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Case Study: JSW ISPAT Steel

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Namaste.While our continuing of our discussion on marginal costing CVP, BEP, short term decisionmaking we have discussed various cases.Today, let us see how taking a real-life scenario we can compute break-even point or we are able to make some decisions taking the real figures. So, I hope you have taken the print out of this case.Let us try to solve it together.So, we have been given a profit or loss account of JSW Ispat steel.They are primarily operating on two product lines.So, these are the actual figures from P and L net sales, other income, raw material, powerful, employee cost, other manufacturing expenses, selling admin, interest.Then a break up is given about each of these costs because there are two product lines A and B.Cost structure has been estimated that what is a percentage of direct costs.So, the raw material is 100 percent; power 80 percent; employees are 70 percent and so on.Since the costs of selling and admin is given together break up is given for selling 80percent and admin 20 percent.All indirect costs are fixed.Admin overheads are common costs and cannot be linked to any product line. The breakup of other costs is given.So, this particular breakup is not applicable to admin overheads, but for other things, you can break them down as per the given percentage. Now, you are required to compute the following. A few things have been asked like for example, total employee cost broken into product lineA and B; variable admin expenses again are broken; variable selling expenses; operating profit and PV ratio.And, then we have to advise the management on certain short term decisions and compute the resultant operating profit based on those decisions.Now, which product line should be focused if total sales can be increased by 20 percent for any one of the product lines? So, assuming that you cannot go for both the lines any one product line you can increase the sales. So, which one will you focus? And, for that, you have to calculate contribution FC and revised operating profit.In the second part which product line should be focused if direct labour is in short supply. Now, the company proposes to increase the sales of the anyone product line by 20 percent, but they do not have any extra direct labour.So, using direct labour from the other line by cutting down it is direct labour and calculate the incremental contribution etcetera for this decision ok. So, let us go ahead. First of all please do the basic calculation because we know the total information; break it down into product line A and B. Simultaneously, we also have to break down variable and fixed because we know that in marginal costing our emphasis is on segregating variable and fixed costs and we write in a particular format.So, take sales of each line; calculate the variable cost for that line and separate it into A and B; first of all only variable cost, you will get the contribution from contribution to reducing the fixed costs that will give you profit ok.So, please calculate along with me. Now, this is the given data.Do not worry, I will not show you a solution so that you can solve it yourself.I have just shown you the structure. To begin with for current revenue and cost total net sales are given percentages are given. Please apply the percentage and compute the relevant cost for A and B.Now, to do this you will have to, first of all, divide the variable component and then for variable charge it to A and B separately, for fixed charge it to A and B.So, what is the variable component of sales? It is 100 percent and then you will be easily able to charge the sales forA and B. Now, what is the variable component of raw material?Again it is 100 percent; charge it in relevant proportion, getting it?Like that you will have to go ahead.For sales and raw material it is simple, but what will you do with power and fuel? First of all, you will have to look at the variable component which is 80 percent; compute the total VC. So, the total cost is 1193. No problem as far as sales and the raw material is concerned because they were 100 percent variable, but for power 1,993 only 80 percent is variable.So, we have calculated 1595 as a variable portion of power cost and then you can apply it to A and B; are you getting me?The percentage of A and B is given in the problem; for raw material it was 6535 for the power, it was 8020 and so on, getting it?So, what we have done is, first of all, we have calculated the variable component and then80 percent of that was the variable power cost remaining is fixed.So, in sales, nothing is fixed, raw material nothing is fixed, but for power and fuel 399is fixed, getting it?Now, let us do it for all the costs for employee 70 percent is variable.So, you can calculate the total variable and total fixed and then divide it has 119 and64; for employee cost, you know the ratio was 65 to 35.For other manufacturing 60 percent is variable; so, 9564 that 95 is again broken into A and B as 67 and 29.Admin only 10 percent variable; so, 5 VC and 42 FC, it can be broken as 3 and 2; for selling60 percent is variable.So, 111 and 74 divided as 72 and 39.Now, at this stage you will be able to compute the total variable cost for the whole company segregated into A and B, are you able to do it?You can cross-check it for the whole company the total variable cost is 9632 and total fixed cost is 656.VC plus FC will match with the total right.Now, using this data compute the contribution because for most of the decision making contribution calculation is anyway required.So, we will compute the contribution for A is 1268, for B 204, the total for the company is 1473, getting it?We have to make certain decisions on product mix which product to focus on and so on for that, this is useful. Also, let us calculate the PV ratio you know the formula contribution upon sales.So, PVR is 0.16 and 0.06 for A and B and 0.13 average, are you getting me?Now, you can also complete this table for the whole of the company without breaking into fixed and variable.This particular calculation will be useful when the breakup is only product-wise.So, they have given a particular breakup. So, based on that you can break it down into A and B and compute the operating profit from A and B. Please keep in mind that originally there were two more figures given that is other income and interest other income has nothing to do with operations.So, please do not include it in cost calculation; interest is a finance cost.So, that is also not included in cost calculations, but the other cost calculations have been done.Have you got it?Any questions?So, we have separately done for the total cost we have also done it for variable cost.Now, there were few questions which were asked: for current they have asked what is the total employee cost for A and B and also a total of the total?I think since now we have calculated all the costs.You can easily take these figures and go for showing the total employee costs, getting it? The same way you can record calculate the variable admin expenses, variable selling expenses, operating profit and so on.For variable, go to the lower table where we have separately shown the variable costs.So, admin, selling and total, getting it? Operating profit is broken into A and B, here you can take the total operating profit. I hope you are able to do with me and the last one was PV ratio. We have already calculated the PV ratios both for the company as a whole and as per the product line ok. So, you will be able to easily mention the answers for the first part if you do this to working notes carefully.Now, there is a decision making part; this was just the calculation.The decision making part says that which product line should be focused if total sales can be increased by 20 percent for any one of the products.So, out of A and B which product line will you choose? Will you go by operating profit or contribution or sales or PV ratio? Here you can see all the information. I think most of you know that we will emphasis on PV ratio because PV ratio in a scenario of limitation on sales will maximize your contribution.Since fixed costs are anyway going to remain constant we will emphasize on PV ratio and if you look at the PV ratio product line a has a better PV ratio which is 0.16.So, to respond to this question which product line will be focused? The answer is A and now the question is what will be the resultant contribution. So, compute the total contribution and the revised operating profit.Keep in mind that fixed cost is anyway not going to change. So, what is going to change is only your operating only your contribution which will change the operating profit. Now, this product line currently has a contribution of 1268. Just increase the contribution by 20 percent, are you getting it? There is no need to do any other calculation like new sales, new raw material cost, etcetera, because whenever there is an increase in the sale of 20 percent in the same proportion you experience an increase in the contribution.So, compute the revised total contribution. So, what I will do is we will take the current contribution, I think that will clarify it more.So, you are having a total A and B current contributions. Now, the revised total contribution is very simple to calculate.We will continue the current contribution and to that add only 20 percent of A. So, revised total contribution becomes 1726; your current fixed costs which are 656 is unchanged and the revised profit will be new contribution minus fixed costs, so, 1070.What was your old profit?The old profit was 816.Now, this 20 percent increase in sales of A has led to a net profit of 1070, are you getting me? So, the answer was which product line to be focused the answer is A should be focused and the revised profit is 1070.13, fine.Now, in the second part what has been asked is which product line should be focused if labour is in short supply? So, what company wants to do is wanting to increase the sale of one product by cutting down the labour of other product.So, out of the two products A and B which product, first of all, will you prefer? Which product has a more rank? If labour is in short supply.I hope you remember this is called as a decision making with limiting factor or a key factor. So, what will be your decision making factor?In question number 1, we had emphasized on PV ratio, but in scenario 2 since labour is in short supply contribution per direct labour will be your key decision making factor.So, let us calculate the contribution per direct labour cost. We know the contribution individually for A and B. You also know the employee cost now this is the variable portion of employee cost.So, it is nothing, but the direct labour cost.So, you can divide it and get the direct labour cost contribution per direct labour cost directly separately for A and B. you will realize that it is very high for A. So, A continues to be favourite.So, even in the second part, the question was the company proposes to increase the sale of which product line? So, the answer is A and it will increase the sale by 20 percent by cutting down the labour fromB. So, now, you have to calculate what will be the incremental contribution of A and what happens what will be the revised contribution. Now, in B portion what happens is, first of all, revise the sales of A. Your current sales of A is 7773 it will increase by 20 percent.So, you can get new sales of A. When sales increase the VC also increases in the same proportion.Now, this increase in sales comes to A which is 20 percent of sales, it will require extra direct labour hour. So, we have worked out the original direct labour which is 118 revised direct labour will be 142, are you getting me?So, 118 was the original direct labour from our original calculation revised direct labour is to accommodate an extra 20 percent of sales. So, it will now require since it is variable it will require 20 percent more labour which is 142. Now, proportionately, since we want more direct labour to go to A, we will cut down the labour for B in the same proportion in the by the same quantum.So, the original direct labour for B was 63, you can find the difference between the two which is 23; that means, we are going to give 23 more labour to A. Now, the labour is in short supply, it cannot come for free.So, we will reduce the labour from B. So, 63.9 is the original labour for B.We will reduce it by 23 making it only 40 that leads to changed sales for B.So, the original sale for B was 333 point 3331.46.It will substantially come down to 2098; substantially means in the same proportion as we are cutting down the labour, are you getting me?Quantum amount wise it would not be same, but proportionately it is same.So, whatever is the proportion of 40 to 63 same by the same proportion their sales come down that is why the revised sales of B will be 2094 and in the same proportion they would cut down their contribution.So, the original contribution from B which was if you remember our last calculation which was 208, now has come down only to 128.I will show some more calculations for clarity.You can also note their PV ratios and the contribution so, 1522.Those of you want more clarification I have also this was done in a short cut way.If you want to see the full calculation that has also been shown; see, this was the original scenario.Now, product line B is facing a reduction in sales.So, from 3331 it becomes 2094.In the same proportion, all of their variable cost will also come down.So, you can see here there is a reduction in the labour available to them from 63 to40 which is in the ratio 0.62.So, their variable cost will also reduce in the same proportion, the contribution will come down to 128 ok.You can either do it by PV ratio or by contribution to direct labour ratio.So, what happens is direct labour shifted is 24, but the incremental contribution is minus 76; for B there is a loss of 75.82, but for A there is a gain of 253.89.So, the company as a whole gain by 177.87.So, the original operating profit which was 816 will increase by 177 and the revised operating profit is now 994.303.I hope you are getting it?Now, they had asked us to compute a few things as to what will be the revised operating profit. Keep in mind, there is not going to be any change in the fixed costs.Total fixed cost will be same and revised operating profit will be 993.We could do it in two ways. Here we had done it in shortcut directly computing the revised contribution you get operating profit or do this full calculation then also you get revised operating profit as 994. I hope you are getting it? So, in this case, which is like a little detailed case we have seen how from the total you can break down the portion related to A and B; how separately applied for VC and FC and then a decision-making scenario, one with the total change of sales, other with the limiting factor where labour is a limiting factor.I hope this would have been good learning to you. With this we will stop here, Namaste, thank you.