Test Series: April, 2018

MOCK TEST PAPER - 2

FINAL (NEW) COURSE: GROUP – II
PAPER – 5: STRATEGIC COST MANAGEMENT AND PERFORMANCE EVALUATION
SUGGESTED ANSWERS/HINTS

1. DMAIC technique analyses operational problems by assessing them in the following phases (1)
Define; (2) Measure; (3) Analyze; (4) Improve and (6) Control.
(1) Define the problem, project goals and customer requirements: Poor quality leading to erosion of
clientele.
Customers feedback indicates that product quality requires improvement. Dis-satisfaction is
reflected in the form of sale returns and warranty claims. Competitors have no sale returns on
account of poor quality as well as no warranty claims on its products. Hence, in an environment
where 100% quality can be achieved, DFS is facing quality issues. This is the problem to be
addressed. Failure to do so would result in loss of clientele, leading to a possibility of going out of
business. The goal of the project is to identify what is the sigma level at which the company is
operating and to suggest improvements to the production process it achieve 6σ level of
operations.
(2) Measure current performance: Indicators of poor quality to find out what is the sigma level of the
current operations?
Current performance focusing on quality can be determined based on the cost incurred in the
following phases:
(a) Sale returns: Sale returns are 1% of total sales. Gross sales are 25,000 units per annum at
selling price of Rs.20,000 each, therefore having a value of Rs.50,00,00,000. Sales returns
@1% amount to Rs.50,00,000 that represent the return of 250 units per annum. The cost of
poor quality on account of these sale returns is the variable cost of the product Rs. 12,500
per unit. This is an avoidable cost amounting to Rs.31,25,000 per annum that is 0.63% of
sales (Rs.31,25,000/Rs. 50,00,00,000).
(b) Warranty claims: Warranty is an undertaking given by the company to repair the electronic
component free of cost if defect occurs within a specific period of time. Hence, when the
customer files a claim that is accepted by the company, it means that there has been an
issue with the quality of the product. This is a liability / cost that should ideally be kept
minimum, if not nil like DFS’s competitors.
Warranty for the product is for one year from the date of sale. Warranty claims this year is
Rs.30,00,000, which is given to be representative of the average yearly warranty cost.
Therefore, currently this cost amount to 0.60% of sales (Rs.30,00,000/ Rs.50,00,00,000).
Summarizing sale returns and warranty claims alone represent 1.23% of current sales.
Considering the current percentage of deficiency, the company is operating between 3σ and
4σ level. The rest of the industry is able to achieve 6 σ level of operations. At zero defective
production, there are no sale returns on account of quality and no warranty claim costs.
Therefore, is tremendous scope for improvement in DFS’s operations.
(3) Analyze: What is the cause of poor quality? What is the cost of resources focused on quality?
Six sigma team studied the production process in detail. Replicating the issues detailed in the
given problem:
(a) Problem 1: Assembly line workers, including new hires, learnt on the job as to how to
assemble the input material to produce the final electronic component. This lead to many
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 errors due to lack of proper standardized training. Therefore, on account of these errors, the
entire electronic component has to assembled again.
(b) Problem 2: Sub-standard quality of raw material is detected on inspection only at the
assembly line. Inspection leads to 10% rejection of units. By this time, the defective material
is already fitted into the final electronic component. Therefore, to entire component has to be
reworked upon to replace the defective raw material input.
(c) Problem 3: Machines are outdated and are not entirely suitable for the current production
methodology.
The above factors result in rework on products, an internal failure cost, that lead to wastage of
material, resources and capacity.
Two costs incurred to focus on quality are cost of inspection and cost of rework,
2,525 units are reworked upon. Time required to rework 2,525 units per year = 2,525 units / 5
units per hour = 505 hours per year. Cost of rework is given to be Rs.6,250 per hour. Therefore,
total cost of rework per year = Rs.31,56,250.
Inspection cost for 2,000 hours at the assembly line is given to be Rs.10,00,000 per annum.
Therefore, total cost of resources currently incurred for quality = Rs.41,56,250 per annum.
(4) Improve: Reduce errors and improve quality of the product
While cost of resources currently incurred for quality is only 0.83% of sales
(Rs.41,56,250/Rs.50,00,00,000), a detailed analysis brings forth many qualitative aspects that
DFS needs to be address. If its competitors are able to achieve excellence in quality, so must
DFS, in order to remain in business. Therefore, following are the proposals that can provide
solutions to the problems referred to above:
(a) Solution to Problem 1: Periodic training sessions to educate new hires and update workers
in the assembly line on the latest techniques in production. Standardized and informed
working will lead to lower errors and thereby improving product quality. Cost per year =
5,000 hours yearly training × Rs.1,000 per hour = Rs.50,00,000.
(b) Solution to Problem 2: Delay in detection of poor quality input can be resolved by
streamlining the work flow. New function for quality planning and improvement, at the
beginning of the process helps in early detection, without wastage of resources. Cost per
year for introducing this functionality = Rs.1,50,00,000.
(c) Solution to Problem 3: Replace old machines with newer ones. Machine upgrade will align
the resource with the production requirements. This reduce chances of errors in the
production process.
Cost of procurement: Rs.3,60,00,000 has a life of 3 years. Therefore, annual depreciation is
Rs.1,20,00,000.
(d) Consequences of implementing these proposals, as given in the problem, can result in the
following improvements:
(i) Rework of products can be entirely eliminated.
(ii) Sale returns will reduce from 1% to 0% due to better quality of products.
(iii) Yearly Warranty claims will reduce from Rs.30,00,000 to nil per annum.
(iv) With the introduction of the new facility, time required for inspection at the assembly
line would reduce from 2,000 hours to 1,200 hours. Cost of inspection at the assembly
line would reduce from Rs.10,00,000 per annum to Rs.6,00,000 per annum.

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 (v) Due to better quality, DFS can build better reputation with the customers which can
further yield additional sales of 5,000 units per year.
When the company is capable to achieve points (i), (ii) and (iii) milestones, it would have
achieved 6 σ operational level. The cost of quality report summarizes the above discussion:
Cost of Quality Report
Cost of Quality Component Before After
Improvements Improvements
Current % Projected %
Cost of Cost of
Rs. Sales Rs. Sales
Preventive Cost
Training ××× ××× 50,00,000 0.83%
(5,000 hrs. × Rs.1,000 per hour)
Quality Planning and ××× ××× 1,50,00,000 2.50%
Improvement
Appraisal Cost
Inspection Cost 10,00,000 0.20% 6,00,000 0.10%
Internal Failure Cost
Rework 31,56,250 0.63% ××× 0.00%
External Failure Cost
Sale Returns 31,25,000 0.63% ××× 0.00%
Warranty Claims 30,00,000 0.60% ××× 0.00%
Total Cost of Quality 1,02,81,250 2.06% 2,06,00,000 3.43%
Yearly Sales 50,00,00,000 60,00,00,000
Total Cost of Quality / Sales (%) 2.06% 3.43%
(e) Cost of quality is 2.06% of sales of which 1.23% alone is external failure cost. This has an
impact on the customer experience and can erode customer base. By implementing the six
sigma team’s proposal, this external failure cost on account of sale returns and warranty
costs, can completely eliminated. Internal failure cost can also be eliminated. The increase
in cost of quality proposed to be made would be a preventive cost to avoid failure of quality.
The company should focus on preventing the error such that it ensures that product is of
good quality when it reaches the customer at the very first instance. This enhances the
customer experience and therefore eliminating the scope for external failures like sales
returns and warranty claims. Better quality can yield further sales of 5,000 units per year.
Therefore, an increase in spending on quality measures is justified since it not only yields
significant improvements to quality but also brings in more sales orders.
Improvement to the financial position of the firm is summarized below:
Particulars Amount (Rs.)
Improved Contribution Margin (Ref. note 1) 3,75,00,000
Elimination of Goods Replacement 31,25,000
Elimination of Warranty Claims 30,00,000
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 Elimination of Rework 31,56,250
Savings in Inspection Cost 4,00,000
Total Benefit …(A) 4,71,81,250
Additional Costs Incurred
Training 50,00,000
Quality Planning and Improvement 1,50,00,000
Increase in Fixed Cost 1,20,00,000
(Yearly Depreciation of Upgraded Machines)
Total Additional Cost …(B) 3,20,00,000
Net Benefit …(A) - (B) 1,51,81,250
Note 1: Incremental Contribution:
Sales have increased by 5,000 units. Selling Price is Rs.20,000 per unit while variable cost
is Rs.12,500 per unit. Contribution is Rs.7,500 per unit.
Conclusion: Six Sigma team’s proposals are focused on preventing the error from
occurring. Consequently, quality improves, sale improves and thereby can yield a net
benefit of Rs.1,51,81,250 per year to the company.
(5) Control: Maintain quality at 6σ level and keep the production facilities updated.
(i) Training sessions with workers can serve as two way communication platform to detect
other problems that can be resolved in more timely manner. Inputs received can also be
used to improve the production work flow as well.
(ii) New function of quality planning and improvement can help the company be better informed
about the latest production methodologies.
(iii) Updated machines are better equipped to handled changes in the production process sin ce
they are built with the latest technology. DFS should do a continuous assessment of the
state of its machines and upgrade them when necessary.
2. (i) Statement of ‘Expected Quality Costs’
Particulars Current Proposed
Situation (Rs.) Situation
(Rs.)
Prevention Costs --- 4,50,000
Appraisal Costs --- 50,000
External Failure Costs 3,20,000 2,35,120
Internal Failure Costs 7,55,556 3,91,538
Total Quality Costs 10,75,556 11,26,658
Workings
External Failure Cost
Particulars Current Proposed
Situation Situation
Customer’s Demand …(A) 28,000 units 28,000 units
Number of units Dispatched to Customers …(B) 32,000 units 30,939 units

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  28,000 units   28,000 units 
 ;  
 87.5%   90.5% 
Number of units Replaced …(B) – (A) 4,000 units 2,939 units
External Failure Cost Rs.3,20,000 Rs.2,35,120
{4,000 units × Rs.(35+25+15+5)};
{2,939 units × Rs.(35+25+15+5)}
Internal Failure Cost
Particulars Current Proposed
Situation Situation
Number of units Dispatched to Customers …(A) 32,000 units 30,939 units
Number of units Produced & Rejected …(B) 40,000 units 34,377 units
 32,000 units   30,939 units 
 ;  
 80%   90% 
Number of units Discovered Faulty … (B) – (A) 8,000 units 3,438 units
Cost of Faulty Production …(D) Rs.6,00,000 Rs.2,57,850
{8,000 units × Rs.(35+25+15)};
{3,438 units × Rs.(35+25+15)}
Material Scrapped 4,444.44 units 3,819.67 units
 40,000 units   34,377 units 
  10%  ;   10% 
 90%   90% 
Cost of Material Scrapped …(E) Rs.1,55,556 Rs.1,33,688
{4,444.44 units × Rs.35}; {3,819.67 units × Rs.35}
Internal Failure Cost …(D)+(E) Rs.7,55,556 Rs.3,91,538
(ii) Recommendation
On purely financial grounds the company should not accept the proposal because there is an
increase of Rs.51,102 in quality costs. However there may be other factors to consider as the
company may enhance its reputation as a company that cares about quality products and this
may increase the company’s market share.
On balance the company should accept the proposal to improve its long-term performance.
3. (i) Customer Wise Profitability Statement and Overall Profitability Statement
SN. Particulars P M W Total Rs.
A Sales (net proceeds) –Table 1 241,288 237,500 272,812 751,600
B Variable Cost of Goods Sold 1,50,000 1,42,500 1,87,500 4,80,000
C Assignable- Marketing and Administration
Cost - Table 2
• Order Taking and Processing 1,200 600 4,500 6,300
• Sale Return Processing 150 - 1,200 1,350
• Billing Cost 200 100 750 1,050
• Customer Visit 800 - 4,000 4,800

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 Total Assignable Marketing and 2,350 700 10,450 13,500
Administration Cost
D Assignable- Distribution Cost - Table 2
• Expedited / Rush Orders 250 - 1,250 1,500
• Delivery Costs 8,000 4,000 - 12,000
• Inventory Carrying Cost 10,000 9,500 12,500 32,000
Total Assignable Distribution Cost 18,250 13,500 13,750 45,500
E Non- Assignable Fixed Cost - - - 100,000
F Total Costs (B+C+D+E) 170,600 156,700 211,700 639,000
G Net Profit (Step A - F) 70,688 80,800 61,112 112,600
H Profit % of Sales (G / A) 29% 34% 22% 15%

Workings
Table 1: Customer Sales Analysis - Revenue Analysis
All figures in Rs.
Particulars P M W Total Rs.
Sales {Sale Units × Sale Price (gross)} 2,50,000 2,37,500 3,12,500 8,00,000
Less: Sale Return (Step 1 × Return%) 1,250 - 31,250 32,500
Net Sales 2,48,750 2,37,500 2,81,250 7,67,500
Less: Cash Discount 7,462 - 8,438 15,900
Net Proceeds 2,41,288 2,37,500 2,72,812 7,51,600
Final Collections vs Original Sale 97% 100% 87% 94%

Table 2: Assignable Marketing, Administrative and Distribution Costs

All figures in Rs.
Particulars P M W Total
Order Taking and Processing 1,200 600 4,500 6,300
(# of orders × cost per order)
Expedited / Rush Orders 250 - 1,250 1,500
(# of orders × cost per order)
Delivery Costs 8,000 4,000 - 12,000
(Distance in km. × cost per km)
Sale Return Processing 150 - 1,200 1,350
(# of returns × cost per return)
Billing Cost 200 100 750 1,050
(# of invoices × cost per invoice)
Customer Visit 800 - 4,000 4,800
(#of customer visits × cost per visit)
Inventory Carrying Cost 10,000 9,500 12,500 32,000
(# of units × inventory carrying cost p.u.)

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 (ii) Customer strategy: It can be seen that Pamphlet LLP has an overall profit of Rs.112,600 or 15% of
sales. While the performance is good, the firm’s management has to analyze customer wise
profitability.
(a) W is the largest customer in terms of units sold. However, Table 1 above shows that sale
returns at 10%, which is unusually large compared to other customers. Pamphlet LLP has to
investigate why the returns are of such large quantity. Possibly, there could be
communication gap between the firm and W. Possible non-conformity 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) W has placed many rush orders, which requires Pamphlet LLP to ship these orders
immediately, using costlier means of transportation. Currently, there is no charge for
shipping rush orders. In order to deter W from repeatedly placing rush orders, Pamphlet 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.
(c) W has placed 15 orders for 1,250 units. Comparatively, P and M placed 4 and 2 orders for
approximately 1,000 units each. W can be requested to place fewer orders with larger
quantity per order, in order to optimize ordering cost.
(d) Being the largest customer, W has 5 sale visits from Pamphlet LLP, which is more than the
other 2 customers. Priced at Rs.800 per visit, this very costly. At the same time, W is
yielding the least profit. Therefore, Pamphlet 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 W seems to need more hand-holding in terms of more sales visits as well as higher
rush orders, Pamphlet LLP may assess 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 W can be migrated to a higher profitabi lity, Pamphlet LLP
need not lose out its market share.
(f) Customer M is the most profitable yielding 34% return over sales, although in terms of
‘Advanced Learner’s Dictionary’ ordered, it is the smallest of the three. Pamphlet LLP can
assess if it can extend some discount, in order to encourage more sales. Currently,
Customer M does not get any discount.
(g) Pamphlet LLP can assign more sales visits to Customer P and M to encourage them
purchase more as well as provide high quality customer service.
4. (a) 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 Gulf Oil, 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
Gulf Oil 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.

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 In Gulf Oil, 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 av oid 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 minim ize 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 Gulf Oil 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, Gulf Oil 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 Gulf Oil like:
 Conducting periodic energy audits for identifying energy saving opportunities.
 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. Th ere should be
continuously monitoring on optimum utilization of crude oil to improve gross refining margin. The
gross refining margin 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.
Gulf Oil 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 Gulf

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 Oil, 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.
(b) The budgetary control system appears to have several very important shortcomings which reduce
its effectiveness and may in fact cause it to interfere with good performance. Some of the
shortcomings are explained below.
Lack of Coordinated Goals: Mr. Singh had been led to believe high quality output is the goal; it
now appears low cost is the goal. He does not know what the goals are and thus cannot make
decisions which lead toward reaching the goals.
Influences of Uncontrollable Factors: The actual performance relative to budget is greatly
influenced by uncontrollable factors i.e. rush orders. Thus, the variance reports serve little
purpose for evaluation of performance.
The Short-Run Perspectives: The monthly evaluation and the budget tightening on a monthly
basis result in a very short-run perspective. This will result in inappropriate decisions.
The improvements in the budgetary control system must correct the deficiencies described
above. Accordingly:
− Budgetary control system must more clearly define the company’s objectives.
− Budgetary control system must develop an accounting reporting system which better
matches controllable factors with supervisor responsibility and authority.
− Establish budget values for appropriate time periods which do not change monthly simply as
a result of a change in the prior month’s performance.
The entire company from top management down must be educated in sound budgetary procedures
so that all parties will understand the total process and recognize the benefit to be gained.
5. (a) The incremental cost associated with the IMAX show appears to be Rs.10,000 i.e. cost of running
the show. The allocated fixed cost per show is not relevant because the total amount of fixed
costs for the year will not change as a result of the special show. Further, the stated ticket prices
are not relevant because the show will take place at 08:30 AM when the IMAX is not usually open
– thus, the students will not be displacing any regular visitors. Based on the financial data
provided, the minimum price quote appears to be Rs.10,000.
‘X’ should consider the following factors:
 Does the station have a souvenir shop and/or cafeteria?
If so, many students are likely to buy food and/or souvenir items, thereby increasing the station’s
contribution. In turn, this would reduce the minimum price quote.
 What is the impact on future revenue?
After seeing the show, many students may return with their parents, thereby increasing future
revenue.
 Are there costs linked with the special showing that are not included in the Rs.10,000
variable cost number?
For example, will the station have to pay an overtime premium.
‘X’ should also consider the educational mission of the Planetarium Station. Such shows directly
contribute to this mission, the station, and, hopefully, the betterment of the student s. The special
shows may be an excellent way to expose some students to earth science – these students may
have never gone through the Planetarium Station if it were not for the school excursion.

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 Overall, the “best” price to charge is unclear and requires some judgment as ‘X’ needs to
balance an array of financial and non-financial factors.
(b) Aspects that need to be reported in the TBL report:
S.N. Aspect Category on the TBL Report
(i) Caregiver, with the help of traffic police, Social bottom line, since green corridor
has implemented a "green corridor" for would unable the ambulance to transport
ambulances that carry donor organs for harvested organs between the hospitals at
transplantation. Organs harvested from the earliest this would be beneficial for
the donor at one hospital can reach patients in need of critical care.
another hospital with the recipient
patient at the earliest.
(ii) Medical waste is discarded at a landfill in Environmental bottom line, as it affects
a nearby dumpsite. Some of the waste the ecological surroundings of the town.
are not bio-degradable.
(iii) Lab reports are being made available Environmental bottom line, since paper,
online within the hospital computer cartridge and storage requirement would be
system. This would reduce printing costs lower. This preserves environmental
and storage space needed to maintain resources.
older records.
(iv) The hospital is planning to market Not relevant to TBL report. This is a
‘medical check-up packages’ so that marketing strategy to improve profitability.
facilities in its outpatient department can
be utilized better.
(v) The number of inpatient hospital deaths Social bottom line, since hospital mortality
decreased 8%, from 776 in 2016 to 715 in rate measures the clinical quality.
2017.
6. (a) Analysis of Cost plus Pricing Approach
The company has a plan to produce 2,00,000 units and it proposed to adopt Cost plus Pricing
approach with a markup of 25% on full budgeted cost. To achieve this pricing policy, the company
has to sell its product at the price calculated below:
Qty. 2,00,000 units
Variable Cost (2,00,000 units × Rs. 32) 64,00,000
Add: Fixed Cost 16,00,000
Total Budgeted Cost 80,00,000
Add: Profit (25% of Rs. 80,00,000) 20,00,000
Revenue (need to earn) 1,00,00,000
 Rs. 1,00,00,000 
Selling Price per unit   50 p.u.
 2,00,000 units 

However, at selling price Rs. 50 per unit, the company can sell 1,40,000 units only, which is
60,000 units less than the budgeted production units.
After analyzing the price-demand pattern in the market (which is price sensitive), to sell all the
budgeted units market price needs to be further lowered, which might be lower than the total cost
of production.
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 Statement Showing “Profit at Different Demand & Price Levels”
I II III IV Budgeted
Qty. (units) 1,68,000 1,52,000 1,40,000 1,28,000 1,08,000
Rs. Rs. Rs. Rs. Rs.
Sales 73,92,000 72,96,000 70,00,000 71,68,000 64,80,000
Less: Variable Cost 53,76,000 48,64,000 44,80,000 40,96,000 34,56,000
Total Contribution 20,16,000 24,32,000 25,20,000 30,72,000 30,24,000
Less: Fixed Cost 16,00,000 16,00,000 16,00,000 16,00,000 16,00,000
Profit (Rs.) 4,16,000 8,32,000 9,20,000 14,72,000 14,24,000
Profit (% on total cost) 5.96 12.87 15.13 25.84% 28.16%
Determination of the Best Course of Action
(i) Taking the above calculation and analysis into account, the company should produce and
sell 1,28,000 units at Rs. 56. At this price company will not only be able to achieve its
desired mark up of 25% on the total cost but can earn maximum contribution as compared
to other even higher selling price.
(ii) If the company wants to uphold its proposed pricing approach with the budgeted quantity, it
should try to reduce its variable cost per unit for example by asking its supplier to provide a
quantity discount on the materials purchased.
(b) Either
COMPUTATION OF VARIANCES
Traditional Variance (Actual Vs Original Budget)
Usage Variance = (Standard Quantity – Actual Quantity) × Standard Price
= (2,500 Kg – 2,700 Kg) × Rs. 1.50
= Rs. 300 (A)
Price Variance = (Standard Price – Actual Price) × Actual Quantity
= (Rs. 1.50 – Rs. 2.40) × 2,700 Kg
= Rs. 2,430 (A)
Total Variance = Rs. 300 (A) + Rs. 2,430 (A) = Rs. 2,730 (A)
Operational Variance (Actual Vs Revised)
Usage Variance = (2,500 Kg – 2,700 Kg) × Rs. 2.25
= Rs. 450 (A)
Price Variance = (Rs. 2.25 – Rs. 2.40) × 2,700 Kg
= Rs. 405 (A)
Total Variance = Rs. 450 (A) + Rs. 405 (A) = Rs. 855 (A)
Planning Variance (Revised Vs Original Budget)
Controllable Variance= (Rs. 2.00 – Rs. 2.25) × 2,500 Kg
= 625 (A)

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 Uncontrollable Variance
= (Rs. 1.50 – Rs. 2.00) × 2,500 Kg
= 1,250 (A)
Total Variance = Rs. 625 (A) + Rs. 1,250 (A) = Rs. 1,875 (A)
Traditional Variance = Operational Variance + Planning Variance
= 855 (A) + 1,875 (A) = 2,730 (A)
Or
INTERPRETATION
Direct Labour Rate Variance:
Adverse Labour Rate Variance indicates that the labour rate per hour paid is more than the set
standard. The reason may include among other things such as:
(1) While setting standard, the current/ future market conditions like pending labour negotiation/
cases, has not been considered (or predicted) correctly.
(2) The labour may have been told that their wage rate will be raised or bonus will be paid if
they work efficiently.
Direct Labour Efficiency Variance:
It indicates that the workers has produced actual production quantity in less time than the time
allowed. The reason for favourable labour efficiency variance may include among the other things
as follows:
(1) While setting standard, workers efficiency could not be estimated properly, this may happen
due to non-observance of time and motion study.
(2) The workers may be new in the factory, hence, efficiency could not be predicated properly.
(3) The foreman or personnel manager responsible for labour efficiency, while providing his/ her
input at the time of budget/ standard, has adopted conservative approach.
(4) The increase in the labour rate might have encouraged the labours to do work more
efficiently.
In this particular case it may have happened that since labour payment has been increased
labour efficiency has also been increased. In a nutshell because of additional labour rate
(Adverse), labour efficiency has gone up (Favourable)
Workings
Labour Rate Variance = Standard Cost of Actual Time – Actual Cost
= (SR × AH) – (AR × AH)
Or
= (SR – AR) × AH
= (Rs.8.00 – Rs.8.14) × 3,00,000 hrs.
= Rs.42,000 (A)
Working
ActualPaid
Actual Labour Rate per hour =
ActualHours

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 Rs. 24,42,000
=
3,00,000hrs.

= Rs. 8.14
Labour Efficiency Variance
= Standard Cost of Standard Time for Actual
Production – Standard Cost of Actual Time
= (SH × SR) – (AH × SR)
Or
= (SH – AH) × SR
= (3,12,000 hrs. – 3,00,000 hrs.) × Rs.8.00
= Rs.96,000 (F)
Working
Standard Hours = Actual Production × Std. hrs. per unit
= 52,000 units × 6 hrs.
= 3,12,000 hrs.

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