Strategic Cost Management Assignment

Ans 1.

Introduction

Pricing strategy is a critical aspect in any business endeavor as it directly impacts profitability
and market competitiveness. For Shubham Limited, a fashion designing firm, precise
calculation of prices is essential to ensure the financial sustainability of the company and fulfil
the expectations of its customers and stakeholders. The inquiries below will explore various
pricing strategies, each with its unique characteristics and implications. Appropriate application
of these strategies will be determined through careful analysis of cost structures and market
conditions.

Concept and Application

To address each pricing scenario, we will first need to calculate the total production cost of the
25,000 jackets.

1. Cloth: 2,500 reams of cloth at Rs. 4,000 per ream totals Rs. 10,000,000.

2. Threads and other decoration: Rs. 1,250,000.

3. Labour: 5,000 hours at Rs. 500 per hour totals Rs. 2,500,000.

4. Factory overheads: Rs. 800,000.

5. Selling expenses (including delivery charges): Rs. 75,000.

Adding all these costs together, the total cost of production is Rs. 14,625,000.

1. Cost Plus 10% margin on cost: In this pricing strategy, a profit margin is added to the
total cost of producing a product to determine its selling price. The advantage of this
strategy is its simplicity and assurance of a profit margin, though it may not take into
account market conditions or competition.

Total cost: Rs. 14,625,000

Plus 10% margin: Rs. 14,625,000 * 10% = Rs. 1,462,500
Total price: Rs. 16,087,500

Thus, the price per jacket in this scenario would be Rs. 16,087,500 / 25,000 = Rs. 643.50.
 2. Variable cost + 20% margin: This strategy takes into account only the variable costs,
excluding fixed costs. The resulting price can be more competitive, but it may not cover
all the costs in the long term.

Variable costs in this scenario include cloth, threads and other decoration, and labour, totaling
Rs. 13,750,000. Adding a 20% margin gives Rs. 16,500,000.

Thus, the price per jacket in this scenario would be Rs. 16,500,000 / 25,000 = Rs. 660.00.

3. Target profit of Rs. 200 per jacket: In this scenario, we aim for a specific profit per
unit. The PV Ratio, or Profit-Volume Ratio, is a useful tool in cost-volume-profit
analysis, reflecting the change in total contribution margin relative to a change in total
sales revenue.

Adding a profit of Rs. 200 per jacket to the total cost gives Rs. 19,625,000. Thus, the price per
jacket in this scenario would be Rs. 19,625,000 / 25,000 = Rs. 785.00.

The PV ratio is calculated as (Selling Price per unit - Variable Cost per unit) / Selling Price per
unit. The variable cost per unit in this scenario is Rs. 550. Therefore, the PV Ratio is (Rs. 785
- Rs. 550) / Rs. 785 = 0.30, or 30%.

4. Shubham Limited prices it at Rs. 2,400 per jacket: This strategy is called 'premium
pricing'. It involves setting the price of a product higher than similar products. It is used
to boost the product's perceived quality and to establish a high-quality brand image.
This strategy can only be successful if the company has a unique product or if
consumers perceive the product to be worth the higher price.

Conclusion

Each of the pricing strategies discussed above has its own advantages and disadvantages. The
cost-plus pricing ensures a profitable margin but might not consider the competitive landscape.
Variable cost pricing can offer more competitive prices but might not cover all long-term costs.
Target profit pricing allows for specific profit goals, and premium pricing can establish a high-
quality brand image but relies heavily on consumer perception.

Therefore, Shubham Limited must carefully consider its costs, target audience, brand image,
and market conditions when choosing the most appropriate pricing strategy. It's not a one-size-
fits-all decision, and the best strategy may change over time or for different product lines.

Ans 2.
Introduction

Costing is a significant part of managerial decision-making in any manufacturing firm. It

allows managers to estimate the cost of production, determine prices, and analyze profitability.
Two common costing methods used in business are traditional costing and Activity-Based
Costing (ABC). In this essay, we will explore how these methods are applied to M/s Priya
Industries, a manufacturer and seller of lubricants.

Concept: Traditional Costing

Traditional costing, also known as absorption costing or cost-plus costing, is a method where
the manufacturing overhead costs are absorbed into the products based on a single, volume-
related cost driver such as labor hours or machine hours. The idea is to evenly distribute
overhead costs over all products, regardless of the actual resources consumed by each product.

In calculating the cost per unit, the formula is as follows:

Cost per unit = (Total Direct Costs + Allocated Overhead Costs) / Total number of units
produced

Application: Traditional Costing

Given the data provided for M/s Priya Industries, we first need to determine the total direct
costs which include Salaries and Wages, Supervisor Cost, Factory Overheads and Packaging
costs. We then need to allocate these overhead costs based on a cost driver, typically, the
number of units produced.

Summing up the provided costs, we have:

Salaries and Wages = Rs 2,500,000

Supervisor Cost = Rs 75,000
Factory Overheads = Rs 1,000,000
Packaging costs = Rs 600,000
Total Costs = Rs 4,175,000

We'll use the total number of units produced as our cost driver which is 6,000 units. Dividing
the total costs by the total units gives us:

Cost per unit = Rs 4,175,000 / 6,000 = Rs 695.83

Concept: Activity-Based Costing (ABC)

Activity-Based Costing (ABC) is a more sophisticated approach that allocates overhead costs
based on each product’s use of activities. It identifies specific activities related to the production
of each product and then assigns the cost of these activities only to the products that actually
use them. This avoids the shortcomings of traditional costing, making ABC a more accurate
and fair approach in complex environments where products consume resources differently.

The steps to conduct ABC Analysis are:

1. Identify and define activities.

2. Assign costs to activities (Cost Pool).

3. Identify cost drivers for each activity.

4. Calculate a cost rate per cost driver unit.

5. Assign costs to products using the cost driver rate.

Application: Activity-Based Costing

For M/s Priya Industries, we have the following activities and cost drivers:

1. Labour Activity: Cost Driver is Labour Hours

2. Supervisor Activity: Cost Driver is Units Produced

3. Machine Activity: Cost Driver is Machine Hours

4. Packaging Activity: Cost Driver is Packets Produced

We'll first calculate the cost rate per cost driver unit for each activity:

1. Labour Activity: Rs 2,500,000 / 1,000 Labour Hours = Rs 2,500 per Labour Hour

2. Supervisor Activity: Rs 75,000 / 6,000 Units Produced = Rs 12.5 per Unit Produced

3. Machine Activity: Rs 1,000,000 / 1,250 Machine Hours = Rs 800 per Machine Hour

4. Packaging Activity: Rs 600,000 / (Total Units/Units per Packet) = Rs 60,000 per Packet

Then, we'll assign these costs to each product using the cost driver rates.

Conclusion

Traditional costing and ABC are two distinct methods for allocating costs to products.
Traditional costing is simple and less time-consuming but may not provide an accurate picture
of product profitability when different products consume overhead resources at different rates.
ABC, on the other hand, offers a more accurate reflection of resource consumption but can be
more complex and costly to implement.

In the case of M/s Priya Industries, application of both methods will yield different unit costs
for their products. These differences could have significant implications for management
decisions around pricing, product mix, and profitability. Therefore, it is crucial for managers
to understand the strengths and limitations of each method and choose the one that most
accurately reflects their production process and provides the most valuable information for
decision making.

Ans 3a.

Introduction

The preparation of a budgeted profit and loss statement is a critical financial planning exercise
that allows a company to anticipate its expected income, expenses, and profitability for a given
period. A budgeted profit and loss statement, or income statement, is a forward-looking
document that uses estimated sales and costs based on historical data, market research, and
business strategy. It provides a detailed projection of a company's financial health, thereby
enabling decision-makers to plan, monitor, and control the financial resources effectively. This
analysis will be conducted for XYZ Ltd., a company that produces four different products - P,
Q, R, and S.

Concept and Application

To prepare the budgeted profit and loss statement, we need to calculate the revenues, cost of
goods sold (COGS), and overheads for each product.

1. Revenue: Revenue is calculated by multiplying the number of units produced by the

sales price per unit.

2. Cost of Goods Sold (COGS): This comprises the labour costs and raw material costs.
Labour costs per product are calculated by multiplying the labour hours per unit by the
labour cost per hour. Raw material costs per product are found by multiplying the raw
material quantity per unit by the raw material cost per kg.
 3. Overheads: Overheads, which include factory rent and other overheads, are fixed costs
that do not vary with the level of production.

Now, let's proceed with the calculations:

Product P

• Revenue: 50 units x Rs. 700/unit = Rs. 35,000

• Labour cost: 50 units x 10 hours/unit x Rs. 10/hour = Rs. 5,000

• Raw material cost: 50 units x 6 kg/unit x Rs. 25/kg = Rs. 7,500

• Total COGS for P: Rs. 5,000 + Rs. 7,500 = Rs. 12,500

Product Q

• Revenue: 45 units x Rs. 700/unit = Rs. 31,500

• Labour cost: 45 units x 12 hours/unit x Rs. 10/hour = Rs. 5,400

• Raw material cost: 45 units x 5 kg/unit x Rs. 25/kg = Rs. 5,625

• Total COGS for Q: Rs. 5,400 + Rs. 5,625 = Rs. 11,025

Product R

• Revenue: 80 units x Rs. 900/unit = Rs. 72,000

• Labour cost: 80 units x 8 hours/unit x Rs. 10/hour = Rs. 6,400

• Raw material cost: 80 units x 10 kg/unit x Rs. 25/kg = Rs. 20,000

• Total COGS for R: Rs. 6,400 + Rs. 20,000 = Rs. 26,400

Product S

• Revenue: 90 units x Rs. 950/unit = Rs. 85,500

• Labour cost: 90 units x 4 hours/unit x Rs. 10/hour = Rs. 3,600

• Raw material cost: 90 units x 12 kg/unit x Rs. 25/kg = Rs. 27,000

• Total COGS for S: Rs. 3,600 + Rs. 27,000 = Rs. 30,600

Next, we calculate the total revenue, total COGS, and overheads for XYZ Ltd.:
 • Total Revenue: Rs. 35,000 (P) + Rs. 31,500 (Q) + Rs. 72,000 (R) + Rs. 85,500 (S) =
Rs. 224,000

• Total COGS: Rs. 12,500 (P) + Rs. 11,025 (Q) + Rs. 26,400 (R) + Rs. 30,600 (S) = Rs.
80,525

• Total Overheads: Rs. 1,00,000 (Factory Rent) + Rs. 20,000 (Other Overheads) = Rs.
1,20,000

Finally, we calculate the budgeted profit by subtracting the total COGS and total overheads
from the total revenue:

Budgeted Profit = Total Revenue - Total COGS - Total Overheads = Rs. 224,000 - Rs. 80,525
- Rs. 1,20,000 = Rs. 23,475

Conclusion

After careful calculation and analysis, the budgeted profit for XYZ Ltd. for the year,
considering the sales and cost variables provided for products P, Q, R, and S, is estimated to be
Rs. 23,475. This budgeted profit and loss statement can help XYZ Ltd. plan and control its
resources, set performance standards, and make strategic decisions toincrease the company's
profitability. It's important to remember, however, that this is a projected figure. Actual results
may vary depending on a range of factors, including market conditions, operational
efficiencies, and managerial effectiveness. Thus, XYZ Ltd. should consider this as a guide,
periodically reviewing and revising its budget as needed to reflect the company's changing
circumstances.

This analysis underscores the importance of strategic budgeting in business operations. By

understanding the costs associated with producing each product and the revenue each product
generates, businesses can make informed decisions about where to allocate resources for
maximum profitability. It's worth noting that budgeting is not a one-time exercise but a
continuous process of planning, implementation, and control. Regular monitoring of the budget
helps in identifying deviations between the planned and actual results and taking corrective
actions promptly.

Also, it's important to note that while we have treated overheads as fixed for the purpose of this
exercise, in reality, some overheads may behave as semi-variable costs, changing with the level
of production but not always in direct proportion. The approach to handling such costs would
need to be more nuanced.

In conclusion, the budgeted profit and loss statement is a crucial planning tool that helps
businesses anticipate future financial performance, manage resources effectively, and strategize
for profitability and growth. For XYZ Ltd., the projected profit of Rs. 23,475 provides a
valuable benchmark against which to measure actual performance, identify potential
challenges and opportunities, and guide strategic decision-making.

Ans 3b.

Introduction

Profit and loss statements are essential financial documents that provide comprehensive details
about a company's revenues, costs, and net income during a specific period. They play a pivotal
role in helping stakeholders understand the financial health and performance of an enterprise.
In this analysis, we will delve into the profit and loss statement of SRT & Co., using it to
calculate the contribution per unit, the profit/volume (P/V) ratio, and the number of units that
must be sold to earn a profit of Rs. 70,000. These metrics are crucial for understanding a
company's break-even point, cost structure, and profitability potential, and they provide
valuable insights for strategic decision-making.

Concept and Application

1. Contribution Per Unit: The contribution margin per unit is the selling price per unit
minus the variable cost per unit. It represents the amount each unit contributes to
covering fixed costs and then generating profit.

2. P/V Ratio: Also known as the contribution margin ratio, the P/V ratio is the ratio of the
contribution margin to the sales revenue. It provides a measure of the profitability for
each unit of sales and indicates how changes in sales volume will affect profits.

3. Number of Units to Be Sold for a Specific Profit: This can be calculated by adding
the desired profit to the fixed costs and then dividing the result by the contribution per
unit. This gives the number of units that need to be sold to cover all costs and achieve
the targeted profit.

Now, let's apply these concepts to the data from SRT & Co.
a) Contribution per unit: To calculate this, we first need to determine the total variable cost
and the variable cost per unit.

• Total variable cost is the sum of the raw material cost, labour cost, and variable
overheads, which is Rs. 250,000 + Rs. 345,000 + Rs. 150,000 = Rs. 745,000.

• Variable cost per unit is the total variable cost divided by the number of units sold,
which is Rs. 745,000 / 25,000 units = Rs. 29.8 per unit.

• Now, we can calculate the contribution per unit, which is the sales price per unit minus
the variable cost per unit. That's Rs. 50 - Rs. 29.8 = Rs. 20.2 per unit.

b) P/V Ratio: The P/V ratio is the contribution per unit divided by the selling price per unit,
multiplied by 100 to get a percentage. That's Rs. 20.2 / Rs. 50 * 100 = 40.4%.

c) Number of units to be sold for a profit of Rs. 70,000: To calculate this, we add the desired
profit to the fixed costs and divide by the contribution per unit.

• The total amount to be covered is the fixed costs plus the desired profit, which is Rs.
400,000 + Rs. 70,000 = Rs. 470,000.

• The number of units to be sold is this total divided by the contribution per unit, which
is Rs. 470,000 / Rs. 20.2 = approximately 23,267 units. Since we cannot sell a fraction
of a unit, we round up to the nearest whole unit, so SRT & Co. would need to sell 23,268
units to achieve a profit of Rs. 70,000.

Conclusion

The analysis of SRT & Co.'s profit and loss statement reveals significant insights about the
company's cost structure and profitability potential. The contribution margin per unit of Rs.
20.2 indicates that for each unit sold, Rs. 20.2 goes towards covering the fixed costs and
generating profit. The P/V ratio of 40.4% shows that for each rupee of sales, the company
makes a profit contribution of 40.4 paise. Lastly, to achieve a profit of Rs. 70,000, the company
must sell 23,268 units.

These metrics are crucial for strategic decision-making. For instance, understanding the
contribution per unit can help the company set optimal pricing and sales strategies. The P/V
ratio provides insight into how changes in sales volume will affect profits, which is vital for
forecasting and planning. Furthermore, knowing the number of units needed to achieve a
specific profit can guide production and sales targets.
However, it's essential to remember that these calculations are based on several assumptions,
including that costs are divided neatly into fixed and variable components, and that these per-
unit costs remain constant. In reality, costs can behave differently, and managers need to be
aware of this while making decisions based on these metrics.

In summary, while the profit and loss statement provides a snapshot of a company's financial
performance over a period, the derived metrics like contribution per unit, P/V ratio, and
breakeven point offer valuable insights that can drive strategic decisions to enhance
profitability and business growth. For SRT & Co., these metrics serve asguidelines that can
guide their pricing, production, and sales strategies, ultimately leading to improved financial
performance.

By understanding the contribution margin per unit, the company can better appreciate how each
unit sold contributes to covering fixed costs and generating profits. This can inform pricing
strategies and help manage variable costs more effectively. Similarly, understanding the P/V
ratio provides insights into the relationship between profits and sales volume, enabling the
company to forecast profits based on projected sales volumes effectively.

Moreover, knowing the number of units needed to achieve a specific profit level enables the
company to set more accurate sales and production targets. For SRT & Co., knowing that
23,268 units need to be sold to achieve a profit of Rs. 70,000 can guide their production
planning and sales effort.

However, while these metrics are insightful, they are not without their limitations. They are
based on the assumption that costs can be neatly categorized into fixed and variable costs and
that these costs per unit remain constant. In the real world, however, costs may not always
behave this way. Costs can have elements of both fixed and variable components (semi-variable
costs), and per-unit costs may not remain constant due to factors like economies of scale.

Furthermore, these metrics do not consider other factors that could influence profitability, such
as changes in market demand, competitor actions, or changes in the broader economic
environment. Therefore, while these metrics provide valuable insights, they should be used as
part of a broader set of tools for financial analysis and decision-making.

In conclusion, a thorough understanding of the profit and loss statement and the derived metrics
of contribution per unit, P/V ratio, and the number of units to be sold for a specific profit is
crucial for strategic decision-making in any company. For SRT & Co., these insights can inform
their pricing, production, and sales strategies, ultimately leading to improved financial
performance. However, these metrics should be used with an understanding of their limitations
and in conjunction with other financial analysis tools to form a comprehensive understanding
of the company's financial health and profitability.