What is Relevant Cost?

Relevant costs are those that differ across

decision alternatives. Cost that remain the same
across decisions are not considered relevant.
Relevant costs are used for forward looking, or
future decisions.
Why should decision makers focus
only on the relevant costs for
decision making?
In evaluating the different alternatives from
which managers can choose, it is better to
focus only on the relevant costs that differ
across different alternatives because it does
not divert the manager’s attention with
irrelevant facts. If some costs remain the same
regardless of what alternative is chosen, then
those costs are not useful for the manager’s
decisions, as they are not affected by the
decision. Therefore, it is better to omit them
from the cost analysis used to support the
decision.
Are Sunk Cost Relevant?
• No, sunk costs are not relevant costs. Sunk
costs are the costs of resources that have
already been committed and, regardless of
what decision is made by the managers, these
costs cannot be avoided. Therefore, they are
irrelevant for the decision.
Are Direct Material and Direct labor
cost always relevant?
• Both direct labor (DL) and material (DM) costs can be
either relevant or irrelevant depending on the
decision context and the alternatives that are
available to the managers. When considering the
purchase of automated equipment that will decrease
the defect rate, both DL and DM are, in general,
relevant costs because these costs are likely to
decrease if the new machine is purchased. However,
DM can be a sunk cost in the short-run if the
materials usable only with the old machine have
been already purchased or purchase commitments
have been made. Similarly, if labor has been
contracted for a specified period and the company
cannot eliminate the extra labor when the
automated equipment is purchased, then the DL cost
also will be irrelevant in the short-run.
Are fixed costs always irrelevant?
 No, fixed cost are not always irrelevant. For example,
in comparing the status quo and a proposal to
substantially increase the quantity of goods or
services provided, additional fixed costs (that is,
costs not proportional to volume) may be incurred to
provide the increased quantity.
Give two examples of costs and decision
contexts in which the costs are not
relevant for a short term context but are
relevant for a long term context
• Two examples of costs that are not relevant in
the short-run, but are relevant in the long-run:

1. Costs of production engineering, if the

number of engineers cannot be changed in
the short-run.
2. Facility rental costs, if the lease commits
the firm for the short-run. These costs can be
avoided in the long-run.
 (a) Relevant costs:

• Acquisition cost of Ford Escort

• Repairs on the Impala
• Annual operating costs on the Ford Escort
• Annual operating costs on the Impala

Irrelevant costs:
• Acquisition cost of Impala
Don will buy the Ford Escort if he bases the decision only on the available cost information.

Year 1: (If Don buys the Ford Escort)

Cash savings:

Repairs on the Impala $5,400

Operating cost—Impala 2,900

8,300

Cash expenditures:

Acquisition cost—Ford Escort 5,400

Operating cost—Ford Escort 1,800

7,200

First Year Savings

$1,100
Additional quantitative considerations:
1. Number of years before car is replaced
2. Expected resale values of both cars when they
will be replaced.
3. Cost of capital (interest rate) to consider the
time value of money.

Qualitative consideration:
1. Subjective preference for driving an Impala
rather than a Ford Escort.
5.31
a) The original cost of $50,000, accumulated
depreciation of $40,000, and annual
operating costs (before overhaul) of $18,000
are all irrelevant when the choice is between
overhauling the old machine and replacing it
with a new machine.

Note that the $18,000 operating costs are not sunk

costs, yet they are irrelevant.
b) Relevant costs include the acquisition cost of
the new machine, the cost of overhauling the
old machine, current salvage of $4,000 for the
old machine and the annual operating costs
for both the new machine and the overhauled
old machine.
 Replacement Overhauling Difference

Net $66,000a $25,000 $41,000

acquisition
cost

Operating
costs for 65,000b 70,000c (5,000)
5 years

Total relevant $131,000 $95,000 $36,000

costs
$70,000 – $4,000 = $66,000
$13,000  5 = $65,000
$14,000  5 = $70,000
 Make Buy

Cost of purchase: $120  20,000 = $2,400,000

Direct material cost: $55  20,000 = $1,100,000

Direct labor cost: $30  20,000 = 600,000 —

Variable support: $25  20,000 = 500,000 —

Savings in facility-sustaining costs — (113,000)

Relevant costs $2,200,000 $2,287,000

 Management Accounting
• It refers to a system of collection and
presentation of relevant information, financial as
well as other, relating to an enterprise for helping
managers in planning, controlling and decision
making.
• Management accounting may be defined as the
process of identification, measurement,
accumulation, interpretation and communication
of information that assists managers in specific
decision- making with in the framework of
fulfilling the organizational objectives.
 Comparison between Financial and
Management Accounting
• Internal and External uses
• Emphasis on the future
• Generally accepted accounting standards
• Relevance and Flexibility of information
• Emphasis on precision
• Organizational focus
• Freedom of choice
• Use of other disciplines
 Cost Concepts
• Cost Unit – A unit of quantity of product ,
service or time , in relation to which cost may
be ascertained or expressed
• Examples

Industry Cost Unit

Building House or Square Foot area
Cement Tonne
Cables Meter
Power Kilowatt Hour
Automobiles Number
 Cost Centre
• For the purpose of ascertaining costs, the
whole organization is divided into small parts
or sections. Each small section is treated as
cost centre of which cost is ascertained.

• Technically cost centre is defined as ‘ a

location, person or item of equipment for
which costs may be ascertained and used for
the purpose of cost control’
 Mini Case
• Bakoya is a Japanese company that makes
packages which hold the silicon chip in electronic
computers. The packages or containers are made
from alumina powder
• The powder is first made into sheets and wiring
patterns are then screen printed on the sheets. The
sheets are next converted into interconnected
stacks and the stacks are baked in ovens. The final
step is quality control.
• Identify the main cost centers of Bakoya Factory
Following are the various cost centres of bakoya
factory

 Sheet making department

 Screen Printing Department
 Stack making department
 Baking department
 Quality Control department
 Classification of the cost
• Basic Classification:
 Direct Material
 Direct Labor
 Overheads
• Factory overheads
• Office overheads
• Selling and distribution overheads
On the basis of Cost Behavior

 Fixed Cost
 Variable Cost
 Semi Variable cost
Fixed Cost – Fixed costs are those which remain
fixed in total with increase or decrease in the
volume of output or activity for a given period of
time or for a given range of output.

Fixed cost per unit vary inversely with the volume

of production
Variable Cost - Variable costs are those costs
that vary directly and proportionately with the
output. There is a constant ratio between the
change in the cost and the change in the level
of output.

However it should be noted that it is only the

total variable costs that change as more units
are produced; the per unit variable cost
remains constant.
• Semi Variable – These costs are made up of
fixed and variable elements.
Because of the variable component, they
fluctuate with volume; because of the fixed
component, they do not change in direct
proportion to output.
XYZ has an annual production of 90,000 units for a component. The
component cost structure is as follows:
Particulars
Material 270 per unit
Labor (25% fixed) 180 per unit
Variable expenses 90 per unit
Fixed Expenses 135 per unit

i) The purchase manager has an offer from a supplier, who is willing to

supply the component at Rs. 540. Should the component be
purchased?
ii) Assume that the resources now used for this component
manufacture are to be used to produce another new product for
which the selling price is Rs. 485. In this case the material price will
be Rs. 200 per unit. 90,000 units of this product can be manufactured
at the same cost basis as above for labor and other expenses. Discuss
if it would be advisable
Variable cost of making the component
Material 270
Labor (180 x 75%) 135
Variable Expenses 90
Total 495

If the component is purchased the loss is 540 – 495 = 45

b) If a new product is produced

Material 200
Labor 135
Variable Expenses 90
Total 425
Cont. per unit 485 – 425 = 60
Loss : If present component is purchased 45
Gain: If new product is produced 60
Net Gain 15
Exploring new Markets

Q1 A company manufactures 10,000 units annually of a product at a cost

of Rs. 4 per unit and there is home market for consuming the entire
volume of production at the sale price of Rs. 4.25 per unit. It is
anticipated that in the year 2011, there would be a fall in the demand
for home market which can consume 10,000 units only at a sale price
of Rs. 3.72 per unit. The analysis of the cost per 10,000 units is:
Material Rs. 15,000 Fixed Overhead Rs. 8,000
Wages Rs. 11,000 Variable overhead Rs. 6,000at
The foreign market is explored and it is found that this market can
consume 20,000 units of the product if offered at a sale price of Rs.
3.55 per unit. It is also discovered that for every additional 10,000
units of the product (over initial 10,000 units) the fixed overheads
will increase by 10%. Is it worthwhile to try to capture the foreign
market.
 Year 2010 Home Market 10,000 units
Sales 42,500
Materials 15,000
Wages 11,000
Overheads:
Fixed 8,000
Variable 6,000
Profit 2,500
 Home Market (10,000 Foreign Market (20,000
units) units)
Sales 37,200 71,000
Material 15,000 30,000
Wages 11,000 22,000
Overheads:
Fixed 8,000 1,600
Variable 6,000 12,000
Profit (2,800) 5,400
Q 2 A company currently is operating at 80% capacity has the following
particulars:
Sales 32,00,000
Direct Materials 10,00,000
Direct Labor 4,00,000
Variable overheads 2,00,000
Fixed overheads 13,00,000

An export order has been received that would utilize half the capacity of
the factory. The order cannot be split i.e it has to be taken in full and
executed at 10% below the normal domestic prices, or rejected
totally. The alternatives available to the management are
i) Reject the order and continue with the domestic sales only or
ii) Accept the order, split capacity between overseas and domestic sales
and turn away excess domestic demand.
Suggest the best alternative.
Particulars 80% Capacity (Only 100% Capacity
Domestic) (Domestic + Foreign)
Domestic Sales 32,00,000 20,00,000
Export Sales 18,00,000
Total Sales 32,00,000 38,00,000
Material Cost 10,00,000 12,50,000
Labor Cost 4,00,000 5,00,000
Variable Overhead 2,00,000 2.50,000
Contribution 16,00,000 18,00,000
Fixed Overheads 13,00,000 13,00,000
Profit 3,00,000 5,00,000
A company produces a single product and sells it at Rs. 200
each. The variable cost of the product is Rs.120 per unit
and the fixed cost for the year is Rs. 96,000.
Calculate:
i) P/V Ratio
ii) Sales at Break even point
iii) Sales unit required to earn a target profit of Rs. 1,20,000

iv) Sales units required to earn a target net profit of Rs.

1,00,000 after income tax, assuming income tax rate to be
50%
v) Profit at sales of Rs. 7,00,000
Contribution = Sales – Variable cost
= 200 - 120 = Rs. 80 per unit

P/V Ratio = (Cont./ sales) x 100

= (80/ 200) x 100 = 40%

Sales at break even point = (Fixed cost / P/v ratio)

= (96,000 / 40%)
= Rs. 2,40,000
Sales in units required to earn a target profit of Rs.
1,20,000

=(Fixed Cost + Desired profit)/Contribution per unit

= (96000 + 1,20,000) / 80

= 2,700 units
Sales in units to earn a target after tax profit of Rs.
1,00,000
Tax rate is 50% so before tax target profit would be

(1,00,000 / 1 – 0.5) = 2,00,000

Sales required to earn a target profit of Rs. 2,00,000

= ( 96,000 + 2,00,000) / 80 = 3,700 units

Profit at sales of Rs. 7,00,000

P/V Ratio = 40%

Contribution at sales of Rs. 7,00,000 = 2,80,000
Profit = Contribution – fixed cost
= 2,80,000 - 96,000
= 1,84,000
The following data is obtained from the records of an industrial unit:
Sale of 4000 units @ Rs.25 each 1,00,000
Material Consumed 40,000
Variable overheads 10,000
Labor Charges 20,000
Fixed Overheads 18,000 88,000
Net Profit 12,000
Calculate :
i) The number of units by selling which the company will neither lose
nor gain anything
ii) The sales needed to earn a profit of 20% on sales
iii) The extra units which should be sold to obtain the present profit if
it is proposed to reduce the selling price by 20%
iv) The selling price to be fixed bring down its break even point to 500
units under present conditions
i) The number of units by selling which the company will neither lose
nor gain anything i.e the break even point
= (Fixed Cost / Contribution per unit)
= ( 18,000 / 7.50 ) = 2,400

Notes:

Total variable cost = (40,000 + 10,000 + 20,000) = 70,000

No. of units = 4000
Variable cost per unit = 70,000 / 4,000
= 17.50
Contribution per unit = 25 – 17.50
= 7.50
ii) Sales needed to earn a profit of 20% on sales
Let the units sold be X
Sales = 25 X
Profit = 20% of 25 X i.e 5 X
Sales – Profit = Fixed Cost + Variable Cost
25 X – 5X = 18,000 + 17.5 X
X = 7,200
Sales = 7,200 X 25 = 1,80,000
Extra units to be sold to maintain present profit if selling price is
reduced by 20%
Present Selling price Rs. 25
Less: Reduction 20% Rs. 5
------------
New Selling price Rs. 20
Less : Variable cost Rs. 17.5
-------------
Contribution per unit Rs. 2.50

Units to be sold = (Fixed cost + Desired profit)/Contribution per unit

= ( 18,000 + 12,000) / 2.50
= 12,000
Extra units to be sold = 12000 - 4000 = 8000
Selling price for break even point at 500 units
Let the selling price be x

500 = Fixed cost/ contribution per unit

500 = 18,000 / x – 17.5

x = Rs. 53.5 per unit
Cadbury Schweppes limited, a british chocolate and soft
drink company, is planning to establish a subsidiary company
in India to produce ‘Schweppes Mineral water’.
Based on the estimated annual sales of 40,000 bottles of the mineral
water, cost studies produced the following estimates for the indian
subsidiary:
Total Annual costs Per cent of total annual cost
that is variable
Material 1,93,600 100%
Labor 90,000 70%
Overhead 80,000 64%
Administration 30,000 30%

The Indian production will be sold by manufacture’s representatives

who will receive a commission of 8% of the sale price. No portion
of the British office expenses is to allocated to the Indian subsidiary.
Required :

i) Compute the sale price per bottle to enable

management to realize an estimated 10% profit on
sale proceeds in India, and

ii) Calculate the break even point in rupee sales for

the Indian subsidiary on the assumption that the
sale price is Rs. 11 per bottle.
Let the selling price per unit be X
Total Sales 40,000 X
Total Commission 3,200 X
Total Profit 4,000 X
Total Sales = Total Cost + Profit
40,000 X = 1,93,600 + 90,000 + 80,000 + 30,000 + 3,200 X + 4000 X
40,000 X = 3,93,600 + 7,200 X
32,800 X = 3,93,600
X = Rs. 12
ii) Computation of break even point
BEP = Fixed Cost / Cont. P.U

S.P Per unit = 11

Total variable cost per unit = 7.92 + 0.88
Contribution per unit = 11 – 7.92 – 0.88 = 2.2

BEP (Units) = 76,800 / 2.2 = 34,910

BEP (Rupee sales) = 34,910 x 11 = 3,84,010

Second City Airlines operates 35 Scheduled round trip flights each week
between NewYork and Chicago. It charges a fixed one way fare of
$200per passenger. Second city airlines can carry 150 passengers per
one way flight. Fuel and other flight related costs are $5000 per
flight. On flight meals and refreshment cost average $5 per passenger.
Flight crew, ground crew, advertising and other administrative
expenditures for the Newyork to Chicago route amount to $4,00,00
each week.
A) How many passengers must each of the 70 one way flights have on
average to break even each week.
B) If the load factor is 60% on all flights, how many flights must be
operated on this route to earn a total profit of $5,00,000 per week?
C) What is the variable cost to the airline company for one additional
passenger on flight if the passenger takes a seat that would otherwise
go empty.
Q 2.42 Attkinson

a) Costs that vary with number of passengers:

Meals and refreshments = $5
Let X  number of passengers needed to break even
each week
Total revenue per week – costs per passenger per week
– costs per flight per week – fixed costs per week =
profit per week
($200  X  70) – ($5  X  70) – ($5,000  70) –
$400,000 = $0
$13,650X = $750,000
X  $750,000 ÷ $13,650 = 54.95 (i.e., 55 passengers per
flight)
b) Let N  number of flights to earn a profit of
$500,000 per week
Number of passengers per flight = 60%  150 =
90
($200  90  N) – ($5  90  N) – ($5,000  N –
$400,000) = $500,000
N  71.71 (i.e., 72 flights)
c) Fuel costs are fixed once the flights are
scheduled, but these costs vary with the number
of flights.

d) The variable cost for the additional passenger

is $5 for the meals and refreshments
A company produces a single product and sells it at Rs. 200
each. The variable cost of the product is Rs.120 per unit
and the fixed cost for the year is Rs. 96,000.
Calculate:
i) P/V Ratio
ii) Sales at Break even point
iii) Sales unit required to earn a target profit of Rs. 1,20,000

iv) Sales units required to earn a target net profit of Rs.

1,00,000 after income tax, assuming income tax rate to be
50%
v) Profit at sales of Rs. 7,00,000
Contribution = Sales – Variable cost
= 200 - 120 = Rs. 80 per unit

P/V Ratio = (Cont./ sales) x 100

= (80/ 200) x 100 = 40%

Sales at break even point = (Fixed cost / P/v ratio)

= (96,000 / 40%)
= Rs. 2,40,000
Sales in units required to earn a target profit of Rs.
1,20,000

=(Fixed Cost + Desired profit)/Contribution per unit

= (96000 + 1,20,000) / 80

= 2,700 units
Sales in units to earn a target after tax profit of Rs.
1,00,000
Tax rate is 50% so before tax target profit would be

(1,00,000 / 1 – 0.5) = 2,00,000

Sales required to earn a target profit of Rs. 2,00,000

= ( 96,000 + 2,00,000) / 80 = 3,700 units

Profit at sales of Rs. 7,00,000

P/V Ratio = 40%

Contribution at sales of Rs. 7,00,000 = 2,80,000
Profit = Contribution – fixed cost
= 2,80,000 - 96,000
= 1,84,000
The following data is obtained from the records of an industrial unit:
Sale of 4000 units @ Rs.25 each 1,00,000
Material Consumed 40,000
Variable overheads 10,000
Labor Charges 20,000
Fixed Overheads 18,000 88,000
Net Profit 12,000
Calculate :
i) The number of units by selling which the company will neither lose
nor gain anything
ii) The sales needed to earn a profit of 20% on sales
iii) The extra units which should be sold to obtain the present profit if
it is proposed to reduce the selling price by 20%
iv) The selling price to be fixed bring down its break even point to 500
units under present conditions
i) The number of units by selling which the company will neither lose
nor gain anything i.e the break even point
= (Fixed Cost / Contribution per unit)
= ( 18,000 / 7.50 ) = 2,400

Notes:

Total variable cost = (40,000 + 10,000 + 20,000) = 70,000

No. of units = 4000
Variable cost per unit = 70,000 / 4,000
= 17.50
Contribution per unit = 25 – 17.50
= 7.50
ii) Sales needed to earn a profit of 20% on sales
Let the units sold be X
Sales = 25 X
Profit = 20% of 25 X i.e 5 X
Sales – Profit = Fixed Cost + Variable Cost
25 X – 5X = 18,000 + 17.5 X
X = 7,200
Sales = 7,200 X 25 = 1,80,000
Extra units to be sold to maintain present profit if selling price is
reduced by 20%
Present Selling price Rs. 25
Less: Reduction 20% Rs. 5
------------
New Selling price Rs. 20
Less : Variable cost Rs. 17.5
-------------
Contribution per unit Rs. 2.50

Units to be sold = (Fixed cost + Desired profit)/Contribution per unit

= ( 18,000 + 12,000) / 2.50
= 12,000
Extra units to be sold = 12000 - 4000 = 8000
Selling price for break even point at 500 units
Let the selling price be x

500 = Fixed cost/ contribution per unit

500 = 18,000 / x – 17.5

x = Rs. 53.5 per unit
 (Amounts in ‘000)
Particulars Product A Product B Product C Total
Sales Revenue 800 1,950 200 2,950
Less : Variable Cost 350 1,000 140 1,490
Contribution Margin 450 950 60 1,460
Less : Direct Fixed Exp. 150 300 70 520
Segment Margin 300 650 (10) 940
Less: Common Fixed expenses 340
Operating Profit 600
Direct Fixed expenses include depreciation on the equipment dedicated
to the product lines of 20,000 for ‘A’, 1,20,000 for ‘B’, and 25,000 for
‘C’. None of the equipment can be sold.
Q1. What impact on profit would result from dropping product ‘C’.
Q2. Now, Suppose that 10% of customers for product ‘B’ choose to buy
from this company coz it offers a full range of products, including
product ‘C’. If ‘C’ would no longer be available these customers will
go elsewhere to purchase ‘B’. Now what is the impact of dropping ‘C’
 17.4 (H&M)

1. In case Product ‘C’ is dropped, Direct fixed

expenses relating to this product would be
eliminated. But the depreciation expense of Rs.
25,000 would still be there since as per the question
the equipment cannot be sold
As a result, in case product ‘C’ is dropped, the
total loss from its segment would be Rs.25,000, i.e
Rs. 15,000 more from the present situation.
2.
Particulars Product A Product B Total
Sales Revenue 800 1,755 2,555
Less : Variable Cost 350 900 1,250
Contribution Margin 450 855 1,305
Less : Direct Fixed Exp. 150 300 450
Segment Margin 300 555 855
Less: Common Fixed expenses 365 (340 +25)
Operating Profit 490
Wright company has been approached by anew customer with an offer
to purchase 3800 units of wright’s products at a price of Rs. 7.50
each. The new customer is geographically separated from the wright’s
other customers and there would be no effect on existing sales.
Wright normally products 12,000 units but only plans to produce and
sell 8,000 in the coming year. The normal sales price is Rs 12 per unit.
Unit cost information is as follows:

Direct Material 2.00

Direct Labor 3.10
Variable Overhead 1.80
Fixed Overhead 2.00
If Wright accepts the order, no fixed manufacturing activities will be
affected because there is sufficient excess capacity.
Q 1 Should wright accept the special order? By how
much will profit increase or decrease if the order is
accepted.
Q2 Suppose that Wright’s distribution center at the
warehouse is operating at full capacity and would
need to add capacity costing Rs.1000 for every 5,000
units to be packed and shipped. Should wright
accept the special order? By how much will profit
increase or decrease if the order is accepted.
1.
Direct materials $ 2.00
Direct labor 3.10
Variable overhead 1.80
Relevant cost per unit $ 6.90

Yes, Thomson should accept the special order,

because operating income will increase by
$2,280 [($ 7.5  $6.9)  3,800].
2.
Particulars Amount
Additional Revenue (3,800 x 7.50) 28,500
Less : Material (2 x 3800) 7,600
Labor ( 3.10 x 3,800) 11,780
Variable Overhead 6,840
Total Contribution 2,280
Additional Fixed cost 1,000
Additional profit 1,280
A Ltd is currently manufacturing part Z911, producing 40,000 units
annually. The part is used in the production of several products made by
A Ltd. The cost per unit for Z911 is as follows:
Direct Material 9.00
Direct Labor 3.00
Variable Overhead 2.50
Fixed Overhead 4.00
Total 18.50

Of the total fixed overheads assigned to Z911, Rs. 88,000 is direct fixed
overhead, neither of which will be needed if the line is dropped. The
remaining fixed overhead is the common fixed overhead. An outside
supplier has offered to sell the part to A Ltd for Rs. 16
Q1. Should A Ltd company make or buy part Z911.
Q 2 What is the most A Ltd would be willing to pay an outside supplier
Q3 If A Ltd bought the part, by how much would income increase or
decrease.
1. Total cost of manufacturing one unit of part Z911
Particulars Amount
Direct Material 9.00
Direct Labor 3.00
Variable Overhead 2.50
Direct Fixed Overhead per unit ( 88,000 / 40,000) 2.20
Total cost per unit to produce 16.70

Supplier is offering to sell Z911 at Rs. 16 which is less

than the total cost of producing in house so A Ltd
company should buy Z911.
Q1. Prepare the cost sheet

Direct Materials 1,00,000

Direct Wages 30,000
Indirect Wages 2,500
Electric Power 500
Lighting:
Factory 1,500
Office 500
Rent:
Factory 5,000
Office 2,500
Commission to Salesman 1,250
Advertising 1,250
Income Tax 10,000
Sales 1,89,500

Q 2 Prepare a cost sheet for the year ended March 31,2023

Stock of finished goods ( April 1, 2022) 6,000

Stock of raw materials (April 1, 2022) 40,000
Work in Progress (April 1, 2022) 15,000
Purchase of raw Material 4,75,000
Carriage inwards 12,500
Factory rent 7,250
Other Production Expenses 43,000
Wages 1,75,000
Work Manager’s Salary 30,000
Factory Employees Salary 60,000
Power Expenses 9,500
General Expenses 32,500
Sales 8,60,000
Stock of finished goods (March 31, 2023) 15,000
Stock of raw materials (March 31,2023) 50,000
Work in Progress (March 31,2023) 10,000
Q 3 Vijay Industries manufactures a product ‘X’. On April 1, 20X1, there were 5000 ( @ 12.50 per unit)
units of finished product in stock. Other stocks on April 1. 20X1 were as follows:

Work in Progress 57,400

Raw Material 1,16,200

The information available from cost records for the year were as follows:

Materials Purchased 9,06,900

Direct Labor 3,26,400
Freight on raw material purchased 55,700
Indirect Labor 1,21,600
Other factory overheads 3,17,300
Stock of Raw materials on March 31, 20X2 96,400
Work-in-progress as on March 31, 20x2 78,200
Sales (1,50,000 units) 30,00,000
Indirect Materials 2,13,900
Selling expenses @ 50 Paisa per unit sold

There are 15000 units of finished stock in hand on March 31,20X2. You are required to prepare a
statement of cost.
Case Study - 1

Costra Ltd is into the manufacturing of toys for children. Following are the extracted figures from the
cost records of Costra Ltd for the year 20X1. During 20X1 the company produced 1000 identical toys.

Consumption of raw materials Rs. 20,000

Labor Cost Rs. 12,000

Factory Overheads Rs. 8,000

Office Overheads Rs. 4,000

Selling Expenses Rs. 1,000

Profit Margin was set as 25% of the selling price.

Costra Ltd has decided to produce 1,500 units for 20X2. Some cost are expected to increase in the year
20X2. Following are the details of the estimations:

 Cost of the raw materials are estimated to go up by 20%

 Labor cost is expected to increase by 10%

 Overhead - 50 % of the charges are fixed and the rest 50% are directly proportional to the
production.

 The selling expenses are expected to go down by 20%.

 Costra Ltd is willing to earn the same profit margin as the last year i.e 25% of the selling price.

Prepare a cost sheet for the year 20x2 and work out the estimated selling price per unit of the product.
Case Study -2

Fedra enterprises have started the business in the year 20X1 and is into manufacturing of door handles.
Since they are new in the business they are not maintaining any closing stocks. In the year 20X1 they
produced and sold 1000 door handles. For the coming year i.e 20X2 they are hopeful of getting good
number of orders. They expect to produce approximately 10,000 door handles in 20X2.

Fedra Enterprises has consulted you to determine the minimum price that they should quote to their
prospective customers.

You have been given the following cost data for the year 20X1

Materials Rs. 39,000

Direct Labor Rs. 24,000

Works overhead Rs. 21,000

Office Overheads Rs. 8,400

Selling Expenses Rs. 9,600

Profit Rs. 15,000

Sales Rs. 1, 17,000

Some of the additional information is given to you as follows:

 40% of the Works overhead is directly proportional to the production

 70% of the selling expenses fluctuates with sales

 Direct Labor charges are expected to reduce by 20%

 Fixed Works overhead is expected to increase by Rs. 9,000

 Fixed Selling expenses are expected to show an increase of 25%

 Office overheads are also expected to increase by 25%

Prepare the computation for submission to your client

Q A company produces a single product and sells it at Rs. 200 each. The variable cost of the product
is Rs.120 per unit and the fixed cost for the year is Rs. 96,000.

Calculate:

i) P/V Ratio

ii) Sales at Break even point

iii) Sales unit required to earn a target profit of Rs. 1,20,000

iv) Sales units required to earn a target net profit of Rs. 1,00,000 after income tax, assuming
income tax rate to be 50%

v) Profit at sales of Rs. 7,00,000

Sol

i) Contribution = Sales – Variable cost

= 200 - 120 = Rs. 80 per unit

P/V Ratio = (Cont./ sales) x 100

= (80/ 200) x 100 = 40%

Sales at break even point = (Fixed cost / P/v ratio)

= (96,000 / 40%)

= Rs. 2,40,000

ii) Sales in units required to earn a target profit of Rs. 1,20,000

=(Fixed Cost + Desired profit)/Contribution per unit

= (96000 + 1,20,000) / 80

= 2,700 units

iii) Sales in units to earn a target after tax profit of Rs. 1,00,000

Tax rate is 50% so before tax target profit would be

(1,00,000 / 1 – 0.5) = 2,00,000

Sales required to earn a target profit of Rs. 2,00,000

= ( 96,000 + 2,00,000) / 80 = 3,700 units

iv) Sales in units to earn a target after tax profit of Rs. 1,00,000

Tax rate is 50% so before tax target profit would be

(1,00,000 / 1 – 0.5) = 2,00,000

Sales required to earn a target profit of Rs. 2,00,000

= ( 96,000 + 2,00,000) / 80 = 3,700 units

v) Profit at sales of Rs. 7,00,000

P/V Ratio = 40%

Contribution at sales of Rs. 7,00,000 = 2,80,000

Profit = Contribution – fixed cost

= 2,80,000 - 96,000

= 1,84,000

Q The following data is obtained from the records of an industrial unit:

Sale of 4000 units @ Rs.25 each 1,00,000

Material Consumed 40,000

Variable overheads 10,000

Labor Charges 20,000

Fixed Overheads 18,000 88,000

Net Profit 12,000

Calculate :

i) The number of units by selling which the company will neither lose nor gain anything

ii) The sales needed to earn a profit of 20% on sales

iii) The extra units which should be sold to obtain the present profit if it is proposed to reduce
the selling price by 20%

iv) The selling price to be fixed bring down its break even point to 500

units under present conditions

Process Costing
Q 1) Candid, Inc. is a manufacturer of digital cameras. It has two departments: assembly and
testing. In January 2017, the company incurred $800,000 on direct materials and $805,000 on
conversion costs, for a total manufacturing cost of $1,605,000.

Required:
1. Assume there was no beginning inventory of any kind on January 1, 2017. During
January, 5,000 cameras were placed into production and all 5,000 were fully completed at
the end of the month. What is the unit cost of an assembled camera in January?
2. Assume that during February 5,000 cameras are placed into production. Further assume
the same total assembly costs for January are also incurred in February, but only 4,000
cameras are fully completed at the end of the month. All direct materials have been added
to the remaining 1,000 cameras. However, on average, these remaining 1,000 cameras are
only 60% complete as to conversion costs. (a) What are the equivalent units for direct
materials and conversion costs and their respective costs per equivalent unit for February?
(b) What is the unit cost of an assembled camera in February 2017?
3. Explain the difference in your answers to requirements 1 and 2.
Solution:
Equivalent units, zero beginning inventory.

1. Direct materials cost per unit ($800,000 ÷ 5,000) $ 160.00

Conversion cost per unit ($805,000 ÷ 5,000) 161.00
Assembly Department cost per unit $321.00
2a.
Summarize the Flow of Physical Units and Compute Output in Equivalent Units;

(Step 2)

(Step 1) Equivalent Units

Physical Direct Conversion

Flow of Production Units Materials Costs

Work in process, beginning (given) 0

Started during current period (given) 5,000
To account for 5,000
Completed and transferred out
during current period 4,000 4,000 4,000
Work in process, ending* (given) 1,000
1,000  100%; 1,000  60% 1,000 600
Accounted for 5,000

1
Equivalent units of work done in current period 5,000 4,600

*Degree of completion in this department: direct materials, 100%; conversion costs, 60%.

Compute the Cost per Equivalent Unit,

Total
Production Direct Conversion
Costs
Costs Materials

(Step 3) Costs added during February $1,605,000 $800,000 $805,000

Divide by equivalent units of work done
 4,600
in current period (Solution Exhibit 17-21A)  5,000
Cost per equivalent unit $ 160 $ 175

2b. Direct materials cost per unit $ 160

Conversion cost per unit 175
Assembly Department cost per unit $335

3. The difference in the Assembly Department cost per unit calculated in requirements 1
and 2 arises because the costs incurred in January and February are the same but fewer
equivalent units of work are done in February relative to January. In January, all 5,000 units
introduced are fully completed resulting in 5,000 equivalent units of work done with respect
to direct materials and conversion costs. In February, of the 5,000 units introduced, 5,000
equivalent units of work is done with respect to direct materials but only 4,600 equivalent
units of work is done with respect to conversion costs. The Assembly Department cost per
unit is, therefore, higher.
Q 2) The assembly division of Quality Time Pieces, Inc. uses the weighted-average method
of process costing. Consider the following data for the month of May 2017:
Physical Units Direct Conversion
(Watches) Materials Costs
Beginning work in process (May 1)a 100 $ 459,888 $ 142,570
Started in May 2017 510
Completed during May 2017 450
Ending work in process (May 31)b 160
Total costs added during May 2017 $3,237,000 $1,916,000

2
 Physical Units Direct Conversion
(Watches) Materials Costs
a
Degree of completion: direct materials, 80%; conversion costs, 35%.
b
Degree of completion: direct materials, 80%; conversion costs, 40%.
Required:
1. Compute equivalent units for direct materials and conversion costs. Show physical
units in the first column of your schedule.
2. summarize the total costs to account for, calculate the cost per equivalent unit for
direct materials and conversion costs, and assign costs to the units completed (and
transferred out) and units in ending work in process.
Solution:
(Step 2)
(Step 1) Equivalent Units
Physical Direct Conversion
Flow of Production Units Materials Costs
Work in process beginning (given) 100
Started during current period (given) 510
To account for 610
Completed and transferred out during current period 450 450 450
Work in process, ending* (160  80%; 160  40%) 160 128 64
Accounted for 610 ___ ___
Equivalent units of work done to date 578 514

*Degree of completion in this department: direct materials, 80%; conversion costs, 40%.

Total
Production Direct Conversion
Costs Materials Costs
(Step 3) Work in process, beginning (given) $ 602,458 $ 459,888 $ 142,570
Costs added in current period (given) 5,153,000 3,237,000 1,916,000
Total costs to account for $5,755,458 $3,696,888 $2,058,570

(Step 4) Costs incurred to date $3,696,888 $2,058,570

Divide by equivalent units of work done to
date (Solution Exhibit 17-24)
 578  514
Cost per equivalent unit of work done to $ 6,396 $ 4,005

3
 date
(Step 5) Assignment of costs:
Completed and transferred out (460 units) $4,680,450 (450*  $6,396) + (450*  $4,005)

Work in process, ending (120 units) 1,075,008 (128†  $6,396) + (64† 

$4,005)
Total costs accounted for $5,755,458 $3,696,888 +
$2,058,570

*
Equivalent units completed and transferred out from Solution Exhibit 17-24, Step 2.
†
Equivalent units in work in process, ending from Solution Exhibit 17-24, Step 2.

4
Job Costing
Q 1) Atkinson Construction assembles residential houses. It uses a job-costing system with two direct-cost
categories (direct materials and direct labor) and one indirect-cost pool (assembly support). Direct labor-hours is
the allocation base for assembly support costs. In December 2016, Atkinson budgets 2017 assembly-support costs
to be $8,800,000 and 2017 direct labor-hours to be 220,000.
At the end of 2017, Atkinson is comparing the costs of several jobs that were started and completed in 2017.

Direct materials and direct labor are paid for on a contract basis. The costs of each are known when direct
materials are used or when direct labor-hours are worked. The 2017 actual assembly-support costs were
$8,400,000, and the actual direct labor-hours were 200,000.

Required:
Compute the (a) budgeted indirect-cost rate and (b) actual indirect-cost rate. Why do they differ?
What are the job costs of the Laguna Model and the Mission Model using (a) normal costing and (b) actual
costing?
Solution:

Budgeted indirect- Budgeted indirect costs (assembly support) $8,800,000

= =
cost rate Budgeted direct labor-hours 220,000 hours

= $40 per direct labor-hour

Actual indirect- Actual indirect costs (assembly support) $8,400,000

= =
cost rate Actual direct labor-hours 200,000 hours

= $42 per direct labor-hour

2a. Laguna Mission
Model Model
Normal costing
Direct costs
Direct materials $106,550 $127,450
Direct labor 36,250 41,130
142,800 168,580
Indirect costs
Assembly support ($40  970; $40  1,000) 38,800 40,000
Total costs $181,600 $208,580
2b. Actual costing
Direct costs
Direct materials $106,550 $127,450
Direct labor 36,250 41,130
142,800 168,580
Indirect costs
Assembly support ($42  970; $42  1,000) 40,740 42,000
Total costs $183,540 $210,580

1
Q 2) The Ride-On-Wave Company (ROW) produces a line of non-motorized boats. ROW uses a normal-costing
system and allocates manufacturing overhead using direct manufacturing labor cost. The following data are for 2017:

Inventory balances on December 31, 2017, were as follows:

Required:
1. Calculate the manufacturing overhead allocation rate.
2. Compute the amount of under or overallocated manufacturing overhead.
3. Calculate the ending balances in work in process, finished goods, and cost of goods sold if under or overallocated
manufacturing overhead is as follows:
a. Written off to cost of goods sold
b. Prorated based on ending balances (before proration) in each of the three accounts
c. Prorated based on the overhead allocated in 2017 in the ending balances (before proration) in each of the three
accounts
4. Which method would you choose? Justify your answer.
Solution:
1. Budgeted manufacturing Budgeted manufacturing overhead cost
=
overhead rate Budgeted direct manufacturing labor cost

$125, 000
  50% of direct manufacturing labor cost
$250, 000
2. Overhead allocated = 50%  Actual direct manufacturing labor cost
= 50%  $228,000 = $114,000
Underallocated Actual
Allocated plant
manufacturing = manufacturing –
overhead costs
overhead overhead costs
= $117,000 – $114,000 = $3,000
Underallocated manufacturing overhead = $3,000
3a. All underallocated manufacturing overhead is written off to cost of goods sold.
Both work-in-process (WIP) and finished goods inventory remain unchanged.
Dec. 31, 2017 Proration of $3,000 Dec. 31, 2017
Balance Underallocated Balance
(Before Proration) Manuf. Overhead (After Proration)
Account (1) (2) (3) = (1) + (2)
WIP $ 50,700 $ 0 $ 50,700
Finished Goods 245,050 0 245,050
Cost of Goods Sold 549,250 3,000 552,250
Total $845,000 $3,000 $848,000

3b. Underallocated manufacturing overhead prorated based on ending balances:

2
 Dec. 31, 2017
Dec. 31, 2017 Account
Account Balance Account Proration of $3,000 Balance
(Before Balance as a Underallocated (After
Proration) Percent of Total Manuf. Overhead Proration)
Account (1) (2) = (1) ÷ $845,000 (3) = (2)  $3,000 (4) = (1) + (3)
WIP $ 50,700 0.06 0.06  $3,000 = $ 180 $ 50,880
Finished Goods 245,050 0.29 0.29  $3,000 = 870 245,920
Cost of Goods
Sold 549,250 0.65 0.65  $3,000 = 1,950 551,200
Total $845,000 1.00 $3,000 $848,000

3c. Underallocated manufacturing overhead prorated based on 2017 overhead in ending balances:

Allocated Dec. 31,

Dec. 31, Manuf. Allocated Manuf. 2017
2017 Overhead in Overhead in Account
Account Dec. 31, 2017 Dec. 31, 2017 Balance
Balance Balance Balance as a Proration of $3,000 (After
(Before (Before Percent of Total Underallocated Proration)
Proration) Proration) (3) = (2) ÷ Manuf. Overhead (5) = (1) +
Account (1) (2) $114,000 (4) = (3)  $3,000 (4)
WIP $ 50,700 $ 10,260a 0.09 0.09  $3,000 =$ 270 $ 50,970
Finished Goods 245,050 29,640b 0.26 0.26  $3,000 = 780 245,830
Cost of Goods
Sold 549,250 74,100c 0.65 0.65  $3,000 = 1,950 551,200
Total $845,000 $114,000 1.00 $3,000 $848,000
a,b,c
Overhead allocated = Direct manuf. labor cost  50% = $20,520; $59,280; $148,200  50%
4. Writing off all of the underallocated manufacturing overhead to Cost of Goods Sold (COGS) is usually warranted
when COGS is large relative to Work-in-Process and Finished Goods Inventory and the underallocated manufacturing
overhead is immaterial. Both these conditions apply in this case. ROW should write off the $3,000 underallocated
manufacturing overhead to Cost of Goods Sold Account.

Q 3) The Matthew Company uses a normal job-costing system at its Minneapolis plant. The plant has a machining
department and an assembly department. Its job-costing system has two direct-cost categories (direct materials and
direct manufacturing labor) and two manufacturing overhead cost pools (the machining department overhead,
allocated to jobs based on actual machine-hours, and the assembly department overhead, allocated to jobs based on
actual direct manufacturing labor costs). The 2017 budget for the plant is as follows:

Required:
1. During February, the job-cost record for Job 494 contained the following:

Compute the total manufacturing overhead costs allocated to Job 494.

3
 2. At the end of 2017, the actual manufacturing overhead costs were $1,800,000 in machining and $5,300,000 in
assembly. Assume that 33,000 actual machine-hours were used in machining and that actual direct
manufacturing labor costs in assembly were $3,200,000. Compute the over or underallocated manufacturing
overhead for each department.
Solution: Budgeted manufacturing overhead divided by the budgeted quantity of the allocation base:
$1,500, 000
Machining Department overhead: = $50 per machine-hour
30, 000
$5,100, 000
Assembly Department overhead: = 170% of direct manuf. labor costs
$3, 000, 000

2. Machining department overhead allocated, 2,800 hours  $50 $140,000

Assembly department overhead allocated, 170%  $19,000 32,300
Total manufacturing overhead allocated to Job 494 $172,300

3. Machining Dept. Assembly Dept.

Actual manufacturing overhead $1,800,000 $ 5,300,000
Manufacturing overhead allocated,
$50  33,000 machine-hours 1,650,000 —
170%  $3,200,000 — 5,440,000
Underallocated (Overallocated) $ 150,000 $ (140,000)