Sums- MCS

Q4: Kiran Company (MCS-2004) Numerical

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

Budget Actual Actual better

(worse) than budget

Sales and other income 800 740 (60)

Variable expenses 480 436 44

Fixed expenses 120 120 0

Sales promotional expenses 40 28 12

Operating profit 160 156 4

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,
company’s 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.
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 Div B Div C Total

Budgete Actua Budgete Actual Budgete Actua Budgete Actual

d l d d l d

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 Div B Div C Total

Budgete Actua Budgete Actual Budgeted Act Budgete Actual

d l d ual d

ROA 18% 16% 9% 9% 6% 6% 10% 9%

EVA 208 170.4 44 50.4 -32 -60 220 160.8

b) Comment upon both methods, based on results.

There are three apparent benefits of an ROA measure. First, it is a comprehensive measure in
that anything that effects the financial statements is reflected in this ratio. Secondly, ROA is
easy to calculate, easy to understand, and meaningful in absolute sense. Finally, it is a common
denominator that may be applied to any organizational units responsible for profitability, no
matter what its size or what business it practices. The performance of different units may be
compared directly to each other. Also, ROI data is available for competitors that can be used as
a basis for comparison. Nevertheless, the EVA approach has some inherent advantages over
ROA.

There are three compelling reasons to use EVA over ROI. First, with EVA all business units have
the same profit objective for comparable investments. The ROI approach, on the other hand,
provides different incentives for investment across business units. For example, a business unit
that is currently achieving 30% ROA would be most reluctant to expand unless it is able to earn
a ROI of 30% or more on additional assets. Second, decision that increase a centre’s ROI may
decrease its overall profits. Third advantage of EVA is that different interest rates may be used
for different types of assets. For example, a relatively low rate May be used for inventories
while a higher rate may be used for different types of fixed assets.
 (Numerical) MCS – 2004

Division B of Shayana company 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 Vs Budgetred Performance
b) Its implications for Management Control?

Solution:
a)
Particulars Budgeted (Rs. Budgeted (Total Actual Actual
Per Unit) in Rs.) (Rs. Per Unit) (Total in Rs.)

For 20,000 Units For 19,600 Units

Direct and Variable 20 4,00,000 20 3,92,000
Labour Cost
Material Cost 60 12,00,000 57 11,17,200
Fixed Overheads 20 4,00,000 4,00,000
Total Cost 100 20,00,000 19,09,200
Transfer Price 120 24,00,000 119.86 23,49,200
Profit 20 4,00,000 4,40,000
Investment 20 20,00,000 22,00,000
ROI = 20% 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.
 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.
a) Assuming that no alternate use exists for excess capacity in Div. B, will company as a whole benefit if di v
A buys from the market.
b) 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
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?

Justify your answers with figures.

Solution
a) 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
b) 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

c) Option C ( if excess capacity of Div B could be used for alternative sales at yearly cost savings of Rs 1 4.5
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 Option A Option B Option C

Amount Amount Amount
Total Purchase Cost 1,00,00,000
(Rs.) 92,00,000
(Rs.) 1,00,00,000
(Rs.)
Total outlay if transferred inside 95,00,000 95,00,000 95,00,000
Total opportunity cost if transferred inside - - 14,50,000
Total relevant cost 95,00,000 92,00,000 1,00,00,000
Net advantage/disadvantage to company as a whole if it buys 5,00,000 (3,00,000) (9,50,000)
from inside
Question 20.

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 Product B Product C

*Purchase of outside material (Rs.) 40 60 20

Direct. Labour (Rs.) 20 20 40
Variable overhead (Rs.) 20 20 40
*Fixed overhead per unit. (Rs.) 60 60 20
Average Inventory (Rs.) 14 lacs 3 lacs 6 lacs
Net Fixed Assets (Rs.) 6 lacs 9 lacs 3.2 lacs
Standard Production (Units) 2 lacs 2 lacs 2 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.
Exhibit 1

Exhibit 2

1. NUMERICAL – ANANYA Ltd. (2004)

We know that formula for Return on Investment is:

ROI = NET PROFIT

INVESTMENT

Now, Investment = Fixed assets + Net working Capital

(We assume Current Assets as the Net Working Capital as there are no Current Liabilities given in the
question)

Therefore, Investment for:

M = 0 + 200 = 200

P = 200 + 1000 = 1200

C = 200 + 500 = 700

Now, Net Profit for M, P and C:

Particulars M P C

Profit before Depreciation & Operating 400 400 400

Expenses

Less- Depreciation (NIL) (100) (50)

Less- Operating Expenses (200) (100) (150)

TOTAL 200 200 200

Therefore,
ROI for:

M = 200 = 100 %

200

P = 200 = 16.67 %

1200

C = 200 = 28.57 %

700

Since there are no fixed assets in marketing division, the ROI is higher, but the operating expenses are
much higher for these division.

Hence, any further increase in op exp is likely to drag the ROI down

Since the asset is depreciated for10 years as per SLM method, the depreciation rate is 10 %.

So going ahead if the operating expenses for div P & C remains at the same level, reduction in the value
of an asset due to depreciation is likely to have a positive impact on ROI.

Even the rate of increase in ROI for Div P would be higher since the asset of a higher

value is depreciated than the Div C.

Ananaya & Company comprises of five divisions A, B, C, D and E and the present performance. metric
is 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

--

A 300 800 160

- - ----

B 220 400 1600

C 100 600 1000

________

D 110 400 800

E 180 200 800

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

Division Return on Assets (R.O.A.) Economic Value Added (E.V.A.) (Rs.

lakhs)

A 31.25% 212

B 11.00% 100

C 6.25% -10

D 9.17% 30
 E 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 Standard at nominal volume Budgeted at actual actual

volume

Management 720 720 582

Supervision

Indirect labour 12706 11322 12552

Idle time 420 361 711

Materials, Tools 3600 3096 3114

Maintenance, scrap 14840 13909 17329

Allocated expenses 21040 21040 21218

Total per ton (Rs.) 2133.04 2103.39 2413.3

(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 factory’s 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 department for instance, accounts receivable, accounts payable, and payroll sections in
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 management’s 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 management’s 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 deference’s 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 New TV OLD TV Service Parts

Sales 14150 5000 470 235
Selling
commission 0 250 0 0
Gross profit 2730 -505 470 235
Overhead 835 665 114 32
Servicing 0 470 0 0
Net profit
before
common exp 1895 -1640 591 123
If the trade-in is recorded @ $3500

Particulars New TV OLD TV Service Parts

Sales 14150 5000 470 235
Selling
commission 0 250 0 0
 Gross profit 2730 1045 470 235
Overhead 835 665 114 32
Servicing 0 470 0 0
Net profit before
common exp 1895 -340 356 123
Q 46.Sum 10)

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.

Q47) 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.u Div 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 10,00,000 9,50,000

To The 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 9,20,000 9,50,000

To The Company
As A Whole

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 1,45,000

Using These
Facilities
Net Cash Outflow 8,55,000 9,50,000
To The Company
As A Whole

Yes, without cloud of doubt Company should purchase from outside.

 Q.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) Amount (Rs. Lakh)

Cash inflow (a) 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 20

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

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 X’s 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%.
 Q.2 Suresh Ltd. (Numerical) (MCS-2007)

(a) Define profit in this case and prepare a statement for both divisions and overall company.

Solution:

i) Profitability statement of Division A:-

Particulars Amount(Rs.)
Selling price p.u. 35
Variable Cost p.u. 11
Contribution p.u. 24

Contribution p.u. Expected sales Total Total Fixed cost Net profit (Rs.)
(no. of units) contribution (Rs.)
24 2000 48000 60000 (12000)
24 3000 72000 60000 12000
24 6000 144000 60000 84000

ii) Profitability statement of Division B:-

Selling p.u. Total Contribution Expected Total Total Fixed Net profit
variable p.u. sales (no. contribution cost (Rs.) (Rs.)
cost p.u. of units)
90 42 48 2000 96000 90000 6000
80 42 38 3000 114000 90000 24000
50 42 8 6000 48000 90000 (42000)
[Note: Total Variable cost p.u. = Variable cost p.u. (Rs.7) + Transfer price of intermediate
product (Rs.35)]

iii) Profitability statement of Company as a whole:-

Expected sales Net profit of division Net profit of Division Total Net profit
A (Rs.) B (Rs.)
2000 (12000) 6000 (6000)
3000 12000 24000 36000
6000 84000 (42000) 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 Company’s profit, it
would suffer a loss of Rs.42000. Therefore, Division B would not select Selling price p.u. of
Rs.50.