relevant costs for decison making

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R ELEVANT COST A CCOUNTING

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DECISIONMAKING

Identify and define the problemIdentify the possible solutions to the problem

Select only the feasible solutionCollect data about relevant costs and revenues foreach of the feasible solutionSelect the solution with maximum benefit

Implement the solution

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R ELEVANT COST

Relevant costs can be defined as the future coststhat differ among the alternatives

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M AKE OR B UY

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P ROBLEM

The company has manufacturing unit where itmanufactures many different components. Thereis one component whose manufacturing cost of

one unit isR

s. 630.Now, the company has found one supplier who iswilling to supply the same component at cost ofone unit as Rs. 540.The management has to take decision whether tocontinue manufacturing the component or to buyit from supplier.The company manufactures 90000 units of thiscomponent every month.

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The manufacturing cost for 1 unit of this component

is as follows:

P articulars Amount

Direct Materials 270Direct labour 135

Variable Expenses 90

Fixed Expenses 135Total cost 630

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The cost of 1 unit of component when purchased

from supplier is as follows:

P articulars AmountDirect Materials -

Direct labour -Variable Expenses -

P urchased price 540

Fixed Expenses 135Total cost 675

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So for producing 90,000 units,

The company has to keep manufacturing theproduct.

Difference = 675-630 = 45/- per unit

Difference = 45 * 90,000 = 40,00,000/-

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A DD OR DROP PRODUCTS

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P ROBLEM

The company manufactures three differentproducts say P roduct A, B and C. When themanufacturing cost and sale prices of theseproducts are compared, the P roduct B shows a lossof Rs. 1000.The management has to take decision on whetherto drop this product or not.

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P articulars P roduct A P roduct B P roduct C

Direct Material 7500 1000 1500

Direct Labor 15000 2000 2500Fixed Factory Overheads 4500 600 750

Fixed Admin & sellingOverheads 5000 3000 2000

Variable Factory Overheads 3000 400 500Variable Admin & selling

Overheads 7500 1500 2000

Total Cost 42500 8500 9250

Selling price 50,000 7500 12500P rofit 7500 -1000 3250

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Now, Suppose we drop product B,

P articulars P roduct A P roduct B P roduct CDirect Material 7500 0 1500

Direct Labor 15000 0 2500Fixed Factory Overheads 4500 600 750

Fixed Admin & sellingOverheads 5000 3000 2000

Variable Factory Overheads 3000 0 500Variable Admin & selling

Overheads 7500 0 2000Total Cost 42500 3600 9250

Selling price 50,000 0 12500P rofit 7500 -3600 3250

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The Company will have additional loss of Rs.2600/-,

If they drop product B.

Difference = 3600 - 1000 = 2600

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S PECIAL ORDER

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PR OBLEM

The company produces 20000 units of someproduct. Now, the company wants to give specialoffer to some of its regular customers.

The company is willing to sell additional 10000units as special offer. So now it has to decide onthe selling price for these additional products.The company wants to earn a profit of 1 Rs. P erunit in this special offer.

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With Special Order

10,000

42500

57500

77500

0

0

0

P articularsWithout Special

order

No. of units 20,000Direct Material 85000

Direct Labor 115000Variable Factory

Overheads 155000

Variable Selling costs 16500Fixed Factory

Overheads 125000

Fixed Selling Overheads 52500

Total Cost 569000Sales 600000P rofit 31000

177500

10000187500

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E XPORT ORDER

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P ROBLEMS

The company is operating at 80% capacity sells itsproducts in domestic market to earn a profit of Rs.300000.

The company decides to go in the export marketby working at 100% capacity.The management has to decide doing so will bebeneficial or not.

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ParticularsDomestic sales(only at

80% capacity)

Sales 32,00,000

Direct Material 10,00,000

Direct Labor 4,00,000

Variable Overheads 2,00,000

Fixed Overheads 13,00,000

Total cost 29,00,000

Profit 3,00,000When company decides to make sales in both domestic &

export, its profit will increase fromRs.3,00,000/- to Rs.5,00,000/- .So company should sell its products in domestic & export

market

Domestic & export sales(at100% capacity)

38,00,000

12,50,000

5,00,000

2,50,000

13,00,000

33,00,000

5,00,000

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T HANK YOU