Description

Strategic Cost Management

September 2024 Examination

 

 

1. ABC Ltd. produces 3 products A, B & C. The following data is available for the year ended 31st March 2023.

	Product A	Product B	Product C
Production Qty (Units)	4,000	3,000	1,600
Total Machine hours for production	60	30	20
Resources Per Unit –
Direct Material (Kgs)	4	6	3
Direct Labour (Mins)	30	45	60

 

Cost of Labour is Rs. 10 per hour and material cost Rs. 2/kg. Production Overheads (Fixed) were Rs. 99,450. ABC Ltd. used Traditional Costing method and absorbed the Overheads to products based on Labour hour rate. It is now considering to adopt Activity Based Costing method. The following information was digged out and analysed by the Cost Accountant. Overheads were comprised of the following: Material Handling Rs. 29,100, Storage Costs Rs. 31,200 and Power Cost Rs. 39,150.  Further the area occupied for storage of materials was in the ratio of 2:1:3.

Prepare Cost sheet showing Unit cost and Total cost of each product using both Traditional Costing and ABC methodology.   (10 marks)

Ans 1.

Introduction

In the pursuit of refining cost allocation methods, ABC Ltd. is transitioning from traditional costing to Activity Based Costing (ABC) to gain a more accurate depiction of product costs. Traditional costing methodologies, typically simplistic, distribute overheads based primarily on a single cost driver such as labor or machine hours, which can lead to significant cost distortions for companies producing multiple products. This analysis explores the implications of this shift for three different products—A, B, and C—over a fiscal year. By dissecting the overhead components such as Material Handling, Storage Costs, and Power Cost, and examining the allocation based on specific activities, the intent is to demonstrate how ABC provides a more precise cost distribution reflecting actual resource usage. This exercise not only helps in identifying the true cost of products but also aids strategic decision-making related to pricing, product focus, and process improvements.

Concept and Application

In cost accounting, the choice between Traditional Costing and Activity-Based Costing (

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2. Sitaram Ltd. is an ice cream manufacturer company. Its current revenue is Rs. 650,000 a month and a 40% contribution margin. Its fixed costs are Rs. 200,000. Ghanshyam Ltd. is another player in the ice cream business with a current sales of Rs. 420,000 and a 30% contribution margin. Its fixed costs are Rs. 90,000.
3. What is the margin of safety for Sitaram and Ghanshyam Ltd? Compare the margin of safety in value between the two companies. Which is stronger?
4. Compare the margin of safety in percentage between the two companies. Now which one is stronger?
5. Prepare a budget for both companies showing their estimated profit at the current levels and at 75% of the current capacity. State your observations with respect to the Profit/Loss levels in both situations and their relation to Margin of Safety percentage. (10 marks)

Ans 2.

Introduction

In the competitive landscape of business management, the analytical frameworks provided by managerial accounting, such as the margin of safety (MoS) and break-even analysis, play pivotal roles. These tools allow businesses to gauge their financial stability and operational risk by highlighting how much sales can decline before a company starts incurring losses. This analysis is crucial for businesses operating in volatile markets, such as the ice cream industry, where companies like Sitaram Ltd. and Ghanshyam Ltd. navigate through fluctuating demand and varying cost structures. By comparing these companies through the lens of margin of safety in both value and percentage terms, alongside profitability assessments at different operational capacities, we can derive meaningful insights into their

 

 

 

 

3a. Precision Limited is motor manufacturer. The company currently produces three different models of motors. It also produces all the blades of the motors as it requires. The requirement is of 3 different blades for each motor model (i.e. 9 different blades).

Precision Limited received a proposal from a supplier who wants to sell the company blades for the motors line. The supplier would charge Rs. 25 per blade, regardless of blade type.

For the next year the Company has projected the costs of its own blade production as follows (based on projected volume of 10,000 units):

Direct materials                Rs. 75,000

Direct labour                   Rs. 65,000

Variable overhead            Rs. 55,000

Fixed overhead

Factory supervision    Rs. 35,000

Other fixed cost          Rs. 65,000

Total production costs      Rs. 2,95,000

Assume:

(1) the equipment utilized to produce the blades has no alternative use and no market value,

(2) the    space occupied    by    blade    production    will    remain    idle    if    the company purchases rather than makes the blades, and

(3) factory supervision costs reflects the salary of a production supervisor who would be dismissed from the firm if blade production is ceased.

Determine the net profit or loss if the blades are purchased rather than manufactured. (5 marks)

Ans 3a.

Introduction

In the realm of manufacturing, decisions between making components in-house or outsourcing them are crucial for cost management and operational efficiency. Precision Limited, a motor manufacturer, is faced with such a decision regarding the production of motor blades. They must choose between continuing to manufacture these blades in-house or accepting a proposal from a supplier offering to sell the blades at a fixed price. Given specific financial and operational conditions, analyzing the cost implications of each option will help

 

 

1. Priya Motors is planning to coming up with a new electric car. The promotor of the company has been conducting research in this field on and off for the past 2 years. The approximate amount spent on the R&D till date is Rs. 2 lacs. The cost of production of the vehicle is estimated to be Rs. 3 lacs. Marketing and promotional expenses are to the tune of Rs. 50,000. Based on prior experience, car has a after sales service expenses of Rs. 25,000 on an average during its life time. Being an electric car the cost is estimated lower at Rs. 20,000. If the company wants to earn a profit margin of Rs. 40,000 per car, at what price should Priya Motors price it? (Time value of money is ignored)

What is the approach used for costing the car? Considering the stage of the product, what should be the considerations for spending on the following costs:

1. a) Advertisement
2. b) Maintenance cost. (5 marks)

Ans 3b.

Introduction

Priya Motors, a company delving into the electric vehicle market, has been conducting research and development (R&D) for a new electric car over the past two years, with expenses amounting to Rs. 2 lacs. The estimated production cost of the vehicle is Rs. 3 lacs, with additional marketing and promotional costs projected at Rs. 50,000. The average after-sales service cost for traditional cars has been Rs. 25,000, but for the electric car, it is estimated to be lower at Rs. 20,000. Priya Motors aims to achieve a profit margin of Rs. 40,000 per car. This scenario presents a classic case of cost-plus pricing strategy, where the