Shut Down Decisions

Q.1 Operate or Shut Down

Agro Limited produces tomato paste and market it in 500 gms tins. The full capacity of
plant is 120,000 tins per annum. The sale price is Rs. 30 per tin. The capacity achieved
in the previous year was 50% and the plant is presently operating at that level.
The details of expenses are as under:
Rs.
Direct material 12.00 per tin
Direct labour 3.00
Overhead-variable 3.00
Overhead-fixed 7.00
Total 25.00 per tin

Owing to certain temporary climatic changes, the quality of raw tomatoes has become
very poor, and as a result the tomato paste produced by the company is not being
accepted in the market and the stock is accumulating and can be disposed of at Rs. 20/-
per tin only. It is expected that with the proper training of farmers for which Rs. 100,000
will have to be spent and some R & D activities requiring further one-time expenditure of
Rs. 50,000, the company can start production of tomato paste of acceptable quality and
start marketing after a gap of four months. By closing down all other operation for 4 months
there will be a reduction in fixed overhead by Rs. 40,000 and it has been further suggested
by the marketing department that by reducing sales price by 10% and improving quality
by consuming 5% excess material the capacity utilization can be increased to 80%.
If the above mentioned changes are not undertaken then poor quality of raw tomatoes will
continue for next six months and then the quality of raw tomatoes will be improved.
The company is evaluating the following alternatives.
1 Close down the plant for six months.
2 Close down the plant for four months and go for improvements.
3 Close down the plant for four months and go for improvements and accept
the suggestion of marketing department.
4 Continue the plant and sell the poor quality product at reduced price for
6 months
Required:
Calculate the profit of each of the above alternatives.

Q.2 Sale of Division 5

Shafaq Company manufactures and sells a wide range of products. The
products are manufactured in various locations and sold in a number of quite
separate markets. The company's operations are organised into five divisions
which may supply each other as well as selling on the open market.
The following financial information is available concerning the company for
the year just ended.
Rs. '000'
Sales 8,600
Production cost 5,332
Gross profit 3,268
Other expenses 2,532
Net profit 1 736
 an offer to purchase Division 5 which has been performing poorly, has been
received by the company.
The gross profit percentage of sales, earned by Division 5 in the year, was half that earned
by the company as a whole. Division 5 sales were 10% of total company sales. Of the
production expenses incurred by Division 5, fixed costs were Rs. 344,000. Other expenses
incurred by the Division 5 totaled Rs. 256,000, all of which can be regarded as fixed. These
include Rs.138,000 apportionment of general company expenses which would not be effected
by the decision concerning the possible sale of Division 5. In the year ahead, if Division 5 is
not sold, fixed production cost of the division would be expected to increase by 5% and variable
expenses to remain at the same percentage of sales. Sales would be expected to increase by
10%. If the division is sold it is expected that some sales of other division would be lost. These
would provide a contribution to profits of Rs. 20,000 in the year ahead. Also, if the division is
sold the capital sum received could be invested so as to yield a return of Rs. 75,000 p.a.
Required:
a) Calculate whether it would be in the interest of the company, based upon
the expected situation in the year ahead, to sell Division 5 Marks: 14
b) Calculate the percentage increase in Division 5 sales required in the year
ahead - compared with the current year, for the financial viability of the two
alternatives to be the same. You are to assume that all other factors in the
above situation will remain as forecast for the year ahead. Marks: 6

Q.3 PMS is a large diversified organisation with several departments. It is concerned over
the performance of its department - Department P, PMS is concerned that department
P has not been able to meet its sales target in recent years and is considering either
to reduce the level of production or to shut down the department.
The following information has been made available.

Budgeted sales and production in units 50,000

Rs. '000'
Sales 500
Cost of goods produced and sold:
Material A - 1 kg per unit 50
Material B - 1 litre per unit 25
Labour - 1 hour per unit 125
Variable overhead 100
Fixed overhead 50
Non production costs 50
Total costs 400
Budgeted profit 100

The following additional information has also been made available:

1) There are 50,000 kgs of material A in stock. This originally cost Re. 1 per kg. Material
A has no other use and unless it is used by the division it will have to be disposed at
a cost of Rs. 500 for every 5,000 kgs.
2) There are 30,000 kgs of material B in stock. Any unused material can be used by
another department to substitute for an equivalent amount of a material, which
2 cost of material B was Rs. 0.50 per
currently costs Rs. 1.25 per litre. The original
 litre and it can be replaced at a cost of Rs 1.50 per litre.
3) All production labour hours are paid on an hourly basis. Rumors of the closure of
the department have led to a large proportion of the department's employees leaving
the organisation. Uncertainty over its closure has also resulted in management not
replacing these employees. The department is therefore short labour hours and has
sufficient to produce 25,000 units. Output in excess of 25,000 units would require the
department to hire contract labour at a cost of Rs. 3.75 per hour. If the department
is shut down the present labour force will be fired.
4) Included in the fixed production overhead is the salary of the manager of department
P which amounts to Rs. 20,000. If the department were to shut down the manager
would be made redundant with a redundancy pay of Rs. 25,000. All other costs
included in the fixed production overhead are general factory overheads and will not
be affected by any decision concerning department P.
5) The non production cost charged to department P is an apportionment of the total
non-production costs.
6) The marketing manager suggest that either;
- sales volume of 25,000 units at SP of Rs. 9 per unit with advertising cost Rs. 25,000.
- sales volume of 35,000 units at SP of Rs. 7.5 per unit with advertising cost Rs. 30,000.
Required:
AS the management accountant of PMS you have been asked to investigate the following
options available to management:
a) reduce production to 25,000 units
b) reduce production to 35,000 units
c) shut down department P Marks: 20

Q.4 In May 2015, the board of directors of Sahil Limited (SL) had decided to close one of SL’s
operating segments at the end of the next year. The sales and production for the next year
were budgeted at 50,000 units and on the basis thereof, the budget of the segment for the
next year was approved as follows:
Rs. in ‘000
Sales 5,000
Direct material (50,000 kg) 950
Direct labour 1,000
Variable production overheads 500
Fixed production overheads 1,750
Administrative and selling overheads 500
Budgeted net profit 300
However, rumours of the closure prompted majority of the segment’s skilled labour to leave
the company. Consequently, the management is considering the following alternatives to
cope with the issue:
Close the segment immediately and rent the factory space for one year at a rent of
Rs. 40,000 per month; or
Employ contract labour which would be able to produce a maximum of 40,000 units in
the year. The quality of the product is however expected to suffer due to this change.
The following further information is available:
(i) The sales manager estimates that a sales volume of 30,000 units could be achieved at
the current selling price whereas sales volume of 40,000 units would only be achieved
if the price was reduced to Rs. 90 per unit. 3
 (ii) 25,000 kg of raw material is in stock. Any quantity of the material may be sold in the
market at a price of Rs. 19 per kg after incurring a cost of Rs. 2 per kg. Up to 15,000 kg
can be used in another segment of the company in place of a material which currently
costs Rs. 18 per kg.
(iii) Wages of contract labour would be Rs. 24 per unit. SL would also be required to spend
Rs. 40,000 on the training of the contract labour.
(iv) Due to utilization of contract labour, variable production overheads per unit are
expected to increase by 20%.
(v) Fixed production overheads include:
Depreciation of three machines used in the segment amounting to Rs. 170,000.
These machines originally costed Rs. 1.7 million and could currently be sold for
Rs. 830,000. If the machines are used for production in the next year, their sales
value would reduce by Rs. 5 per unit of production.
All other costs included in ‘fixed production overheads’ represent apportionments
of general overheads.
(vi) 40% of administrative and selling overheads are variable whereas the remaining
amounts represent apportionment of general overheads.
Required:
Advise the best course of action for Sahil Limited.

Q. 5 Kemia Industries Ltd., has its home office in Lahore with three factories situated at
Feb Shaikhupora, Sialkot and Faisalabad. The operations at Sialkot have been unprofitable for a
2013 number of years. The leasehold of Sialkot will also expire by the end of current year.
In view of the continued losses the management has decided to close down the said factory
rather than lease again. The factory’s plant and machinery can be sold at a price higher than
the written down value and the surplus funds will be sufficient to cover all termination costs.
The projected profitability of the factories for the year are as under:
Rs. in million
Shaikhupora Sialkot Faisalabad Total
Sales 6,000 1,500 4,500 12,000
Variable costs 3,300 1,125 2,925 7,350
Fixed costs: -
Factory 1,200 450 600 2,250
Selling and admin 750 75 225 1,050
Home office expenses apportioned 375 225 375 975
Profit and loss 375 (375) 375 375

The company, however, would like to continue to serve the customers now being served by
Sialkot factory, if it could do so economically. Accordingly following proposals were put
forward for consideration based on a selling price of Rs. 37,500 per unit:
Proposals:
(a) Close down Sialkot factory and expand the operations of the Faisalabad factory for
which capacity is existed there. This proposal will involve the following changes:

(b) Close down Sialkot factory and expand the operations of the Shaikhupora factory
subject to the following changes in the result4of Shaikhupora factory:
 (c) Close down Sialkot factory and enter into a long-term contract with an independent
manufacturer to serve the customers of Sialkot factory. The manufacturer will pay the
royalty of Rs. 750 per unit to the company. In that event the sales of the area served by
the Sialkot factory will fall by 25%.
(d) Close down Sialkot factory and discontinue serving the present customers of the area.
Required:
Evaluate each of the above proposals and advise the management for the action to be taken
in the interest of improving profitability of the company. 20

Decision Making - Make or Buy

Q1 "That old equipment for producing subassemblies is worn out" said Managing
Director of Tahir Company. "We need to make a decision quickly." The Company
is trying to decide whether it should purchase new equipment and continue to
make its subassemblies internally or whether it should discontinue production
of its subassemblies and purchase them from an outside supplier.
The alternatives are:
Alternative 1
New equipment for producing the subassemblies can be purchased at a
cost of Rs. 350,000. The equipment would have a five-year useful life and
a salvage value of Rs. 50,000.
Alternative 2
The subassemblies can be purchased from an outside supplier who has
offered to provide them for Rs. 8.00 each under a five year contract.
Tahir Company’s present cost per unit of producing the subassemblies internally
with the old equipment are given below:
These costs are based on annual production of 40,000 units.

Direct materials 2.75 per unit

Direct labour 4.00
Variable overhead 0.60
Fixed Overhead 3.65 ( Rs. 0.75 supervision, 0.90 depreciation and
Total cost 11.00 2.00 general overhead)

The new equipment would be more efficient and, according to the manufacturer,
would reduce direct labour cost and variable overhead cost by 25%. Supervision
cost Rs. 30,000 per year and direct material cost per unit would not be affected
by the new equipment. The new equipment's capacity would be 60,000 units per
year. The company has no other use for the space now being used.
Required:
1 Assume 40,000 subassemblies are needed each year, which course
of action would you recommend to the MD? Marks: 8
2 Would your recommendation in (a) above be the same if the
5
 company's needs were (i) 50,000 units per year or (ii) 60,000 units
per year? Show computation. Marks: 6
3 What other factors would you recommend that the company consider
before making a decision? Marks: 6

Q.2 Automatic or Semiautomatic

A company proposes to install a machine for the manufacture of a component which at
present is being purchased at Rs. 24 each. There are two alternatives, installation of an
automatic machine, and installation of a semi automatic machine.
The details of the machines are as under.
Automatic Semi automatic
machine machine
Initial cost of the machine Rs 900,000 600,000
Life Years 10 10
Variable expenses Rs 12 15
Fixed overheads except depreciation 162,000 84,000
The company charges depreciation on straight line method. Scrap value of the machine
at the end of life is nil. The demand of the components at present is 20,000 per annum.
This demand is expected to increase to 40,000 units.
Required:
a) For each of the two volume of output, namely, 20,000 and 40,000 units, state
with supporting computations, whether the components should be purchased
or manufactured. If your decision is in favor of installation of machine, which
method do you advise?
b) At what volume of output should the company change over from purchase of
components to manufacture by installation of semi-automatic machine and
automatic machine.
c) At what volume of output should the company change over from installation of
one type of machine to the other?

Q.3 Taxi Fares (ICMAP Nov 1999)

A practicing cost and management accountant now spends Rs. 5.00 per km on Taxi fares
for his clients work. He is considering two alternatives, the purchase of a new small car or
an old bigger car. The estimated cost figures are:

Alternative I Alternative II
Purchase of new Purchase of old
small car Bigger car
Purchase price 350,000 200,000
Sale price after 5 years 190,000 120,000
Repair, servicing per
annum 10,000 12,000
Taxes & Insurance per
annum 17,000 7,000
Petrol Consumption
per litre 10 km 7 km
Petrol price per litre 25.00 25.00
He estimates that he travels 10,000 kms. annually.
6
 Required:
1 To evaluate the three alternatives (i.e. use of Taxi as per existing practice or
purchase of new small car or old bigger car.
2 If his practice expends and has to travel 25,000 kms. per annum, what would
be his decision.
3 At how many kilometers per annum the costs of two cars break-even

Q.4 Electric Equipment

The Electric Equipment Manufacturing Company has a proposal of bringing out a new
washing machine. The machine requires an electric motor that the firm does not use in its
current line of products. A local supplier has offered to supply any number of motors needed
at the rate of Rs. 150 per motor. Delivery is guaranteed within 15 days of the order received.
The production manager of the co. thinks that they could make the motor by extensively
converting an existing model. Additional space and machinery would be required it the firm
were to make the motor. The space to make motors could be rented at Rs. 140,000 p.a.
Moreover, some space of the existing building rented out at Rs. 60,000 p.a. would have to
be vacated and required for the purpose of storing material. The equipment needed to
convert the motor could be rented for Rs. 150,000 p.a. The accountant of the company
has developed the following unit cost based on the expected demand of 10,000 units p.a.
Material Rs. 50
Labour 50
Rent for space 14
Machinery rent 15
Variable overhead 11
Fixed overhead (allocated) 20
Required:
1 Determine whether the motors should be made or bought from a local supplier.
2 Determine the volume of the motors at which the company would show the same
total income whether it bought or made the motors.

Q5 Decimal World Limited manufactures and sells modems. It manufactures its own circuit
ICAP boards (CB), an important part of the modem. The present cost to manufacture a CB is as
Autumnfollows: Rupees
2008 Direct material 440
Direct labour 210
Variable overheads 55
Fixed overheads
Depreciation 60
General overheads 30
Total cost per unit 795
The company manufactures 400,000 units annually. The equipment being used for
manufacturing CB has worn out completely and requires replacement. The company is
presently considering the following options:
(A) Purchase new equipment which would cost Rs. 240 million and have a useful life of six
years with no salvage value. The company uses straight-line method of depreciation. The
new equipment has the capacity to produce 600,000 units per year. It is expected that the
use of new equipment would reduce the direct
7 labour and variable overhead cost by 20%
 (B) Purchase from an external supplier at Rs.730 per unit under a two year contract.
The total general overheads would remain the same in either case. The company has no other
use for the space being used to manufacture the CBs.
Required:
(a) Which course of action would you recommend to the company assuming that 400,000
units are needed each year? (Show all relevant calculations) (Marks: 7)
(b) What would be your recommendation if the company’s annual requirements were
600,000 units? (Marks: 6)
(c) What other factors would the company consider, before making a decision? (Marks: 3)

Q6 Artery Limited (AL) produces and markets three products viz. Alpha, Beta and Gamma. Following
ICAP information is available from AL’s records for the manufacture of each unit of these products:
Autumn Alpha Beta Gamma
2012 Selling price (Rs.) 66 88 106
Material-A (Rs.4 per kg) (Rs.) 8 0 12
Material-B (Rs.6 per kg) (Rs.) 12 18 24
Direct labour (Rs. 10 per hour) (Rs.) 25 30 25
Variable overhead based on:
− Labour hours (Rs.) 1.5 1.8 1.5
− Machine hours (Rs.) 1.6 1.4 1.2

Other data:
Machine hours 8 7 6
Maximum demand per month (units) 900 3000 5000
Additional information:
(i) AL is also engaged in the trading of a fourth product Zeta, which is very popular in the
market and generates a positive contribution. AL currently purchases 600 units per month of
Zeta from a supplier at a cost of Rs. 40 per unit. In-house manufacture of Zeta would
require: 2.5 kg of material-B, 1 hour of direct labour and 2 machine hours.
(ii) Materials A and B are purchased from a single supplier who has restricted the supply of
these materials to 22,000 kg and 34,000 kg per month respectively. This restriction is likely
to continue for the next 8 months.
(iii) AL has recently accepted a Government order for the supply of 200 units of Alpha, 300 units
of Beta and 400 units of Gamma each month for the next 8 months. These quantities are in
addition to the maximum demand stated above.
(iv) There is no beginning or ending inventory.
Required:
Determine whether AL should manufacture Zeta internally or continue to buy it from the supplier
during the next 8 months. (10 marks)

Q.7 Zargham Foods Limited has a high reputation of producing quality fresh juices which is in
Nov high demand as compared to its supply. These fresh juices are extracted from company’s
2010 own fresh fruit farms through a semi-manual machine at the rate of 30 packs (for single
use) per minute sold in cartons of ten packs per carton.
The company is now planning to increase its supply by replacing the semi-manual machine
with an state-of-the-art latest digital machine that will operate at the rate of 40 packs per
minute. 8
 Semi-manual machine was purchased 5 years ago for Rs.6,000,000 with an estimated life
of 10 years and a residual value of Rs.50,000. The proposed digital machine will cost
Rs.8,000,000 while estimated life and residual value will be 10 years and Rs.50,000
respectively. The supplier of the digital machine has offered Rs.900,000 as trade-in
allowance for semi-manual machine. Company has a policy of straight-line depreciation.
The proposed digital machine will occupy only 80% of the floor space of semi-manual
machine. The company plans to use the spare floor space for some other business
activities the whole floor will save Rs.500,000 per annum.
The following additional details are available for the evaluation of the proposal:
Semi-manual Digital
Particulars machine Machine
Operating hours per annum 1,300 1,650
Rs Rs
Direct labour required per annum 157,000 165,000
Repair & maintenance cost per annum 150,000 119,000
Cost of utilities per annum 130,000 110,000

Anticipated loss, if any on replacement of semi-manual machine is to be included in the

estimated cost of digital machine.
Required:
(a) Prepare a comparative cost estimate with cost per carton of ten packs for one year
for both the machines (semi-manual and digital). Also calculate saving per carton, if
any in case the company decides to replace the semi-manual machine with digital
machine (Ignore taxation for evaluation of the proposal). 16
(b) Calculate how many packs of juices must be produced by the digital machine to yield
saving equal to extra capital outlay involved in its procurement. 04

Q.8 Karachi Electrics (K.E) Ltd., a local company produces electrical household
(May equipment including 50,000 electric irons per annum. For each iron, they use a
2008) specialized component which they import at a cost of Rs.115.
Recently the management of K. E Ltd., instructed their Chief Accountant to advise
on the costs involved, if the company were to manufacture the components
instead of importing them since the company has the necessary technological
know-how.
The Chief Accountant after consulting various departmental managers made
calculation based on the following information:
(i) Direct materials to produce 50,000 components would cost Rs.3,000,000.
(ii) Direct labour at the standard hourly rate of Rs.50 would cost Rs.2,000,000.
(iii) The company's overheads excluding depreciation and supervision costs
would increase from Rs.2,100,000 to Rs.2,400,000.
(iv) With the level of overheads Rs.2,400,000 the overhead recovery rate would
be Rs.6 per direct labour hour.
(v) For the components to be produced locally, the K. E Ltd., would have to buy a new
machine worth Rs.1,000,000. The expected useful life of this machine is 5 years
(vi) Production of these components would also utilize 10% capacity of an
existing machine which was bought in the previous year at a cost of
Rs.40,000,000. The expected useful life of this machine is 8 years.
Currently, only 70% of the machine's capacity
9 is being utilized.
 (vii) The supervision of production will fall on Mr. Ubaydullah who earns a salary of
Rs.500,000 per annum. Management thinks that Mr. Ubaydullah is only half utilized
(viii) The company uses straight line method of depreciation, which reduces
salvage value of the machines to zero.
After making all the calculations be deemed necessary, the Chief Accountant
concluded that the standard cost of manufacturing the components was Rs.125
per unit. On the basis of this information the management decided to continue
importing the components as this would save the company Rs.500,000 per
annum.
Required:
(a) Prepare a comprehensive statement, showing how the Chief Accountant
worked out the standard cost of Rs.125 per component.
(b) State whether the management made use of relevant costs in arriving at
their decision. If you think that management did not use relevant costs, then
prepare a statement and apply the criteria of relevant costs.
(c) Assuming that the costs of producing or importing the components were
equal, give six major advantages of manufacturing the components.

Q.9 Gujrat Engineering Ltd., produces and sells washing machines. It also manufactures the
(Feb spindles for its machines. It expects to produce and sell 24,000 washing machines during the
2013 year 2013-14. It is considering an offer from an outside vendor to supply any number of
spindles at price of Rs.300 per spindle.
The accounts of the company reports the following costs for producing 24,000 spindles:
Rupees
Cost per Unit Total Cost
Direct material 125.00 3,000,000
Direct labour 100.00 2,400,000
Variable manufacturing overhead 50.00 1,200,000
Quality control, down time etc. 25.00 600,000
Machine leasing cost 25.00 600,000
Allocated fixed overhead 31.25 750,000
356.25 8,550,000
The following additional information is available:
(i) Quality control, down time etc., vary with the number of batches in which the spindles are
produced. Currently spindles are being produced in the batch size of 2,000 units.
(ii) Direct labour cost represents wages to workers who are exclusively engaged in the
manufacturing of spindles. The workers are highly trained and skilled hence cannot be
terminated.
(iii) If company procures all its spindles from outside vendor, it will not require the machine
which it has hired for manufacturing of these spindles.

Required:
(a) Assume that if Gujrat Engineering Ltd., purchases spindles from outside vendor, the
facility (including workers) where the spindles are currently manufactured will remain
idle. Should the company accept the offer from outside vendor at the anticipated
production and sale volume of 24,000 units? 05
(b) Whether your decision in (a) above will change if facilities can be used to upgrade the
10
 washing machine which will result in an incremental revenue of Rs. 550 per machine.
The variable cost of upgrading would be Rs. 450 and tooling cost would be Rs. 400,000. 06
(c) Assume that facilities will be used as stated in (b) above. Further, assume that with
better planning, Gujrat Engineering Ltd., will be able to manufacture these spindle in the
batch size of 4,000 units (instead of 2,000 units), if it decides to produce spindles
in-house.What will you advise? Show all workings. 07

Q.10 An international airline, planning to outsource its local operations due to heavy load of
(Feb international flights. The local flight division currently operates 20 flights per annum. The
2014 costs currently assigned to the local operation are as follows: Rupees
Total Cost of Operations Per Flight Cost
Direct cost –Non-contractual 1,400,000 70,000
Direct cost –Contractual 1,100,000 55,000
Variable overheads 120,000 6,000
Fixed overheads 700,000 35,000
Allocated other overheads 600,000 30,000
3,920,000 196,000
The numbers of flights and above costs are expected to remain unchanged in the foreseeable
future, if the airline continues to operate locally. Contractual direct cost will be made
redundant. No redundancy cost will be incurred. Non-contractual direct cost and variable
overhead are avoidable and fixed overhead would be reduced by Rs. 100,000 per annum and
allocated other overheads will remain unchanged, if local operations got outsourced. Vacant
facilities after outsourcing will generate a cash flow of Rs. 800,000 per annum.
Blue Shine Limited, a local airline, has offered to operate required number of flights per
annum at a price of Rs. 170,000 per flight.
Required:
Would you recommend the outsourcing to local operations of Blue Shine Limited?
Substantiate your answer with analyses. 08

Q.11 An engineering company produces product P in its production shop A. The overhead recovery
rate is 100% of direct wages based on the following budgeted figures:

Rs. '000'
Direct wages 1,600
Variable overheads 640
Fixed overheads 960

The production plan for the same budget period envisages an output of 18,000 units of product
P whose sales and cost data is as under:

Selling price Rs. 420 per unit

Direct material 120 per unit
Direct wages 80 per unit
Overhead 80 per unit

The company proposes to use the balance capacity of shop A after completing the above
11 Q whose cost data is as under:
production pan, for the manufacture of component
 Direct material Rs. 80 per unit
Direct wages 160 per unit
Overhead 160 per unit
The component Q is used by the company in the manufacture of some other product in
another production department.
The company receives an export order for the purchase of 2,000 units of product P at Rs. 300
each. This offer can be accepted by diverting the capacity from component Q. In that event,
the company has to buy the component which is available from an outside supplier at a price
of Rs. 400 each.
Required:
Advice the management with supporting calculation as to whether component
Q should be produced or bought from the outside supplier.

Q.12 M/s Deltex Limited is engaged in the manufacture of consumer products,

(Nov has developed a special glue called “Delglue”to utilize its spare production
2008) capacity. Delglue is to be sold in tubes of 50ml capacity to distributors packed in
cartons of 40 tubes at Rs.1,200 per carton. The company estimates sales of 200,000
tubes per month at the cost estimates based on this volume of production as under:
Rs. per carton
Direct materials 500
Direct wages 300
Variable overhead 300
Allocated fixed overhead 60
Total 1,160
The company expects that in course of time the sales can be increased to
300,000 tubes per month and ultimately to 500,000 tubes per month. The
sales of Delglue require a special tube manufacturing capacity. The
company has a machine which is capable of producing 200,000 empty
tubes of the required size per month and this machine is at present idle. It
can be used for producing the empty tubes required for packing Delglue.
Alternatively, the company can purchase empty tubes from the market at a
cost of Rs.450 per 100 tubes. In that event, there will be a saving of 20% in
materials cost and 10% in labour and overhead cost of Delglue estimated above.
If the company however, desires to manufacture the empty tubes in excess
of 200,000 tubes, a new tube making machine will have to be installed
involving a fixed overhead of Rs.200,000 per month. The capacity of the
new machine is 500,000 empty tubes per month.
Required:
(i) Prepare statements to show whether the company should make or buy
empty tubes at each of the three levels of production of Delglue of 200,000,
300,000 and 500,000 empty tubes per month.
(ii) At what volume of sales of Delglue will the company find it justifiable to
install the new empty tube manufacturing machine.
(iii) Prepare a statement to show the overall profit at the three volume of
production and sales of Delglue, viz., 200,000, 300,000 and 500,000 tubes
based on your decision at (i) above to make or buy the empty tubes.

12
Decision Making - Sale or Process further

Q1 Product X, Y and Z are output from a joint operation in the following proportions
Product X - 50%
Product Y - 30%
Product Z - 20%

Product Y and Z are sold without further processing. Product X can either be sold
without further processing or it can be further processed and sold as product FP
which is currently the case. A by-product BP results from the further processing.

The total weight of output from the joint process in a period was 1,600 kgs. Cost incurred in the
joint process in the period were Rs. 73,600. Expenditure on further processing of product X was
Rs. 25,800 (including an additional 200 kgs of material). Product BP was 8% of input quantity
.
50 kgs of product FP were in stock at the beginning of the period at a cost of
Rs. 3,170. There were no opening stocks of Products X, Y, Z and BP.

Sales and sales prices per kg in the period were:

SP per SALES
KG KG
Product X 50.00
Product Y 75.00 480
Product Z 39.00 320
Product FP 84.00 900
Product BP 12.00 80

Required: Marks: 20
a) Calculate the gross profit/ loss of each of product Y, Z and FP
(Note: The sales value of by product is added in the sales value of main product
The FIFO method is used. )
b) Comments on the profitability of product Z and advise management of action that
could be taken.
c) Determine whether more profits would have been earned if Product X had been
sold without further processing.

Q2 C ltd operates a process which produces three joint products. In the period just
ended costs of production totaled Rs. 509640. Output from the process during
the period was:

Product W 276,000 Kgs

Product X 334,000 Kgs
Product Y 134,000 Kgs

There were no opening stocks of the three products. Product W and X are sold
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in this state. Product Y is subjected to further processing. Sales of Product W
 and X during the period were:

Product W 225,000 Kgs. @ 0.945 per kg

Product X 312,000 Kgs. @ 0.890 per kg

128,000 Kgs of Product Y were further processed during the period. The balance
of the period production of the three products W, X & Y remained in stock at the
end of the period. The value of closing stock of individual products is calculated
by apportioning costs according to weight of output.

The additional costs in the period of further processing Product Y, which is

converted into Product Z, were:
Rs.
Direct labour 10,850
Production overhead 7,070

96,000 kgs of Product Z were produced from the 128,000 Kgs of Product Y. A
by-product BP is also produced which can be sold for Rs. 0.12 per kg. 800 Kgs
of BP were produced and sold in the period.

Sales of Product Z during the period were 94,000 Kgs for Rs. 100,110. Opening
stock of Product Z was 8,000 Kgs valued at Rs. 8,640.The FIFO method is
used for pricing transfers of Product Z to cost of sales.

Selling and administration costs are charged to all main products when sold at
10% of revenue.

Required:
1 Prepare a profit and loss account for the period, identifying separately
the profitability of each of the three main products. Marks: 15
2 C Ltd has now received an offer from another company to purchase
the total output of Product Y for Rs. 0.62 per kg. Calculate the
viability of this alternative. Marks: 5

Q3 Maxon Chemicals engaged in manufacturing of two joint products ‘A’ and ‘B’ both
used as basic ingredients for textile industry. Chief Financial Officer of the company
has provided you the following information:

Consolidated units sold –Numbers 1,000

Selling price per unit Rs. 750
Material @ Rs 225 per kg kgs 1,500
Labour hours @ Rs.50 per hour hours 2,200
Variable overheads % of direct labour 150%
Fixed overheads 200,000

The trend analysis of sales of last ten (10) years reveals that one third (1/3) of
consolidated revenue relates to product ‘B’. Company has an option to process
further the joint products and sell them at higher
14rates to maximize profit. Company is
 properly equipped for this further processing. The incremental revenues and
expenses involved in further processing are as under:

Consolidated revenue after further processing Rs. 975,000

Additional quantity of material required for ‘A’ 350 kgs
Additional quantity of material required for ‘B’ 120 kgs
Additional direct labour hours required for ‘A’ 570 hours
Additional direct labour hours required for ‘B’ 200 hours

Required:
Advise the company whether further processing should be undertaken or not.

Q4 The Data Company produces three products, ‘A’, ‘B’, and ‘C’, as the result of initial joint
processing plus separable processing after the split-off point. Records for July show the
following:
A B C Total
Materials used (Rs.) ––– 300,000
Joint processing cost (Rs.) ––– 340,000
Separable processing costs (Rs. 100,000 160,000 140,000
Unit produced 6,000 12,000 6,250
Unit sold 4,000 9,000 4,250
Unit sales price (Rs.) 100 75 80

Required:
(i) Calculate the cost assigned to ending inventory for each product and in total,
assuming no beginning inventory and using the market value method for joint cost
allocation. 09

(ii) A prospective customer is willing to buy all the output of product ‘B’ at the split-off
point for Rs. 60 per unit. Would you recommend the Data Company to accept this
offer? Is there any advantage which would make the sale of product ‘B’ at split-off
point desirable? 04

Q5 Zee Chemicals Limited (ZCL) produces two joint products, Alpha and Beta from a single
production process. Both products are processed upto split-off point and sold without any
further processing.
Presently, ZCL is considering the following proposals:
A) Expansion of the existing facility by installing a new plant
B) Installation of a refining plant to sell either Alpha or Beta after refining

To assess the above proposals, following data has been gathered:

(i) Actual cost incurred in the month of December 2014:
Rs. in '000
Direct material 15,000
Variable conversion costs (Rs. 230 per hour) 4,890
Fixed overheads 2,600
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(ii) Actual production and selling price for the month of December 2014:
Litres Selling price per
litre (Rs.)
Alpha 11,300 1,000
Beta 14,700 1,125

(iii) There is no process loss and joint costs are apportioned between Alpha and Beta
according to the weight of their output.
(iv) Details of the proposed plans are as follows:
Expansion of Installation of
existing facility refining plant
Capacity in machine hours per month 5,000 5,000
------------ Rs. in '000 ------------
Cost of plant and its installation 20,000 25,000
Estimated residual value at the end of life 1,400 2,800
Estimated additional fixed overheads per month 250 500
Estimated useful life of the plant 20 Years 20 Years
(v) Estimated variable cost of refining and sales price of refined products:
Alpha Beta
Rupees per liter
Direct material 90 125
Conversion cost (Rs. 150 per hour) 68 80
Selling price 1,380 1,525
(vi) There would be no loss during the refining process. There is adequate demand for
Alpha and Beta at split-off point and after refining.
Required:
Evaluate each of the above proposals and give your recommendations.

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