Page 95 - DMGT514_MANAGEMENT_CONTROL_SYSTEMS

Management Control Systems

Notes Problem 6: Division A of Better Margins Ltd. has been given a budgeted target of selling 2,00,000
components CoM 21, it manufactures at a price which would fetch a return of 25% on the average
assets employed by it. The following figures are relevant:
Fixed overhead ` 4,00,000
Variable cost ` 1 per unit
Average Assets:

Sales debtors ` 2,00,000
Stocks ` 6,00,000
Plant and other assets ` 4,00,000
However, the marketing department of the company finds out by a survey that the maximum
number of CoM 21, the market can take at the proposed price is only 1,40,000 units.
Fortunately, division B is willing to purchase the balance 60,000 units. The manager of division
A is willing to sell to division B at a confessional price of ` 4 per unit. But the manager of division
B is ready to pay ` 2.25 per unit, as he feels he can himself make CoM 21 in his division at that
price.
Rather than selling to division B at ` 2.25 per unit, the manager of division A feels that he will
restrict the activity of his division to the manufacture and sale of 1,40,000 components only. By
this, he can reduce ` 80,000 in stocks, ` 1,20,000 of plant and other assets and ` 40,000 in selling
and administration expenses.

As a management accountant, do you agree with the proposition of the manager of division A
to restrict the activities to 1,40,000 components, from the overall interest of the organisation.
Give detailed workings.
Solution: Division A accepts a return of 25% on the average assets employed by it. Average
assets employed = ` 2,00,000 + 6,00,000 + 4,00,000 = ` 12,00,000. Hence profit is 25% on ` 12,00,000
i.e., ` 3,00,000. Total sales will be
1. Profit 25% on 12,00,000 3,00,000
2. Fixed overhead 4,00,000

3. Variable overhead 2,00,000 × ` 1 2,00,000
Total sales for 2, 00,000 units 9, 00,000
Hence sales per unit ` 9,00,000/ 2,00,000 units = ` 4.50

Transfer to Division B and sales Sales to outside parties
to outside parties only
No. of units 2,00,000 1,40,000
Sales value 1,40,000  4.50 6,30,000 6,30,000
60,000  2.25 1,35,000
7,65,000 6,30,000
Less: variable cost @ ` 1 per unit 2,00,000 1,40,000
Contribution 5,65,000 4,90,000
Less: Fixed overhead 4,00,000 3,60,000 (Reduction of
` 40,000)
Net profit 1,65,000 1,30,000
Average assets employed 12,00,000 10,00,000
Return on investment 13.75% 13.0%

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