Decision Making – Cost Accounting

ratiocinations Involving ersatz Choices Structure 13. 1 Introduction Objectives 13. 2 Decision fashioning 13. 3 Types of woos 13. 4 Types of Choices Decisions 13. 5 Make or get Decisions 13. 6 entree / Discontinuance of a harvest-time spot 13. 7 distribute or member nevertheless 13. 8 flow or Shut d avouch 13. 9 Exploring New Markets 13. 10 Maintaining a desire aim of development 13. 11 thickset 13. 12 Terminal Questions 13. 13 outcomes to SAQs and TQs 13. 1 Introduction In the previous social building block we learnt about b atomic number 18(a) Costing.Marginal be is the ascertainment of borderline be and of the lay out on remuneration of flip-flops in passel by differentiating betwixt immovable follow and multivariate be. Marginal court is the cadence at all granted volume of output by which aggregate be atomic number 18 changed if the volume of output is change magnitude or decreased by one whole. Marginal constituteing is a rattling us eful barb for management because of its applications. It is utilise in providing aid to the management in vital termination- do some(prenominal) short term and large term. first derivative abstract is the bear upon of estimating the proceedss of substitute sues that a close maker may take.It is used devil for short term and commodious term terminations. Short term stopping points relates to location charge for the w ar, selecting a suitable crossing cockle, diversification of the yield etc while long term deals with capital budgeting stopping points. Objectives After studying this social unit, you should be able to Explain the travel take away in last fashioning process K outright mixed types of decision picks Analyze and interpret various decision choices 13. 2 Decision Making Decision devising is the process of evaluating deuce or more substitute(a)s leading to a last(a) choice cognise as option choice decisions.Decision fashioning is closely associated with mean for the future day and is enjoin towards a unique(predicate) objective or goal. Decision prototype contains the hailing decision-making steps or elements 1. appoint and define the hassle 2. Identify alternating(a) as executable solutions to the problem. 3. Eliminate secondarys that ar clearly non possible 4. mode come in germane(predicate) entropy ( be and benefits) associated with apiece feasible alternative 5. Identify monetary value and benefits as relevant or irrelevant and carry away irrelevant be and benefits from regard. . Identify to the fulfilment possible, non-financial return and disadvantage about each feasible alternative. 7. follow the relevant damage and benefits for each alternative 8. Select the alternative with the greatest overall benefits to make a decision 9. Implement or fill the decision 10. Evaluate the results of the decision do. 13. 3 Types of Costs A decision involves selecting among various choices . Non turn types of decisions ar crucial and fine to the firm as it involves huge investments and involve much uncertainty.Short term decision making is based on relevant data obtained from accounting information. Relevant Cost argon approach which would change as a result of the decision. Opportunity be argon mo internetary benefits foregone for not move the alternative draw. When a decision to follow one course of study of action is made, the hazard to pursue some another(prenominal)(a) course is foregone. Sunk be atomic number 18 historic toll that dejectionnot be retrieve in a given situation. These woo atomic number 18 irrelevant in decision making. avoidable cost atomic number 18 be that bottom be avoided in future as a result of coachial choice.It is overly k in a flashn as discretional be. These cost are relevant in decision making. Incremental / first derivative costs are costs that include variable costs and transmititional fixed costs re sulting from a quiticular decision. They are implemental in finding out the gainfulness of increased output and give a break in measure than the middling cost. Self appraisal Questions 1. Relevant Costs are costs which would _________as a result of the decision. 2. ___________ are historic cost that cannot be recovered in a given situation. 3.Opportunity costs are _________________for not pursuing the alternative course 4. ____________ is also known as discretionary cost. 13. 4 Types of Choices Decisions The application of incremental / first derivative costs and revenues for decision making is known as decision situations or types of choice decisions. Make or Buy decisions pickaxe of a suitable increase mix Effect of change in wrong Maintaining a desired level of profit Diversification of ingatherings Closing down or suspending activities Alternative course of action feature or Lease Retain or Replace Change or spot quo Export or Local gross cut- pose gros s revenue Expand or Contract bourgeon or Refuse instal tooshie surplus orders Select sales events territories denounce at split-up point or process further. 13. 5 Make or Buy Decisions Make or defile decisions nobble when a confederation with unused proceeds condenser consider the spare-time activity alternatives a) To vitiate certain raw materials or subassemblies from away(p) providers b) To use takeressable force to larn the points within the friendship. c) The quality and type of item which affects the return schedule d) The space required for the merchandiseion of item ) Any superman involved due to the location of yieldion facility f) Cost of acquiring special know how required for the item. instance 1 The Anchor Compevery Ltd start outs most of its electrical component office staffs in its own mark. The high society is at present considering the feasibility of acquire a fork from an after-school(prenominal)(a) supplier for Rs. 4. 5 per part. If this were through with(p), monthly costs would increase by Rs. 1,000 The part on a lower floor(a) consideration is industriousnessd in Department 1 along with numerous other split. On account of discontinuing the proceedsion of this part, Department 1 would bewilder somewhat reduced operating theaters.The average monthly usage cropion of this part is 20,000 units. The costs of producing this part on per unit basis are as follows. square Rs. 1. 80 task ( fractional-hour) 2. 40 stubborn overheads 0. 80 Total costs 5. 00 declaration pic The conjunction should last out the practice of producing the part in Department1. Illustration 2 first principle ltd plans utilize its idle cognitive content by making components move instead of buying them from suppliers.The following are the data in stock(predicate) for decision to make or buy building block cost accost strong 12. 5 sway Labour 8. 0 protean manufacturing overhead 5. 0 The company purchases the part at a unit cost of Rs. 30. The company has been operating at 75% of normal expertness. touch on manufacturing cost is 17 lakhs. The cost to manufacture 50000 units is Unit cost Total cost position material 12. 5 6,25,000 Direct toil 8. 0 4,00,000 uncertain manufacturing o/h 5. 0 2,50,000 Total incremental cost 25. 5 12,75,000 Cost to purchase part 30. 15,00,000 Net advantage in part intersection pointion 4. 5 2,25,000 Inference The gibe incremental cost by producing the part in-house is Rs. 25. 50 while the cost incurred on purchase of the part from suppliers is Rs. 30. 00. There is a clear advantage to the company to produce the part in-house. 13. 6 Addition or Discontinuance of a yield line or motion The decision to contribute or eliminate an unprofitable crossing is a special case of harvest profitability evaluation.When a firm is divided into multiple sales outlets, crossing lines, divisions, divisions it may have to evaluate their individual execut ion to decide whether or not to continue exploits of each of these segments. Illustration 3 The Hi-tech Manufacturing Company is presently evaluating two possible processes for the manufacture of a toy, and makes available to you the following information Particular Process A Process B Rs. Rs. inconsistent cost per unit 12 14 sales hurt per unit 20 20 Total fixed costs per socio-economic class 30,00,000 21,00,000 cogency (in units) 4,30,000 5,00,000 Anticipated sales (next course of instruction, in units) 4,00,000 4,00,000 You are required to designate ) Which process should be chosen? actualise your answer. ii) Would you change your answer as given above if you were informed that the capacities of the two processes are as follows A 6, 00,000 units B 5, 00,000 units? wherefore? Substantiate your answer. base Comparative favorableness Statement Particular Process A Process B Rs. Rs. (i) change hurt per unit 20 20 multivariate cot per unit 12 14 constitu ent per unit 8 6 Total annual ploughshare (as per judge sales) 32,00,000 24,00,000 Total fixed costs per year 30,00,000 21,00,000 Total Income 2,00,000 3,00,000 Process B may be chosen Total parting (if utilized to present capacity and sell) 34,40,000 30,00,000 less(prenominal) Fixed costs 30,00,000 21,00,000 Total Income 4,40,000 9,00,000 Process B may be chosen (ii) Total share (if capacity of A of 6,00,000 units and48,00,000 30,00,000 of B 5,00,000 units) little Fixed costs 30,00,000 21,00,000 Total Income 18,00,000 9,00,000 Process A may be chosen. Illustration 4 Addition of minute of arc shift Ulfa Ltd produces a iodine intersection in its plant. This harvest-time sells for Rs. coulomb per unit. The standard production cost per unit is as follows Raw materials (5 kgs Rs. 8 Rs. 40 Direct project (2 hours Rs. ) 10 inconsistent manufacturing overheads 10 Fixed manufacturing overheads 20 80 The plant is currently operating at full capacity of 1, 00,000 units per years on a single shift. This output is forgetful to meet the finded sales manager has estimated that the firm leave behind lose sales of 40,000 units next years if the capacity is not expanded Plant capacity could be doubled by adding a cooperate shift. This would require supererogatory out-of-pocket fixed manufacturing overhead costs of Rs. 10,00,000 annually. Also, a iniquity work charter premium equal to 25 per penny of the standard wage would have to be paid during the second shift.However, if annual production volume were 1,30,000 units or more, the company could take advantage of 2 per cent quantity discount on its raw material purchases. You are required to advise whether it would be profitable to add the second shift in order to obtain the sales volume of 40,000 units per year? etymon Decision depth psychology Particulars meshwork without expansion returns with expansion gross revenue revenue Rs. 1,00,00,000 Rs. 1,40,00,000 Less variable costs Raw materials (Rs 39. 0 x 1,40,000) 40,00,000 54,88,000 Direct aim 10,00,000 15,00,000 variable quantity manufacturing overhead 10,00,000 14,00,000 Contribution 40,00,000 56,12,000 Less fixed costs (Rs. 1,00,000 x 20) 20,00,000 30,00,000 Net Income 20,00,000 26,12,000 Yes, it would be profitable to add the second shift as it would increase profits by Rs. 6, 12,000.Illustration 5 arrogate a company is considering swing outping product B from its line because accounting statements shows that product B is being interchange at a loss. Product A B C Total sales revenue 50,000 7,500 12,500 70,000 Cost of sales D. Material 7,500 1,000 1,500 10,000 D.Labour 15,000 2,000 2,500 19,500 validating manufacturing cost (50% of 7,500 1,000 1,250 9,750 Direct labour) Total 30,000 4,000 5,250 39,250 realize margin On sales 20,000 3,500 7,250 30,750 Selling & Admn 12,500 4,500 4,000 21,000 Net income 7,500 (1,000) 3,250 9,750 Additional information a) milling machinery command overhead cost is made up of fixed cost of Rs. 5850 and variable cost of Rs. 3900. b) unsettled cost by products are A Rs 3000, B Rs 400 and C Rs 500 c) Fixed costs and get down result not be changed if product B is eliminated d) Variable securities industrying and administrative put downs are to the extent of Rs. 1 coulomb0 can be traced to the product A-Rs. 7,500 B- Rs. 1500 and C- Rs. 2000 e) Fixed change and admn expense are Rs. 10000 Solution picIf the sale of product B were discontinued, the marginal contribution would be lost and the net income would be reduced by Rs. 2,600. Assume that later discardping product B, the sales of product A increased by 10%. The total profit of the firm entrust not increase by this sales increase. Product A makes only a marginal contribution of 34% (17000/50000) gross revenue revenue of Product A 50000 100% Variable cost of Product A 33000 66% Marginal contribution of Product A 17000 34% On additional sa les of Rs. 5000 the marginal contribution would be Rs. 700 Sales revenue 10% of 50000 5000 Variable cost 66% 3300 Marginal contribution (34%) 1700 This contribution is less than Rs. 2,600 now being realized on the sales of product B. it would take additional sales of product A of approximately Rs. 7,647 to equal the marginal contribution of Rs. 2,600 mow being made by product B pic= Rs. 7,647 It is possible that dropping product B may result in reduction in some of the fixed costs. Products B now contributes Rs. 2,600 towards recovery of fixed costs and expenses. only when if the fixed costs and expenses can be reduced by more than this amount, it will be advisable to drop product B. 13. Sells or Process Further A firm is frequently faced with the problem of continuing with the existing policies or plans or change to refreshing ones. Such change could be in the form of selling a partially polished product (semi finished) or process further. While taking a decision about muc h(prenominal) matters, the management must keep in mind the long term consequence and the interest of the firm. Illustration 6 A firm sells semi finished product at Rs. 9 per unit. The cost to manufacture the semi finished product is Rs. 6. Further processing can be done at an additional cost of Rs. 3 per unit and the final product can be sold at Rs. 15 per unit. The firm can produce 10,000 units.The analysis is shown below Sell Process & Sell Sales revenue (10,000 units) Rs. 90,000 1,50,000 Less Manufacturing costs 60,000 90,000 Profit 30,000 60,000 There is a net advantage of Rs. 30,000 in processing the product further. The foodstuff value of the partially processed product (Rs. 90,000) is considered to be opportunity cost of further processing. The figure of net advantage of Rs. 30. 00 can be arrived at in the following manner also taxation from sale of final product (10,000 x 15) Rs. 1,20,000 Less Additional processing cost (10,000 x 3 ) 30,000 Revenues from sale of intercede product 90,000 1,20,000 Net advantage in further processing Rs. 30,000 13. 8 keep in line or Shutdown Various factors both external and internal affect the mental process of the firm. In such situations it becomes necessary for a firm to temporarily suspend or culmination the activities of a particular product, plane section or a unit as a whole.Illustration 7 A company operating below 50% of its capacity expects that the volume of sales will drop below the present level of 10,000 units per month. way is concerned that a further drop in sales volume will create a loss and has under consideration a recommendation that operation be suspended, until better merchandise conditions die hard and also a better selling equipment casualty. The present operation income statement is as follows Rs Rs Sales revenue (10,000 units Rs. 3. 00) 30,000 Less Variable costs Rs. 2. 0 per unit 20. 000 Fixed costs 10,000 Net Income 0 declare oneself the management at what point should the operation be suspended. The fixed cost corpse only Rs 4000 if operation is shutdown. The following income statements have been prepared for sales at different capacities pic It would appear that shutdown is desirable when the sale volume drops below 6,000 units per month, the point at which operating losses exceed the shutdown cost. 13. 9 Exploring New MarketsDecisions regarding entering young markets whether within the country or other the country should be interpreted after(prenominal) considering the following factors Whether the firm has surplus capacity to meet the new demand? What charge is being offered by the new market? Whether the sale of goods in the new market will affect the present market for the goods? Illustration 8 The following figures are obtained from the budget of a company which is at present working at 90% capacity and producing 13,000 units per annum. 90% 100% Rs. Rs. Sales 15,00,000 16,00,000 Fixed Expenses 3,00,500 3,00,600 Semi- Fixed Expenses 97,500 1,00,500 Variable Overhead Expenses 1,45,000 1,49,500 Units made 13,500 15,000 Labour and material costs per unit are constant under present conditions. Profit margin is 10 per cent. a) You are required to determine the derivative cost of producing 1,500 units by increasing capacity to 100 per cent. b) What would you recommend for an trade price for these 1,500 units taking into account that overseas prices are much lower than indigenous prices? Solution Basic Calculation Rs. Sales at 90% capacity 15,00,000 Less Profit 10% 1,50,000 Cost of Goods sold 13,50,000 Less Expenses (Fixed, semi-variable and variable) 5,43,000 Cost of Material and Labour 8,07,000 Labour and Material at 100% capacity = Rs. 8,07,000 x 100/90 = 8,96,667 unalikeial cost analysis can now be done as follows Capacity levels 90% 100% Different cost Production (Units) 13,500 15,000 1,500 Material and Labour 8,07,000 8,96,667 89,667 Variable overhead expenses 1,45,00 0 1,49,500 4,500 Semi-variable expenses 97,500 1,00,500 3,000 Fixed expenses 3,00,500 3,00,600 100 13,50,000 14,47,267 97,267 a) Different Cost = Rs. 97,267 (Rs. 14,47,267 13,50,000) b) Minimum price for export = pic= Rs. 64. 84 per unit At this price, in that respect is no addition to revenue any price above Rs. 64. 84 per unit may be acceptable. Note It has been presumed that i) No capital investment is necessary ii) No export charges are incurred and ii) The export price will have no effect on the home market where the product will continue to be sold at the old price. It has also been fictive that necessary precaution have been taken to ensure that the product is not dumped cover charge. 13. 10 Maintaining a Desired level of profit When deciding between alternative courses of actions the criterion should be to select the project which yields the greatest contribution. Illustration 9 A company is considering expansion. Fixed costs amount to Rs. 4, 20,000 and are pass j udgment to increase by Rs. 1, 25,000 when plant expansion is completed. The present plant capacity is 80,000 units a year. Capacity will increase by 50 per cent with the expansion. Variable costs are currently Rs. 6. 0 per unit and are expected to go down by Rs. 0. 40 per unit with the expansion. The current selling price is Rs. 16 per unit and is expected to stay on same under either alternative. What are the break- even points under either alternative? Which alternative is better and why? Solution pic The profitability after expansion is very good and hence it is better to expand. Illustration 10 Disposal of inventories ABC Ltd has on hand 5,000 units of a product that cannot be sold through regular sales. These were produced at a total cost of Re. 1, 50,000 and would usually have been sold for Rs. 40 per unit. triad alternatives are being considered. i. Sell the items as scrap for Rs. per unit ii. Repackage at a cost of Rs. 20,000 and sell them at Rs. 8 per unit iii. Dispose t hem off at the city dump at removal cost of Rs. 500. Which alternative should be received? Solution Exhibits the decision analysis pic Alternative II should be accepted. 13. 11 summary Decision making is the process of evaluating two or more alternatives leading to a final choice known as alternative choice decisions. Decision making is closely associated with planning for the future and is directed towards a specific objective or goal. A decision involves selecting among various choices. Non routine types of decisions are crucial and critical to he firm as it involves huge investments and involve much uncertainty. Short term decision making is based on relevant data obtained from accounting information. Relevant Cost are costs which would change as a result of the decision. Opportunity costs are monetary benefits foregone for not pursuing the alternative course. When a decision to follow one course of action is made, the opportunity to pursue some other course is foregone. S unk costs are historical cost that cannot be recovered in a given situation. These costs are irrelevant in decision making. Avoidable costs are costs that can be avoided in future as a result of managerial choice. It is also known as discretionary costs.These costs are relevant in decision making. Incremental / Differential costs are costs that include variable costs and additional fixed costs resulting from a particular decision. They are helpful in finding out the profitability of increased output and give a better measure than the average cost. 13. 12 Terminal Questions 1. Avon garments Ltd manufactures readymade garments and uses its cut-pieces of cloth to manufacture dolls. The following statement of cost has been prepared. Particulars Readymade garments Dolls Total Direct material Rs. 80,000 Rs. 6,000 Rs. 6,000 Direct labour 13,000 1,200 14,200 Variable overheads 17,000 2,800 19,800 Fixed overheads 24,000 3,000 27,000 Total cost 1,34,000 13,000 1,47,000 Sales 1,70,000 12,000 1,82,000 Profit (loss) 36,000 (1,000) 35,000 The cut-pieces used in dolls have a scrap value of Rs 1,000 if sold in the market. As there is a loss of Rs. 1,000 in the manufacturing of dolls, it is suggested to discontinue their manufacture. terminate the management. 2. The ABC Company Ltd produces most of its own parts and components. The standard wage rate in the parts department is Rs. 3 per hour. Variable manufacturing overheads is applied at a standard rate of Rs. 2 per labour hour and fixed manufacturing overheads are supercharged at a standard rate of Rs 2. 50 per hour. For its current years output, the company will require a new part. This part can be made in the parts department without any expansion of existing facilities.Nevertheless, it would be necessary to increase the cost of product testing and inspection by Rs. 5,000 per month. Estimated labour time for the new part is half an hour per unit. Raw materials cost has been estimated at Rs. 6 per unit. The alte rnative choice out front the company is to purchase part from an outside supplier at Rs 9 per unit. The company has estimated that it will need 2,00,000 new parts during the current years. Advise the company whether it would be more economical to buy or make the new parts. Would your answer be different if the requirement of new parts was only 1,00,000 parts? 13. 13 Answers to SAQ and TQs Answer to SAQ 1. Change 2 Sunk cost 3. Monetary benefits foregone 4. Avoidable cost Answers to TQs . Discontinue manufacture of dolls Readymade garments Dolls Total Total cost 134000 13000 147000 Profit (loss) 36000 (1000) 35000 2. Decision analysis 200000 units The company is advised to make the new part. The differential costs favouring the decision of making the component is Rs40000 Decision analysis lakh units The company is advised to buy from an outside supplier. Total cost to manufacture lakh units is Rs. 9,10,000.