Service Cost Management in Service industry - Mumbai-Pune Shivneri Bus

Prepared by Manohar M. M. Iyer

Ref. No. VAS2010XMBA15P005

Batch XMBA – 15

Term I

Faculty Mr. Phadke

Prepared on January 11, 2011

Management Accounts Assignments

January 2011

Prepared by: Manohar M. M. Iyer, VAS2010XMBA15P005 Page 2

Disclaimer: This document is prepared purely as an educational project assignment to be submitted as a component of

the XMBA curriculum being conducted by ITM (Institute for Technology and Management) at Vashi, Navi

Mumbai. The information contained within this document is for sample representation purposes only.

Though this document is prepared by taking due references from the “Cost Accounting” book, fourth

edition, published by “The McGraw-Hill companies” and various websites, including the website of MSRTC.

However, no information contained in this document should be considered by any individual, investor,

share holder, group, organization, company or any other entity as true & correct information.

The reader of this document is strongly advised not to use this document as a guide that may influence any

of your ideas/views/interests/feedback related to any of the companies/ business interests.


January 2011


Contents

• List of Assignments .................................................................................................................................... 4

• Individual Assignment – Analysis of service sector- Shivneri Bus, MSRTC. .................................................. 5

Data Collected & Assumed:....................................................................................................................... 5

Some Basic Calculations ............................................................................................................................ 6

Operating Cost statement per month ....................................................................................................... 7

Charges & Rate per passenger KM ............................................................................................................ 7

Conclusions .............................................................................................................................................. 8

• Individual Assignment – Budgeting – ITM Case Study 10-06-2007- Mr. Zara. ............................................. 9

The problem ............................................................................................................................................. 9

Solution: Given data ............................................................................................................................... 10

Production Budget: ................................................................................................................................. 11

Purchase Budget: .................................................................................................................................... 12

Monthly Cost Statements: ...................................................................................................................... 12

Cash Budget: .......................................................................................................................................... 12

Master Budget: ....................................................................................................................................... 13

Suggestions for Mr. Gosh ........................................................................................................................ 13

• Individual Assignment – CVP analysis - Marginal Costing - Pankaj Raina- XYZ Ltd. .................................... 14

The Problem: .......................................................................................................................................... 14

Solutions: Given data .............................................................................................................................. 14

Assumptions & Problem areas ................................................................................................................ 15

Arithmetic/ Accounting solutions & Results ............................................................................................ 15

Innovative ideas ..................................................................................................................................... 16

• Group Assignment – Export Order received at rate lower than domestic market. .................................... 17

The problem: .......................................................................................................................................... 17

Solution .................................................................................................................................................. 17

Our Group conclusions were: .................................................................................................................. 18

Additional individual inputs: ................................................................................................................... 18

• Group Assignment – Operate or Shut down a loss making manufacturing unit. ....................................... 19

The problem: .......................................................................................................................................... 19

Solution: ................................................................................................................................................. 19

Our Group conclusions were: .................................................................................................................. 19

Additional individual inputs: ................................................................................................................... 20

Note from the author. ................................................................................................................................ 23


January 2011


• List of Assignments

Individual Assignments

1. Individual Assignment-5 (Individual participation 20 marks)

Analysis of service sector considering the cost of operation, number of customers, fees to be

charged, pricing strategy etc.


Budgeting Case study.

Ref: ITM Vashi case study 10-06-2007 related to Mr. Zara, the MD & Mr. Gosh the finance manager.


CVP analysis - Marginal Costing Case study.

Ref: Pankaj Raina related to M/s. XYZ Ltd. that wishes to start a new project.

Group Assignments

4. Group Assignment-1 (Group participation 10 marks, Individual participation 10 marks)

Decision to be made on an Export order received at a rate lower than domestic market.

5. Group Assignment-2 (Group participation 10 marks, Individual participation 10 marks)

Decision to be made whether to operate or shut down, a loss making manufacturing unit.


January 2011


• Individual Assignment – Analysis of service sector- Shivneri Bus, MSRTC.

MSRTC’s (Maharashtra

State Road Transport

Corporation) has Shivneri

AC bus service (Volvo B7R

9400) plying on the Mumbai

– Pune route.

Data Collected & Assumed:

On analyzing this service the following Facts & assumptions are arrived at:

Particulars Data

Distance between Mumbai & Pune 163 kms

Number of buses 20 (10 from Mumbai, 10 from Pune)

Bus time table from both Mumbai & Pune. From 4:30 am till Midnight every 30 minutes

Trips made per bus 2 return trips

No of Seats per bus 53

Average Passenger load factor 79%

The Standing Charges (Fixed) involved are:

Particulars Data

Cost of Bus Volvo B7R 9400 Rs. 75 lakhs

Depreciation 15% pa

Salary for support staff 9000 pm

Insurance per annum per bus 15% of cost after depreciation

Permit fee Rs. 1000 pm per bus

Other taxes Rs. 2000 pa per bus

Misc expenses Rs. 1000 pm per bus

The Running Charges (Variable) incurred are:

Particulars Data

Fuel average 4 KM per litre

Fuel cost Rs. 40 per litre

Oil & grease Rs. 100 per trip

Driver’s Salary per bus 6500 pm

Conductors Salary per bus 3000 pm

Toll tax Rs. 410 per trip

The Maintenance Charges calculated are:

Particulars Data

Repairs & Maintenance Rs. 35 per km

Other Factors affecting Costs are:

Passenger Tax 20% of net takings

Profit margin 50% of net takings


January 2011


Trip details

From Mumbai 4:30 5:00 5:30 6:00 6:30 7:00 7:30 8:00 8:30 9:00

Bus no A1 A2 A3 A4 A5 A6 A7 A8 A9 A10

9:30 10:00 10:30 11:00 11:30 12:00 12:30 13:00 13:30 14:00

b1 b2 b3 b4 b5 b6 b7 b8 b9 b10

From Pune 4:30 5:00 5:30 6:00 6:30 7:00 7:30 8:00 8:30 9:00

Bus no b1 b2 b3 b4 b5 b6 b7 b8 b9 b10

9:30 10:00 10:30 11:00 11:30 12:00 12:30 13:00 13:30 14:00

A1 A2 A3 A4 A5 A6 A7 A8 A9 A10

From Mumbai 14:30 15:00 15:30 16:00 16:30 17:00 17:30 18:00 18:30 19:00

Bus no A1 A2 A3 A4 A5 A6 A7 A8 A9 A10

19:30 20:00 20:30 21:00 21:30 22:00 22:30 23:00 23:30 0:00

b1 b2 b3 b4 b5 b6 b7 b8 b9 b10

From Pune 14:30 15:00 15:30 16:00 16:30 17:00 17:30 18:00 18:30 19:00

Bus no b1 b2 b3 b4 b5 b6 b7 b8 b9 b10

19:30 20:00 20:30 21:00 21:30 22:00 22:30 23:00 23:30 0:00

A1 A2 A3 A4 A5 A6 A7 A8 A9 A10

Based on the above data we will attempt to:

- Do some basic calculations

- Prepare Operating Cost statement for the month

- Compute charges per passenger per KM

Some Basic Calculations

1) Total KM covered per month

Particulars Data

Mumbai to Pune 163 kms x 4 trips x 20 buses x 30 days 391200 kms

2) Fuel Costs

Particulars Data

Diesel Required = (391200 kms / 4kmpl average) x Rs. 40 pl Rs. 39,12,000

Oil & grease = Rs. 100 per trip x 4 trips x 20 buses x 30 days Rs.2,40,000

Total Rs. 41,52,000

3) Total effective passenger Km per month

Particulars Data

Total effective passenger Km per month = 391200 kms x 79% 309048 kms

4) Calculation of Salary

Particulars Data

Drivers salary per month = Rs. 6500 x 20 buses Rs. 1,30,000

Conductors Salary per month = Rs. 3000 x 20 buses Rs. 60,000


January 2011


5) Calculation of Other costs

Particulars Data

Toll tax per month = Rs. 410 per trip x 4 trips x 20 buses x 30 days Rs. 9,84,000

Cost of 20 buses = (75 Lakhs x 20 buses) (A) Rs. 15,00,00,000

Depreciation per annum = (75 Lakhs x 20 buses x 15%) (B) Rs. 2,25,00,000

Depreciation per month = (75 Lakhs x 20 buses x 15%) / 12 Rs. 18, 75,000

Insurance per annum = ((A) – (B)) x 15% Rs. 1,91,25,000

Insurance per month = (((A) – (B)) x 15%) / 12 Rs. 15,93,750

Permit Fee per month = Rs. 1000 x 20 buses Rs. 20,000

Other Taxes per month = (Rs. 2000 x 20 buses)/12 Rs. 3,333.33

Misc Expenses per month = Rs. 1000 x 20 buses Rs. 20,000

Repairs & Maintenance per month = Rs. 35 per km x 391200 kms Rs. 1,36,92,000

Operating Cost statement per month

Particulars Rs. Rs.

Fixed Charges

Drivers salary 130000

Conductors Salary 60000

Salary of support staff 9000

Insurance 1593750

Other taxes 3333.33

Permit fee 20000

Misc expenses 20000

Total Fixed Charges (A) 1836083.33

Running charges

Depreciation 1875000

Repairs & Maintenance 13692000

Toll tax 984000

Fuel cost 4152000

Total Running Charges (B) 20703000

Total Cost per month 22539083.33

Charges & Rate per passenger KM

Particulars Rs.

Calculation of Net takings

Let total takings X

Profit is 50% of Total takings 0.50X

Therefore

X= Total Cost per month + Profit = 22539083.33 + 0.50X

0.50X = 22539083.33

X = 45078166.66

Total Takings (C) 45078166.66

Passenger Tax = Total takings x 20% (D) 9015633.332

Total Fare = (C) + (D) 54093799.99


January 2011


Rate per Passenger KM

Particulars Rs.

Rate Per Passenger KM =

Total Fare/ effective passenger KM per month Rs.54093799.99 / 309048 kms 175.03

Conclusions

Thus as per calculations based on data collected & assumed we can see that every passenger boarding any

AC Volvo bus service plying on the Mumbai - Pune route should be charged atleast Rs.175.03/- which will

provide a profit margin of 50% on total costs.

In real life as on today it is seen that such passengers is charged between Rs. 200/- and Rs. 250/- which is

very close to our calculations. They also provide additional facilities like bottled water, music, Films, etc.

Also industry news is that KSRTC, MSRTC and other transport companies have shown interest in placing

further orders of Volvo B7R 9400 buses in bulk quantities.

To service these orders the Sweden based bus company is planning to start a plant in Bangalore that will

create the body parts for the bus & will assemble them. This will reduce the bus price from current Rs. 75

lakhs per bus to Rs. 40 Lakh per bus.

This in turn will further reduce the cost for the transport companies, giving rise to more profits.


January 2011


• Individual Assignment – Budgeting – ITM Case Study 10-06-2007- Mr. Zara.

The problem Mr. Zara the M.D. was asking his finance manager Mr. Patel don’t you have the budget? How our company

suffered a loss this year? Why there is heavy stock in our godown? Why there is huge recovery pending?

Why people are saying we are not good pay masters? Why reputation of our company is on stake in your

area only, when the other areas are giving profits. Mr. Patel resigned the same day & Mr. Gosh took the

charge.

He called his deputy finance manager to organize a meeting of all department heads and ask them to come

with the past, present & future rates. All met at 5:00 pm in a conference hall. Mr. Gosh was ready with his

key note address. He presented the segmented income statement of 31st March 2007. It reflected Material

A Rs. 1.2 crs, Material B Rs. 3.6 crs & other material A Rs. 1.2 crs. The expenses on administration, selling &

other expenses were Rs. 3 Cr out of these the establishment manager said 2.4 crs are for salaries. Bank

certificate was put on table which showed interest payment of Rs. 0.6 crs at the rate of 10% pa on CC

10025397255. Sales achieved was Rs. 12 crs. Mr. Zara pointed out that the fixed assets of this segment are

Rs. 5 crs and depreciation @ 20% is not considered in above statement. Tax consultant Mr. Pandey

proposed to charge @ 30% income tax.

Everyone was impressed with the action taken by Mr. Gosh.

Mr. Gosh then explained the intention of the meeting and asked everyone to focus about his needs and

estimate of April 2007.

The production manager Mr. Zende came with pie chart of the material cost as follows

Mr. Zende said his final product needs 2 units of material A and one unit of B.

The purchase manager Mr. Thakur said that the prices for material A & B are Rs. 500 PU & Rs. 3000 PU

respectively.

The inventory manager intimated that it is the policy of the company to maintain 20% of sale of finished

product in stock which is required to be sold in the next month and 25% of raw material required for the

next month production.

The sales Manager forecasted that 1200 units of final product will be sold in April, 1500 units in May, 1000

units in June and 800 units in July 2007. He also forecasted that sales in June 2007 will be Rs. 1 cr.

Mr. Zara got confused and asked what is the cost of final product? Mr. Gomes advertising manager said

that we are advertising the same price last year, since we had promised that price will remain constant for

the next year, also to compete with the attractive offer of our competitors, quoting “buy 2 get 1 free”.

72

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January 2011


It was 7 pm & drinks entered the hall. Mr. Gosh everyone to join & assemble back at 8 pm. The meeting

continued till 10pm but failed to conclude on budget for May 2007 & June 2007.

At 11 pm the cashier stood up & started condemning others. He shouted loudly saying that he has to pay to

creditors after one month. Wages & other expenses are paid on the same month, but he does not have

enough cash from the bank at the required time.

The recovery manager got angry on his statement and said what can be done if the debtors are paying only

after two months, when company has asked to pay in one month. By 1 am the meeting concluded with no

conclusion. You are asked to help Mr. Gosh.

Solution: Given data

a. Income statement as on 31st March 2007

Particulars Annual Fixed assets 50000000 Sales 120000000 Material A 12000000 Material B 36000000 Other material 12000000 Salaries 24000000 Administration & Selling expenses 6000000 Bank Interest 6000000 Depreciation at 20% 10000000 Total expenses 106000000 NPBT 14000000 Tax at 30% 4200000 NPAT 9800000

b. Issues per Mr. Zara

Issues Loss to company Heavy stock in warehouse Recovery pending from debtors Bad pay master

c. Our objective

To Prepare Production budget Purchase Budget Statements Master budget Suggestions

d. Materials required to produce one unit of final product

Materials Units Material A 2 Material B 1


January 2011


e. Price of purchase

Particulars Cost Rs.

Material A 500 Material B 3000

f. Inventory guidelines

Particulars Qty With reference to Finished Product 20% of sales estimated next month Raw Material 25% of requirement for next month production

g. Expected Sales

Expect. Sales Apr-07 May-07 Jun-07 Jul-07

Units 1200 1500 1000 800 Amount 12000000 15000000 10000000 8000000

Calculated Selling Price per unit in Rs 10000

h. Selling price Guidelines

Selling Price Should be same as last year Competitors offer is buy 2 get 1 free

i. Payment Guidelines

Particulars Period of Settlement Wages Same month Expenses Same month Creditors After one month

j. Recovery Guideline & actual

Recovery from Guideline Actual practice Debtors Within 1 month After 2 months

Production Budget:

Particulars Mar-07 Apr-07 May-07 Jun-07 Jul-07 Closing stock to be kept 240 300 200 160 0 Units to be sold 0 1200 1500 1000 800 Total units required 240 1500 1300 840 800 Less opening stock 0 240 300 200 160 Total to be produced 240 1260 1000 640 640


January 2011


Purchase Budget:

Particulars Mar-07 Apr-07 May-07 Jun-07 Jul-07 Material A Closing stock to be kept 630 500 320 320 0 Add units to be purchased 480 2520 2000 1280 1280 Less opening stock 0 630 500 320 320 Total to be purchased 1110 2390 1820 1280 960 Amount @ Rs.500 555000 1195000 910000 640000 480000 Material B Closing stock to be kept 315 250 160 160 0 Add units to be purchased 240 1260 1000 640 640 Less opening stock 0 315 250 160 160 Total to be purchased 555 1195 910 640 480 Amount @ Rs.3000 1665000 3585000 2730000 1920000 1440000 Total Cost of purchase 2220000 4780000 3640000 2560000 1920000

Monthly Cost Statements: Statement Mar-07 Apr-07 May-07 Jun-07 Jul-07

Sales 0 12000000 15000000 10000000 8000000 Received from Debtors 0 0 12000000 15000000

Paid to creditors 0 0 2220000 4780000 3640000 Paid to Salaries 0 2000000 2000000 2000000 2000000 Admin expenses 0 500000 500000 500000 500000

Other material Cost 0 1000000 1000000 1000000 1000000 Bank interest 0 500000 500000 500000 500000

Depreciation at 20% 0 833333.3 833333.3 833333.33 833333.333

Cash Budget:

Particulars Mar-07 Apr-07 May-07 Jun-07 Jul-07 Opening balance 500000 8280000 4316667 786333.3 2179100 Received from Debtors 0 0 0 12000000 15000000 Bank overdraft 10000000 7500000 7500000 2500000 0 Total A 10500000 15780000 11816667 15286333 17179100 Less Creditors 0 0 2220000 4780000 3640000 Materials 2220000 4780000 3640000 2560000 1920000 Salaries 0 2000000 2000000 2000000 2000000 Other materials 0 1000000 1000000 1000000 1000000 Bank interest 0 500000 500000 500000 500000 Admin expenses 0 500000 500000 500000 500000 Depreciation at 20% 0 833333.3 833333.3 833333.3 833333.3 Total B 2220000 9613333 10693333 12173333 10393333 NPBT 8280000 6166667 1123333 3113000 6785767 Less Tax @ 30% 0 1850000 337000 933900 2035730 NPAT 8280000 4316667 786333.3 2179100 4750037

Indicates Assumptions


January 2011


Master Budget:

Particulars 31.3.2007 Apr-07 May-07 Jun-07 Jul-07 Sales 120000000 12000000 15000000 10000000 8000000 Less Material A 12000000 1195000 910000 640000 480000 Material B 36000000 3585000 2730000 1920000 1440000 other Material 12000000 1000000 1000000 1000000 1000000 Salaries 24000000 2000000 2000000 2000000 2000000 Other est. expenses 6000000 500000 500000 500000 500000 Bank Interest 6000000 500000 500000 500000 500000 Depreciation at 20% 10000000 833333.33 833333.33 833333.33 833333.33 Total expenses 106000000 9613333.33 8473333.33 7393333.33 6753333.33 NPBT 14000000 2386666.67 6526666.67 2606666.67 1246666.67 Less tax @ 30% 4200000 716000 1958000 782000 374000 NPAT 9800000 1670666.67 4568666.67 1824666.67 872666.67

Suggestions for Mr. Gosh

A. Since the debtors are practically paying only after 2 months, to ensure sufficient amount of cash

reserves, we need to take bank overdraft in the months of March(1st of April), April, May & June as

mentioned in the Cash Budget.

B. We can offer some discounts on early payments to debtors. This can helps us to avoid relying entirely

upon the bank overdraft for our cash reserve requirements.

C. We can either provide advance training on recovery skills to the recovery manager or replace him

with a better resource.

D. The above three points will ensure that there are enough cash reserves for making timely payments to

creditors and thus reviving the pay master image of the company.

E. We can see that the company is making an average monthly profit of Rs. 22,34,166.67/- per month.

Even If we give a raise of 10% to all employees it will reduce the profit only by Rs. 2 Lakhs, but this will

also help in reviving the pay master image of the company.

F. We can show to Mr. Zara that he is under wrong impression & there are no heavy stocks kept in our

godown as is evident from the production budget.

G. When we compare the cost of production with the selling price per unit, as on 31st

March 2007 we can

see the profit margin is only 8%. It is advisable to revise the pricing strategy, with higher profit margins

so as to be in a better financial position in future.

H. To compete with the competitor’s offer of buy 2 get 1 free, we do not necessarily have to compromise

on our pricing strategy. Instead we can publicize our product to be of a better quality and create a

brand value to justify our pricing, just like NIKE, Mercedes, etc.


January 2011


• Individual Assignment – CVP analysis - Marginal Costing - Pankaj Raina- XYZ Ltd.

The Problem: M/s XYZ ltd wish to start a new project. A meeting was organized with the Project Consultant, Marketing

Agencies, and head of departments. The Marketing agencies are of the opinion that:

1. If selling price is Rs.40/-, then 1,00,000 units can be sold.



The operations team found out that material cost per unit would be Rs.12/-, wages per unit will be Rs.2/-,

other variable expenses per unit will be Rs.1/-, and fixed costs will be 20 lakhs.

The project consultant have presented the data stating investments in the project will be Rs. 1 crore and

reasonable rate of return can be expected to be 12%.

This will be first year of the product in the market. Accordingly you are asked to calculate the strategy of

the company and suggest proper sale price.

Steps for case study

1. Facts of case

2. Problem areas

3. Assumptions

4. Result of Arithmetical/ accounting solutions

5. Innovative ideas.

Solutions: Given data a. Expected sales

Particulars Scenario A Scenario B Scenario C Selling price per unit 40 25 20 Units expected to be sold 100000 400000 500000 Total expected Sales in Rs. 4000000 10000000 10000000

b. Variable costs

Particulars Data Material cost Per unit in Rs. 12 Wages Per unit in Rs. 2 Other variable expenses in Rs. 1 Total Variable Cost per unit in Rs. 15

c. Fixed Costs

Particulars Data Fixed costs in Rs. 2000000

d. Project Investments

Particulars Data Project cost in Rs. 10000000 Expected Rate of return in % 12


January 2011


Assumptions & Problem areas

• We will be using CVP analysis - Marginal costing for our calculations.

• It is assumed that all costs involved are separated into variable costs & fixed costs. There are no

semi-variable costs involved.

• The total fixed costs and variable costs remain constant at all sales levels.

• Volume is assumed to be only factor affecting the cost behavior and other factors like production

efficiency; material costs, technology used, etc. remain unchanged.

• The decisions are guided solely by Contribution. Other key factors are not linked.

• Marketing agencies will tend to devise a pricing strategy solely on the marginal costs and not total

costs, which may result in differences in projected profit & actual profit after audit.

• Since this is the first year of the product, to devise a strategy, there are no historical data available

for comparison.

• Because of above mentioned assumptions & limitations, CVP analysis done below is just an

approximation at best and may not be true always. The final financial results may vary.

Arithmetic/ Accounting solutions & Results For all scenarios, we will be calculating:

A. Profit to Volume Ratio i.e. PV ratio, Break- even sales and Margin of safety

B. Marginal costing income statement & Expected Return on investment

A. PV ratio/Break-even sales/Margin of safety

Particulars Scenario A Scenario B Scenario C Selling price per unit 40 25 20 Units expected to be sold 100000 400000 500000 Total expected Sales in Rs. 4000000 10000000 10000000 Material cost Per unit in Rs. 12 12 12 Wages Per unit in Rs. 2 2 2 Other variable expenses in Rs. 1 1 1 Total Variable Cost per unit 15 15 15 Contribution per unit 25 10 5 Fixed costs in Rs. 2000000 2000000 2000000 Break even volume = fixed costs/contribution 80000 200000 400000 Excess volume = units sold - break even 20000 200000 100000 Variable cost for number of units expected to be sold 1500000 6000000 7500000 Total Contribution in Rs. 2500000 4000000 2500000 PV ratio = Total contribution / expected sales 0.625 0.40 0.25 Break even sales = fixed costs/ PV ratio 3200000 5000000 8000000 Margin of safety = expected sales - break even 800000 5000000 2000000

B. Marginal Costing Income statement & Expected Return on Investment

Particulars Scenario A Scenario B Scenario C Expected Sales in Rs. 4000000 10000000 10000000 Variable cost for number of units sold in Rs. 1500000 6000000 7500000 Fixed costs in Rs. 2000000 2000000 2000000 Total costs= Variable costs + Fixed costs 3500000 8000000 9500000 Net income = Expected Sales - Total costs 500000 2000000 500000 Project cost in Rs. 10000000 10000000 10000000 Expected Rate of return in % 5 20 5


January 2011


C. Results

Thus we can see that:

- If we keep the selling price of the product at Rs. 40/-, then the margin of safety is eight

lakh rupees and Expected ROI is 5%.

- If we keep the selling price of the product at Rs. 25/-, then the margin of safety is 50


- If we keep the selling price of the product at Rs. 20/-, then the margin of safety is 20


A better Margin of safety indicates that even if there is a drop in production, the business can

still make profits.

A better ROI indicates that the investments are recovered within a lesser period of time.

As we can see, when the selling price is kept at Rs.25/- per unit we have a better Margin of

safety and better ROI indicating that entire investment can be recovered within five such

sales periods.

Hence as per the CVP analysis we should keep selling price at Rs.25/- per unit.

Innovative ideas

A. If we take an average of all three scenarios discussed above we can approximately see that:

1. The average selling price comes to Rs. 28/-

2. The average expected sales comes to 333333 units.

3. The calculated PV ratio comes to 0.46

4. The Break- even sales comes to Rs. 4307692/-

5. The margin of safety comes to Rs. 5025631.69/-

6. The return of investment comes to 23.33%

So keeping the selling price closer to Rs.30/- per unit will ensure better Margin of safety &

better ROI and entire investment can be recovered almost within four such sales periods

instead of five as indicated by the CVP analysis above.


January 2011


• Group Assignment – Export Order received at rate lower than domestic market.

This was jointly done as a Group Assignment by Myself, Mr. Mohit Gupta & Mr. Surjit Grover.

The problem:

M/s XYZ ltd had received a fax from US client. Order of 1000 units confirmed @ Rs. 410 per unit.

• Mr. Sam, the sales manager wish to accept the order and increase his commission which is

based upon the sales.

• The cost Accountant submits the data as below about the existing situation

- Material cost per unit � Rs. 220

- Wages per unit � Rs. 100

- Variable expenses � Rs. 80

- Factory rent (fixed cost)� Rs. 25

- Total Cost � Rs. 425

• Distribution manager added Rs. 5 as special packaging required for US client

• The production manager wish to reject the order saying that presently we are

manufacturing & selling 8000 units whereby 80% of the capacity is utilized. Additional

order will force the worker to use the plant for more time.

• The finance manager is also not in favor of the deal reason being the selling price in India is

Rs. 500 per unit. Thus the export prices should be always double or triple depending upon

the richness of the country.

• MD is confused on the issue & wishes to consult you for this.

Solution Facts of the case:

Particulars Per Unit

Export order received 1000 units

Buying Price quoted 410

Cost

Material 220

Wages 100

Variable 80

Total Cost 400

Factory rent 25

Special packaging 5

selling price domestic 500

Points to ponder:

- Whether to accept the export order or not

- If yes at what price

- Sales manager wish to maximize his commission, all other managers wish to keep him

away from his intention, nobody is worried about the company


January 2011


Arithmetic Calculations:

Particulars Before accepting

order export order

After accepting

export order

Units 8000 1000 9000

Sales 4000000 410000 4410000

Less

material cost 1760000 220000 1980000

Wages 800000 100000 900000

Variable Costs 640000 80000 720000

Special packaging Costs 0 5000 5000

Total 3200000 405000 3605000

contribution 800000 5000 805000

less fixed cost 200000

200000

Surplus 600000 5000 605000

Thus we can see that after even after accepting the order we earn a profit of Rs. 5000

Our Group conclusions were: We should take this order since:

a. This will provide visibility of the company in the global arena

b. The company can earn due to fluctuations in the foreign exchange rates.

Other possibilities discussed in class:

a. Due to export the company will get advantage of not paying excise duty, Vat, Cess, & other taxes

b. We can request sales manager not to accept commissions on export orders

c. Brand value in the domestic market will be increase if the export order is serviced

d. Chance of bargaining cost price increases

Additional individual inputs:

A. Company after accepting the export order may apply for Advance Licence under Duty Exemption

Entitlement Scheme (DEEC).

- In this scheme advance licence, either quantity based (Qbal) or value based (Vabal), is

obtained against which the raw materials and other components may be imported without

payment of customs duty provided the manufactured goods are exported.

- Also if the company does not have any import needs, then these licences are transferable

in the open market at a price and additional revenue can be generated from it.

B. After servicing the export order if the company wishes to go public or is already listed, then this

order will influence the share price greatly.

C. If this order is properly serviced, then this can be shown as a testimonial, which will increase the

chances to grab future export orders from other foreign companies. More such orders will in the

long run help to offset sales fluctuations in the domestic market.


January 2011


• Group Assignment – Operate or Shut down a loss making manufacturing unit.

This was jointly done as a Group Assignment by Myself, Ms. Jigna Ganatra, Ms. Renuka Jaidka, Mr. Mohit

Gupta & Mr. Saroj Kumar.

The problem:

M/s XYZ ltd is manufacturing Computers & calculators. Following is the information we have:

Particulars Computers Calculators Total

Units produced & sold 10000 90000

Material cost 2000 lakhs 27 lakhs

Labor 1000 Lakhs 27 lakhs

Inspection done per batch 100 units 10 units

Units per batch for inspection 100 1000

Other expenses 100 Lakhs

Selling price per unit 30500 100

• The cost accountant has allocated other expenses (Mainly relating to inspection & quality

checking) on the basis of the units produced and sold.

• He advises the management to shutdown the calculator plant since there is huge loss of Rs. 54

lakhs.

• Management wishes to consult you

Solution:

Given Facts & calculations:

Particulars Computers Calculators Sales in units 10000 90000 Selling price in Rs. 30500 100 Sales in Rs. 305000000 9000000 Material cost 200000000 2700000 Labor costs 100000000 2700000 other expense 1000000 9000000 Total expenses 301000000 14400000 Profit 4000000 -5400000 Profit per unit 400 -60

Our Group conclusions were:

We should operate the unit with following changes:

- We should increase the production of computers

- We should reduce the production of calculators

- This is due to the fact that the ratio of cost of inspection w.r.t. earnings for calculators are very high

compared to computers.


January 2011


Additional individual inputs:

A. If this case is analyzed with profit before adding the cost of inspection & after inspection, we have

the following data:

Particulars Computers Calculators Sales in units 10000 90000 Selling Price 30500 100 Sales in Rs. 305000000 9000000 Material Cost 200000000 2700000 labor Costs 100000000 2700000 Total cost 300000000 5400000 Total cost per unit 30000 60

Before inspection Profit 5000000 3600000 Profit per unit 500 40 Profit margin 0.016 0.400

After inspection Inspection done per batch 100 units 10 units


Total inspection done 1000 900

Expense for inspection 1000000 9000000

Cost of inspection done for one unit 100 1000

Total expenses 301000000 14400000

Profit 4000000 -5400000

Profit per unit 400 -60

Profit margin 0.013 -0.600

B. The above data shows that the cost for inspecting one calculator is Rs. 1000/- which is absurd.

Hence the assumption of the cost accountant of allocating other expenses (Mainly relating to

inspection & quality checking) on the basis of the units produced and sold is wrong.

C. Let us what happens if the allocation of other expenses (Mainly relating to inspection & quality

checking) is done on the basis of actual units inspected w.r.t. to cost of production of that unit.

Particulars Data Total expense for inspection 10000000 Total units inspected 10900 cost of production of 1000 computers (A) 300000000 cost of production of 900 calculators (B) 54000 Total cost of production for the inspected units= A + B 300054000 Ratio of Cost of inspection w.r.t. cost of production = C 0.033327334 Cost of inspection of 1000 computer = A x C 9998200.32 Cost of inspection of 900 calculators = B x C 1799.68

D. The above data shows that the cost for inspecting one calculator is approximately Rs.2/- which is

acceptable.


January 2011


E. Based on assumption mentioned in point c if the case is analyzed we get the following data:

Particulars Computers Calculators Sales in units 10000 90000 Selling Price 30500 100 Sales in Rs. 305000000 9000000 Material Cost 200000000 2700000 labor Costs 100000000 2700000 Total cost 300000000 5400000


After inspection

Inspection done per batch 100 10



Expense for inspection 9998000.40 1799.68 Cost of inspection for one unit 999.8000 1.9996 Total expenses 309998000.40 5401799.68 Profit -4998000.40 3598200.32 Profit per unit -499.800 39.980 Profit margin -0.016 0.400

F. We can note that the calculator plant does not show any losses. However the computer plant is

loss. We can also note that the profit margin kept for calculators are 40% while for computers it is

very low. Let us see what happens when the selling price of the computers are increased by 10%.

We get the following data:

Particulars Computers Calculators Sales in units 10000 90000 Selling Price 33550 100 Sales in Rs. 335500000 9000000 Material Cost 200000000 2700000 labor Costs 100000000 2700000 Total cost 300000000 5400000


After inspection

Inspection done per batch 100 10



Expense for inspection 9998000.40 1799.68 Cost of inspection for one unit 999.8000 1.9996 Total expenses 309998000.40 5401799.68 Profit 25501999.60 3598200.32 Profit per unit 2550.200 39.980 Profit margin 0.076 0.400


January 2011


G. Thus the solutions to this case are:

1. We can continue operating the calculator unit.

2. In the costing, the allocation of other expenses (Mainly relating to inspection & quality

checking) should be done on the basis of actual units inspected w.r.t. to cost of

production of that unit.

3. The selling price of the computer should be increased by at least 10%, to have a better

profit margin.


January 2011


Note from the author.

Dear Reader & user of this document,

I hope I was able to attempt to complete the Management Account Assignments correctly to the fullest of

my knowledge, abilities and by taking due references from the sources mentioned in this document. I

request the reader & user of this document once again to read and understand the disclaimer mentioned

at the start of the document for your own best interests.

I thank one and all who have provided me the knowledge & support to do this analysis including Mr.

Phadke, The authors of “Cost Accounting” book, fourth edition published by “The McGraw-Hill companies”,

various websites including website of MSRTC, the ITM management & my class mates from XMBA 15 batch

at ITM & most Important of all my mom Mrs. Manjula M. Aiyer, my dad Mr. Mani P. Aiyer & My brother

Mr. Manoj M. Aiyer.

Please feel free to forward your valuable feedback, comments, queries and suggestions related to this

analysis at [email protected].

Thank you,

Warm regards,

Manohar M. M. Iyer

Business

Service Cost Management in Service industry - Mumbai-Pune Shivneri Bus