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Name: Bhavinkumar Parmar,

Roll No: 2010PGP084, Section A

MAC-II

Assignment on Lilac Flour Mills


About Lilac Flour Mills:
Lilac Flour Mills processes wheat to produce white flour, suji, wholemeal
flour, and bran. In term of physical proportions, the average yield from a
ton of wheat is 60 percent for white flour, 10 percent for suji, 10 percent
for whole meal flour and 20 percent for bran.
The production process: Plant consisted of several floors and is divided
into two parts: i) cleaning section and ii) milling section. Wheat is fed
through a bin in the ground floor, which is passed through dust and chaff
removal buckets and then through a triour equipment to remove corn,
round seeds,maize and stones from wheat. It is then washed, dried and
stored in a clean bin.
Cleaned wheat is then passed through an aspiration-cleaning meachine
where it is brushed and then it reaches double roller mill. Wheat corn is
then passed through roller mills and plantsifters successively until all flour
was won. The bran that remained is collected by means of bran separator.
The end products wer passed thorough wooden channels to the ground
floor where they were collected and packed.
Inventory Accumulation: Lilac processed about 36 tons of wheat
perday. Every ton of wheat yielded about 0.2 tons of bran which comes to
about 7.2 tons per day. Wheat bran was primarily used as cattle feed by
livestock breeding centers where as flour, suji, and wholemeal flour were
used by direct household consumers and industrial units.
Existing Joint Cost Allocation Method: An average unit cost for each
product was arrived at by dividing the total joint costs by the combined
output of the four products. The reason behind this was that in as much as
all the four products were obtained by the same process. The cost of
packing, selling and distribution incurred after the sieving stage was
identified with individual products and treated as separable costs.

White flour
Suji
Wholemeal
flour
Bran

Selling prices
Rs 2100
Rs 2480

Cost Prices
Rs 1850
Rs 1850

Separable
Costs
Rs 78
Rs 84

Rs 2000
:Rs. 1140.

Rs 1850
Rs 1850

Rs 34
Rs 16

Problems identified from the case:


1. As on December 31, 1973, Lilac Flour Mills was carrying an
inventory of 2000 tons of bran, which was valued at Rs.37,32,000

Name: Bhavinkumar Parmar,


Roll No: 2010PGP084, Section A

MAC-II

2. This is because the purchase offers ranged from Rs.1000 to


Rs.1350, which was far lower than the total cost that was calculated
by the followed accounting procedure.
3. In the current procedure, the Joint costs in the process are allocated
based on the physical quantities proportion of the output. Because
of this, we are getting a total cost of Rs.1866 per ton for bran.
4. Hence if they are selling bran at the market price at the purchase
prices available in the market, they will incur a loss of around Rs.
760 which is why they are not able to sell it. Hence a lot of bran is
still left as inventory.

From the above points, it is evident that the problem is due to the
allocation of the joint costs based on physical distribution.
Range of possible Solutions: When there are two are more products that
undergo the same process at the same time in the course of conversion,
the joint costs should be allocated to each of the products based on some
allocation basis.
The allocation basis can be of different types:
1. Physical Quantity method: This is the method currently followed
by Lilac Flour mills. This is not yielding the required results as we
end up allocating high cost to bran and so not able to sell it.

Product
While
Flour
Suji
Whole
meal
Flour
Bran

The ratio of the products in physical quantity produced per


each unit of wheat is 6:1:1:2 in the order of white flour, suji,
wholemeal flour and bran respectively. Calculation of Average
unit product cost(Input=900 tons)

Productio
n

Joint
cost
allocated
basis
on
physical
quantity

Joint
cost
per
ton

Separa
ble
Cost
per ton

Total
Cost
per
ton

Sales
price
per
ton

Profit
per
ton

Total
profit

540
90

999000
166500

1850
1850

78
84

1928
1934

2100
2480

172
546

92880
49140

90

166500

1850

34

1884

2000

116

180
900

333000
1665000

1850

16

1866

1140

-726

10440
13068
0
2178

Name: Bhavinkumar Parmar,


Roll No: 2010PGP084, Section A

MAC-II
0

Table I

Allocating the joint costs in the same proportion, we can split


the joint costs among the different products based on this
proportion. Adding separable costs to the joint costs will give
the total cost per each product.

The selling price is assumed to be the market price for


different product as of now in the market. The selling price for
bran is assumed to be Rs.1140 per ton.

The profitabilities of different products based on this method are


tabulated in table I

2. Sales Value Method:

Product
While
Flour

In sales value method, we use the sales value as the basis for
allocation.

Producti Sales
on
in price
tons
per ton
540

2100

Suji
Whole
meal
Flour

90

2480

90

2000

Bran

180

1140

900

Sales
Value
11340
00
22320
0
18000
0
20520
0
17424
00

Joint cost
allocated
on basis
of sales
value

Joint
cost
per
ton

Separa
ble
Cost
per ton

Total
Cost
per
ton

Profi
t
Total
per
profi
ton
t

1083626

2007

78

2085

15

8254

213285

2370

84

2454

26

2355

172004

1911

34

1945

55

4936

196085

1089

16

1105

35

6235
2178
0

1665000

Table II

We allocate the joint costs based on the proportion of the


Sales value of the four products

Name: Bhavinkumar Parmar,


Roll No: 2010PGP084, Section A

MAC-II

The following table-II gives the profitability of different


products when this method is adopted:

3. Net Realization Value(NRV) method:

84
34
16

306
0
288
0

10918
80
21564
0
17694
0
20232
0
16867
80

10777
81
21285
6
17465
5
19970
8
16650
00

1996

78

2365

84

1941

34

1109

16

Total Cost per ton

Joint cost allocated on


basis of sales value

Separable Cost
421
20
756
0

Net Realizable Value


at Split off Point

18000
0
20520
0
17424
00

Separable Cost
per ton

Sales Value

200
0
114
0

78

207
4
244
9
197
5
112
5

Total profit

90
18
0
90
0

11340
00
22320
0

Profit per ton

90

210
0
248
0

tonSeparable Cost per

Bran

54
0

Joint cost per ton

Suji
Whole
meal
Flour

In NRV method, we use (selling price separable costs) as the


allocation basis for the different products

Sales price per ton

While
Flour

Production in tons

Product

26

1409
9

31

2784

25

2285

15

2612
2178
0

Table III

Table III gives the allocation of the joint costs based on this
method, and also the profitability of the different products
when this method is followed

4. Assuming all the three products other than white flour as


by-products:

In this case, we assume only white flour as the main product


as it constitutes 60% of the total output. The remaining three
products namely suji, wholemean flour and bran are treated
as by-products.

Name: Bhavinkumar Parmar,


Roll No: 2010PGP084, Section A

MAC-II

Table IV

Sale
s
Producti price
on
in per
tons
ton

Product
While
Flour

540

2100

Suji

90

2480

Wholeme
al Flour

90

2000

Bran

180

1140

900
Table: IV

Sales
Value
11340
00
22320
0
18000
0
20520
0
17424
00

Joint cost
allocated
on basis
of
assuming
3
byproducts
1070100
215640
176940
202320

Join
t
cost
per
ton
198
2
239
6
196
6
112
4

Separa
ble
Cost
per ton
78
84
34
16

Tota
l
Cost
per
ton
206
0
248
0
200
0
114
0

Profit
per
ton
40

Total
profit
2178
0

0
2178
0

1665000

When some of the products are treated as by-products, we


presume that the total cost of the by-product is just equal to
the selling price of it. Or in other words, profit for these
products is zero.

Hence, when we allocate the joint costs to the different


products, we see that the allot the joint costs to the byproducts such that the total cost of these equal their selling
price. The remaining costs are allocated to the main product
which is the white flour.

The tabe IV gives the cost allocation and the profitability for
the different products when this method is used

5. Assuming only Bran as by-product:

Here, we assume only Bran as by-product. The other three


products namely white flour, suji and wholemeal flour are
considered as main products

Hence, we allocate the joint costs to Bran such that the total
cost of Bran equals its selling price.

The remaining joint costs are allocated to the three main


products based on their sales value.

Name: Bhavinkumar Parmar,


Roll No: 2010PGP084, Section A

Table V gives the cost allocation and profitability calculation


for the different products based on this method:

Sale
s
Producti price
on
in per
tons
ton

Product
While
Flour

MAC-II

540

2100

Suji

90

2480

Wholeme
al Flour

90

2000

Bran

180

1140

900

Sales
Value
11340
00
22320
0
18000
0
20520
0
17424
00

Joint
cost
allocate
d
on
basis of
bran as
a
by
product
107902
6
212380
171274
202320
166500
0

Join
t
cost
per
ton
199
8
236
0
190
3
112
4

Separa
ble
Cost
per ton
78
84
34
16

Tota
l
Cost
per
ton
207
6
244
4
193
7
114
0

Profit
per
ton
24

Total
profit
1285
4

36

3260

63

5666
6

0
2178
0

Table: V
6. Constant Gross margin NRV method:

In this method, we calculate the total Gross margin on all the


products together, and we assume the same gross margin for
different products

Evaluating the solutions:


Table VI gives the summary of all the alternatives discussed above and
the gross margins calculated for different methods:
1. Physical Quantity method:
From the case, it is clear that this method does not give the results
that we expect. We end up allotting a very high cost for Bran. So,
this is not the appropriate method
Production
Value
Method

Sales
Value
Method

Net
Realization
Value

assuming 3
by-products

Assuming
Bran
as
byproduct

Name: Bhavinkumar Parmar,


Roll No: 2010PGP084, Section A

MAC-II
Tota
l
Cost

Produc
t
While
Flour
Suji
Whole
meal
Flour
Bran

Sale
s
pric
e
per
ton
210
0
248
0

Total
Cost
( Inve
ntory
Value
)
Gross
per Margi
ton
n
1928

8.20%

1934

22%

200
0

1884

114
0

1866

5.80%
63.70
%

Total
Cost
( Inve
ntory
Value Gross
) per Margi
ton
n
0.70
2085
%
1.10
2454
%

Total
Cost
( Inve
ntory
Value) Gros
s
per
Marg
ton
in
1.20
2074
%
1.20
2449
%

2480

0%

( Inv
ento
ry
Valu
e)
per
ton
207
6
244
4

Total
Cost
( Inven
tory
Gross
Value) Margi
per ton n
1.90
2060
%

Gross
Margi
n
1.10
%
1.50
%

1945

2.70
%

1975

1.30
%

2000

0%

193
7

3.10
%

1105

3%

1125

1.30
%

1140

0%

114
0

0%

Table VI
2. Sales value method:
This method is better than Physical Quantity method as we do not
observe any loss on any of the products. But if we adopt this
method, we will have gross margin of only 0.7% for the white flour,
which is our main product. This might cause a concern especially for
the senior management.
3. Net Realization Value(NRV) method:
By this method we are getting a good and even profit margin among
all the products. Also we are getting a decent 1.2% gross margin
(which is very close to our overall margin) on our main product
white flour.
4. Assuming all the three products other than white flour as
by-products:
In this method, as according to our assumption, we can see that we
are getting a profit margin of 0% on our main product, white flour.
Also, we are observing a gross margin of 1.9% on white flour.
We have to be careful when we use this method, because we should
note that we are allocating the extra joint costs of by-products to
white flour. In case the market prices of the three by-products fall,

Name: Bhavinkumar Parmar,


Roll No: 2010PGP084, Section A

MAC-II

then it leads to an increase in overall cost of the white flour and


hence decreases its margin. Also, there will be a lot of volatility in
the cost allocation every time.
5. Treating only Bran as by-product:
From the table we can see that, if we adopt this method we are
getting a gross margin of at least 1.1% on the three joint products.
Also, the inventory costs of the three products bear some cost
corresponding to Bran(as we assume it as by-product).

Best solution:
From the above analysis, we can arrive at two final methods which we can
adopt:
1. Net Realization Value method
2. Treating only Bran as By-Product
If we have to choose one method from these two, we can go for the Net
Realization Value method. The reason being, in the long term, it might
happen that the selling price of Bran changes and it leads to a change in
the Inventory costs of other products too. So, to avoid volatility in our
values, we can go for the former method.
Lessons from the case:
From the case analysis, we can identify the following points as learnings:
a) When multiple products are produced using the same processes
simultaneously, the costs involved in the process (Joint costs) should
be allocated after choosing an allocation basis to arrive at the right
costs for each product.
b) Physical distribution method though easy to implement, it can be
used only when the products produced from the process are of
comparable value.
c) We should be careful when treating some of the products as byproducts. Since we will be allocating part of their joint costs to the
main products, this increases the inventory costs of our main
product, which reflects on the balance sheet. So, we should make
sure that there is no significant impact because of this.

Name: Bhavinkumar Parmar,


Roll No: 2010PGP084, Section A

MAC-II

d) Finally, we should keep in mind that the cost allocation of joint costs
should not cause any change in the economic decisions of the firm.
So, which ever method we adopt should not have any impact on the
managerial decisions made. These methods should be viewed only
from accounting perspective.