 Namaste. In our earlier sessions, we have been discussing CVP and particularly its applications. So, we have seen variety of decision making cases involving let us say sales mix, involving product planning. We have also discussed in our last session about decision making in case of a key factor. Now, let us do one more case where profit planning is involved. So, different decision scenarios and how will you react to those decision scenarios? Please take the sheet which you have, read the problem with me and to try to solve it along with me. Let us start. The budgeted data of pranam chemicals for the year is as follows. Direct materials 30, direct wages 24 and production overhead variable 18. All these 3 A is on per unit basis and fixed production overhead in total is given as 30 lakhs. Admin costs again are fixed. They are 18 lakhs. Selling and distribution 18 lakhs. Selling price is 152 per unit. Now, company operates at a margin of safety of 25 percent. In order to improve its operations, few proposals have been put forth. So, often different people in the company different levels of managers come out with suggestions and naturally management wants to improve profitability. So, for taking decision it becomes important to calculate the profitability PV ratio, BEP and so on for each of the decision scenarios. So, let us see what are the different proposals. The first one, increase the sales volume by 10 percent and advertising expenditure of 2 lakhs will be incurred. Then fixed production and selling and distribution overheads also will increase by 2 lakh and 95000 respectively. What should be the selling price in order to achieve a total profit of 25 lakhs? Remember each proposal is separate, the second proposal. Reduction of selling price by 5 percent that will increase the volume by 20 percent. Fixed production overheads will also increase by 3 lakhs. Fixed selling and distribution overheads will increase by 2 lakhs. Advertising expenditure of 3 lakhs is required and find the impact on profit. Third one, increase the selling price by 10 percent by spending 2 lakhs on advertising. Fixed production overheads will increase by 2 lakhs. Fixed selling and distribution will also increase by 1 lakh. Find the increase in the volume of sales required in units to earn 10 percent more profit than budgeted and there is one more fourth proposal also. Let us take first three proposals right now. So, you already have a budget data. Let us first put it in a proper format and compute the profitability as for the budget and then make enough number of columns. First we will start with the existing budget and then we will go for proposal 1, 2, 3 and so on. So, I will shift to excel sheet for you in your notebook. Please make the budget in the proper format. I hope you know the proper format now. We start with selling price then reduce variable cost, get contribution and then compute the profits. So, please it make it in that format. I hope you do not need my solution. You can do it on your own. So, first of all starting with the budget we have taken total of dm then dl that is direct labor and variable overheads. Variable cost per unit is 72. Take the selling price compute the contribution. Selling price is 152. So, contribution is 80 sp minus vc. What is the number of units? Is it given? It is not given although they have given some fixed costs. So, we can write the fixed costs. We can even write the total fixed costs because we know the three fixed costs. So, cost structure is available. You know selling price, you know contribution, you know fixed costs. How do you know the level of activity? How do you know the number of units? Anyone has a suggestion? Please read the problem once again carefully. What else is given to you for the current budget? They have given a hint to you that company operates at a margin of safety of 25 percent. Now, what is the formula of MOS? It is sales minus BEP sales divided by sales that is actual sales. You do not know actual sales. You do not know BEP also. Can you calculate BEP? I think you can. If you remember the formula, it is fixed cost divided by contribution per unit. You know fixed costs, you know contribution. So, you can calculate BEP and you know that the company is operating at MOS of 25 percent. So, BEP is known to you. If existing sale is 100, the BEP is 75. So, you can also calculate the current sales. So, BEP is FC minus PVR. Number of units is not known to you, but you know the you can calculate the PV ratio because contribution upon sales is PVR. How much is a PVR? 0.5263. FC upon PVR gives you this much of BEP which is 1 crore 25 lakhs 40,000 and we know that sales is equal to BEP upon 0.75 because margin of safety is 75 percent. This is equal to MOS upon sales and MOS is also equal to sales minus BEP. In other words, sales is equal to BEP upon 0.75. So, you can calculate the sales which is 1 crore 67 lakhs 20,000. Are you able to get it? Now, based on this you can work back and compute the number of units and also compute the other things. So, if you compute number of units, you will get 1 lakh 10000 because selling price is known to you, total sales is known to you. So, total sales upon selling price gives you number of units as 1 lakh 10000. Total contribution is 8 lakh 80,000 because 80 into 110 and 8 sorry 88 lakhs and 88 lakhs minus 66 lakhs gives me profit of 22 lakhs. I hope you are all getting it, got it? Now, this is the starting point. Firstly, whatever is available with us is a current budget we have put it in proper format. Now, let us go to each of the proposals. Now, proposal 1. Proposal 1 is a proposal which involves increase in the sales volume and they are spending more on advertising and because of increase in the sales volume even other overheads are increasing and based on that we have to calculate the selling price which should be fixed to achieve a target profit of 25 lakhs. So, management is not happy with the sales of 22 lakh sorry profit of 22 lakhs, they want more profit and change all other figures as per what is given. Selling price is not known to us. So, we cannot calculate contribution. What we know is that the revised profits will be 25 lakhs. We can also calculate new level of fixed overheads. So, please calculate that production overhead will increase by 2 lakhs, admin overheads is unchanged, selling overheads will increase. We have included advertising plus other increases. So, 2,95,000 increase of selling overheads making it 20,95,000. Total fixed cost is 70, 85. So, 25 lakhs profit plus 70,95,000 is a fixed cost. We do not know the selling price. In fact, selling price is required to be calculated. So, what we will do is we will work back because we know profit and we know FC. We can calculate the total contribution first by working back which comes to this 25 plus 70, 95 gives you 95, 95. Do you know number of units? Yes, because it is given that, see here it is given that the increase in the sales volume by 10 percent. So, if you add 10 percent you get 121,000 as number of units. Now, you can work back and compute the contribution. That means you must earn a contribution of 79.30 to achieve this profit and take care of this cost. Now, you can work back the selling price. So, selling price comes to 151.30. Are you getting? Perhaps what management is trying to test is in this proposal does it need increase of the selling price. But you can see that selling price is almost same like in the budget. So, now the management will be happy because they are getting extra profit, extra fixed costs are taken care and there is no much need to increase the selling price. Because the sales units have increased our contribution is more and that is taken care taking care of extra fixed costs. We will also calculate PV ratio. So, you will get a PV ratio of 0.5241, which is almost same. So, management would not be much disturbed with proposal 1. Of course, this is not asked, this is more of a discussion. The solution to proposal 1 is 151.30, that is why I have made it in bold. Are you getting it? Now, let us go to second proposal. Once again read it carefully. Now, this is a proposal which involves reduction in selling price because company wants to increase sales by 20 percent. They have proposed to reduce selling price. There will be some extra cost of advertising and so on and now management wants to know the impact on profit. So, go to one more column. Variable costs are not changed. So, I have kept them constant. Company has decided to decrease the selling price. So, they know the selling price now. Remember this decrease is vis-a-vis the budget not last column. So, from budget that is from 152, you decrease the selling price by 5 percent. So, it will become 144.4. What will be the new number of units? Anyway, first of all, you can calculate new contribution, which is SP minus VC. So, 72.4. What will be the revised number of units? From the current units, there is an increase of 20 percent. So, 132000 is the new units. You can also compute the new total contribution, which is 9556. Now, take each and every overhead and go on increasing the fixed overheads as per the given information. So, production overheads goes up by 3 lakhs. It becomes 33 lakhs. Admin is same. Selling overheads were increased by 2 lakhs plus advertising of 3 lakhs. So, 23 lakhs. So, what is the total overhead? 74 lakhs is a new total fixed overhead and profits are 21,56,000. And what is the revised PVR? It is 0.5014. So, how is proposal 2 now? It looks like management may not be very happy, because decrease in the selling price means your PV ratio has gone down a bit. Many fixed overheads have increased. So, the profits of the company have slightly declined. Instead of increasing to target of 25, in fact, profits have declined. But is this proposal 2 has any advantage? Yes, it has, because company is able to substantially increase its number of units. Now, it depends on the management's priority. If management wants to increase the market share, perhaps they may also think of proposal 2. Now, our main purpose is to make various calculations easy, so that management can take appropriate decision. Now, let us tweak the proposal a bit. That is why I have made column 2A. Now, what is likely to happen is company wants to at least maintain the current profit, because it is most unlikely that any company will accept a proposal with lesser profit. So, I have kept the same profit now 22 lakhs and then we can do other calculations. So, how to do other calculations? If you want to keep profit of 22 lakhs, what will be the number of units company has to sell? So, please make column 2A. There will not be any change here, because there is no difference in the earlier variable cost and this variable cost. Even the contribution will remain unchanged. Number of units however, will go up to 132 596. How did you get this? Because this part is also unchanged, right? There is no need to even write again. Total FC is same, contribution per unit, I think I have not written here, but it is written here. So, it will go to 72.4. If you want to achieve target profit of 22 lakhs, check what contribution you must earn 22 plus 74. So, you must achieve contribution of 96 lakhs divided by 72.4, you will get 132 596. Though it was not asked in the case, I have just made one more calculation in case the proposal 2 is slightly tweaked and you are asked that to maintain the same profit, how many units should be sold? The answer will be 132 596. Getting it? Okay. Let us go to proposal 3 now. Now in proposal 3, there is an increase of selling price by 10 percent. Now this is a more aggressive strategy. Company is willing to increase its selling price, there will be somewhat increase in the advertising and other expenditures. And we want to know the increase in the volume of sales required in order to earn 10 percent more profits than budgeted. So, I hope you can do the calculations now. I am just making these columns slightly smaller. So, in proposal 3, again the variable cost is essentially same, fixed cost you can recalculate. So, there will be an increase in production, no change in admin, increase in selling, giving you new fixed cost to be 71 lakhs. Have they given new selling price? Yes, they have given that company will increase its selling price. By what percent? By 10 percent. That means new selling price is 167.2, compute new contribution which is 95.2, company wants to earn 10 percent more profit than budgeted. That means from 22 lakhs, the profits will go up to 24 lakhs, 20,000 plus fixed cost of 71. So, the total contribution to be earned becomes 95 lakhs, 20,000. The question was about number of units. So, if you check number of units by total contribution upon contribution per unit, you will get answer as 1 lakh. So, the question was find the increase in the volume of sales required to earn 10 percent more profits. You find that no increase is required. In fact, even if volume drops by 10000, company is able to earn higher profits. What will be the contribution, what will be the PVR? Now, the PVR is also improved significantly, it becomes 0.56 because since the price has gone up, contribution per unit has also gone up. So, the profit volume ratio will also be better. So, how do you compare now proposal 3? Is it a good proposal? Prima Facy yes, because company is getting more profit, it is also able to improve its PVR. Only problem with proposal 3 is number of units have come down. That means the market size or the market share of the company will slightly shrink. So, see as management accountants, we will provide different type of information to various levels of management and then management has to take call. Now, let us go to proposal 4. Now, company desires to quote for government order for 20,000 units, existing sales will not be affected and fixed production overheads will increase by 3 lakhs profit of 1 lakh on the order is expected. Find the lowest price which can be quoted. So, please do the calculations. Now, let us go to proposal 4. I hope you can calculate on your own. Variable costs are again same. The question is how much price can be quoted? How much will be the fixed costs? They have given that company wants to earn a profit of 1 lakh and there will be an increase in production overheads by 3 lakhs. So, total fixed extra fixed costs will be only 3 lakhs. Profit expected is 1 lakh. That means target contribution is 4 lakhs. What is the number of units? It is 20,000. So, contribution which you are supposed to earn is 20 rupees and the price which you can you quote is only 92. The question was what lowest price can be offered? You will be surprised that though our normal price is about 150, we are able to quote it at as low as 92. This is possible because it is given that the existing sales are not affected. So, you can afford to sell at much lower price. This is called as a penetration pricing. That since you want to target and enter new market, you are willing to offer at a much lesser price. Remember you are not covering any of the fixed costs. Offering much lesser price just to ensure that you get enough of money for variable cost plus incremental fixed cost. This is a variable cost or marginal cost based pricing. So, overall if you see the problem once again, you will realize that this is a very interesting problem for 2-3 things. Firstly, we have looked at different decision scenarios with tweaking of sales, with tweaking of number of units, with tweaking of selling prices, with tweaking of fixed costs. What different prices can be offered or what different units are required for achieving certain target. These types of short term decisions are required to be made by management. Many times it is known as profit planning. One more thing you would have observed, when we studied CVP analysis earlier, we had made number of assumptions. Like fixed cost is always constant, variable cost per unit is constant, sale price is constant. If you remember at that time I had told that some of the assumptions can be changed. You can give little longer rope, you allow the assumptions to be tweaked a bit. Now you will see here that we have changed many assumptions and still CVP analysis as a technique continues to be very much useful for decision making. So, I hope you have got the whole case. Namaste. Dhaniwal.