Q Girish

Engineering (MCS-2004) Numerical

Monthly report (in part) for an expense centre in factory is:

All figures in Rs. Lacs
Actual
Variance
Direct Labour
Indirect Labour
Total Controllable Costs
Department Fixed Costs
Allocated Costs

66.34

100.13
0.21 (Favourable)
8.10 (Unfavourable)
168.47
8.50 (Unfavourable)
38.82
-------53.62
--------

Questions:
1. Why no variance is shown in two items? Is this correct approach in performance
reporting?
2. Should overhead expenses mentioned above be included in Controllable Costs?
Why? Why not?
Solution (a):

Variances between actual and budgeted departmental fixed costs are

obtained simply by subtraction, since these costs are not affected by
either the volume of sales or the volume of production. Thats why no
variance is shown for departmental fixed costs.
Allocated costs are a share of the costs of a resource used by a project,
where the same resource is also used by other activities. These are
different to the Incurred costs because these costs are not exclusively
related to any individual project. However, the cost of the resource still
needs to be recovered, and making a fair and reasonable charge to all
projects using the resource does this.
The key difference between costs and Allocated costs is that the latter
will be charged based upon an estimate, rather than actual cash
values. Thus as it is charged based upon an estimate the budgeted
figure is the same as the actual figure and hence no variances.
Solution (b):
Overhead Expenses mentioned above should not be included in
controllable costs because some costs are uncontrollable like fixed
costs. . They don't vary with the change in short run managerial
decisions and output. And some costs are controllable i.e. they can be
managed and changed with the managerial decisions and output.

As the above overhead expenses would have certain portion of fixed

expenses this is hard to control. So, these should not be a part of
controllable cost.
Kiran Company (MCS-2004) Numerical

Budget versus Actual comparison for div Z of Kirancompany is as follows:

Budg

Actua

Actual better

et

(worse) than
budget

Sales and other income

800

740

(60)

Variable expenses

480

436

44

Fixed expenses

120

120

Sales promotional expenses

40

28

12

Operating profit

160

156

Net working capital

400

412

12

Fixed assets

160

148

(12)

(a)

Carry out and overall performance analysis to decide areas

needing investigation.
From the given data, we see that there is a certain amount of variance
between the budgeted operating profit and actual operating profit. In
order to analyze the variances, we need to understand the key causal
factors that affect profit, namely, revenues and cost structure. The profit
budget has embedded in it certain expectations about the state of total
industry, companys market share, selling prices and cost structure.
Results from variance computation are actionable if changes in actual
results are analyzed against each of this expectation.
Revenue variances, that is a negative Rs 60 lakhs, could be a result of
selling price variance, mixed variance and/or volume variance. A
combination of above three factors must have been unfavorable that is
either the volume of sales must have been below the budgeted volumes
( this must be particularly true since actual variable expenses are less

than budgeted) and/or the selling price must have been below expectation
and/or the proportion of products sold with a higher contribution must
have been less than budgeted.
One more factor could have been the overall industry volume. However,
this factor is beyond the managements control and largely dependent on
the state of economy.
Variable expenses are directly proportional to volumes and hence as is
evident are less than budgeted.
Sales promotional expenses also show a negative variance which could be
a cause of lower sales volumes.
A cause of concern is that despite lower sales, the net working capital is
more than budgeted which indicates capital block in higher inventory.
Another issue is that the fixed assets are lower than the budget by Rs 12
lakhs which may indicate slower capacity expansion then expected or
distressed sale of assets to tide over cash flow.

(b) What are the remedial measures if any would you suggest
based on analysis?
The budgeted estimates may be too optimistic and far from reality, one
needs to ensure that estimates the as realistic as possible. Given the
estimates are correct, in that case depending upon the above analysis,
the

management

needs

to

take

corrective

action

areas

needing

improvement, sales volume could be improved by better marketing,

quality standards and promotional efforts, product mix could be improved
by selling more of higher contribution products. Better sales will ensure a
higher

inventory

turnover.

Better

credit

management

to

recover

receivables, will ensure improve cash flow situation since less capital will
be tied up in working capital.

Q.5ABC ltd. (MCS-2008) Numerical

Particulars
ROI
Sales
Investment
EBIT

Division X (Rs.)
28%
100 Lacs
25 lacs
7 Lacs

Division Y (Rs.)
26%
500 lacs
100 Lacs
26 lacs

Analyze and comment upon performances of both the divisions

Solution:
Division X
ROI

(Profit / investment)* 100

Profit

(28/100)*25lacs

7lacs

(Profit/sales)*100

(7/100)*100

Profit margin
=
Turnover of investments

7lacs
=

(Sales/investment)*100

(100/25)*100

4 times

ROI

(Profit / investment)* 100

Profit

(26/100)*100lacs

26lacs

(Profit/sales)*100

Division Y

Profit margin
=

(26/500)*100

5.2lacs

Turnover of investments

(Sales/investment)*100

(500/100)*100

5 times

Profit margin of X is better than profit margin of division Y. Turnover of investment of division Y is better than
Division X.
Hence cost management of Division X is better than Division Y.

MCS 2006

(SUM NO 7)

Q) Soniya Company has two Divisions: A & B. Return on Investment for both divisions is 20%.
Details are given below:Particulars

Div A

Div B

Divisional sales

4000000

9600000

Divisional Investment

2000000

3200000

Profit

400000

640000

Analyse and comment on divisional performance of each.

ANSWER
As Profit Margin = Profit *100
Sales
Profit Margin for Division A= 4,00,000 /40,00,000 *100 = 10%
Profit Margin for Division B = 6,40,000/ 96,00,000 *100 = 6.6%
Turnover of Investment = Sales * 100
Investment
Turnover of Investment for Division A = 40,00,000/20,00,000 = 2 times
Turnover of Investment for Division B = 96,00,000/32,00,000 = 3 times
As Return on investment for both Divisions A and B is 20%.
COMMENTS:Division A Although A has more profit margin than Division B that is 10% as compared to
6.6% of B, so it has more profitability but inspite of it, division A has lower turnover of
investment that its assets management is bad than Division B, it can be improved by increased sales
or reducing investment.
Division B Needs to improve profit margin by increasing sales and reduce variable cost and sales
at same price or by reducing salesprice and increase the volume of sales so that its profit would
improve. As it has good assets management shown by its turnoverof Division B that is 3 times which
is better than Division A. So it can become profitable organisation by improving Profit Margin

Q5: Shandilya Ltd. (MCS-2008) Numerical

Shandilya Ltd. has adopted Economic Value Added (EVA) technique for the appraisal of performance of its
three divisions A,B and C. Company charges 6% for current assets and 8 % for Fixed Assets, while computing
EVA relevant data are given below :Particulars

Div A
Budgeted

Div B
Actual

Div C

Budgete

Actual

Budgete

Total
Actual

Budgete

Actual

Profit

360

320

220

240

200

200

780

760

Current Assets

400

360

800

760

1200

1400

2400

2520

Fixed Assets

1600

1600

1600

1800

2000

2200

5200

5600

Solution:
Particulars

Div A
Budgeted

Div B
Actual

Div C

Budgete

Actual

Budgeted

Total
Actua

Budgete

Actual

ROA

18%

16%

9%

9%

6%

6%

10%

9%

EVA

208

170.4

44

50.4

-32

-60

220

160.8

Q 2)Suresh Ltd. (Numerical) (MCS-2007) and same as Ananya Ltd (MCS 2009)
(a) Define profit in this case and prepare a statement for both divisions and overall company.
Solution:
i) Profitability statement of Division A:-

Particulars
Selling price p.u.
Variable Cost p.u.
Contribution p.u.

Amount(Rs.)
35
11
24

Contribution p.u.

Expected

24
24
24

(no. of units)
2000
3000
6000

sales

Total contribution

Total Fixed cost

Net profit (Rs.)

48000
72000
144000

(Rs.)
60000
60000
60000

(12000)
12000
84000

ii) Profitability statement of Division B:-

Selling p.u.

Total

Contribution

Expected

Total

Total Fixed

Net

variable cost

p.u.

sales (no. of

contribution

cost (Rs.)

(Rs.)

p.u.
units)
90
42
48
2000
96000
80
42
38
3000
114000
50
42
8
6000
48000
[Note: Total Variable cost p.u. = Variable cost p.u. (Rs.7) + Transfer price

profit

90000
6000
90000
24000
90000
(42000)
of intermediate product

(Rs.35)]
iii) Profitability statement of Company as a whole:-

Expected sales

Net profit of division A

Net profit of Division B

Total Net profit

2000
3000
6000

(Rs.)
(12000)
12000
84000

(Rs.)
6000
24000
(42000)

(6000)
36000
42000

(b) State the selling price which maximizes profits for division B and company as a whole.
Comment on why the latter price is unlikely to be selected by division B.
Solution:
As per the calculation in part (a), selling price p.u. of Rs.80 maximizes profit for division B
whereas selling price p.u. of Rs.50 maximizes profit for the Company as a whole. However, if
Division B opts for selling price p.u. of Rs.50 in order to maximize Companys profit, it would
suffer a loss of Rs.42000. Therefore, Division B would not select Selling price p.u. of Rs.50.

MCS 2007
Two Divisions A and B of Satyam Enterprises operate as Profit centers. Division A normally
purchases annually 10,000 nos. of required components from Div. B; which has recently
informed Div. A that it will increase selling price per unit to Rs.1,100. Div.A decided to purchase
the components from open market available at Rs. 1000 per unit. Naturally, Div. B is not happy
and justified its decision to increase price due to inflation and added that overall company
profitability will reduce and the decision will lead to excess capacity in Div. B, whose variable
and fixed costs per unit are respectively Rs. 950 and Rs. 1,100.
Assuming that no alternate use exists for excess capacity in Div. B, will company as a whole
benefit if div A buys from the market.
If the market price reduces by Rs. 80 per unit. What would be the effect on the company
(assuming Div. B still has excess capacity) if A buys from the market
If excess capacity of Div. B could be used for alternative sales at yearly cost savings of Rs. 14.5
lacs, should Div. A purchase from outside?
Justify your answers with figures.
Solution
Option A ( Div A buys from outside)
Total Purchase Cost = 10,000 Units * Rs. 1000 = Rs. 1,00,00,000
Total outlay if transferred inside = 10,000 Units * Rs. 950 = Rs. 95,00,000
Since total outlay if transferred inside is lesser than total purchase cost if bought from outside,
relevant cost is the lesser one i.e. Rs. 95,00,000 and overall benefit for the company would be Rs.
5,00,000
a) Option B ( if the market price is reduced by Rs. 80 per unit and A buys from the market)
Total Purchase Cost = 10,000 Units * Rs. 920 = Rs. 92,00,000
Total outlay if transferred inside = 10,000 Units * Rs. 950 = Rs. 95,00,000
Since total purchase cost is lesser than the total outlay if transferred inside, relevant cost is the
lesser one i.e. 92,00,000 and overall benefit for the company would be Rs. 3,00,000
b) Option C ( if excess capacity of Div B could be used for alternative sales at yearly cost
savings of Rs 14.5 lacs, should Div A purchase from outside)
Total Purchase Cost = 10,000 Units * Rs. 1,000 = Rs. 1,00,00,000
Total outlay if transferred inside = 10,000 Units * Rs. 950 = Rs. 95,00,000
Total opportunity cost if transferred inside = Rs. 14,50,000
Total relevant cost becomes Rs. 1,00,00,000
If Div A purchase from outside, overall benefit for the company would be Rs. 9,50,000.
Therefore, Div A should purchase from outside.
Particulars
Total Purchase Cost
Total outlay if transferred inside
Total opportunity cost if transferred inside
Total relevant cost
Net advantage/disadvantage to company as a
whole if it buys from inside

Option A
Amount
1,00,00,000
95,00,000
95,00,000
5,00,000

(Numerical) MCS 2004

Option B
Amount
92,00,000
95,00,000
92,00,000
(3,00,000)

Option C
Amount
1,00,00,000
95,00,000
14,50,000
1,00,00,000
(9,50,000)

Division B of Shayanacompany contracted to buy from Div. A, 20,000 units of a

components which goes into the final product made by Div. B. The transfer price for this
internal transaction was set at Rs. 120 per unit by mutual agreement. This comprises of
(per unit) Direct and Variable labour cost of Rs. 20; Material Cost of Rs.60; Fixed
overheads of Rs.20 (lumpsum Rs.4 lacs) and Rs.20 lacs that Div. A would require for this
additional activity. During the year, actual off take of Div. B from Div. A was 19,600
units. Div. A was able to reduce material consumption by 5% but its budgeted
investment overshot by 10%.
a) As Financial controller of Div. A, compare Actual VsBudgetred Performance
b) Its implications for Management Control?
Solution:
a)
Particulars

Direct and

Budgeted
Budgeted (Total
(Rs. Per
in Rs.)
Unit) For 20,000 Units

Actual
(Rs. Per Unit)

20

20

4,00,000

Actual
(Total in Rs.)

For 19,600 Units

3,92,000

Variable Labour
Cost
Material Cost

60

12,00,000

Fixed Overheads

20

4,00,000

Total Cost

100

20,00,000

Transfer Price

120

24,00,000

Profit

20

4,00,000

4,40,000

Investment

20

20,00,000

22,00,000

ROI =

20%

57

11,17,200
4,00,000
19,09,200

119.86

23,49,200

20%

Profit/Investment
Despite of increase in investment by 10%, there is negligible difference in transfer price. Also the
sales have decreased by 400 units. Therefore we can say that additional investment has not achieved
any positive results.

Q) Division of Aparna Company manufactures Product A, which is sold to another division

as a component of its product B; which then is sold to third division to be used as part of its
Product C (sold to outside market). Intra company transactions rule: standard cost plus a
10 percent return on fixed assets and inventory, to be paid by the buying division.
Standard Cost per Unit

Product A

*Purchase of outside material

(Rs.)
Direct. Labour
(Rs.)
Variable overhead
(Rs.)
20
*Fixed overhead per unit.
(Rs.)
60
Average Inventory
(Rs.)
3 lacs
6 lacs
Net Fixed Assets
(Rs.)
9 lacs
3.2 lacs
Standard Production
(Units)
2 lacs
2 lacs

40
20
20
40
60
20
14

Product B

Product C

60
20

20
40

lacs

lacs

lacs

(a) Determine from above data, transfer prices for Products A, B and Standard Cost of
Product C.
(b) Product C could become uncompetitive since upstream margins are added. Comment.
Answer
(a):Standard Cost of Product A
Outside material (40 * 2 lac units)

80,00,000

Direct Labour (20 * 2 lac units)

40,00,000

Variable O.H. (20 * 2 lac units)

40,00,000
1,60,00,000

+ 10% on (FA + Inventory)

i.e. 10% on 20 lacs

2,00,000
1,62,00,000

Transfer Price for Product A = 1,62,00,000 = 81

2,00,000
Standard Cost of Product B
Outside material (60 * 2 lac units)

1,20,00,000

Direct Labour (20 * 2 lac units)

40,00,000

Variable O.H. (20 * 2 lac units)

40,00,000
2,00,00,000

+ 10% on (FA + Inventory)

i.e. 10% on 12 lacs

1,20,000
2,01,20,000

Transfer Price for Product A = 2,01,20,000 = 100.6

2,00,000
Standard Cost of Product C
Outside material (20 * 2 lac units)

40,00,000

Direct Labour (40 * 2 lac units)

80,00,000

Variable O.H. (40 * 2 lac units)

80,00,000

Fixed O.H. (20 * 2 lac units)

20,00,000
2,20,00,000

(b): While arriving at the cost of Product C, margins of Product A, which become an input to Product
B, and Product B, which in turn become an input to Product C, are added. So when it is sold to outside
market, it suffers a disadvantage from its competitors as far as pricing is concerned, as its price will
normally be high compared to products of similar category. So it might become uncompetitive.
But in the long run, customers will distinguish between a good product and a bad product and the one
with the best quality will survive. So if the quality of product C is better than its competitors than only
it can survive in this competitive market.
Another strategy for the company is to cut the margins added by Products A and B, and then come out
with Product C with a lower price tag on it. This may do well to the product by making higher
revenues and capturing the market share.

Q) Ananaya& Company comprises of five divisions A, B, C, D and E and

the present performance. metricis return on assets. However, the
controller has suggested management to switch over to economic value
added(EVA) as the criterion rather than return on assets. Compute and
tabulate both return on assets and EVA on the basis of following
information (Rs. lakhs) and comment on divisional performance.
Division

Profit

Fixed Assets

Current Assets
--

300

800

220

160
----

400

1600

100

600

1000

110

400

800

180

200

800

________
D
E

Controller feels corporate finance rates on current assets and.fixed assets should
be 5% and 10% respectively.
Solution:
Working Note:
Return on Assets =

Profit * 100

Total Assets

A = 300/960*100 = 31.25%
B = 220/2000*100 = 11%
C = 100/1600*100 = 6.25%
D = 110/1200*100 = 9.17%
E = 180/1000*100 = 18%
Economic Value Added (EVA) = Profit (W.A.C.C.* Capital Employed)

In this case,
EVA = Profit (W.A.C.C. on Fixed Assets * Total Fixed Assets) + (W.A.C.C. on
Current Assets * Total Current Assets)
A = 300 (0.10*800) + (0.05*160) = 212 lakhs
B = 220 (0.10*400) + (0.05*1600) = 100 lakhs
C = 100 (0.10*600) + (0.05*1000) = -10 lakhs
D = 110 (0.10*400) + (0.05*800) = 30 lakhs
E = 180 (0.10*200) + (0.05*800) = 120 lakhs

Summary
Divisio

Return on Assets (R.O.A.)

Economic Value Added

(E.V.A.) (Rs. lakhs)

31.25%

212

11.00%

100

6.25%

-10

9.17%

30

18.00%

120

Comments:
1. It appears from the above analysis that division A has performed the best
among the five divisions.

2. Also, it can be clearly noticed that divisions C and D seem to be in trouble.

3. Division A has performed the best when seen in terms of return on assets and
economic value added.
4. The reason why division A has performed the best is that it has the best
working capital management that can be reflected in the total amount invested
in current assets and which is the least among the five divisions.
5. The above reason holds true for the poor performance of divisions C and D as
can be seen that they have a huge amount invested in current assets which
does not indicate good signs about their operational efficiency.
6. A company which is into an expansion and overall growth mode primarily
invests into fixed assets and this is also one of the major reasons why the
performance of division A is the best amongst all.
7. Though division C has also invested a huge amount in fixed assets the
advantage is offset due to the fact that it perhaps has a larger investment in
current assets.
8. Division E is the second best both in terms of R.O.A. as well as E.V.A.
9. Though division E has the same amount invested in current assets as that of
division D and perhaps a lesser amount invested in fixed assets its profitability
is much better and hence it has delivered a better performance.
10.Division B is a better performer than divisions C and D in terms of R.O.A. as well
as E.V.A. but the major problem with this division is that it has a terrible
working capital management. Its current assets are the highest and this
reflects that it has huge sums of money held up either in debtors or inventory
or rather it is holding a large amount of cash which is not a good sign.

Q: 32 Pritam Engineering manufacturers (MCS-2005) Numerical

Pritam

Engineering

manufacturing

variety

of

metal

product

at

many

factories.Currently. It is experiencing crisis, Management has, therefore, decided

to detailed expense control system including responsibility budgets for overhead
expense items at each factory. From historical data, Controller developed a
standard for each overhead expense item (relating expense to volume of
activity).

Summarized

expenses

for

November,2005

given

to

concerned

Production Supervisor for comments is tabulated. All figures are in Rs. 000.
Item
Management
Supervision
Indirect labour
Idle time
Materials, Tools
Maintenance,
scrap
Allocated
expenses
Total per ton
(Rs.)

Standard at nominal
volume
720

Budgeted at actual
volume
720

actual

12706
420
3600
14840

11322
361
3096
13909

12552
711
3114
17329

21040

21040

21218

2133.04

2103.39

2413.3

582

(A) Explain with justification which of the two (1) or (2) is more meaningful for
expense control.
(B) Can the supervisor be held responsible for all overhead expenses
included? Why/why not?

Ans. (A) There is two general types of expense centers: engineered

and discretionary. This label relate to two types of cost. Engineered
costs are those for which the right or proper amount can be
estimated with reasonable reliability for example, a factorys costs for
direct labor, direct material, components, supplies, and utilities.
Discretionary costs (also called managed costs) are those for which
not such engineered estimate is feasible. In discretionary expense
centers, the costs incurred depend on managements judgment as to
the appropriate amount under the circumstances.
Engineered expense centers
Engineered expense centers are usually found a manufacturing
operations. Warehousing, distribution, trucking, and similar units

within the marketing organization may also be engineered expense

centers, as may certain responsibility centers within administrative
and

support

accounts

department

payable,

and

for

instance,

payroll

sections

accounts
in

receivable,

the

controller

department; personnel records and the cafeteria in the human

resources department; shareholder records in the corporate
secretary department; and the company motor pool. Such units
perform

repetitive

tasks

for

which

standard

costs

can

be

developed. These engineered expense centers are usually located

within departments that are discretionary expense centers.
In an engineered expense center, output multiplied by the standard
cost of each unit produced measures what the finished product
should have cost. The difference between the theoretical and the
actual cost represents the efficiency of the expense center being
measure.
We emphasize that engineered expense centers have other
important tasks not measured by cost alone; their supervisors are
responsible for the quality of the products and volume of
production as well as for efficiency. Therefore, the type and level of
production are prescribed, and specific quality standards are set.
So that manufacturing costs are not minimized at the expense of
quality. Moreover, managers of engineered expense centers may be
responsible

for

activities

such

as

training

and

employee

development that are not related to current production; their

performance reviews should include an appraisal of how well they
carry out these responsibilities.
There are few, if any, responsibility centers in which all cost items
are engineered. Even in highly automated production departments,
the use of indirect labor and various services can vary with
managements discretion. Thus the term engineered expense
center refers to responsibility centers in which engineered costs
predominate. But it does not imply that valid engineered estimates
can be made for each and every cost item.
Discretionary expense centers

Discretionary expense centers include administrative and support

units (e.g. accounting, legal, industrial relations, public relations,
human resources), research and development operations, and most
marketing activities. The output of these centers cannot be
measured in monetary terms.
The

term

discretionary

does

into

imply

that

managements

judgment as to optimum cost is capricious or haphazard. Rather it

reflects

managements

decisions

regarding

certain

policies:

whether to match or exceed the marketing efforts of competitors;

the level of services the company should provide to its customers;
and the appropriate amounts to spend for R&D, financial planning,
public relations, and a host of other activities.
One company may have a small headquarters staff, while another
company of similar size and in the same industry may have a staff
10 times as large. The senior managers of each company may each
be convinced that their respective decisions on staff size are
correct, but there is no objective way to judge which (if either) is
right; both decisions may be equally good under the circumstances,
with the differences in size reflecting other underlying deferences
in the two companies.
As far as above stated over heads are concern, we can easily
estimate proper or right amount with responsible reliability.
There for standard (1) is more meaningful for expenses control.
Ans. (B)

A responsibility center is an organization unit that is

headed by a manager who is responsible for its activities. In a

sense, a company is a collection of responsibility centers, each of
which is represented by a box on the organization chart. These
responsibility centers form a hierarchy. At the lowest level are the
centers of the sections, work shift, and other small organization
units. Departments or business units comprising several of these
smaller units are higher in the hierarchy. From the standpoint of
senior management and and the board of directors, the entire
company is a responsibility center, though the term is usually used
to refer to units within the company and there for Supervisor is
responsible for the uses of the Above stated Resources (over heads)

like Indirect labor, idle time, Materials, tools, maintenance, scrape

and Management supervision by proper supervising supervisor can
control the listed overhead expenses.

Q:2005 )A TV dealership Veena Television (VT) is organized into four profit centers.
colour TV, Black and White, spare parts(SP) and servicing (SG) each headed by
manager BTV in addition to BVTV sales; also sells old TV exchanged (under scheme)
by customer while purchasing new TV . in one particular instance a new TV was sold
for 14150(financed by cash rs2000, Bank loan 7350and Rs 4800;exchange price for old
TV agreed by CTV manager )cost of new TV was Rs 11420.Shivangi Manager of BTV,
examined the old TV (valued at Rs 3500 by TV trade magazine) and felt that she could
get Rs 5000 for that TV offer repairing cabinet, resulting and servicing for which she
would use services of SP and SG price chargeable to BTV by SP and SG are at market
rates Rs235 for parts by SP and Rs 470 for services by SG. Market price are arrived at
after marking up cost by 3.5 times SG and 1.4 times SP. BTV pays a service commission
of Rs 250 per TV sold .overhead fixed per sale are CTV Rs 835;BTV Rs 665;SP RS
32 ;SG Rs 114.
Compute the profitability of the transaction assuming sales commission of $250 for the
trade in on a selling price of $5000
Compute at market price
At cost price
Gross and net profit each
SOLUTION:
SP of New TV by CTV = $14150.
Original cost= $11420 ($14150= $2000 cash down payment + $4800
trade in allowance + $7350 bank loan)
Guide Book Value =$3500
Ms. Shivangi of BTV Dept, believed that she could sell the trade in at $5000
Other Cost: Rs235 for parts by SP and Rs 470 for services by SG
When trade-in is recorded @ $4800
4800+470+235=5505; 5000-5505= (-505)
Particulars
Sales
Selling commission

New TV
14150
0

OLD TV
5000
250

Service
470
0

Parts
235
0

Gross profit

2730

-505

470

235

Overhead

835

665

114

32

0
1895

470
-1640

0
591

0
123

Service

Parts

Servicing
Net profit before common exp
If the trade-in is recorded @ $3500

Particulars

New TV

OLD TV

Sales

14150

5000

470

235

Selling commission

250

Gross profit

2730

1045

470

235

Overhead

835

665

114

32

Servicing

470

1895

-340

356

123

Net profit before common exp

2006: sum(11)
Two divisions A and B of sonali enterprises operate Profit centers. Div A normally
purchases annually 10000 nos. of required components from Div B, which has recently
informed Div A that it will increase selling price p.u to Rs. 1100. Div A decided to
purchase the components from open market available at Rs.1000 p.uDiv B is not happy
and justified its decision to increase price due to inflation and added that the overall
company profitability will reduce and decision will lead to excess capacity in Div B,
whose V.C and Fixed cost p.u. are Rs. 950 and Rs.1100.
1. Assuming that no alternate use exists for excess capacity in Div B, will company
benefit as a whole if Div A buys from the market.
2. If the market price reduces by Rs.80 p.u. What would be the effect on the
company (assuming Div B has still excess capacity) if A buys from market.
3. If excess capacity of Div B could be use for alternative sales at yearly costs
savings of Rs. 14.5 lacs, should Div A purchase from outside?
Justify your answers with figures
ANSWER
1) Division A action
BUY OUTSIDE (Rs.)

(Rs.) BUY INSIDE

Total Purchase Cost

10,00,000

Nil

Total Outlay Cost

Nil

9,50,000

Net Cash Outflow To The

10,00,000
9,50,000
Company As A Whole
The Company as a whole will benefit if Division A buys inside from Division B.

2) If the market price reduces by Rs.80 p.u

Division A action
BUY OUTSIDE (Rs.)

(Rs.) BUY INSIDE

Total Purchase Cost

9,20,000

Nil

Total Outlay Cost

Nil

9,50,000

Net Cash Outflow

To The Company
As A Whole

9,20,000

9,50,000

The Company as a whole benefit if A buys from outside supplier at Rs. (1000-80) = 920

3) If excess capacity of Div B could be use for alternative sales at yearly costs savings of
Rs. 14.5 lakhs
Division A action
BUY OUTSIDE (Rs.)

(Rs.) BUY INSIDE

Total Purchase Cost

10,00,000

Nil

Total Outlay Cost

Nil

9,50,000

Revenue From
Using These
Facilities
Net Cash Outflow
To The Company
As A Whole

1,45,000
8,55,000

9,50,000

1 Girish Engineering Ltd. (Numerical) (MCS-2006)

(1) On the basis of costing, will the manager be interested in accepting the market offer?
Solution:
Particulars

Amount (Rs./unit)

Amount (Rs./unit)

Cost of critical component for 220

division X
Cost of other material

500

Fixed & processing costs

290

Total cost for division X

1010

Selling price of final product

1000

Net loss for division X

10

Desired profit for division X

60

Thus on the basis of full actual cost incurred by division X, it would suffer a loss of
Rs.10/unit if it accepts the market offer whereas its target profit margin is Rs.60/unit. So,
division X would not accept the market offer.

(2) Is this offer beneficial to the company as a whole? Justify with figures.
Solution:
Particulars

Amount (Rs. Lakh)

Cash inflow (a)

Amount (Rs. Lakh)

50 (5000 units * Rs.1000/unit)

Cash outlay:
Variable cost for division Y

5 (Working note)

Material bought by division X 25 (5000 units * Rs.500/unit)

from outside
Total cash outlay (b)

30

Net cash inflow to Company

as a whole [(a)- (b)]

20

Thus, the Company as an entity would receive cash inflow of Rs.20 lakh. So, the offer is
beneficial to the company as a whole.

Working notes:

Variable cost for division Y:

Desired RoI =10% of Rs.2.4 Cr. p.a. = Rs.24 lakh p.a. i.e. Rs.2 lakh per month
Fixed cost assigned to division X = Rs.4 lakh per month
Fixed cost p.u. = 400000/5000 = Rs.80
Contribution per month = Rs.6 lakh
Total sales value for division Y = 220 * 5000 = Rs.11 lakh per month
So, total Variable cost per month for division Y = 11 lakh 6 lakh = Rs.5 lakh
Variable cost p.u. for division Y = 500000/5000 = Rs.100

An annual investment of Rs2.4 Cr. is assigned by division Y to division X but it

does not imply that a special investment of Rs.2.4 Cr. is made by division Y
exclusively to produce the component required by division X. Therefore, cash
outflow associated with this investment is not relevant for the above concerned
decision regarding accept the market offer.

(3) If yes, how should the company organize its transfer pricing mechanism?
Illustrate.
Solution:
Currently, Girish Engineering Ltd. is following 2 step transfer pricing method wherein the
selling division charges actual variable cost along with profit mark-up & separately
allocates a particular amount of fixed costs per month to the buying division. However, in
the case of division X (buying division) & division Y (selling division), this method of
transfer pricing is not feasible as division X would suffer loss if it accepts the market
offer under this scenario. So, divisions X & Y can negotiate a transfer price by taking into
account full actual variable cost (Rs.100 p.u.) & half of fixed costs incurred by division Y
that is assigned to division X (Rs.40 p.u.) & add a mark-up of say Rs.10/unit. Taking into
consideration only half of the fixed costs of selling division i.e. division Y prevents
shifting of any operational inefficiencies from selling division to buying division i.e.
division X, which would unnecessarily increase the costs for division X and thereby eat
up its profit margin. In this case, division Xs total costs would turn out to Rs.940 (500 +
290 + 150) & would earn a profit margin of Rs.60 p.u. (desired profit margin). Also,
contribution p.u. for division Y would be Rs.50 (150 100). Thus, total contribution for
division Y would be Rs.250000 resulting in RoI of 12.5% (250000/2000000) which is
more than the desired RoI of 10%.