Illustration
A small scale manufacturer produces an article at the operated capacity of 5,000 units while the normal capacity of his plant is 7,000 units. Working at a profit margin of 20% on sale realization, he has formulated his budget as under:
|
Units
Particular
|
5,000
Rs.
|
7,000
Rs.
|
|
Sales realization
|
1,00,000
|
1,40,000
|
|
Variable overheads
|
25,000
|
35,000
|
|
Semi-variable overheads
|
10,000
|
11,000
|
|
Fixed overheads
|
20,000
|
20,000
|
He gets an order for a quantity equivalent to 20% of the operated capacity and even on this additional production, profit margin is desired at the same percentage on sales realization as for production to operated capacity.
Assuming prime cost is constant per unit of production, what should be the minimum price to realize this objective?
Solution
Computation of differential cost of production of 1,000 additional units (Rs.)
|
Units
|
5,000
Rs.
|
6,000
Rs.
|
Differential cost for 1,000 units
|
|
Prime cost (see Note a)
|
25,000
|
30,000
|
5,000
|
|
Variable overheads
|
25,000
|
30,000
|
5,000
|
|
Semi-variable overheads (see Note b)
|
10,000
|
10,500
|
500
|
|
Fixed overheads
|
20,000
|
20,000
|
-
|
|
Total cost
|
80,000
|
90,500
|
10,500
|
For an additional output of 1,000 units over the operated capacity of 5,000 units, the differential cost is Rs.10,500 or Rs.10.50 per unit.
Profit Margin = 20% on sales or 25% on cost
Minimum selling price = Rs. 10.50 + 25% on Rs. 10.50 = 10.5 + 2.625 = Rs. 13.125.
Working Notes:
-
Cost of Sales
= 80% of sales (since profit is 20% on sales)
= 80% of Rs. 1,00,000
= Rs. 80,000
|
|
Rs.
|
|
Rs.
|
|
Less: Variable overheads
|
|
|
25,000
|
|
Semi variable overheads
|
10,000
|
|
|
|
Fixed overheads
|
20,000
|
=
|
55,000
|
|
Prime cost
|
|
|
25,000
|
-
An additional production of 2,000 units will result in an increase of Rs.1,000 in semi variable overheads. Hence, additional production of 1,000 units will result in an increase of Rs. 500 in semi variable overheads.
Illustration
An institute for correspondence studies teaches wholly through the correspondence method using self-study packs, which enable students to prepare for professional qualifications.
Each course of study was sold at Rs.150 last year and a total of 10,000 units were produced and sold. The production costs of the various courses offered by the institute are the same.
The variable cost of producing a study course last year was:
Direct materials Rs.50; Direct labor Rs.60; other direct costs (postage) Rs.6, and variable overheads Rs.4.
The fixed overhead for the institute during the year was Rs.2,00,000. In the coming year, the costs of the organisation are expected to increase by the following:
Direct material 20%; direct labor 16.67%; other direct costs 67%; variable overheads 25% and fixed overheads 5%.
For the coming year, you are required to find out the selling price of the study courses if the number of study courses sold and the annual profits are to remain as before.
Solution
Last year's selling price = Rs.150
Total variable cost = Rs.120
Therefore, contribution per unit = Rs.150 - Rs.120 = Rs.30
Profit = Contribution - Fixed cost
= Rs.10,000 × 30 - Rs.2,00,000 = Rs.1,00,000
New Variable Costs
|
|
|
Rs.
|
|
Material
|
(50 × 1.2)
|
60.00
|
|
Labor
|
(60 × 1.1567)
|
70.00
|
|
Other direct costs
|
(6 × 1.67)
|
10.00
|
|
Variable overhead
|
(4 × 1.25)
|
5.00
|
|
Total
|
|
145.00
|
|
New contribution
|
=
|
Profit + Fixed cost
|
|
|
=
|
Rs. 1,00,000 + (2,00,000 × 1.05)
|
|
|
=
|
Rs. 3,10,000
|
|
Contribution per unit
|
=
|
Rs. 3,10,000/10,000 = Rs.31 per unit
|
|
Therefore, Selling price
|
=
|
Variable cost + Contribution
|
|
|
=
|
Rs.145 + Rs.31 = Rs.176
|
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