Understanding the meaning of Learning Curve. Understanding the meaning of Learning Curve Effect. Feature and Limitations of Learning Curve Theory.

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1 C H A P T E R 15 Learning Curve Learning Objectives: Understanding the meaning of Learning Curve. Understanding the meaning of Learning Curve Effect. Feature and Limitations of Learning Curve Theory. Past Examinations Coverage: Year N-13 M-13 N-12 M-12 N-11 M-11 N-10 N-10* M-10 M-10* Q No (b) - 7 (b) 1 (c) 4 (a) - Marks # - 4 # Year N-09 N-09* J-09 J-09* N-08* M-08 N-07 M-07 N-06 M-06 Q No. 6 (c) 1(c) - 1(c) 1 (b) 2 (c) 2(b) 5 (c) 3 (c) 6 (c) Marks 6 4 # # 4 # 2 # 4 # Year N-05 M-05 N-04 M-04 N-03 M-03 N-02 M-02 N-01 M-01 Q No. - 3 (b) - 3 (b) - 4 (a) 5 (b) Marks # - 4 # Year N-00 M-00 N-99 M-99 N-98 M-98 N-97 M-97 N-96 M-96 Q No Marks CA. B L Chakravarti (FCA, CPA, CAIIB) Page 15.1

2 Advance Management Accounting Learning Curve Theory The Theory of learning curve was first introduced by T.P. Wright of Curtiss Wright, Buffalo, U.S.A. engaged in production of airframes. As the production quantity of a given item doubled, the cost of that item decrease at a fixed rate. This phenomenon is the basic premise on which the theory of learning curve has been formulated. The key words, doubled and rate are important as the quantity produced doubles, the absolute amount of cost increase will be successively smaller but the rate of decrease will remain fixed. This is the essence of the learning curve theory. Distinctive Features of Learning Curve Theory in manufacturing environment: (i) Better tooling methods are developed and used; (ii) More productive equipments are designed and used to make the product; (iii) Designed bugs are detected and corrected; (iv) Engineering changes decrease over the time. Designed engineering are prompted to achieve better design for reducing material and labour cost. (v) (v) Earlier teething problems are overcome. As the product involves monthly, management is prompted to strive for better planning and better management. (vi) Rejections and rework tend to diminish over time. There happen a significant influence of all these features on labour as the quantity produced increases and the cost per unit drops. The reasons for this are that each unit will entail: (a) less labour; (b) less material; (c) more units produced from the same equipments; (d) cost of fewer delays and less loss time. Every Time Study engineer or industrial engineer experienced in work measurement has seen this phenomenon happening. Learning curve applications are fast growing with time in manufacturing environment. A company should never blindly adopt another company's learning curve. The product approach for a company should be to develop knowledge of its own learning preference in its plant. Learning Curve Effect Learning is the process during which a person acquires the skill to do a job. When a job is taken up for the first time, the worker is new to the job and he takes considerable time to complete it because his performance is not at its best. But, when the same job is repeated he is able to improve his performance because of the skill he has acquired by doing a similar job earlier. This phenomenon is known as learning effect. It applies only to labour oriented operations. Learning Curve Learning curve is a geometrical progression, which reveals that there is steadily decreasing cost for the accomplishment of a given repetitive operation, as the identical operation is increasingly repeated. The amount of decrease will be less and less with each successive unit produced. The slope of the decision curve is expressed 1. Page 15.2

3 Learning Curve as a percentage. The other names given to learning curve are Experience curve, Improvement curve and Progress curve. The Learning Curve Ratio In the initial stage of a new product or a new process, the learning effect pattern is so regular that the rate of decline established at the outset can be used to predict labour cost well in advance. The effect of experience on cost is summaries in the learning ratio or improvement ratio: Average labour cost of first 2N units Average labour cost of first N units Learning Curve Equation Mathematicians have been able to express relationship in equations. The basic equation is Y = ax b Where, X is the cumulative number of units or lots produced Y is the cumulative average unit cost of those units X or lots. a is the average cost of the first unit or lots is the improvement exponent or the learning coefficient or the index of learning which is calculated as follows: b = log of learning ratio / log 2 Uses of Learning curve: 1) To analyse CVP Relationship during familiarization phase: Learning curve helps to analyse costvolume-profit relationship during familiarization phase of product or process and thus it is very useful for cost estimates. Learning curve is of immense value as a tool for forecasting. 2) Budgeting and Profit Planning: Budget executive should select those costs which reflect learning effect and then he should be able to incorporate this effect in process of developing budgets or in the exercises relating to project planning. 3) Pricing: The use of cost data adjusted for learning effect helps in development of advantageous pricing policy. 4) Design makers: It helps design engineers in making decisions based upon expected (predictable from past experience) rates of improvement. 5) Negotiations: It is very helpful to Government in negotiations about the contracts. Government receives full advantage of the decreasing unit cost in establishing the contract price. 6) Setting Standards: The learning curve is extremely useful in setting standards in learning phase. Limitations of Learning Curve: 1. All activities of a firm are not subject to learning effect i.e. activities being performed by already experienced workmen, thoroughly familiar with all activities, activities where workers are shifted even before completion of one unit of work etc. 2. The following types of activities are subject to learning effect: CA. B L Chakravarti (FCA, CPA, CAIIB) Page 15.3

4 Advance Management Accounting (a) Those that have not been performed in this present operational mode. (b) Those which are being performed by new workmen, new employees or others not familiar with the particular activity. In contrast, activities being performed by experienced workmen, who are thoroughly familiar with those activities will not be subject to learning effect. (c) Those involving utilization of material not used by firm so far. 3. It is correct that learning effect does take place and average time taken is likely to reduce. But in practice it is highly unlikely that there will be a regular consistent rate of decrease, as exemplified earlier. Therefore any cost predictions based on covernational learning curves should be viewed with caution. 4. Considerable difficulty arises in obtaining valid data, that will form basis for computation of learning effect. 5. Even slight change in circumstances quickly renders the learning curve obsolete. While the regularity of conventional learning curves can be questioned, it would be wrong to ignore learning effect altogether in predicting future costs for decision purposes Page 15.4

5 Learning Curve Previous Examinations :- Theoretical Questions Q: What are the limitations of the learning curve theory? [N11, 7b, 4M] Q: Explain distinctive features of learning curve theory in manufacturing environment. [N10, 7b, 4M] Q: [SA-2] [N09*, 1c, 4M] The following information is provided by a firm. The factory manager wants to use appropriate average learning rate on activities, so that he may forecast costs and prices for certain levels of activity. (i) A set of very experienced people feed data into the computer for processing inventory records in the factory. The manager wishes to apply 80% learning rate on data entry and calculation of inventory. (ii) A new type of machinery is to be installed in the factory. This is patented process and the output may take a year for full fledged production. The factory manager wants to use a learning rate on the workers at the new machine. (iii) An operation uses contract labour. The contractor shifts people among various jobs once in two days. The labour force performs one task in 3 days. The manager wants to apply an average learning rate for these worker You are required to advise to the manager with reasons on the applicability of the learning curve theory on the above information. Q. What are the distinctive features of learning curve theory in manufacturing environment? Explain the learning curve ratio. [N07, 2b, 9M] Q. Discuss the application of the learning curve. [M07, 5c, 4M] Q: Briefly explain the learning curve ratio [N06, 3c, 2M] Q: Explain the concept Learning Curve. How can it be applied for Cost Management? [RTP M 09] [M06, 6c, 4M] Q: Explain the concept Learning Curve and discuss its relevance to pricing decision [M04, 3b, 4M] Q: State the areas in which the application of Learning Curve theory can help a manufacturing organization [M03, 4a, 4M] CA. B L Chakravarti (FCA, CPA, CAIIB) Page 15.5

6 Advance Management Accounting Practical Questions P1: [SM-1] [SA-3] XYZ Co. has observed that a 90% learning curve ratio applies to all labour related costs each time a new model enters production. It is anticipated that 320 units will be manufactured during Direct labour cost for the first lot of 10 units amounts to 1,000 hours at 8 per hour. Variable overhead cost is assigned to products at the rate of 2 per direct labour hour. You are required to determine: i. Total labour and labour-related costs to manufacture 320 units of output. ii. Average cost of (a) the first 40 units produced (b) the first 80 units, (c) the first 100 units. iii. Incremental cost of (a) units and (b) units [Ans: ] P2: [SM-2] [SA-4] Illustrate the use of learning curves for calculating the expected average unit cost of making using the data below for: (a) 4 machines (b) 8 machines (i) Direct labour needed to make first machine 1,000 hours (ii) Learning curve = 90% (iii) Direct labour cost 15/per hour (iv) Direct materials cost 1,50,000 (v) Fixed cost for either size orders 60,000. P3: [SA-25] A company manufactures specialized equipment. Direct labour required to make the first equipment in 2000 hours Learning curve is 80%. Direct Labour Cost is 4 per hour. Direct Material needed for one equipment is 7,200 and Fixed Overhead is 32,000. Required: (i) Using the Learning Curve Concept, calculate the expected average unit cost of making (a) 4 equipment, (b) 8 equipment. (ii) After manufacturing 8 equipments, if a repeat order for manufacturing another 8 equipments is received, what lowest price can be quoted for the repeat order? 1. Page 15.6

7 Learning Curve P4: [SM-3] [SA-5] XYZ & Co. has given the following data: 80% Average Time Curve Cumulative Units (x) Average Hours Total Hours Marginal Hours ??? ? You are required to fill in the blanks P5: [SM-4] [SA-6] A customer has asked your company to prepare a bid on supplying 800 units of a new product. Production will be in batches of 100 units. You estimate that costs for the first batch of 100 units will average 100 a unit. You also expect that a 90% learning curve will apply to the cumulative labour cost on this contract. Required: a) Prepare an estimate of the labour costs of fulfilling this contract. b) Estimate the incremental labour cost of extending the production run to produce an additional 800 units. c) Estimate the incremental labour cost of extending the production run from 800 units to 900 units. P6: [SA-14] a) Your company has been approached by a customer to supply four units of a new product made to the customer s individual specification. The company experiences a 90% learning rate. The estimated labour time for the first unit of this product is 150 hours and the company s direct labour cost is Rs. 5 per hour. Estimate the labour cost for this order. b) After receiving the first order, if the customer places a repeat order, what will be the labour cost for the second order? c) If the customer had ordered all eight units at the same time, calculate the labour cost per unit for the combined order. [Ans.: (a) 2430 (b) 1944 (c) 4374] CA. B L Chakravarti (FCA, CPA, CAIIB) Page 15.7

8 Advance Management Accounting P7: [SA-13] ABC Co. Ltd. has observed that a 80% learning curve ratio applies to all labour-related costs relating Model X, which has been recently introduced in the market. It is expected that first unit will take a time of 10 minutes. What is the expected time per unit (i) when cumulative production is 20 units, and (ii) when cumulative production is 10 units? [Ans.: (i) minutes & (ii) minutes] P8: [SA-7] [SA-24] A Company with two production department has set the following standard for the forthcoming year: Department S Department W Direct labour hours available per period Standard wage rate per hour 6 5 Expected learning curve 80% 70% Standard Variable overhead per hour 9 5 Standard fixed overhead per hour 12 8 Direct Labour Hours required for first unit in lot of 100 units 18 9 The Direct materials are introduced in Department S. The company is able to negotiate the following prices for purchase of direct materials during the year. Level of Output Price of Direct Materials (Units) per unit of output Overtime, if required is paid at the time and a half. The overhead rates as given above does not include overtime premium. It is policy of the company to add profit margin as under in quoting the prices: Department Percentage on total labour and overhead cost S 25% W 15% Subcontracted Work 5% on subcontracted price The Company has received a special order. Special tooling cost of the order amount to 1,200. If this order is for 200 units or less, it will be executed in the period which has a work load of 3840 direct labour hours in Department S and 2100 direct labour hours in Department W. For the work, which is done in Department W. A subcontract, an associate company quotes price of 50 per unit. Required: 1. Page 15.8

9 Learning Curve 1) If the company decided to get the work executed entirely with in the company, what price, on cost plus basis, should be quoted for the order, if it consist of 100 units, 200 units 2) Assuming that the initial order placed by the customer is for 200 units, What lowest price should be quoted for a repeat order of 600 units? Assume that this order will be executed when there are no capacity constraints 3) State the output level at which the company should close down Department W to get the work executed through subcontractor P9: [SA-8] Godrej Appliance Ltd. makes household appliances. It is now examining a three-year old contract to make electrical bread toasters for sale through a departmental store. During the entire contract period, it will receive for its toaster a fixed price of 40 per piece for whatever quantities it can produce in 3 years. Skilled labour is the constraint and this cannot be increased above that currently available in the Company for making the toaster. Capital investment required 50,000 payable down cash with nil scrap value. Additional overhead 25,000 per annum Material 30 per toaster Labour (skilled) 5 per hour. The production manager envisages a learning curve effect for labour in the form of y = at x -0.3 where y = average labour hour per unit, a = labour hours per first unit and x = cumulative production. He estimates that the first toaster will take 10 hours to produce and the fixed amount of skilled labour available will enable 5000 toasters to be produced in the first year. Assume all cash inflows to arise at year end and the cost of capital is 15%. What is your advice? [Ans: ] P10: [SA-17] You have been asked to give a quote for the production of 50 units of a new product. Estimates for the assembly of the first units are: Direct materials 100 Direct Labour 50 Variable overheads 30 Notes: 1. Labour costs are 5 an hour. 2. Variance overhead is based on labour hours (activity based) at a rate of 3 per labour hour. CA. B L Chakravarti (FCA, CPA, CAIIB) Page 15.9

10 Advance Management Accounting 3. The company quotes prices on a 20 per cent mark-up on the estimated costs to cover fixed overheads and profits. 4. The company operates an 80 % learning curve. (i) The company wishes to estimate the marginal cost of making the 50 units and hence calculate the quoted price per unit. (ii) What will be the impact, if the company decides to ignore the learning curve effect? Present comparative data showing the price per unit. [Ans: P11: [RTP M05 #] [SA-9], Engine Ltd manufactures engine mounting for wide bodied airlines, They have been asked to bid on a prospective contract for 90 engine mounting for the Jumbo Jet aircraft. They have just completed an initial run of 30 of these mountings at the following cost: Direct materials 20,000 Direct Labour: per hour 24,000 Variable overheads ( 0.50 per Labour Hr) 3,000 Special tools (re-usable) 3,000 Fixed overheads apportioned 6,000 Total 56,000 At 80% learning curve is thought to be pertinent in this case. The marketing director believes that the quotation is unlikely to be accepted if it exceeds 1,10,000 and as the company are short of work, he believe the contract to be vital. You are required to comment whether is it worth accepting at 1,10,000. State assumption clearly. [Ans:-(i) , (ii) ] P12: [SA-23] An electronics firm has developed a new type of fire alarm system. A first unit assembled has a material cost of 18,000 and took 400 hours of direct labour to assemble. Labour rate is 25 per hour. This type of assembly is known to experience a learning curve effect of 80% (index of learning = ). Demonstration of this unit to potential customers resulted in an order of 20 units during the next quarter. The firm wishes to popularize this system and will therefore pass on the benefit of cost savings due to learning effect to the customers while settling the sale price. (i) Determine the price to be set for the first lot 20 units to be sold. The initial unit will not be sold as this is required for demonstrations. The firm follows a practice of imputing a fixed overhead at 125% of direct labour cost and will set the selling price to earn a 20% gross margin on sale price. (ii) Assume that a further order for a lot of 60 units was received on a contract basis from a single customer. The price was set on the basis of the contracted total. However, after delivery of 30 units 1. Page 15.10

11 Learning Curve against the contract, the contract was cancelled. Determine the deferred learning cost that may have to be written-off consequent to the cancellation of contract for balance not supplied. P13: [ICWA Jun 00] [SA-10] [SA-20] A company has accepted an order for making 15 items of a specialized machine at a price of 4 lacs each. The delivery is to be completed within 4 months. The company works 23 days a month and the normal direct wages per day amounts to However, in case of need, the company can work overtime up to 8 days during the said period at double the normal rate of wages. Overheads amount to per normal working day but no overheads are charged on overtime working days. The material cost is per machine. The company has estimated that it will take 10 working days to manufacture the first machine. The company is expected to experience a learning effect of 90% (b=-0.152). The contract stipulates a penalty of per machine delivered beyond the schedule of 4 months. You are required to calculate the costs and advise the company whether it is preferable to work only during normal working days and pay penalty for any delayed delivery of the machines or to work overtime to avoid paying penalty P14: [SA-26] A company has designed a Prototype Electronic Starter for which the following information are available: Direct Labour 260 Hours Direct Material Cost 30,000 Direct Labour Rate 20 per hour Variable overheads 130% of direct labour Fixed overheads 70% of direct labour Based on the demonstration of the prototype, the company has received order for 50 units during first six months and another 75 units during the following six months thereafter. A learning curve effect of 80% is applicable. It is expected that in view of large volume, a 5% discount on material cost will be available inn first six months and a 10% discount thereafter. The rates of overhead will remain unchanged and the same percentage would apply. The company sets the selling price with a 40% mark upon cost. Determine the selling price per unit for the first 50 units and the next 75 units. (The index of learning rate of learning curve effect of 80% is ) CA. B L Chakravarti (FCA, CPA, CAIIB) Page 15.11

12 Advance Management Accounting P15: [SA-22] SV Ltd, which has a fairy full order book is approached by a customer with the offer of a contract for a model that is a variant, in terms of dimensions and material used, of one of its existing products. Though the customer expects to pay a normal price for the model, he wants SV Ltd. To take account of an 80% learning curve in its price calculation; this level has been shown to be reasonable in SV Ltd s industry for relevant work. The Prospective contract is for a total 464 units made up of an initial order of 160 units, two subsequent orders of 80 units each, and three subsequent orders of 48 units each. SV Ltd. Estimates the following costs for the initial order: Direct Materials: P per mtr. Q per kg. Direct Wages: Department Hours per hour Variable overhead: 20% of direct wages Fixed overhead: Department per hour The nature of the work in the three production departments is as follows: Department 1 uses highly automatic machines. Although the operators on these machines need to be fairly skilled. Their efficiency only affects the quality of the work but can have little impact on the quantity of his department s output which is largely machine-controlled. Department 2 is partially mechanized, whilst Department 3 is an assembly department. In both departments 2 and 3 the skill of operators is a major determinant of the volume of output. The terms of the contract price allow for: Direct materials cost plus 2% profit margin Conversion cost plus 12% profit margin You are required to calculate the price per unit for: (i) the initial order of 160 units (ii) the second, third and fourth orders, if given successively but without guarantee of further orders, and (iii) the whole contract of six orders it given from the start but on the same basis of production and delivery. Note: An 80% learning curve on ordinary graph paper would show the following relationship between the X- axis (volume) and Y-axis (cumulative average price of elements subjects to the learning cure): 1. Page 15.12

13 X Y% X Y% Learning Curve [Ans: ] P16: [RTP N11, N10, M10*] [SA-28] In your company, production manager has observed that learning curve theory is very much applicable in the newly procured 90%. A batch of production is of 100 units. The average labour cost for the first batch is R 200. Material Cost and Overhead are R 150 and R 50 per unit respectively. If Profit Margin is 25% on cost, estimate the price per unit if the order size is for (a) 800 Units and (b) 1600 units (c) 2000 units P17: [RTP M11] [SA-27] A Company has developed an Electronic gadget. Material cost per unit Rs 20,000. The assembling of the product follows a learning curve of 80% i.e Learning curve index The first unit was produced for demonstration purpose which consumed 200 labour Rs 200. Seeing the demo, one party gave order of 20 units. The company offered a rate based on labour hours required, charging production overheads of 120% of labour cost and 20% profit on price quoted. The company supplied the 20 units with full satisfaction of the party. Subsequently, another party placed an order for 50 units on the basis of the quotation placed by the company according to the above pricing policy. After receiving the supply of half of the quantity, the second party cancelled the order for balance qty.first unit produced will be preserved for demonstration and will not be sold. Calculate the profit in supplying 25 units to the second party. CA. B L Chakravarti (FCA, CPA, CAIIB) Page 15.13

14 Advance Management Accounting P18: [RTP N08, M 08*] A company developed and manufactured a new machine. The manufacture of the first machine took 800 direct labour hour The direct wages rate is 20 per hour. The company experienced a learning curve effect of 80% (index is ). The first piece was used as a demonstration piece and was not intended for sale. On the basis of the demonstration, the company obtained an order for the manufacture of 20 machines. The direct material cost is 16,000 per machine. The variable overhead rate is 25 per direct labour hour. The fixed overheads on absorption costing amounted to 40 per direct labour hour. The selling price is to include a profit margin of 20% on selling price. Subsequently, after the delivery of the 20 machines, the company received a repeat order for supply of 30 machines. Required: i. Calculate the selling price per machine of the first lot of 20 machines. ii. What reduction in selling price can the company allow in respect of the repeat order? P19: [RTP M06] A Company has made 6000 units of a product. The labour content to make each thousand unit is as follows Unit No Labour Content (000) (person-hr) ) Estimate the learning rate for this product using 1000 units of the product as the unit of production. 2) Predict the Labour requirements to make the next 2000 units. P20: [RTP May 2005] A company has just completed the manufacture of 40 units of a new product. The manufacturing costs are as under: Direct materials 2,00,000 Direct Labour: per hour 1,60,000 Variable overheads 80,000 Special tools (re-usable) 10,000 Fixed overheads apportioned 1,00,000 Total 5,50, Page 15.14

15 Learning Curve The company s policy is to add a profit of 12% on selling price. The company received another order for 120 units of this product for which the company quoted, based on its policy on absorption cost basis, a price of 15,625 per unit. The customer struck the order to 11,000 per unit. The company is short of work and so is keen to take up more orders but it is reluctant to accept this order price because it is against the policy to accept any price before its cost. The company experiences is learning curve of 90%. Required: i. Compute the gain or loss arising from acceptance of the order at 11,000 per unit. ii. Advise whether the company should accept this order for 120 units or not. CA. B L Chakravarti (FCA, CPA, CAIIB) Page 15.15

16 Advance Management Accounting Practical Questions Previous Examinations Q 1: [Nov 10*, 1c, 12M] A factory has a special offer to produce 4 units of a labour intensive product by using its existing facilities after the regular shift timings. The product can be produced by using only overtime hours which entails normal rate plus 25%, so that usual production is not affected. Two workers are interested in taking up this additional job every evening after their usual shift is over. One is an experienced man who has been working on a similar product. His normal wages are 48 per hour. The other worker is a new person who earns ` 42 an hour as normal wages. He can be safely considered to have a learning curve ratio of 90% for this work. The company wants to minimize labour cost for the order and only one person is to be chosen for the job. The experienced man will take 20 hours for the first unit while the new worker will take 30 hours for the first unit. Evaluate who should be chosen for the job. [Ans: ] Q 2: [May 10, 4a, 11M] [May 05, 3b, 8M] [RTP Nov 09] [SA-12] An electronics firm which has developed a new type of fire-alarm system has been asked to quote for a prospective contract. The customer requires separate price quotations for each of the following possible orders: Order Number of fire-alarm systems First 100 Second 60 Third 40 The firm estimates the following cost per unit for the first order: Direct Materials 500 Direct Labour Deptt. A (Highly automatic) 20 hours at 10 per hour. Deptt. B (Skilled labour) 40 hours at 15 per hour. Variable overheads absorbed 20% of direct labour Fixed overheads absorbed Deptt. A 8 per hour Deptt. B 5 per hour Determine a price per unit for each of the three orders, assuming the firm uses a markup of 25% on total costs and allows for an 80% learning curve. Extract from 80% learning curve table: X Y (%) X represents the cumulative total volume produced to date expressed as a multiple of the initial order. Y is the learning curve factor, for a given X value, expressed as a percentage of the cost of the initial order Page 15.16

17 Learning Curve [Ans: (i) Price of First (100 units) Order = 2275; (ii) Price of Second (60 units) Order = ; (iii) Price of First (40 units) Order = ] Q 3: [Nov 09, 6c, 6M] The Gifts Company makes mementos for offering chief guests and other dignitaries at functions. A customer wants 4 identical pieces of hand-crafted gifts for 4 dignitaries invited to its function. For this product, the Gifts Company estimates the following costs for the 1st unit of the product /unit Direct variable costs (excluding labour) 2,000 Direct labour (20 50 hour) 1, % learning curve ratio is applicable and one labourer works for one customer s order. You are required to i. What is the price per piece to be quoted for this customer if the targeted contribution is 1,500 per unit? ii. If 4 different labourers made the 4 products simultaneously to ensure faster delivery to the customer, can the price at (i) above be quoted? Why? [Ans: ] Q: [M 09, 1c, 4M] PQ Ltd. makes and sells a labour-intensive product. Its labour force has a learning rate of 80%, applicable only to direct labour and not to variable overhead. The cost per unit of the first product is as follows: Direct materials 10,000 Direct labour 8,000 4 per hour) Variable overhead 2,000 Total variable cost 20,000 PQ Ltd. has received an order from X Ltd. for 4 units of the product. Another customer, Y Ltd. is also interested in purchasing 4 units of the product. PQ Ltd. has the capacity to fulfill both the orde Y Ltd. presently purchases this product in the market for 17,200 and is willing to pay this price per unit of PQ's product. But X Ltd. lets PQ choose one of the following options: (i) A price of 16,500 per unit for the 4 units it proposes to take from PQ. Or (ii) Supply X Ltd.'s idle labour force to PQ, for only 4 units of production, with PQ having to pay only Re. 1 per labour hour to X Ltd.'s worker. X Ltd.'s workers will be withdrawn after the first 4 units are produced. In this case, PQ need not use its labour for producing X Ltd.'s requirement. X Ltd. assures PQ that its labour force also has a learning rate of 80%. In this option, X Ltd. offers to buy the product from PQ at only 14,000 per unit. X and Y shall not know of each other's offer. CA. B L Chakravarti (FCA, CPA, CAIIB) Page 15.17

18 Advance Management Accounting If both orders came before any work started, what is the best option that PQ may choose? Present suitable calculations in favour of your argument. Q 5: [Nov 08*, 1b, 3M] A company which has developed a new machine has observed that the time taken to manufacture the first machine is 600 hour Calculate the time which the company will take to manufacture the second machine if the actual learning curve rate is (i) 80% and (ii) 90%. Explain which of the two learning rates will show faster learning. Q 6: [May 08, 2c, 7M] M Ltd. Manufactures a special product purely carried out by manual labour. It has a capacity of 20,000 units. It estimates the following cost structure: Direct material 30 / unit Direct labour (1 hour / unit) 20 / unit Variable overhead 10 / unit Fixed overheads at maximum capacity is 1,50,000. It is estimated that at the current level of efficiency, each unit requires one hour for the first 5,000 units. Subsequently it is possible to achieve 80% learning rate. The market can absorb the first 5,000 units at 100 per unit. What should be the minimum selling price acceptable for an order of 15,000 units for a prospective client? Q 7: [May 05, 3b, 8M] [May 10, 4a, 11M] [RTP Nov 09] 12] An electronics firm which has developed a new type of fire-alarm system has been asked to quote for a prospective contract. The customer requires separate price quotations for each of the following possible orders: Order Number of fire-alarm systems First 100 Second 60 Third 40 The firm estimates the following cost per unit for the first order: Direct Materials 500 Direct Labour Deptt. A (Highly automatic) 20 hours at 10 per hour. Deptt. B (Skilled labour) 40 hours at 15 per hour Page 15.18

19 Learning Curve Variable overheads absorbed 20% of direct labour Fixed overheads absorbed Deptt. A 8 per hour Deptt. B 5 per hour Determine a price per unit for each of the three orders, assuming the firm uses a markup of 25% on total costs and allows for an 80% learning curve. Extract from 80% learning curve table: X Y (%) X represents the cumulative total volume produced to date expressed as a multiple of the initial order. Y is the learning curve factor, for a given X value, expressed as a percentage of the cost of the initial order. [Ans: (i) Price of First (100 units) Order = 2275; (ii) Price of Second (60 units) Order = ; (iii) Price of First (40 units) Order = ] Q 8: [Nov 02, 5b, 8M] [SA-11] [SA-21] A company has 10 direct workers, who work for 25 days a month of 8 hours per day. The estimated down time is 25% of the total available time. The company received an order for a new product. The first unit of the new product requires 40 direct labour hours to manufacture the product. The company expects 80% (index is ) learning curve for this type of work. The company uses standard absorption costing and the cost data are as under: Direct materials 60 per unit Direct labour 6 per direct labour hour Variable overheads 1 per direct labour hour Fixed overheads 7500 per month Required: (i) Calculate the cost per unit of the first order of 30 units. (ii) If the company receives a repeat order for 20 units, what price to be quoted to yield a profit of 25% on selling price? [Ans.: (i) (ii) ] CA. B L Chakravarti (FCA, CPA, CAIIB) Page 15.19

20 Advance Management Accounting 1. Page 15.20

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