1993(M) Page 6-Decision Making

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Question 3
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IJP Bhd, a retail group whose head office is in Kuala Lumpur, operates branches in Ipoh,
Johore Bharu and Penang. All buying is centralised at head office and goods are charged
to each branch at the same cost prices. Branch managers have the authority to make
variations in their mark up, in order to remain competitive.

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The following budget has been prepared for next year:
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!

Sales
Costs
Cost of good sold
Staff wages and salaries
Overheads

Profit/(Loss)

Ipoh
$000

Johore
Bharu
$000

Penang
$000

Total
$000

6,300
=====

3,900
====

5,800
=====

16,000
=====

3,780
640
1,280

2,600
480
1,020

3,770
500
1,230

10,150
1,620
3,530

600
=====

(200)
======

300
=====

700
======

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% of sales
9.52%
(5.13%)
5.17%
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Overhead costs at each branch consist of three items, as follows:
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(1)
(2)
(3)

4.38%

Head office fixed costs, budgeted at $1,760,000, apportioned on the basis of sales.
Variable overheads as a % of branch sales Ipoh 5%, Johore Bharu 8% and Penang
6%.
Fixed (occupancy) costs.

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Staff wages and salaries are treated as fixed cost at each branch.
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The directors are very concerned about Johore Bharu branch and are considering
immediate closure to avoid the budgeted loss.

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REQUIRED:
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(i)

(ii)
(iii)

Present the above data in a meaningful way to assist the directors in making a
decision concerning the Johore Bharu branch.
(10 marks)
State clearly whether you recommend closure after making a calculation of the
groups profit if closure does take place.
(4 marks)
Assuming the present apportionment of head office fixed costs to each branch
remains unchanged, calculate to the nearest $000 the sales required at each
branch for the group to break even.
(6 marks)
(Total 20 marks)

Suggested Answer 3

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(i)
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MARGINAL COST STATEMENT OF IJP BHD

Sales
Less: Marginal cost
Cost of good sold
Variable overhead(W1)

Contribution
Less: Direct fixed cost
Staff wages and salaries
Fixed occupancy
Costs (W3)

(ii)

!
(iii)
!
!

Johore
Bharu
$000

Penang
$000

Total
$000

6,300

3,900

5,800

16,000

3,780
2,600
3,770
10,150
315 4,095 312 2,912 348 4,118
975 11,125
2,205
640
272

Net contribution
Less: Common fixed costs
(W2)

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Profit/(Loss)
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!

Ipoh
$000

988

1,682

480
912

500

279

759

4,875
1,620

244

744

795

2,415

1,293

229

938

2,460

693

429

638

1,760

600

(200)

300

700

==========================================

The Johore Bharu branch should not be closed as it yields a contribution of

$988,000. The higher the contribution, the higher would be profits as fixed costs are
assumed to remain constant. Total profit of IJP Bhd would also be higher by net
contribution $229,000 from Johore Bharu branch.

Total fixed cost

Direct fixed cost + Common fixed cost

Ipoh
Johore Bharu
Penang

:
:
:

$912,000 + $693,000 = $1,605,000

$759,000 + $429,000 = $1,188,000
$744,000 + $638,000 = $1,382,000

Contribution to Sales (C/S) ratio:

Ipoh
Johore Bharu
Penang

:
:
:

$2,205,000/ $6,300,000 = 0.35

$988,000 / $3,900,000 = 0.2533
$1,682,000 / $5,800,000 = 0.29

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WORKINGS:
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Analysis of overheads
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(1)
Variable overhead of a % of Branch Sales
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Ipoh

5/100 x $6,300,000

= % of sales
=

$315,000

!
!

Johore Bharu

8/100 x $3,900,000

$312,000

Penang

6/100 x $5,800,000

$348,000
$975,000
=======

(2) Head Office Fixed Cost (apportioned on the basis of sales)

Ipoh

$6,300,000 / $16,000,000 x $1,760,000 = $693,000

Johore Bharu:

$3,900,000 / $16,000,000 x $1,760,000 = $429,000

Penang

$5,800,000 / $16,000,000 x $1,760,000 = $638,000

$1,760,000
===========

(3) Fixed (Occupancy cost) = Total Variable Overheads - (Head Office Fixed Cost +
Variable Overhead of Branch)

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!

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!
!
!
!
!
!
!
!

Ipoh

:
=
=

$1,280,000 - $(693,000 + 315,000)

$1,280,000 - $1,008,000
$272,000
========

Johore Bharu

:
=
=

Penang

:
=
=

$1,020,000 - $(429,000 + 312,000)

$1,020,000 - $741,000
$279,000
========
$1,230,000 - $(638,000+348,000)
$1,230,000 - $986,000
$244,000
========

Decision making- Page 24-26

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Question 3
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Emmeno Ltd makes and sells three products, Products M, N and O, each of which
requires processing in all of the 4 production departments. There is a shortage of the
specially skilled labour required in Department 3 and there are no short-term prospects of
solving the problem. The directors are therefore considering concentrating the resources
of the company on just one product. The market is such that the total factory output of any
one product can be sold at normal selling prices.

Budgets of the available direct labour and fixed overhead costs for the next year in each
department as:

Department

Hours !
(000)

Labour Cost !
($000)

Fixed Overheads
($000)

330

2,970

1,155

700

7,350

2,450

180

2,160

630

520

7,020

1,820

Department

Product M

Product N

Product O

11

12

12

Product M

Product N

Product O

Direct material

145

225

220

Variable overhead

100

125

175

Selling price

680

700

825

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The standard hours for each product are:
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Other data, per unit of product is:
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REQUIRED

(i)

Providing detailed calculations to support your answer, recommend the product on

which Emmeno Ltd should concentrate all its resources.
(13 Marks)

(ii)

Calculate the amount of profit expected in the next year if your advice in (i) is
implemented.
(4 marks)
(iii)
Assuming that each direct employee works 1,800 hours per annum, calculate, to
the nearest employee, the surplus or shortage in each department against the
staffing level required to meet your recommendations.
(3 marks)
(Total 20 marks)
Suggested Answer 3

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(i)
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TOTAL VARIABLE COST PER UNIT

Workings

Product M!
$

Product N!
$

Product O!
$

145

225

220.00

Dept. 1

27

72

99.00

Dept. 2

126

42

73.50

Dept. 3

36

24

60.00

Dept. 4

108

162

40.50

Variable overheads

100

125

175.00

Total marginal cost

542

650

668.00

Direct material
Labour cost:

(1)

Marginal Cost Statement

(ii)

Product M!
$

Product N!
$

Product O!
$

Selling price

680

700

825

Less: Total marginal cost

542

650

668

Contribution

138

50

157

Labour hours - Dept. 3

Contribution per labour hour

$46

$25

$31.40

Ranking

1st

3rd

2nd

Therefore, the company should concentrate on Product M which gives the highest
contribution per labour hour.
Total labour hours available in Dept. 3 is 180,000 hours.
Labour hours per unit in Dept. 3 is 3 hours for Product M.
Quantity of M that can be produced with the available hours.

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!
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Profit

(iii)

=
=

(Quantity x Contribution per Unit) - Total Fixed Cost

(60,000 x $138) - ($1,155,000 + $2,450,000 + $630,000 +
$1,820,000)
=
$8,280,000 - $6,055,000
=
$2,225,000
========
REQUIRED STAFFING LEVEL
Required quantity of Product M
Dept. 1

60,000 units

Dept. 2

Dept. 3

Dept. 4

Direct labour hours

available

330,000

700,000

180,000

520,000

Direct labour hours for

Product M!
(Quantity x Hours per unit
of M)

180,000

720,000

180,000

480,000

Surplus/(Shortage)

150,000

(20,000)

40,000 (A)

1,800

1,800

1,800

1,800 (B)

83

(11)

22 (A/
B)

Direct hours per worker

Surplus/(Shortage)

WORKINGS

1.

Labour Cost per Unit

= Labour Rate per Hour x Standard Hours
where Labour Rate per Hour
= Labour cost No. of Hours
Dept. 1
:
$2,970,000
330,000
=
9.00
Dept. 2
:
$7,350,000
700,000
=
10.50
Dept. 3
:
$2,160,000
180,000
=
12.00
Dept. 4
:
$7,020,000
520,000
=
13.50
Labour cost per Unit

Dept. 1
Dept. 2
Dept. 3
Dept. 4

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!
!
!
!
!
!

Product M
9 x 3 = 27
10.5 x 12 = 126
12 x 3 = 36
13.5 x 8 = 108

Product N
9 x 8 = 72
10.5 x 4 = 42
12 x 2 = 24
13.5 x 12 =162

Product O
9 x 11 = 99.0
10.5 x 7 = 73.5
12 x 5 = 60.0
13.5 x 3 = 40.5

Decision making- Page 46-47

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Question 5
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Sunk costs and opportunity costs are important considerations when deciding which costs
are relevant to a particular management decision.

Relkos Bhd is a small engineering business making products to order according to each
customers specification. Three months ago, when Job 1672 was almost completed, the
customer went into liquidation. At that stage, the job card recorded the following production
costs:

Direct materials
Direct wages
Variable overheads absorbed
Fixed overheads absorbed

$
25,000
10,500
3,800
5,700
45,000
======

No other customer can be found for this particular specification, but a potential customer is
interested in buying the product if certain conversion work is undertaken and a special
price can be negotiated.

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Alternatively, in its existing condition, Job 1672 could be sold for $7,800 as scrap.
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The production cost of the conversion work is estimated as follows:
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Materials at cost
Direct wages
Variable overhead absorbed
Fixed overhead absorbed
Supervision
Hire of special machine

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Additional information:
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(1)

(2)

(3)

$
7,500
5,000
800
1,300
900
2,600

The materials for use in the conversion have been in stock for 6 months. They could
now be used on another current order. The replacement cost of these material is
$8,800.
The direct workers and supervisor, who would work on the conversion, are
employed in a section which is currently working at only 70% capacity. All are paid
on a fixed salary basis regardless of output.
It is normal company policy to absorb fixed administration and selling overheads by
adding 10% to total production cost.

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REQUIRED
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(i)
(ii)

Define and briefly explain sunk costs and opportunity costs in the context of
decision making.
(6 marks)
Appraise the detailed information given regarding Job 1672 at Relkos Bhd and
prepare detailed calculations to arrive at the relevant cost to use as the basis for
quoting a price for the converted job. Give brief reasons why you have included or
excluded each particular item in your calculation.
(14 marks)
(Total 20 marks)

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SUGGESTED ANSWER 5
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(i)
Sunk costs are costs that have already been incurred and which costs will remain
the same regardless of any change(s) in decision. They are not differentiated costs and
are ignored in decision making. Example of sunk costs are all historical cost, whether
original or book value.

(ii)

Opportunity costs are the benefits forgone by selecting a course of action in

preference to the most profitable alternative available e.g. a company has two
mutually exclusive projects, Project A and Project B. Project A gives a profit of $400
whilst Project B gives a profit of $350. The selection of Project A will result in having
to forgo the next best alternative course i.e. Project B. Therefore, the profit forgone
in Project B is the opportunity cost.
JOB 1672

Materials
Variable overhead
Hire of special machine
Opportunity cost
Total relevant cost

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NOTES:
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(1)

(2)

(3)

(4)

(5)

(6)

Note
(1)
(2)
(3)
(4)

$
8,800
800
2,600
7,800
20,000
======

The replacement cost of the material will be the relevant cost because the same
material is to be used on another current order and has to be purchased at $8,800.
Variable overhead is a relevant cost because it has to be incurred when executing
the order.
Hire of the special machine is specifically used on the conversion work and
therefore should be included in the relevant cost.
Since the job can be sold as scrap, it would be the revenue foregone if the
conversion work is to be undertaken.
Since the direct workers and supervisor working on the conversion are paid fixed
salaries regardless of output, they are irrelevant in decision making.
All fixed and selling overheads absorbed are regarded as irrelevant in decision
making.

(7)

The production costs recorded in the job card were incurred three months ago are
historical costs, being sunk costs, are irrelevant in decision making.