventory philosophy has been adopted
(c) The company carries significant amount of inventory
(d) Actual production costs are debited to work-in-progress
(ix) The preparation and use of standard cost, their comparison with actual costs and the
measurement and analysis of variances to originating causes is defined as:
(a) Marginal Costing
(b) Standard Costing
(c) Throughput Costing
(d) Kaizen Costing
(x) The following are cost data for two alternative ways of processing the clerical work for
legal cases brought before the district court:
Semi-automatic Fully automatic
Monthly fixed costs (`):
Occupancy 15,000 15,000
Maintenance contract 5,000 10,000
Equipment lease 25,000 1,00,000
Unit variable cost (per report) (`)
Supplies 80 20
Labour 60 20
The cost indifference point will be:
(a) 800 cases
(b) 850 cases
(c) 750 cases
(d) 700 cases

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Answer:

1. (i) (d)
Explanation: 120 units as per the following computation:
EOQ = 2AB/C, where
A = Annual Requirement of the material = 3,600 units.
B = Buying or Ordering Cost /Order = ` 40.
C = Carrying or Stockholding Cost per unit per annum = ` 100 × 20%
EOQ = 2 x 3,600 x 40/20 =120 units (d).

(ii) (c)
Explanation: Contribution margin = Sales Less Variable Cost
So, reduction in variable cost will increase contribution.
BEP = FC/Contribution Margin
Hence, increase in contribution will reduce BEP.

(iii) (d)
Explanation: Variable Cost per unit = 4.00 + 3.00 = ` 7.00
Total FC (included in Production Overheads and Selling Overheads) is as follows:
Units 1,000 2,000
Total OH 4.50 × 1,000 = 4,500 3.00 × 2,000 = 6,000
Difference in Overhead = ` 1,500
Difference in Volume = 1,000
 Variable per unit = `1.50
Add this to Variable cost per unit of ` 7.00.
The Total variable cost = ` 1.50 + ` 7.00 = ` 8.50
Fixed Cost = `4,500 - (1,000 × 1.50) = ` 4,500 - ` 1,500 = ` 3,000.

(iv) (a)
FC ` 48,000
Explanation: BEP = = = ` 1,20,000 or 12,000 units.
C/S Ratio 0.4
When sells are ` 1,40,000, the volume is ` 1,40,000 ÷ 10 = ` 14,000 units
 Margin of Safety is 14,000 – 12,000 = 2,000 units.

(v) (a)
Explanation: Because cost is allocated based on the cost pool rates. So, whole
process starts with identification of cost drivers followed by identification of cost pools,
determination of rates and then allocation.

(vi) (c)
Explanation:
Maximum Capacity 80,000 Units
Present Sale 20,000 Units @ ` 100/-per Unit
Selling Price/Unit Demand
100 20,000
90 40,000
80 80,000
Target Price ` 80
Target Cost/Unit 80 - 25% of Sales = 80 - 20 = ` 60/- per unit
Total Target Cost 80,000 Units × `60/- per unit = ` 48 lakhs.

(vii) (d)
Explanation:
Material Price Variance (MPV) = Standard cost of Actual Quantity - Actual Cost
480 = 7.20 × 1,600 - Actual Cost
or, Actual Cost = 11,520 - 480 = 11,040
Actual Price / Unit = 11,040 ÷ 1,600 = ` 6.90.

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(viii) (b)
Explanation: A Just-in-Time inventory philosophy has been adopted. The reason for this
is that JIT assumes zero inventory for raw materials, work-in-progress and finished goods
and the system of backflush accounting records the transaction only at the
termination of the production and sales cycle.

(ix) (b)
Explanation: Because standard costing only involves the process described.

(x) (a)
Explanation: Cost Indifference Point is calculated as follows:
Difference in monthly FC
Difference in unit VC
`1,25,000 - ` 45,000 ` 80,000
= = = 800 Cases.
`140 - ` 40 `100

Section – B
Answer any five questions.
Each Question carries 16 Marks.
16×5=80

2. (a) What is Value Chain? How does it help modern cost management? 2+4=6

(b) (i) What are the problems of Traditional Costing arising out of volume-based cost
allocation to products?
(ii) How can Activity-Based Costing help refining such costing system? 1+3=4

(c) (i) What are relevant costs and relevant revenues?

(ii) In making repetitive decisions using relevant costs and benefits, should a decision
maker be aware of several pitfalls? If so, mention a few and briefly explain them.
2+4=6

Answer:

2. (a) A value chain is the sequence of business functions in which utility (usefulness) is
added to the products or services of the firm. Through proper analysis and
management of each segment of the value chain, customer value is enhanced. Non-
value creating activities are eliminated.
In value chain analysis, each of the business functions is treated as an essential and
valued contributor and is constantly analyzed to enhance value relative to the cost
incurred. Like business functions, in value chain approach also, it is important that the
efforts of all functions are integrated and co-ordinated to increase the value of the
products or services to the customers.
The following diagram shows the important functions or activities of a firm and the role
of the cost accountant in cost management.

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Michael Porter introduced the value chain concept in cost management is 1985. It
was developed further by Ahw subsequently. When the supplier and customers are
included, the firm is viewed as an extended value chain as shown below:

The value chain approach is an integral part of strategic cost management, which is
an approach to Management Accounting that explicitly highlights strategic issues
and concerns. It sets cost analysis as a broader context in which cost information is
used to develop superior strategies.

Modern cost accountant has an important role to play in analyzing cost information
relating to each of the segments of the value chain and supplying the same to other
functional managers for improved decisions.

(b) (i) Under traditional costing, overhead which occupies and important share of the
total cost structure of the firm is generally allocated based on volume-based
allocation rates viz. rates per labour hour, rate per machine hour, % of labour cost,
etc. It does not take into consideration disproportionate consumption service
department services. As a result, the product cost gets distorted i.e., some
products are over costed while others are under costed. The basic assumption in
cost allocation is; the higher the volume, the greater the share of indirect costs to
the product or service. This simplistic assumption dies not hold good in reality.

(ii) The Activity-Based Costing (ABC) is a system that focuses on activities as the
fundamental cost objects and uses the cost of these activities for computing the
costs of products. The Activity-Based Costing refines the problems of Traditional
Costing System by the following means:
1) In the traditional system, cost analysis is done by product. In ABC, the
managers focus attention on activities rather than products because activities
in various departments may be combined and costs of similar activities
ascertained, e.g., quality control, handling of materials, repairs to machines
etc., If detailed costs are kept by activities, the total company costs for each
activity can be obtained, analysed, planned and controlled.
2) Unlike the Traditional Costing Systems, managers under ABC, manage activities
and not products. Changes in activities lead to changes in costs. Therefore, if
the activities are managed well, costs will fall and the resulting products will be
more competitive.
3) Allocating Overhead Cost to production based on a single cost driver
(allocation base, such as unit basis, percentage of material, percentage of
prime cost, labour hour rate, machine hour rate etc.) can result in an unrealistic
product cost because the traditional system fails to capture cause-and-effect
relationships. To manage activities better and to make wiser economic
decisions, managers need to identify the relationships of causes (activities)
and effects (costs) in a more detailed and accurate manner.
4) ABC highlights problem areas that deserve management's attention and more
detailed analysis. Many actions are possible, on pricing, on process
technology, on product design, on operational movements and on product

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mix. Traditional Costing can lead to under costing for over costing of products
or services. Over or Under Costing of products distorts cost information. A poor
quality of cost information causes management to make poor decisions for
pricing, product emphasis, make or buy etc.
ABC differs from the traditional system only in respect of allocations of
overheads or indirect costs. Direct Costs are identified with, or assigned to, the
cost object, in the same manner as is done in case of traditional costing
system. Overhead costs are linked to the cost objects based on activities.

(c) (i) Relevant costs are costs appropriate to aiding the making of specific
management decisions (CIMA). They are estimated future costs that differ among
alternatives. Similarly, relevant revenues and expected future revenues that differ
among alternatives. The two key aspects of relevance are:
(1) The costs and revenues must occurs in future, and
(2) They must differ among alternatives.

(ii) In such decision making, the decision maker must be aware of some pitfalls.
Examples are:
(1) Sunk cost – be ignored as not relevant.
(2) Fixed Costs – if they change for the decision at hand, the changed portion
only becomes relevant.
(3) Opportunity costs – They need not be overlooked (e.g., to outsource an
activity when there is no idle capacity). An opportunity cost is the cost of an
opportunity foregone by not using a limited resource in its next best alternative
use.

3. (a) Accelerate Co. Ltd., manufactures and sells four types of products under the brand
names of A, B, C and D. The sales mix in value comprises 33 1/3%, 41 2/3%, 16 2/3%
and 8 1/3% of products A, B, C and D, respectively. The total budgeted sales (100%)
are ` 60,000 p.m. Operating Costs are — Variable costs: Product A 60% of selling
price, Product B 68% of selling price, Product C 80% of selling price, Product D 40% of
selling price; Fixed costs: ` 14,700 p.m.
Required:
Calculate the break-even-point for the products on overall basis. 8

(b) A2Z p.l.c supports the concept of tero technology or life cycle costing for new
investment decisions covering its engineering activities. The financial side of this
philosophy is now well established and its principles extended to all other areas of
decision making. The company is to replace a number of its machines and the
Production Manager is torn between the Exe Machine, a more expensive machine
with a life of 12 years, and the Wye machine with an estimated life of 6 years. If the
Wye machine is chosen, it is likely that it would be replaced at the end of 6 years by
another Wye machine. The pattern of maintenance and running costs differs between
the two types of machine and relevant data are shown below:

Exe Wye
Purchase price ` 19,000 `13,000
Trade-in value/breakup/scrap ` 3,000 ` 3,000
Annual repair costs ` 2,000 ` 2,600
Overhaul costs (at year 8) ` 4,000 (at year 4) ` 2,000
Estimated financing costs 10% p.a. 10% p.a.

averaged over machine life

Required: Recommend with supporting figures, which machine to purchase, stating
any assumptions made? 8

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Answer:

3. (a) Computation of overall breakeven point

A B C D Total
a Sales (`) 20,000 25,000 10,000 5,000 60,000
b Variable cost (`) 12,000 17,000 8,000 2,000 39,000
c Contribution (`) 8,000 8,000 2,000 3,000 21,000
d Fixed cost (`) 14,700
e Profit (`) 6,300
f P/V ratio (%) 40% 32% 20% 60% 35%
g Break even sales (`) 14700/35% = 42,000

(b) Profitability of Alternate Machines

Exe Machine WYE Machine
Initial cost(`) 19,000 13,000.00
Less: Scrap at the end of the (3,000x0.32) 960.00 (3,000x0.56) 1,680.00
life(`)
18,040.00 11,320.00
Present value of total annual (2,000x6.81) 13,620.00 (2,600x4.36) 11,336.00
cost(`)
Overhaul Cost (4,000x0.47) 1,880.00 (2,000x0.68) 1,360.00
33,540.00 24,016
Capital recovery factor (1/6.81) 0.15 (1/4.36) 0.23
Equivalent annual cost (`) 5,031.00 5,523.68
Conclusion:
As the equivalent annual cost is less for Exe Machine, it is better to purchase the same.

4. (a) SRM Ltd. has developed a new product 'Kent' which is about to be launched into the
market and anticipates to sell 80,000 of these units at a sale price of ` 300 over the
product's life cycle of four years. Data pertaining to product 'Kent' are as follows:
Costs of Design and Development ` 10,25,000
of Moulding Dies and Other tools
Manufacturing costs ` 125 per unit
Selling costs ` 12,500 per year + ` 100 per unit
Administration costs ` 50,000 per year
Warranty expenses 5 replacement parts per 25 units at ` 10 per part,
1 visit per 500 units (cost ` 500 per visit)
Required:
(i) Compute the product Kent's Life Cycle Cost.
(ii) Suppose SRM Ltd. can increase sales volume by 25% through 15% decrease in
selling price, should SRM Ltd. choose the lower price? 8

(b) BCG Manufacturers sell their product at ` 1,000 per unit. Their competitors are likely to
reduce the price by 15%. BCG Manufacturers want to respond aggressively by cutting
price by 20% and expect that the present volume of 150000 units per annum will
increase to 200000 units. BCGM want to earn a 10% target profit on sales. Based on a
detailed value engineering, the comparative position is given below:
Particulars Existing (`) Target (`)
Direct Material Cost per unit 400 385
Direct Labour Cost per unit 55 50
Direct machinery costs per unit 70 60
Direct Manufacturing expenses per unit 525 425
Manufacturing Overheads
No. of orders (` 80 per order) 22,500 21,250
Testing hours (` 2 per hour) 45,00,000 30,00,000
Units reworked (` 100 per unit) 12,000 13,000

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Manufacturing overheads are allocated using relevant cost drivers. Other operating
costs per unit for the expected volume are estimated as follows:
Research and Design ` 50
Marketing and Customer Service ` 130
` 180
Required:
(i) Calculate target costs per unit and target costs for the proposed volume showing
break up of different elements.
(ii) Prepare target product profitability statement. 4+4=8

Answer:

4. (a)
Statement showing 'Kent's Life Cycle Cost (80,000 Units)
Particulars Amount (`)
Costs of Design and Development of Moulds, Dies and other tools 10,25,000
Manufacturing Costs (`125 × 80,000 units) 1,00,00,000
Selling Costs (`100 × 80,000 units + ` 12,500 × 4) 80,50,000
Administration Costs (` 50,000 × 4) 2,00,000
Warranty :
(80,000 units / 25 units × 5 parts × ` 10) 1,60,000
(80,000 units / 500 units × 1 visit × ` 500) 80,000
Total cost 1,95,15,000

Statement showing 'Kent's Life Cycle Cost (1,00,000 Units)

Particulars Amount (`)
Costs of Design and Development of Moulds, Dies and other tools 10,25,000
Manufacturing Costs (`125 × 1,00,000 units) 1,25,00,000
Selling Costs (`100 × 1,00,000 units + ` 12,500 × 4) 1,00,50,000
Administration Costs (` 50,000 × 4) 2,00,000
Warranty:
(1,00,000 units / 25 units × 5 parts × `10) 2,00,000
(1,00,000 units / 500 units × 1 visit × ` 500) 1,00,000
Total cost 2,40,75,000

Statement showing "Kent's Life Time Profit"

Particulars Amount (`) 80,000 units Amount (`) 100,000 units
Sales (80,000 × ` 300) 2,40,00,000 (1,00,000 × ` 255) 2,55,00,000
Less : Total Cost 1,95,15,000 2,40,75,000
Profit 44,85,000 14,25,000
Decision: Reducing the, price by 15% will decrease profit by ` 30,60,000. Therefore,
SRM Ltd. should not cut the price.

(b) Part 1:
Target Selling Price: ` 1000 less 20% ` 800
Less: Target Profit Margin (10% of ` 800) ` 80
Target Cost per unit ` 720

The breakup of the target cost per unit of ` 720 per unit is as follows:
Direct Materials 385
Direct Labour 50
Direct Machinery costs 60
Direct Manufacturing Costs 495
Add: Manufacturing Overheads:
Ordering and receiving (21250 × ` 80)/200000 8.50

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Testing and Inspection (30,00,000 × `,2)/200000 30.00

Rework (13,000 × ` 100)/200000 6.50 45
Other Operating Costs:
Research and Design 50
Marketing and Customer Service 130 180
Full Product Costs 720

Part 2:
Target Product Profitability
Particulars Per Unit (`) Total for 200000 units (`)
1. Sales 800 16,00,00,000
2. Cost of Goods Sold:
Direct Materials 385 7,70,00,000
Direct Labour 50 1,00,00,000
Direct Manufacturing Costs 60 1,20,00,000
495 9,90,00,000
Manufacturing Overheads 45 90,00,000
540 10,80,00,000
3. Gross Margin (1-2) 260 5,20, 00,000
4. Operating Costs:
Research and Design 50 1,00,00,000
Marketing and Customer Service 130 2,60,00,000
180 3,60,00,000
5. Operating Profit (3 - 4) 80 1,60,00,000

5. (a) A manufacturing company currently operating at 80% capacity has received an

export order from Middle East, which will utilise 40% of the capacity of the factory. The
order has to be either taken in full and executed at 10% below the current domestic
prices or rejected totally.
The current sales and cost data are given below:
Sales ` 16.00 lakhs
Direct Material ` 5.80 lakhs
Direct Labour ` 2.40 lakhs
Variable Overheads ` 0.60 lakhs
Fixed Overheads ` 5.20 lakhs

The following alternatives are available to the management:

(I) Continue with domestic sales and reject the export order.
(II) Accept the export order and allow the domestic market to starve to the extent of
excess of demand.
(Ill) Increase capacity so as to accept the export order and maintain the domestic
demand by:
(i) Purchasing additional plant and increasing 10% capacity and thereby
increasing fixed overheads by ` 65,000, and
(ii) Working overtime at one and half time the normal rate to meet balance of the
required capacity.
Required:
Evaluate each of the above alternatives and suggest the best one. 6

(b) The following particulars are extracted from the records of Ajanta Works Limited:

Particulars Product A Product B

Selling price per unit ` 1,000.00 ` 1,200.00
Consumption of Material Kg. 20.00 Kg. 30.00
Material cost ` 100.00 ` 150.00

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Direct wages `150.00 ` 100.00

Direct expenses ` 50.00 ` 60.00
Machine Hours used 3 2
Overhead Expenses:
Fixed ` 50.00 ` 100.00
Variable ` 150.00 ` 200.00

Note: Direct wages per hour is ` 50.00

Required:
(i) Comment on the profitability of each product (both use the same raw material)
when:
(I) Total sales potential in units is limited
(II) Total sales potential in value is limited
(III) Raw Material is in short supply, and
(IV) Production Capacity (in terms of Machine Hours) is the limiting factor.

(ii) Assuming raw material as the key factor, availability of which is 10000 Kg., and
maximum sales potential of each product being 3500 units, find out the product
mix which will yield the maximum profit. 4+6=10

Answer:

5. (a)
Present 40% - Foreign 40% - Foreign
Sales 80% 60% - Domestic 80% - Domestic
1. Sales 16.00 (7.20+12.00)= 19.20 (7.20 + 16.00) = 23.20
2. Variable Cost
Direct Material 5.80 7.25 8.70
Direct Labour 2.40 3.00 3.60
Variable Overheads 0.60 0.75 0.90
Overtime Premium -- --- 0.15
8.80 11.00 13.35
3. Contribution 7.20 8.20 9.85
4. Fixed Cost 5.20 5.20 (5.20 + 0.65) = 5.85
5. Profit 2.00 3.00 4.00

As per the above calculations, it is evident that the profit is maximum in Alternative III i.e.,
accepting the foreign order fully and monitoring the present domestic sales. It is the best
alternative to be pursued by the management.

(b) Marginal Cost Statement of Ajanta Works Limited

Particulars Cost Per Unit (`)
A B
Selling Price 1000 1200
Direct Materials 100 150
Direct Wages 150 100
Direct Expenses 50 60
Variable Overheads 150 200
Marginal Cost 450 510
Contribution Margin 550 690
P/V Ratio 55% 57.50%
Contribution per Kg of material 27.5 23.0
Contribution per Machine Hour 183 345

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(i) The comments based on the above statement are as follows:
I. When total sales potential in units is a limiting factor, Product B is more profitable, as it
is making a larger contribution margin per unit as compared to A.
II. When total sales potential in value is a limiting factor, Product B is still more profitable,
as its P/V ratio is more than that of A.
III. When Raw Material is in short supply, A is more profitable as its contribution in per kg,
of material is more than that of Product B.
IV. When production capacity is limited, B is more profitable as it makes larger
contribution per machine hour than A.
(Note: Best position is reached when contribution per unit of key factor is maximum.)
(ii) Contribution per kg. of materials of A is more than that of B. So, 10,000 kg. ÷ 20 kg.
= 500 units of A will only be produced and sold.
6. (a) Nikee Ltd. manufactures and sells one variety of sports-shirt in India. Noted football
clubs and supporters of these clubs are the main customers. Nikee's products show
some rectifiable defects. These problems can generally be detected and repaired
during internal inspection at a cost of ` 15 per unit.
During 2016, 50000 shirts were produced and sold. After inspection defect was
detected in respect of 5% of output. Inspection cost is `25 per shirt. After sales,
customers reported defects in respect of 6% of output. These shirts were received
back from customers at a transportation cost of `8 per unit. Because of negative
publicity due to defects, there would be loss of sales in 2017 to the extent of 5% of
external failures.
Required:
(i) Analyse costs of quality showing separately (with workings) the:
(I) Inspection or appraisal cost
(II) Internal failure cost
(III) External failure cost
(IV) Opportunity cost due to external failure, and
(V) Total costs of quality
(ii) If the selling price per shirt is `250 and variable cost is 60% of sales, fixed cost
`5,50,000 p.a., prepare a statement showing profitability of the product during
2016. 6+2=8
(b) You are given the following estimates for next year's budgeted sales and costs of
single product produced by Bee Ltd.:
Selling Price *12
Sales demand: Units Probability
3200 0.50
4000 0.30
5000 0.20
` Probability
Variable cost per unit 5.00 0.3
6.00 0.5
7.00 0.2
Fixed cost for the period: ` 20,000
Required:
(i) Expected value of sales for the period.
(ii) Expected variable cost and contribution for the period.
(iii) Expected profit or loss for the budget period. 2+4+2=8
Answer:
6. (a)
Statement of Costs of Quality
`
(a) Inspection or Appraisal Cost (` 25 × 50,000 shirts) 12,50,000
(b) Internal failure (re-work) cost (5% × 50,000 × ` 15) 37,500

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(c) External failure cost (i.e., transportation + re-work cost) 39,000

[6% × 50,000 × (` 8 + 15)]
(d) Opportunity cost (i.e., loss of contribution) 25,000
[10% × (5% × 50,000) × (` 250 × 40%)]
Total Quality Cost 13,51,500

Profitability statement
`
Sales (50,000 × ` 250) 1,25,00,000
Less: Variable Cost (60%) 75,00,000
Contribution 50,00,000
Less: Quality Cost (as above) 13,51,500
Contribution, net of quality costs 36,48,500
Less: Fixed Cost 10,00,000
Net Profit 26,48,500

(b)
(1) Expected Value of Sales:
Expected Sales × Profitability
3,200 × 0.5 = 1,600
4,000 × 0.3 = 1,200
5,000 × 0.2 = 1,000 3,800 @ ` 12 45,600

(2) Expected Variable Cost:

Unit Variable costs × Profitability
` 0.5 × 0.3 = 1.5
` 0.6 × 0.5 = 3.0
` 0.7 × 0.2 = 1.4 5.9 × 3,800 22,420
Expected Contribution 23,180

(3) Expected Profit:

Expected Contribution 23,180
(-) Fixed Cost 20,000
Expected Profit ` 3,180

7. (a) XYZ Auto-manufacturing company has to prepare a design of its latest model of
motorcycle. The various activities to be performed to prepare a design are as follows:
Activity Description of activity Preceding activity
A Prepare drawing -
B Carry out cost analysis A
C Carry out financial analysis A
D Manufacture tools C
E Prepare bill of material B,C
F Receive material D,E
G Order sub-accessories E
H Receive sub-accessories G
I Manufacture components F
J Final assembly I,H
K Testing and shipment J
Prepare an appropriate network diagram. 8

(b) In a processing industry two products A and B are made involving two operations. The
production of B also results in a by-product C. The product A can be sold at a profit of ` 3
per unit and B at a profit of ` 8 per unit. The by-product C has a profit of ` 2 per unit.
Forecast shows that upto 5 units of C can be sold. The company gets 3 units of C for each

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unit of B produced. The manufacturing times are 3 hours per unit for A on each of the
operation one and two and 4 hours and 5 hours per unit for B on operation one and two,
respectively. Because the product C results from producing B, no time is used in
producing C. The available times are 18 hours and 21 hours of operation one and two
respectively. The company desires to know how much of A and B should be produced
keeping C in mind to make the highest profit.
Required:
Formulate LP model for this problem. 8

Answer:

7. (a) The network diagram will be as follows:

(b) Let X1, X2, X3 be the number of units produced of products A, B and C respectively.
Objective function:
Then the profit gained by the industry is given by
Z = 3x1 +8x2 + 2x3
Here it is assumed that all the units of products A and B are sold.

Condition-1:
In first operation, A takes 3 hrs of manufacturer's time and B takes 4 hrs of
manufacturer's time. Therefore, total number of hours required in first operation
becomes - 3x1 +4x2

In second operation, per unit of A takes 3 hrs of manufacturer's time and per unit B
takes 5 hrs of manufacturer's time. Therefore, the total number of hours used in second
operation becomes - 3x1 + 5x2

Since there are 18 hours available in first operation and 21 hours in second operation,
the restrictions become
3x1+4x2 ≤ 18
3x1+5x2≤21

Condition-2:
Since the maximum number of units of C that can be sold is 5, therefore,
X3 ≤ 5

Condition-3:
Further, the company gels three units of by product C for every unit of product B
produced, therefore,
X3 = 3X2

Now, the allocation problem of the industry can be finally put in the following linear
programming problem:
Maximise
Z = 3x1 + 8x2 + 2x3

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Subject to the Constraints

3x1+4x2≤18
3x1 + 5x2 ≤ 21
x3 ≤ 5
x3 = 3x2
x 1, x 2 , x 3 ≥ 0

8. Write short notes on any four of the following: 4x4= 16

(a) Variants of Backflush Accounting
(b) Transfer Pricing
(c) Principles of Total Quality Management (TQM)
(d) Learning Curve Theory
(e) Simulation Technique

Answer:

8. (a) There are a number of variants of the Backflush system, each differing as to the
'trigger points' at which costs are recognized within the cost accounts and thus
associated with products. Variant-1-This has two trigger points (TP): TP 1 - purchase of
raw materials/components. A 'raw and in process (RIP)' account will be debited with
the actual cost of materials purchased, and creditors credited. TP 2 - completion of
good units. The finished goods (FG) account will be debited with the standard cost of
unit produced and the RIP and CC account will be credited with the standard cost.
Variant-2- This has only one trigger points - the completion of good units. The FG
account is debited with the standard cost of units produced, with corresponding
credits to the CC account and the creditors account.

(b) Transfer Pricing:

A transfer price is the price of one segment(sub unit, department, division etc.,) of an
organization charges for a product or services supplied to another segment of the
same organization. Transfer prices are used when individual entities of a larger multi-
entity firm are treated and measured as separately run entities.

The benefits of Transfer Pricing Policy are as under:

(i) Divisional performance evaluation is made easier.
(ii) It will develop healthy inter-divisional competitive spirit.
(iii) Management by exception is possible.
(iv) It helps in co-ordination of divisional objectives in achieving organizational goals.
(v) It provides useful information to the top management in making policy decisions
like expansion, sub-contracting, closing down of a division, make or buy decisions,
etc,
(vi) Transfer Price will act as a check on supplier's prices.
(vii) It fosters economic entity and free enterprise system.
(viii) It optimizes the allocation of company's financial resources based on the relative
performance of various profit centres, which in turn, are influenced by transfer
pricing policies.

(c) Principles of Total Quality Management (TQM):

The philosophy of TQM rest on the following principles, which are enlisted below:
(i) Clear exposition of the benefits of a project.
(ii) Total Employee Involvement (TEI).
(iii) Process measurement.
(iv) Involvement of all customers and contributors.
(v) Elimination of irrelevant data.
(vi) Understanding the needs of the whole process.
(vii) Use of errors to prompt continuous improvement.
(viii) Use of statistics to tell people how well they are doing.

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(d) Learning Curve Theory:

Learning Curve Theory is concerned with the idea that when a new job, process or
activity commences for the first time, it is likely that the workforce involved will not
achieve maximum efficiency immediately. Repetition of the task is likely to make the
people more confident and knowledeable and will eventually result in a more
efficient and rapid operation. Eventually the learning process will stop after continually
repeating the job. As a consequence the time to complete a task will initially decline
and then stabilize once efficient working is achieved. The cumulative average time
per unit is assumed to decrease by a constant percentage every time that output
doubles. Cumulative average time refers to the average time per unit for all units
produced so far, from and including the first one made.

Learning is the process by which an individual acquires skill, knowledge and ability.
When a new product or process is started, the performance of a worker is not at its best
and a learning phenomenon takes place. As the experience is gained, the
performance of a worker improves, time taken per unit of activity reduces and his
productivity goes up. This improvement in productivity of a worker is due to learning
effect. Cost predictions especially those relating to direct labour cost must allow for the
effect of learning process. This technique is a mathematical technique. It can be very
much used to accurately and graphically predict cost.

Learning Curve is essentially a measure of the experience gained in production of an

article by an individual or organization. As more units are produced, people involved
in production become more efficient than before. Each subsequent unit takes fewer
man-hours to produce. The amount of improvement will differ with each type of article
produced. This improvement or experience gain is reflected in a decrease in man-
hours or cost.

The learning curve ratio can be calculated with the help of the following formula:
Learning Curve ratio = Average cost of first 2 units/Average labour cost of first unit.

(e) Simulation:
Simulation is a modelling and analysis tool that is widely used for the purpose of
designing, planning and control of manufacturing systems. Simulation in general is to
pretend that one deals with a real thing while really working with an imitation. In
Operations Research, the imitation is a computer model of the simulated reality. The
task of executing simulations provides insight and a deep understanding of physical
processes that are being modelled.

Simulation is generally referred to as computer simulation, which simulates the

operation of a manufacturing system. A computer simulation or a computer model is a
computer program, which attempts to simulate an abstract model of a particular
system.

A simple example of a simulation involves the tossing of a ball mto the air. The ball can
be said to "simulate" a missile, for instance. That is, by experimenting with throwing balls
starting at different initial heights and initial velocity vectors, it can be said that we are
simulating the trajectory of a missile.

Monte Carlo method of simulation is the most popular method of simulation. In Linear
Programming, Simulation is called as the 'technique of last resort'. It means, when all
other methods fails, we resort to Simulation as the last resort.

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