Strategic Analysis of Operating Income – CA Final SCMPE Study Material

Strategic Analysis of Operating Income – CA Final SCMPE Study Material is designed strictly as per the latest syllabus and exam pattern.

Strategic Analysis of Operating Income – CA Final SCMPE Study Material

Part-1(Strategic Profitability Analysis)

Question 1.
(Strategic Analysis of Operating Profit)
Goyal & Sons buys T-shirts in bulk, applies its own trendsetting silk-screen designs, and then sells the T-shirts to a number of retailers, Goyal & Sons wants to be known for its trendsetting designs, and it wants every teenager to be seen in a distinctive Goyals T-shirt, The firm presents the following data for its first two years of operations, 2010 and 2011.

 2010 2011 1. Number of T-shirts purchased 2,00,000 2,50,000 2. Number of T-shirts discarded 2,000 3,300 3. Number of T-shirts sold (row 1 – row 2) 1,98,000 2,46,700 4. Average selling price $25.00$26.00 5. Average cost per T-shirt $10.00$8.50 6. Administrative capacity (number of customers) 4,000 3,750 7. Administrative costs $12,00,000$ 11,62,500 8. Administrative cost per customer (row 7 ÷ row 6) $300$ 310

Administrative costs depend on the number of customers that Goyal and Sons has created capacity to support, not on the actual number of customers served. Goyals had 3,600 customers in 2010 and 3,500 customers in 2011.
Required:
(1) Calculate Goyal & Sons operating income in both 2010 and 2011.
(2) Calculate the growth, price-recovery, and productivity components that explain the change in operating income from 2010 to 2011.
(3) Comment on your answers, what does each of these components (Growth, Price-recovery & productivity) indicate?
(1) Calculation of Operating Income:
Operating Income Statement

 2010 2011 Number of T-shirts sold 1,98,000 2,46,700 Average selling price per Shirt $25$ 26 Total Revenue ($) 49,50,000 64,14,200 Cost of T Shirts (sold + discarded) 2,00,000 @ S 10 20,00,000 2,50,000 @$ 8.50 21,25,000 Administrative costs 12,00,000 11,62,500 Total Cost ($) 32,00,000 32,87,500 Operating income ($) 17,50,000 31,26,700

Change in operating income = $31,26,700 –$ 17,50,000
= $13,76,700 (Favourable) (2) Calculation of Growth Component: The Growth Component = Revenue Effect + Cost Effect (Variable cost & Fixed Cost) Revenue Effect of Growth = [Actual units of Output sold in 2011 – Actual units of Output sold in 2010] × Selling Price in 2010 = [2,46,700 – 1,98,000] ×$ 25
= $12,17,500 (Favourable) Cost Effect of Growth for Variable Costs (i.e. Direct material costs) = [Units of input required to produce 2011 output in 2010 – Actual units of input used to produce 2010 output] × Input Price in 2010 Units of input required to produce 2011 output in 2010 = [$$\frac{2,46,700}{1,98,000}$$ × 2,00,000] = 2,49,192 shirts It has been assumed that the 2010 input-output relationship continued into 2011. Cost effect of growth for Variable cost = [2,49,192 – 2,00,000] ×$ 10
= $4,91,920 (Adverse) Cost Effect of Growth for Fixed Costs (i.e. Administrative costs) = [Actual Units of Capacity in 2010 because ad-equate capacity exists to produce 2011 output in 2010 – Actual units of capacity 2010] × Price per unit of capacity in 2010 Administrative capacity will not change since adequate capacity exists in 2010 to support year 2011 output and customers. Therefore: Cost effect of growth for Fixed cost = [4,000 – 4,000] ×$ 300 = Nil
The Net Cost Effects of Growth Component
(a) Variable cost (Direct material) = $4,91,920 U (b) Fixed Cost (Administrative costs) = 0 Cost effect of growth$ 4,91,920 U

Net increase in operating income as a result of the growth component:
Revenue effect of growth $12,17,500 F Cost effect of growth 4,91,920 U Change in operating income due to growth$ 7,25,580 F

Calculation of Price-recovery component:
Price Recovery Component = Revenue Effect + Cost Effect (Variable & Fixed)
Revenue Effect of Price Recovery = Revenue Effect of Price Recovery
= [Selling Price in 2011 – Selling Price in 2010] × Actual Units of Output sold in 2011
= [$26 –$ 25] × $2,46,700 =$ 2,46,700 (Favourable)
Cost Effect of Price Recovery for Variable Costs [Direct materials costs]
Cost Effect of = Price – Recovery for Variable Costs
= [Input Price in 2011 – Input Price in 2010] × Units of input required to produce 2011 output in 2010
= [$8.50-$ 10] × 2,49,192
= $3,73,788 (Favourable) Cost Effect of Price Recovery for Fixed Costs [Administrative costs] = Cost Effect of = Price – Recovery for Fixed Costs = [Price Per Unit of Capacity in 2011 – Price Per Unit of Capacity in 2010] × Actual Units of Capacity in 2010 because adequate capacity exists to produce 2011 output in 2010 = [$310-$300] × 4,000 =$ 40,000 (Adverse)
The Net Cost Effects of Price Recovery Component

 (a) Variable cost (Direct material) = $3,73,788 Favourable (b) Fixed Cost (Administrative costs) = 40,000 Adverse (c) Cost effect of Price Recovery =$ 3,33,788 Favourable

Net increase in operating income due to the Price Recovery component:

 Revenue effect of Price Recovery $2,46,700 F Cost effect of Price Recovery 3,33,788 F Change in operating income due to Price Recovery$ 5,80,488 F

Calculation of Productivity component:
The Productivity Component = Cost Effect only (Variable & Fixed)
Revenue Effect of Productivity
NOT Applicable
Cost Effect of Productivity for Variable Costs [Direct materials costs]
Cost Effect of Productivity for Variable Costs
= [Actual Units of input used to produce 2011 output – Units of Input required to produce 2011 output in 2010] × Input Price in 2011
= [2,50,000 – 2,49,192] × $8.50$ 6,868 (Adverse)
Cost Effect of Productivity for Fixed Costs [Administrative costs]
Cost Effect of Productivity for fixed Costs
= [Actual Units of capacity in – 2011 Actual Units of capacity in 2010 because adequate. Capacity exists to produce 2011 output in 2010 × price per unit of capacity in 2011]
= [3,750-4,000] × $310 =$ 77,500 (Favourable)
Administrative costs (3,750 – 4,000) × $310 = 77,500 F Net increase in operating income due to productivity  (a) Variable cost (Direct material) =$ 6,868 Adverse (b) Fixed Cost (Administrative costs) = 77,500 Favourable Change in operating income due to Productivity = $70,632 Favourable Analysis of change in operating income (componentwise): (3) Comment on results of components: The analysis of operating income indicates favourable change in operating income with positive changes in growth, price-recovery, and productivity components. The product differentiation adopted by the firm has proved to be beneficial to the company which has resulted in significant change in operating income. The company was able to continue to charge a premium price while growing sales. It was also able to earn additional operating income by improving its productivity. Question 2. (Strategic Analysis of Operating Profit; Reconciliation of Operating Profit) Rihana Pvt. Ltd. is a manufacturer of ecofriendly cardboard boxes. An analysis of its operating income between 2020 and 2021 shows the following: Rihana Pvt. Ltd. sold 2,00,000 boxes and 2,10,000 boxes in 2020 and 2021 respectively. During 2021 the market for ecofriendly cardboard boxes grew 3% in terms of number of units and all other changes are due to company’s differentiation strategy and productivity. Required Compute how much of the change in operating income from 2020 to 2021 is due to the industry market size factor, productivity and product differentiation and also reconcile the profit of both years due to these factors. Answer: Statement of Reconciliation of Operating Income  Particulars Amount (Rs.) Operating Income in 2020 5,40,000 Add: Change Due to Industry Market Size Factor (Working Note-1) 42,000 Changes Due to Productivity (Working Note -2) 29,000 Changes Due to Product Differentiation (Working Note -3) 1,10,000 Operating Income in 2021 7,21,000 Comment: Total Increase in Sale of Cardboard Boxes 10,000 Boxes (2,10,000 Boxes – 2,00,000 Boxes). Out of this increase in Sales of 10,000 Boxes, 6,000 Boxes (3% of 2,00,000) is due to growth in market size, and the remaining 4,000 Boxes (10,000 Boxes – 6,000 Boxes) are due to an increase in market share. Working Note 1: = Rs. 70,000 × $$\frac{6,000 \text { Boxes }}{10,000 \text { Boxes }}$$ = Rs. 42,000 (F) Working Note 2: Effect of Productivity on operating income: = Cost Effect of Productivity Component in 2021 = Rs. 29,000 (F) Working Note 3: Effect of Product Differentiation on operating income:  Particulars Amount (Rs.) Increase in the Selling Price (Revenue Effect of the Price Recovery Component) 2,10,000 (F) Increase in Prices of Inputs (Cost Effect of the Price Recovery Component) 1,28,000 (A) Growth in Market Share Due to Product Differentiation (Working Note- 4) 28,000 (F) Total 1,10,000 (F) Working Note 4: = Revenue and Cost Effect of Growth Component in 2021 × $$\frac{\text { Increase in Sales Unit Due to Product Differentiation }}{\text { Total Growth in Sales Unit (from } 2020 \text { to 2021) }}$$ = Rs. 70,000 × $$\frac{4,000 \text { Boxes }}{10,000 \text { Boxes }}$$ = Rs. 28,000 (F) Part-2(Profitability Analysis Through Activity Based Costing) Question 3. (Direct Product Profitability) Parly Pvt. Ltd. (PPL) is a confectionery company has 30 retail stores of uniform sizes ‘Sweet and Delicious Retails’ across the country. Mainly three products namely ‘Popeens Nuts’, ‘Parly Jiffs’ and ‘Sixer Icy’ are sold through these retail stores. Parle Pvt. Ltd. maintain stocks for all retail stores in a centralized warehouse. Finished products are transferred from the warehouse to the retail stores as per requisition raised by the stores. Products are carry to the stores through two types of Mini trucks i.e normal and refrigerated. These mini trucks are to be hired by the Parly Pvt. Ltd. Costs per month of PPL are as follows:  Rs. Warehouse Costs: Labour & Staff Costs 54,000 Refrigeration Costs 3,04,000 Material Handling Costs 56,000 Total 4,14,000 Head Office Cost: Salary & Wages to Head Office Staff 1,00,000 Office Administration Costs 2,54,000 Total 3,54,000 Retail Stores Costs: Labour Related Costs 66,000 Refrigeration Costs 2,18,000 Other Costs 94,000 Total 3,78,000 Average transportation cost of PPL per trip to any retail stores are as follows: Normal Mini Truck Rs. 6,400 Refrigerated Mini Truck Rs. 9,800 The directors for the purpose of decision making asked his Finance managers to calculate profitability based on three products sold through ‘Sweet & Delicious Retails’ stores rather than traditional method of calculating profitability. The following information regarding Sweet and Delicious Retail stores are gathered: Popeens Nuts and Sixer Icy are required to be kept conditions. Additional information: under refrigerated Total Volume of All Goods Sold per month – 40,000 m3 Total Volume of Refrigerated Goods Sold per month – 25,000 m3 Carrying Volume of each van – 64 m3 Required CALCULATE the Profit per unit using Direct Product Profitability (DPP) method. [May Exam 2021] Answer: Direct Product Profitability (DPP) Statement  Popeens Parly Sixer Icy Nuts Jiffs . Selling Price per unit 168.00 84.00 52.00 Less: Purchase Price per unit 152.00 68.00 44.00 (A) Gross Profit 16.00 16.00 8.00 Direct Product Costs: Warehouse Costs per m3 (WN 1) 14.91 4.125 7.46 Retail Stores Costs per m3 (WN 2) 12.72 8.00 12.72 Transportation Costs (WN 3) 153.13 100.00 153.13 Total DPP costs per m3 180.76 112.13 173.31 Items per m3 (WN 4) 12,600 4,032 2,880 (B) Cost per item 0.014 0.028 0.060 Direct Product Profit (A) – (B) 15.986 15.972 7.94 Working Note 1 Warehouse Related Costs  General Costs (Rs.) Cost Related with Refrigerated Goods (Rs.) Labour & Staff Costs 54,000 — Refrigeration Costs — 3,04,000 Material Handling Costs 56,000 __ Total 110,000 3,04,000 Volume of Goods Sold 40,000 m3 25,000 m3 Cost per m3 per month 2.75 12.16 Working Note 2 Retail Stores Related Costs Working Note 3 Transportation Costs  Normal Mini Trucks Costs Refrigerated Mini Trucks Costs Cost per trip Rs. 6,400 Rs. 9,800 Volume of Mini Truck 64 m3 64 m3 Cost per m3 per trip Rs. 100.00 Rs. 153.13 Working Note 4 No. of Items per m3 Question 4. (Direct product profitability) Aiken Supermarkets sells over 30,000 product lines. It wishes to introduce Direct Product Profitability analysis and a team of management accountants have ascertained the following information relating to the following year:  Budgeted weekly overhead$ Warehouse costs 75,000 Supermarket costs 40,000 per supermarket Transportation costs 400 per delivery

The warehouse is expected to handle 10,000 cubic meters (m3) of goods. Each supermarket will handle 5,000 m3 of goods each week. Each transportation vehicle holds 40 m3 of goods. Three products sold by Aiken are Kitchen Roll (KR), Tinned Spaghetti (TS) and Toothpaste (T):

 KR TS T Retail price per item $1.00$0.60 $1.75 Bought in price per item$0.60 $0.30$1.00 Number of items per case 10 25 40 Number of cases per m3 20 30 20 Time in warehouse 1 week 2 weeks 3 weeks Time in supermarket 2 weeks 4 weeks 2 weeks

Required:
CALCULATE the Profit per unit using Direct Product Profitability (DPP) method.
Direct Product Profitability (DPP) Statement

Working Note 1: Calculation of Warehouse Cost:
Warehouse cost $75,000 ÷ 10,000 =$7.50 per m3
Supermarket cost $40,000 ÷ 5,000 =$8.00 per m3
Transportation cost $400 ÷ 40 =$10 per m3

 KR TS T Number of items per meter Cube 10 × 20 = 200 25 × 30 = 750 40 × 20 = 800

Warehouse cost:
1 Kitchen roll ($7.50 ÷ 200) × 1 week = 0.0375 4 Tinned spaghetti ($7.50 ÷ 750) × 2 weeks = 0.02 §
Toothpaste ($7.50 ÷ 800) × 3 weeks = 0.028125 Working Note 2: Calculation of Supermarket cost: Kitchen roll ($8.00 ÷ 200) × 2 weeks = 0.08
Tinned spaghetti ($8.00 ÷ 750) × 4 weeks = 0.0427 Toothpaste ($8.00 ÷ 800) × 2 weeks = 0.02

Working Note 3: Calculation of Transportation costs:
Kitchen roll $10 per m3 (÷ 20 cases per m3) (÷ 10 items per case) = 0.05 per item Tinned spaghetti$10 per m3 (÷ 30 cases per m3) (÷ 25 items per case) = 0.0133 per item
Toothpaste $10 per m3 (÷ 20 cases per m3)(÷ 40 items per case) = 0.0125 per item Question 5. (Direct Profit profitability) Kashi Pearl Ornament company has a recognized name in city since 80’s. With rich experience in the gems and jewellery business, this brand has become a celebrated name for stunning collections, designs, following highest quality standards. It has been designing at wide range products for more than two decades and known for its perfection. Such high quality standard is achieved through years of experience and integrity that is maintain by the company. RSS has approached Kashi Pearl Ornament to make inquiry of two products ‘Sparkle’ and ‘Glimmer’. Mr Rachit the management accountant of Kashi Pearl Ornament, has estimated the variable cost per unit of the product ‘Sparkle’ and ‘Glimmer’ ad being ₹ 311.25 and ₹ 51.875 respectively. Mr Rachit has estimated his calculations considering the following information. (1) Products Data (2) Total variable overheads for Kashi Pearl Ornament are Rs. 60,00,000 out of which 30% belong to the procurement, warehousing and use of direct materials. While all other variable overheads are related to direct labour (3) Kashi Pearl Ornament presently allocate variable overheads into products units using percentage of total direct material cost and total direct labour cost. (4) RSS is willing to purchase ‘Sparkle’ at ₹ 410 per unit and ‘Glimmer’ at ₹ 90 per unit. (5) Kashi Pearl Ornament will not accept any work yielding an estimated contribution to sales ratio less than 28%. The directors of Kashi Pearl Ornament are considering switching to an activity-based costing system and recently appointed a management con-sultants firm to undertake an in-depth review of existing operations. As result of that review, the consultants concluded that estimated relevant cost drivers for material and labour related overhead costs attributable to ‘Sparkle’ and ‘Glimmer’ are as follows: Required (i) Give a financial ANALYSIS of the decision strategy which Kashi Pearl Ornament may implement about the manufacture of each product using the unit cost information available. (ii) DISCUSS whether activity-based management should be adopted in companies like Kashi Pearl Ornament, [RTF 2020] Answer: (i) Financial Analysis The calculation of product costs per unit along with the respective contribution per unit can be done either by employing an Activity Based Costing Approach or alternatively by using the existing basis for the allocation of overhead cost. The current scenario of product costing suggests that ‘Glimmer’ should be produced as per the request of RSS because the contribution to sales ratio is 42.36%. However, the current scenario of product costing also suggests that Kashi Pearl Ornament should not undertake production of ‘Sparkle’ at a selling price of ₹ 410 per unit, since the estimated contribution to sales ratio is 24.09%, which is lower than the desired contribution to sales ratio of 28%. Activity Based Costing approach uses multiple cost drivers to ensure greater accuracy and determines area that generate greatest profit or loss. Table (d) shows how much the contribution to sale (%) for each product changes when the overhead allocation method changes to activity based costing. As shown in Table, contribution to sales ratio on ‘Sparkle’ increased to 42.48% from 24.09% while contribution to sales ratio on ‘Glimmer’ reduced from 42.36 % to – 8.4%. Thus, Kashi Pearl Ornament should opt to produce ‘Sparkle’ for RSS as contribution to sales ratio is 42.42 which is higher than the desired one. (ii) Activity based management (ABM) The term is used to describe the cost management application of ABC. Activity based costing tool used to manage costs at activity level is known as Activity Based Management (ABM). In order to continuously improve the value received by customers and to improve strategic and operational decisions in an organization, ABM focusses on the efficient and effective management of activities. Kaplan and Cooper divide Activity Based Management into Operational and Strategic. Operational Activity Based Management covers the actions that increase efficiency, lower cost i.e. reduce the cost driver rate of activities and lead to higher revenue through better resources utilization. In other words, it is all about ‘doing things right’, using Activity Based Costing information to improve efficiency. It also helps in identifying and improving value added activities and removing non -value added activities as to reduce cost without distorting product value. Strategic ABM is about ‘doing the right things’. It uses Activity Based Cost information to determine which products is to be manufactured and which activities is to be used. Kashi Pearl Ornament can also use this for customer profitability analysis, identifying that which customers are the most profitable and focusing on them more. A risk with Activity Based Management is that some activities have an implicit value are not reflected in a financial value added to any product. For example, a good and pleasant working environment can attract and retain the best human resources, but might not be identified as value added activities in operational ABM. Activity Based Management provides the managers to understand cost as well it helps the team to make necessary decisions that benefits the whole 4 organizations and not just their own activities. Therefore, some companies like Kashi Pearl Ornament may adopt ABM to improve their operations and obtain useful activity information. Workings (a) Direct Material Cost per unit  Sparkle Glimmer Total Costs (Rs.) 11,25,000 3,75,000 Production units 10,000 20,000 Cost per unit (Rs.) 112.50 18.75 (b) Direct Labour Cost per unit  Sparkle Glimmer Total Costs (Rs.) 7,50,000 2,50,000 Production units 10,000 20,000 Cost per unit (Rs.) 75.00 12.50 (a) Variable Overheads Material Related  Particulars Units Required per unit Total Volume Sparkle 10,000 5 50,000 Glimmer 20,000 8 1,60,000 Other 80,000 5 4,00,000 Total Volume Factor 6,10,000 Overhead Cost = 30% × Rs. 60,00,000 = Rs. 18,00,000 Total Volume Factor Overhead per unit of volume = Rs. 18,00,000/ 6,10,000 = Rs. 2.95. Therefore, Overhead Cost per product unit will be as follows:  Sparkle 5 Rs. 2.95 14.75 Glimmer 8 Rs. 2.95 23.6 Labour Related Overhead Cost = 70% × Rs. 60,00,000 = Rs. 42,00,000 Total Operations Factor  Particulars Units Required per unit Total Volume Sparkle 10,000 7 70,000 Glimmer 20,000 6 1,20,000 Other 80,000 5 4,00,000 Total Operations Factor 5,90,000 Overhead per operation = Rs. 42,00,000/ 5,90,000 = Rs. 7.12. Therefore, Overhead Cost per product unit will be as follows:  Sparkle 7 Rs. 7.12 49.84 Glimmer 6 Rs. 7.12 42.72 (a) Product Information (by unit) is as follows: Total Variable overheads are ₹ 60,00,000, out of which 30% i.e., 18,00,000 relates to material and 70% ie., 42,00,000 relates to labour. Now allocate variable overheads into product units using % of total direct material cost and total direct labour cost. VO Material Related 40% of Material Cost ₹ (18 L /(11.25L + 3.75L + 30L)) VO Labour Related 105% of Labour Cost ₹ (42 L/(7.5L + 2.5L + 30L)) Spark and Glimmer VO Material Related ₹ 45 = 40% of ₹ 112.50 ₹ 7.5 = 40% of ₹ 18.75 VO Labour Related ₹ 78.75 = 105% of ₹ 75 ₹ 13.125 = 105% of ₹ 12.5 Question 6. (Customer Profitability Analysis) XY provides accountancy services and has three different categories of client: • limited companies • self-employed individuals • employed individuals requiring taxation advice. XY currently charges its clients a fee by adding a 20% mark-up to total costs. Currently, the costs are attributed to each client based on the hours spent on preparing accounts and providing advice. XY is considering changing to an activity based costing system. The annual costs and the causes of these costs have been analysed as follows:  Accounts preparation and advice$580,000 Requesting missing information $30,000 Issuing fee payment reminders$15,000 Holding client meetings $60,000 Travelling to clients$40,000

The following details relate to three of XY’s clients and to XY as a whole:

Required:
CALCULATE the effect on fees charged to each of these three clients of changing to the new costing system.
Client Cost:

Accounts preparation and advice $580,000/18,000 hours =$32,222 per hour
Requesting missing information $30,000/250 times =$120 per request
Issuing fee payment reminders $15,0000/400 times =$37.50 per reminder
Holding client meetings $60,000/250 meetings =$240 per meeting
Travelling to clients $40,000/$10,000 = $4 per mile (*)$725,000/18,000 hours = $40.28 per hour (W1) Client fees calculations, new basis Client A: Total costs$ 34,337 × (1 + 20% mark-up on costs) = $41,204 Client B: Total costs$ 12,195 × (1 + 20% mark-up on costs) = $14,634 Client C: Total costs$ 12,530 × (1 + 20% mark-up on costs) = $15,036 Question 7. (Customer Profitability Analysis) Bhula Associates is an organic tea grower having acres of farm land. For organic tea farming they recommends to their organization the ‘ 1 hectare and 1 cow’ formula, which means that the fertiliser made from cow urine and dung is sufficient to grow in one hectare of land. Bhula Associates supplies their tea leaves to two customers Packy and Munch. Selling price of Tea leaves to each customer is of ₹60 per kg. It costs ₹25 per kg to grow a tea leaves and get it to the point of sale. Additional costs incurred by the farm are ₹100 per order fulfilled and delivery costs of ₹ 500 per order delivered. Details of two of the farm’s customers (Packy and Munch) for the previous period are as follows:  Customer “Packy” Customer “Munch” Tea Leaves purchased 960 kg 650 kg Discount allowed 15% 20% Orders fulfilled 8 (each for 120 Kg Tea Leaves) 10 (each for less than 100 Kg Tea Leaves) Deliveries made 8 0 Customers are given a 15% discount on orders for 100 kg Tea Leaves or more. Customer ‘Munch’ is given a 20% discount for collecting the Tea Leaves using its own transport. Required: CALCULATE and ANALYSE the Customer Profitability for each of the two customer “Packy” and “Munch”. Answer:  Packy (₹) Munch (₹) Gross Revenue 57,600 39.000 Discounts allowed 8,640 7,800 Net Revenue 48,960 31,200 Cost of Tea Leaves 24,000 16,250 Delivery costs 4,000 0 Order processing 800 1,000 Net profit 20,160 13,950 Tea Leaves sold 960Kg 650Kg Profit per Kg of Tea Leaves sold ₹21 ₹21.46 Number of orders 8 10 Profit per order ₹2,520 ₹1,395 Profit per ₹ 1 gross revenue ₹0.35 ₹0.36 Comments: The difference between the profit per ₹ of gross revenue from customers: Packy and Munch is very little. Despite the large discount given to Munch for using their own transport, the customer Packy earns lower profit per Kg of Tea Leaves The discount for using own transportation offered to Customer Munch seems generous. The discount costs the farm ₹ 7,800 in lost revenue but only saves (based on the order frequency shown) 5,000 in delivery costs. Why has this discount been given? Might be the transport being used to full capacity and it is not possible to make the sale unless the customer collects the Tea Leaves themselves or might be Munch situated at a large distance away from the farm. The analysis shows that Packy earns the higher absolute profit for the farm because of the higher number of Tea Leaves purchased. However Munch earns the highest profit per kg of Tea Leaves. The analysis could be used by the Bhulla associates farm to assess the impact of the discounts it offers to the customers. For example, analysing the impact on delivery schedules and costs of reducing the discount offered on orders for more than 100 Kg of Tea Leaves. It is noticeable that the farm is happy to earn a profit margin of 35% and to offer incentives to achieve that margin. Question 8. (Customer Profitability Analysis) YUM is a Dry Fruits distribution company which buys dry fruits and nuts in bulk from manufacturers, repackages the product into smaller packs and then sells the packs to retail customers through online and retail stores. All food products are heavily regulated by the FDA, not to mention state and local agencies. The demand for healthy and protein packed nuts and vitamin rich dry fruits continue to rise. In the growing competition, YUM’s creative packaging design for nuts and dry fruits with unique concepts to stand among all. The size of YUM’s customers vary and consequently the size of their order’s also varies. Some of the customer order large quantities, each time they place an order while some of them order only a few packs each time. YUM provide a wide range of cheapest best quality dry fruits to them. YUM is unaware of the costs of servicing individual customers since the current accounting system of YUM produces very basic management information system that reports only the overall company’s profit. It is difficult for YUM to identify the costs of servicing individual customers. However one of the director of the company advices the company in board meeting to use the Direct Customer Profitability Analysis (DCPA). YUM would like to see the results from a small sample of customers before it decides whether to fully introduce Direct Customer Profitability Analysis. The company has consider the information of its two customers, for the previous period was as follows:  Activity costs:$000s Safes visits to customers 100 Processing orders placed by customers 140 Normal deliveries to customers 240 Urgent deliveries to customers 120

Required
(a) CALCULATE Direct Customer Profitability for customers.
(b) Explain how YUM could use Direct Customer Profitability Analysis to increase its profits.
(a)

 B $000 D$000 Costs Sales visits 12 6 Orders processing 15 4 Normal deliveries 45 15 Urgent deliveries 20 0 Total costs 92 25 Factory contribution 150 81 Profit 58 56

Working Notes:

 Activity Cost driver rate Working Sales visits 8500 visit $100,000, 200 Order processing$200/order $140,000/700 Normal delivery$l,000/delivery $240,000/240 Urgent deliveries$4,000/urgent delivery $120,000/30 (b) YUM could improve its profitability by: • reflecting the additional costs caused by customer behaviour in the prices it charges; or • by changing the behaviour of its customers, particularly in relation to urgent deliveries; or • by considering how it could change its operations to reduce the costs of these activities Question 9. (Customer Profitability Analysis) XYZ Pvt. Ltd. is engage in a business of travel and tourism through Luxury Maharaja Train, They provide separate trips for women’s considering the safety of women’s who wants to travel alone, it has two divisions Women Passenger division and Other Passenger division, organized as profit centers. The following divisional information were given for the year ended 31st March 2021: The service department charge rate for the service department costs was based on revenue. Since the revenue of both the divisions were the same, the service department charges to each division were also the same. Required (i) COMMENT on whether the income from operations for the two divisions accurately measures performance. (ii) PREPARE the divisional income statement using the activity bases provided above in revising the service department charges. Answer: (i) Reported income from operations for the two division does not accurately measure performance because the service department charges are based on revenue. Revenue is not associated with the profit center 1 manager’s use of the service department services. For e.g., the Reservations Department serves only the Other Passenger Division and number of reservation requested by Women’s passenger Division is NIL. Thus, by charging this cost based on revenue, these costs are incorrectly charged to the Women’s Passengers Division. Further, the Other Passenger Division requires additional personnel. Since these other personnel must be trained, the training costs assigned to the other Passenger Division should be greater than the Women’s passenger Division. (ii) XYZ Pvt. Ltd. Divisional Income Statement For the Year Ended March 31, 2021 Working Note 1: Calculation of Training Charges  Women’s Passenger Division (Rs.) Other Passenger Division (Rs.) Training Cost $$\frac{200}{1000}$$ × 320,000 = 64,000 $$\frac{800}{1000}$$ × 320,000 = 256,000 Working Note 2: Calculation of Flight Scheduling Charges  Women’s Passenger Division (Rs.) Other Passenger Division (Rs.) Trip Scheduling $$\frac{360}{600}$$ × 150,000 = 87,500 600 $$\frac{250}{600}$$ × 150,000 = 62,500 Working Note 2: Calculation of Reservation Charges  Women’s Passenger Division (Rs.) Other Passenger Division (Rs.) Reservation Nil $$\frac{700}{700}$$ × 105,000 = 105,000 Question 10. (Customer Profitability Analysis) Crale & Co manufactures replacement batteries for smartphones. The battery retails for$40 and costs $10 to make. Crale & Co currently sells 1 million batteries every year through its e-commerce website, and 1 million batteries a year via its network of retail distributors across the country. Overheads incurred to recruit and retain website administrators amount to$800,000 yearly, and other employee costs amount to $310,000 for the e-commerce channel. Via its retail distribution network, the company must also offer a$1.50,
discount per unit to distributors; also, the administrative cost of processing retail orders amounts to $620,000, Required: (i) Which of the two channels is more profitable for Crale & Co.? (ii) In light of the following further analysis, which of the two channels is now more profitable? Further analysis of Crale & Co.’s financial data reveals that: • 2% of the batteries sold via the website go unpaid every year, due to payment fraud; • Packaging and distribution costs linked to the website operation have been calculated at$0.80 per battery.
• Furthermore, 50% of the batteries ordered on the website qualify for free shipping due to web promotional vouchers. Batteries which qualify for this free shipping incur an additional cost of $1.20 per battery to process the vouchers and ship to customers (not including the$0.80 packaging and distribution costs mentioned above).

The cost of shipping inventory in bulk to distributors is $1 per unit Answer: (i) The website is without question the more profitable channel, offering an extra$1.01 in margin per battery

 Website (e-commerce) Retail distribution Retail price $40$40 Direct costs ($10) ($10) Contribution per unit $30$30 unit sales 1,000,000 1,000,000 Total contribution $30,000,000$30,000,000 Website administration overheads ($800,000) Other employee overheads ($310,000) Cost of discounts to distributors $1.50 per battery ($1,500,000) Admin cost of processing retail orders ($620,000) Net profit$28,890,000 $27,880,000 Net profit per unit$28.89 $27.88 (ii) When all channel-related costs are taken into account, the retail distri- g bution channel becomes more profitable than the e-commerce channel. The 5 management decisions that will be made as a result of this more thorough . analysis will be far different.  Website (e-commerce) Retail distri­bution Total net profit as in (a)$28,890,000 $27,880,000 Bad debts (Payment fraud) (Wl) ($800,000) Cost of free shipping (W2) ($600,000) Packaging and distribution costs ($800,000) Cost of shipping inventory in bulk (W3) ($1,000,000) Net profit$26,690,000 $26,880,000 Net profit per unit$26.69 $26.88 Workings: (W1) Payment fraud applies to 2% × 1,000,000 = 20,000 batteries 20,000 ×$40 revenue per battery = total non-payment $800,000 (W2) Free shipping applies to 50% × 1,000,000 = 500,000 batteries 500,000 ×$1.20 cost per battery = $600,000 (W3) Cost of shipping inventory in bulk applies to all batteries for retail 1,000,000 batteries ×$1 per battery = \$1,000,000 shipping cost.

Question 11.
(Customer Profitability Analysis)
Banjara Is a firm engage in business of homemade raft items. The firm as recently Introduce a new article ‘dom bell’, that have been sold three distributors Bell, Rang and Wang The firm’s financials reflect profit in the first year of operations. The management is pleased with the results. However, they are now interested with th e profitability of each customer in order to formulate their sales strategy.

In order to get market share, Bell and Wang have been extended credit terms to avail discount if payment is made within 10 days. Customer Rang does not have much bargaining power and hence has been allowed only 30 days’ credit period without any benefit of availing discount for g early payment. Both Bell and Wang have made payments within 10 days to avail of the discount extended.
On the cost front, variable cost of goods sold attributable to the net sales | to customers Bel!, Rang and Wang are Rs. 1,50,000, Rs. 1,42,500. and Rs. 1,87,500 respectively. Key metrics of customer assignable marketing, administrative and distribution costs are as below:

Assume no opening and closing stock
Fixed cost that are not assignable to any customer is Rs. 1,00,000 p.a.
Required
(i) PREPARE the customer wise profitability statement as also the overall profitability statement of Banjara LLP.
(ii) RECOMMEND a strategy for Banjara LLP regarding its customers. (20 Marks) [RTF May 2018]
(i) Customer’s Profitability Statement

Working Note 1:

Working Note 2:
Assignable Marketing, Administrative and Distribution Costs

(ii) Strategy for Banjara LLP regarding its customers
It can be seen that Banjara LLP has an overall profit of Rs. 112,600 or 15% of sales. While the performance is good, the firm’s management has I to analyze customer wise profitability.
a. Wang is the largest customer in terms of units sold. However, Working Note 1 above shows that sale returns at 10%, which is unusually large compared to other customers. Banjara LLP has to investigate why the returns are of such large quantity. Possibly, there could be communication gap between the firm and Wang. Possible non-con-formity in goods delivered has resulted in returns. Only 87% of the original sale value is being collected. The root cause of the problem has to be identified and rectified. This will also reduce the sale return processing costs.

b. Wang has placed 15 orders for 1,250 units. Comparatively, Bell and [ Rang placed 4 and 2 orders for approximately 1,000 units each. Wang can be requested to place fewer orders with larger quantity per order, in order to optimize ordering cost.

c. Wang has placed many rush orders, which requires Banjara LLP to ship these orders immediately, using costlier means of transportation. Currently, there is no charge for shipping rush orders. In order to deter Wang from repeatedly placing rush orders, Banjara LLP can charge the customer for shipping such orders beyond a threshold number of orders. Say rush orders beyond 2 orders will be charged to the customer.

d. Being the largest customer, Wang has 5 sale visits from Banjara LLP, which is more than the other 2 customers. Priced at Rs 800 per visit, this very costly. At the same time, Wang is yielding the least profit. Therefore, Banjara LLP should reassess if resources can be reallocated to the other two more profitable customers. That may encourage more sales from higher yielding customers.

e. Since Wang seems to need more hand-holding in terms of more sales visits as well as higher rush orders, Banjara LLP may assess p if it wants to discontinue or reduce business. Alternatively, it may reassign these resources towards existing or newer customers to get better profitability. However, if Wang can be migrated to a higher profitability, Banjara LLP need not lose out its market share.

f. Customer Rang is the most profitable yielding 34b return over sales, although in terms of ‘ Door bell’ ordered, it is the smallest of the three. Banjara LLP can assess if it can extend some discount, in order to encourage more sales. Currently, Customer Rang does not get any discount.

Banjara LLP can assign more sales visits to Customer Bell and Rang to encourage them purchase more as well as provide high quality customer service.

Question 12.
(Customer Profitability Analysis)
Ac and Bb are two customers of Maya Electronics Ltd., a manufacturer of audio players. Selling price per unit is Rs. 54,000. Its cost of production per unit is Rs. 44,200.

 Order Processing Cost Rs. 20,000 per order Delivery Costs Rs. 35,000 per delivery

Details of customers Ac and Bb for the period are given below:

 Customer Ac Customer Bb Audio Players purchased (Nos.) 350 500 | No. of orders 5 (each of 70 units) 10 (each of 50 units) 1 No. of deliveries 5 0

The company’s policy is to give a discount of 5% on the selling price on orders for 50 units or more, and to further give 8% discount on the un-discounted selling price if a customer uses his own transport of collect the order. Assume that production levels are not altered by these orders.
Required
(i) ANALYSE the profitability by comparing profit per unit for each customer. (6 Marks)
(ii) COMMENT on the discount policy on delivery. (4 Marks) [MTP Aug. 2018]
(i) Customer’s Profitability Statement

Analysis
It is observed that even though Ac has lower sales volume (3096 lesser from Bb), it is contributing almost double profit that is being contributed by Bb as overall discount offered to customer Ac is quite less.

(ii) Comments on the “Discount Policy on Delivery”
The amount of discount on delivery offered to customer Bb is ₹ 4320 per unit. If transport for delivery is provided to customer Bb then the cost would have been ₹ 700 per wm7 (10 deliveries × ₹ 35,000/ 500 units), which is lesser by ₹ 3620. It may also be noted that delivery cost in case of customer Ac is only ₹ 500 per unit (₹ 1,75,000 ÷ 350 units). Hence, company needs to review discount policy on delivery but significance of profitability of customer Bb should also be kept in mind while doing so.

Question 13.
(Customer Profitability Analysis)
SNAIL Limited has decided to analyse the profitability of its four retail customers. It buys product ‘Tupper’ at ₹ 2180 per case and sells to them at list price less discount. The data pertaining to four customers are:

It’s four activities and cost drivers are:

 Activity Cost Driver Rate Sale visits ₹ 7,500 per sale unit Order taking ₹ 8,000 per purchase order Deliveries ₹ 105.0 per delivery km travelled Product handling cost ₹ 25.0 per case sold

Required
(i) COMPUTE the customer level operating income.
(ii) ANALYZE the profitability for each customer. [RTP Nov. 2018]
(i) Customer’s Profitability Statement

(ii) If we first consider the sale volume of cases, customer Cc is the biggest customer alone accounting for 56% of total sales volume, followed by customer Bb (27%), customer Dd (11%) and customer Aa (6%). However, in terms of profit per customer, Customer Bb is the most profitable accounting for 39.72% of the cumulative customer profits of ₹ 1,42,82,350. Customer Cc contributes to 38.10% of the same. Comparing customers Bb and Cc, customer Bb is more profitable despite accounting for sales volume that is less than half of customer Bb (customer Cc’s 56% of sale volume versus customer B’s 27%). The primary reason for this is because the discount given to customer Cc (8.8%) is higher than that given to customer Bb (5.6%). The difference is terms of sale could be due to the fact that customer Cc is the biggest customer and hence is able to negotiate for a higher discount. Consequently, for each case sold, customer Cc gets an additional discount of ₹ 80 as compared to customer Bb, this value is reflected in contribution generated per case.

Sale of one case to customer Cc generates ₹ 100 contribution versus sale of one case to customer Bb generates ₹ 180 contribution. This has a huge impact on profitability. In terms of profit generated per case sold, customer Cc has the lowest contribution at ₹ 69.3 per case. The organisation may review whether this difference in terms of sale to each of its customers is justified. If the discount to customer Cc at 8.8% was initially extended to promote sales, negotiations can be made ® to reduce this to mutually acceptable rates. However, care must be taken not to lose customer Cc to competitors.

Customer Dd is the least profitable accounting for just 10.37% of the total customer profits. In terms of sale volume, the customer ranks third providing 11% volume. However, the customer is not profitable because of the following reasons:

a. A discount rate of 7.2% is provided to the customer. Each case sold after a discount of ₹ 180 per case, generates a contribution per case of only ₹ 140 per case. This is much lower compared to the contribution per case of customer A (₹ 270 per case) and customer Bb (₹ 180 per case). This discount policy may need to be reviewed. One scenario where such a high discount may be justified would be where customer Dd supplies the products that it manufactures at a discounted rate to a sister concern of the company. Therefore, at a parent company/ overall level, the higher discount rate for a low volume customer Dd may be justified.

b. For a customer that provides 11% of volume, the number of site visits during the year were 10. Customer Cc giving 56% of volume had only 16 visits and customer B giving 27% of volume had only 12 visits. This indicates that customer Dd, although a smaller customer, requires more visits than regular customers. Therefore, site visit costs are higher for this customer. The reason for a higher handholding by the company for this customer has to be analyzed. For example, one possible reason could be that customer Dd requires the cases customized to its production requirement. This may require more site visits by the company’s personnel. To resolve this, due to the extra work involved, the company may wish to charge a higher sale price for the cases customized for customer Dd. On the other hand considering other scenario, it may choose to charge the customer a fixed rate for each site visit

c. For a customer that provides 1196 of volume, the number of orders placed in a year are 24. Customer Cc giving 56% of volume placed 35 orders in a year and customer B giving 27% of volume placed 18 orders in a year. This indicates that customer Dd, although a small customer, I places orders more frequently than other larger customers. Therefore, order processing costs are higher for customer Dd. The company may revise ordering schedule for this customer or find out the reason for higher proportion of purchase orders, in order to pass on some of the cost to the customer. For example, let us say, customer Dd has an agreement with the company to provide cases “just in time” resulting in more frequent orders as compared to other customers. Therefore, the company is providing flexibility in procurement to customer Dd. For this convenience, it may pass on some of the ordering cost to customer Dd by way of a higher selling price or a lower discount.

d. Again, given the volume, the number of deliveries to customer Dd (400) is at a higher proportion compared to the larger customers Cc (450) and Bb (350). The company may revise delivery schedule for this customer or find out the reason for higher proportion of deliveries, in order to pass on some of the cost to the customer. For example, let us say, customer Dd has an agreement with the company to provide j cases “just in time” resulting in more frequent deliveries as compared to other customers. Therefore, the company is providing flexibility in j procurement to customer Dd. For this convenience, it may pass on some of the delivery cost to customer Dd by way of a higher selling price or a lower discount.

Customer Aa is the smallest customer providing only 6% of total sale volume. However, with a contribution per case at ₹ 270 per case and a profit per case at ₹ 222.5 per case, it is the most profitable of all customers. The primary reason for this is the discount of 2% offered is much lower than other customers. Each case sold to customer Aa yields a Contribution of ₹ 270 as compared to a contribution of ₹ 100 from customer Cc, the biggest customer. Possible reason for a lower discount maybe customer Aa, being a smaller player, may have lesser bargaining power compared to other customers. If the company wishes to have a longer business relationship with customer Aa, it may wish to provide more favourable discount terms to this party. However, since customers Bb and Cc are much larger customers, any benefit passed onto customer Aa should not impact the company adversely in the long run. For example, in order get more orders from customer Aa, the company gives a 1096 discount to the party.

Consequently, the profitability of customer A will decrease. Let us say customer Aa places huge orders due to which there are capacity constraints within the company. Sales to customers Bb and Cc, the current larger customers, may be impacted. This could affect the company adversely in terms of lost sales to customers Bb and Cc and loss of business relationships with these parties. Therefore, careful consideration should be given before extending discounts to improve sales from customer Aa.

As regards product handling cost, each customer is currently charged ₹ 25.0 per case sold. The company, if feasible, apply Activity Based Costing technique to find out if this can be allocated based on the cost driver for each customer. Let us say, packing cost before shipment is part of product handling cost. If customer Bb requires special packing to ship the goods, then customer Bb needs to be allocated a higher packaging cost as compared to the others. This cost can be recouped from customer Bb through a higher selling price.

Question 14.
(Customer profitability Analysis)
Bio-Intuitive Ltd is a hearing aid manufacturing company distributing its products through Wholesalers and retailers. The organisation is following Activity Based Costing system. Average cost per hearing aid is ₹ 600 and listing price is ₹ 1,000. But it is sold at a discount of 25% listed price on order for above 200 units, and at a discount of 20% on order for 200 or less. The organization wants to analyse the profitability of two of its wholesaler customers Aa and Bb and two of its retail customers Xx and Yy on the basis of the business with them during last year. This is to explore the opportunities to increase the profitability from the customers. The appropriate data for the last year are given below:

The activity, cost driver and the rate are as follows:

 Activity Cost Driver Cost per unit of Driver (₹) Order processing No. of purchase orders 1,300 Visiting customers No. of customers visited 7,400 Ordinary delivery No. of ordinary deliveries 2,000 Speed delivery No. of speed deliveries 6,000

Required
(i) EVALUATE the customer profitability by calculating the profit per hearing aid from each customer.
(ii) RECOMMEND steps to be taken to improve profitability from less profitable customers.
(iii) LIST down the service organizations for which customer profitability analysis is useful.
(iv) EXPLAIN the specific benefits of customer profitability analysis. [Nov. 2018] (12 + 4 + 2 + 2 Marks)
(i) Statement Showing Profit per Customer per unit

Working Note 1:
Customer Sales Analysis – Net Sale Proceeds and Cost of Sales

Working Note 2:
The Company has a policy of providing discount of 25% on listed price on orders above 200 units and 20% on orders less than 200 units. Each order of customers Aa and Bb is for more than 200 units while each order of Xx & Yy is for less than 200 units. Therefore, Aa and Bb get a discount of 25% and Xx and Yy get a discount of 20° on the listed price per order.

Working Note 3:
ABC Technique to allocate assignable marketing, administrative and distribution cost

Evaluation of the Customer Profitability
As per the calculation done above, it can be concluded that the average I profit per hearing Aid sold is ₹ 114.12. Sales to all the concerned customers are profitable. However, it can be observed that, sales to customers Aa and Bb, who are wholesale buyers, yield above average profit per hearing Aid ₹ 139.64 and ₹ 130.23 respectively. While sales to customers Xx and Yy, who are retail buyers, yield below average profit per hearing Aid ₹ 76.74 and ₹ 39.04 respectively. Therefore, it can be concluded that sales to wholesale buyers are more profitable than sales to retail buyers. In terms of units of hearing Aid sold, sales to Aa and Bb account for nearly 72% of the sales (Customer Aa 25,000 units, Customer Bb 19,500 units from total sales of 61,800 units). Therefore, Bio Intuitive Ltd. seems to have a profitable business. However, analysis to improve the profitability from sales to retail customers like customers Xx and Yy, would enable Bio Intuitive to improve its overall bottom-line.

(ii) Recommendation
Steps to be taken to improve profitability from less profitable customers
For improving the customer profitability of retail customers Xx and Yy steps to be follow; Referring to Working Note 1, a major portion of the
assignable marketing, administration and distribution cost can be traced to customers Xx and Yy. Breaking this down into various cost heads:

a. Order Processing Costs: A total 615 purchase orders relating to sale of 61,800 hearing Aid have been raised by the four customers. Customer Xx has raised 3796 of the orders to buy 9,200 (1596) hearing, Customer Yy has raised 4496 of the orders to buy (1396) of the hearing Aid, while the balance 1996 to buy 7296 of the hearing Aid have been raised by Customers Aa and Bb. Therefore, the retail customers Xx and Yy are raising proportionally far more purchase orders as compared to wholesale customers. To process these orders, Bio Intuitive has to incur order processing charges on a higher scale. While the nature of sale to retail customers may entail sales in much smaller lots as compared to wholesale customers, Bio Intuitive Ltd. may require retail customers to place a threshold of minimum order quantity to be ordered in each purchase order. Fewer orders with larger quantity will reduce resources that would be needed for order processing, which will contribute towards lowering the processing cost for Bio Intuitive Ltd.

b. Customer Visit Costs: These are marketing costs incurred by the organization for providing support by understanding customer’s needs and sorting operational issues. A total 72 visits relating to the four customers show that majority of visits have been made to customers Xx (25 visits) and Yy (22 visits). However, sales to these customers account only for 28% of the hearing Aids sold (Customer Xx 9,200 units Customer Yy 8,100 of a total of 61,800 units sold). These retail customers are in need of a lot of hand-holding from the company. Bio Intuitive Ltd. needs to understand the reasons for so many visits to these two customers. Despite having so many visits, the sales are not as much as the wholesale customers. Therefore, Bio Intuitive has to analyze why so many visits are required to be made? This may suggest any improvements that can be made to business operations that can provide the required level of customer support, without so many customer visits. If this can be understood and implemented, resources required for customer visits would reduce, thereby reducing these costs.

c. Ordinary Deliveries: Out of a total of 470 deliveries to the four customers, Customer Xx has 175 deliveries and Customer Yy has 200 deliveries. Again, as explained above in point (a), retail customer orders lesser quantity as compared to wholesale customers. Therefore, the number of deliveries will be more. However, if Bio intuitive Ltd needs customers to order a minimum quantity each time, this can reduce the number of deliveries. This would reduce the resources needed for making deliveries, thereby reducing the costs as well.

d Speed Deliveries: Speed Deliveries are rush orders placed by the customers to meet their urgent requirements. Since demand is required to be met in a short time span, Bio Intuitive may have to employ faster means of delivery. In the given problem, the cost of speed delivery is thrice the cost of an ordinary delivery. Out of a total of 135 deliveries, Customer Xx has 50 and Customer Yy has 65 speed deliveries. At the same time, they account for only 28% of hearing Aid sales. Bio Intuitive Ltd. Can need these customers to place an amount of minimum order as part of their regular orders, which could reduce the requirement for speed deliveries. And which could also make speed deliveries chargeable, if the number of such orders exceed a certain threshold say 10 orders in a year. This will enable Bio Intuitive Ltd. to recover some portion of the costs that it incurs to for these deliveries.

(iii) List of organizations in services using customer profitability analysis
a. Financial institutions like Banks and Insurance Companies.
b. Hospitality services like Hotels, Tour Operators and Travel Agents.
c. Professional services like Law firms, Audit and Accounting Firms, Consultancy Firms like Management Consultancy, IT Consultancy.
d. Hospitals and Healthcare providers.
e. Companies in Logistics and Freight, that transport goods to various destinations.

(iv) Benefits of Customer Profitability Analysis
a. It helps the supplier to identify the customers which erode the overall profitability and the customers which contributes to profitability.
b. It can help to provide a basis for constructive dialogue between buyer and seller to enhance margins.

Question 15.
(Customer Profitability Analysis & Customer Relationship Analysis) ,
Camel Stationary Depo (CSD) is located in centre of city “X” and popular for wide range of stati(?nary products at competitive rate. Box files and cobra files are am^ng the major product of CSD. CSD clients majorly, include medium and large corporate offices apart from reasonable base of retail clients. Mr. Amit who done his masters in operations and marketing, recently join the family business (CSD). Mr. Amit during first week itself, identify there are regular complaints from corporate clients regarding ‘delivery of items, which are different from what is ordered’ and ‘for not meeting the requirements’. Mr, Amit understands consumer behavior is very’critical in nature, if understood well and used through-out the business operation; then can be key success factors. Hence with intent to establishing the integrated relations with customers at CSD, Mr. Amit advise marketing team to start recording the date regarding customer in systemic mariner and reporting of same.
Following is information regarding five major customers, who are regularly orders printed cobra files (Product code – J-Cobra 10) from CSD.

Cost of processing the order is INRs 2.000 per order and cost of handling material is INR 0.15 per item, whereas transport cost is 3 per kilometer for delivery of goods. 3 rushed deliveries made to ‘B\ cost for rush delivery is INRs 800 per delivery.
Required
(i) ANALYZE customer profitability for CSD.
(ii) EXPLAIN three fundamental aspects of CRM to facilitate building relationship with profitable customer/(s). [RTP Nov. 2020]
(i) Customer Profitability Statement

Analysis
From above customer profitability statement, it can be concluded that customer A, C, and D are less profitable than customer E; whereas customer B is causing losses. Customer B provides a positive operating margin but is unprofitable when customer attributable costs are considered. This is because customer B requires more sales orders than the other customers. In addition, the customer has rush delivery costs.

This analysis can make sense, if interpreted, considering the ‘Pareto Analysis’.
1 Pareto Analysis named after economist Vilfredo Pareto, who specifies that 80°o of consequences come from 20°o of the causes i.e. 20°o of customer provide 80Qo of the profit. Means input and output may not be balanced. (Curve of revenue, as shown in figure; represent that initially large amount of revenue comes from small portion of sales/customers only – such small proportion of customers is critical to success of entity).

Although here proportion of 80:20 don’t hold truth, but for CSD; major portion of profit (around 6096) coming from customer E only, therefore, customer E is critical to CSD. Special attention can then be given to enhancing the relationships with the customer E to ensure that customer E cannot migrate to other competitors. In addition, greater emphasis can be given to attract new customers that have the same attributes as the most profitable customer E.

Further, there is no point in serving customer B, but instead of refusing to trade with customer B, if possible; it may be better to turn it into profitable customer. Customer B can be made profitable if action is taken to convince the customer B to place a smaller number of larger quantity orders and avoid rush deliveries. If customer B cannot be convinced to change its buying behaviour, selling prices should be increased to cover the extra resources consumed.

(ii) Supply chain management is the technique to integrate the supplier, manufacturing, store, and distribution function efficiently; in order to procure, produce and distribute at/in right time, quantity and place re-spectively. For effective distribution, CRM can be enabling tool. CRM is an integrated approach to manage and coordinate customer interactions to identifying, acquiring, and retaining customers. CRM enables businesses to understand and retain customers (through better customer experience) apart from attracting new customer, in order to increase profitably and decrease customer management costs. CRM system, comprises following three fundamental aspects to facilitate building relationship with profitable customers –

• Operative CRM takes care of individual transactions and is used by operational team. Interactions by customers are kept in the data base and are used later by the service, sales, and marketing team for operational decisions. In CSD, the staff who is responsible to deal with customer must be given access to customer’s details including all the information of activities performed earlier. This will enhance the CSDs’ staff’s efficiency to deal with customer-facing processes in a better way.
• Analytical CRM analyses the data created on the operational side of the CRM effort for evaluation and prediction of customer behaviour. In CSD, analytical CRM can highlight the patterns in customers’ behaviour which will help sale team while pitching the product at CSD.
• Collaborative CRMensures that information about customer must flow seamlessly throughout the supply chain, majorly distribution channel; in form of collaborative effort by all associated department of CSD to increase the quality of services provided to customers. Increase in utility at customer end will result in increased loyalty. Collaborative CRM comprises interactive technology like email, digital meek: t.c simplify the communications between customers and start wilier would help in building relationships

Question 16.
(Activity Based Budgeting)
Chipotle-R is an Indian – Japanese international chain of convenience stores for food, snacks, hot and cold beverages is formulating its activity based budget for January 2021. Chipotle-R has only three product types; Apple Drinks, Mango Drinks, and Ready to Eat Food. The budgeted data relating to three products are as under:

Chipotle-R has a continuous improvement system to budgeting monthly activity costs for each month of 2021. February’s budgeted cost-driver rate is 0.996 times the budgeted January 2021 rate. March’s budgeted cost-driver rate is 0.996 times the budgeted February 2021 rate and so on. Required
(i) COMPUTE total budgeted cost for each activity in January 2021.
(ii) DISCUSS advantages might Chipotle-R gain by using an activity-based budgeting approach over, say, an approach that allocates the cost of these activities to products as a percentage of the cost of goods sold.
(iii) COMPUTE total budgeted cost for each activity in March 2021 if March 2021 has the same budgeted amount of cost-driver usage as January 2021.
(iv) STATE benefits of Chipotle-R adopting a kaizen budgeting approach. IDENTIFY limitations? ’
(i) Total Budgeted Cost for Each Activity in January 2021

(ii) How different products require different mixes of support activities is identified by an Activity Based Budgeting approach.
The relative percentage of how each product area uses the cost driver at each activity area is:

By identifying these differences, Chipotle-R managers are better able to budget for different unit sales levels and different mixes of individual product-line items sold. Using a single cost driver such as ‘Cost of Goods Sold’ considers similarity in the use of indirect costs (support activities) across product lines which does not occur at Chipotle-R.
Other benefits cited by managers include:
(1) Better identification of resource needs.
(2) Clearer relating costs with staff responsibilities, and
(3) Identification of budgetary slack.

(iii) Calculation of the total budgeted, cost for each activity area in March 2021 (Using WN1).

Working Note 1:
March 2021 Rates

(iv) kaizen budgeting approach shows the management’s commitment to organized cost reduction and continuous improvement. Compare the budgeted costs from previous part.

The kaizen budget figures will show unfavourable variances for managers whose activities do not the expected monthly cost reductions. This likely will put more pressure on managers to creatively seek out cost reductions by working ‘better’ within Chipotle-R.

As illustrated one of the limitation of kaizen budgeting is that it considers minor incremental improvements each month. It is possible that some cost improvements arise from irregular fluctuations in operating processes, supplier networks, or customer interactions. Organizations require to high-light the importance of finding these improvements as well as the minor incremental improvements

Question 17.
(Manufacturing Cycle Efficiency)
Roxmet is world famous printer machine manufacturing company, pro-duces high quality printers since 1906. The company has recently faced stiff competition due to technological improvement specially after COVID 19. In order to deal with the present situation, the management is now emphasizing more on creativity, engineering, innovation and experience to provide the customers high quality technology experience through their product. The following information pertains to operations during April month.
Processing time 9.0 hrs*
Inspection time 1.5 hrs*
Waiting time 5.5 hrs.*
Move time 7.5 hrs.*
Units per batch 60 units
(*) average time per batch Required
COMPUTE the following operational measures:
(i) Average non-value-added time per batch
(ii) Average value added time per batch
(iii) Manufacturing cycle efficiency
(iv) Manufacturing cycle time
(i) Average Non-Value Added Time per batch
= Inspection Time + Waiting Time + Move Time
= 1.5 hr. + 5.5 hrs. + 7.5 hrs. = 14.5 hrs.

(ii) Average Value Added Time per batch
= Processing Time = 9 hrs.

(iii) Manufacturing Cycle Efficiency
= $$\frac{\text { Processing Time }}{\text { Processing time }+ \text { Inspection Time }+ \text { Waiting Time }+ \text { Move Time }}$$
= $$\frac{9.0 \text { Hrs. }}{9.0 \text { Hrs. }+1.5 \text { Hrs. }+5.5 \text { hrs. }+7.5 \text { Hrs }}$$ = 38.30%

(iv) Manufacturing Cycle Time
= $$\frac{\text { Total Production Time }}{\text { Units per Batch }}$$ = $$\frac{23.5 \text { Hrs. }}{60 \text { Units }}$$ = 0.3917 Hrs. per Unit

Question 18.
(ROI and Manufacturing Efficiency)
FAB Pvt Ltd is a traditional Indian garment brand, it has three autonomous divisions. These autonomous divisions are evaluated on the basis of ROI, with year end bonuses given to divisional managers who have the highest ROI. Operating results of Second Division of FAB Pvt. Ltd. for the last year are given below:

 Rs. Sales 2,10,00,000 Less: Variable Expenses 1,26,00,000 Contribution margin 84,00,000 Less: Fixed Expenses 67,20,000 Net Operating Income 16,80,000 Divisional Operating Assets 52,50,000

The organisation’s overall ROI for the last year was 18% (considering all ; divisions). Second Division has an opportunity to add a new product line “zay” that would require an investment of Rs. 30,00,000. Other details of the new product line “Zay” are as follows:

 Rs. Sales Rs. 90,00,000 per annum Variable Expenses 65% of sales Fixed Expenses Rs. 25,20,000 per annum Life cycle of the product line 5 years

Though second Division is performing well, but many times customers complained that they had to wait for long after placing the orders. The organisation is interested in cutting the amount of time between when a customer places an order and when the order is completed. For the last year, the following data were reported in respect of second Division:
Inspection time = 0.5 days per batch
Process time = 2.8 days per batch
Wait time = 16.0 days per batch
Queue time = 4.0 days per batch
Move time = 0.7 days per batch
In addition to financial performance measures, the company wishes to introduce a variety of non-financial performance measures.
FAB Pvt. Ltd. has set aggressive targets in both sales growth and ROI for the coming year. The organisation’s strategy for achieving these goals includes a campaign aimed at building brand recognition, customer retention, improvement in product quality, on time delivery to customers, expansion of eco-friendly product line and introduction of limited edition items.
Required:
(a) (i) CALCULATE last year’s ROI of second Division. (I Mark)
(ii) DISCUSS whether the manager of second Division would accept or reject the new product line, if he takes his decision based solely on divisional ROI. (2 Marks)
(iii) ADVISE how residual income approach can be used as an alternative financial measure for evaluation of managerial performance in the best interest of the company. (2 Marks)
(iv) CALCULATE Manufacturing Cycle Efficiency (MCE) and interpret the result. (3 Marks)
(v) STATE what percentage of the production time is spent in non-value added activities. (1 Mark)
(vi) CALCULATE the delivery cycle time. (1 Mark)
(vii) CALCULATE the new MCE if by using Lean Production all queue time can be eliminated. (2 Marks)
(b) Based on the above information and using a Strategy Map TABULATE two objectives and two measures for each perspective across the four dimensions of a balanced scorecard in the following format:

 Perspective Strategic Objective Measure

(8 Marks)
(a) (i) Calculation of last year ROI of second Division
= Controllable Profit/Controllable Net Asset
= Rs. 16,80,000/Rs. 52,50,000
= 32%

(ii) Calculation of ROI of New Product Line “Zay”

 Particulars Amount (Rs.) Sales 90,00,000 Less: Variable Cost 58,50,000 Controllable Contribution 31,50,000 Less: Fixed Cost 25,20,000 Controllable Profit 6.30,000 Investment Available 30,00,000 Return on the Proposed Line (ROI) 21%

The manager of second Division would be unwilling to invest the additional Rs. 30 lacs because this would decrease the second Division’s ROI of 32% to 28%.
[Rs. 16,80,000 + Rs. 6,30,000/(Rs. 52,50,000 + Rs. 30,00,000)]

(iii) Generally, a manager who is evaluated based on ROI will reject anv project whose rate of return is below the Division’s current ROI even if the rate of return of the project is above the company’s minimum required rate of return. In contrast, managers who are evaluated using residual income will pursue any project whose rate of return is above the minimum required rate of return, because it will increase their residual income. So, in the best interest of the company as a whole, residual income approach can be used for evaluation of managerial performance.
Alternative
To overcome some of the dysfunctional consequences of ROI, the residual income approach can be used. For the investment decision for Divisions II, the residual income calculations are as follows.

 Proposed Investment Rs. 30,00,000 Controllable Profit Rs. 6,30,000 Cost of Capital (18%) Rs. 5,40,000 Residual Income (RI) 90,000

This calculation indicates that the residual income of second Division will increase if manager accept the project. However, it is important to note that Residual Income does not always point to the right decision, because notional interest on accounting capital employed is not the same as IRR on cash investment. This Project has 1.65% IRR.
Overall, Residual Income is more likely than ROI to improve when managers make correct investment decisions, and so is probably a ‘safer’ basis than ROI on which to measure performance.

(iv) Manufacturing Cycle Efficiency (MCE)
= $$\frac{\text { Processing Time }}{\begin{array}{c} \text { Inspection Time }+ \text { Process Time }+ \text { Queue Time }+ \\ \text { Move Time }+ \text { Wait Time } \end{array}}$$
= $$\frac{2.8 \text { days }}{0.5 \text { days }+2.8 \text { days }+4.0 \text { days }+0.7 \text { days }+16.0 \text { days }}$$ = 11.67%

Interpretation
In FAB Pvt. Ltd., the MCE is 11.67%, which means that 88.33% of the time a unit is in process is spent on the activities that do not add value to the product. Monitoring the MCE helps companies to reduce non-value added j activities and thus get products into the hands of customers more quickly and at a lower cost.

(v) Percentage of Time Spent on Non-Value Added Activities
= 100% -11.67%
= 88.33%

(vi) Delivery Cycle Time
= 0.5 days + 2.8 days + 4.0 days 4- 0.7 days + 16 days
= 24 days

(vii) Revised MCE
= $$\frac{2.8 \text { days }}{0.5 \text { days }+2.8 \text { days }+0 \text { days }+0.7 \text { days }+16 \text { days }}$$ = 14%

Alternative (iv) to (vii)

(iv) Manufacturing Cycle Efficiency (MCE)
= $$\frac{\text { Value Added time (processing time) }}{\text { Throughput (Manufacturing Cycle) Time }}$$
= $$\frac{2.8 \text { day }}{0.5 \text { days }+2.8 \text { days }+4.0 \text { days }+0.7 \text { days }}$$
= 35%

Interpretation
In FAB Pvt. Ltd., the MCE is 35%, which means that 65% of the time a unit is in process is spent on the activities that do not add value to the product. Monitoring the MCE helps companies to reduce non-value added activities and thus get products into the hands of customers more quickly and at a lower cost.

(v) Percentage of Time Spent on Non-Value Added Activities
= 100% – 35%
= 65%

(vi) Delivery Cycle Time
= 0.5 days + 2.8 days + 4.0 days + 0.7 days + 16 days %
= 24 days

(vii) Revised MCE
= $$\frac{2.8 \text { days }}{0.5 \text { days }+2.8 \text { days }+0 \text { days }+0.7 \text { days }}$$ = 70%

(b)

 Perspective Strategic Objective Measure Financial Increase Sales Improve ROI % increase in slaes % increase in ROI Customer Perspective Improve brand recognition Customer retention % of target audienece who recognize brand % of suggestions/complaints responded % increase in repeat customers/Number of repeat customers Internal Perspective Reduction in time spent in non-value added activities Improve on time delivery to customers Improve in product quality % reduction in defect rate % of orders on time % increase in MCE Learning & Innovation Introduction of limited edi­tion items Expansion of eco-friendly product line No. of limited editions intro­duced. No. of eco-friendly products developed.