RK Forging Case Study Notes

Introduction

• Company: RK Forging, based in Coimbatore.
• Industries Served: Power, Automotive, Oil & Gas, Construction, Mining, Locomotive, Marine, Aerospace.
• Capacity Utilization: Currently 62% (Idle: 38%).
• Profitability (2014):
  • Revenue: ₹137 million
  • Profit: ₹19 million
  • Operating Profit Margin: 14% (declined from 18% over the years)
• Production Overhead Rate: ₹20,000 per machine hour (Based on: ₹29.76 million fixed overhead / 1,488 hours).

Order from Rinki Automotive

• Order Size: 1,000 units (front axle beams).
• Potential Future Orders: 2 additional orders (1,000 units each), uncertain.
• Cost Estimates:
  • Material + Labour: ₹500 per unit → ₹5,00,000 for 1,000 units.
  • Machine Hours: 72 hours @ ₹20,000/hour → ₹14.4 lakh.
  • Fixed Product Cost (mold, drawings, etc.): ₹15 lakh (same for all quantities).

Pricing Approaches

1. Accounting Department Approach

• Full Costing: Load full ₹15 lakh product cost in first order.
• Quote per unit: ₹4,000
• Total Sales: ₹40,00,032
• Total Cost: ₹34.4 lakh
• Profit (1 order only): ₹5,60,032

2. Marketing Department Approach

• Spreads ₹15 lakh over 3 orders → ₹5 lakh for 1st order.
• Quote per unit: ₹2,837
• Total Sales: ₹28,37,232
• Total Cost: ₹24.4 lakh
• Profit (1 order only): ₹3,97,232

If All 3 Orders Are Received (2,000 units used for example):

• Total Profit (All 3 Orders):
  • Accounting: ₹46,80,000
  • Marketing: ₹11,91,696

Alternative: Relevant Costing Approach

• Material + Labour: ₹5,00,000
• No machine overhead included (fixed cost already recovered).
• Full ₹15 lakh included as fixed cost (product related).
• Total Cost: ₹20,00,000
• Markup (16.28%): ₹3,25,600
• Quote per unit: ₹2,326

Profits (Relevant Costing):

• First Order: ₹3,25,600
• Two Additional Orders (assuming only material + labour):
  • Sales: ₹46,52,800
  • Cost: ₹10,00,000
  • Profit: ₹36,51,200
• Total Profit (All 3 Orders): ₹39,76,800

Executive Committee Discussion Summary

• Tanya (Chief Accountant):
  • Full ₹15 lakh should be recovered in first order.
  • Concerned with declining profit margins due to liberal pricing.
• Siddharth (Marketing):
  • Proposes spreading cost over three orders.
  • Believes competitive pricing is key to winning orders.
  • Highlights issue with flat machine overhead rate (₹20,000/hour), regardless of machine type.
• Rahul (Chair): Suggests evaluating customer, finding middle ground, considering relevant costing.

Decision Framework for Special Orders

• Use Relevant Costing where:
  • Only incremental and relevant costs are considered.
  • Ignore sunk or non-incremental fixed costs (e.g., production overhead already recovered).
• Relevant costing helps in utilizing idle capacity and offering competitive pricing.