Determination of variable costs April May Total standard cost of sales 31,20,000 81,50,000 Less fixed overheads a 8 per unit: April (10,000 x 18) (80,000) May (12,500 x 18) (1,00,000) Variable costs (balancing figure) 40,000 50,000 P.15.10 Aggarwal Industries Ltd has taken a loan from a large bank. Among the provisions of the loan agreement are that: (a) the current ratio must be at least 300 per cent and that (b) the ratio of total debt to shareholders' equity must not be higher than 75 per cent. The balance sheet of the firm for the current year is as follows: Liabilities Amount Assets Amount Equity capital 15,20,000 Inventory (40,000 units at 12 % Long term bank loan 6,00,000 variable cost) 24,00,000 Current liabilities 4,00,000 Cash and debtors 9,20,000 Fixed assets (net) 12,00,000 25,20,000 25,20,000 The budgeted income statement for next year is as follows: Sales (1,00,000 units) 220,00,000 Less variable production costs 10,00,000 Contribution (manufacturing) 10,00,000 Less other variable costs (van able with sales) 1,00,000 Contribution (final) 9,00,000 Less fixed costs Manufacturing 16,00,000 Other costs 1,00,000 7,00,000 Profit 2,00,000 Budgeted production is 1,00,000 units. The chief accountant of the firm anticipates substantial ex- penditure for fixed assets and intends to obtain a new loan to help finance these expenditures. For the purpose, he is negotiating with a bank. To complete the requisite papers, he projects the following proforma balance sheet for March, next year: Liabilities Amount Assets Amount Equity capital (15,20,000 Inventory and receivables 18,00,000 Profit and loss Ac 2,00,000 Inventory (40,000 units at 12% Long-term bank loan 9,20,000 variable cost) 4,00,000 Current liabilities 4,80,000 Fixed assets (net) 19,20,000 31.20.000 31,20,000 He sees that the firm will be in default on both provisions of the loan agreement. To resolve the problem, he lists the following points: 1. To work at normal capacity of 1,50,000 units. 2. The firm could perhaps benefit if absorption costing were used. You are required to do the following: (a) Recast the income statement and balance sheet using absorption costing, taking the normal capac- ity of 1,50,000 units as the basis for absorption of fixed manufacturing overheads. 142 (b) Assume that all increased production costs are paid in cash. Is the firm safe within limits of the loan agreement? (C) is the firm better off using absorption costing