Short Term Decision Making

A. Selection of product mix when there is Limiting Factor(s)

a. There is onle ONE limiting factor
1. X Ltd. manufactures and sells A, B, C.
A B C

Selling Price per unit(Rs.) 500 625 935

Variable cost per unit (Rs.) 260 375 465

Machine hour per unit( hour) 0.6 0.5 1

Direct labour Hour per unit(hour) 1 1.2 2.5

The compnay wishes maximise the profit.

Find out P/V Ratio of each product

Required to find out the order of production priority –

i. If machine hours is limiting factor or

ii. If direct labur hours is limiting factor

Particulars A B C

S.P. per unit 500 625 935

(-) VC per unit (260) (375) (465)

Contribution per unit 240 250 470

P/V Ratio 48% 40% 50.27%

i.

Contribution per unit(a) 240 250 470

Machine hour to produce an unit(b) 0.6 0.5 1

Contribution per machine hour [a/b](c) 400 500 470

RANK III I II

ii.

Contribution per unit(a) 240 250 470

Direct labour hour to produce an unit(b) 1 1.2 2.5

Contribution per LHR [(a/b)= c] 240 208.33 188

RANK I II III

2. ABC Ltd . manufactures and sells X, Y, Z. Sales demand X 6200 units, Y

8000 units, Z 11500 units/
Particulars X Y Z
SP per unit 97 111 138
VC -
DM per unit 28 39 49
Direct Labour(Rs.80 per hour) 24 24 32
Variable Overhead 9 9 12
Fixed overheads 27 27 36
Available direct LHR is maximum of 8500 hours. Determine the product
mix.

Particulars X(Rs.) Y(Rs.) Z(Rs.

Variable cost per unit 61 72 93
SP per unit 97 111 138
Contribution per unit [A] 36 39 45
Direct labour hour to produce one unit[B]0.3hr 0.3hr 0.4hr
Contribution perDLH to produce one unit
[C= A/B] 120 130 112.5
RANK II I III
Product Mix when DLH is 8500 hours available
Products No of units DLH per unit Total direct LHRs
Y 8000 0.3 [8000*0.3]= 2400
X 6200 .0.3 [6200*0.3]= 1860
 Z 10600 0.4 [10600*0.4]=4240
8500

Total DLH = 8500hrs.

After producing Y &X available hours = [ 8500- (2400+1860)] = 4240
hours
To produce one unit of Z DLH needed = 0.4 hr
By utilizing 4240 hours Z can be produced = 4240/0.4 = 10600 units

3. Super Ltd. is producing X, Y, Z.

X Y Z

Maximum capacity 5000units 2000units 3000units

Direct material @ 10 per kg Rs.40 Rs.10 Rs.30

Other variable costs Rs.36 Rs.25 Rs.10

SP per unit Rs.100 Rs.50 Rs.60

Fixed costs Rs.20000 Rs.15000 Rs.10000

Calculate best product mix if,

i. Availability of raw material is of 18000kg;

ii. More than 7500 units of three products combined together cannot be
produced;
iii. Total sales value of three products combined together cannot exceed
Rs.650000

Solution :

i. SP per unit 100 50 60

 VC per unit 76 35 40
Contribution per unit (SP-VC) 24 15 20
Material reqd to produce one unit 4kg 1kg 3kg
Contribution per kg of material Rs.6 Rs.15 Rs.6.67
RANK III I II
Maximum capacity 5000 units 2000units 3000units

Product mix
Y 2000units*1kgs = 2000 kgs
Z 3000 units*3 kgs =9000kgs
X 1750units*4kgs=7000 (balancing fig)
18000

Profit in this product mix:

X (1750units *24) = 42000
Y (2000*15) = 30000
Z (3000*20) = 60000
Total Contribution 132000
(-) Fixed cost (45000)
Profit 87000

ii. No. of units is the limiting factor:

Contribution per unit 24 15 20
RANK I III II

Max. capacity in units 5000 2000 3000

PRODUCT MIX
X 5000 units
Z 2500 units (balancing fig)
7500 units
Calculation of Profit:
X (5000*24) = 120000
 Z (2500*20) = 50000
Total Contribution 170000
(-) Fixed Cost (45000)
Profit 125000

iii. Sales value is the limiting factor:

Contribution per unit 24 15 20
P/V ratio 24% 30% 33.33%
RANK III II I
Max. Capacity 5000 2000 3000

Product Mix
Z (3000*60)= 180000
Y (2000*50)= 100000
X ( 3700 *100)= 370000 (Balancing fig)
650000
Calculation of Profit:
X 3700*24 = 88800
Y 2000*15 = 30000
Z 3000*20 = 60000
178800
(-) Fixed cost (45000)
PROFIT 133800
4. A company manufacture three products X, Y, Z. All direct operatives are
the same grade and are paid at Rs.11 per hour. It is anticipated that there
will be shortage of direct operatives in the following period, which will
prevent the company from achieving the following sales target:
X 3600units
Y 8000 units
Z 5700 units

Particulars X Y Z
SP per unit 100 69 85
Variable cost-
Production 51.6 35 42.4
Non production 5 3.95 4.25
Fixed costs-
Production 27.2 19.8 21
Non production 7.1 5.9 6.2
Variable production includes
Cost of direct operatives 24.2 16.5 17.6

The fixed costs per unit are based on achieving the sales targets. There
would not be any savings in fixed costs if production & sales are at a
lower level.
I. Determine the production plan that would maximize profit in the
following period, if the available direct operative hours total 26400
hours;
II. Calculate net profit

Solution:

Statement showing the production priority

X Y Z

SP per unit 100 69 85

(-)VC [Production+non production] 56.6 38.95 46.65

 Contribution per unit (A) 43.4 30.05 38.35

LHR reqd to produce one unit

(direct labour cost / hourly rate)(B) 2.2 h 1.5h 1.6h

Contribution per LHR[A/B= C] 19.73 20.03 23.97

RANK III II I

i. Production plan:

Z 5700units * 1.6 hour = 9120 hrs.

Y 8000units * 1.5 houur = 12000hrs
X 2400units* 2.2 hour = 5280 hrs (balancing fig)
26400hrs

ii. Calculation of profit:

X (2400*43.4) = 104160
Y (8000*30.05)= 240400
Z (5700*38.35)= 218595 563155
(-) Fixed cost
X [3600*(27.2+7.1)]= 123480
Y[8000*(19.8+5.9)]= 205600
Z[5700*(21+6.2)]= 155040 (484120)
PROFIT 79035

B. Make or Buy Decision:

Cost of Making Cost of buying
Variable cost of making Purchase price
1. X Ltd. manufactures automobile parts and accessories. The following are the
total costs of processing 100000units:
Direct Material Cost Rs.500000
Direct labour Cost Rs. 800000
Variable factory overhead Rs.600000
Fixed factory overhead Rs.500000
The purchase price of the component is Rs.22. the fixed overhead would
continue to be incurred even when the component is bought from outside,
although there would have been reduction to the extent of Rs.200000.
Required:
i. Should the part be made or bought outside considering that the present
facility when released following a buying decision would be remain
idle?

Solution:

Compare the cost of making with the cost of buying of 100000units

Particulars Cost of making Cost of buying

a. Variable cost of prod. 19L -

b. Cost of buying - 22L
c. Saving in fixed cost - (2L)
Net Outflow 19L 20L

Decision: If the present facility is remaining idle, then it is economical to

make the product in house.

ii. In case the released capacity can be rented out to another

manufacturer for Rs.150000 having good demand, what should be the
decision?

Particulars Cost of making Cost of buying

a.Variable cost of prod. 19L -

 b.Cost of buying - 22L

c.Saving in fixed cost - (2L)

d.income from renting the capacity - (1.5L)

Net Outflow 19L 18.5L

Decision: If the present facility is rented out, then it is economical to BUY

the product from outside.

2. Cycles Ltd. purchases 20000 bells per annum from an outside supplier at
Rs.50 each. The management feels these bells be manufactured and not
purchased. A machine costing Rs.500000 will be required to manufacture
the item within the factory. The machine has an annual capacity of 30000
units & life of 5years. The additional information is available:
Material cost per unit Rs.20
Labour cost Rs.10
Variable O/H 100% of Labour cost
Required:
i. Should the company make or buy?
ii. Should the accept an order of 5000units @ Rs.45 per unit from
outside?

Solution:

i. For 20000units

Cost of buying = Rs.50 per unit

Cost of making of one unit

 Material 20

Labour 10

Variable O/H 10

Depreciation [(500000/5)/20000] 5

Total Cost of making one unit 45

Decision: Make the in house which will lower the total cost

iii. Additional order of 5000 units,

Cost of making = Rs.40
Total gain will be = (45-40) *5000 = Rs.25000

C. Acceptance of Special Order:

Special order means one time order without disturbing the present
production.
Cost of executing the order must be calculated on the basis of
MARGINAL COST. However specific fixed cost must be taken into
consideration.

Therefore, special order will be accepted

MARGINAL COST < PRICE OFFERED

Rejected if,
MARGINAL COST > PRICE OFFERED

1. A company manufacturing electric motors at a price of Rs.6900 each

made up as under:
Direct material Rs.3200
Direct labour Rs.400
Variable O/H Rs.1000
 Fixed O/H Rs.200
Depreciation Rs.200
Variable selling O/H Rs.100
Royalty Rs.200
Profit Rs.1000
Rs.6300
GST Rs.600
Rs.6900
Required:
i. A foreign buyer has offered to buy 200 such motors at Rs.5000
each. Would you accept the order?
ii. What should the company quote for a motor to be purchased by a
company under the same management if it should be at cost?

i. Whether the order to be accepted when the offer price is Rs.5000

each:
Price Offered 5000
(-) Variable cost
DM 3200
DL 400
Variable O/H 1000
Variable selling o/H 100
Royalty 200 4900
Contribution 100

Decision: To accept the special order as it gives you a positive

contribution.
ii. Price to be quoted :
Variable production cost: 4800
Fixed Cost:
Fixed O/H 200
Depreciation 200 400
Total Cost 5200
2. A company currently operating at 80% capacity has the following
particulars:
Sales Rs.32L
Direct Materials Rs.10L
Direct Labour Rs.4L
Variable O/H Rs.2L
Fixed O/H Rs.13L
An export order has been received that would utilize half 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 sale only (as at
present); or
ii. Accept the order, split capacity between overseas and domestic
sales and turn away excess domestic demand.

Prepare a comprehensive statement of profitability and suggest the best

alternatives.

Alternative I: Reject the export order

Sales 3200000

(-) V. costs[10+4+2] (1600000)

Contribution 1600000

(-) Fixed Cost (1300000)

Profit 300000

Alternative II:

Currently the company operates at 80%

Domestic sales at 100% capacity = 3200000/80% = Rs.40L

 If the co. accepts the export order that will utilize 50% capacity

Domestic sales = 50% of 40L = Rs.20L

Export sales = 90% [50% of 40L] = 18L

Sales revenue [20L+18L] 3800000

(-)V. cost [16L/80*100] (2000000)

Contribution 1800000

(-) Fixed cost (1300000)

Profit 500000

Decision: Alternative II i.e. accept the export order & turn down a
portion of domestic sale.

D. Discontinuing of a product
Following points to be considered:
a. No product will be discontinued if the contribution is positive;
b. Total fixed cost (common) for the business as a whole will remain same
or decrease.
c. Share of fixed cost of discontinued product will have to be borne by the
remaining products.
d. Effect on sale of other products because of discontinuation of a product.

1. The following data relates to a company manufacturing four types of

detergent powder:
Product A B C D
Sales 825000 1125000 300000 390000
Variable cost 495000 825000 150000 240000
Fixed cost 150000 112000 188000 165000
Profit/Loss 180000 188000 (38000) (15000)
It has been suggested the product C & D should be discontinued from
production as both the products are loss making.
Should the product C& D be discontinued?
 Statement showing the contribution of each product

Sales 825 1125 300 390

(-) VC (495) (825) (150) (240)
Contribution 330 300 150 150
Contribution of C & D is positive. So, both the products are to be
continued.

Statement showing the profit under continuation of all the products &
discontinuation of C& D.
Original production If C&D discontinued
Contribution
A 330 330
B 300 300
C 150 ---
D 150 ---
Contribution 930 630
(-) FC (615) (615)
Profit 315 15

If C&D are discontinued then the co. is going to have only Rs.15000 as
profit. So, it is better to continue production of all the products A, B, C,
D.

E. Shut Down point

Total Shut down cost with Loss to be incurred if operation continued

Total shut down cost:

Total present fixed cost ---

(-) contribution from present sales ---

Shut down cost / loss

Loss to be incurred for continuation:

Sales revenue ----

(-) VC (----)

Contribution -----

(-) FC (-----)

Profit /loss -----

Factors to be considered :

i. The possibility of losing customers

ii. The possibility of losing skilled labours
iii. The reaction of the labour unions and the Government
iv. The chance of obsolescence of raw materials
v. The agreement with the suppliers
vi. The possibility of bad debt due to non payment by existing customers
vii. The chance of obsolescence of plant & machinery.

The shut down cost includes the following:

i. Unavoidable fixed cost;

ii. Cost of maintenance of plant & machinery;
iii. Cost of overhauling the plant at the time of re-opening;
iv. Cost of training of employees;
v. Cost of new recruitment.

1. A Ltd. at present manufactures 20000 units of X in a year at its normal

production capacity, the selling price per unit is Rs.50. the variable cost
per unit and fixed costs at this level are Rs.13 and Rs.4 respectively. Due
to trade depression, it is expected that only 2000 units of X could be sold
in the coming year. The management plans to shut down, the fixed cost
 will be Rs.33000, during the next year. Additional cost of plant shut
down is Rs.12000. Should the plant shut down?

Profit /Loss during the next period

Sales (2000 units*Rs.50) 100000

(-) VC [2000*13] (26000)

Contribution 74000

(-)FC [20000*Rs.4] (80000)

Loss (6000)

Shut down cost:

Unavoidable FC 33000

(+) Additional Shut down cost 12000

Shut down cost 45000

Decision: If it opts for shut down the loss it needs to face is Rs.45000 which is
more compared to the loss if it continues its production process. So it is advisable
to continue its production of 2000 units in the next year.

Shut down Point:

one should suspend its production

Above the point should be continued

Below the point should be suspended

Shut down point = [FC- Shutdown cost] / contribution per unit

= Avoidable FC / contribution per unit

2. M Ltd. when operated at normal capacity, produces 20000 of a product,
the manufacturing cost per unit at normal capacity is as follows:
Direct material Rs.6.50
Direct labour Rs.2.60
Variable O/H Rs.3.30
Fixed O/H Rs.4.00
Total Rs.16.40
Each unit of product is sold at Rs.20 with variable selling &
administrative expenses 60 paise per unit of product. The company
expects that during the next year only 2000 units can be sold.
Management plans to shut down the plant, estimating that the fixed
manufacturing overhead can be reduced to Rs.45000 for the next year.
When the plant is operating, the fixed overhead costs are incurred at an
uniform rate throughout the year. An additional cost of plant shut down is
estimated at Rs.14000. should the plant shut down? What is the shut
down point?

Profit /loss if the plant is in operation:

Sales [2000units *20] 40000
(-) V Costs
[6.5+2.6+3.3+0.6= 13] (26000)
Contribution 14000
(-) FC [4*20000] (80000)
Loss (66000)
Shut Down Cost:
Unavoidable FC 45000
Additional cost 14000
59000

Decision: it is better to shut down its operation to minimize the loss upto
Rs.59000.

Shut down point = FC- shutdown cost/contribution per unit

 = [80000 – 59000] / [20-13]
= 3000 units

At 3000 units,
Contribution [7*3000] 21000
(-) FC (80000)
Loss 59000
At 3000 units i.e. the shut down point the co. may shut down or continue
its production as both will give the same amount of loss of Rs.59000.
Absorption Costing:

As per Marginal Costing Profit Statement:

Sales ***

(-) Variable Cost [Production & adminis, selling] ***

Contribution ***

(-) Fixed Cost [Production & adminis, selling] ***

PROFIT ***

As per Absorption Costing Profit Statement

Sales ***

(-) Cost of goods Sold ***

[Op.st. +Goods manufactured- Cl.St]

Gross Profit ***

(-) Selling O/H ***

Net Profit ***

1. Total production Cost Rs.7.50/unit

Variable production Cost Rs.4.80/unit
Total Variable cost rs.5.90/unit
Total Cost Rs.10.00 / unit
Total Production 11400units, number of units sold during the period 11200
units. what is the profit difference using absorption costing rather than
marginal costing?
Solution:
Fixed production Cost = (7.50-4.80) = Rs.2.70 per unit
Total Production 11400units
(-) No.of units sold (11200)units
Closing Stock 200units
 under Marginal costing closing stock = 4.8*200units = Rs.960
under Absorption costing closing stock = 7.5*200units = Rs.1500
Profit difference Rs.540

2. Opening Stock of Fgoods NIL

No. of FG manufactured 10000units
No. of FG sold during the year 9000units
S.P./unit Rs.1500
Variable cost / unit :
D.Materials 200
D.Labour 100
D.Expenses 100
Variable Manu. O/H 300
Variable Selling & Admin.O/H 100
FC p.a.
Fixed manu. O/H 20L
Fixed Selling & Adminis. O/H 10L
Calculate profit as per marginal costing & absorption costing.

Solution:
Profit as per Marginal Costing: Rs. in ‘000
Sales [9000*1500] 13500
(-) Variable Manufacturing cost
[Rs.700*10000] 7000
(-) Cl.St.[Rs.700*1000] (700)
Variable Cost of Goods Sold 6300
(+) Variable Selling & Distri 900 (7200)
Contribution 6300
(-)Fixed manu. O/H 2000
(-)Fixed Selling & Adminis. O/H 1000 3000
PROFIT 3300
Profit as per Absorption Costing: Rs. in ‘000

Sales 13500
(-) COGS:
Op.St. Nil
+ Cost of goods Manufactured[10000*900] 9000
- Closing Stock [ 1000units*900] (900) (8100)

Gross Profit 5400

(-) Total Selling &admin O/H[(100*9000)+10L] (1900)

Net Profit 3500

Reconciliation Statement

Profit as per Absorption Costing 3500

(-) Over valuation of closing stock (200)

Profit as per Marginal Costing 3300

***Total Production Cost per unit = [700+(20L/10000)]= Rs.900

***cost of goods sold= total manufacturing / production cost

3. A company has a production capacity of 2L units p.a. Normal capacity

utilization is reckoned as 90%. Standard variable production costs are Rs.11
p.u. The fixed costs are Rs. 360000 p.a. variable selling costs are Rs.3 per
unit & fixed selling costs are Rs.270000 p.a. The unit selling price is Rs.20.
In the year end the production is of 160000 units and sales were 150000
 units. The closing stock at the year end being 20000 units. The actual
variable production costs for the year were Rs.35000 higher than the
standard.
i. Calculate the profit of the year;
a. By absorption method;
b. By marginal costing
ii. Explain the differences in profit.

Opening stock (10000units)

VC per unit 11

(+) FC per unit [360000/180000] 2

13

Value of opening stock (10000*13) = 130000

Absorption Costing:

Sales (150000*20) 3000000

(-)COGS

Opening Stock 130000

(+) VC of production (160000*11) 1760000

FC of production 360000

Increase in FC 35000

2285000

(-)Closing stock [2155000*20000/160000] (269375) (2015625)

Gross Profit 984375

(-)Selling Expenses
VC [150000*3] 450000

FC 270000 (720000)

Net profit 264375

Marginal Costing:

Sales 3000000

(-)VC of Production

Opening Stock [11*10000] 110000

VC of production [(11*160000)+35000] 1795000

(-) ClosIng Stock [ 1795000*20000/160000] (224375)

1680625

(+) VC of selling [3*150000] 450000 (2130625)

Contribution 869375

(-) FC

Production 360000

Selling 270000 (630000)

Profit 239375

Profit as per absorption costing 264375

(+) Adjustment of op st [130000-110000] 20000

(-) over valuation of cl st [269375-224375) (45000) (25000)

Profit as per marginal costing 239375