Cost & Management Accounting Lecturer-44

Deprival Value Deprival Value Replacement Cost Recoverable Amount Whichever is less Realizable Value Whichever is higher Value in Use

Deprival Value It represents the value that an entity would have to recover if it were deprived of an asset.

Example A machine cist Rs. 70,000five years ago. It is expected that the machine will generate future revenue of 50,000. Alternatively, the machine could be scrapped for Ts. 45,000. An equivalent machine in the same condition cost 48,000 to buy now. What is the deprival value of the machine. 48,000 48,000 50,000 Whichever is lower 50,000 45,000 Whichever is higher

Example A company has been making a machine to order for a customer. Cost incurred to date in manufacturing the machine are Rs 80,000 and progress payments of Rs. 30,000 had been received from prior to the liquidation. The sales department has found another company willing to buy the machine Rs. 40,000 once it has been completed. To complete the work , the following cost would be incurred: a). Material has been bought at a cost of Rs. 10,000. They have co other use, and if the machine is not finished, they would be sold for scrap Rs. 6,000. b). Further labor costs would be Rs 12,000. Labor is in a short supply and if the machine is not finished, the work force would be switched to another job, which would earn Rs. 30,000in revenue an din cur direct cost of Rs. 20,000 and absorbed overhead Rs. 8,000. c). Consultancy fee Rs. 14,000 if the work is not completed, the consultant’s contract would be cancelled at a cost Rs. 6,000. d). Allocation of general overhead cost Rs. 10,000 would be added to the cost of additional work. `

Solution Relevant cost may be summarized as follows: Revenue from completing work 40,000 Less Relevant cost: Material: Opportunity cost 6,000 Labor: Basic pay 12,000 Opportunity cost 10,000 Incremental cost of consultancy 8,000 (36,000) (4,000) 32,000

Approaches of decision-making: Contribution margin approach Differential cost approach

Scenarios under contribution margin approach: Product mix Product addition Deletion of product Drop out of department Make or buy decision Shut down decision

Scenarios under differential cost approach: Increase the production in respect of demand Shut down decision Make or buy decision Assets replacement

Question F S co. makes two products, the F & S. Per unit. Variable cost are as follow: Variable cost: F (Rs) S (Rs) Direct material 1 3 Direct labor 6 3 Variable cost 1 1 8 7 The sales price per unit id Rs. 14 per for F and Rs 11 for S. During July the available direct labor id limited to 8,000 hours. Sales demand in July is expected to be 3,000 units for F and 5,000 units for S Required: Monthly fixed costs are Rs 20,000.and opening stocks of finished goods and work in progress are nil. Determine profit maximizing production mix.

Solution Step-1 Confirm that the limiting factor is something other than sales demand: F S Total Labor hours per unit 2 hrs 1 hr --- Sales demand 3,000 units 5000 units --- Labor hours needed 6,000 hrs 5,000 hrs 11,000 hrs Labor hours available 8,000 hrs Short fall 3,000 hrs Labor is limiting factor in production. Step-2 Identify the contribution earned by each product per unit F (Rs) S (Rs) Sales price 14 11 Variable cost 8 7 Unit contribution 6 4 Labor hours per unit 2 hrs 1 hrs Contribution per labor hour 3 4

Solution Product Demand Hours required Hours available F 5,000 S 3,000 Step-3 Determine the optimum production plan: a). Product Demand Hours required Hours available F 5,000 S 3,000 6,000 Total ----- 11,000 8,000 b). Product Units Hours needed Contribution per unit F 5,000 S 3,000 6,000 Total ----- 11,000 8,000 Total 20,000 9,000 29,000 Less Fixed cost 20,000 9,000

Question: You are the sales director of Edith Manufacturing Company. The results of last year’s trading were submitted to you by the accountant and show: Sales Rs.200,000 Less: Marginal cost of sales 100,000 Contribution 100,000 Less: Fixed costs 75,000 Net Profit Rs. 25,000 You have conducted a study of the profit potential of two new products; the manufacture of one can be undertaken without incurring additional fixed costs. Solution: Product Pat Pad Selling price per unit Rs.40 Rs.50 Variable cost of manufacturing Rs.10 Rs.10 Other variable costs Rs.20 Rs.10 Available capacity can produce 20,000 units 6,000 units Projected Income Statement for next year Sales: 20,000 x Rs.40 Rs.800,000 6,000 x Rs.50 Rs.300,000 Less: Marginal cost: 20,000 x Rs.30 600,000 6,000 x Rs.20 120,000 (Fund) net contribution Rs.200,000 Rs.180,000

Question: Assume that the RA & RB Manufacturing Company produces and sells three products: The income statement at the end of Period 7 appears below: Management is considering dropping product F because it believes that it has reduced profits by Rs. 3,000. Management believes that by an intensive sales campaign of Rs. 50,000 per annum it could drop product F and sell 2,000 additional units of product S. The Company would save the separable fixed costs if product F is dropped. Would you advise the company to do this? F S N Total Sales (units) 1,000 2,400 3,200 - Sales value per unit Rs. 80 Rs. 48 Rs. 40 Variable cost per unit Rs. 24 Rs. 16 Contribution margin per unit Contribution fund 32 Rs.32,000 24 Rs.57,600 Rs.76,800 Rs.166,400 Fixed costs Separable Rs.25,000 Rs.10,000 Rs.20,000 Rs. 55,000 Joint (Allocated on value basis) Rs.24,000 Rs. 66,000 Net Profit Rs.(3,000) Rs.23,600 Rs.24,800 Rs. 45,400

F S N Total Sales (units) - 4,400 3,200 Contribution per unit Rs. 24 Total Contribution Rs. 105,600 Rs.76,800 Rs.182,400 Separable fixed costs 10,000 20,000 30,000 Advertising 50,000 Joint fixed costs 24,000 32,000 56,000 Allocated fixed costs apportioned to F Rs.(10,000) Rs. 21,600 Rs.24,800 Rs. 36,400 It is better to leave things as they are. The adoption of the proposal would lead to a drop in profits of Rs. 45,400 – Rs. 36,400 = Rs. 9,000.