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Unit4

MODULE6

AbsorptionandMarginal
Costing

PracticalProblems

(withsolutions)



1. Pepsi Company produces a single article. Following cost data is given about its
product:
Sellingpriceperunit Rs.40
Marginalcostperunit Rs.24
Fixedcostperannum Rs.16000
Calculate:
(a)P/Vratio (b)breakevensales(c)salestoearnaprofitofRs.2,000(d)Profit
atsalesofRs.60,000(e)Newbreakevensales,ifpriceisreducedby10%.

Solution:
Weknowthat(Sv)/S=F+P OR sxP/VRatio=Contribution
So, (A)P/VRatio=Contribution/salesx100
=(4024)/40x100=16/40x100 OR 40%

(B)Breakevensales
SxP/VRatio=FixedCost
(Atbreakevensales,contributionisequaltofixedcost)
Puttingthisvalues:sx40/100=16,000
S=16,000x100/40=40,000 OR 1000units

(C)ThesalestoearnaprofitofRs.2,000
SxP/VRatio=F+P
Puttingthisvalues:sx40/100=16000+2000
S=18,000x100/40
S=Rs.45,000OR 1125units

(D)Profitatsalesof60,000
SxP/VRatio=F+P
Puttingthisvalues:Rs.60,000x40/100=16000+P
24,000=16000+P
24,00016,000=P
8,000

(E)Newbreakevensales,ifsalepriceisreducedby10%
Newsalesprice=4010%=404=36
Marginalcost=Rs.24
Contribution =Rs.12
P/VRatio = Contribution/Sales
= 12/36x100 OR 33.33%
Now,sxP/VRatio=F (atB.E.P.contributionisequaltofixedcost)
Sx100/300 =Rs.16000
S=16000x300/100
S=Rs.48,000.

2. Fromthefollowinginformation'sfindout:
a.P/VRatio
b.Sales&
c.MarginofSafety
FixedCost =Rs.40,000
Profit =Rs.20,000
B.E.P. =Rs.80,000

Solution:
a.P/VRatio.
WeknowthatSV=F+P OR S(SV)/S=F+P
B.E.S.xP/VRatio=F(ValueofPiszeroatBESales) OR P/VRatio=F/BES
Puttingthevalue,
P/VRatio=40,000/80,000 = 50/100 OR 50%
b.Sales.
WeknowthatSalesxP/VRatio=F+P OR SalesxP/VRatio=Contribution
ORSales=Contribution/P/VRatio
So, =(40,000+20,000)/50/100
=(60,000x100)/50
=Rs.1,20,000
c.MarginofSafety.
MarginofSafety=SalesB.E.PSales
So, MOS=1,20,00080,000
MOS=Rs.40,000

3. BansicompanymanufacturesasingleproducthavingamarginalcostofRs.1.50per
unit.
FixedcostisRs.30,000perannum.Themarketissuchthatupto40,000unitscan
besoldatapriceofRs.3.00perunit,butanyadditionalsalemustbemadeatRs.
2.00perunit.CompanyhasaplannedprofitofRs.50,000.Howmanyunitsmustbe
madeandsold?

Solution:
a.Contributiondesired=Fixedcost+DesiredProfit
=30,000+50,000=80,000
b.Calculationofcontributionbyproducing40,000units.
Contributionperunit=SellingpriceMarginalcost
=3.001.50
=1.50
c.Contributionforproducing40,000units.
=1.50x40,000units
=Rs.60,000
d.AdditionalunitstobeproducedandsoldatRs.2.00perunitafter40,000units.
=Rs.80,000Rs.60,000
=Rs.20,000
e.UnitstobeproducedforcontributionofRs.20,000afterchangeinprice.
Contributionperunit=Rs.2.00Rs.1.50=Rs.0.50
f.AdditionalunitstobeproducedforcontributionofRs.20,000.
=(20,000x100)/50=40,000units.
Totalunitstobeproducedtoearnplannedprofit=40,000+40,000=80,000units.


4. Mitanshi & company manufacture three products. The following is the cost data
relatingtoproductsA,B,andC.
Products A B C Total
Rs. Rs. Rs. Rs.
Sales 1,50,000 90,000 60,000 3,00,000
VariableCost 1,20,000 63,000 36,000 2,19,000
Contribution 30,000 27,000 24,000 81,000
FixedCost 40,500
Profit 40,500
Prove that how knowledge of marginal costing can help management in changing
thesalesmixinordertoincreaseprofitofthecompany.

Solution:Letsfindoutrelativeprofitabilitysothatwecancompareitlateron.
Products A B C Total
Rs. Rs. Rs. Rs.
Sales 1,50,000 90,000 60,000 3,00,000
VariableCost 1,20,000 63,000 36,000 2,19,000
Contribution 30,000 27,000 24,000 81,000
FixedCost 40,500
Profit 40,500
P/VRatio 20% 30% 40% 27%
FromtheabovetableitisclearthatwiththecomparisonofproductBandC,Ais
less profitable. Keeping total production same, company should change the sales
mixinawaythatemphasisshouldbeonproducingproductCandB.
Now assume that the company decides to use its production capacity more for
productBandCthanA.Lets seetheeffectonprofitifsaleofproductBandC is
increasedbyRs.30,000eachandproductAbyreducingRs.60,000.
Products A B C Total
Rs. Rs. Rs. Rs.
Sales 90,000 1,20,000 90,000 3,00,000
VariableCost 72,000 84,000 54,000 2,10,000
Contribution 18,000 36,000 36,000 90,000
FixedCost 40,500
Profit 49,500
Fromtheabovetable,wecanobservethatproposedchangeinproductmixleadsto
anincreaseinprofitfromRs.40,500toRs.49,500.

5. AcompanyhasamachineNo.9whichcanproduceeitherproductAorB.Thecost
datarelatingtomachineAandBareasfollows:

Particulars Product ProductB
A
Sellingprice Rs.20.00 Rs.30.00
Variable Rs.14.00 Rs.18.00
expenses
Contribution Rs.6.00 Rs.12.00

AdditionalInformation:
a.CapacityofmachineNo.9is1,000hrs.
b.InonehrsmachineNo.9canproduce3unitsofAand1unitofB.
WhichproductshouldmachineNo.9produced?

Solution:
StatementshowingcontributionperhourformachineNo.9

Particulars Product Product
A B
Sales 20.00 30.00
Variableexpenses 14.00 18.00
Contributionperunit 6 12
Contributionperhour 18.00 12.00
Contribution per 1, 000 18,000 12,000
units
FromtheabovetablewecanseethatcompanyshouldproduceproductAwiththe
helpofmachineNo.9.

6. Meet&companyLtd.hasthreedivisionseachofwhichmakesadifferentproduct.
Thebudgeteddataforthenextyearisasfollows:

Divisions A B C
Rs. Rs. Rs.
Sales 1,12,000 56,000 84,000
Directmaterial 14,000 7,000 14,000
Directlabor 5,600 7,000 22,400
Variableoverhead 14,000 7,000 28,000
Fixedcost 28,000 14,000 28,000
Totalcost 61,600 35,000 92,400
The management is considering closing down division C. There is no possibility of
reducingvariablecosts.AdvicewhetherornotdivisionCshouldbecloseddown.

Solution:
MarginalCostStatement

Division A B C
Rs. Rs, Rs.
Sales 1,12,000 56,000 84,000
Marginalcost 33,600 21,000 64,400
(Direct material + Direct cost +
Variableoverheads)
Contribution 78,400 35,000 19,600
Fixedcost 28,000 14,000 28,000
Profit 50,400 21,000 (8,400)


7.Costdataforlastyear:
Sales 60,00,000 (Operatingat75%capacity)
Marginalcost(50%ofsale) 30,00,000
Contribution 30,00,000
Fixedcost 20,00,000
Profit 10,00,000
Percentageofprofitoversales 16.7%
Areportontheperformancefortheyearstates:
Sales 80,00,000
Profit 16,00,000
Percentageonprofitonsale 20%
Should the performance of current year be commended? What option should be
conveyed to the managing director on the basis of the Cost Volume Profit
analysis?

Solution:

StatementshowingprofitforlastyearandprofitatasaleofRs.80,00,000
Particulars Lastyearperformance Performanceinpresent
75%capacity activitylevel,i.e.,100%
Rs. Rs.
Sales 60,00,000 80,00,000
Marginal cost 30,00,000 40,00,000
(50%ofsales)
Contribution 30,00,000 40,00,000
Fixedcost 20,00,000 20,00,000
Profit 10,00,000 20,00,000

From the above table we can say that result of current years performance is not
commendable because profit should have been 25% of sales after operating at
100%capacity,whereasitisonly20%ofsales.

8.Thefollowingbudgethasbeenpreparedat70%levelofhomemarket:
Units 4,200
Wages 12,600
Materials 21,000
Fixedcost 7,000
Variablescost 2,100
Total 42,700

ThesellingpriceinIndiaisRs.15.InSriLankaabout800unitsmaybesoldonlyat
Rs.10andinaddition25paiseperunitwillbeexpensesasfreightetc,Doyouadvise
tryingforthemarketintheSriLanka?
Solution:

Particulars India SriLanka Total
(4200units) (800units) (5000units)
Rs. Rs. Rs.
Sales(unitsxprice)(A) 63,000 8,000 71,000
Materials(Rs.5perunit) 21,000 4,000 25,000
Wages(Rs.3perunit) 12,600 2,400 15,000
Variables(Rs.0.50perunit) 2,100 400 2,500
Freight(OnlyforSriLankaRs.0.25perunit) 200 200
Marginalcost(B) 35,700 7,000 42,700
Contribution(AB) 27,300 1,000 28,300
Less:Fixedcost 7,000 7,000
20,300 1,000 21,300
Suggestion: It is advisable to try for the Sri Lankan market at Rs. 10 per unit as by
doingsothereisanincreaseofRs.1000.

9. Asianpaintsmanufacture1,000tinsofpaintswhenworkingatnormalcapacity.It
incursthecostofRs.16inmanufacturingoneunit.Thedetailsofthiscostaregiven
below:
Particulars Rs.
Directmaterial 7.50
Directlabor 2.00
Variableoverheads 2.50
Fixedoverheads 4.00
Production cost (per 16.00
unit)
Each unit of product is sold for Rs. 20 with variable selling and administrative
expensesofRs.0.50perunitofproduction.
Duringthenext3months,only500unitscanbeproducedandsold.Management
planstoclosedownthefactoryestimatingthatthefixedmanufacturingcostcanbe
reducedtoRs.2,000forthequarter.
Whentheplantisoperating,thefixedoverheadcostsareincurredatauniformrate
throughout the year. Additional cost of plant shut down for the three month is
estimatedatRs.2,800.
Express your view whether the plant should be shut down for three months, and
calculatetheshutdownpointforthreemonthsinunitsofproducts.

Solution:
(A)StatementshowingContributionperunit:
Particulars Perunit
Rs.
Directmaterial 7.50
Directlabor 2.00
Variableoverheads 2.50
Variablesellingand 0.50
administrativeexpenses
Marginalcost(Total)(A) 12.50
Sales(B) 20.00
Contribution(A B) 7.50
(B)ComputationofLoss,iftheplantisoperated:
500unitstobeproduced:
Contributionon500units:
500xRs.7.50 =Rs.3,750
Fixedcostforthreemonths
10,000x4x3/12 =Rs.10,000
ExpectedcostonOperation
(ContributionFixedcost) =Rs.6,250
(C)Computationofloss,iftheplantisshutdown:
UnfavorableFixedcost =Rs.2,000
AdditionalcostofShutdown =Rs.2,800
Totallossonshutdown =Rs.4,800
(D)Advise: From the above calculation, it is clear that it is in the interest of
companytoshutdown.
(E)Calculationofshutdownpoint:
Avoidablefixedcostfortheperiod
=Totalfixedcostsfortheperiodunavoidablefixedcostadditionalcostforshut
down
=Rs.10,000Rs.2,000Rs.2,800
=Rs.5,200
Shutdownpoint=Avoidablefixedcost/Contributionperunit
=5,200/7.50 =693units.

10. A company is providing its product to the consumer through the wholesalers. The
managingdirectorofthecompanythinksthatifthecompanystartssellingthrough
retailersortotheconsumersdirectly,itcanincreaseitssales,chargehigherprices
andmakemoreprofit.
Onthebasisofthefollowinginformation,advisethemanagingdirectorwhetherthe
companyshouldchangeitschannelofdistributionornot:

Particulars Wholesaler Retailer Consumer
Rs. Rs. Rs.
Salesperunit 3.60 5.25 6.00
Estimated Sales per year 1,00,000 1,20,000 1,80,000
(units)
Sellinganddistribution 0.40 1.00 1.50
overheads(perunit)
Costofproduction:VariablecostRs.2.50perunit,FixedcostRs.50,000.

Solution:

Statementofprofit
Particulars Wholesaler Retailers Consumers
Rs. Rs. Rs.
No.ofunitsold 1,00,000 1,20,000 1,80,000
Sales revenue (unit x 3,60,000 6,30,000 10,80,000
price)(A)
Variablecost 2,50,000 3,00,000 4,50,000
Selling and distribution 40,000 1,20,000 2,70,000
overheads
Marginalcost(B) 2,90,000 4,20,000 7,20,000
Contribution(A B) 70,000 2,10,000 3,60,000
Less:Fixedcost 50,000 50, 000 50,000
Profit (Contribution 20,000 1,60,000 3,10,000
Fixedcost)
Advise: Sales should be made directly to the consumers as this channel contributes
higherprofit.

11.ThecostanalysisoftwoproductsAandBisgivenbelow:
Particulars ProductA ProductB
Rs. Rs.
MaterialRs.2.50perunit 25 45
Labor@Rs.1perhour 12
Labor@Rs.1.50perhour 15
Variableoverheads 2 5
Sellingprice 70 80

On the basis of above information, which product would you recommend to be
manufacturediflaboriskeyfactorandifmaterialiskeyfactor?

Solution:
Herefirstofallwehavetofindoutcontributiononthebasisofboth,materialasakey
factorandlaborasakeyfactor.
Statementshowingmarginalcostandcontribution
Particulars ProductA ProductB
Rs. Rs.
Sellingprice(A) 70 80
Material 25 45
Labor 12 15
Overheads 2 5
Marginalcost(B) 39 65
Contribution(A B) 31 15
Contributionperunitof 31/10units=3.10 15/18=0.83
Material (25units/2.50=10units) (45units/2.50=18units)
Contributionperlabor 0.258 1.50
Hour (31/12hrs) (15/10hrs)
Advise:IflaboriskeyfactorthenproductBandifmaterialiskeyfactorthenproductA
shouldbeproduced.

12. Amanufacturerproduces1500unitsofproductsannually.Themarginalcostofeach
productis Rs. 960andtheproduct is sold for Rs. 1200. Fixed cost incurredby the
companyisRs.48,000annually.CalculateP/VRatioandwhatwouldbethebreak
evenpointintermsofoutputandintermsofsalesvalue?

Solution:
A.Contributionperunit=SalesVariablecost=Rs.1200Rs.960=Rs.240
B.P/VRatio=Contribution/Salesx100=240/1200x100=20%
C.Breakevenpoint(inunits)=Fixedcost/Contributionperunit=
=48,000/240=200units
D.Breakevenpoint(inRs.) =Breakevenpointxsellingpriceperunit
=200x1200=2,40,000
OR
D.Breakevenpoint(inRs.) =Fixedcost/P/VRatio
=48,000/20%=2,40,000

13. FromthefollowingdatacalculateMarginofSafety.
Particulars Rs.
Sales 15,00,000
Fixedexpenses 4,50,000
Profit 3,00,000

Solution:
P/VRatio =Fixedexpenses+Profit/Salesx100
=Rs.4,50,000+3,00,000/15,00,000x100
=7,50,000/15,00,000x100
=50%
MarginofSafety=Profit/P/VRatio
=3,00,000/50%
=6,00,000

14.FollowingdataisofDevmanufacturingcompany.
Costs Variablecost Fixedcost
(%ofSales) Rs.
Directmaterials 23.8
Directlabor 18.4
Factoryoverheads 21.6 37,980
Distributionexpenses 4.1 11,680
General&administrativeexpenses 11.1 13,340
BudgetedsalesforthenextyearareRs.3,70,000.
Calculatethefollowings:
Thesalesrequiredtobreakeven.
Profitatthebudgetedsalesvolume
Theprofit,ifactualsalesA.Increasesby5%fromthebudgetedsalesandB.Drop
by10%fromthebudgetedsales.

Solution:
A.Variablecost=23.8+18.4+21.6+4.1+11.1=79%(ofsales)
So,itwillbe79%ofsales=3,70,000x79/100=2,92,300
B.Fixedcost=Rs.37,980+Rs.11,680+Rs.13,340=63,000
C.Contribution=10079=21%
D.P/VRatio =Contribution/Salesx100
=21/100x100=21%
Breakevenpoint=Fixedcost/P/VRatio
=63,000/21%
=Rs.3,00,000
ProfitatbudgetedsalesofRs.3,70,000
Contribution=SalesxP/VRatio
=3,70,000x21%
=Rs.77,700
Contribution =Fixedexpenses+Profit
So,Profit =ContributionFixedexpenses
=Rs.77,70063,000
=Rs.14,700


Profitifactualsalesincreasedby5%fromthebudgetedsales.
Particulars Rs.
Sales 3,70,000
Add:5%increaseonRs.3,70,000 18,500
Revisedsales 3,88,500
Less: Variable cost 79% of Rs. 3, 88, 3,06,915
500
Contribution 81,585
Less:Fixedcost 63,000
Profit 18,585
Profitifactualsalesdroppedby10%
Particulars Rs.
Sales 3,70,000
Less:10%decreaseonRs.3,70,000 37,000
Revisedsales 3,33,000
Less:Variablecost79%of3,33,000 2,63,070
Contribution 69,930
Fixedcost 63,000
Profit 6,930

15. Gyanlimitedmanufacturesandsellsfourtypesofproductsunderthebrandnames
A,B,C,andD.Thesalesmixinvaluecomprises30%,40%,20%,and10%ofA,B,C,
and D respectively. The total budgeted sales are Rs. 60, 000 per month. The
operatingcostsare:
ProductA 60%ofsellingprice
ProductB 70%ofsellingprice
ProductC 80%ofsellingprice
ProductD 70%ofsellingprice
FixedcostRs.12,000permonth.Calculatethebreakevenpointandpercentageof
marginofsafetyfortheproductonoverallbasis.

Solution:
CalculationofSalesMix
Products
A B C D Total
Particulars 30% 40% 20% 10% 100%
Rs. Rs. Rs. Rs. Rs.
Sales 18,000 24,000 12,000 6,000 60,000
Less:Variablecost 10,800 16,800 9,600 4,200 41,400
Contribution 7,200 7,200 2,400 1,800 18,600
Less:Fixedcost 12,000
Profit 6,600


P/VRatio =Contribution/Salesx100
=18,600/60,000x100
=31%
Breakevenpoint=Fixedcost/P/VRatio
=12,000/31%
=38,709
Marginofsafety=ActualsalesBreakevenpoint/Actualsalesx100
=60,00038,709/60,000x100
=35.48%

16. Fromthefollowinginformation,calculateBreakevenpointandSalestoearnprofit
ofRs.2,40,000.

Particulars Rs.
Sales 8,00,000
Fixedcost 3,60,000
Variablecost 5,60,000

Solution:
Contribution=SalesVariablecost
=8,00,0005,60,000
=2,40,000
P/VRatio=Contribution/Salesx100
=2,40,000/8,00,000x100
=30%
SalestoearnaprofitofRs.2,40,000
=Fixedcost+DesiredProfit/P/VRatio
=3,60,000+2,40,000/30%
=6,00,00/30%
=20,00,000

17. Fromthe informationgiven below, calculate P/V Ration, Fixed expenses, Expected
profitifsalesisbudgetedatRs.90,000.
Year sales Profit
2004 1,80,000 30,000
2005 2,60,000 50,000

Solution:
P/VRatio=(ChangeinprofitRs./ChangeinsalesRs.)x100
=50,00030,000/2,60,0001,80,000x100
=20,000/80,000x100
=25%
Contribution=SxP/VRatio
=1,80,000x25%
=45,000
Fixedcost =Contribution=F+Profit
=45,000=F+30,000
=F=45,00030,000
=F=15,000
WhensalesisbudgetedasRs.90,000
Contribution=SalesxP/VRation
=90,000x25/100
=22,500
Profit=ContributionFixedcost
=22,50015,000=7,500

18.ThebudgetedresultsofDevlimitedcompanyincludethefollowing:
Products SalesvolumeRs. P/V
Ratio
A 2,00,000 40%
B 1,20,000 50%
C 80,000 25%
Total 4,00,000 30%
Fixed overheads for the period are Rs. 80, 000. The management is very much
concerned at the result forecasts for the company. They have requested you to
prepare a statement showing the amount of loss expected and recommend a
changeinsalesmixwhichwilleliminatetheexpectedloss.

Solution:
A.Contribution=4,00,000x30/100=1,20,000
Loss=ContributionFixedcost
=1,20,00080,000
=40,000
B.Recommendedchangeinsalesmix:

UnderrecoveryoffixedcostorLoss/P/VRatiooftheproduct
ProductA=40,000/40%
=1,00,000
ProductB=40,000/50%
=80,000
ProductC=40,000/25%
=1,60,000
C.IncreaseintotalsaletoeliminatelossofRs.40,000:
=ExpectedLoss/CompositeP/VRatio
=40,000/30%
=1,33,334


19. Use the following information and explain that how the reduction in selling price
wouldaffectthemarginofsafety?
Particulars Rs. Rs.
Sellingpriceperunit 40
Variablecost
Material 12
Labor 8
Overheads 4 24
FixedcostisRs.8,000.
FullcapacityofthePlantis5,000units.
ReducedsellingpriceisRs.32perunit.

Solution:
1.WhensellingpriceisRs.40,thenMarginofSafety:
MOS=TotalsalesSalesatB.E.P.
So,firstofallwehavetocalculateTotalsalesandSalesatB.E.P.

A.TotalSales=TotalunitsxSalespriceperunit
=5,000x40
=2,00,000

B.SalesatB.E.P.=FixedcostxPrice/PriceVariablecost
=8,000x40/4024
=3,20,000/16
=20,000

FromtheaboveinformationnowwecancalculateMarginofSafetybythefollowing
way:
MarginofSafety=TotalsalesSalesatB.E.P.
=2,00,00020,000
=1,80,000

2.MarginofSafetywhenreducedsellingpriceisRs.32:
B.E.P.=FixedcostxPrice/PriceVariablecost
=8,000x32/3224
=8,000x32/8
=32,000
MarginofSafety=1,80,00032,000
MarginofSafety=1,48,000
3.Impact:Fromtheabovecalculationwecanseethatthereducedpricewilldecrease
marginofsafetyandB.E.P.willincrease.