Marginal Costing Concept - Key Factor Analysis PDF

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Marginal Costing Concept - Ke Keyy Factor Ana Analysis lysis Marginal costing can also be used in budgeting, to help management to determine the profit maximising budget. Planning is necessary when one or more factors of production or other business resources are short in supply. Marginal costing really shows its merit when scarce resources are being considered. Examples of resource restrictions which may apply are as follows: 

Limit to the availability of a particular grade of labour



Shortage of raw material



Limit of machine capacity



Shortage of cash to finance production (working capital)

If labour supply, materials availability, machine capacity or cash availability limit production to less than the volume which could be achieved, management is faced with the problem of deciding what to produce and what not to produce, because there are insufficient resources to make everything. The limiting factor is often sales demand itself, in which case the business should produce enough goods or services to meet the demand in full, provided that sales of the goods earn a positive contribution towards fixed costs and profits. However, when the limiting factor is a production resource, the business must decide which part of sales demand it should meet, and which part must be left unsatisfied. Marginal costing analysis can be used to indicate the profit-maximising. Analysis when only one “Limiting Factor” exists: To maximise the profit, the contribution must be maximised, within the constraints given. The simple approach to tackle this kind of situation would be as follows: Step 1 Identify the Limiting Factor or Key Factor. Doubt: How to identify whether a key factor exist?

i. ii. iii.

Step 2

That is very simple: Calculate the volume of resources required to produce maximum units demanded Calculate the volume of resources available Compare the two volumes above; if (i) exceed (ii), there is a limiting factor.

Ascertain the contribution per unit of the various products.

Step 3 Ascertain the contribution per unit of the Key Factor. For example, if raw material is the Key Factor, calculate the contribution per kg of the raw material; if labour is in short supply, calculate the contribution per hour of the labour, etc. Step 4 Rank the products on the basis of the contribution per unit of the Key Factor. (The product with the highest contribution per unit of the scarce resource should receive priority in the allocation of the resource in the production budget) Step 5 Allocate the scarce resources on the basis of the ranks given above, taking into account the maximum demand.

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X Ltd manufactures and sells 3 products, details of which are mentioned below: No. of units produced and sold Selling Price per unit (`) Direct Material Cost per unit (`) (@` 3/- per Kg) Direct Labour Cost per unit (`) (@` 4/- per Hr.) Other Variable Cost per unit (`)

A 20,000 50 15

B 20,000 50 9

C 20,000 50 6

20

28

32

5

3

2

The total fixed cost for the year is ` 2,40,000. You are required to: 1. 2.



Prepare a statement of operating income for the current year. If in the next year there is shortage of Direct Materials, which will be available only to the extent of 80% of the total requirement, find the optimal product mix for the next year in order to maximize the profit. Assume that the number of units sold at present is the maximum possible sale.

The relevant data of X Ltd. for its three products A, B and C are as under: Particulars Direct Material Direct Labour Variable Overheads Selling Price Machine Hours Required

A 260 130 110 860 12

B 300 270 230 1040 6

C 250 260 180 930 3

The estimated fixed overheads at three different levels of 6,000, 8,400 and 10,800 machine hours are ` 1,50,000, ` 2,20,000 and ` 3,00,000 respectively. The maximum demand of A, B and C in a cost period are 500, 300 and 1,800 units respectively. You are required to find out 1. 2.



The most profitable product-mix at each level and The level of activity where the profit would be maximum.

Fortune Ltd. manufactures Product N using one unit each of three components named P, Q & R and sells it at ` 37.50 per unit. It has two divisions. In production division it produces all the types of components by using its full capacity of 42,000 machine hours. In assembly division the remainingjob is performed by the workers manually before N is ready for sale: Product N is manufactured in batches of 100 units and the data relating to the current production per batch are:

Particulars

Production Division Component - P Component - Q Component -R Assembly Division Assembly

Machine hours

Variable costs `

Fixed Costs `

Total costs `

15 25 30

375 450 450

150 175 450

525 625 900

-

800 2,075

325 1,100

1125 3,175

For the next year the company has estimated that its sale would go up by 50% more than the present sales and probably even by 75% if the production capacity is made available. The machine capacity cannot be increased during the next year even though the workers in the assembly division can be increased as per requirement without any increase in fixed costs. To meet the increased demand, production can be taken up and processed in assembly division by procuring the components from the open market. The company has received the following price quotations for the purchase of components: P 5.55

Price offered per component

Q 7.00

(`) R 8.40

You are required to: 3. Determine the production and profits being earned at present. 4. Indicate which of the component(s) should be purchased and in what quantities at the two estimated levels of output viz. increase by 50% and 75% of existing production. 5. Prepare a statement showing the company’s profitability at both the estimated levels of output. 

Priya Gadgets Ltd. specializing in household gadgets, has just perfected and test marketed a modified version of a popular gadgets. It has three components X, Y and Z one of each is required per gadget. All these components are made and assembled in its own factory and capacity utilizationof the machines is full. The modification essentially involves a special machining and fixing a new attachment for which the company has provided for double the existing production capacity to take care of possible increased demand. The cost structure of the modified gadget is as under: Component

X Y Z Special machining & assembly Selling price

Machine hours per unit Hours 16 24 32 -

Variable cost per unit ` 50 56 54 60 220

Fixed cost allocated per unit ` 15 20 30 45 110

Total cost ` 65 76 84 105 330 500

Since the response to the modified gadgets is very good the Company would like to capture the market in the ensuing year itself by increasing sales. While all the existing machines in the factory are capable of making all the components X, Y and Z, increase of machine capacity can not be

achieved / made during the budget year. However the special machining process and capacity permits one of the components, either X, Y or Z to be bought from outside. The following offers have been received: Component X Y Z

Price per unit ` 66 ` 78 ` 94

The marketing manager feels that sales can be increased at least by 50% during the year and with a little advertisement support even 75%. You are required to give your recommendation as to which components should be bought from outside if production is to be increased by 50% and 75% respectively. 

K Ltd. manufactures and sells a range of sport goods. Management is considering a proposal for an advertising campaign which would cost the company ` 3,00,000. The marketing department has put forward the following two alternative sales budgets for the following year: (‘000 units) Products Particulars A B C D Budget 1 -Without Advertising 216 336 312 180 Budget 2 -With Advertising 240 372 342 198 Selling prices and variable production costs are budgeted as follows: (` Per unit) Products Particulars Selling Prices Variable Production Costs: - Direct Material - Direct Labour - Variable Overheads

A 11.94

B 14.34

C 27.54

D 23.94

5.04 2.04 0.72

6.60 2.04 0.72

15.24 3.36 1.20

12.48 3.18 1.08

Other Data: 1. The variable overheads are absorbed on a machine hour basis at a rate of ` 1.20 per machine hour. 2. Fixed overheads total ` 30,84,000 per annum. 3. Production capacity during the budgeted period is 8,15,000 machine hours. 4. Products A and C could be bought in at ` 10.68 per unit and ` 24 per unit respectively. Required: (i) Determine whether investment in the advertising campaign would be worthwhile and how production facilities would be best utilized. (ii) Explain the assumptions and reasoning behind your advice.



An agriculturist has 480 hectares of land on which he grows potatoes, tomatoes, peas and carrots. Out of the total area of land, 340 hectares are suitable for all the four vegetables but the remaining 140 hectares of land are suitable only for growing peas and carrots. Labour for all kinds of farm work is available in plenty.

The market requirement is that all the four vegetables must be produced with a minimum of 5,000 boxes of any one variety. The farmer has decided that the area devoted to any crop should be in terms of complete hectares and not in fractions of a hectare. The only other limitation is that not more than 1,13,750 boxes of any one vegetable should be produced. The relevant data concerning production, market prices and costs are as under: Annual yield: Boxes per hectare Costs: Direct material per hectare Direct labour: Growing per hectare Harvesting & packing per box Transport per box Market price per box Fixed expenses per annum: Growing Harvesting Transport General administration

Potatoes

Peas

Carrots

Tomatoes

350

100

70

180

` 952

` 432

` 384

` 1,792 ` 7.20 ` 10.40 ` 30.76

` 1,216 ` 6.56 ` 10.40 ` 31.74

` 744 ` 8.80 ` 8.00 ` 36.80

` 624 ` 1,056 ` 10.40 ` 19.20 ` 44.55

` 1,24,000 ` 75,000 ` 75,000 ` 1,50,000

It is possible to make the land presently suitable for Peas and Carrots, viable for growing Potatoes and Tomatoes as well, if certain land development work is undertaken. This work will involve a capital expenditure of ` 6,000 per hectare, which a bank is prepared to finance @ 15% p.a. If such improvement is undertaken, the harvesting cost of the entire crop of Tomatoes will decrease on an average by ` 2.60 per box. Required: 1. Calculate, within the given constraints, the area to be cultivated in respect of each crop to achieve the largest total profit and the amount of such total profit before land development work is undertaken. 2. Assuming that the other constraints continues, advice the grower whether the land development scheme should be undertaken and if so the maximum total profit that would be achieved after the said land development scheme is undertaken. 

Universe Ltd. manufactures two products X and Y. it is facing severe competition in the market. The monthly sales potential in units at different selling prices as anticipated by the sales manager are as under:

Selling Price Per Unit (`) 110 108 107 103 96

Product X Sales Potential (in units) 5,000 7,500 8,000 8,400 9,000

Product Y Selling Price Sales Potential Per Unit (`) (in units) 78 30,000 77 32,000 75 35,000 72 40,000 69 45,000

The total costs as disclosed by the budgets of the company are as follows:

Product X Y Output and sales per month (units) 5,000 Total costs per month (` In lacs) 5 Labour hours needed per month 20,000

Product

9,000 6.6 36,000

30,000 18 60,000

45,000 25.5 90,000

You are required to find out the selling price and units to be sold to earn maximum profit where: 1. 2. 

Labour hours are available without any restrictions and Only 95,000 labour hours are available.

On a turnover of ` 20 crores in 1984, a large manufacturing company earned a profit of 10% beforeinterest and depreciation which were-fixed. The product mix was as under: Products P Q R S

Mix % to total sales 10 30 20 40

PV ratio % 30 20 40 10

Raw material as % on sales value 40% 35% 50% 60%

Interest and depreciation amounted to ` 150 lacs and ` 77 lacs respectively. Due to fluctuations in prices in the International Market, the company anticipates that the cost of raw materials which are imported will increase by 10% during 1985. The company has been able to secure a license for the import of raw materials of a value of ` 1,023 lacs at 1985 prices. In order to counteract the increase in costs of raw materials the company is contemplating to revise its product mix. The market survey report recently prepared indicates that the sales potential of each of the products P, Q and R can be increased up to 30% of the total sales value of 1984. There is no inventory of finished goods or work in process in both the years. 3. Set an optimal product mix for 1985 and find the profitability. 4. What percentage increase in overall price is required in 1985 to raise the sales value to maintain the margin of safety at 10%.

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