Differential Cost Analysis Examples

Differential cost Analysis / Decision Making Solution of Exercise No. 01 Req: 1 Differential cost between 80% level of activity and 90% level of activity Normal Capacity At 90% Level of activity At 80% Level of activity

90,000 units (100% level of activity) ========= (90,000 units x 90%) 81,000 units (90,000 units x 80%) 72,000 units Differential units 9,000 units

Differential Cost = 9,000 units x 12 variable production cost Differential Cost = 108,000 ====== Req: 2

Differential cost of producing 5,000 units Additional cost incurred in fixed cost Variable cost (5,000 units x 12) Differential cost

= 10,000 = 60,000 = 70,000 =======

Req: 3

Per unit cost of 95,000 units Variable cost (95,000 units x 12) Fixed Cost (240,000 + 10,000) Total Cost incurred Per unit cost = 1,390,000 95,000 units

= 1,140,000 = 250,000 = 1,390,000 ========= = 14.63

Req: 4

Per unit differential production cost of 5,000 units Per unit differential cost = 70,000 5,000 units

= 14

Solution of Ex. 2: Required No. 1: Average annual differential Cost for the first 5 years (including income tax): Cost of merchandise Depreciation of equipment Marketing Expenses Differential ware house rent Cost excluding Income Tax Amount of Income Tax: Sales revenue = 500,000 Less: Cost of sales = (450,000) INCOME = 50,000

= 385,000 = 30,000 = 10,000 = 25,000 = 450,000

Income Tax (50,000 x 46%) AVERAGE ANNUAL DIFFERENTIAL COST FOR THE FIRST 5 YEARS

=

23,000

= 473,000 ========

Required No. 2: Minimum Annual net income Minimum Annual net income = (Investment in the proposal / 2) x rate of return = (Rs. 150,000 / 2) = Rs. 75,000 x 11% = Rs. 8,250 ======= Required No.3: Estimated annual differential income: Differential Sales revenue = 500,000 Less: Differential cost (including income tax) = 473,000 Rate of return required = 8,250 = (481,250) ESTIMATED ANNUAL DIFFERENTIAL INCOME = 18,750 ========= Required No. 4: Estimated Cash flow during third year:

Cash Inflows: Sales revenue = Rs. 500,000 Cash Outflows: Differential Cost = 473,000 Less: Non Cash expenses: Depreciation Exp. = (30,000) = Rs. 443,000 ESTIMATED CASH INFLOW DURING THIRD YEAR = Rs. 57,000 ===========

Solution of Ex. 3 ABC Company Projected Income Statement For the period ended --Sales (5,000 kgs. X 1.80)

= 9,000

Less: Cost of goods sold: Direct material used (0.6 + 0.01 = 0.61 x 5,000 kgs.) = 3,050 Direct Labor used (0.5 x 5000 kgs.)

= 2,500

Factory Overhead – Variable Cost: Indirect labor (0.2 x 5,000 kgs.) = 1,000 Power (0.02 x 5,000 kgs.) = 100 Supplies (0.02 x 5,000 kgs.) = 100 Maintenance and Repair (0.027 x 5,000 kgs.)= 135 Insurance (0.007 x 5,000 kgs.) = 35 Additional Cost incurred to accept an order Additional payroll taxes = 210 Depreciation on new machine (3,000 / 24 months) = 125 = 335 = 1,705 COST OF GOODS SOLD Gross margin to accept an order

= (7,255) = 1,745 =======

Note: All per unit rates are calculated on the basis of 30,000 units.

Solution of Ex. 4 Req 1: Conclusion: The company should accept a special order, because it is currently working below 100% normal capacity i.e. 62.5% and from this order it will cover the variable manufacturing cost. Working No. 1 Sales price per unit Less: Variable Manufacturing cost Direct Material = 5.00 Direct Labor = 3.00 Variable FOH cost = 0.75 Gross contribution margin

= Rs. 10.00

= (Rs. 8.75) = Rs. 1.25 =========

Working No. 2 Contribution margin = Rs. 1.25 Less: Variable marketing expenses = (Rs. 0.25) Net contribution margin = Re. 01 ========= Req 2: The company will pay at most Rs. 8.75 to outside supplier because it covers the variable manufacturing cost. Req 3: Where direct costing is involved the unit cost will be Rs. 8.75 because it is variable cost of manufacturing a product. Req 4: Contribution margin at present level of activity: Sales price = Rs. 15 Variable cost = Rs. 09 Contribution margin = Rs. 6 x 10,000 units Contribution margin at increase level of activity 10%: Sales price = Rs. 14 Variable cost = Rs. 09 Contribution margin = Rs. 5 x 11,000 units Reduction on contribution margin

= Rs. 60,000

= Rs. 55,000 = Rs. 5,000 =========

Solution of Ex. 6 Req 1:

Differential Cost Analysis for special order Sales price per unit Less: Variable cost per unit Direct Material Direct Labor Variable FOH Variable marketing expenses Contribution Margin per unit

Differential Contribution margin

= 0.1225 = 0.040 = 0.021 = 0.010 = 0.005

= (0.0760) = 0.0465 =======

= 0.0465 x 3,600,000 units = Rs. 167,400 ===========

Solution of Ex. 7 Req 1:

Relevant cost per unit Part A4

Part B5

0.40 1.00 1.60 3.00 ===

8.00 4.70 0.80 13.50 ====

Part A4

Part B5

Purchase price per unit Relevant unit cost Potential saving per unit on production Machine hour required for production

5.00 (3.00) 2.00 4 hours

15.00 (13.50) 1.50 2 hours

Potential saving per unit per machine hour

2 / 4 = 0.5

1.5 / 2 = 0.75

Direct Material Direct Labor Variable Factory overhead (40%) Relevant Cost per unit Req 2:

Available Idle machine hours = 30,000 hours Used in production Part B5 (8,000 units x 2 hours per unit) = 16,000 hours Available hours for the production of Part A4 = 14,000 hours ============ Units required of Part A4 Per unit required machine hours

= 6,000 units. = 4 hours

Available hours = 14,000 hours Available hours used in production of Part A4 (14,000 hours / 4 hours per unit) = 3,500 units Total units needed Units produced for available hours Purchase from outsider

= 6,000 units = 3,500 units = 2,500 units ==========

SOLUTION OF EXCERCISE NO. 8:

Cost to Manufactured Part No. 1700 Direct Material Cost per unit Direct Labor Cost per unit Variable Factory overhead per unit Variable cost per unit Units required to produce

= 2 = 12 = 5 = 19 = 5,000 units =========

Cost to manufacture (5,000 units x Rs. 19) = Rs. 95,000 Fixed Cost eliminated (5,000 units x Rs. 3) = Rs. 15,000 Saving from alternative use of facilities = Rs. 40,000 SAVING TO MANUFACTURED (5,000 units)= Rs. 150,000 COST TO PURCHASE PART 1700 (5,000 units x 27)= Rs. 135,000 SAVING FROM BUYING INSTEAD OF MAKING = Rs. 15,000 ===========

Solution of Exercise No. 10: ALTERNATIVE “A” Ex Present Variable Cost: Variable Cost to manufacture= Rs. 285,000 Variable Cost of Expenses = Rs. 270,000 Ex Proposed Variable Cost: (52% of Sales revenue) Sales Revenue = Rs. 925,000 New Variable Cost =========== (Rs. 925,000 x 52%) REDUCTION IN VARIABLE COST

= Rs 555,000

= (Rs. 481,000) = Rs. 74,000

Ex Present Fixed Cost: Fixed Cost to manufacture = Rs. 304,200 Fixed Cost of Expenses = Rs. 125,800 = Rs 430,000 New Fixed Cost = Rs. 480,000 INCREASE IN FIXED COST = Rs. 50,000 ADVANTAGE IN ALTERNATIVE A = Rs. 24,000 ========== ALTERNATIVE “B” Zee revenue increase by 50%, which also increase the Zee variable cost by 50% Incremental Zee Revenue (Rs. 575,000 x 50%) = Rs. 287,500 Less: Incremental Zee Variable cost Variable Cost (Rs. 150,000+Rs. 80,000) = Rs. 230,000 x 50% = Rs. 115,000 ZEE Incremental Contribution Margin = Rs. 172,500 Add: Rental income from space used for Ex product = Rs. 157,500 Reduction in fixed cost due to discontinuation = Rs. 30,000 BENEFIT IN PRODUCTION OF ZEE = Rs. 360,000 Reduction in Ex revenue due discontinuation Less: Ex Variable Cost Reduction in Ex- Contribution margin DISADVANTAGE IN ALTERNATIVE “B”

= Rs. 925,000 = Rs. (555,000) = Rs. 370,000 = Rs. 10,000 ============