Page 285 - DMGT403_ACCOUNTING_FOR_MANAGERS

Accounting for Managers

Notes
Example: A company manufactures three products X, Y and Z. It has prepared the
following budget for the year 2003:
Total Product X Product Y Product Z
Sales 4,20,000 80,000 2,50,000 90,000
Factory Cost
Variable 2,90,500 40,000 1,74,000 76,500
Fixed 29,500 5,000 16,000 8,000
Production Cost 3,20,000 45,000 1,90,000 85,000
Selling and
Administration Cost
Variable 35,000 14,000 14,000 7,000
Fixed 8,000 3,500 3,200 1,300
Total Cost 3,63,000 62,500 2,07,200 93,300
Profit 57,000 17,500 42,800 - 3,300 (loss)

On the basis of above information, we understand that the company management is thinking to
discontinue with the production of product Z which has shown loss. The management seeks
your expert opinion on the issue before they take a final decision. You are required to comment
on the relative profitability of the products.
Solution
The information contained in the budget may be rearranged in the form of a marginal cost
statement as shown below:
Marginal Cost Statement

Particulars Total Product X Product Y Product Z
Sales 4,20,000 80,000 2,50,000 90,000
Variable Costs:
Factory Cost 2,90,500 40,000 1,74,000 76,500
Selling and Admn.Cost 35,000 14,000 14,000 7,000
Total Marginal Cost 3,25,500 54,000 1,88,000 83,500
Contribution 94,500 26,000 62,000 6,500
Fixed Costs 37,500 8,500 19,200 9,800
Profit 57,000 17,500 42,800 -3,300 (loss)
Profit-Volume Ratio 22.5% 32.5% 24.8% 7.2%

Profit-Volume (P/V) ratio is the ratio of contribution to sales. It is expressed in terms of percentage.
After preparing the above statement and analysis, we can make the following recommendations:
As discussed in the marginal cost statement, the contribution of product Z is 6,500 which goes
toward the recovery of fixed cost of 9,800. If the production of product Z is discontinued, the
company will lose the marginal contribution of 6,500 while it will have to incur the fixed cost
of 9,800. The total profit of 57,000 will be reduced to 50,500 (57,000 - 6,500). Thus, it is
advisable that the production of Z should not be discontinued. As regards the relative profitability,
product X is more profitable than Y and Z as the P/V ratio in this case is highest. The production
and sales of product X should, therefore, be encouraged.

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