ADVANCE MANAGEMENT ACCOUNTING TEST -3

SUGGESTED ANSWERS / HINTS

A-1

Div A B B

Rs. / unit Rs. / unit Rs. / unit

Direct Material (Other than A) 50 24

Direct Labour 25 14

Variable Overhead (Production) 20 2

Variable Production Cost (excl. A) 95 40 40

From A 144

From Outside ____ 160

Variable production Cost / unit 184 200

Selling Price

From outside 160 300

Less: Selling Overhead 13 26

Net Selling Price (outside) 147 274

Net Selling Price to B 144

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 Net Selling Price to S 250

Net Selling Price (outside) 147 274 274

Variable Production Cost - 95 - 184 - 200

Contribution / unit (outside) 52 90 74

(Sale to B & S respectively) 144 250 250

Variable Production Cost - 95 - 184 - 200

Contribution / unit 49 66 50

(4 Marks)

Best strategy for A:

A = Maximise Production; Sell maximum no. of units @ 52 / unit (outside)

= 18,000 x 52 = 9,36,000

(To B) remaining units = 2,000 x 49 = 98,000

Total Contribution for A = 10,34,000

Best strategy for B:

Maximise contribution / unit by selling outside and procuring from A 90 / unit Contribution x
2,000 units

Balance units can yield contribution of either 74/ unit for outside or Rs. 50 / unit to S Ltd.
Production Capacity = 28,000.

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 Option I Option II

Outside Sales Sales to S Outside Sales x contribution / Unit

20,000 x 74 = 14,80,000 6,000 x 50 = 3,00,000 24,000 x 74 = 17,76,000

2,000 x 90 = 1,80,000 2,000 x 90 = 1,80,000

16,60,000 3,00,000

Total Contribution (16,60,000 + 3,00,000) 19,60,000 19,56,000

(B) Choose Option I i.e. get 2,000 units from A, sell 6,000 units to S and 20,000 to outside.
Make 28,000 units @ full capacity. Total Contribution Rs. 19,60,000.

If A and B are allowed to act independent of the group synergy,

Total contribution A – 10,34,000

B – 19,60,000
Total contribution for X Ltd. 29,94,000

Cost from X Ltd.’s Perspective

Variable Cost of production Div A Rs. 95

Div B

Variable cost of production other than A 40 40

A supplied by Division A – 95
Variable Cost

A purchased 160

135 200

Option I Outside 26,000 units Option II

Outside 20,000 x (274 – 135) 27,80,000 20,000 (274 – 135) 27,80,000

2,000 x (274 – 200) 1,48,000 6,000 (274 – 200) 4,44,000

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 22,000

S Ltd. 6,000 units (250 – 200) 3,00,000

32,28,000 32,24,000

Choose Option I

Contribution = Rs. 32,28,000 for X Ltd. as a whole

Transfer (2,000 units)

Make A transfer all output to B. Sell 6,000 units of B to S and 22,000 units to outside market.
This will make X Ltd. better off by 32,28,000 – 29,94,000 = Rs. 2,34,000 (i.e. 18,000 units of A
sold to outside increases contribution to A by 3 Rs. / unit and decreases contribution to B by 16
Rs. / unit Net negative effect = 13 x 18,000 = Rs. 2,34,000).

(4 Marks)

A-2

Contribution Analysis of Divisions:

(i) Contribution – Division PQR

Selling Price (Rs.) 200 300 400

Variable Cost (Rs.)

110 110 110

Contribution per Unit (Rs.) 90 190 290

Demand (units)
30,000 20,000 10,000

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 Total Contribution(Rs.) 27,00,000 38,00,000* 29,00,000

*Optimal

The above table shows Rs. 300 price to be the most profitable and that cutting prices would
not result in increased profits.

(2 Marks)

(ii) Contribution – Division RPQ (transfer price at Rs. 290)

Selling Price (Rs.) 800 900 1,000

Variable Cost (Rs.) 680 680 680

Contribution per Unit (Rs.) 120 220 320

Demand (units)
14,400 10,000 5,600

Total Contribution(Rs.) 17,28,000 22,00,000* 17,92,000

*Optimal

(2 Marks)

(iii) Contribution – Division RPQ (at alternative transfer price Rs. 120)

Selling Price (Rs.) 800 900 1,000

Variable Cost (Rs.)

510 510 510

Contribution per Unit (Rs.) 290 390 490

Demand (units)
14,400 10,000 5,600

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 Total Contribution(Rs.) 41,76,000* 39,00,000 27,44,000

*Optimal

(2 Marks)

The maximum capacity of the PQR division is given as 30,000 units. Hence there is no
question of internal transfer if the entire 30,000 units are sold by PQR in the external
market. However, from the above computations it is clear that Division PQR would sell
20,000 units in external market to optimize its profit and therefore the maximum transfer
to division RPQ is 10,000 units only. The question of transferring 14,400 units would arise as
an alternative to analyze the overall profitability only when PQR sells 10,000 units in the
external market. Based on the demand projection of RPQ, the demand level of 5,600 units
is not relevant. It can be further noted from the question that Division RPQ will purchase
the entire quantity only from Division PQR and not externally. Hence the various options
would be as follows.

Option-1 Option-2 Option-3

PQR External Sales (units) 20,000 10,000 10,000

Transfer to RPQ (units) 10,000 14,400 10,000

Overall Profitability of the Company:

(iv) Transfer Price at Rs. 290

PQR External Sales (units) 20,000 10,000 10,000

Transfer to RPQ (units) 10,000 14,400 10,000

Rs. Rs. Rs.

Contribution PQR (External) 38,00,000 29,00,000 29,00,000
[Refer computation (i) above]

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Contribution PQR (Transfer) @ Rs. 19,00,000 27,36,000 19,00,000
190 [Rs. 290 less Rs. 100 Variable

cost#]

Contribution RPQ 22,00,000 17,28,000 22,00,000

[Refer computation (ii) above]

Total Contribution for the Company 79,00,000* 73,64,000 70,00,000

Fixed Costs 24,00,000 24,00,000 24,00,000

[PQR 30,000 units x Rs.40 + RPQ 10,000 units x
Rs.120]

Total Company Profit (Contribution-Fixed 55,00,000 49,64,000 46,00,000

costs)

*Optimal

(2 Marks)

(v) Transfer Price at Rs. 120

PQR External Sales (units) 20,000 10,000 10,000

Transfer to RPQ (units) 10,000 14,400 10,000

Rs. Rs. Rs.

Contribution PQR (External) 8,00,000 29,00,000 29,00,000
[Refer computation (i) above]
Contribution PQR (Transfer) @ Rs. 2,00,000 2,88,000 2,00,000
20 [Rs. 120 less Rs. 100 Variable

cost#]

Contribution RPQ 39,00,000 41,76,000 39,00,000

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[Refer computation (iii) above]

Total Contribution for the Company 79,00,000* 73,64,000 70,00,000

Fixed Costs 24,00,000 24,00,000 24,00,000

[PQR 30,000 units x Rs.40 + RPQ 10,000 units x

Rs.120]

Total Company Profit (Contribution-Fixed 55,00,000 49,64,000 46,00,000

costs)

*Optimal

The revision of transfer price has no impact on the overall profitability of the company.
However, it will alter the profitability of the Divisions.

*The optimal level is 30,000 of PQR of which 20,000 units are for external sale and 10,000
units are transferred to RPQ under both the transfer prices.

#On internal transfers, PQR’s variable cost per unit is Rs. 100, since the Rs. 10 on selling is not

incurred.

(2 Marks)

A-3

(A) Advantages of Inter-firm comparison: The main advantages of inter-firm comparison are:

 Such a comparison gives an overall view of the industry as a whole to its members– the
present position of the industry, progress made during the past and the future of the
industry.
 It helps a concern in knowing its strengths or weaknesses in relation to others so that
remedial measures may be taken.

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 It ensures an unbiased specialized reporting on particular problems of the concern.
 It develops cost consciousness among members of the industry.
 It helps Government in effecting price regulation.
 It helps to improve the quality of products manufactured and to reduce the cost of
production. It is thus advantageous to the industry as well as to the society.
(3 Marks)

(B) Limitations of Uniform Costing

 Sometimes it is not possible to adopt uniform standards, methods and procedures of

costing in different firms due to differing circumstances in which they operate. Hence,
the adoption of uniform costing becomes difficult in such firms.
 Disclosure of cost information and other data is an essential requirement of a uniform
costing system. Many firms do not wish to share such information with their competitors
in the same industry.
 Small firms in an industry believe that uniform costing system is only meant for big and
medium size firms, because they cannot afford it.
 It induces monopolistic trend in the business, due to which prices may be increased
artificially and supplies withheld.
(3 Marks)

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A-4

The problem may be treated as an assignment problem. The solution will be the same even if
prices are halved. Only at the last stage, calculate the minimum cost and divide it by 2 to
account for fall in oil prices.

A B C

X 15 9 6

Y 21 12 6

Z 6 18 9

Subtracting Row minimum, we get

A B C

X 9 3 0

Y 15 6 0

Z 0 12 3

A B C

Subtracting Column minimum,

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No of lines required to cut Zeros = 3

Cost / u Units Cost Revised Cost

Allocation: X B 9 10 90 45

Y C 6 10 60 30

Z A 6 10 60 30

210 105

Minimum cost =105 Rs. (8 marks)

Alternative Solution I

Least Cost Method

X– B

Y–C

Z–A

Test for optimality No. of allocation = 3

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No. of rows m =3, no. of column = 3
m+n–1=3+3–1=5
2 very small allocation are done to 2 cells of minimum costs, so that, the following table is got:

A B C
X 15 9 6
10 e

Y 21 12 6
10

Z 6 18 9
10 e

m+n-1=5

Now testing for optimality

ui + vj for unoccupied cells

A B C

X 6 - -

Y 6 9 -

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 Z - 9 -

Diff = Cij – (ui + vj)

A B C

X 9 - -

Y 15 3 -

Z - 9 -

All Δij > 0, Hence this is the optimal solution.

Original Costs Reduced Costs due to Qty. Cost

Oil Price

X–B 9 4.5 10 45

Y–C 6 3 10 30

Z–A 6 3 10 30

105

Total cost of transportation is minimum at Rs.105

Alternative solution II

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 A B C

X 7.5 4.5 3
10 e

Y 11.5 6 3
10

Z 3 9 4.5
10 e

No. of rows + no. of column – 1 m + n –

1=5
No. of allocation = 3

Hence add ‘e’ to 2 least cost cells so that

A B C

X 7.5 4.5 3
10 e

Y 11.5 6 3
10

Z 3 9 4.5
10 e

Now m + n – 1 = 5

Testing for optimality,

ui, vj table

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ui + vj for unoccupied cells

3 - -

3 4.5 -

- 4.5 -

Cij

7.5 - -

11.5 6 -

- 9 -

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ui+vj

3 - - -

3 4.5 - -

- 4.5 - -

Δij = Cij – (ui + vj)

4.5 - - -

11.5 1.5 - -

8.5 4.5 - -

All Δij > 0. Hence the solution is optimal

Qty. Cost/u Total Cost

X–B 10 4.5 45

Y–C 10 3 30

Z–A 10 3 30

Total minimum cost at revised oil prices 105

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A-5

(i) Is this solution feasible?

A necessary and sufficient condition for the existence of a feasible solution to the
transportation problem is that

Where

ai = quantity of product available at origin i.

bj = quantity of product available at origin j.

In other words, the total capacity (or supply) must equal total requirement (or demand)

As the supply 55 units (10+25+20) equals demand 55 units (25+10+15+5), a feasible solution to
the problem exists.

(2 Marks)

(ii) Is this solution degenerate?

When the number of positive allocations at any stage of the feasible solution is less than the
required number (rows + columns -1), the solution is said to be degenerate solution.

In given solution total allocated cells are 6 which are equal to 4+3-1 (rows + columns -1).
Therefore, the initial basic solution is not a degenerate solution.

(2 Marks)

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(iii) Is this solution optimum?

Test of Optimality:

(ui +vj) matrix for allocated cells ui

4 -1

6 2 2

4 2 5 0

4 2 5 0

(ui +vj) matrix for unallocated cells

3 1 -1 -1

4 7 2

0 0

2 5 0

(2 Marks)

∆ij= Cij— (ui +vj) matrix

2 9 6

4 0

Since, all cells values in ∆ij= Cij— (ui +vj) matrix are non- negative, hence the solution provided
by XYZ Company is optimum.

It may be noted that zero opportunity cost in cell (B, III) indicates a case of alternative optimum
solution.

(2 Marks)

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