Question 1. Analysis of Cost Structure of MRF Limited
Question 1. Analysis of Cost Structure of MRF Limited
Question 1. Analysis of Cost Structure of MRF Limited
Classification of cost
Cost can be classified in following broad categories
Based on Nature:
1. Material
2. Labour
3. Other
Based on Function
1. Production/Manufacturing
2. Administrative
3. Selling
4. Distribution
5. Research and development
Based on identification
1. Direct
2. Indirect
Based on Behavior
1. Fixed
2. Variable
3. Semi-variable
Considering above classification, all costs of MRF ltd have been plotted as per different
classification basis as below
Classification of cost
Amount in Basis of classification
Percentage
Particulars Crores Behavio
of Total cost identifiably Function Nature
(Mar'20) ur
Materia
COGS 9508.91 63.72% Direct Production Variable
l
Employee
Administrati
Benefit 1320.51 8.85% Indirect Labour Fixed
ve
Expenses
Finance Administrati
274.26 1.84% Indirect Other Fixed
Cost ve
Depreciatio
n and Administrati
980.62 6.57% Indirect Other Fixed
amortizatio ve
n cost
Power and
720.79 4.83% Indirect Production other Variable
Fuel
Selling
828.9 5.55% Indirect Selling Other Variable
Expenses
Other Semi-
1288.33 8.63% Indirect Others Other
Expenses Variable
Question 2.
Application of the concept of two-dimensional Activity based costing analysis in an
automobile firm.
For every company there is an ongoing need to improve the cost management system to
capture the cost information accurately for its various products manufacture and services
provided. Many organizations have converted to ABC costing system from traditional costing
approach to achieve this objective. In ABC costing approach, cost of each activity is collected
in functional activity cost pool and then applied to products and services based on individual
cost drivers. In this way, cost is allocated based on events and transitions that occurs in
manufacturing a product or providing a service.
Resource cost
Performance
Root Causes Activity Triggers Activities Measures
Measure
Cost Objects
The vertical dimension in above diagram represents the cost allocation view from cost of
resources to the cost objects. Cost reduction is the main objective of this dimension All
activity cost is collected in activity cost pools and based on activity drivers, cost are assigned
to cost objects such as products, services, customers.
The horizontal dimension depicts the process view of ABC costing model. The focus here is
on the activity. i.e. the process followed. It includes analysis of activities with its root causes
and activity triggers and then evaluating it through performance measures.
Overhead cost
Classification of cost:
All cost in the organization is classified based
on the nature or behavior into pools such as
Material cost, Labor cost, direct cost, indirect
cost, Production overhead, Administrative cost,
Fixed cost, Variable cost etc.
Such bifurcation is necessary for analysis and
better control of cost
Establishment of a committee:
Computation of Variances:
Reconciliation of profits:
Pros:
Cons:
Opportunities:
Challenges:
Question 4.
Question 5.
Particulars
Sales Revenue 49,00,000
Units sold 70000 Units
70
Selling price per
(49,00,000/70000
unit
)
variable cost per
Rs 20
unit
Contribution per
Rs 50 (70-20)
unit
Total fixed cost 28,00,000
= 28,00,000 / 50
= 56,000 Units
Scenario no. 1: Company is facing hectic competition and price war and is unable to raise
their market share. The management desires to lower the firm's break-even point
Below listed are few ways in which a entity can reduce its breakeven point given the
condition that company is unable to increase the selling price
Reduction in total fixed cost: by reducing the total fixed cost and assuming the
contribution remains same, the company will able to lower its break-even point
Reduction in variable cost per unit: Contribution per unit is result of two factors.
Selling price and variable cost per unit. As we cannot increase the selling price, the
only way in which firm can lower the break- even point is by reducing its variable
cost per unit
Scenario no. 2: The Company anticipates a hike in the marked variable cost per unit and
projects all other costs to remain constant. Consequently, the management desires to
maintain the firm's current break-even point.
From the details of scenario, we can understand that company desires to maintain its current
break-even point keeping all other cost constant, which means that there won’t be any
changes in total fixed cost. Here in such a situation the only way to maintain the current
breakeven point is to Increase selling price to maintain the current contribution per unit,
which will eventually maintain the current breakeven point
Question 6.
Abhinav Akshay
Particulars
Chennai Hyderabad
Turnover (Revenue) 20,00,000 20,00,000
5,00,000 (Balancing 1550000 (Balancing
Less: variable Cost
Figure) Figure)
Contribution 15,00,000 4,50,000
1350000 (Balancing 3,00,000 (Balancing
Less: Fixed Cost
Figure) Figure)
Profit 150000 (Given) 150000 (Given)
It is assumed the Akshay runs a operating unit in Hyderabad and Abhinav runs a operating
unit in Chennai. This assumption is derived from the fact that Akshat believed to operate the
unit with highly efficient manual labor which and Abhinav preferred automated production
process. We can clearly observe from the table that variable cost in Hyderabad is higher due
to manual labor force and fixed cost is higher in Chennai due to automated production
process.
A Chennai unit having automated process will tend to have higher break-even point due to its
higher fixed costs. Higher the breakeven point, higher are the sale units required to be sold to
recover its fixed cost. This situation is a potential to report losses. Even the safety margins
with higher fixed cost are very narrow.
However, the automated production system tends to have a greater throughput. Greater
throughput comes with greater potential of profitability, but increased risk and greater profit
potential go hand in hand.
In tough times like recession, company with automated production process will face survival
crises as it will be difficult to adjust to falling consumer demand and falling prices of goods
and services with higher fixed cost, However it will be relatively easier for a company with
intensive labor production process due to its lower fixed cost commitment
Conclusion:
Considering all above facts, If I were the venture capitalist, I would choose to fund the
Hyderabad location which is more labor-intensive production process
Question 7.
Please refer the excel sheet for summary of current cash collection strategy
The main objective of any cash collection strategy is to collected maximum amount of cash
in least amount of time. Let’s analyze Sarah’s collection strategy keeping this objective in
mind.
Credit sales have been increased from 60% to 80%. This strategy is adopted to
increase the sales as most customers prefer credit purchase over cash purchase,
but the shortfall is that this strategy will negatively impact the working capital
structure of the company.
Another shortfall of increasing the credit sales is that it will deplete the cash
reserves which can be invested to returns. There is clear loss of such opportunity
gain in such a scenario
In current cash collection strategy, the, 70% of credit revenue was recovered in
same month and remaining 30% is recovered in subsequent month. However, in
Sarah’s collection strategy, only 15% is collected in current month while 75% of
credit revenue is collected in subsequent month.
Sarah has introduced a sales-based commission for all sales force in order to
improve the sales. The effectiveness of this strategy should be analyzed along
with the additional sales generated from this approach.
A strategy with greater credit period will always have greater risk of credit going
bad than a strategy where credit period is shorter. Sarah’s collection strategy has
offered greater credit periods to its customer that what was offered currently. This
approach has resulted in uncollected amount of 10%
Conclusion:
We have identified many shortfalls in Sarah’s cash collection strategy, but the upside is that
there has been a dramatic increase in sales volume.
To conclude, Sarah’s collection strategy should be continued if the gain achieved from
increase sales volume less commissions of sales force, opportunity cost and uncollected
amount is positive.
Question 8.
Standard costing is a mechanism which is used as a tool of cost control. As per this system,
the estimated cost and actual cost are compared and the variances among them are deeply
analyzed to understand the root causes of such variances.
How would an unfavorable price variance on a particular purchase affect the overall
price variance for the year and the manager's bonus?
To avoid a situation of unfavorable price variance, actual purchases must be lower that
estimated or standard cost.
The overall price variance is the sum total price variances of all products. So, any variance,
whether favorable or unfavorable will affect the overall price variance accordingly. Here the
unfavorable price variance will end up reducing the net favorable balance if any
As the purchase manager is paid bonus based on the net favorable material price variance, if
there are no sufficient favorable variable balance accumulated on account of purchases of
other products, then unfavorable price variance on this particular purchase would wipe out
the bonus of materials purchasing manager.
Would the use of the materials price variance as a basis for the manager's bonus lead to
a
desirable or undesirable behavioral outcome?
The job of the materials purchasing manager is to ensure that the products of required quality
are being procured at most economical prices while looking for opportunities in the market.
Such an function in the organization should not be under any biasing while performing its
duties. If any kind of remuneration is linked to material price variance, then more chances are
there that purchasing manager will have certain preferences and inclination to ensure
maximum remuneration to him, which may not be beneficial to the organization. This will
not be a justice to his role.
Thus, use of materials price variance as basis for manger’s bonus will lead to a undesirable
behavioral outcome.
Question 9. Evaluate the continuity of the shoe department and justify your answer
Please refer the excel sheet.
Clothing Accessories
Particulars Shoes (Rs) Total
(Rs) (Rs)
7,22,5 2,20, 9,42,5
Sales
00 000 00
4,33,5 1,28, 5,61,5
Less: Variable cost
00 000 00
2,90,0 25, 42 3,57,0
Less: Fixed Cost
00 000 ,000 00
16
Remodeling cost
,000
7,23,5 25, 1,86, 9,34,5
Total cost
00 000 000 00
Operating Profit
-1,000 -25,000 34,000 8,000
(Loss)
Workings,
Sales:
Variable cost:
Variable cost current is at 60% of sales for clothing. Taking that into consideration
variable cost will be reduced to 4,33,500. As there are no sales, there wont be any
variable cost for Shoe department. In case of accessories, for initial sales of 1,50,000/-
, the variable cost will be 55% of sales and for incremental sales of 70,000 the
variable cost will be 65% of total sales as contribution margin mentioned is 35%.
Putting it together it comes to 5,61,500 (82500+45500).
Fixed Cost:
Fixed cloth for clothing won’t change. A salaried salesperson at shoe department is
terminated, hence the reduced fixed cost of shoe department will stand at 25,000
(70,000 – 45000) as other departmental fixed cost shall continue. There won’t be any
changes in fixed cost of accessories.
Remodeling cost:
Therefore, the loss if shoe department is closed will be (55,500 – 8000) = 47500
Question 10.
Here we have a situation to decide whether to provide the food facility inhouse or to
outsource the food services
Note: Allocated fixed overhead of Rs 60,000 is not considered as this is allocated cost and it
is irrelevant in decision making
Note: Allocated fixed overhead of Rs 60,000 is not considered as this is allocated cost and it
is irrelevant in decision making
Conclusion: There is a net gain of Rs 1,15,750 (9,30,000 – 814250) from outsourcing food
service and also NIFS is offering improved menu, It is advisable that the food services should
be outsourced to NIFS
Question 11.
Let’s examine the situation based on various scenarios
Scenario 1: If Icon Pvt ltd pays another 50,000 as demanded by UKL for manufacturing
and continues the manufacturing of Shirts.
Notes:
Here, already paid costs such as initial amount paid to UKL of 85,000 and
Manufacturing cost of 4,10,000 paid to date are not considered as these are sunk cost
and in relevant costing sunk cost are irrelevant for decision making.
Cost of T-shirts manufactured is not considered as this cost is independent of decision
being taken. This cost is non-avoidable, irrespective of any decision taken. Hence this
cost becomes irrelevant here
Scenario 2: If Icon Pvt ltd decides to fight a lawsuit against UKL and UKL ends up
winning the case (As they have a strong case as per lawyer of Icon Pvt Ltd)
There would be no revenue, nor any cost would be required to incurred in this case. However,
the initial amount of 85,000 paid to UKL will be not be recovered. But as this is sunk cost, it
is irrelevant for any decision making
Observing the above two scenarios closely, it is recommended that Icon Pvt ltd accepts the
offer of UKL to pay additional 50,000 for manufacturing rights.
Question 12:
The service department is not involved directly in the production of goods and services in an
organization. They provide services that helps the organization to produce and deliver the
products or services. For example, the human resources department is recruiting manpower to
work on the production side of the organization and they also cater to the needs of the
employees or the workforce to ensure smooth sailing of production chain.
In the current year, even though there is a slight increase in service revenue the sales
have decreased.
We know that, costs must be assigned to that certain cost objective that caused it.
There are three broad reasons why costs are allocated: -