Cost Academy

ICWA Final Stage- IV June 2007

Paper 17: Management Accounting-Decision Making
Question 1 In each of the cases given below one out of four answers is correct. Indicate the correct answer (=1 mark) and give your working/reasons in support of your answer (= 3 marks): (a) If the time taken to produce the first unit of a product is 4,000 hours, what will be the total time taken to produce the 5th to 8th units of the product, when a 90% learning curve applies? (A) (B) (C) (D) (b) 10,500 hours 12,968 hours 9,560 hours 10,368 hours

In a process, three raw materials are mixed together to produce a product. The standard mix of inputs required to produce 160 kgs. Of finished product is as under: Raw Material A B C Kgs. 100 60 40 Price/kg. Rs. 150 200 250

During May 2007, the company produced 920 kgs. Of output and the actual consumption of raw materials was as under: Raw Material A B C Kgs. 595 330 255 Price/Kg. Rs. 140 212 270

The material yield and mix variances respectively for May 2007 are (A) Rs. 5,550 (A) and Rs. 8,000 (A) (B) Rs. 700 (F) and Rs. 5,500 (A) (C) Rs. 5,550 (A) and Rs. 700 (A) (D) Rs. 11,500 (A) and Rs. 1,180 (F) (A) or (F) under brackets after the figures denotes Adverse or Favourable. (c) 4

A company proposes to undertake a capital project. The life of the project is 4 years and the annual cash inflows are estimated at Rs. 40,000. The internal rate of return of the project is 15% and the cumulative present value factor for 15% for 4 years is 2.855. The profitability index is 1.064. The net present value of the project is (A) Rs. 7,309 (B) Rs. 4,000; (C) Rs. 10,000; (D) Rs. 14,200 4

(d)

Black flush costing is most likely to be used when (A) Management desires sequential tracking of costs (B) A Just-in-Time inventory philosophy has been adopted (C) The company carries significant amounts of inventory (D) Actual production costs are debited to WIP

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(e)

A particular job requires 800 kgs. of a material. 500 kgs of the particular material is currently in stock. The original price of the material was Rs. 300 but current resale value of the same has been determined as Rs. 200. The current replacement price of the material is Re. 0.80 per kg. The relevant cost of the material required for the job is (A) Rs. 640 (B) Rs. 440 (C) Rs. 300 (D) Rs. 540

Solution (a) (D) No. of units 1 2 4 8 (b) RM A B C

Average time per unit 4,000 3,600 3,240 2,916

Total time (hrs.) 4,000 7,200 12,960 23,328

Incremental time (hrs.)

10,368[23,328-12,960]

(C) Total consumption = 200 kg. Standard output = 160 kg. Standard input for 920 kg. of output = 920200/160 = 1,150 kg. Ratio SQ AQ in Std. ratio AQ SP (Rs.) SQSP (Rs.) AQSP (Rs.) AQSP (Rs.) 100 575 590 595 150 86,250 88,500 89,250 60 345 354 330 200 69,000 70,800 66,000 40 230 236 255 250 57,500 59,000 63,750 1,150 1,180 1,180 2,12,750 2,18,300 2,19,000 Yield Variance: Rs. (2,12,750-2,18,300) = Rs. 5,550 (Adv.) Mix variance : Rs. (2,18,300- 2,19,000) = Rs. 700 (Adv.)

(c)

(A) Present value of cash inflows at 15% in 4 years = Rs. 40,0002.855 = Rs. 1,14,200, which is the cost of the project. Since at IRR 15% NPV = 0. The profitability index is 1.064. Hence cash inflows = 1,14,2001.064 = Rs. 1,21,509 (Less) cost of the Project Rs. 1,14,200 4 Net present value Rs. 7,309 (B) Back flush costing is used with JIT, as it minimizes the efforts and expenses devoted to accounting of inventories. Back flush costing is most appropriate when inventories are low and change in inventories is minimal. (B) 500 kg. in stock at resale value (Balance) 300 kg. at current price of Re. 0.80 Rs. 200 Rs. 240 Rs. 440

(d)

(e)

Question 2 (a) Explain clearly the distinction between Joint Products and By-products. 4 (b) The Petal perfume company processes a secret blend of flower petals into three products. The process works in such a way that petals are broken down into a high-grade perfume, Charm and a low-grade flower oil. The flower oil is then processed into a low-grade perfume, Wild Scent and a Cologne, Personally. The company used 10,000 kgs. of petals last month. The costs involved in reducing the petals inot Charm and Flower oil were as follows:

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Direct Materials Direct labour Indirect costs Rs. 1,50,000 90,000 ___60,000 3,00,000

The costs of producing Wild Scent and Personally from the flower oil were Rs. Direct materials 5,000 Direct Labour 10,000 Indirect costs ___5,000 20,000 Total production for the month, with no closing Work-in-process Charm 250 litres Wild Scent 500 litres Personally 1,250 litres The sale price of Charm is Rs. 40 for 25 ml; that of Wild Scent is Rs. 10 for 25 ml and that of personally is Re. 1 per 25 ml. Additional costs, entirely separate for each product, of processing and selling are Rs. Charm 70,000 Wild Scent 1,60,000 Personally 40,000 You are required: i) To allocate the joint costs of producing charm, Wild Scent and personally, using the appropriate relative sales value method; ii) To prepare a product-line income statement, assuming no opening or closing stocks. 6+6 Solution (a) Joint products are products that arise simultaneously from the same process, each having a significant sales value to merit classification as a main product. An example is oil refining, where diesel, petrol and paraffin are joint products. By-products are products that arise incidentally in the production of the main product(s), and have a relatively small sales value in comparison. An example is a sawmill, where sawdust is a by-product. Joint costs, i.e. costs up to split-off point are apportioned to main products, but not to by-product. The distinction between joint products and by-products is often a matter of judgment by management.

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(b) (i) Charm, 250 lt, costs Rs. 70,000 Sales value Rs. 4,00,000

Wild Scent 500 lt, Costs Rs. 1,60,000 Costs Rs. 3,00,000 S1 Flower oil, Costs Rs. 20,000 S2

Rs. 2,00,000

S1 is the 1st separation point S2 is the 2nd separation point.

Personally 1,250 lt, Costs Rs. 40,000

Rs. 50,000

Relative sales value at separation point 1 Charm Rs. 4,00,000 Rs. 70,000 Flower oil Rs. 2,00,000- Rs. 1,60,000 Rs. 50,000 Rs. 40,000 Less: Total Sales value Rs. 2,00,000 _50,000 2,50,000 Rs. 3,30,000 40,000 10,000 50,000 (20,000) 30,000 3,60,000 Joint cost 1 Rs. 20,000 _5,000 25,000 Personally Rs. 50,000 40,000 49,000 __1,000 Rs. 2,75,000

25,000 3,00,000 Joint cost 2 Rs. 16,000 __4,000 20,000 Total Rs. 6,50,000 2,70,000 5,90,000 _60,000

Wild Scent Personally

Separation Point 2 own costs Net sales value Rs. Rs. 1,60,000 40,000 _40,000 _10,000 2,00,000 50,000 Charm Rs. 4,00,000 70,000 3,45,000 55,000 Wild Scent Rs. 2,00,000 1,60,000 1,96,000 4,000

(b) (ii) product-line income statement Sales revenue Own costs Net Income

Question 3 (a) Write a short note on Relevant Costs in decision making. (b)

Pooja company manufactures cookware. Expected annual volume of 1,00,000 sets per year is well below its full capacity of 1,50,000. Normal selling price is Rs. 40 per set. Manufacturing cost is Rs. 30 per set (Rs. 20 variable and Rs. 10 fixed). Total fixed manufacturing cost is Rs. 10,00,000. Selling and administrative expenses are expected to be Rs. 5,00,000 (Rs. 3,00,000 fixed and Rs. 2,00,000 variable). A departmental store offers to buy 25,000 sets of Rs. 27 per set. No extra selling and administrative costs would be caused by the order. Further, the acceptance of this order will not affect regular sales. Should the offer be accepted? You are to adopt incremental approach only for your decision making 5

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(c)

Accuracy Calculators Ltd. manufactures engineering calculators and the selling price was fixed at Rs. 400. The following are the cost particulars: Rs. Direct Material costs 140 Direct Labour Cost 40 Variable Factory overhead 20 Other variable costs 20 Fixed overhead 5,00,000 p.a. Commission 30% on selling price The company was producing only 10,000 units, since the demand was only 10,000 units. However, the company has the capacity to produce another 1,000 units without any additional fixed overheads. One of the distributors offered that he will take 1,000 units in addition to his normal quota, but at a selling price of Rs. 320 per unit. He was also prepared to accept only half of his regular commission for this transaction. The Managing Director wants you as the Cost and Management Accountant to prepare a statement to the Board of Directors with your specific recommendations, based on this calculations in the statement. 8

Solution (a) Relevant Costs in decision making Relevant costs are costs appropriate to specific management decision. Information produced must be relevant for the intended purpose, otherwise it is useless. So goes the management accounting phrase: different costs for different purposes. For example, a cost prepared for fixing selling price may not be suitable for a make or buy decision. All decision making relates to the future. Here, we are concerned with future costs and revenues. The factors that are common to all the alternative courses can be ignored, only the differences are relevant. In other words, costs may differ under various options: only incremental or differential costs are taken to be relevant costs. Relevant costs are cash flows only. It implies that options which do not occasion cash movement are irrelevant, e.g. depreciation, absorbed overheads, shares of any existing fixed expenses, notional costs etc. All costs incurred in the past (Sunk Costs) are irrelevant, unless they have future tax effect, e.g., when an old depreciated asset is sold. Past cost implies joint costs, cost of obsolete inventory. In Economic theory the correct cost for evaluating a decision is termed the opportunity cost. Opportunity cost is the value of the next best alternative, i.e. the net receipts foregone by not accepting the best available alternative course of activity. As a matter of fact, economically relevant cost =opportunity cost = avoidable cost. In certain cases where resources used are not represented by outlay costs, it may be necessary to impute a value for opportunity cost. (b) Incremental approach Incremental revenue (25,000Rs. 27) Incremental cost (25,000Rs. 20) Benefit of accepting the order Rs. 6,75,000 (5,00,000) Rs. 1,75,000

From financial point of view, operating income increases by Rs. 1,75,000. So, Pooja Company can accept the order.

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(c) Particulars Statement of profitability Present production Additional production Total Production & Sales (units) 10,000 1,000 11,000 Sales 40,00,000 3,20,000 43,20,000 Direct Material at Rs. 140/unit 14,00,000 1,40,000 15,40,000 Direct labour at Rs. 40/unit 4,00,000 40,000 4,40,000 Variable factory overhead at Rs. 20/unit 2,00,000 20,000 2,20,000 Other variable cost at Rs. 20/unit 2,00,000 20,000 2,20,000 Commission at 30% on sales value 12,00,000 12,0000 At 155 on sales value ________ __48,000 __48,000 Total variable cost 34,00,000 2,68,000 36,68,000 Contribution (Sales-variable cost) 6,00,000 52,000 6,52,000 Less: Fixed overhead (5,00,000) (__--__) (5,00,000) Profit Rs. 1,00,000 52,000 1,52,000

Recommendation: The proposal gives a contribution of Rs. 52 per unit. Additional profit will be Rs. 52,000. Hence, the proposal should be accepted. Question 4 (a) A company uses complex electronic control systems in its production processes. There are 20 of these systems and each system contains 25 components, which are subject to failure. The company has been recording the pattern of failure over four periods of time with the results as shown below. % of failed original components during the period 20 25 35 20 if the components are replaced as they fail, it will cost Re. 1 per component to effect the replacement. However if all the components are replaced at once, the cost in Re. 0.50 per component. Management is considering the following alternative replacement policies. i) Replacement of components as they fail. 3 ii) Replacement of components, entirely at the end of the fixed number of periods, together with replacement of failures during the interval. 3 You are required to advise the management on which is the more economic replacement policy. 2 An engineering workshop wishes to appoint a mechanic to repair motors that breakdown at an average rate of 4 per hour, the number of breakdowns being Poisson distributed. Two candidates have been short-listed of which one has to be appointed. A is experienced and can repair on an average 8 motors per hour and asks for a daily wage of Rs. 160. B is not so experienced and can repair on an average 6 motors per hour and asks for a daily wage of Rs. 96. The number of repairs in either case follows a Poisson distribution whenever a motor is down an idle time cost at the rate of Rs. 60 per hour is incurred. The workshop works an 8 hour day. Give your recommendation as to who should be appointed. 8 Solution (a) Total number of components = 2025 = 500 Average life of components Period 4

(b)

Probability of failure Expected life in periods 0.20 0.80 1.00 2.55 Average failure of components = 5002.55 = 196 nos. per period. Individual replacement policy cost as and when a component fails will be 196Re. 1 = Rs. 196 per period. Cost under Group replacement policy: Let n denote the no. of components; so

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n0 (=500 as given) will be the number to start with. n1 denote the no. added (replaced) in period 1. n2 denote the no. added (replaced) in period 2 and so on p denote the probability of failure in a period p1 denote the probability of failure in period 1 p2 denote the probability of failure in period 2 and so on

Now, let us find the cumulative numbers of replacement of those components that are likely to fail in the 4 periods. Period 0 P4 1 2 3 4 0.20 0.25 0.35 0.20 1 n0P4 100 125 175 100 2 n1P3 -20 25 35 3 n2p2 --29 36 4 n3p1 ---46 sum 4 niP4-1 i =0 100 145 229 217 Cum Si 100 245 474 691

Cost evaluation of Group replacement. Period 1 2 3 4 Lot of 500@Re. 0.50 Rs. 250 250 250 250 Cum. Individual si@Re 1 Rs. 100 245 474 691 Total Rs. 350 495 724 941 period average Rs. 350 247 241 235

It is seen from above working that cost of Group replacement in any of the periods is more than the cost of individual replacement (as and when a component fails). So, individual replacement policy is advised. (b) =average rate of arrival of broken motors per hour = 4; cost of idle time = Rs. 60 Repairman A = average no. of repairs per hour = 8. Hourly wage changes = Rs. 1608 = Rs. 20 per hour. Average no. of units in the system = (-) =4(6-4) =42 =2 Motor hours lost per hour = 2 motor hours. Total cost per hour = Rs. 12+2Rs. 60 = Rs. 132 Conclusion It is seen that on an overall cost basis, appointment of A should be made as it is less expensive. Problem 5 Mr. X is trying to decide whether to travel to Sri Lanka from New Delhi to negotiate the sale of a shipment of China novelties. He holds the novelties in stock and is fairly confident but by no profit of Rs. 30,000. He puts the probability of obtaining the order at 0.6. if he does not make the trip, he will certainly not get the order. It the novelties are not sold in Sri Lanka, there is an Indian customer who will certainly buy them at a price that leaves him a profit of Rs. 15,000 and his offer is open at least till Mr. X however, concerned that his absence, even for only three days, may lead to production inefficiencies in the factory. These could cause him to miss the deadline on another contract, with the consequence that a late penalty of Rs. 10,000 will be invoked. Mr. X assesses the probability of missing the deadline under these circumstances at 0.4.

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Further, he believes that in his absence, there will be a lower standard of housekeeping in the factory and the raw material and labour cost on the other contract will rise by about Rs. 2,000 above the budgeted figure. Draw an appropriate decision tree for Mr. Xs problem and using the expected monetary value (EMV) as the appropriate criterion for decision, find the appropriate initial decision. 16 Solution SL order received 0.60 SL order not received and goods sold in India Rs. 24,000 0.40 Go Rs. 15,500 - Trip cost Rs. 2,500 - Cost increase in another contract Rs. 2,000 - Failure to keep deadline of another contract 0.4 Rs. 10,000 Rs. 15,000 Rs. 30,000

D
Rs. 15,000

Do not go and goods sold in India

Rs. 15,000

The required decision tree is drawn above. Using Roll Back Technique, we calculate the expected monetary value of going to Sri Lanka (SL): At node A, expected gross profit is (Rs. 30,0000.6+ Rs. 15,0000.4) = Rs. 24,000 The Net profit will then be = GP, Rs. 24,000- direct cost of the trip, Rs. 2,500- relevant increase in Cost of material and labour on another order resulting from lack of monitoring by Mr. X, Rs. 2,000- relevant probable cost of penalty for not keeping to the dead line of that other order, Rs. 10,0000.4 = Rs. 15,500. Should Mr. X take the alternative decision to stay back in India and sell the China novelties, he will make profit of Rs. 15,000. Since going to SL appears to be fetching Rs. 500 more [Rs. 15,500-Rs. 15,000], the decision to go will be the appropriate initial decision for him. Question 6 (a) Many traditional management accounting practices are criticized because they fail to include assumption about human behaviour. For the following areas viz., 1. Budgetary control 2. Absorption costing 3. Installation of a Costing & Management Accounting system. Discuss, with reference to practical situation, how the effects of human behaviour should be recognized in the introduction and operation of the system. 3+3+3 (b) A company makes two kinds of leather belts. Belt A is a high quality belt and Belt B is of lower quality.

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The respective profits, are Rs. 40 and Rs. 30 per belt. Each belt of type A requires twice as much time as belt of type B and if all belts were of type B, the company could make 1,000 per day. The supply of leather is sufficient for only 800 belts (both A and B combined). Belt A requires a fancy buckle and only 400 per day are available. There are only 700 buckles a day available for Belt B. You are required to only formulate the linear programming problem. Do not solve the LPP. 7

Solution (a) Understanding peoples aspirations and emotions and, in general, human behaviour at work is now being recognized as an important input for operating techniques like Budgetary control, Absorption Costing, etc., and for installing Costing and Management Accounting system. Budgetary control: In its traditional form, Budgetary control was largely a collection of techniques-the assumption being that the people operating the system would react in a mechanistic way to the imposition of budgets and to an analysis of variances. This is not true. While introducing a system of budgetary control, it is now felt best to communicate to managers the objectives to be achieved and to actively involve them in the very process of budget preparation. It is very much necessary to train them in such a way that they become better managers and may derive personal satisfaction in the success of the organization. This requires good leadership, which must also be used in judging a managers performance against his budget. To blame a manager for failing to achieve a target under circumstances not envisaged when the budget was set can lead only to discontent rather than providing any impetus to new achievements. Absorption Costing: Absorption costing is based on the progressive reapportionment of costs through cost centres until all non-production costs are identified with production centres where they can be absorbed into the cost of saleable products or services. To avoid behaviour problems in the operation of this system, there are three desirable features: (i) Costs apportioned into a cost centre should be reported separately from those costs incurred by the manager of that cost centre. Only the latter category of costs is controllable by him in the short term and it is only in relation to such costs that his performance should be judged. If this is not done, a disproportionate part of that managers time may be spent in disputing the apportioned costs rather than in running his department. (ii) The amounts apportioned should, for control purposes, be at budgeted amounts. Any excess or saving compared with budget should be recognized as the responsibility of the manager of the department where the costs were incurred. At the time of setting budgets there should be a full discussion of cost apportionment proposals. This may give receiving cost centres an opportunity to challenge the level of service department costs, or at least it will ensure that every manager understands how and why the apportionment is made.

(iii)

Installation of Cost and Management Accounting system: Any such system will process data to produce information. The value of the information will depend on the accuracy of the data introduced, and that data will be provided by people outside the accounting department-mostly by managers at various levels, who will be required to fill in the data forms. The success of the system will, therefore, depend on the cooperation by these managers. Cooperation will be forthcoming only if

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1. The purpose of the system is explained to the managers so that are satisfied that it will help them (or their colleagues) in their work and also that the information obtained will not be used unfairly in apportioning praise or blame. 2. The system is practicable. The coding system used should not be over-complex. 3. Training is give in the operation of the system and adequate time allowed for trail running before it is fully implemented. If these requirements are not satisfied, it is likely that people will not make any particular effort to ensure smooth running of the system and may attempt to regress to earlier methods, either in substitution for or in parallel with the new system. (b) Linear programming problem: Formulation suppose the company manufactures Xi belts of type of A and Xii belts of type B each day. Then the objective will be the maximize the linear function: Z = 40Xi+ 30Xii Subject to 2Xi +Xii < 1,000 (time constraint) Xi +Xii < 800 (leather constraint) Xi < 400 (Fancy buckle constraint) Xii < 700 (buckle constraint) Xi, Xii > 0 (non-negativity constraints) Problem 7 (a) State the advantages of Just-in-time production system. 4 (b) A company has two manufacturing divisions, A and C. Each division operates as an independent profit centre. A, which produces two components Bright and Light has a capacity of 1,00,0000 hours per annum. The annual fixed costs of A amount to Rs. 20 lakhs. The product cost data is an under: Direct material/unit Direct labour & variable overheads @ Rs. 35/labour hour Bright Rs. 10 Rs. 140 Light Rs. 5 Rs. 35

A has a permanent customer for the purchase of 15,000 units of Bright per annum at a selling price of Rs. 300 per unit. The balance capacity is devoted to the production of Light, for which there is an unlimited sales potential at a price of Rs. 602 per unit. C assembles tight by using imported component. The annual fixed costs of division C amount to Rs. 4,00,000. The product cost data is as under: Imported component Direct Materials Direct labour & variable overheads @ Rs. 25/hr. Selling price Rs. 300 40 250 700

With a view to minimizing dependence on imported components, the possibility of using Bright was explored. It was found that the import substitution was possible with slight modification, which will take two extra hours per unit of Tight in Division C. The production of Tight is estimated at 5,000 unit per annum. You are requested to present the division-wise profit statement and the companys profit as a whole on the basis of the following conditions. (i) Division C imports 5,000 components for producing Tight.

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(ii) (iii)

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Division C substitutes Bright by drawing Bright from division A at Rs. 300 per unit. Same condition as in (ii) above but division A supplies Bright at Rs. 250 per unit. 3+4+5

Solution (a) The following are the advantages of JIT (Just-In-Time) production system: JIT production system leads to simplification of production process so that only essential activities are conducted. The production line will be stopped automatically if some parts are missing or some defective work has been noticed. It ensures 100% on-time delivery leading to customer satisfaction Breakdowns are minimized leading to fuller utilization of plant. Zero defects, thereby reducing the cost of production Zero inventory, thereby reducing inventory costs It eliminates non-value added activities Aim is placed on minimizing cycle/lead time. (b) Working for basic data: Marginal contribution from Selling price Variable costs Marginal contribution Production time required per unit (hours) Bright 300 _150 150 4 Division A Rs. Contribution from 15,000 Bright 40,000 Light 5,000 Tight Less: Fixed costs Profit (ii) 22,50,000 8,00,000 (20,00,000) 10,50,000 5,50,000 (4,00,000) 1,50,000 12,00,000 Light 60 _40 20 1 Division C Rs. Tight 700 _590 110 Company Rs.

(i)

Contribution from 15,000 Bright (for sale outside) 22,50,000 5,000 Bright (for supply to C) 7,50,000 20,000 Light (using balance hours) 4,00,000 5,000 Tight (contribution at Rs. 60/unit) Less: Fixed Costs (20,00,000) Profit+/ Loss +14,00,000

3,00,000 (4,00,000) -1,00,000

+13,00,000

[Rs. 110 as per working above less cost of two extra hours of machining @ Rs. 25/hour].

(iii)

Since the transfer price is Rs. 50 less than in the case (ii) above, Division As profit will reduce by Rs. 505,000 or Rs. 2,50,000 to Rs. 11,50,000 and Division Bs profit will be Rs. 1,50,000making the companys profit of Rs. 13,00,000.

Problem 8 Write short notes on any four out of the following 44 i) Target Costing ii) Objectives to be kept in mind while setting transfer pricing by multinationals; iii) Differences between Traditional Product Cost System and Throughput Accounting; iv) Reasons for emergence of Activity Based Costing; v) Life Cycle Costing. Solution Short notes:

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(i)

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Target Costing: This technique has been developed in Japan. It aims at profit planning. It is a device to continuously control costs and manage profit over a products life cycle. In short, it is a part of a comprehensive strategic profit management system. For a decision to enter a market, prices of the competitors products are given due consideration. Target costing initiates cost management at the earliest stages of product development and applies it throughout the product life cycle by actively involving the entire value chain. In the product concept stage selling price and required profit are set after consideration of the medium term profit plans, which links the operational strategy to the long term strategic plans. Target cost = Planned selling price Required profit. From this, the necessary target cost can be arrived at. Target cost, then, becomes the residual or allowable sum. If it is thought that the product cannot generate the required profit, it will not be produced as such and aspects of the product would be redesigned until the target is met. Value engineering and value analysis may be used to identify innovative and cost effective product features in the planning and concept stages. Throughout the products life target costing continues to be used to control costs. After the initial start up stage target costs will be set through short-period budget. Thus all costs including both variable and fixed overheads are expected to reduce on a regular (monthly) basis. Target profit is a commitment agreed by all the people in a firm, who have any part to play in achieving it.

(ii)

Objectives to be kept in mind while setting transfer pricing by multinational: International intra-group transfer pricing has it own special considerations. The following are some of the important objectives that are to be borne in mind, while setting transfer pricing by multinational: a. The goal congruence is the basic objective. The divisional managers must so settle the transfer price between themselves, which will foster motivation and attain the target of the multinational company. b. c. The transfer price to be fixed should prima facie be fair to the authorities concerned. It must comply with govt. regulations. Impact of import duty on transferred goods and direct and indirect taxes on the goods produced and sold (transferred) may be sought to be reduced by fixing suitable transfer price, but care should be taken not to attract wrath and penalty of the government that may suffer from such unfair fixation of transfer price. In some countries there may be restrictions in repatriation of profit. In such cases, a price may be so fixed as will be advantageous to both the home and foreign countries while not violating the relevant regulations. In case of transfers between two foreign subsidiaries, they must deal with each other at arms length to the extent possible, as the minority parties have a legal right to a fair share of their corporations profit. If the subsidiary is in a very competitive market, transfer price may be so fixed that the subsidiary can market the end product at a competitive price. Joint ventures create additional complications in transfer pricing. The transfer price must satisfy both the home and foreign ventures.

d.

e.

f. g. (iii)

Differences between Traditional product Cost system and Throughput Accounting Traditional product costing Throughput Accounting Production adds to value. Sale of the production adds to value. Capacity utilization of labour & facility is taken As the measure of efficiency. Effective utilization is measured by adherence To schedule of production &

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Deviations from standards set are studied. Labour & certain costs are taken as variable Costs. In reported Accounts stock is valued at Cost of production. Product costing is mainly done for short term Decision. (iv) Only the deviation from the scheduled All costs except materials are treated as Fixed costs. Stock is valued at material cost only. TA is for planning and improving profit by Increasing flow of production.

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Reasons for emergence of Activity Based Costing: Some of the reasons for emergence of Activity Based Costing are: Traditional system of costing was good when a narrow range of products were manufactured. Today, wide ranges of products are undertaken. Keener competition under present day open global economy necessitates more realistic cost information. For that matter, ABC is superior. Costs are driven by activities and ABC is built on this principle. Direct Labour hour as well as Machine hour method is a volume driven technique and is not suitable for many items of costs. ABC helps management to identify and eliminate non-value added activities, thereby increasing profitability. ABC creates cost pools for activities and helps in Customer profitability analysis. ABC provides management with an economic map of their enterprise. It identifies where money is being made and where it is lost. Thus ABC helps managers to understand the sustainable economies of their business. (v) Life Cycle Costing Life Cycle Costing (LCC) estimates and accumulates costs over a products entire life cycle in order to determine whether the profits earned during the manufacturing phase will cover the costs incurred during the pre-and post-manufacturing stages. It highlights the fact that costs are committed at the design stage itself. Thus LCC improves management decision making. Suppose we want to computerize our office. The staff training cost and the maintenance costs which are many times more than the purchase cost of the computer, will be considered in LCC. It is thus an improvement over Traditional Production Costing. The aim is to adopt a policy which will maximize the return over the cost objects total life. Since the whole life cycle of the cost object is considered, the importance of cost reduction and revenue opportunity is stressed under LCC. Hence it is also helpful to consumers.