Cost Management Techniques – CA Final SCMPE Study Material

Cost Management Techniques – CA Final SCMPE Study Material is designed strictly as per the latest syllabus and exam pattern.

Cost Management Techniques – CA Final SCMPE Study Material

Question 1.
(Strategic Analysis of Operating Profit)
Royal Ltd., forms a Panel consisting of its Production, Marketing and Finance Directors to prepare a budget for the next year. The Panel submits a draft budget as detailed below:

Particulars
Selling price per unit 50
Direct material cost per unit (9)
Direct labour cost per unit (9)
Variable overhead (3 hrs. @ ₹ 2) (6)
Contribution per unit 24
Budgeted Sales Quantity 25,000 Units
Budgeted Contribution (25,000 × ₹ 26) ₹ 6,50,000
Budgeted Fixed Cost ₹ 5,00,000
Budgeted Profit ₹ 1,50,000

The Management of Royal Ltd. is not happy with the budgeted profit as it is almost equal to the previous year’s profit. Therefore, it asks the Panel to prepare a budget to earn at least a profit of ₹ 3,00,000. To achieve the target profit, the Panel reports back with the following suggestions:
(a) The unit selling price should be raised to ₹ 55.
(b) The sales volume should be increased by 5,000 units.
(c) To attain the above said increase in sales, the Royal Ltd. should spend ₹ 40,000 for advertising.
(d) The production time per unit should be reduced.
(e) To win the acceptance of the workers in this regard the hourly rate should be increased by ₹ 3 per unit besides an annual group bonus of ₹ 30,000.
(f) There is no change in the amount and rates of other expenses. The Royal Ltd. has sufficient production capacity.
As the implementation of the above proposal needs the acceptance of the work force to increase the speed of work and to reduce the production time per unit, the Board wants to know the extent of reduction in per unit production time.
Required:
(1) Calculate the target production time per unit and the time to be reduced per unit.
(2) Identify the other problems that may arise in production due to decrease in unit production time and also suggest the remedial measures to be taken.
(3) State the most suitable situation for the adoption of Target Costing [Nov. 2018] (14 + 4 + 2 Marks)
Answer:
(1) Target Production Time per unit and Time to be Reduced per unit

Alternative 1 2 3
Target Production Time per unit (₹ 12 +  ₹ 2 × hrs.) × 30,000 units = ₹ 5,10,000 Hrs. = 2.50
Time to be reduced per unit = 3 hrs. – 2.50 hrs.
= 0.50 hrs.       ‘
Verification Labour Rate per unit = ₹ 12

Cost Management Techniques – CA Final SCMPE Study Material

Alternative 1 Alternative 2 Alternative 3
Target Production Time per unit
(₹ 12 + ₹ 2 × hrs.) × 30,000 units
= ₹ 5,10,000 Hrs. = 2.50
Target Production Time per unit
(₹ 3 + ₹ 3 + ₹ 2) × hrs. × 30,000 units
= ₹ 5,10,000 Hrs. = 2.125
Target Production Time per unit
[(₹ 9 + ₹ 3)/3 + ₹ 2] × hrs. × 30,000 units
= ₹ 5,10,000 Hrs. = 2.833
Time to be reduced per unit
= 3 hrs.- 2.50 hrs.
= 0.50 hrs.Verification Labour Rate per unit = ₹ 12
Time to be reduced per unit
= 3 hrs. – 2.125 hrs.
= 0. 875 hrs.Verification Labour Rate per unit
= ₹ 6 × 2.125 hrs.
= ₹ 12.75
Time to be reduced per unit
= 3 hrs. – 2.83 hrs.
= 0. 17 hrs.Verification Labour Rate per unit
= ₹ 4 × 2.83 hrs.
= ₹ 11.32

Workings
Statement Showing Target Cosi (Direct Labour and Variable Overhead)

Particulars Amount (₹)
Target Sales (₹ 55 × 30.000 Units) 16,50,000
Less: Target Profit 3,00,000
Less: Direct Material Cost (₹ 9 × 30,000 Units) 2,70,000
Less: Budgeted Fixed Costs 5,00,000
Less: Proposed Advertising 40,000
Less: Proposed Annual Group Bonus 30,000
Target Cost (Variable Overhead and Direct Labour) for 30,000 units 5,10,000

(i) Problem
The target-costing method is applicable particularly for repetitive manufacturing. It should however be recognised that some products often bear a high degree of repetition and that there often are considerable repetitions where reduction targets could come into play as a framework for improving design. Working under pressure to finish new design assignments in a short time .may take development resources away from efforts to optimise or re-engineer production ; processes. If approaching product design as an activity to be optimised independently there is a risk that target costing may not succeed to j satisfactorily addressing overall performance, so in short decrease in unit production time may lead to unwanted pressure on design and 5 its implementation stage.

Remedial Measures
As a remedial action organisation should retain strong control over the design teams headed by a good team leader. This person must have an exceptional knowledge of the design process, good interpersonal skills, and a commitment to staying within both time and cost budgets for a design project. If the time is too short even an organisation may reject a project for the time being. Later, it can be tried out with new cost reduction methods or less expensive materials to achieve target cost and control overall production activities.

(ii) Target costing is most useful in situations where the majority of product costs are locked in during the product design phase. This is the case for most manufactured products, but few services. In the services area, such as consulting, the bulk of all activities can be reconfigured for cost reduction during the “production” phase, which is when services are being provided directly to the customer. In the services environment, the “design team” is still present but is more commonly concerned with streamlining the activities conducted by the employees providing the service, which can continue to be enhanced at any time, not just when the initial services process is being laid out.

Question 2.
Xstream Industries Ltd. manufactures standard heavy duty steel storage racks for industrial use. Each storage rack is sold for ₹ 750 each. The company produces 10,000 racks per annum. Relevant cost data per annum are as follows:
Cost Management Techniques – CA Final SCMPE Study Material 1
The actual and budgeted operating levels are the same. Actual and standard rates of material procurement and hourly labour rate are also the same. Any variance in cost is solely on account of difference in the material usage and hours required to complete production. Aggressive pricing from competitors has driven down sales. A comparable rack is available in the market for ₹ 675 each. Vishal, the marketing manager has determined that in order to maintain the company’s existing market share of 10,000 racks, Xstream Industries must reduce the price of each rack to ₹ 675. Required
(i) CALCULATE the current cost and profit per unit. IDENTIFY the non-value added activities in the production process.
(ii) CALCULATE the new target cost per unit for a sales price of ₹ 675 if the profit per unit is maintained.
(iii) RECOMMEND what strategy Xstream Industries should adopt to attain target cost calculated in (ii) above. [RTP-May 2018]
Answer:
(i) Calculation of current cost and profit per unit:

Cost Component Units Actual Cost p.a. for 10,000 racks (₹) Actual Cost per rack (₹)
Revenue 10,000 racks 75,00,000 750
Direct Material 5,20,000 sq. ft. 20,00,000 200
Direct Labour 1,00,000 hrs. 10,00,000 100
Machine Setup 15,000 hrs. 1,50,000 15
Mechanical Assembly 200,000 hrs. 30,00,000 300
Total Cost 61,50,000 615
Profit 13,50,000 135

Identification of Non-Value Added Activities:
Machine setup is the time required to get the machines and the assembly line ready for production. In this case, 15,000 hours spent on setting up does not add value to the storage racks directly. Hence, it is a non-value added activity.

(ii) Calculation of New Target Cost per unit:

New sale price per rack.
Less: Required Profit per unit
₹ 975 per unit
₹ 135 per unit
New target cost per unit ₹ 540 per unit

(iii) Strategy to attain target cost of ₹ 540 per unit:
Reduction in cost required:
The comparison of calculations of above two parts reveals that the current cost per unit is ₹ 615 while the target cost per unit is ₹ 540. Hence, the cost has to be reduced at least by ₹ 75 per unit.

Analysis of the cost data:
It shows the variances between the budget and actual material usage and labour hours. It is given that the material procurement rate and labour hour rate is the same for budgets and actuals. Hence, the increments in both the costs are due to inefficient use of material and labour hours to complete the same level of production of 10,000 storage racks.

Corrective action to address these inefficiencies could result in the following savings:
(a) Cost component: Direct Material
Extra usage of Material due to inefficiencies = 20,000 sq. ft
Material cost per sq. ft. = \(\frac{\text { Actual Cost }}{\text { Actual Labour Usage }}=\frac{₹ 20,00,000}{5,20,000 \mathrm{Sq} \cdot \mathrm{ft}}\) = 13.85 per sq.ft.
Extra material cost due to inefficiencies = 20,000 × ₹ 3.85 = ₹ 77,000
If corrective action is taken, for 10,000 racks this translates to a saving of ₹ 7.70 per unit

(b) Cost component: Direct Labour
Extra labour hrs spent in production due to inefficiencies = 10,000 hrs.
Labour cost per hr. = \(\frac{\text { Actual Cost }}{\text { Actual Labour Hrs. }}=\frac{₹ 10,00,000}{10,000 \mathrm{hrs} .}\) = ₹ 10 per hr.
Extra labour cost due to inefficiencies = 10,000 × ₹ 10 = ₹ 1,00,000
If corrective action is taken, for 10,000 racks this translates to a saving oft 10 per unit

(c) Cost component: Machine Setup
Machine setup cost is a non-value added cost. Value analysis can be done to determine if the setup time of 15,000 hrs. can be reduced. However, since these activities have been carried out for a reason, care should be taken to ensure that this change should not adversely impact the production activity later down the stream.

(d) Cost component: Mechanical Assembly
Mechanical assembly cost is almost half of the total cost. These are costs incurred during the production process on the assembly line. Value analysis can be done to determine if the production process can be made more efficient. For example, the process can be streamlined, such that steps can be combined that can be handled by fewer people (process centering). Similarly, value analysis/value engineering can focus on the product design.
While target costing is a dynamic and corrective approach, care must the taken the product quality, characteristics and utility are maintained.

Some questions to rise may be:
– Can the product be designed better to make the production more efficient?
– Can the design be minimized to include fewer parts and thus make it easier and efficient to manufacture?
– Can be substitute parts to make it more efficient? or
– Is there simply a better way of producing the same product?

While target costing is a dynamic and corrective approach, care must the taken the product quality, characteristics and utility are maintained.

Question 3.
Ham leys Toy Company is planning to launch a toy “Donald” based on a Disney character. Hamleys must pay 15% royalty on the selling price to the Disneyland. Hamleys targets a selling profit of 25% on selling price.
The following are the cost data forecast:

₹ per Toy
Component M1 8.50
Component M2 7.00
Labour : 0.40 hr. @ ₹ 60 per hr. 24.00
product Specific Overheads 13.50

In addition, each toy requires 0.6 kg. of other materials, which are supplied at a cost of ₹ 16 per kg. with a normal 4% substandard quality, which is
not useable in the manufacture. Required
DETERMINE if the above cost structure is within the target cost. If not, what should be the extent of cost reduction?
Answer:
Calculation of Target Cost per Toy “Donald”

Target Selling Price
Less: Royalty @15%
100 per Toy
15 per Toy
Less: Profit @ 25% 25 per Toy
Target cost (₹) 60 per Toy

Calculation of current total manufacturing cost per toy:

Cost Structure “Donald” ₹ per Toy
Component M1 8.50
Component M2 7.00
Labour : 0.40 hr. @ ₹ 60 per hr. 24.00
Product Specific Overheads 13.50
Other Material (0.6 Kg./96% × ₹ 16) 10.00
Total cost of manufacturing 63.00

Cost Reduction required:
Cost Gap = Actual Total Cost of Manufacturing – Target Cost = ₹ 63 – ₹ 60
= ₹ 3 per toy
The company should make efforts to reduce its manufacturing cost by ₹ 3 to achieve Target Selling Price of ₹ 100 per toy.

Cost Management Techniques – CA Final SCMPE Study Material

Question 4.
Suppa Ltd. was one of the leading Ceiling fan company in country “yu” however due to atmospheric changes temperature of the Country “Yu” has increased much. Resulted in increased use of AC at home which somehow effected the sale of Suppa Ltd. The CEO has observed that Suppa Ltd. manufacture a ceiling fan through two consecutive processes; assembly and finishing. Blades and Motor are Raw material used as input at the commencement of the assembly process. For the absorption of product specific conversion cost activity based costing approach is being used.

The following estimated information of Suppa Ltd. is available for current period.

Production/sales units 12,000
Selling price per unit ₹ 750
Direct material cost per unit ₹ 200
Suppa Ltd variable conversion cost per unit:
Assembly ₹ 200
Finishing ₹ 120
Product specific fixed costs 117,00,000
Company fixed costs ₹ 5,00,000

The CEO of Suppa Ltd. wishes to achieve an overall net profit of 12% on sales in order to meet return on capital target and to survive in the market. Required:
(a) CALCULATE the extent of cost reduction required by Suppa Ltd.
(b) LIST specific areas of investigation to identify potential areas of cost reduction that will not compromise the quality of the products.
Answer:
(a) Calculation of extent of cost reduction required:
Calculation of Target Cost per Ceiling Fan

Target Selling Price
Less: Profit @1296
750 per Fan 90 per Fan
Target cost 660 per Fan

Calculation of expected current cost per Fan:

Cost Structure “Donald” ₹ per Toy
Direct materials 200.00
Suppa Ltd. conversion cost Assembly 200.00
Finishing 120.00
Product specific fixed cost 141.70
Company fixed cost 41.70
Total expected current cost per unit 703.40

Cost Reduction required:
Cost Gap = Actual Total Cost of Manufacturing – Target Cost
= ₹ 703.40 – ₹ 660
= ₹ 43.40

(b) Identification of potential areas of cost reduction:
The company Suppa Ltd. is falling considerably short of its 12% net profit margin target. CEO of Suppa Ltd. observed that if sales quan-tities and prices are to remain unchanged, costs must be reduced if the required return is to be reached.
Exercise of Cost reduction methods must be concentrated particulariy on this product if its production is to continue to be seen to be ss worthwhile.
Examine designed specification for product and the production methods for potential areas of cost reduction that will not compromise the quality of the products. It includes:

  • Is it possible to eliminate any material, e.g. cut down on packing materials?
  • Is it possible to substitute a cheaper material without effecting quality?
  • Is it possible that a part assembled components be bought in to save on assembly time?
  • Check if there is any overlap between the product related fixed costs that could be eliminated from the organization by combining j service department or resources?
  • Is it possible to reduce the incidence of cost drivers?

Question 5.
(Value Chain Analysis/Target Costing) Intelligent inc. is a leading educational gaming toy manufacturing company operating since 1990, the firm has a state-of-the-art manufacturing facility in India. It sells its
product through company’s website and through retail outlets. Intelligent inc. has been pioneering the concepts of quality and safety in toys and has been instrumental in raising the quality standards of toys in the Indian Market. Intelligent inc’s mission is to influence parents to spend on toys that enable every child to grow with quality toys that contributes to his/ her wholesome development.
Intelligent inc. procures the materials from a number of different suppliers. All of the purchased material are dispatched to its warehouse located at its factory and are held there unless they are moved to production. After production is completed, finished toys are moved to Intelligent inc’s retail outlets by its own vehicles. Each week, the vehicles follow the same time schedule regardless of the weight they are carrying. Finished toys that are sold through the Intelligent inc’s website are dispatched to its distribution centre.
Intelligent has recently got the contract to manufacture a new gaming toy that is ‘ToZ’, a mini cartoon based on a character from a famous Hulk film. Intelligent has not been given any target price, hence is free to set the selling price of ‘ToZ’, however, must pay a royalty of 10% of the selling price to the film director. Intelligent is also planning to sell ‘ToZ’ through its retail outlets.
Intelligent has decided to follow a target costing technique for ‘ToZ’. Marketing manager has determined the selling price to be around “1,750 per ‘ToZ’. Intelligent needs a margin of 26% of the selling price of ‘ToZ’. The following is the estimated costs per ‘ToZ’:

Material C 150.50
Material D 122.50
Other Material See note below
Labour (0.4 hours at 1,050 per hour) 420.00
‘ToZ’-specific production overhead cost 132.30
‘ToZ’-specific selling and distribution cost 166.60

Note- Each ‘ToZ’ requires 0.70 kg. of ‘other materials’. These ‘other materials’ are procured from a supplier at a cost of 1280 per kg and around 5% of all purchased materials are found to be downgraded.
Required
DISCUSS three primary activities of value chain through which Intelligent can minimize gap if any. [RTP Nov. 2020]
Answer:
Statement Showing Computation of Cost GAP

Sales Price 1,750.00
Less: Royalty @1096 175.00
Less: Profit @26% 455.00
Target Cost ‘ToZ’ 1,120.00
Material C 150.50
Material D 122.50
Labour (0.40 hours at ₹ 1,050 per hour) 420.00
Other Material (0.70 kg. × ₹ 280 per kg.)/0.95 206.32
Production Overheads Cost 132.30
Distribution and Sales Cost 166.60
Estimated Cost ‘ToZ’ 1,198.22
Cost Gap 78.22

The Cost gap of ₹ 78.22 can be removed by reducing the cost over all the Value Chain through the development of the spirit co-operation and understanding among all members of organizations associated with the product from suppliers, producers, customers, agents and service providers. In Intelligent inc’s Value Chain, three primary activities are:-

Inbound
logistics These are activities concerned with receiving, storing and distributing the inputs (raw material) to the production process. The relationship with supplieris akey component in this process. Currently, Intelligent inc procures materials from multiple suppliers and stores these materials in its store. Shifting to a just-in-time (JIT) system technique in procurement of materials could possibly save substantial storage costs provided the JIT supplier must agree to take the responsibility for the good quality of materials supplied. This will also become a source of savings because downgraded items will be removed. However, Intelligent inc might have to pay additional payout to a supplier for JIT purchasing to work.

Outbound
logistics These activities involve collecting, storing and distributing the products to the customers. At Intelligent, scheduled transportation of toys to retail outlets is outbound logistics activity. Potentially, the scheduled transportation of toys to retail outlets every week is not an efficient way. Such deliveries do not consider whether toy is required at retail outlets or not, hence Intelligent inc. may possibly deliver toys to retail outlets those do not need toys and suffer unnecessary transportation costs.

Intelligent should plan to implement EDI system that will help it to improve warehousing and logistics by automatically tracking inbound shipments as well as outbound products. Adopting EDI, Intelligent can not only improve processes but also streamline inventory management across many channels. However, it will require setup time and a learning curve to implement the same.

Marketing and sales
Marketing and sales provide the means by which the customers are made aware of the product. At Intelligent inc, the sales of toys via its retail outlets and website are marketing and sales activities.
Intelligent is planning to sell ToZ’ via retailers. If Intelligent sales ‘ToZ’ through its website rather than through retail outlet, significant cost could easily be avoided. Simultaneously, Intelligent inc. will be able to expose itself to attract international customers to buy ‘ToZ’ as product is based on character from a famous international animated film.
Overall, Intelligent inc. may create a cost advantage by reconfiguring the Value Chain. Reconfiguration means structural changes such a new production process, new distribution channels or a different sales approach as discussed above.

Question 6.
Ajay Furniture Ltd. is a leading manufacturer and supplier of furniture for students of pre-primary classes. The full cost of one set (comprising one Table and one chair) is ₹ 900 per set. The company has fixed its selling price so as to earn 30% return on investment of ₹ 45,00,000. The company produces and sells 6,000 sets per annum. Relevant cost data per annum are as follows:

Cost Component Budget Actual Actual Cost p.a. (₹)
Direct Material 90,000 sq. ft. 1,00,000sq.ft. 16,50,000
Direct Labour 35,000 hrs. 40,000 hrs. 10,32,000
Mechanical Assembly 60,000 hrs. 60,000 hrs. 12,00,000
Machine Setup 5,000 hrs. 5,000 hrs. 1,68,000

It has been revealed that the actual and budgeted operating levels are the same, Actual and standard rates of material purchase and labour rate per hour are also the same. Any variance in cost is solely on account of difference in the material usage and hours required to complete the production. A competitor has introduced a product very similar to product of the company at an aggressive price of ₹ 820 per set which has resulted in downtrend, in the sales volume the company. The management has called urgent meeting of the marketing team. After the meeting, following recommendations of the marketing team are approved by the management:
To maintain the company’s existing sales volume and amount of present return on investment, reduce the selling price by 10%.
To make slight improvement in design to have edge over the competitors which will also reduce the direct material cost by ₹ 30 per set.
To make the table and chair more attractive, print picture of Disney character on them, which will cost ₹ 5 per set.
Required
(i) CALCULATE the present selling price and profit per unit from the above. Also CALCULATE the mark-up % on the full cost per unit.
(ii) IDENTIFY the non-value-added activities in the production process.
(iii) (a) CALCULATE the new target cost per unit and new revised cost per unit after implementation of above recommendations.
(b) How much reduction in cost is required to achieve the new target cost?
(iv) RECOMMEND what strategy the company should adopt to attain the target cost calculated above. [Nov. 2020] (4 + 2 + 2 + 2 Marks)]
Answer:
(i) Calculation of Present Selling Price and Profit per unit:

Full cost per set ₹ 900
Desired return per set [(30% of ₹ 45,00,000)/6,000 sets] ₹ 225
Present selling price per unit (set) ₹ 1, 125

Calculation of mark-up on full cost per unit:
Mark-up = \(\frac{\text { Profit perset }}{\text { Full cost per set }}\) × 100 = \(\frac{\text { Rs. } 225}{\text { Rs. } 900}\) × 100 = 25% on cost or 20% on sales.

(ii) Non-Value Added Activities:
Machine setup is the time required to get the machines and the assembly line ready for production. Ajay furniture limited spent 5,000 hours on setting up, which does not add value to the furniture set directly. Hence, it is a non-value added activity.

(iii) (a) New Target Cost per unit (set)

Particular Amount (₹)
Target Price (1,125 – 10% of 1,125)
Less: Desired Return per set
1,012.50
225.00
Target Cost per unit (set) 787.50

Revised Cost per unit (set)

Particular Amount (₹)
Present cost per unit (set)
Less: Reduction in material cost
Add: Incremental Cost to print picture
900.00
(30.00)
5.00
Revised Cost per unit (set) 875.00

(b) Cost Reduction Target

Particular Amount in ₹
Revised Cost per unit (set)
Less: Target Cost per unit (set)
875.00
787.50
Cost Reduction Target per unit (set) 87.50

(iv) The cost has to be reduced at least by ₹ 87.50 per unit. Critical aspects at which Ajay furniture limited shall focus-wastage in term of productivity i.e. usage of material and efficiency in labour; design of product in term of quality and function it renders, and material or components used as input; design of processes including lay-out through which product will be manufactured i.e. machine set-up and mechanical assembly. Value analysis/ value engineering shall be applied (by answering following questions) to focus on the above stated aspects in order to attain the target cost-

  • Can the product be designed better to make the production more efficient?
  • Is reduction of design (reduce features only, not functions) possible?
  • Can the design be minimized to include fewer parts and thus make it easier and efficient to manufacture?
  • Can any process eliminate or reduced?
  • Can be substitute parts to make it more efficient? Or
  • Is there simply a better way of producing the same product?

It is important to note that target costing is a dynamic and corrective approach, care must be taken for product quality, characteristics, and utility.

Analysis of the cost data:
The analysis of the cost data shows the variances between the budget and actual material usage and labour hours. It is given that the material procurement rate and labour hour rate is the same for budgets and actuals. Hence, the increment in cost of direct materials and labour is due to inefficient use of material and labour hours to complete the same level of production of 6,000 sets of furniture.

Corrective action to address these inefficiencies could result in the following savings:
(a) Cost component: Direct Material
Extra usage of Material due to inefficiencies = 10,000 sq. ft
Material cost per sq. ft. = \(\frac{\text { Actual Cost }}{\text { Actual Material Usage }}\)
= \(\frac{₹ 15,50,000-(₹ 30 \times 6,000)}{1,00,000 \mathrm{Sq} \cdot \mathrm{ft}}\) = ₹ 14.70 per sq. Ft.
Extra material cost due to in efficiencies = 10.000 × ₹ 14.70 = ₹ 1,47,000
If corrective action is taken, for 6,000 sets of Furniture this translates to a saving of ₹ 24.50 per unit

(b) Cost component: Direct Labour
Extra labour hrs. spent in production due to inefficiencies = 5,000 hrs.
Labour cost per hr. = \(\frac{\text { Actual Cost }}{\text { Actual Labour Hrs. }}=\frac{₹ 10,32,000}{₹ 40,000 \text { hrs. }}\) = ₹ 25.80 per hr.
Extra labour cost due to inefficiencies = 5,000 × ₹ 25.80 = ₹ 1,29,000
If corrective action is taken, for 6,000 sets of Furniture this translates to a saving of ₹ 21.50 per unit

(c) Cost component: Machine Setup
Machine setup cost is a non-value-added cost. Value analysis can be clone to determine if the setup time of 5,000 hours/₹ 1,68,000/- can be reduced. However, since these activities have been carried out for a reason, care should be taken to ensure that this change should not adversely impact the production activity later down the stream.

(d) Cost component: Mechanical Assembly
Mechanical assembly costs are costs incurred during the production process on the assembly line. Value analysis can be done to determine if the production process can be made more efficient. For example, the process can be streamlined, such that steps can be combined that can be handled by fewer people (process centering).

Cost Management Techniques – CA Final SCMPE Study Material

Question 7.
(Pricing Strategy; Target Costing) Ujjala Pvt. Ltd. manufactures multicolour glow bulb (GCM8) used for lighting and decoration. GCM8 considered as reliable product in market due to zero-defect. Ujjala company sells GCM8 through retail-chains and individual shopkeeper apart from factory outlet. GCM8 has demand throughout the year but there is high demand during festival seasons especially ahead of Diwali. Company follows the lot purchase system and manufacture the product ahead of peak season of festivals. Presently the Ujjala is working at 80% of capacity and manufacture 4,00,000 bulbs annually, at following per unit cost:

Particulars Behaviour Amount (In ₹)
Direct Material Variable 22
Direct Labour Variable 6
Factory Overhead
1. Engineering Cost Fixed 10
2. Machining Cost Fixed 5
3. Inspection Cost Variable 5
Administration Overheads Fixed 12
Selling and Distribution Overheads Fixed 12
Total Cost 72

Recently the competition in decorative light & electronic markets has escalated, due to goods imported from Chinese manufactures at cheap rates. Such imported light bulbs are also sold through same shops at which GCM8 is available for sale. Due cheaper in rate customer prefer imported light bulb rather GCM8.
To be competitive in market, the marketing department of Ujjala Company conducted applied research and suggested that price should be 12.5% lower than the current price. Ujjala company during last three financial years and during current year records the pre-tax profit @ 10% rate of sale, management of Ujjala company wish to earn the same rate of profit (margin) in upcoming years too.
Production and operation manager is of opinion that cost reduction, in order to be competitive in market may result .in reduction in quality, whereas Manager – Quality control suggest, if number of inspection staff increased, then inspection can be performed at each stage and defect can be curtailed at the earliest stage to eliminate rework cost.
Management accountant is of opinion that since GCM8 is mature product, hence majority of cost associated in production of GCM8 are committed in nature, prince cutting seems difficult; it may hit the top line and bottom line adversely. In response to him, Chief engineer suggest product (GCM8) can be redesigned; but marketing manager shown his resistance on the suggestion of redesigning of product because according to him ‘existing product appearance and features are key reasons for popularity of product in market and leads to sale’.
Required
(i) CALCULATE the price suggested by marketing department.
(ii) COMPUTE the target cost and new margin, appraise percentage decline in margin.
(iii) If proportionate cost reduction plan is applied, then
(a) CALCULATE planned cost reduction for each cost category.
(b) EXPLAIN proportionate cost reduction plan.
(vi) Based upon discussion taken place among the functional manager, EVALUATE the possibility of cost reduction in order to analyse the possibility of application of target costing. Also suggest course of action to adopt.
Answer:
(i) Price suggested by marketing department (Target Price)
Current cost per unit – ₹ 72 p.u.
Profit (Margin) @10% of sale price
Sale Price = ₹ 72 + 10% of Sale
Price So, let presume sale price is ‘x’
X = ₹ 72 + 10% of
XX = ₹ 72 + 0.1X
X – 0.1X = ₹ 72
0.9X = ₹ 72
X = ₹ 72/0.9
X = ₹ 80
New price will be 12.5% less than current price ₹ 80 – 12.5% of ₹ 80
₹ 80 – ₹ 10 = ₹ 70

(ii) Target cost and new margin
Target Price – Margin (i.e. 10% of sale price) = Target Cost
Target Cost = ₹ 70 – 10% of ₹ 70
₹ 70 – ₹ 7 = ₹ 63
New Margin (under target costing) is ₹ 7
Percentage decline in margin
= \(\frac{\text { Existing Margin }- \text { New Margin (under target costing) }}{\text { Existing Margin }}\) × 100
= \(\frac{8-7}{8}\) × 100
= 12.5% Note
There is decline in margin in absolute term, whereas in relative term the margin remains same i.e., 10% of sale price.

(iii) Planned cost reduction for each cost category under proportionate reduction plan

Particulars Existing Cost Target Cost
Direct Material 22 19.25
Direct Labour 6 5.25
Factory Overhead
1. Engineering Cost 10 8.75
2. Machining Cost D 4.375
3. Inspection Cost 5 4.375
Administration Overheads 12 10.5
Selling and Distribution Overheads 12 10.5
Total Cost 72 63

Under proportionate reduction plan cost for each category is propor-tionately reduced in proportion of existing weight. Here, a presumption is needed to be taken that all the cost are avoidable in nature, where as in case of every business; there are some of cost categories which are true sense unavoidable and committed in such a way that, these continue to occur even in shut down situation (e.g. salary to guard, minimum rental for electricity and water meter etc.); same is pointed by Management Accountant, that product is matured in nature (means not in designing or research phase) hence committed cost may be unavoidable in nature.

Note
Student must note that fixed costs are not as same as unavoidable cost. Fixed cost may be avoidable in nature.

(iv) Possibility of cost reduction & Suggested course of action for Ujjala Company
Target costing comprises four stages. First being determining the product target price, quality, and functionality; second determine the target cost; thirdly designing the product and production process to achieve the target costing, and fourth use pilot project to evaluated feasibility. Based upon discussion taken place among the functional managers, it is evidential that Ujjala Company is presently moving towards third stage.
As stated by management accountant that product GCM8 is mature nature hence majority of cost are of committed nature, hence may be unavoidable in nature. Product GCM8 is material-oriented product and raw material cost is around 30% of total cost. So, if gain sharing arrangement can be entered with vendor then surely Ujjala Company can save some portion of material cost.

As said by production and operation manager, cost reduction may lead to compromise with quality. He may be right, but he needs to look for scientific way to reduce the cost of operations like change in batch size (if required can shift to JIT) or outsource some part of operations; scientific management can also be applied in order to curtail motion time and reduction in labour cost.

Quality Manager is of opinion with extra inspection staff, quality can be assured, but appointment of additional inspector and supervisor will also lead to increase in cost; hence effective way to ensure quality while reducing cost of application of practice of TQM and Kaizen. U Kaizen costing will be great help to management of Ujjala to cut the cost, with support and participation from worker.

Chief engineer suggestion is appreciable, because target costing is most beneficial in those case where the product is in designing and planning phase. As per research around 70-80% of cost is committed at stage of designing of product. It is important to note that the word ‘committed’ is used as ‘not incurred; therefore, cost being committed (i.e., not incurred cost) will be incurred when it became due in course j of production. But redesigning is not feasible from the prospects | of marketing of product as per the statement made by marketing manager.
Marketing manager can conduct applied research in order to develop understanding the temperament of customer of GCM8, whether they are price sensitive or conformance to need is their priority. If customer found price sensitive (existing recommendation of marketing team shows high possibility of this, because marketing team feels customers can be retained is price is reduced by 12.5%) then product redesign may be opted. But if conformance to need is their (customers) priority, then value chain analysis can be used to identify the activities which creates value to customer and other than these activities (which are not creating the value) can be eliminated in order to reduce the cost.
So, there are possibility to reduce the cost, even if not in all the cost category then surely in some of categories; so that target cost can be achieved.

Cost Management Techniques – CA Final SCMPE Study Material

Question 8.
(Target Costing and JIT) Mxl Limited is a toy manufacturing company. It sells toys through its own retail outlets. It purchases materials needed to manufacture toys from a number of different suppliers. Recently, due to the entity of few reputed foreign brands in the toy market and particularly in the segment in which Mxl Ltd. is doing business, it is facing a threat to operate profitably.
Each toy requires 4 kg. of materials at ₹ 19 per kg. and 5% of all materials supplied by the suppliers are found to be sub-standard. Labour hour requirement for each toy is 0.4 hour at ₹ 120 per hour.
Market research has determined that the selling price will be ₹ 240 per toy. The company requires a profit margin of 15% of the selling price. Expected demand for toy in the coming year will be 50,000 toys. Sales and variable overhead per unit for the four quarters of the year will be as follows:
Cost Management Techniques – CA Final SCMPE Study Material 2
The production manager has decided to produce 12,500 units in each quarter. Inventory holding costs will be ₹ 18 per unit of average inventory per quarter. Inventory holding costs are not included in above.
Normal production capacity per quarter is 15,000 toys. The company can produce further up to 6,000 units per quarter by resorting to overtime working. Overtime wages will be at 150% of normal wage rate. Assume zero opening inventory.
Required
(a) (i) CALCULATE the cost gap that exists between the total cost per toy as per the production plan and the target cost per toy.
(ii) DISCUSS howjust-in-time purchasing and just-in-time production will remove the cost gap calculated in (i) above. Show calculations in support of your answer.
(b) EXPLAIN, how implementation of JIT production method can be a major source of competitive advantage and success of the company. [NOV 2019 Exam.] (9+7+4 Marks)
Answer:
(a) (i) Cost gap between Total Cost per toy as per the production plan and the Target Cost per toy
Target Cost per toy

Sr.No. Particulars ₹ per unit For Annual Sales of 50,000 units
A Selling Price per toy 240 1,20,00,000
B Required Profit Margin (15% of selling price = 15% × ₹ 240 per unit) 36 18,00,000
C Target Cost per annum (Step A-B) 1,02,00,000
D Target Cost per toy (C/ 50,000 units) 204.00

Therefore, Target Cost is ₹ 204 per toy.

Total Cost as per production plan
Mxl Ltd. has an annual production requirement of 50,000 toys, which is also its annual sales. Given that opening inventory for the first quarter is nil. The production manager wants to produce 12,500 units per quarter irrespective of the sales demand for the quarter. This implies that during some quarters, there might be unsold inventory, for which inventory holding cost has to be borne. This type of production is called “produce to stock”.

Production Schedule and Inventory Holding Cost for the year
Cost Management Techniques – CA Final SCMPE Study Material 3

Total Cost of Production per toy as per production plan
Cost Management Techniques – CA Final SCMPE Study Material 4
Note 1
Each toy requires 4 kg. of material, 596 of all materials is sub-standard.
Therefore, procurement should factor this sub-standard quality.
Material required per unit= 4 kg./95% = 4.21 kg.
Material Cost per toy produced = 4.21 kg. × ₹ 19 per kg. = ₹ 80 per unit

Note 2
Each toy requires 0.40 hours. Rate per hour is ₹ 120 per hour.
Therefore, Cost per toy = 0.40 × ₹ 120 = ₹ 48 per unit

Cost Gap
= Total Cost per toy as per production schedule – Target Cost per toy
= ₹ 208.09 – ₹ 204.00 per toy
= ₹ 4.09 per toy

JIT System
(ii) Just in Time Purchasing and Just in Time Production is aimed at eliminating inventory holding of raw material and finished goods respectively. Components are purchased only when there is a requirement in the production process. Si milarly, finished goods are produced oniv when there is a demand for them. This type of production is called “produce to order’’. Hence, there is neither any opening inventory nor any closing inventory, thereby no inventory holding cost.

In the given problem, this savings is off-set by the extra payment to be made to labour for overtime. Production capacity is 15,000 toys per quarter. This can be increased by 6,000 toys per quarter by incurring additional overtime cost.

The Production Plan under the Just in Time System
Cost Management Techniques – CA Final SCMPE Study Material 5

Total Cost of Production under JIT System
Cost Management Techniques – CA Final SCMPE Study Material 6

Note 1
Carefully selected suppliers of delivering high quality materials in a timely I manner directly at the shop floor, reducing the material receipt time and loss due to sub-standard material.

Note 2
Overtime wages are 15096 of normal wage rate. Therefore, for every toy ) produced over the quarterly production capacity of 15,000 toys, 50% extra 1 wage over and above the hourly rate has to be paid as overtime wages. Each toy needs 0.40 hours for production. Therefore, overtime cost for excess production = excess production units × 0.40 × 50% × ₹ 120 per hour.

Cost Gap
The cost of production per toy under the JIT system is ₹ 199.38 per toy as compared to the target cost of ₹ 204 per toy and save t 4.62 per toy.
The savings primarily comes from eliminating the inventory holding cost of ₹ 3,42,000 per annum and sub-standard material cost of ₹ 2,00,000 per 1 annum under the previous production system. This is slightly offset by the additional cost of ₹ 84,000 per annum that has to be paid towards overtime s labour charges and ₹ 22,500 towards additional variable overheads. However, by switching to the JIT system, Mxl Ltd. could reduce its production cost below the target cost per toy.
This question can also be solved by assuming “continued material wastage” due to substandard material from suppliers.

(b) JIT system aims at:

  • Meeting customer demand in a timely manner.
  • Providing high quality products and
  • Providing products at the lowest possible price. The main features of the JIT production system are:
  • Material handling cost is reduced

Materials move from one machine to another in an organized sequence. The production process is grouped into to manufacturing cells. These can be managed with minimal labour. This reduces material handling costs as also any pile I up of inventory in the form of work-in-progress. In JIT procurement process, the raw material is received only when needed. Due to significant reduction in inventory, inventory holding costs, normal wastage cost and spoilage can be avoided. Optimum arrangement of cells can lead to lesser floor space requirement, thereby reducing factory rental and overhead cost.

Multi-skilled labour: Hire and retain multi-skilled workers who are capable of performing a variety in operations including repairs and maintenance. Therefore, a worker is not confined to only one process in the production process. He can contribute towards other processes as well. This reduces the workforce requirement and labour idle time, The company can have a more efficient workforce, with lesser number j of workers. There is potential to reduce labour cost on account of this,

Minimizing defects rework and scrap: Each stage of the production process is tightly linked in a sequential manner. Defective output from one stage will stop the work at the next stage. Due to this, workers can identify and correct errors or defects instantaneously. JIT creates urgency for eliminating defects as quickly as possible since the downstream work also stops due to error in any workstation. Production process efficiency improves and reduces rework or scrap. The overall j quality of production improves. There are other benefits to streamlining production process: lesser need for inspection of final output I and lesser sales returns due to defects. This would contribute to the | product’s brand value.

Reduced set-up time: Streamlined production process under JIT reduces set-up time at the workstations. When the production process has to change to make the product per the customers’ demands, set-up time is incurred at the workstation. By streamlining operations, JIT system aims at reducing the set-up time, so that production can continue with the least possible interruption. This brings flexibility in the operations since the company can quickly change the production requirement, to make products to meet the customer’s demand. Quick turnover improves productivity of the machine, thereby increasing the production capacity. Lesser time is spent on set-up which is not a value adding activity.

Question 9.
(Value Analysis & Functional Analysis) A family-run business Raghav Furniture Co. began 29 years ago, supplying customized home furniture. Now RFC has grown into a thriving hub of experts specialized in either customized, locally sourced or high quality imported commercial grade furniture.
The newly appointed CFO is concerned about trends in dropping sales volumes, increasing costs, and hence falling profits over the last three years. He observed that these observed trends may increased cut-throat competition that has emerged over the last three years. For many years, RFC has been known for high quality but now this quality is being matched by the competitors. RFC’s share of the market is declining due to equivalent products being sold by competitors at lower prices. It is considered that, to offer such low prices, the furniture’s production costs of the competitors must be lower than RFC’s.
Required
ADVISE how RFC can improve its sales volumes, .costs and profits using Value Analysis and Functional Analysis.
[MTP October 2018] (10 Marks)
Answer:
VALUE ANALYSIS – (Notation – Cost Reduction, Removal of Non-Value Added Activities, Emphasis on Value Added Activities)
Values Analysis is a method of identifying and removal of all non-value added activity which further helps to reduce the cost. This technique analyze the process of existing product to identify and eliminate any cost which is waste, which do not provide any contribution to performance or value.

VA is a scientific, planned approach which reviews the material composition of a product and production design, so that modification and improvements can be made to reduce the cost and improving the value of the product to the customer (i.e. quality for purpose should not be compromised.).

FUNCTIONAL ANALYSIS – (Notation – Reducing Cost by eliminating unnecessary features, adding cost effective new features)
Functional analysis is applied to the design of new products and breaks the product down into functional parts. For example, a new furniture j chair may have the movable feature. The value that the customer places on each feature is considered and accordingly value is added to give a target cost. Thus, functional analysis aims to improve profits by reducing costs through elimination of unnecessary features and/ or by adding cost- effective new features that are so attractive to customers that the product becomes more lucrative.

The result of the above analysis is to enhance the value of the furniture while maintaining costs and/or cutback the costs of the furniture without compromising with value. It is clear from the scenario that RFC needs to cut back its selling prices to compete in the market. This selling price reduction can only be possible by a reduction in RFC’s unit costs; however, such reduction must not be accomplished by compromising with quality. Both value analysis and functional cost analysis may be used for RFC; however, value analysis is likely to be a more useful technique because office tables and chairs are such items which are demanded more on the basis of considering their use value rather than their esteem value.

Reduces lead time for receiving materials since the suppliers of raw material are capable of delivering high quality materials in a timely manner directly at the shop. Proper selection of such suppliers is imperative for the JIT system to be successful. If this can be achieved, then it is beneficial for the company since inventory holding of material is eliminated along with receiving better quality of raw material in a timely manner.

Eliminating inventory holding, scrap, material wastage, flexibility in operations by reducing set-up time, better response time to customer’s demands, better skilled workforce, better quality of production, lower workforce requirement, lower floor space requirement all of these contribute towards lowering working capital requirements. These contribute to a company’s competitive edge and success.

Cost Management Techniques – CA Final SCMPE Study Material

Question 10.
Regain Ltd. has developed a new product ‘axy’ which is about to be launched into the market. Company has spent ₹ 30,00,000 on R&D of product ‘axy’. It has also bought a machine to produce the product ‘axy’ costing ₹ 11,25,000 with a capacity of producing 1,100 units per week. Machine has no residual value. The company has decided to charge price that will change with the cumulative numbers of units sold:

Cumulative Sales (units) Selling Price Rs. per unit
0 to 2,200 750
2,201 to 7,700 600
7,701 to 15,950 325
15,951 to 59,950 450
59,951 and above 300

Based on these selling prices, it is expected that sales demand will be as shown below:

Weeks Sales Demand per week (units)
1-10 220
11-20 550
21-30 825
31-70 1,100
71-80 880
81-90 660
91-100 440
101-110 220
Thereafter NIL

Unit variable costs are expected to be as follows:

₹ per unit
First 2,200 units 375
Next 13,750 units 300
Next 22,000 units 225
Next 22,000 units 188
Thereafter 225

Regain Ltd. uses just-in-time production system. Following is the total contribution statement of the product ‘axy’ for its Introduction and Growth stage:
Cost Management Techniques – CA Final SCMPE Study Material 7
Required:
(i) PREPARE the total contribution statement for each of the remaining two stages of the product’s life cycle.
(ii) DISCUSS Pricing Strategy of the product ‘axy’.
(iii) FIND possible reasons for the changes in cost during the life cycle of the product ‘axy ’.
Note: Ignore the time value of money. [Nov. 2017 RTP/March 2018 MTP] (4+6+4 Marks)
Answer:
(i) Total Contribution Statement

“Total Contribution- for remaining two stages”
Cost Management Techniques – CA Final SCMPE Study Material 8

(ii) Pricing Strategy for Product ‘axy’
Regain Ltd. is following the skimming price strategy that’s why it has planned to launch the product axy initially with high price tag. A skimming strategy may be recommended when a firm has incurred ) large sums of money on research and development for a new product. I
In the problem, Regain Ltd. has incurred a huge amount on research and development. Also, it is very difficult to start with a low price and then raise the price. Raising a low price may annoy potential customers.
Price of the product axy is decreasing gradually stage by stage. This is happening because Regain Ltd. wants to tap the mass market by lowering the price.

(iii) Possible Reasons for the changes in cost during the life cycle of the product ‘axy’
Product life cycle costing involves tracing of costs and revenues of each product over several calendar periods throughout their entire life cycle. Possible reasons for the changes in cost during the life cycle of the product are as follows:
Regain Ltd. is expecting reduction in unit cost of the product axy over the life of product as a consequence of economies of scale and learning/experience curves.
Learning effect may be the possible reason for reduction in per unit cost if the process is labour intensive. When a new product or process is started, performance of worker is not at its best and learning phenomenon takes place. As the experience is gained, the performance of
worker improves, time taken per unit reduces and thus his productivity goes up. The amount of improvem ent or experience gained is reflected in a decrease in cost.
Till the stage of maturity, Regain Ltd. is in the expansion mode. The % Regain Ltd. may be able to take advantages of quantity discount
offered by suppliers or may negotiate the price with suppliers.
Product axy has the least variable cost ? 188 in last phase of maturity stage; this is because a product which is in the mature stage may
require less marketing support than a product which is in the growth stage so, there is a saving of marketing cost per unit.

Again, the cost per unit of the product axy jumps to ₹ 225 in decline stage. As soon as the product reaches its decline stage, the need or demand for the product disappear and quantity discount may not be available. Even Regain Ltd. may have to incur heavy marketing expenses for stock clearance.

Workings
Cumulative Sales along with Sales Price and Variable Cost
Cost Management Techniques – CA Final SCMPE Study Material 9

Question 11.
[Pricing Decision, PLC Costing] RAL has recently research and develop a new product which has cost $800,000. It has also bought a machine for production of this new product costing $ 300,000, it is capable of producing 1,000 units of the product per month and due to its specialized nature, it is not expected to have any residual value.
The company has decided that selling price it charges for the units will change with the cumulative numbers of units sold as follows:

Cumulative sales units Selling Price $ per unit in this band
0 to 2,000 200
2,001 to 7,000 160
7,001 to 14,500 140
14,501 to 54,500 120
54,501 and above 80

Based on the changes in these selling prices, sales demand w ill be expected as shown below: .

Sales demand per month
Months (units)
1-10 200
11-20 500
21-30 750
31-70 1,000
71-80 800
81-90 600
91-100 400
101-110 200
Thereafter NIL

Unit variable costs are expected to be as follows:

$ per unit
First 2,000 units 100
Next 12,500 units 80
Next 20,000 units 60
Next 20,000 units 50
Thereafter 60

RAL follows a Just in Time (JIT) purchasing and production system and operates its business on a cash basis.
After the completion of Introduction and Growth stages; a columnar statement showing the cumulative cash flow of the product is set out below:

 

i

Introduction Growth
Months 1-10 11-30
Number of units produced and sold 2,000 5,000 7,500
Selling price per unit $200 $160 $140
Unit variable cost $100 $80 $80
Unit contribution $100 $80 $60
Total contribution $200,000 $850,000
Cumulative cash flow ($900,000) ($50,000)

Requirements
(a) Complete the cash flow statement for each of the remaining two stages of the product’s life cycle. Ignore the time value of money.
(b) Explain, the possible reasons for the changes in costs and selling prices during the life cycle of the product.
Answer:
(a)
Cost Management Techniques – CA Final SCMPE Study Material 10

(b) Reduction in unit costs over time might occur due to economies of scale, or might be due to the impact of learning curve and the benefits of bulk purchase discounts. It is noted though that the unit variable cost of the product rises in the decline stage and this is consistent with the diseconomy of scale, say material purchase prices increases due to reduce volume. Other costs also start to increase, possibly as a consequence of the reducing efficiency of the equipment being used, The reduction in selling prices over time is typical of the product life cycle. Market skimming in the introduction stage reflects high unit prices paid by a select few customers. The company’s competitors enter the market in the growth phase and selling prices reduce (a) to stimulate demand, (b) to compete with new market entrants, and (c) to reflect the effect of economies of scale on costs.
It is observed that selling prices stabilise at $ 120 per unit that is at the g maturity stage, this may reflects an established oligopolistic market § price.
At declining stage sales volume decline, prices fall to attract what f demand is still available, as of better and less costly substitute in the (market accounts for the arrival of this stage.

Cost Management Techniques – CA Final SCMPE Study Material

Question 12.
(Pricing Decision, PLC Costing) Fossill. Ltd. Makes fashionable high quality digital watches. Fossill Ltd. now is preparing a product life cycle budget for a new watch. Development on the new watch is to start shortly. Estimates for new watch are as under:

Life Cycle Units Manufactured and Sold 2,40,000
Selling Price Per Watch (₹) 500
Life Cycle Costs:
R&D and Design Cost (₹) 80 Lakh
Manufacturing:
Variable Cost Per Watch (₹) 120
Variable Cost Per Batch (₹) 4,000
Watches Per Batch 300
Fixed Costs

Customer Service Cost Per Watch

(₹) 112 lakh (₹) 10
Marketing:
Variable Cost Per Batch ( ) 24
Fixed Costs (₹) 8 Lakh
Distribution:
Variable Cost Per Watch (Batch) (₹) 240
Watches Per Batch 96
Fixed Costs (₹) 45 Lakh

Required
(i) CALCULATE the budgeted life cycle operating income for, the new watch. OR
SUGGEST the strategies to be adopted by the Fossil Ltd. to develop a new watch.
(ii) What percentage of the budgeted total product life cycle costs will be incurred by the end of the R&D and design stage?
(iii) An analysis reveals that 75% of the budgeted total life cycle costs of new watch will be locked in at the R&D and design stage. What are the implications for managing costs of the new watch? [May 2018] (5+2+3 Marks)
Answer:
(i) Statement Showing Budgeted Life-Cycle Operating Income
Cost Management Techniques – CA Final SCMPE Study Material 11
Or
Cost Management Techniques – CA Final SCMPE Study Material 12
We can see from the above figure that approximately 80% of a prodnet’s cost are committed during the planning and design stage. At j this stage product designers determine the product’s design and the production process. In contrast, the majority of costs are incurred at the manufacturing stage, but they have already become locked in at the planning and design stage and are difficult to alter.
The pattern of cost commitment and incurrence will differ based on the industry and specific product introduced. For developing a watch, Fossill Ltd. needs to commit around 80,00,000 for its R&D and design Cost. So, Cost Management of Fossill Ltd. can be most effectively exercised during the planning and design stage of its new watch and not at the manufacturing stage when the product design and processes have already been determined and costs have been committed. At this latter stage the focus is more on cost containment rather than on Cost Management. An understanding of life-cycle costs and how they are committed and incurred at different stages throughout a product’s life
cycle of the watch will also led to the emergence of target costing, a technique that focuses on managing costs during a product’s planning and design phase.

(ii) % of Budgeted Total Product Life-Cycle Costs incurred till the R & D and Design Stages:
= \(\frac{₹ 80,00,000}{₹ 11,65,60,000}\) x 100 = 6.86%

(iii) Implications:
An analysis reveals that 75%* of the total product life-cycle costs of the new watch will be locked in at the end of the R&D and design stages when only 6.8696 of the costs are incurred (as calculated in the above case). The implication is that it will be difficult to alter or reduce the costs of Fossill digital vcatches once the design is finalised. To reduce and manage total costs, Fossill must act to modify the design before costs get locked in. (Question states 75%, hence 75% is taken)
*This question can be solved by taking appropriate assumption in respect of Marketing Costs and Distribution Costs,

Question 13.
Shrivastav Pvt, Ltd. is a manufacturing organization, they are following Life Cycle Costing. Its four products X4, X3, X2 and X1 are in the market respectively in Introduction, Growth, Maturity and Decline stages (phases). The Management wants to analyse the marketing challenges faced by the products to take strategical measures to stabilise the products in the market. For this purpose, the Board directed the Secretary to get a product-wise report from the marketing chief of each product. The chiefs were asked to give one characteristic possessed by the product because of which the product is being classified in the respective stage and two strategical measures to be taken to overcome the market challenges faced at that stage (phase). The Secretary received the report from all the chiefs and handed them over to the computer operator to get it printed in a tabulated form. But the operator, without understanding the significance of the products, phases, characteristics and strategies, mixed all the twelve items [(1 + 2) X 4] and got it printed as a list as given below:
(i) Over capacity in the industry.
(ii) The company can continue to offer the product to our loyal customers at a reduced price.
(iii) Few competitors produce basic version of our product.
(iv) Product features may be improved or enhanced to differentiate our product from that of the competitors.
(v) Attracting customers by raising awareness about our product through promotion activities.
(vi) High volume of business and increase in competition.
(vii) Use the present product as replacement product for launching another new product successfully in the market.
(viii) Value-based pricing strategies may be considered.
(ix) Profits start declining and at times become negative
(x) Maintain control over product quality to assure customer satisfaction.
(xi) Strengthening or expanding channel and supply chain relationships.
(xii) Prices may have to be reduced to attract the price-sensitive customers. The items are required to be TABULATED as in the format given below:
Required
(i) Complete the table given below by entering the twelve items under appropriate category columns. You need not rewrite the items. Write the serial numbers of the items only in columns (3) and (4).

Products (1) Phases (Stages) (2) Characteristics (3) Strategies (4)
X4 Introduction
X3 Growth
X2 Maturity
X1 Decline

 

(ii) LIST down the importance (any four) of Product Life Cycle Costing.
(iii) STATE the benefits (any four) of Product Life Cycle Costing. [Nov 2018](12 + 4+4 Marks)
Answer:
Part (i) and (ii) are missing
(i) Statement Showing Product Life Cycle Characteristics and Strategies

Products (1) Phases (Stages) (2) Characteristics (3) Strategies (4)
X4 Introduction (iii) (v), (xi)
X3 Growth (vi) (x), (viii)
X2 Maturity (i) (iv), (xii)
X1 Decline (ix) (ii). (vii)

(ii) Importance of Product Life Cycle (PLC) Costing

  • As a Planning tool, it characterizes the marketing challenges in each stage and poses major alternative strategies, ie. application of Kaizen.
  • As a Conlrollool, the PLC concept allows the company to measure product performance against similar products launched in the past.
  • As a Forecasting tool, it is very important because sales histories exhibit diverse patterns and the stages vary in duration.
  • It leads to appropriate strategy formulation depending on the stages of the product life cycle.

(iii) Benefits of Product Life Cycle Costing
The benefits of product life cycle costing are summarized as follows:

  • The product life cycle costing results in earlier actions to generate revenue or to lower costs than otherwise might be considered. There are a number of factors that need to the managed in order to maximize return on a product.
  • Better decisions should follow from a more accurate and realistic assessment of revenues and costs, at least within a particular life cycle stage.
  • Product life cycle thinking can promote long-term rewarding in contrast to short-term profitability rewarding.
  • It provides an overall framework for considering total incremental costs over the entire life span of a product, which in turn facilitates analysis of parts of the whole where cost effectiveness might be improved.
  • It is an approach used to provide a long-term picture of product line profitability, feedback on the effectiveness of life cycle planning and cost data to clarify the economic impact of alternatives chosen in the design, engineering phase etc.
  • It is also considered as a way to enhance the control of manufacturing costs. The thrust of product life cycle costing is on the distribution of costs among categories changes over the life of the product, as does the potential profitability of a product. Hence it is important to track and measure costs during each stage of a product’s life cycle.
  • Product life cycle costing traces research and design and development costs etc., incurred to individual products over their entire life cycles, so that the total magnitude of these costs for each individual product can be reported and compared with product revenues generated in later periods.

Cost Management Techniques – CA Final SCMPE Study Material

Question 14.
Pace & Game (P&G) was established in 1980 and has enormous wealth of experience in the mould manufacturing industry and serves wide range of plastic moulds all over nation. Over the past decade, P&G has developed the reputation for quality products & services for customer focused approach. It deals in injection moulds, blow moulds, die sets, moulds base etc.
With a state-of-the-art infrastructure facility, P&G is able to meet the qualitative and quantitative demands of its clients. Its vision & mission is to provide high class manufactured products by using best quality raw materials.
P&G has developed a new product “M” which is about to be launched into the market and anticipates to sell 80,000 of these units at a sales price of ₹ 300 over the product’s life cycle of four years. Data pertaining to product “M” are as follows:

Costs of Design and Development of Molds, Dies, and Other Tools ₹ 8,25,000
Manufacturing Costs ₹ 125 per unit
Selling Costs ₹ 12,500 per year + ₹ 100 per unit
Administration Costs ₹ 50,000 per year
Warranty Expenses 5 Replacement Parts per 25 units at ₹ 10 per part; 1 Visit per 500 units (Cost ₹ 500 per visit)

Required:
(i) COMPUTE the product “M’s” ‘Life Cycle Cost’.
(ii) SUGGEST two ways to maximize “M’s” lifecycle return.
Note: Ignore time value of money [RTP Nov. 2019, 2021]
Answer:
(i) Statement Showing “M’s Life Cycle Cost (80,000 units)”

Particulars Amount (₹)
Costs of Design and Development of Molds, Dies, and Other 8,25,000
Tools
Manufacturing Costs (₹ 125 × 80,000 units) 1,00,00,000
Selling Costs (₹ 100 × 80,000 units + ₹ 12,500 × 4) 80,50,000
Administration Costs (₹ 50,000 × 4) 2,00,000
Warranty
(80,000 units/25 units × 5 parts × ₹ 10) 1,60,000
(80,000 units/500 units × 1 visit × ₹ 500) 80,000
Total Cost 1,93,15,000

(ii) Following ways are suggested to maximize “M” lifecycle return:
R&D Costs
Often significant part of cost is incurred at the R&D phase of new product, hence P&G should carefully plan and design its new product “M” as it will determine the number of parts, production process to be used etc. P&G can apply value engineering here. It involves improving product quality, reducing product costs, fostering innovation, eliminating unnecessary and costly design elements, ensuring efficient investment in product, and developing implementation procedures. Value engineering is most successful when it is performed early in product development stage. A value engineering study should be performed within the first 25-30% of the design effort prior to selecting the final design alternative. Here, it is also important that R&D team should work as a part of cross functional team i.e. (participate in a group of people from different functional areas), to minimise lifecycle cost and the production cycle time in new development.

Speed up the Product Launch
In cut throat competitions, it is important for P&G to get new product ‘M’ launch into the market as soon as possible since this will give “M” a long stay in the market place without competition in the market. Competitor always try to launch a rival product as quickly as possible in order to gain ‘competitive edge’. P&G may lose overall profitability if it delays in launching of Product ‘M’. It is usually worthwhile incurring extra costs to keep the launch on schedule or to speed up the launch.

Question 15.
(Life Cycle Costing)
HUM international has developed ultra-modern smart LED TV with latest features. It has been developed after extensive research and is ready for manufacturing. The firm has incurred ₹ 6,50,000 as development cost on this LED TV. The firm is deciding on plant capacity, which could cost ₹ 40,00,000 for manufacturing of 600 units.
With additional outlay of 40%, plant capacity can be increased by 50%. The relevant data pertaining to the life cycle of the LED TV at different capacity levels is as under :

Expected Sales 600 Units 900 Units
Selling Price ₹ 45,000 per unit ₹ 41,400 per unit
Variable Selling Costs 12% of the Selling price 12% of the selling price
Salvage Value of the plant 20% of the total plant cost 20% of the total plant cost
Profit Volume Ratio 30%

Required
ADVISE HUM International regarding the ‘Optimal Plant Capacity’ to install. The LED TVs life cycle is two years. (Note: Ignore the time value of money.) [Nov. 2020] (10 Marks)
Answer:
(a) Advise → If we consider Financial perspectives HUM international shall consider 900 units level (low price and high volume) as ‘optimal j plant capacity’, because the net profit at 900 units level is ₹ 66,98,000; which is more than ₹ 49,00,000 (the net profit at 600 unit level). See working note below for details. Operating at 900 units level also ensure larger market share. However, in order to be sustainable, non-financial considerations are also given due importance. These may not contribute directly to profits in the short run but may have significance in long run. Here, it is important to note that life cycle of product is two years and difference between the net profits at both levels is ₹ 17,98,000 (around 26.84% of profit at 900 units level). The availably of raw material and labour also need to be considered, and in case of scarcity of any of these or any other factor of production, HUM international may opt the plant having 600 units capacity.

Working Note 1 – Statement Showing “expected profit”

Particulars Amount in ₹
600 units 900 units
Sales 2,70,00,000 (45,000 * 600) 3,72,60,000 (41,400 * 900)
Contribution (30% of Sale) 81,00,000 1,11,78,000
Less: Cost of Plant 40,00,000 56,00,000 (40,00,000 + 40%)
Add: Salvage Value (20% of plant cost) 8,00,000 11,20,000
Net Profit 49,00,000 66,98,000

Development cost is already incurred hence become sunk and not relevant here; Additional outlay of 40% has been considered as part of plant cost.

Alternate non-financial factors are also possible.

ALTERNATIVE 5(a)
ADVISE →
Based on the above ‘Expected Profit’ statement firm may go for High Price – Low volume i.e. 600 units level which is purely based on financial f considerations. However, non-financial considerations are also to be given I due importance as they account for actions that may not contribute directly j to profits in the short run but may contribute significantly to profits in long run. Here, it is important to note that life cycle of product is just two years and there is no significant difference (₹ 81,200) between the profits at both levels. In this scenario firm may opt the plant having high capacity not only to increase its market share but also to establish a long-term brand image.

Working Note 1 – Statement Showing “expected profit’’
Particulars Amount in ₹
600 units 900 units
Sales 2,70,00,000 3,72,60,000
(45,000,600) (41,400,900)
Less: Variable manufacturing cost @26,100 working note 1,56,60,000 2,34,90,000
Less: Variable Selling cost (12% of Sales) 32,40,000 44,71,200
Less: Cost of Plant 40,00,000 56,00,000
Add Salvage Value (20% of plant)cost 8,00,000 (40,00,000 + 40%) 11,20,000
Net Profit (?) 49,00,000 48,18,800

Working Note 2 – Calculation of Variable Manufacturing Cost per unit
= Selling price – contribution – variable selling cost
= ₹ 45,000 – 30% of ₹ 45,000 – 12% of selling price
= ₹ 45,000 – ₹ 13,500 – ₹ 5,400
= ₹ 26,100 per unit

Development cost is already incurred hence become sunk and not relevant here; Additional outlay of 40% has been considered as part of plant cost.

Alternate non-financial factors are also possible.

Cost Management Techniques – CA Final SCMPE Study Material

Question 16.
(Life Cycle Costing)
Aggarwal is a Baker famous for its cakes and cookies. Mr Purshottam Aggarwal, the owner of Aggarwal Bakers is interested in offering affordable products, hence keen to capture the small scope of cost-effectiveness. Aggarwal Bakers located in the centre of the city where Rental cost is high and Aggarwal Baker runs out of space during peak hour causing loss of sale. Aggarwal Bakers have most of their regular(Loyal) customer. Aggarwal Baker is known for its fast service, Mr Purshottam wish to be true to the tagline ‘Close your eyes to wish and open them to find it cooked for you’. The hurdle rate is 12%.
Non-availability of skilled worker and high attrition rate of worker including chef is the cause of worry for Mr.- Purshottam. In order to retain worker, Aggarwal Baker is paying a higher salary than industry standards. The raw material is easily available as and when it is required., Aggarwal Bakers is considering two different models of baking oven machine to replace its old oven. The baking capacity of both machines are the same and both will occupy a similar amount of space.
The first model is the automatic oven which will cost about ₹ 10,00,000. Another model is the semi-automatic oven which will cost at ₹ 5,60,000.
The annual operating cost (including depreciation) is 40% of the acquisition cost and ₹ 4,20,000 in case of automatic and semi- automatic oven respectively. After 3 years of use, the automatic oven can he  salvage at ₹ 70,000, whereas semi-automatic oven will fetch ₹ 20,000 only. The automatic oven is more advanced and equipped with latest technologies to speed up the baking, because only ingredients need to be inserted in right proportion and mix. Whereas in semi-automatic machine some part of the process needs to be performed manually by the workers.
Required
ADVISE which oven shall Aggarwal baker acquire.
Note- You can ignore taxes but need to consider the time value of money; decimal accuracy up-to two digits is expected.
Answer:
Statement of the Comparable Life Cycle Cost

Particulars Automatic Semi­-Automatic
Acquisition Cost 10,00,000 5,60,000
PV of Entire Life Cash Operating Cost (W.N.2) 2,16,000 5,76,000
PV of Salvage Value (W.N.3) (49,700) (14,200)
Total Cost of the Oven over the life cycle 11,66,300 11,21,800

Working Note 1 – Depreciation

Particulars Automatic Semi­-Automatic
Acquisition Cost 10,00,000 5,60,000
Salvage Value 70,000 20,000
Depreciable Value 9,30,000 5,40,000
Useful life in a number of years 3 3
Depreciation on SLM basis 3,10,000 1,80,000

Working Note 2 – Present Value of Entire Life Cash Operating Cost

Particulars Automatic Semi­-Automatic
Annual Operating Cost 4,00,000 4,20,000
Depreciation (see W.N.1) 3,10,000 1,80,000
Annual Cash Operating Cost 90,000 2,40,000
Cumulative PV factor @ 12Qo for 3 years 2.40 2.40
PV of Entire Life Cash Operating Cost 2,16,000 5,76,000

*Annual operating cost is 4,00,000 ie., 40% of 10 Lakhs, in case of automatic machine.

Working Note 3 – Present Value of salvage value

Particulars Automatic Semi­-Automatic
Salvage Value 70,000 20,000
PV Factor @ 12% for 3rd year 0.71 0.71
PV of Salvage Value 49,700 14,200

Advise
Based upon life cycle cost, Aggarwal Bakers are advised to acquire semi-automatic oven, because it causes a saving of 144,500. The cost has qualitative implicationstoo, apart from quantitative or monetary implications. Similarly, a management decision is also impacted by qualitative and non-monetary quantitative factors. Hence, decision taken in part a above may differ if Aggarwal Bakers consider-

Finishing of bake products – the look and taste
It is obvious the presence, which one important feature for bakery product in order look delicious and tempting; will be way different if cooked in the automatic and semi-automatic machine. The taste may also be different, which is more critical from prospective of customer retention because a large number of the customers are regular to the Aggarwal baker, hence maintaining the principal customer is maybe a key consideration. This factor may go in favour of any of version oven. If look goes in favour of automatic oven, then taste may be in semi-automatic due to corrections by the worker during baking and relatively authentic preparation.

Manpower
Availability of skilled worker and retention of worker is the cause of worry presently. In order to operate an automatic oven obviously fewer workers are required; hence money can be saved by cutting down recruitment cost and excess salary paid to the worker in order to retain them. On another hand, skilled workers are already in scarcity, automatic machine obviously requires a more technically competent operator. But largely this factor moves in favour of automatic machine despite is costlier.

Space
Aggarwal Bakers located in the centre of the city where space has a huge cost and Aggarwal baker is running out of space during peak hour causing loss of sale. Although the size of both the ovens are same, the number of worker and space required for them surely be less in case of the automatic oven. Hence this factor again moves in favour of automatic oven.

Power consumption & availability
Although the power consumption cost is presumed to already include in annual operating cost hence considered as a monetary factor but need and availability of power is a very important factor; in order to ensure uninterrupted baking. In absence of stand-by power back-up, power cut may lead to downtime. It will complete downtime for the automatic oven and to a certain extent in the case of semi-automatic (because the manual process will keep going on). Stand- by power back-up will also have an additional cost.

Customisation
In case of cookies, it may ok to produce the standard product; but the cake j needs to base upon the order of the customer, who may seek customisation. Scope of customisation needs to evaluate. In the case of the semi-automatic oven, the scope of customisation and ethnicity will be relatively high.

Speed
Aggarwal Baker is known for fast service, and Mr. Purshottam wish to be J true to tagline ‘Close your eyes to wish and open them to find it cooked for you’. The automatic oven is more advanced and equipped with latest 5 technologies to speed up the production. Hence this factor moves in favour 5 of automatic oven.

Detection of the defect
If speed thrills, then it kills too. In case of the bakery, rework and reprocessing is hardly possible, even if possible then at a huge cost; hence it is essential to keep vigil control over quality and detection of defect at the earliest stage.
In the semi-automatic oven, there is the scope of reviewing the material after stage/s and improvisation can be done.

Overall, Aggarwal Bakers should take the decision only after due and careful consideration of above factors.

Cost Management Techniques – CA Final SCMPE Study Material

Question 17.
Product Life Cycle (Life Cycle Costing)
Cellwell Technologies Ltd. is a manufacturer of mobile phones. It has been an established player in the market having launched various cell phone models in the last 10 years. With the preference for usage of cell phones increasing, the company has grown rapidly since inception. During the last two years, sales have been increasing but at a slower rate. Competition has increased and hence sales growth has been slowing down.
Cellwell Technologies plans to introduce a new smart phone model called XXX21. The company’s research and development team has come up an
additional feature for this cell phone model. This feature will periodically inform the customer using the cell phone regarding any software update required for the model. By installing these updates many existing bugs in the software model and security issues to the software can be fixed. This process can be executed remotely with the help of the new technology that the research and development team has developed. This improves the cell phone performance and keeps it running smoothly. It improves compatibility of the software with that used in other applications and devices. It also enhances customer experience as the software update will bring out new software features (like newest emotions/updated dictionary) that can be used by the customer. Consequently, the general utility of the cell phone life will improve by almost a year. There will be less complaints due to performance/compatibility related issues.
The business development team has come up with a proposal for sales promotion. As per this proposal, customers can trade in older model of their cell phone in order to buy the latest XXX21 model. Due to the trade, customers can buy the latest model XXX21 at a substantial discount.
After discussion with the research and development team, they conclude that this would have an additional advantage. Cellwell Technologies can refurbish (repair and renovate) these older models and resell them in the > market at a substantially lower price. Typically, students or customers in the lower income groups who look for cheaper models may find this offer interesting. This creates a new’ market space for the company to target.
Those older ceil phones traded in, that cannot be refurbished or are beyond repair/use can be recycled. Various parts of these phones can be recycled and fitted into the new cell phone models that are being made. Any cell phone model contains various precious metals like gold, copper, platinum as also rare earth elements like neodypiium, terbium to name a few. These are difficult to obtain and need to be mined out of the earth causing huge damage to the environment. With the demand for cell phone slated to increase, the need for these materials Is going to increase as well. Therefore, if these materials can he extracted from old cell phones that would otherwise have been disposed-off into a landfill, it would benefit the environment while providing an alternate source of material procurement. Since billions of cell phones are used globally, every small measure makes an impact. With increasing awareness about environment hazards, such a proposal is likely to find support among customers. It is also helpful to improve the company’s brand image.
Both proposals to introduce software upgrade feature in the cell phone as well as the trade in sales promotional offer are unique as no other competitor has such features in their products or have made such offers yet.
Required
(i) IDENTIFY the lifecycle phase of Cellwell Technologies Ltd. JUSTIFY your response with reference to the case facts.
(ii) DISCUSS the impact of the decision to allow trade in of the company’s older cell phone models on the product lifecycle of such phone models. [Nov. 2021]
Answer:
(i) Cellwell Technologies Ltd. is in the “Maturity” stage of product life-cycle. It has been an established player in the cell phone market. The company has seen rapid sales growth. Over the last 2 years sales have been increasing at a slower rate due to increased competition. There-fore, the company has decided to introduce a new product model in the form of XXX21.
Retention of existing customers and trying to win over the competitor’s customers is the strategy being used by Cellwell Technologies. The XXX21 model that enables customers to upgrade the software of their smartphone enhances its product features. This differentiates the company’s product with that of its competitors. Technology changes at a fast pace. By enabling customers to upgrade their mobiles would definitely improve performance, lower customer complaints due to breakdown or compatibility issues due to older software. Improved performance along with longer product life would definitely enhance customer satisfaction as well as attract newer customers. The add on benefit is that the execution of this update can be managed from remote locations without the need for in person assistance.
The offer to trade in old cell phones while buying the latest XXX21 model would appeal to price sensitive customers. It will also evince interest of customers who are looking to dispose their cell phones that would otherwise end up in the landfill. The trade in offers monetary benefit in the form of a discount. This sale promotional offer to trade old phones for a discount in the price of the latest model XXX21 would definitely help Cellwell Technologies to effectively compete with its competitors.
Cellwell Technologies would have the first mover advantage by imple-menting both the product enhancing/differentiating feature in model XXX21 as well as the trade in options to customers. This shows that the management has a clear plan on how to effectively beat the competition. This indicates that the company is now in the “Maturity” stage of product lifecycle.

(ii) Cellwell Technologies has introduced a sales feature to allow trade in of older cell phone models in exchange for model XXX21 at a substantial discount. These phones would then be used in 2 ways (1) by refurbishing (repairing and renovating) or (2) recycling useful product parts and extracting precious metals and earth elements from the phones.
The refurbished phones would be sold at a substantially lower price j to customers like students or lower income groups. Thus, the older cell phone model gets a new lease of product life after the requisite repairs. This extends its product life cycle by a further time frame until there may be no use of the cell phone model at a 11.
In the case of phones that are of no use/completely dead, usable parts are being recycled into existing products. Thus, this becomes an alternate source of material procurement for the company at a much lower cost. Consistent use of this measure would definitely reduce the cost of production by a certain margin. The product lifecycle of such cell phones (dead phones) is not being extended. However, they continue to provide value to the company with the help of the recycling process. The intangible benefit of this measure would be the positive impact that recycling would have on the environment. A move that would definitely enhance the company’s brand image.

Question 18.
(Life Cycle Costing)
WIBES Tech is a Japanese based firm, has just developed ultra-thin tablet S-5 with few features like the ability to open two apps at the same time. This tablet cost ₹ 5,00,000 to develop; it has undergone extensive research and is ready for production. Currently, the firm is deciding on plant capacity, which could cost either ₹ 35,00,000 or ₹ 52,00,000. The additional outlay would allow the plant to increase capacity from at different capacity level are as under:

Expected Sales 500 units 750 units
Sale Price ₹ 79,600per unit ₹ 69,600 per unit
Variable Selling Costs 10% of Selling Price 10% of Selling Price
Salvage Value – Plant ₹ 6,25,000 ₹ 9,00,000
Profit Volume Ratio 40%

Required
ADVISE WIBES Tech regarding the ‘Optimal Plant Capacity to install. The tablet’s lifecycle is two years. (Note: Ignore the time value of money.)
Answer:
Advice
Based on the above ‘Expected Profit’ statement which is purely based on financial considerations firm may go for high price – low volume i.e. 500 units level. However, non-financial considerations are also given due importance as they account for actions that may not contribute directly to profits in the short run but may contribute significantly to profits in long run. Here, it is important to note that life cycle of product is two years and there is no significant difference between the profits at both levels. In this scenario firm may opt the plant having high capacity not only to increase its market share hut also to establish a long term brand image.

Workings
Statement Showing “Variable Manufacturing Cost per unit”

Particulars ₹ /unit
Sales 79,600
Less: Contribution (40%) 31,840
Variable Cost 47,760
Less: Variable Selling Costs (₹ 79,600 × 0.1) 7,960
Variable Manufacturing Cost 39,800

Statement Showing “Expected Profit”

Particulars (‘000) ₹ /unit
500 units 750 units
Sales 39,800 (₹ 79,600 * 500) 52,200 (₹ 69,600 * 750)
Less-. Variable Mfg. Cost 19,900 (₹ 39,800 * 500) 29,850 (₹ 39,800 * 750)
Less: Variable Selling Cost 3,980 (₹ 39,800 * 0.1) r 5,220 (₹ 52,200 * 0.1)
Add: Salvage Value 625 900
Less: Cost of Plant 3,500 5,200
Net Profit 13,045 12,830

Development cost is sunk and is not relevant.

Question 19.
(Pareto Analysis)
Arya vision is engage in manufacturing of Spectacle. The management has provided the following information about the type ofdefects during a production period and the frequencies of their occurrence

Defect No. of items
End Frame not equidistant from the centre 10
Non-uniform grinding of lenses 60
Power mismatches 20
Scratches on the surface 110
Spots/Stains on lenses 5
Rough edges of lenses 70
Frame colours-shade differences 25

Required
PREPARE a frequency ruble so that a Pareto Chan can be constructed for the defect type. Also, IDENTIFY key areas of focus.
Answer:
Statement Showing “Pareto Analysis of Defects”

Defect Type No. of Items % of Total Items Cumulative

Total

Scratches on the surface 110 36.67% 36.67%
Rough edges of lenses 70 23.33% 60.00%
Non-uniform grinding of lenses 60 20.00% 80.00%
Frame colours-shade differences 25 8.33% 88.33%
Power mismatches 20 6.67% 95.00%
End frame not equidistant from the centre 10 3.33% 98.33%
Spots/Strain on lenses 5 * 1.67% 100.00%
300 100.00%

Arya Vision should focus on eliminating scratches on the surface, rough edges of lenses and grinding of lenses related defects which constitute 80% portion, according to Pareto Theory.

Question 20.
Question (Pareto Analysis)
Anjali Ayurved is an Indian FMCG company which started in 2006. Anjali was founded with an aim of promoting ayurvedic products among consumers. Anjali had become one of the largest consumer goods company in India. Since the company has initiated its expansion by dealership
partnerships and distribution channels across India and abroad, Company wants to identify its signature product (Signature product is the keystone offering company would recommend to just about any customer if they could special). Anjali has a diverse product offering in its marketing mix. Anjali manufacture and sells seven products. The following data relates to the latest period:

Product Contribution in $000
P 96
0 36
R 720
S 240
T 12
U 60
V 24
1,188

Required:
(i) Prepare a pareto chart of product contribution, and comment on the result. Carry out a Pareto ANALYSIS (80/20 rule) Contribution.
Answer:
(i) The first step is to rearrange the products in descending order of contribution and calculate the cumulative contribution:

Product Contribution in $ Cumulative Contribution in $000 Cumulative %
R 720 720 61
S 240 960 81
P 96 1,056 89
U 60 1,116 94
Q 36 1,152 97
V 24 1,176 99
T 12 1,188 100
1,188

The cumulative data can now be used to produce the required Pareto chart showing product contribution:
Cost Management Techniques – CA Final SCMPE Study Material 13
The analysis shows that more than 80 per cent of the total contribution is earned by two products: R and S. The position of these products needs protecting, perhaps through careful attention to branding and promotion. The other products require investigation to see whether their contribution N can be improved through increased prices, reduced costs or increased 5 volumes.
The analysis shows that more than 80 per cent of the total contribution is earned by two products: R and S. The position of these products needs protecting, perhaps through careful attention to branding and promotion. The other products require investigation to see whether their contribution can be improved through increased prices, reduced costs or increased volumes.
R & S are the company’s signature product, signature products are the most significant product of the company. Since the contribution of these two products are highest that is 80 per cent of the total contribution is earned by these two products it means customer prefer these two products.

Cost Management Techniques – CA Final SCMPE Study Material

Question 21.
(Pareto Analysis)
Emergence Technologies Ltd. develops cutting-edge innovations that are powering the next revolution in mobility and has nine tablet smart phone models currently in the market whose previous year financial data is given below:

Model Sales (₹ ’000) Profit-Volume (PV) Ratio
Tab – R001 5,100 3.53%
Tab – S002 3,000 23.00%
Tab – T003 2,100 14.29%
Tab – U094 1,800 14.17%
Tab – V005 1,050 41.43%
Tab – WO06 750 26.00%
Tab – X007 450 26.67%
Tab – Y008 225 6.67%
Tab – Z009 75 60.00%

Required
(i) Using the financial data, carry out a Pareto ANALYSIS (80/20 rule) of Sales and Contribution.
(ii) DISCUSS your findings with appropriate RECOMMENDATIONS. [MTP Oct. 2019/Oct 2020]
Answer:
(i) “Pareto Analysis”
Cost Management Techniques – CA Final SCMPE Study Material 14
(*) Rounding – off difference adjusted.

(ii) Recommendations
Pareto Analysis is a rule that recommends focus on most important | aspects of the decision making in order to simplify the process of decision making. The very purpose of this analysis is to direct attention and efforts of management to the product or area where best returns can be achieved by taking appropriate actions.
Pareto Analysis is based on the 80/20 rule which implies that 20% of the products account for 80% of the revenue. But this is not the fixed percentage rule; in general business sense, it means that a few of the products, goods or customers may make up most of the value for the organsiation.
In present case, five models namely R001, S002, T003, UGQ4 account for 80% of total sales where as 80% of the company’s contribution is derived from models S002 , V005, T003, U004 and WG06.
Models S002 and V005 together account for 50.34% of total contribution but having only 27.84% share in total sales. So, these two models are the key models and should be the top priority of management. Both T003 and U004 are among the models giving 80% of total contribution as well as 80% of total sales so; they can also he clubbed with S002 and V005 as key models. Management of the Emergence Techno Ltd should allocate maximum resources to these four models.
Model W006 features among the models giving 80% of total contribution with relatively lower share in total sales. Management should focus on its promotional activities.
Model R001 accounts for 35,05% of total sales with only 8.05% share in total contribution. Company should review its pricing structure to enhance its contribution.
Models X007, Y008 and Z009 have lower share ip both total sales as well as contribution. Emergence Techno Ltd can delegate the pricing decision of these models to the lower levels of management, thus freeing themselves to focus on the pricing decisions for key models.

Cost Management Techniques – CA Final SCMPE Study Material

Question 22.
(Pareto Analysis)
XYZPytLtd is a specialized car garage door installation company. XYZ Pvt Ltd receive multiple service calls from customers with variety of requirements. They may have to Install, Replace, Adjust or Lubricate some part or other to make the door functional. They work with 5 parts as given in the table, namely Door, Motor, Track, Trimmer and T -Lock.
Cost Management Techniques – CA Final SCMPE Study Material 15
Required
(i) Using the above data, carry out a Pareto Analysis (80/20 rule) of Total Parts. (3 Marks)
(ii) Using the same data carry out the second level Pareto Analysis on the type of services with respect to Motors only. (2 Marks)
(iii) Give your RECOMMENDATIONS on the basis of your calculations 4 in (i) and (ii) above. (5 Marks)
OR
STATE the business situations in which you recommend to apply Pareto Analysis. [MAY 2019 EXAM] (5 Marks)
Answer:
(i) Statement Showing “Pareto Analysis of Total Parts”

Parts No. of Items % of Total Items Cumulative Total
Motor 30 35.29 35.29%
Trimmer 20 23.53 58.82%
Track 17 20.00 78.82%
Door 8 9.41 88.23%
T-Lock 6 7.06 95.29%
Miscellaneous 4 4.71 100.00%

(ii) Statement Showing “Pareto Analysis of Type of Services (Motor)”

Type of Services No. of Items % of Total Items Cumulative Total
Adjust 16 53.33 53.33%
Lube 9 30.00 83.33%
Install 3 10.00 93.33%
Replace 2 6.67 100.00%
30

(iii) Pareto Analysis is a rule that recommends focus on most important aspects of the decision making in order to simplify the process of decision making. The very purpose of this analysis is to direct attention and efforts of management to the product area where best returns can be achieved by taking appropriate actions.
Pareto Analysis is based on the 80/20 rule which implies that 20% of the products account for 80% of the revenue. But this is not the fixed percentage rule. In general business sense, it means that a few of the products, goods or customers may make up most of the value for the firm.

The present case stands in a difference to 80/20 rule. Because the company installs doors, they sometimes have multiple service calls to install each door piece by piece. They may have to install, replace, adjust, or lubricate some part to get the door working properly. They work with five main parts: door, motor, track, trimmer and t-lock. The service calls with reference to motors are heavy and accounted for as much as 35.29% of the number of calls attended. Motor together with trimmer accounted for 58.82%. So, these two parts are to be considered as key parts and XYZ Pvt. Ltd. must be ever ready to cater to all provisional requirements for attending these classes without any inordinate delay. Any delay in service these calls is likely to damage its service rendering reputation within a very short span of time. Further, the second level Pareto Analysis on motors has revealed a particular reference to the service problems related to motors. Adjustments and Lubrication issues cover up 83.33% of the total service problems exclusively connected to Motors. So, XYZ Pvt. Ltd. must direct its best efforts and develop specific expertise to solve these problems in the best interest of the customers.
Or
Pareto Analysis is generally applicable in the following business situations.
Pricing of a Product
In the case of a firm dealing with multi products, it would not be possible for it to analyse cost-profit- price-volume relationships for all of them. In practice, in case of such firm approximately 20% of products may account for about 80% of total sales revenue. Pareto Analysis is used for analysing the firm’s estimated sales revenues from various products and it might indicate that approximately 80% of its total sales revenue is earned from about 20% of its products.

Customer Profitability Analysis
Instead of analysing products, customers can be analysed for their relative profitability to the organisation. Again, it is often found that approximately 20% of customers generate 80% of the profit. There will always be some customers who are less profitable than others, just as some products are less profitable than others. Such an analysis is useful tool for evaluation of the portfolio of customer profile and decision making such as whether to continue serving a same customer group, what is the extent of promotion expenses to be incurred.

ABC Analysis- Stock Control
Another application of Pareto analysis is in stock control where it may be found that only a few of the goods in stock make up most of the value. In practice, approximately 20% of the total quantity of stock may account for about 80% of its value. The outcome of such analysis is that by concentrating on small proportion of stock items that jointly accounts for 80% of the total value, a firm may well be able to control most of monetary investment in stocks.

Application in Activity Based Costing
In Activity Based Costing it is often said that 20% of an organisation cost drivers are responsible for 80% of the total cost. By analysing, monitoring and controlling those cost drivers that cause most cost, a better control and understanding of overheads will be obtained.

Quality Control
Pareto analysis seeks to discover from an analysis of defect report or customer complaints which “vital few” causes are responsible for most of the reported problems. Often, 80% of reported problems can usually be traced to 20% of the various underlying causes. By concentrating one’s efforts on rectifying the vital 20%, one can have the greatest immediate impact on product quality.

Question 23.
(Environment Management Accounting)
BEEZ is a chemical manufacturing company produces two chemicals XA and XB. Environmental activities and costs associated with the two chemicals are as follows:

XA XB
Unit produced (kg.) 6,00,000 15,00,000
Packing Materials (kg.) 80,000 40,000
Energy Usage (KWH) 60,000 30,000
Toxin releases (Pounds into air) 2,00,000 40,000
Pollution contol machine hours 32,000 8,000

 

Cost of environmental activities :
Packing material Costs 1 3,60,000
Energy Costs 1 96,000
Fines for release of toxins into air 1 48,000
Operating costs of pollution control equipments 11,12,000

Required
CALCULATE the environmental cost per kilogram for each chemical produced by the company. [Nov. 2019 Exam] (5 Marks)
Answer:
Environment Cost Allocation
Cost Management Techniques – CA Final SCMPE Study Material 16
Allocation of environment costs incurred by the company can be allocated to products using
(i) Input-Out analysis
(ii) Flow Cost Accounting
(iii) Life cycle costing and
(iv) Activity Based Costing
Environment costs can be allocated to Chemicals XA and XB using Activity j Based Costing.
The environment cost allocation per kilogram for Chemical XA is ₹ 0.72 per kg and Chemical XB is ₹ 0.12 per kg.
The average environment cost per kg for overall production is ₹ 0.2933 per kg.

Examiner Comment: This question was related to calculation of environmental cost per kilogram. Most of the examinees who attempted this part scored full marks.

Cost Management Techniques – CA Final SCMPE Study Material

Question 24.
(Environmental Management Accounting)
Following three independent situations pertaining to environmental management and sustainability are provided to you:
Situation I
Asco Limited is a chemical company which uses chloro-fluorocarbons (CFC) in the production of chemical. As awareness of the environmental damage caused by CFC spread, Asco Limited stopped using CFC in its production processes and analysed and redesigned its product range much before the legislation controlling use of CFC introduced by the Government.
Situation II
Energy drink manufacturer Cola Limited was ordered to submit a yearly report to the Ministry of Environment and Forests on activities, which contains information concerning collection, recovery and recycling of packaging waste, fulfilment of the targets, volume of recovered and recycled packaging waste by type of material and declaration that all compulsory contributions and taxes have been paid.
Situation III
KOA Limited has achieved a 25% reduction of energy consumption through its “Go Renewable” initiative. For, the company a 25% reduction represents a cost saving of about ₹ 30,00,000/-.
Required
Read the above three situations and EXPLAIN any 2 items from (i), (ii) and (iii) below:
(i) Why Asco Limited stopped using CFC and redesigned its product range much before legislation introduced by Government? (5 Marks)
(ii) The risk exposure of Cola Limited. (5 Marks)
(iii) How focusing on environmental sustainability provides opportunity to KOA Limited for reducing costs? (5 Marks) [MTP Oct. 2019]
Answer:
(i) Ever increasing and demanding environmental regulation is forcing companies to change their practices. In many countries, numerous pieces of legislation cover areas such as air quality, climate change, hazardous substances, packaging, waste, and water quality.
The trend is very much in the direction of increased and more stringent legislation. Environment sustainability is not an issue that can be avoided by any organisation. Organisations need to consider how environmental regulation will impact their operations and the cost of doing business.
By stopping the use of CFC much before the legislation, Asco Limited gained advantages over its rivals. Asco’s actions were integral to its own strategic success, and instrumental in driving through the subsequent legislation from which the company later benefited.

(ii) Organizations increasingly have to demonstrate that they are man-aging all of their risks systematically and responsibly. This includes environmental risks. By assessing the environmental risks associated with their activities, processes, product, and services, organizations can identify their potential legal and business exposure. Non-compliances can cause enormous financial impacts, such as fines, penalties, legal costs, and damages.
Thus, Cola Ltd is exposed to environmental risks.

(iii) Focusing on environmental sustainability will often provide opportunities for reducing costs. For example, reducing carbon impacts often also saves energy costs. Similarly, programmes for reducing wastes improve environmental performance and reduce operating costs.
Reducing environmental impacts can also reduce or eliminate associated tax, levies, and other compliance costs.
Focusing on environmental sustainability thereby making investments in developing clean technologies and more energy-efficient products and processes will not only save the organization money, but could also be patented and/or sold to other organizations, providing an additional source of income. KOA Limited may have carbon credit for efficiency in reducing energy and sell on the open market, thereby actually generating revenue.

Question 25.
Environmental Management Accounting)
MAX is an agro fertilizer company produces Grade Y and Grade Z fertilizers. One kilogram of Grade Y fertilizer sells for ₹ 280 per kilogram and one kilogram of Grade Z fertilizer sells for ₹ 400 per kilogram.
The products pass through three cost centers CX1, CX2 and CX3 during the manufacturing process. Total direct material cost per kilogram of fertilizer produced is ₹ 300 and direct labour cost per kilogram of fertilizer produced is ₹ 200. Allocation between the cost centres is given below:
Cost Management Techniques – CA Final SCMPE Study Material 17
All of expenses (considered to be overheads) per kilogram of fertilizer produced is ₹ 150. This is allocated equally between Grade Y and Grade Z fertilizer. Pricing decisions for the fertilizers is made based on the above cost allocation.
The management accountant of the company has recently come across the concept of environmental management accounting. Pricing of products should aiso factor in the environmental cost generated by each product. An analysis of the overhead expenses revealed that the total cost of ₹ 150 per kilogram of fertilizer produced, includes incinerator costs of ₹ 90 per
kilogram of fertilizer produced. The incinerator is used to dispose the solid waste produced during the manufacturing process. Below is the cost center and product wise information of solid waste produced:
Cost Management Techniques – CA Final SCMPE Study Material 18
Based in the impact that each product has on the environment, the management would like to revise the cost allocation to products based taking into account the incinerator cost that each product generates. The remaining overhead expenses of ₹ 60 per kilogram of fertilizer produced can be allocated equally.
Required
(i) CALCULATE product wise profitability based on the original cost allocation. RECALCULATE the product wise profitability based on activity based costing methodology (environmental management accounting). (12 Marks)
(ii) ANALYZE difference in product profitability as per both the methods. (4 Marks)
(iii) RECOMMEND key takeaways for the company to undertake the above analysis of overhead costs and pricing as per environmental management accounting. [RTF Nov. 2018] (4 Marks)
Answer:
(i) Product Wise Profitability as per Original Allocation Methodology
(Figures in ₹ per kilogram of fertilizer produced)

Particulars Grade Y Grade Z Total
Selling Price 280 400 680
Direct Material (Refer Table 1) 114 186 300
Direct Labour (Refer Table 1) 76 124 200
Overheads (allocated equally) 75 75 150
Total Expenses 265 385 650
Profit 15 15 30
Profitability 5.3696 3.7506 X

Table 1 Allocation of Direct Materials and Labour as per Cost Centre and Product
Cost Management Techniques – CA Final SCMPE Study Material 19
Product Wise Profitability (activity based costing using environmental management accounting) requires the following steps:
1. Overhead expenses of ₹ 150 per kilogram of fertilizer produced be first bifurcated into incinerator costs and other overhead costs.
2. Incinerator costs of ₹ 90 per kilogram of fertilizer needs to be allocated first to the cost centres. This is done based on the waste generated at each cost centre. The individual cost allocated to each cost centre is again allocated to products based on the waste generated at each cost centre by each product. Refer part a of table 2 for detailed calculations.
3. As mentioned in the problem, other overhead costs are allocated to each product at each cost centre level equally. Refer part b of table 2 for detailed calculations.
4. The above allocations to each product at a cost centre level is then summed up to get the product wise overhead cost allocation. Refer part c of table 2 for detailed calculations.

Accordingly, the Revised Product Profitability would be as follows:
(Figures in ₹ per kilogram of fertilizer produced)

Particulars Grade Y Grade Z Total
Selling Price 280 400 680
Less: Direct Material (refer table 1) 114 186 300
Less: Direct Labour (refer table 1) 76 124 200
Less: Overheads (refer table 2) 66 84 150
Profit 24 6 30
Profitability 8.57% 1.50% X

Table 2 Allocation of Overhead Expenses to each Cost Centre and Product
(Figures in ₹ per kilogram of fertilizer produced)
Cost Management Techniques – CA Final SCMPE Study Material 20
Part A: Allocation of Incinerator Cost from Cost Centre to each product (based on waste produced at each cost centre by each product)

Product CX1 CX2 CX3 Total
Grade Y 12 18 6 36
Grade Z 12 12 30 54
Total Incinerator Cost 24 30 36 90

Part B: Allocation of Other Overhead Cost from Cost Centre to each product

Product CX1 CX2 CX3 Total
GradeY 10 10 10 30
GradeZ 10 10 10 30
Total Other Overhead Cost 20 20 20 60

Part C: Total Overhead Cost (Cost Centre and Product Wise i.e. part a + b)

Product CX1 CX2 CX3 Total
GradeY 22 28 16 66
Grade Z 22 22 40 84
Total Overhead Cost 44 50 56 150

Summarizing Product Profitability as per both methods:
Cost Management Techniques – CA Final SCMPE Study Material 21

(ii) As summarized above, originally the profit generated from Grade Y and Grade Z products, was ? 15 per kilogram. Grade Y was the more profitable product giving return of 5.36% compared to Grade Z’s return of 3.75%. This has been calculated by allocating overheads equally to Grade Y and Z.
During the year, 15 tons of waste is produced during the manufac-turing process. Grade Z fertilizer produces more waste that accounts for 60% of the waste. Therefore, Grade Z should bear higher amount of the incinerator cost compared to Grade Y. Allocation based on this premise, dramatically changes the profitability of the products. As calculated above, Grade Y fertilizer, due to lower incinerator cost allocation , generates a profit of ? 24 per kilogram of fertilizer. Grade Z’s profits accordingly are lower, since the product generates more waste and has to bear a larger share of clean-up expenses. Profitabil-ity of Grade Y increases to 8.57% while Grade Z falls dramatically to 1.50%.

(iii) The company can draw a number of conclusions from this analysis of overhead costs as per environmental management accounting. This analysis has helped the company reach the conclusion that Grade Z fertilizer produces more waste.

The company could adopt either of the following approaches:
(a) To maintain the same level of profitability, the company can increase the price of Grade Z by another ? 9 per kilogram. This is a 2.25% increase in the sale price of Grade Z fertilizer. Depending on the market for this grade of fertilizer, the company has to de-cide whether to increase the price of the product. While a price increase may be possible if the company has a strong market hold, it might be difficult if competition in the market is high or
(b) The other approach, a more sustainable approach that is the aim of environmental management accounting, would be to reduce the waste produced in the manufacturing process. This analysis, has quantified the waste generated in the process. Better manufacturing techniques, could save the company incinerator costs, that would yield better profits for the company.

Cost Management Techniques – CA Final SCMPE Study Material

Question 26.
(Environmental Management Accounting)
XYZ Ltd. is the leading manufacturer and exporter of high quality leather products – Product A and Product B.
Selling price per unit of Product A and Product B is ₹ 620 and ₹ 41 respectively.
Both the products pass through three processes – Tanning, Dyeing and Finishing during manufacturing process. Allocation of costs per unit of leather products manufactured among the processes are given below:
Cost Management Techniques – CA Final SCMPE Study Material 22
General overheads per unit of leather products manufactured are ₹ 230 which is allocated equally between Product A and Product B. Above cost allocation is the basis for the decisions regarding pricing of the products.
In this Industry, all the major production processes have environmental impact at all stages of the process, including generation of waste, emission of harmful gases, noise pollution, water contamination etc.
The management of the company is worried about the above environ mental impact and has taken initiative to preserve the environment like – research and development activities aimed at reducing pollution level, planting trees, treatment of harmful gases and airborne emissions, wastewater treatment etc.
The management of the company desires to adopt Environmental Management Accounting as a part of strategic decision making process. Pricing of products should also factor in environmen tal cost generated by each product
General overheads per unit of leather products manufactured are ₹ 230 which includes:
Treatment cost of harmful gases …… ₹ 80
Wastewater treatment cost ……….₹ 100
Cost of plan ti ng of trees ……….₹ 20
Process wise information related to generation of wastewater and harmful gases is given as below:
Cost Management Techniques – CA Final SCMPE Study Material 23
Required.
(a) CALCULATE the product w ise profitability based on the original cost allocation, (2 marks)
(b) RECALCULATE ihe product wise profitability based on activity based costing {Environment driven costs). (5 marks)
(c) ANALYZE the difference in product profitability as pet both the methods. (2 marks)
(d) RECOMMEND and EXPLAIN ihe four management accounting techniques for the identification and allocation of en vironmental costs. (8 marks)
(e) STATE why the management of environmental costs is becoming increasingly important in organizations. Give reasons. [MAY 2019 Exam] (3 marks)
Answer:
(a) Product Wise Profitability as per Original Allocation Methodology
(Figures in ₹ per unit of leather produced)

Particulars Product A Product B Total
Selling Price 620 420 1,040
Direct Material (Refer Table 1) 286 174 460
Direct Labour (Refer Table 1) 186 114 300
Overheads (allocated equally) 115 115 230
Total Expenses 587 403 990
Profit 33 17 50
Profitability (96) 5.32% 4.05% X

Workings
Table 1 Cost Allocation to the Products
(Figures in ₹ per unit of leather produced)
Cost Management Techniques – CA Final SCMPE Study Material 24

(b) Product wise profitability based on activity based costing using envi¬ronment driven costs requires the following steps:

  • Breakdown of overhead cost of ₹ 230 per unit into treatment cost of harmful gases, wastewater treatment cost, cost of planting trees and other overhead costs. Refer Table 2 for the breakup.
  • Treatment cost of harmful gases, wastewater treatment cost need to be individually allocated to various processes based on relevant cost drivers. Refer Table 3 for cost allocation to process.
  • The overheads mentioned in point 2 thus allocated to the various processes, will be further allocated to products based on the spe-cific ratios given in the problem. Refer Table 4 for cost allocation to products.

Product Wise Profitability Statement based on ABC using environment driven costs
(Figures in ₹ per unit of leather produced)

Particulars Product A Product B Total
Selling Price 620 420 1,040
Direct Material (Refer Table 1) 286 174 460
Direct Labour (Refer Table 1) 186 114 300
Allocation of Overheads
Treatment Cost of Harmful Gases (Refer Table 4) 50 30 80
Wastewater Treatment Cost (Refer Table 4) 62 38 100
Cost of Planting Trees (shared equally) 10 10 20
Other Overhead Cost (shared equally) 15 15 30
Total Expenses 609 381 990
Profit 11 39 50
Profitability % 1.77% 9.29% X

Workings
Table 2: Breakdown of General Overheads per unit

Overhead Amount (₹) Allocation basis between products
Treatment Cost of Harmful Gases 80 Emission of Harmful Gases (cc per week)
Wastewater Treatment Cost 100 Wastewater Generated (litres per week)
Cost of Planting Trees 20 Equally between Products A and B
Other Overheads (balancing figure) 30 Equally between Products A and B
Total General Overheads per unit 230

Table 3: Allocation of Treatment Cost to various process
Process Wise Information
Cost Management Techniques – CA Final SCMPE Study Material 25
Cost Allocation to Process
Cost Management Techniques – CA Final SCMPE Study Material 26

Table 4: Allocation of Treatment Cost to Product A and B
Cost Management Techniques – CA Final SCMPE Study Material 27

(c) Analysis of the difference in product profitability as per both the methods
In the first method, general overhead costs are allocated to the prod-ucts A and B, irrespective of the environment costs that each product incurs. General overhead costs are to each product equally. The resultant product profitability shows that Product A yields 5.32% and Product B yields 4.05% profitability. Therefore, the XYZ Ltd. would conclude that Product A is more profitable.

In the next method, general overhead costs are bifurcated to identify “hidden” environment costs that are incurred on account of manufacturing these products. Environment costs are first traced to the process that generates harmful gases and wastewater, for which treatment is done. It can be seen that Tanning process, followed by Dyeing and Finishing process generates the maximum amount of waste. Therefore, by proportioning the cost based on the waste generated, more cost is allocated to Tanning the process. Similarly, Dyeing and Finishing are allocated lesser cost since they do not generate as much waste. It is further given that 70% of the cost of Tanning relates to Product A. This is much higher than the 50% that was allocated to the Product as per the first method.

Accordingly, the revised workings show that Product A yields 1.77% and Product B yields 9.29% profitability. The reason being, Product A generates more environment driven costs as compared to Product B.
XYZ Ltd. would therefore increase the selling price of Product A if it wants to maintain profitability as per the original method. However, the more sustainable approach would be find out ways of reducing wastewater and harmful gases the manufacturing process produces. This would in turn result in reduction of environment driven costs such as wastewater treatment and treatment of harmful gases. This would sustain profits in the long run.

(d) Four Techniques for the identification and allocation of Environmental Costs
Input-Output Analysis: This technique monitors the material input with the output that is produced. For example, if 100kg of material have been bought and input in the process resulting in 80kg output material, the 20kg must been accounted in some way. Some part of this may say 10% (2kgs) may have been sold as scrap while the re-maining 90% (18kgs) of it may be waste. Possibly scrap can be reused therefore may have neutral environment impact. The company can then concentrate on minimizing waste generation.
Flow Cost Accounting: This technique uses not only material flows but also the organizational structure. Classic material flows are recorded as well as material losses incurred at varioils stages of production. Flow cost accounting makes material flows transparent. It tracks:
(i) quantities (physical data);
(ii) costs (monetary data) and
(iii) values = (quantities × costs).

Material flows are divided into three categories: material, system, and delivery/disposal.
(i) The material values and costs apply to the materials which are involved in the various processes.
(ii) The system values and costs are the in-house handling costs, which are incurred inside the company for the purpose of maintaining and supporting material throughput. Example personnel costs or depreciation.
(iii) The delivery and disposal values and costs refer to the costs of flows leaving the company for example transport costs or cost of disposing waste.
The focus of flow cost accounting is on reducing the quantities of materials, which leads to increased ecological efficiency.

Life Cycle Costing: This technique considers the costs and revenues of a product over its whole life rather than one accounting period. Therefore, the full environmental cost of producing a product will be taken into account. In order to reduce lifecycle costs, an organization may adopt a TQM approach. Good environmental management is increasingly recognized as an essential component of TQM. Such organizations pursue objectives that may include zero complaints, zero spills, zero pollution, zero waste and zero accidents. Information systems need to be able to support such environmental objectives via provision of feedback of the organizational efforts in achieving such objectives.

Activity Based Costing (ABC): ABC allocates internal costs to cost g centres and cost drivers on the basis of the activities that give rise to the costs. Environment-related costs can be attributed to joint cost % centers and environment-driven costs are hidden on general overheads, Environment-driven costs are removed from general overheads and traced to products or services. The cost drivers are determined on environment impact that activities have and costs are charged accordingly. This should give a good attribution of environmental costs to individual products that should result in better control of costs.

(e) Reasons why environmental costs is becoming important in organizations
(i) “Carbon footprint” measures the total greenhouse gas emissions caused directly and indirectly by a person, organization, event or product. People are now becoming aware about the carbon footprint and recycling. Several companies have initiated CSR committees as they feel that portraying themselves as environmentally responsible makes them popular among their consumers,
(ii) Environmental costs are becoming huge for some companies particularly those operating in highly industrialized sectors such as oil production. Such significant costs need to be managed.
(iii) Regulation is increasing worldwide at a rapid pace, with penalties for non-compliance.

Cost Management Techniques – CA Final SCMPE Study Material

Question 27.
Case Scenario : (Environmental Management Accounting)
NTA Oil Ltd., an Indian oil company, is the leading manufacturer of all streatns of oil and engaged in refining (processing capacity 50MMTPA of crude oil), pipeline transportation and marketing of petroleum products to research & development, exploration & production, marketing of natural gas and petrochemicals. The company has high -caliber employees, sophisticated technologies and leading-edge R&D. By venturing itself into the renewables and the nuclear energy, NTA has grown and evolved itself from a pure petroleum re fining and marketing company to a full-fledged energy company. Due to government’s new environmental policy, environmental report is mandatorily required to be submitted yearly for the prescribed industries polluting environment substantially otherwise would be penalized. Energy sector also falls in these prescribed industries. NTA has already taken initiatives to control air pollution and water pollution like use of low sulphur fuel oil in boilers and heaters & NOx burners to minimize gas emission, network of underground sewers for segregated collection of various wastewater streams for waste water management, however while preparing and analyzing environmental report, Mr. K V Sharma, CEO, is not happy with high environmental cost in terms of Waste (oily/chemical/ biological sludge, scrape batteries, e-waste, chemical containers, effluents etc.), Raw Material Consumption, Water Consumption, Energy and Transportation. He raised his concern with Board of Directors and they have decided to appoint you as an environmental management accounting expert to manage environmental cost.
Required
APPLY Environmental Management Accounting in NTA to manage environmental costs.
Answer:
Environmental Management Accounting (EMA) is the process of collection and analysis of the information relating to environmental cost for internal decision making. EMA identifies and estimates the cost of environment related activities and seek to control theses cost.
In NTA, during refinery operations, waste water, fugitive emissions, flue gases and solid wastes are generated. Due to this excess waste and gas emission, environmental cost rises. Scarce natural resources should be used in such a way so that their consumption is sustainably optimized. In order to cutback environmental cost, EMA can be applied as follows:

Waste
NTA should measure, manage and monitor waste from operations in order to minimise impact on people and the environment. ‘Mass balance’ approach can be used to determine how much material is wasted in production, whereby the weight of materials bought is compared to the product yield. From this process, potential cost savings may be identified.
In NTA, wastes are oily/chemical/biological sludge, scrape batteries, e- waste, chemical containers, effluent etc. Waste generated in operations is either treated within the premise or disposed through approved waste treatment, storage, and disposal facility. To avoid the usage of chemical drums/containers in large quantity, separate storage tanks can be created for bulk storage of additives to reduce the drum procurement and disposal.
Further, refineries in operation should be upgraded from time to time to minimize waste.

Water Management
Businesses pay for water twice – first, to buy it and second, to dispose of it. If savings are to be made in terms of reduced water bills, it is important for NTA to identify where water is used and how consumption can be decreased.
For water conservation, sustainable water management techniques should be adopted. In refining operation, water is mainly used in boilers and cooling units. Collective efforts should be made to optimize water consumption and maximum reuse of used water. Advanced treatment system like rain water harvesting, ultra-filtration, reverse osmosis etc. may be used for water purification for further use. This would lead to substantial reduction in intake of fresh water.
In addition, NTA staff should be alerted for water conservation through seminars, presentations, conference, awareness campaigns.

Energy
Often, energy costs can be reduced significantly at very little cost. Environmental Management Accounts may help to identify inefficiencies and wasteful practices and, therefore, opportunities for cost savings. Some of energy conservation initiatives may be taken by NTA like:

  • Conducting periodic energy audits for identifying energy saving op-portunities.
  • Phasing out conventional lights and replacement with LED lights/ induction lights.
  • Power factor improvement by installation of capacitor banks.
  • Installation of 5 star rated energy equipment.
  • Prevention of idle running of equipment.
  • Installation of solar lights.
  • Use of Nano molecular thermal additives in ACs.
  • Installation of efficient energy monitoring system for energy intensive equipment.
  • Capacity improvement for batteries.

Consumables and Raw Material
Refineries ‘refine’ crude oil in massive quantities, to produce the fuels need. There should be continuously monitoring on optimum utilization of crude oil to improve gross refining margin. The gross refining margin I is the difference between the total value of petroleum products coming out of an oil refinery (output) and the price of the raw material, (input) which is crude oil. Even not only crude oil there should also be optimum and sustainable utilization of resources like additives, chemicals etc. from procurement to production stages.
NTA may use recyclable technology for raw material and consumable wastages which provides sustainability in terms of environmental protection and reduction in carbon footprint. Periodic testing should be performed to assess the health of equipment and pipelines as to have better process of raw materials and consumables.

Transport
Again, EMA may be used to identify saving in terms of transport of goods and materials. At NTA, in order to cutback emission and fuel consumption due to transportation, route optimization activity may be used like allocation of customer on the basis of nearest depots and locations as to reduce distance, real time fleet tracking using GPS (to make sure that vehicles do not deviate from assigned shortest route) etc.

Question 28.
A chemical company produces two chemicals SX and ZX. Environmental activities arid costs associated with the two chemicals are as follows;

SX ZX
Unit produced (kg.) 6,00,000 15,00,000
Packing Materials (kg.) 80,000 40,000
Energy Usage (KWH) 60,000 30,000
Toxin releases (Pounds into the air) 2.00,000 40,000
Pollution control machine hours 32,000 8,000

Cost Management Techniques – CA Final SCMPE Study Material

Cost of environmental activities:
Packing material Costs ₹ 3.60,000
Energy Costs ₹ 96.000
Fines for release of toxins into the air ₹ 48,000
Operating costs of pollution control equipment ₹ 1,12,000

Required
CALCULATE the environmental cost per kilogram for each chemical produced by the cdinparty.
Answer:
Environment costs can be allocated to Chemicals SX and ZX using Activity Based Costing.
Cost Management Techniques – CA Final SCMPE Study Material 28
The environment cost allocation per kilogram for Chemical SX is ₹ 0.7227 per kg and Chemical ZX is ₹ 0.1216 per kg.
The average environment cost per kg for overall production is ₹ 0.2933 per kg.

Question 29.
(Environmental Management Accounting)
SBL have been recognized as a manufacturers and exporters of fhjgh quality Bangles, designed, and manufactured using optimum quality raw material, sourced from trustworthy vendors of the market.
Manufacturing Process
The process of manufacture of glass bangles is highly skilled labour oriented one comprising of the following main operations:
Cost Management Techniques – CA Final SCMPE Study Material 29
In first phase, glass batch materials like sand, soda ash, lime stone feldspar, borax etc. with other additives and colouring materials in a suitable proportion are mixed manually and fed into the pot places in pot furnace. The raw’ material is melted in the furnace at a temperature of about 1300 – 1400 (°C) to obtain molten glass.
In second phase, molten glass is drawn from the pot of the furnace with the help of the iron pipe and formed into gob to gather required quantity of glass for formation into parisons on iron plates. The parisons of different colours are joined together and reheated in an auxiliary furnace to obtain required designs.
In third phase, the reheated parison is then transferred to ‘Belan Furnace’ from which the glass is further drawn into spiral/coil of bangles on the spindle counted and rotated manually at uniform rate of revaluation synchronizing with the manually at the other end of the furnace. Spiral are then taken out from the spindle and cut with the help of a pencil cutter to separate out the single pieces of bangles from spiral. These cut or unjoined bangles are then sent for joining of end, finishing cutting & polishing, decoration etc. The finished products are then neatly packed for sale.

Environmental Impact
But unfortunately, these processes have environmental impact at all stages of the process, including emissions of airborne pollution in the form of ashes, gases, noise and vibration.

Conditions of the Workplace
Due to limitations of maintaining appropriate temperature for melting and moulding of the glass, furnaces are kept burning. Therefore, workers have to work with such working conditions continuously without proper leisure time.
The abovementioned factors become more harmful while working in immense heat and sound which is normally higher than permissible levels.

Health Impact
A recent study has revealed adverse impact of pollution over workers and people who are living in nearby area.
Management Initiatives
The management of company is worried about environmental impact and health impact and has taken certain initiatives in taking care of environment like-batch house cyclonic dust collector, noise absorbing device, natural gas fired furnace, better refractory materials, training for waste minimization, treatment of solid waste, research and development activities aimed at reducing pollution level, planting trees, treatment of nitrogen oxide and other harmful gases.
Management desires to adopt environmental management accounting as a part of strategic decision making process.
Required
(i) EXPLAIN the requirement to have environmental management accounting and IDENTIFY the SEL’s environmental prevention, appraisal, and failure costs.

(ii) ANALYZE the appropriateness of SBL incorporating the following in implementing Environmental Management Accounting:
Activity Based Costing

  • Life Cycle Costing
  • Input Output Analysis

(iii) EXPLAIN the need of non-financial consideration in decision making and suggest safety measures that can be taken into consideration for workers.
Answer:
Environmental management accounting (EMA) is the generation and analysis of both financial and non-financial information in order to support internal environmental management processes ie. identification, prioritization, quantification and recording of environmental cost into business decision.

By adopting EMA, SBL will have following benefits:

  • Product Pricing.
  • Budgeting.
  • Investment Appraisal.
  • Calculating Investing Options.
  • Setting Quantified Performance Targets.
  • Assessment of Annual Environmental Costs.
  • Environmental Performance Evaluation, Indicators and Benchmarking.
  • External Reporting- Disclosure of Environmental Expenditures, In-vestments and Liabilities.

Environmental Costs of SBL

  • Environmental Prevention Cost: These costs are basically incurred in relation to activities undertaken to prevent the production of waste that could harm the environment. Company’s efforts to minimize the effect of its activities on the environment li ke installing batch house cyclonic dust collector, natural gas fired furnace, better refractory materials, training for waste minimization, research and development activities, noise absorbing device and planting trees can be classified as Environmental Preventive Cost.
  • Environmental Appraisal Costs: It means costs incurred in relation to activities undertaken to determine whether product processes and other activities within firm are complying with environment standards.
    SBL may perform ‘Contamination Test’ to observe the environment compatibility of its processes can be categorized under environmental appraisal cost.
  • Environmental Failure Cost: It means cost incurred in relation to activities dealing with pollution arising from the activities of entity includes costs related to treatment harmful gases and treatment of solid waste.

Appropriateness of Techniques for Identification and Allocation
Activity Based Costing
This costing technique would help the SBL to separate environmental costs from the general overheads and allocate them to glass bangles by identifying appropriate drivers of these environmental cost. Possible environment activities for environmental costs and their drivers are:

Activity Cost Drivers
Planting of trees Number of trees planted
Treatment of nitrogen oxide (in the same way, activity and related cost driver for other gases would he determined) Volume of nitrogen oxide treated
Solid waste removal Volume of such waste
Research and development activities Man hours worked for such activities

By using this costing in EMA, SBL would be able to identify, record and control the environmental costs relating to various stages in the life of glass bangles. At each of following stage environmental cost would be incurred:

  • In raw material stage, some natural product would be purchased.
  • In manufacturing stage, emission and treatment of nitrogen oxide & other gases and treatment of solid waste.
  • In marketing and distribution stage, environmental cost relating to S transportation of glass bangles to various customers.

Input/Output Analysis
Here detail analysis of input and output of a system is done for the purpose of assessment of ecological wellbeing of entity’s products, processes and other activities. This technique is based on the fact that whatever goes into the system has to come out of it.
In case of SBL, it can evaluate the volume of sand, soda ash, lime stone feldspar, borax etc. and the resulting volume of output ie. glass bangles. Through such evaluation, the SBL would be able to allocate and analyses environmental cost attributable to input and output of glass bangles.

Non-Financial Considerations
Entities generally give emphasis on financial measures such as earnings and accounting returns but little emphasis on drivers of value such as customer and employee satisfaction, innovation and quality. Due to which mostly companies could not continue in long term. So for the purpose of achieving long-term organizational strategies, non-financial consideration should be taken into account. Without this it may be that company achieve short term goal but would be difficult to achieve long term goal.
In SBL, it can be clearly seen that there is great impact on health of workers.
By creating a safe and healthy environment for employees, SBL can improve productivity, business performance, staff morale and employee engagement. Further, SBL will also be able to reduce – accidents/work related ill health/sick pay costs as well as insurance costs. A healthy workforce can demonstrate corporate responsibility. If SBL look after employees, business is likely to have a more positive public image.

To create safe and healthy environment following measures can be taken into consideration:

  • Safety monitoring system.
  • workers must be trained.
  • Recruitment of more workers.
  • First aid kit should be available.
  • Protective glasses, clothes, gloves should be provided. Regular health check-up camps and awareness programs.

Cost Management Techniques – CA Final SCMPE Study Material

Question 30.
Case Study
Sweet Homes, a US based MNC, started its Indian operations with opening of few stores in its nascent phase. In recent times, it started running nationwide stores in India selling range of home-based products right from home improvement tools, decors, electronic appliances to small kitchen utilities like steel pans, non-stick dishes, kitchen organizers, knifes, cardboards, countertop stickers, ice cream molds, chocolate molds and alike. It had gained wide popularity particularly among the ladies’group of India since its expansion of the product line. Previously it was selling just the intermittently purchased home-based products like furniture and appliances. It was the extended accessibility to daily utilities that elated the ladies’ group about visiting the stores. Some women referred Sweet Homes as the one stop search for all their necessities.
Sweet Homes manufactured some of the products rather than making an outright purchases and sales thereof of all its products. To make various kinds of furniture and kitchen based small utilities, it derived its raw materials directly from local market which were mostly the recycled materials like plastics, scrapped items, used furniture and alike rather than the raw wood, forest products and firsthand products. Its raw materials were therefore capable of generating various forms of work in progress. The work in progress and finished product relation worked in similar fashion. From a particular WIP, it was capable of generating multiple outputs. Therefore, the firm kept its material cost low and primarily relied on the recycling process, thereby keeping up its pledge to serve the environment.

For the in-house manufactured products, the materials department of the firm functioned in the below manner:
(1) The manager of the department kept a watch on each type of inventory levels in the warehouse.
(2) He then estimated the required production based on historical demand and long-term forecasting policies of the firm.
(3) A room was also left for safety stock so that any unforeseen delay in delivery of the goods could be covered.
(4) Based on the existing inventory and production plans and safety stocks, inventory replenishment levels were calculated.
(5) Once the stock reached its reordering level, an order to replenish the stock was being sent to the vendor.
(6) Based on departmental orders, vendor delivered the materials.
To manufacture the finished products i.e., to convert raw material to finished good, the intervening time was 3 weeks. It will take approximately take 4 weeks to deliver the in-house manufactured product from the time order is received. The standard lead time of sirnilarproducts in industry is 2.5 weeks.
For products purchased out-rightly, a purchase order was prepared by the purchasing department basedon the inventory in hand and expected demand. Some of those products did show a sketchy demand pattern, with surge irtdemand for lame reasons. However, the department did not ta ke intoiuccoun t safety stocks for any of these purchased products, since the cost to maintain such inventories were high and the costs of these products itself were high enough. The problem however was failure to meet surprise order’s or sudden increase in demand.
People weregetting busier and there was hardly any time to procrastinate buying things they need until they could visit the stores based on their availability. Moreover, it was just thilmetro cities, that had overwhelming number of stores, but states like Gujarat and Odisha remained an untapped target with very few stores only in the developed parts of the cities. Sweet Homes ’agenda was not just to add more variety to its existing offerings, but to reach people all around the country since it perceived manifold needs were yet unmet.
Going digital was a challenge since its popularity was limited to its store locations and therefore it was dubious of its acceptability among the nationwide customers. It was prepared for an extensive marketing of is digital channels though and funds were not a problem. Having heard about the peaking demand of businesses for E-Customers, it was support live of the idea and considered to follow the suit.
From is US operations, it was very well aware about the expectations of its E-Customers and the quality of service they desire from their E-Sellers, They tend to be progressively demanding and expect their orders to be processed in couple of hours aftei being placed.
They do not want to grapple with the tracking information of their package. They need real time update of their package location so that there are no abrupt surprises about the delivery rime and the condition of the package. They like to purchase h ow E-Seilers who offers cam petit i ve prices accompanied with free s hipping and on time delivery. That is all mo much tor a developing market, like India.
The biboar cost is relatively low in India but the infrastructure in not adequately sound to guarantee the same level of service at their expected prices. Indian market is not similar to the US market, theie being an immense cultural gap. The income of the middle-class people is also not remarkably high and hence ihev can spend sparingly on things that at e not paramount on their list. Kitchen items though marked as access by the women section of the society were not real necessities In comit sense. Hence the firm thought of applying the pat ad ignis of Target Costing to set the ptice of iheir online products such that they remain competitive before their E Customers. :
The firm also needs a flawless Supply Chain Management [SCM] System in Indian environment, but the back-office team of the firm had Utile knowledge about this usui of the E Commerce project a nr! it did not see the light of the day. Now they need you to help them shape up the SCM look of Sweet Homes.
Required
Given the facts of Sweet Homes, answer the following questions:
(i) DISCUSS the suitability of Target Costing concept to Sweet Homes?
(ii) Critically ASSESS its current inventoty management system and RECOMMEND suitable changes in light of its business strategy.
(iii) AD VISE the SCM look for Sweet Homes as per their requirement.
Answer:
(i) Usually, we notice a suit of prices of products being determined bascd on the cost of their production, keeping a room for desired margin.
In contrary to this, the then originated Japanese concept tells us to estimate selling price at first place, to be determined based on the price the market is currently willing to pay for a similar product. Thus, the prices here are not based on the cost of their products rather costs have to be targeted and thus the name “Target Costing”. This means once price is determined and profits are set aside, the remainder becomes the costs to be achieved. In striving to reach the cost goal, myriad managerial techniques and tools like Value Chain Analysis/ Value Reengineering, Six Sigma, are used. These techniques are used keeping in mind the focus (i.e., to control cost in order to meet the target without compromising the quality and value to be derived from the product). As such, various costs incurred with respect to product like design cost, manufacturing cost, storage cost, transportation cost are destined to be controlled.

Target Cost concept is very much relevant in Sweet Homes’ situation since it is considering to digitize its business where competition is intense specifically with regards to the prices of similar products. Since the products offered by Sweets Homes lack much differentiation, the unique selling point of the firm can be to offer quality products at low prices. Further, E-Commerce will mostly require the firm to 5 operate as per Just in Time (JIT) approach that will reduce inventory g maintenance burden and also reduce wastage, thereby controlling j§ costs. Thus, Target Costing and E-Commerce go hand in hand.

We must also keep in mind that the firm can apply Target Costing concept to both its manufactured products and the products purchased out-rightly. For the merchandise goods, Sweet Homes can plan to control various fixed cost (i. e., storage and inspection cost) and variable cost (ie,, selling cost) incurred to handle such goods such that lower prices can appeal wider customer base. Moreover, to achieve low costs for its supplied products, it will have to enter into long term contracts with dedicated suppliers. Considering the E-Market, the scope of its operations will expand and therefore the demand may also increase. Thus, suppliers can funnel the discounts in form of low prices only if a commitment for long term purchases is made by the firm.

(ii) Currently, Sweet Homes operates physical stores at which time invento-ries of raw materials, WIP and finished products are maintained at the stores and in warehouses considering the demand directly dependent upon the store locations. It has been blocking large assets in form of various inventories piled- up to coordinate its production and retail function.

The three forms of inventories related to products that Sweet House manufactures are maintained in a traditional manner which seems to be out of the place for an E Retailer. Sweet House forecasts demand based on its internal policies and historical trends. Today demand in every sector of the market changes by leaps and bounds, so using historical data is not at all recommended. Demand forecasts should be pulled by current market trends and prediction of future market sentiments. For example, Corona Virus pandemic has drastically changed the face of world, where demand for some products have taken a leap while some will continue sitting on the shelves for a pro-longed period. People are refraining themselves from going to stores and online retailers like Amazon are reaping the benefits from this situation.

In the process of maintaining inventory, Sweet Homes is also building up too much safety stock which takes up cost and space. The lead time of the firm is remarkably high relative to industry standards, which is untenable in an E-Environment. Failure to accommodate customers request as per industry norms, means losinga large chunk of customers who do not want to wait.

Now when the firm is thinking of going digital, the scenario will be totally different. With the switch over to e-commerce, production and purchase mechanism will also have to undergo a drastic change. Just in time purchasing and production technique will put an end to the harrowing task of inventory management. In this form of pull system, purchasing of merchandise goods and production of in-house goods will be based on online customer demands and Sweet Homes will have to accordingly coordinate with its suppliers to supply the right quantity of raw materials required at the right time. JIT inventory management calls for having the inventory as and when needed also taking care of massive holding cost suffered related to large build ups. The trick is to set up plants in close proximity to chain of suppliers’ location to ensure several pick-ups each day rather than holding on to bulks. ERP and other sources of electronic data interchange between supplier and Sweet Homes will act as backbone in supporting the JIT activity. In this environment, Sweet House will also be able to reduce the lead time to deliver the ordered products from 4 weeks to around 2.5 weeks by streamlining the flow of information in entire supply chain.

For the products purchased from its suppliers, it is recommended that Sweet Homes should employ vendor managed inventory technique. Under this, rather than firm controlling the inventory management system, it is the suppliers who manage it. This is implemented by al-lowing the suppliers of the firm to access the inventory information

from all locations ie., warehouse, retail stores and distribution centers. They access the inventory data and then decide accordingly on sending/replenishing the inventories. For example, using the point of , sales technology, data from stores can flow to centralized database showing units sold and units in the stores, that can be accessed by suppliers to anticipate demand and refill requirement in each store. Similarly, to manage the inventory at warehouse, RFID (radio frequency identification) technique can be used to pick up, process and ship the order. For an inbound shipment too, this technology can easily scan the product information in seconds, leaving no room for human intervention. The access of this real time data can be allowed to vendor, to manage Sweet Homes’ inventory.

In a nutshell, the onus and cost of inventory management passes on to the suppliers, thereby underpinning the cost leadership strategy of Sweet Homes. Low cost of inventory management will consequently reduce the overall cost of inventory and thus help, in achieving set cost targets.
(iii) The supply chain management system of Sweet Homes can be designed, in the following manner:
(a) As already known, E-Commerce firms works on low inventories relative to physical stores, therefore Sweet Homes is pondering aj about changing its inventory management technique. So, it is f time for the firm to focus on building strong collaborations with suppliers so that the lead time of orders placed by Sweet Homes can be kept at minimum. Quality of the product offered by such suppliers also cannot be overlooked anymore since E-Sellers not only make speedy shipments but also guarantee hassle free returns of the delivered product if their products fail to meet the specifications given in their website. Strong tie up with suppliers will assist the firm in meeting the ever-changing demand of its customers in this technological landscape.
(b) Moreover, by implementing vendor managed inventory, as an effective SCM tool, much of the onus of inventory management for its purchased products will shift onto suppliers.
(c) For the in-house manufactured products, Sweet Homes needs to ensure that there is pool of dedicated suppliers in the country who can supply expected materials on a timely basis. Further, in the areas where there is dearth of such suppliers, it will have to arrange transportation of the finished goods. To keep the overall cost of product low, it should abide by the cost per touch inven tory system (successfully employed by the prominent furniture brand IKEA. It relies on the concept of passing the cost savings to its customers by putting up their products together in easy to assemble packaging enabling their customers themselves to select and pick up the product from the store. In a nutshell, less the products get touched in shipping and subsequent storage process less will be the overall cost of product).
Most E-Retailers maintain number of distribution centers close to their customer locations such that the outbound logistics process works in a seamless fashion and customers end up receiving their packages on the promised dates. For this to happen, Sweet Homes should be ready to make large capital investments in setting up distribution centers in the densely populated parts of Indian cities.
For the picking process of the goods in line with the order, it can make use of multifaceted robotics technology with some human participation. This technology can assist human pickers in locat-ing the required goods faster and with minimal error, thereby speeding up the entire flow.
In the marketing section of supply chain, Sweet Homes should use skillful data scientists to pull overwhelming data based on customer searches which can be analyzed to recommend products most useful to them. Further it could resort to TV advertisements, public banners and other prominent modes to propagate the digitization of its business.

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