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The Joint Cost Issue at Vikas Hybrid Pvt Ltd

The case relates to a Himachal Pradesh based company, which was a pioneer in the manufacturing of solid-state electronic components. The case highlights certain Joint Cost problems, which the company faced while producing multiple products out of the same manufacturing process. The case was worked upon in the mid 1990’s at the Baddi plant in Himachal Pradesh. However, figures used in the case have been changed to maintain company’s privacy. 

 Joint production processes are common in the agriculture industry, the food manufacturing industry, the chemical industry and many others. Examples may include a poultry plant, an oil refinery, a sugar plant , a milk-processing unit and many others.

About Vikas Hybrid Ltd 


Vikas Hybrid Pvt Ltd is a leading manufacturer and supplier of high-quality application specific standard products within the broad discrete, logic, and analog semiconductor markets. Diodes serve the consumer electronics, computing, communications, industrial, and automotive markets. Diodes' products include diodes, rectifiers, transistors, amplifiers and comparators, power management devices, including LED drivers and linear voltage regulators. The Company`s corporate headquarters, logistics centre, and India’s sales office are located in Delhi, India. Design, marketing, and engineering centres are located in Bangalore, India; Taipei, Taiwan; and Wolfsburg, Germany. The Company`s silicon rod fabrication facilities are located in Baddi,(HP) accompanied with two other factories , one of which is exclusively built for the manufacture of rectifiers  , an important product of the company accounting for more than 30% of total cost of production.


This particular factory initiated work in 1992 as professional manufacturer of all kinds of rectifiers. In the past years, by keeping the principle of "Satisfying Customers with Excellent Quality and Superior Services", the company has obtained very good reputation all over India and elsewhere in the world. 


Rectifier and its characteristics’ 

1906 was one of those years that would shape the world for years to come, although few people, if any, realized it at the time. In October 1906, Greenleaf Whittier Pickard (the grandnephew of the poet John Greenleaf Whittier) received a patent on a method for receiving radio signals that included a silicon point-contact diode. {U.S. Patent 836,531 was filed on August 30, 1906 and issued November 20, 1906}. The seed of thought of the use of silicon for controlling waveforms was probably born then, the tree came into being much later. Development in the theory and practice relating to the family of diodes(rectifiers included) has been rather slow.   Although people didn't know for long how point-contact diodes worked, it didn't stop them from manufacturing and using them.  

Rectifiers are used in power supplies to convert alternating current (AC) to direct current (DC), a process called rectification. Rectifiers allow electricity to flow in only one direction.  Rectifiers are in reality diodes, the latter being the electrical version of a valve and early diodes were actually called valves.

Electricity uses up a little energy pushing its way through the rectifier, rather like a person pushing through a door with a spring.  This means that there is a small voltage across a conducting rectifier. It is called the 'forward voltage drop'.

When a reverse voltage is applied a perfect rectifier does not conduct, but all real rectifiers leak a very tiny current of a few μA or less. All rectifiers have a maximum reverse voltage and if this is exceeded, the rectifier will fail and pass a large current in the reverse direction; this is called 'breakdown'/blockage.


The quality concept

The end user primarily assesses the quality of a rectifier by two distinct characteristics viz the swiftness of response in blocking current reversals and the maximum voltage level the rectifier can withstand. However, engineers at the factory are not aware of any method that could be used to produce rectifiers having exact specific characteristics. It has been noticed that every batch produced differs from the other although the conditions in which the manufacturing is done is the same for all batches. In addition, the characteristics of rectifiers within a batch are significantly different. It has been empirically seen that over a period concerning several production runs the distribution of rectifier characteristics resembles a normal distribution.

The production process


Silicon is used as the intrinsic semiconductor, to which the proper dopants are added. A dopant, also called a doping agent, is a trace impurity element that is added to silicon (in very low concentrations) in order to alter the electrical and physical properties of the product. Typically, the production process is initiated with a batch of 60 silicon rods being heated in a furnace with a temperature of around 1400 degree Celsius. The dopants are added in the same process. In case one alters the quantity of dopants one could bring about significant changes in the characteristics of the ultimate product. However, it is difficult to predetermine the exact quality of rectifier, which shall be produced with some standard quantity of dopant added to standard amount of silicon. It has been noticed that the enhancement of one characteristic is accompanied with a reduction of some other quality. In fact, it is extremely difficult to get exact quality of the finished product because a small variation in the temperature of the furnace and variability in gas distribution could alter substantially, the final product characteristic.

Once the silicon rod is heated in the furnace and dopants added, the following process of production is followed;

1. Each silicon rod is cut into 2,000 silicon chips , each approximately the size of a small pebble possibly as big as a black hole.

2. Every chip is subsequently placed between two metallic cylinders and compressed between them.

3. The above mentioned is then enveloped in a glass sleeve which is then heated in order to form the desired bond with the silicon chip.

4. Silver and copper wires are attached after which the finished product is painted and marked with the product name. 

It has been noticed that only 50% of the 1,20,000 chips initiated in production reach step 3. Out of the ones so processed, only 33.33% are saleable as part of the regular product line. 5,000 rectifiers are produced below quality and are sold in the market as seconds. Marketing efforts are not needed to sell these seconds and they are not assigned any inventory value.

Data relating to Cost of Production is given below;


 

Annual Costs (Rs)

Batch Costs(Rs)

Direct Material 1,27,500

Direct Labour   81,600

Variable Overheads 1,17,300

Total 3,26,400 × 20# 65,28,000

Non variable costs## 16,32,000

Factory Overheads## 20,40,000

Total Manufacturing Costs 1,02,00,000


# Production of rectifiers is done in batches approximating 20 Nos in a year.

## Allocated to N Series rectifiers based on direct labour.


ACCOUNTING ISSUES: HOW TO ACCOUNT FOR JOINT COSTS


Direct material and Direct Labour are costs, which can economically and feasibly be traced to the ultimate product, the N series rectifiers. However, Indirect Costs popularly known as Overheads are not directly assignable and hence need to be allocated. It is popularly understood in the industry that a detailed absorption cost per unit is required for decision-making and inventory valuation purposes.

In the case of silicon rectifiers, different quality finished products are created because of differing impurities (dopants) and variable temperature in the furnace. These different quality rectifiers have different sales value; however, the cost to produce them is “Joint”. This implies that Vikas Hybrid has no mechanism to match any of the costs with any of the individual component produced in one batch. Concisely, all costs are incurred to produce rectifiers with varying electrical and physical characteristics.

Allocation of Joint Costs at Vikas Hybrid can be done by any of the following two popularly known techniques;

1. All Joint Costs are divided by the total number of saleable units produced during the process. The method is known as the average or physical unit method. Such a method shall normally yield a different Gross Profit percentage because different quality rectifiers are sold at different sale value.

2. Joint Costs are assigned to units based on their relative sale value e.g. in case Jont Costs incurred for producing products A,B and C are Rs 1,000 and the sale value of the products is Rs 500, Rs 300 and Rs 200respectively , the allocation of cost to “B” is 30% of Rs 1000 or Rs 300 and so on. In this particular method the Gross Margin percentage of all the products remain the same. 


THE DECISION MAKING DILEMMA


The following table provides a list of the sales price and present inventory levels for the N series rectifiers. The projected annual sales and production are also shown. The breakdown of the products in each batch is similar.

TABLE

Product Blockage Maximum Voltage Annual Sales Orders Sale Price per unit (Rs) Current Inventory Annual Production in units

N71 .30 -.79 200 1,05,000 20.40 3,000 95,000

N72 .80-1.25 300 1,35,000 30.60 10,000 1,15,000

N73 1.26 – 1.75 400 1,05,000 35.70 10,000 95,000

N74 1.76 – 2.30 500    35,000 40.80 10,000 55,000

N75 2.31 – 2.80 600    20,000 51 2,000 40,000

4,00,000 35,000 4,00,000

 

(Note : As mentioned earlier, a  typical batch of rectifier produces approximately 5,000 units of the lower quality rectifiers known as Seconds. These rectifiers are not assigned any inventory value and whatever revenue is generated through their sales is credited to miscellaneous income. At present 65,000 such rectifiers are in stock. The demand for such rectifiers is extremely price sensitive. At present Vikas Hybrid sells these rectifiers at a rate of Rs 12.75 per unit.) 


Geetika , a Chartered Accountant had just begun a six months training programme at the Baddi factory of Vikas Hybrid. She was summoned by her immediate senior, Arvind, who called her attention to a order of  6,000 units of series N71 rectifiers. The inventory level of N71 was not sufficed. Since customers were perfectly OK with units that met their needs or exceeded them, Vikas Hybrid could also deliver from the other units of the N series. However, customers were not willing to pay extra for the higher characteristics.

Arvind asked Geetika to decide from amongst the following options;

1. To fill the order with N72 rectifiers.

2. To initiate a fresh batch of production so as to fulfil the order with N71.

3. To turn down the order because of lack of stock.

The fresh batch of production was an extremely good idea, however, it would entail the production of other units along with, thereby increasing inventory. Since Arvind’s performance was evaluated as a function of the “profits generated less inventory carrying cost”, he was not too eager to adopt the second option. Also there was a chance of this increased inventory getting obsolete. All along, Arvind had maintained inventory levels of one months sale as according to him a turnover ratio of 12 times was an appropriate balance between stock outs and excess investment.

Another matter which Arvind discussed with Geetika was an offer which had recently been received from a electrical manufacturing company to buy 4000 units per month of the N series seconds rectifiers at a price of Rs 7.65 per unit. The company was willing to sign a yearly contract for the same. Arvind told Geetika about his discussions on the same with the production manager. Apparently, the production manager was dead against the order maintaining that the price offered was throw away and would not even recover the out of pocket expenses of Rs 16.32 per unit in the production process of the same. According to him, it was silly to lock an order, which would not even recover the variable costs incurred. Arvind , however, was deeply concerned over the growing inventory levels, even though they were carried at zero inventory value. He asked Geetika whether she agreed with the production manager that it was naive to sell seconds rectifiers at Rs 7.65 per unit. According to him, it represented pure profits as seconds inventory was assigned zero value by the cost accounting department.

Another problem which Arvind shared with Geetika concerned a one time Indian Navy  request for bids on1,00,000 units of   N74 rectifiers. The Indian Navy  had asked for a cost plus bid, however, Arvind was not sure about what constituted  cost. Delivery was to be made uniformly for a period of eighteen months at about 5,500 units per month. Although Vikas Hybrid was not dependent on the government, the concerned work on a prestigious new Indian Navy system would certainly enhance its Goodwill.


Questions

1. Assuming zero opening inventory, how should Vikas Hybrid assign the production output (4,00,000 units) to the sales orders (4,00,000 units)?

2. Calculate per unit cost of the series N rectifiers in case an average costing system is used.

3. Calculate per unit cost of the series N rectifiers in case a relative sale value costing system is used.

4. Compute revenue, cost and profit if the order of 6,000 units of N71 was accepted for immediate shipment? Computations need to be done using both physical unit costing and relative sale value costing systems.

5. What should Geetika advise regarding the order of the electrical manufacturing company?

6. Discuss the behavioural implications of using the physical unit method and the relative sale value methods of costing systems?

7. Give your opinion on the price and manufacturing strategy for the Indian Navy contract?



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