A Delhi based famous chain of restaurants wishes to undergo upgradation of its kitchen facility for which it has purchased a universal cooking line at an annual cost of ₹ 50,00,000. It also considers an opinion to make the necessary equipment in-house. For its departments involved in decision

Question

A Delhi based famous chain of restaurants wishes to undergo upgradation of its kitchen facility for which it has purchased a universal cooking line at an annual cost of ₹ 50,00,000. It also considers an opinion to make the necessary equipment in-house. For its departments involved in decision making, the annual indirect cost rates and hours plus estimated direct material and direct labor costs are given in Table 15.4. The allocated hours in the table represent the time required to produce the cooking equipment for a year. Parts must be purchased with the following estimates: First cost of ₹ 75,00,000; salvage value of ₹ 1,80,000 and life of 10 years. Evaluate between make or buy decision at market M.A.R.R. of 15% per year.

Table 15.4 In house making cost estimates
Department	Indirect Costs			Direct Material cost	Direct Labor cost
Department	Basis, Hours	Rate per hour	Allocated hours	Direct Material cost	Direct Labor cost
P	Labor	₹ 1,200	20,000	₹ 45,00,000	₹ 45,00,00
Q	Machine	₹ 600	20,000	₹ 2,50,000	₹ 10,00,000
R	Labor	₹ 2,800	8,000	₹ 3,00,000	₹ 5,00,000
			Total	₹ 50,50,000	₹ 60,00,000

Accepted Answer

For making the components in-house, the AOC consists of direct labor, direct material, and indirect costs. We use the data given in Table 15.4 to distribute indirect costs.

Department P: 20,000 (₹ 1,200) = ₹ 2,40,00,000

Department Q: 20,000 (₹ 600) = ₹ 1,20,000

Department R: 8,000 (₹ 2,800) = ₹ 2,24,00,000

Total of these = ₹ 5,84,00,000

AOC = direct labor + direct material + indirect costs

AOC = ₹ 60,00,000 + ₹ 50,50,000 + ₹ 5,84,00,000 = ₹ 6,94,50,000

The make alternative annual worth is the total of capital recovery and AOC

[latex]\begin{array}{l}A W_{ ext {make }}=-P(A / P, i \%, n)+ S (A / F, i \%, n)-A O C \A W_{ ext {make }}=-₹ 75,00,000(A / P, 15 \%, 10)+₹ 1,80,000(A / F, 15 \%, 10)-₹ 6,94,50,000 \A W_{ ext {make }}=-₹ 75,00,000(0.19925)+₹ 1,80,000(0.04925)-₹ 6,94,50,000 \A W_{ ext {make }}=-₹ 7,09,35,510\end{array}[/latex]

Currently, the universal cooking line is purchased at [latex]A W_{ ext {buy }}=-₹ 50,00,000[/latex]. It is cheaper to purchase from outside because the AW of costs is less.

For industries expected to incur high indirect costs, ABC is the best method for the allocation of indirect costs. ABC approach requires identification of activities and cost drivers. Following steps are involved in the implementation of ABC method:

Step 1 Identification of each activity and its associated total cost

Step 2 Identification of the cost drivers and their usage volumes

Step 3 Computation of the overhead rate for each activity using the following relation:

[latex]ABC ext { overhead rate }=\frac{ ext { total cost of activity }}{ ext { total volume of cost drivers }}[/latex] (15.15)

It may be noted that activity refers to support departments or functions, e.g., purchase, quality, personnel, etc. Cost drivers are generally expressed in quantity or volumes, e.g., number of purchase orders, number of construction approvals, number of machine set-ups, etc. To understand this concept, suppose a company makes two models of car (cost centers) and has three primary support departments (activities), that is, purchasing, quality and personnel. Purchasing is an overhead activity with a cost driver of number of purchase orders issued. The ABC allocation rate, in rupees per purchase order, is used to distribute budgeted indirect costs to the two other cost centers. Example 15.9 illustrates the use of ABC method.

Question 15.8: A Delhi based famous chain of restaurants wishes to undergo ...

This Question has been Answered.

Already have an account?

Login

Related Answered Questions