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Q10, May 2009, Q11, Nov 2010, Q6, Nov 2012 ATCO Industries Pvt. Ltd.

manufactures variety of metal products at many factories. Currently, it is experiencing crisis. Management has, therefore, decided to instal detailed expenses control system including responsibility budgets for overhead expense items at each factory. From historical data, Controller developed a standard for each overhead expense item (relating expense to volume of activity). Summarized expenses for Dec 2009 given to concerned Production Supervisor for comments is tabulated. Figures Rs. in lacs Standard Budgeted at Normal at Actual Item Volume (1) Volume (2) Actual Management Supervision 720 720 582 Indirect Labour 12706 11322 12552 Idle Time 420 361 711 Material, Tools 3600 3096 3114 Maintenance, Scrap 14840 13909 17329 Allocated Expenses 21040 21040 21218 Total per ton 2133.04 2193.39 2413.3 (a) Explain the observations from the data given (b) Explain with justification which of the two standards (1) or (2) is more meaningful for expense control. (c)Can the supervisor be held responsible for all overhead expenses included? Why or why not?

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Q10, May 2009, Q11, Nov 2010, Q6, Nov 2012, ATCO ATCO some points before we go to the solution: this problem is similar to the two problems solved earlier in the earlier problems, we ourselves worked out the flex budget; in this case, it has been worked out and given since they are more interested in our analysis than the number working. as explained in the class, we have to make the flex budget with the quantity as in "actual" and with the price/cost as in the "budget (standard budget)"; thereafter find the variances. there seems to be a small error in the problem; the figure of total Rs./ton will be Rs. 2193.39, not Rs. 2103.39; working is given below (don't give much weightage to this since it does not play a big role in our analysis. The working here is on basis of Rs. 2193.03. The term 'Budgeted at actual Volume' is the same as what we refer to as 'Flexible Budget'. As you know, overheads are those costs which we cannot directly relate to the quantity (units) of production. However, if we are able to relate the overheads to certain "activities", then we can break down the overheads under those "activities". In this problem, the activities are those given under the heading "Item". After breaking down the overheads under the heads of these "activiites", the management can analyse the variance more meaningfully. This method is more scientific and appropriate when the quantum of overheads are large. Many companies adopt this method to analyse and control the overheads more closely. This mehod is known as "Activity Based Costing". The details above is just for information; just in case this term comes up in a problem. It does not change the method of the analysis that we have adopted for the earlier two problems. Best method to give comments is to go itemwise thru each item of variance in the Price/Cost Variance and only one item viz., the quantity of the Quantity Variance. They are marked in yellow for your reference. Solution:

(Overall Variance) less

Figures Rs. in lacs Price /Cost F/ Variance A Item Actual Controllable Costs Indirect Labour 12552 Idle Time 711 Material, Tools 3114 Maintenance, Scrap 17329 Total Controllable Costs 33706 Non-Controllable / Allocated Costs Management Supervision 582 Allocated Expenses 21218 Total Non-Controllable / Allocated Costs 21800 Total Overheads Total Rs. per ton Million Tons 55506 2413.30 2.30

(Flex Budget) Budgeted Quantity at Actual Variance Volume (2) 11322 361 3096 13909 28688 720 21040 21760 50448 2193.39 2.30 -1384 -59 -504 -931 -2878 0 0 0

F/ A

Standard at Normal Volume (1) 12706 420 3600 14840 31566 720 21040 21760 53326 2133.04 2.50

Total F/ Variance A

(Qnty Var plus Price Var) check 0.0 0.0 0.0 0.0

1 2 3 4

1230 350 18 3420 5018

A A A A A

F F F F

-154 291 -486 2489 2140

F A F A A

5 6

-138 F 178 A 40 A 5058 A 219.91 A 0

-138 F 178 A 40 A 2180 A 280.26 A -0.2

0.0

-2878 F 60.35 A -0.2 A

0.0 0.0 0.0

a)

For the Production Supervisor, the 'Budget at actual Volume (2)' is more meaningful than 'Standard at Normal Volume'. This is because 'Standard at Normal Volume' mainly brings out that the production fell from 2.50 mn to 2.30 mn; all the other points which concern him are provided through the Flexible Budget. Details given below: (i) Production Level: From the standard budget, it is seen that the unit should have manufactured 2.50 mn tons, against which it has produced 2.30 mn tons (lower by 8%). If this due to lower production despite sales orders, then Production Supervisor is responsible, not otherwise. (ii) Indirect Labour: there is an excess cost of Rs. 1230 lacs, which is very large (9.8% of the flex budget). This indicates that there is a large labour force in employment which is not directly related to the production. May be there is a large amount of labour in maintenance, which is reflected later while examining the maintenance costs. (iii) Idle Time: Cost of idle time is very high with excess cost of Rs. 350 lacs (49% of the budgeted cost. This can indicate that the machines need to be stopped frequently giving rise to a break in production. This is also, perhaps, reflecting why the actual production (2.40 mn tons) has fallen below standard budget of 2.50 mn tons.

Idle time in general suggests poor utilisation of machines. (iv) Material, Tools: (Please note that the material referred to here is not raw materials since we are going through the analysis of overheads). These are other materials and tools which do not directly go into the product; they could be some materials in maintenance. Tools are used for machining in the products. Under this head there is a small variance of less than 1% which may be neglected. (v) Maintenance, Scrap: Under this head, there is a variance of 20%. High maintenance indicates that the machines are frequently having breakdowns. High scrap indicates that the net material consumption is high since for the same production, higher scrap is generated. (vi) Management Supervision: These are the expenses which are incurred on account of supervision by Management and for which the Production Supervisor is not responsible. (vi) Allocated Expenses: Allocated expenses are those expenses which pertain to common expenses which are allocated to the manufacturing unit. For example, the costs of the administration and HR departments, cost of the senior management which may be overviewing other units (corporate costs). The Production supervisor is not responsible for any variance in Management Supervision and Allocated Costs. b The Production supervisor can be held responsible for the following, reason also given: (i) Production level: If production was lower despite adequate sales orders, Production Supervisor is responsible. (ii) (iii) (iv) (v) Indirect Labour: why such high indirect labour is being employed Idle Time: machines not running efficiently Material, Tools: large maintenance related costs Maintenance, Scrap: material input/output ratio is high, which indirectly results in higher raw material consumption. The Production supervisor cannot be held responsible for 'Managemnt Supervision' and the 'Allocated Expenses'. c As regards the comparison between the 'Standard at Normal Value Budget -S1' and 'Budgeted at actual Volume S2', in the current context, it seems that S1 is closer to the actuals since there are two favourable and two unfavourable variances under S1. Under S2, all actuals are adverse; this indicates that S2 Budget needs to be made more realistic. Thus, we may say that S1 is a more realistic budget. Nevertheless, the company must endeavour to improve S2 budget by aligning more relevant activities in the activity Budget.

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