Q1.

What are Simplex Method, Feasible Solution, Basic Feasible Solution and Optimal
Solution?

Simplex method is a method in linear programming for solving an optimization problem, usually
one involving a function and several constraints expressed as inequalities. The inequalities will
define a polygonal region, and the solution is usually at one of the vertices.
Feasible solution is any element of the feasible region of an optimization problem. The feasible
region is the set of all possible solutions of an optimization problem.
Basic feasible solution is one that occurs at the corner point of the feasible region in a graph.
According to a theorem in LPP, one or a linear combination of the basic feasible solutions will
turn out to be an optimal solution.
An optimal solution is one that either minimizes or maximizes the objective function.

Q2. When Median could be a better measure of Central Tendency than Mean?

Mean and median are measures of central tendency in a data set. Mean and median both examine
where, in a data set, numbers are likely to occur with the most frequency. However, depending
upon the type of data set, one can be a better way than another of evaluating data and coming up
with statistical results.

Getting the mean of something is the same as obtaining the average number in a data set. The
sum of the numbers in the set is divided by the total of numbers in a set. Thus for example, a
teacher might evaluate five test scores, all weighted equally, to determine a grade for a student.

Say the five test scores are 80, 85, 60, 90, and 100. These numbers are added together and their
sum is 415. The teacher then divides 415 by 5 to get the mean score of 83. When using mean, the
teacher figures the test scores result in a B grade in the class.

In a median measurement, the data is arranged from lowest to highest: 60, 80, 85, 90, and 100.
The middle number in this set is the median. In our example, the median is 85, the third and
middle number of the set. This varies slightly from the mean of 83. A teacher may wish to look
at a median score, as it tends to rule out a low score like 60, a low D.

Mean scores tend to be affected by outliers, data that tends to be far removed from the central
tendency of the number. Thus for example, if the 60 score becomes a 40 score, the mean
continues to reduce, while the median, given 5 test scores remains the same. So in some cases,
median can be a better measure of central tendencies that discounts the importance of numbers
outside the data range.

Q3. How does a company take decision on making? What is the associated profit or loss
attached to it?

The make-or-buy decision is the act of making a strategic choice between producing an item
internally (in-house) or buying it externally (from an outside supplier). The buy side of the
decision also is referred to as outsourcing. Make-or-buy decisions usually arise when a firm that
has developed a product or part—or significantly modified a product or part—is having trouble
with current suppliers, or has diminishing capacity or changing demand.

Make-or-buy analysis is conducted at the strategic and operational level. Obviously, the strategic
level is the more long-range of the two. Variables considered at the strategic level include
analysis of the future, as well as the current environment. Issues like government regulation,
competing firms, and market trends all have a strategic impact on the make-or-buy decision. Of
course, firms should make items that reinforce or are in-line with their core competencies. These
are areas in which the firm is strongest and which give the firm a competitive advantage.

The increased existence of firms that utilize the concept of lean manufacturing has prompted an
increase in outsourcing. Manufacturers are tending to purchase subassemblies rather than piece
parts, and are outsourcing activities ranging from logistics to administrative services. In their
2003 book World Class Supply Management, David Burt, Donald Dobler, and Stephen Starling
present a rule of thumb for out-sourcing. It prescribes that a firm outsource all items that do not
fit one of the following three categories: (1) the item is critical to the success of the product,
including customer perception of important product attributes; (2) the item requires specialized
design and manufacturing skills or equipment, and the number of capable and reliable suppliers
is extremely limited; and (3) the item fits well within the firm's core competencies, or within
those the firm must develop to fulfill future plans. Items that fit under one of these three
categories are considered strategic in nature and should be produced internally if at all possible.

Make-or-buy decisions also occur at the operational level. Analysis in separate texts by Burt,
Dobler, and Starling, as well as Joel Wisner, G. Keong Leong, and Keah-Choon Tan, suggest
these considerations that favor making a part in-house:

• Cost considerations (less expensive to make the part)

• Desire to integrate plant operations
• Productive use of excess plant capacity to help absorb fixed overhead (using existing idle
capacity)
• Need to exert direct control over production and/or quality
• Better quality control
• Design secrecy is required to protect proprietary technology
• Unreliable suppliers
• No competent suppliers
• Desire to maintain a stable workforce (in periods of declining sales)
• Quantity too small to interest a supplier
• Control of lead time, transportation, and warehousing costs
• Greater assurance of continual supply
• Provision of a second source
• Political, social or environmental reasons (union pressure)
• Emotion (e.g., pride)

Factors that may influence firms to buy a part externally include:

 • Lack of expertise
• Suppliers' research and specialized know-how exceeds that of the buyer
• cost considerations (less expensive to buy the item)
• Small-volume requirements
• Limited production facilities or insufficient capacity
• Desire to maintain a multiple-source policy
• Indirect managerial control considerations
• Procurement and inventory considerations
• Brand preference
• Item not essential to the firm's strategy

The two most important factors to consider in a make-or-buy decision are cost and the
availability of production capacity. Burt, Dobler, and Starling warn that "no other factor is
subject to more varied interpretation and to greater misunderstanding" Cost considerations
should include all relevant costs and be long-term in nature. Obviously, the buying firm will
compare production and purchase costs. Burt, Dobler, and Starling provide the major elements
included in this comparison. Elements of the "make" analysis include:

• Incremental inventory-carrying costs

• Direct labor costs
• Incremental factory overhead costs
• Delivered purchased material costs
• Incremental managerial costs
• Any follow-on costs stemming from quality and related problems
• Incremental purchasing costs
• Incremental capital costs

Cost considerations for the "buy" analysis include:

• Purchase price of the part

• Transportation costs
• Receiving and inspection costs
• Incremental purchasing costs
• Any follow-on costs related to quality or service

One will note that six of the costs to consider are incremental. By definition, incremental costs
would not be incurred if the part were purchased from an outside source. If a firm does not
currently have the capacity to make the part, incremental costs will include variable costs plus
the full portion of fixed overhead allocable to the part's manufacture. If the firm has excess
capacity that can be used to produce the part in question, only the variable overhead caused by
production of the parts are considered incremental. That is, fixed costs, under conditions of
sufficient idle capacity, are not incremental and should not be considered as part of the cost to
make the part.

While cost is seldom the only criterion used in a make-or-buy decision, simple break-even
analysis can be an effective way to quickly surmise the cost implications within a decision.
Suppose that a firm can purchase equipment for in-house use for $250,000 and produce the
needed parts for $10 each. Alternatively, a supplier could produce and ship the part for $15 each.
Ignoring the cost of negotiating a contract with the supplier, the simple break-even point could
easily be computed:
$250,000 + $10Q = $15Q
$250,000 = $15Q − $10Q
$250,000 = $5Q
50,000 = Q
Therefore, it would be more cost effective for a firm to buy the part if demand is less than 50,000
units, and make the part if demand exceeds 50,000 units. However, if the firm had enough idle
capacity to produce the parts, the fixed cost of $250,000 would not be incurred (meaning it is not
an incremental cost), making the prospect of making the part too cost efficient to ignore.

Stanley Gardiner and John Blackstone's 1991 paper in the International Journal of Purchasing
and Materials Management presented the contribution-per-constraint-minute (CPCM) method of
make-or-buy analysis, which makes the decision based on the theory of constraints. They also
used this approach to determine the maximum permissible component price (MPCP) that a buyer
should pay when outsourcing. In 2005 Jaydeep Balakrishnan and Chun Hung Cheng noted that
Gardiner and Blackstone's method did not guarantee a best solution for a complicated make-or-
buy problem. Therefore, they offer an updated, enhanced approach using spreadsheets with built-
in liner programming (LP) capability to provide "what if" analyses to encourage efforts toward
finding an optimal solution.

Firms have started to realize the importance of the make-or-buy decision to overall
manufacturing strategy and the implication it can have for employment levels, asset levels, and
core competencies. In response to this, some firms have adopted total cost of ownership (TCO)
procedures for incorporating non-price considerations into the make-or-buy decision.

Q4. How are the profits reconciled amongst the Absorption Costing and Marginal Costing?

The net profit reported by absorption and marginal costing systems may not be the same owing
to the differing treatment of fixed manufacturing overheads. As has been demonstrated above,
whilst marginal costing systems treat fixed manufacturing overheads as period costs (i.e. a
charge against profit in the period incurred), in absorption costing systems they are absorbed into
the cost of goods produced and are only charged against profit in the period in which those goods
are sold.

As a result, if quantities produced and sold in a period are not the same (i.e., if the levels of
work-in-progress or finished goods stock change) a different profit will be reported by the two
systems. The differing profits can be reconciled, and the difference explained, by an analysis of
the product of the stock change and the fixed manufacturing overhead absorption rate.

Example 1
A company sells a single product at a price of £14 per unit. Variable manufacturing costs of the
product are £6.40 per unit. Fixed manufacturing overheads, which are absorbed into the cost of
production at a unit rate (based on normal activity of 20,000 units per period), are £92,000 per
period. Any over-absorbed or under-absorbed fixed manufacturing overhead balances are
transferred to the profit and loss account at the end of each period, in order to establish the
manufacturing profit.

Sales and production (in units) for two periods are as follows:

Period 1 Period 2
Sales 15,000 21,600
Production 18,000 21,000

Required:
(a) Prepare a trading statement to identify the manufacturing profit for Period 2 using the
existing absorption costing method.
(b) Determine the manufacturing profit that would be reported in Period 2 if marginal costing
was used.
(c) Explain, with supporting calculations, why the manufacturing profit in (a) and (b) differs.

Thus, in answer to part (c) of Example 1:

Period 2 finished goods stock reduction 600 units

= £2,760
x fixed manufacturing overhead absorption rate, £4.60 per
difference in profit
unit

i.e., the difference between the absorption costing manufacturing profit of £69,400 and the
marginal costing manufacturing profit of £72,160. Absorption costing has a lower profit because
more goods are being taken out of stock (including a charge for fixed manufacturing overhead)
than are going into stock.

Indirect Method
Format of Cash Flow Statement for the year ended ................
As per Accounting Standard - 3 (Revised)
Particulars
Rs
(i) Cash flows from operating Activities xxx
xxx
Net Profit as per Profit and Loss A/c or difference between
closing balance and opening balance of Profit and Loss A/c
Add : Transfer to reserve xxx
Proposed dividend for current year xxx
Interim dividend paid during the year xxx
Provision for tax made during the current year xxx
Extraordinary items, if any, debited to Profit and Loss A/c xxx
xxx
xxx
xxx
Less : Extraordinary Items, if any, credited to Profit and Loss A/c xxx
Refund of Tax credited to Profit and Loss A/c xxx
xxx
xxx
A. Net profit before taxation and Extra ordinary items
Adjustment for Non-Cash and Non-Operating Items.

B. Add :
– Depreciation xxx
– Preliminary expenses xxx
– Discount on issue of shares and debentures written off xxx
– Interest on borrowings and debentures xxx
– Loss on sale of fixed assets xxx
xxx

xxx
C. Less :
– Interest income/received xxx
– Dividend income received xxx
– Rental income received xxx
– Profit on sale of fixed asset xxx
xxx

D. Operating profits before working capital changes

(A + B – C) xxx

xxx
E. Decrease in current assets and increase in current liabilities xxx
F. Less : Increase in current assets and decrease in current liabilities xxx
G. Cash generated from operations (D + E – F)
xxx
H. Less : Income tax paid (Net tax refund received)
xxx
I. Cash flow from before extraordinary items
xxx
Adjusted extraordinary items (+/–)
xxx
J. Net cash from operating activities
xxx
(ii) Cash from investing accounting
Add :
– Proceeds from sale of fixed assets xxx
– Proceeds from sale of investments xxx
– Proceeds from sale of intangible assets xxx
– Interest and dividend received xxx

xxx
Less :
– Rent income xxx
– Purchase of fixed assets xxx
Purchase of investment xxx
– Purchase of intangible assets like goodwill xxx
xxx

xxx
Advanced extraordinary items (+/–) xxx
Net cash from (or used in) investing activities xxx

xxx
(iii) Cash flows from financing activities
Add :
Proceeds from issue of shares and debentures xxx
Proceeds from other long term borrowings xxx

xxx
Less :
Final dividend fund xxx
Interim dividend fund xxx
Interest on debentures and loans paid xxx
xxx

Repayment of loans
xxx
Redemption of debenture preference shares xxx
xxx
Adjust extraordinary items (+/–) xxx
x xx
Net cash from (or used in) financing activities xxx

xxx
(iv) Net increase/Decrease in cash and cash xxx
equivalent (i + ii + iii)
(v) Add : cash and cash equivalents in the beginning of the year
– cash in hand xxx
– cash at bank overdraft xxx
– short term deposit xxx
– marketable securities xxx
(vi) Less : cash and cash equivalents in the end of the year
– cash in hand xxx
– cash at Bank (by bank overdraft) xxx
– short term deposits xxx
– Cash flow from operation xxx xxx
xxx