A factory is currently working at 60% capacity and produces 12,000 units of a product. Management is thinking to increase the working capacity…

CA Intermediate · Cost and Management Accounting · PYQS · May 2024
A factory is currently working at 60% capacity and produces 12,000 units of a product. Management is thinking to increase the working capacity either to 70% or 90% level. It is estimated that at both the levels, it will be able to sell all the produced units. The other details are as under: At 70% capacity, the cost of raw materials increases by 4% and the selling price falls by 3%.At 90% capacity, the cost of raw materials increases by 5% and selling price falls by 4%.At 60% capacity, the product cost is 360 per unit and it is sold at 400 per unit.The unit cost of 360 consists of the following: Material 200 Labour 60 Factory overhead 60 (50% fixed) Administrative & Selling overhead 40 (60% fixed) Additional advertising cost of 20,000 is to be incurred for selling the product above 80% capacity. You are required to: (i) Calculate the profits of the company when the factory works at 60%, 70% and 90% capacity level. (ii) Offer your comments regarding increase in the capacity based on profit calculated.

Suggested Answer and Working Notes:

(i) Expense Budget at 60%, 70% & 90% level 60% (12,000 units) 70% (14,000 units) 90% (18,000 units) Per unit (₹) Amount (₹) Per unit (₹) Amount (₹) Per unit (₹) Amount (₹) Sales (A) 400 48,00,000 388 54,32,000 384 69,12,000 Variable Costs: Direct Material 200 24,00,000 208 29,12,000 210 37,80,000 Direct Wages 60 7,20,000 60 8,40,000 60 10,80,000 Variable Factory Overheads 30 3,60,000 30 4,20,000 30 5,40,000 Variable Administrative & Selling Overheads 16 1,92,000 16 2,24,000 16 2,88,000 Total Variable Cost (B) 306 36,72,000 314 43,96,000 316 56,88,000 Contribution (C) = (A-B) 94 11,28,000 74 10,36,000 68 12,24,000 Fixed Costs: Fixed Factory Overheads (50%) -- 3,60,000 -- 3,60,000 -- 3,60,000 Fixed Administrative & Selling Overheads (60%) -- 2,88,000 -- 2,88,000 -- 2,88,000 Adverting Cost -- -- -- -- -- 20,000 Total Fixed Costs (D) -- 6,48,000 -- 6,48,000 -- 6,68,000 Profit (C – D) 4,80,000 3,88,000 5,56,000 (ii) Comment: Increase of production capacity to 90% is likely to increase the profit to maximum of 5,56,000 due to increase in contribution while fixed cost is slightly increased due to in advertising cost. At 70% capacity, profit is reduced to minimum of 3,88,00 due to decrease in selling price by 3% along with increase in raw material cost by 4% resulting in decrease of contribution. Therefore, it is recommended that factory should operate at 90% capacity.

Topics: Budgets and Budgetary Control

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