Costing in an Apparel Firm

Mr. Sundaresan Rajan, CEO of an apparel firm, a manufacturer and retailer of jeans in India,
was facing tremendous pressure to improve the financial position of the firm.

Rajan and his colleague at Bombay Dyeing Textiles limited together floated this firm in
Sholapur, Maharashtra in the year 1994. In 2004, the friends decided to convert the firm in to
a private limited company and in the year 2010 with the increase in scale of operations, they
have converted it into a public limited company. The company began manufacturing
operations at a small space with 1,200 square feet and later they have purchased a piece of
two acres land from the Maharashtra State Industrial Infrastructure Corporation to build a
factory and attracted private equity investors. After the private equity investments, the new
promoters advised the company to expand by steadily establishing its own retail stores across
the country. The company established its own retail stores across major cities first and started
to enter the second tier cities to reach approximately 325 stores by the end of fiscal year
2015. The private equity promoters marketed the company to get orders from other countries
creating the company an opportunity to export its products.

Up till the year 2015, the company did very good business in terms of sales. The company
recorded an exceptional growth in the value of shares in the market resulting from good
results quarter by quarter. During this period the private equity investors off-loaded they
shares in the market capitalising on profits to leave the company without such expert
suggestions for future. The stock prices of the company started to fall even though sales
continued to be consistent i.e. though there was no decrease in sales, the profits began to fall.
The friends thought that the decline in the stock prices and profits was due to economic slow-
down and recession. Since there was consistency in sales, they concluded that the profits
were declining because of increase in costs due to inflation. But the stock prices of the
company remained flat and profits continued to decline even after 2010 when the economy
had started reviving, stock indices had started rising, and the stock prices of other companies
had also started soaring.

The shareholders of the company raised concerns over the declining profits of the company.
As a result of a heated shareholders’ meeting, Rajan came under pressure to improve the
company’s financial position and its market valuation. In order to understand the present
status of production, costs, sales, and the future prospects of the company’s product in the
market, he immediately called Mr. Veera Raju, the company’s consultant on cost accounting
and the marketing manager Ms. Neela to discuss on the issue and prepare a report.

The consultant after discussing with Ms. Neela and the production manager Mr. Ravi
furnished the following cost information for the financial year ending 31st March, 2017 and
the changes in costs which were expected in the forth-coming year.
Exhibit – I
Statement for 15,00,000 Units
S. No. Particulars Amt. Rs. (000s)
1 Sales 15,00,000
2 Direct Wages 2,70,000
3 Direct Materials 3,30,000
4 Factory Overheads 3,25,000
5 Administrative Overheads 2,05,000
6 Sales Overheads 90,000

On account of intense competition, the following changes were estimated in the subsequent
year:
1. Production and sales activity would be increased by one third.
2. Material rate would be lowered by 25%. However, there would be a 20 per cent
increase in the consumption which would take care of the increase in production level.
3. Direct wages cost would be reduced by 20 per cent due to automation;
4. Out of the above factory overheads (given in Exhibit – I), Rs. 45,000,000 were fixed
in nature. The remaining factory expenses would be variable in proportion to the
number of units produced.
5. Total administration expenses would be lowered by 40 per cent.
6. Sales overhead per unit would remain the same.

Background:
On the basis of cost and profit estimation for the years ending March 31, 2016 and March 31,
2017, Mr Rajan told that 6% decline in profits on sales was expected in 2017. Rajan realized
from the report that the reason for the decline in profits despite the consistent increase in sales
volume was the heightening competition from the other vendors in the market. Since Ms.
Neela was in direct contact with the market, Rajan asked here to carefully analyse the
potential of the company’s product in the market and suggest the options available to
overcome the problem. He gave Neela ten days’ time to do the same. After ten days, Neela
reported back, in order to carry out a formal analysis of the options available with regard to
business opportunities.

Addressing the meeting, Neela said that in order to overcome the problem, the company
needed to attract new customers and sell more goods to repeat customers. She said the
company needed to add new product lines; however, in order to keep costs down, the product
lines had to be such that they would not require much additional cost. She suggested two new
products which would require the same type of material and similar labour, and would serve
the female segment of the market. Neela said the two products which could be added easily
were Jean Skirts and Jean Handbags for women as there two items would require the same
raw materials. Besides, with a little training the same tailors could undertake the stitching
activity.

After examining the suggestion, Rajan thought that the two products would be good strategic
fit for the existing product line. He sought the opinion of the board of directors and they too
gave a favourable response. With this, it was decided that the company would add these two
products as soon as possible.

After one year of the introduction of the two products i.e. on March 31, 2017, the income
statement of the company was as follows:
Exhibit – II
Income Statement of the Company for the year ending 31st March, 2017
Particulars Details Amt. (in 000s)
Sales 20,00,000
Less: Cost of Goods Sold 12,63,450
Gross Profit 7,36,550
Less: Indirect Expenses – Office Expenses 1,29,150
Less: Indirect Expenses – Selling & Distribution Exps. 1,26,000 2,55,150
Net Profit Before Depreciation 4,81,400
Less: Depreciation 16,400
Net Profit after Depreciation 4,65,000
Less: Tax (35%) 1,62,750
Profit After Tax 3,02,250

From the income statement, Rajan calculated the profit before tax percentage on sales and it
worked out to be 23.25 – 4.25 per cent higher than the previous year’s profit. This
improvement in profit gave him some satisfaction and he was eager to know how the new
products were performing and what their cost structures were. He asked the consultant to
present the cost sheet of both Skirts and Handbags made with Jeans. The consultant presented
the following cost details of all the products:
Exhibit – III
Details of Cost Amount (in 000s)
Particulars Jeans Skirts Handbags
Stock of Materials as on April 01, 2016 200,000
Stock of Materials as on March 31, 2017 150,000 75,000 25,000
Materials Purchased during the year 600,000 300,000 100,000
Sale of Materials (Not Suitable) 25,000
Work in Progress as on April 01, 2016 100,000
Work in Progress as on March 31, 2017 35,000 10,000 5,000
Finished Stock as on April 01, 2016 350,000
Finished Stock as on March 31, 2017 450,000 200,000 120,000
Salaries (Factory) 15,350 10,000 5,000
Office Salaries 25,000 15,000 5,000
Carriage on Purchases 12,000 6,000 2,000
Carriage on Sales 13,000 5,000 2,000
Cash Discount Allowed 1,800 550 400
Bad Debts Written Off 8,000 1,500 500
Repairs of Plant, Machinery and Tools 8,000 4,000 1,600
Rent, Rates Taxes and Insurance (factory) 12,000 6,000 2,000
Rent, Rates Taxes and Insurance (Office) 2,000 700 300
Travelling Expenses Reimbursed to Salesmen 7,000 5,000 3,000
Traveller’s Salaries and Commission 20,000 13,000 7,000
Productive Wages 300,000 120,000 180,000
Depreciation Written off on Plant & Machinery 9,000 3,000 2,000
Depreciation Written off on Office Furniture 1,800 400 200
Director’s Fee 15,000 7,000 3,000
Dyeing and Water Charges 3,000 1,500 500
Gas and Water Charges 850 300 100
General Charges 12,750 5,000 3,000
General Manager’s Salary 8,000 5,000 2,000
Production Manager’s Salary 10,000 6,900 5,000
Advertising 28,000 21,000 8,750

Required:
1. Discuss in detail about the Overheads (Selling and Distribution, Administration and
Factory) that the company is incurring and help decide Rajan on the areas of cost
control;
2. Prepare Cost Sheet for the three different products from the details given in Exhibits.
3. Prepare the Cost Sheet for the projections on the basis of Exhibit – I and comment.