How to approach it
- Rebuild the base budget: units, hours per unit, material at gross and net of discount, labour split normal/overtime, variable vs fixed overhead.
- For each option, recompute volume, hours, labour (normal, overtime, idle), gross purchases and the discount rate that applies, variable overhead.
- Fixed overheads and operating expenses stay unless the question says otherwise.
- Present a side-by-side operating profit table and recommend.
Key rules to apply
- When a discount depends on a purchase threshold, gross up net purchases to test the threshold, then apply the new rate to all purchases.
- Workers who cannot be laid off still cost money when idle: include idle hours at the idle rate.
- Variable overhead that follows hours worked falls with production.
Common mistakes
Drawn from the examiners' comments for this sitting (summarised in our words) and from typical errors on this topic.
- Using the wrong decline percentage for the 'keep price' option (examiners' point).
- Not grossing up purchases before testing the discount threshold, or keeping the higher discount after falling below it.
- Leaving out idle labour pay, or giving contribution when operating profit was asked.
Similar question with worked solution
Written by us with our own numbers; it tests the same skills as Q9 without copying it.
Original practice question
Discontinue or keep a product
Budget: M 10,000 units at Rs 3,000; N 20,000 units at Rs 5,000. Materials net of an 8% discount: M Rs 9m, N Rs 30m; the discount drops to 3% if gross purchases fall below Rs 40m. Each unit takes 2 labour hours; normal capacity 55,000 hours at Rs 300, overtime Rs 400; idle hours are paid at Rs 200 because workers cannot be laid off. Variable overhead Rs 200 per hour worked; fixed factory overhead Rs 12m; operating expenses Rs 20m.
Required: Compare operating profit if M is kept at budget volume, sold at half volume, or discontinued.
Worked solution
| Rs m | Keep M | M at 50% | Drop M |
|---|---|---|---|
| Sales | 130.000 | 115.000 | 100.000 |
| Gross purchases | 42.391 | 37.500 | 32.609 |
| Materials (net of 8% / 3%) | (39.000) | (36.375) | (31.630) |
| Labour worked | (18.500) | (15.000) | (12.000) |
| Idle labour | – | (1.000) | (3.000) |
| Variable overhead | (12.000) | (10.000) | (8.000) |
| Fixed overhead + operating | (32.000) | (32.000) | (32.000) |
| Operating profit | 28.500 | 20.625 | 13.370 |
Keep M: 60,000 hours = 55,000 normal + 5,000 overtime. Half M: 50,000 hours, 5,000 idle. Drop M: 40,000 hours, 15,000 idle.
Answer: Keep M (Rs 28.5m). Dropping it loses its contribution, the volume discount and pays 15,000 idle hours.