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ill
list
s
in
i
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h
In this
chapter
we focus
on a
number
of
short term
decisions made
by
a
business
Make versus
Buy
decisions
shut
down
decisions
one off
contract decisions non recurring
Further
processing
decisions
Relevant Cost
Analysis
Decision
making
involves
making
a
choice
between
2 or more
alternatives
When a business is making
one
of
the shortterm
decisions
it should
consider
only
Relevant
cashflows thatarise
as a result
of
that
decision
Relevant cash
flow
cash position
if
proposal
cashp.gs
proposal
isaccepted
Relevant costs are
costs related
to specificmanagement
decisions
represented
future
incremental cashflow
future
must incur in
future
big
ignored
unless
incremental incremental
only
extra
cashflow
as a
result
of
decision
committed costs
should beignored
cashflow
only
cashflows
relevant to decision
opportunitycostsshould be
included
Opportunity
cost it is thevalue
of
the
bestalternative
foregone
when
particular
decision
or course
of
action is chosen It
arises dueto a
number
of
possibleuses
of
scarce resources andis
relevant in
decision
making
Avoidable
cost specific
costs
of
an activity
which wouldbe
avoided
if
the
activity
didnotexist
Usually
related to
shutdown decisions
and are
relevan
Sunkcost costs that are
already
incurred irrelevant in
decision
making
Committed cost costs
already
committed
to
a
particular activity
or
function
hence not
relevant
in
decision
making
Relevantcosts Irrelevantcosts
opportunity Available
If
copiited Not
I
Notionalcosts
non
cashitems or accounting
entries
Relevant
cost
of
materials
material
when
material
is already
available
frequently
used
fast
moving
the
current
purch
aii
wijait.ae
ii
none price price
or
replacementcost is
relevant cost
acaruses
when
material
isalready
available
rarely
used slow moving
NRVoropportunity
cost
iii
eame.in
iri
tinits
is
the
relevant cost
whenmaterial istobespecifically
procured MPor out
of
pocket
cost is
relevant cost
of
a
material is in short
supply
the
only
way
a proposal can
be
undertaken
would be
denying
another
part
of
the organisation
thatresource Inthiscar
relevant cost
normal
material cost
qptitmut.is
in
other
Relevant cost
of
labour
Whenthere is
excesscabour
already paid
for
itis
a
committed cost andthus not
a
sparecapacity
can
in i k
anitbe
relevant cost
isiiqreciiit.fi
when
cabour
is in shortage
the
decision
may
require
redirection
of
exciting
labour
fro
frigate
tn
current
job
or process
tothenew
job
This
results in the opportunity
cost
becoming
relevant
for
decisions
Whenworkers are tobespecificallyprocured out
of
pocket expense
becomes relevant
to
decision
making
Relevant Cost
of
Overhead
Variable
overheads
are always
relevant unless
they
are sunk
costs
Fixed
overheads
are
always
irrelevant
except in the following
circumstances
specifically
incurred
avoidable
or discretionary
incremental in nature opportunity fined
cost
Profit
Manimisation
Quantity
Economic
Theory
PMO
theory
states
thatprofitis
maximised attheoutput
level where MR MC
BasicPrice Equation P a be
Marginal
Revenue Equation MR
a 2bQ
a priceat
whichdemand is 0
b change
in price change
inquantity
Q profit
manimisation
quantity
Pricing
Methods
CostBased
Pricing
cost
profitmargin
Return
on capital
Employed
variablecost pricing
used in
short runfor
perishable goods
Going
Rate
Pricing
chargingaverage
industryprice
sealed Bidpricing
competing forjobs by
submitting
confidential offer price
conversion
costPricing
Peak load pricing
charging
priceswhendemandapproaches physicalcapacity
PracticalProblems
Relevant cost
Analysis
of
Relevant cost
1 RawMaterial
RI
RIwas bought
earlier
for
7500 sunkcost
Disposalcost 1250
Replacementcost 6000
The company initially
planned on disposing thehighly
toxicrawmaterial butit is
now
redirected towards
the
special
job
Since no
further
information statesthat
compan
would replenish RI
current replacementcost
6000
is
irrelevant
i Relevant MaterialCost 1250 saving of
disposal
cost
Labour
412421
Jobrequires
250 hours
of
G
100 hours
of
Excess capacity 150 hours
of
1
hours
of
Weekly
wages for
hours
1
336
for
Parttime
labour
canbe
hired at same rate as
current
employees
Hourly
rates GI
630142 15 hour
336142 8 hour
consider
GI requires
250 excesscapacity
150
labour required
250 150 100
hours
sincelabour is inshortage it
must be specifically procured
cost 100 15
1500
Eisia
b
Ty
T.in
d
sunkcast
Consider
92 requires
100 excess capacity
Noextracost
i Relevant
labour
cost
1500
Factorsconsidered
beforemaking
a
decision
Quality
control
long
term
pricechanges
supplierdependence strategicimportance
Reliability
Delivery
time
Hidden
costs
of
buying
i
computation
of
Relevant Profit
Particulars K L G
sales
600 300 200
less Cost
material
200 160
30
195 20 10
labour
s
variable
overhead
120
specific
overhead
140 12 so
selling
cost
20 15
Relevant
profit
188 84
i Decision
to
continue not
close Keirproduct line
as it will
reduce
profits
NN 01 specific
overheads
80 based
on DMC
K
200
L
50 10.8 00 2
80
30 so
ii
Factorsconsidered
before
final
decision
Demand
impact
shutdown costs
Price
changes
competitor
reaction
strategic
value
i CostBenefit
Analysis
Consultants
Plan
Cost
amount Benefit amount
Readmission accommodation
25,
cost
saving
50,
Cost
Readmission
variablecost
3,00 000
dm m
readmissions
13 50,
in n
pittits
5100,
Working
Notes
current patient
days
15000
37,
days
AfterPlan patient
days
15000 2 30,
days
days
i Cost
saving
Read
patient
days
600
days
variablecost
600 500 300,
ii
The
proposed
plan
results
in a net benefit
of
23100,
Purely
based on
financial
factors profit the planisfeasible to
beimplemented
However th
main
motive
of
a hospital
is not profit making
but
ensuring
patients are
properly
treated
recovered
Dischargingpatients irrespective
of
recovery
is
not
ethical
Althoughfinancially feasible
plan
is not morally
or ethically
correct
to
implement
Current variablecost
12500
000 1900
cost
of
component purchase
190
t
cost
of
component in
House
Updated
VariableCost
Updated
contribution
ii
Purely
based
on financial
parameters proposalto manufacture
inHousewould
result
in
a loss
of
contribution
to the
extent
of
118 unit In
addition tothis
advertisment
cost is to be
incurred specifically overand
above
existing
cost
Decision
to
make inHouse is not financially feasible
Cost
Benefit
Analysis
discontinuance
of
Division c
cost
amount Benefit amount
loss
of
contribution
2,
Saying
of
specific
Avoidable
fined
Increase
in
variablecost
2 30,
net
cost
57,
4,
500 4, 500
Division C
should
notbe
discontinued
as
discontinuation would
reduce overal
profitability
by
57,
WNOI Variablecost
currentvariablecost are
of
normal
if
volume
falls
by
closing
Division C the
return to
100 Variable
cost
20170,
198
23,
000
variablecost
20 70,
i
Increase in
variablecost
20170,000 23,
000 2,
000
1
Analysis
of
Relevantcosts
1 Material
A
current requirement
units
inventory
available 0 units
entirerequirementmust be specifically procured
i Relevant cost 2000
Material
B
currentrequirement
3000
units
inventory
available 1200
units
further
1800 unitsmustbespecifically procuredwhile
remaining
1200 units
must be
replaced since
material is used
regularly
i Relevant cost
1800 10 1200 10 30,
111
Material
C
current requirement
units
inventory
available 1400 units
further
600 unitsmust be specifically procured
Leftover stock has no other
used would be disposed
off
if
specialorder was not accepted Opporton
cost
i Relevant
cost
21,
IV
Material
D
current requirement
units inventory
available 500 units
inventory availability
meetsdemand Leftoverstock has
following
alternatives disposal NRV
500 12
cost
incurred
on disposal
PracticalProblems
CVP
Analysis
1
Sales Mixratio
2 4 3
computation
of
contribution
per
unit
footballs 7 3
baseballs 6 4 s
rugby
balls
9 5 4
computation
of
weighted
avg
contribution
per
unit
2
4
g
5 4 14 3 2 88pu
computation
of
BEPin units
BEPunits
17
19
pa
0
6923 08 units
computation
of
BEP
Sales
Revenue
no
of
packages
20,
packages
revenue
of
one package
2 7 4 01 13
9 65
TotalBEP
Revenue
65 50,
computation
of
contribution
pu
contribution
Selling price
variable cost
8000
7500 Esoo
CUP Analysis
BEP
2
51
to
101001000
2000 units
soo
Profit total
units
contribution
fixed
cost
10000 500 10,00 000
40
00,
Activity
Based CVPanalysis
ABC fixed
cost volumeindependent fixed
cost setup
cost
800000 400500 10.
000
BEP
10,
000 2000 units
Profit total
units
contribution
fixed
cost
10000 500 10,
000
40
00,
batch size
so
new setup
cost
110, 500
Esoo
100000
new
fixed
cost
800000 100000 50000
950000
newBEP
950000
1900 units
soo
new profit
110000 500
950000 40 50,
evaluation
of
option 01
shutdown
sell
sale
5 million
evaluation
of
option 02 major
refurbishment
cost 4
million
good
result
2 3 13.5 43 9 million
poor
result
1 3 o s
1
3 2. million
total
expected value
million
net
expected value
4 7.
million
evaluation
of
option 03 cheaper
refurbishment
new
contribution 10 6.
Puratio
It
p p
100
34
BEP
111
1
pa
34000
10,000units
MOS salesunits BEP
units
15000 10000 5000 units
salesvolume
2000 units
new
salesunits 17000 units
Puratio
It
p p
BEP
tt 1
tpa
8500 units
MOS sales
units BEPunits
17000 8500 8500 units
fined cost
by
6000
newto
40,
Puratio
It
p p
40
BEP
111
1 p
40900
10000 units
MOS sales
units BEPunits
15000 10000 5000 units
i
PV
ratio change
in profit
13000 8000
changeinsales
140000 120000
100 25
ii
Bep
sales
puratio prifit
1
140000 25 1
13000
88,
Puratio 0.
iii Profit
at
180000
sales
contribution
180000 25
Eusooo
Profit
45000 22000 tc 23,
iv MOS sales BEP
140000 88000
52000
computation
of
totalmonthly
fixed
costs
A
15000
B
15000 5000
25000 45000
C
15000 10000
100000 125,
computation oftotal
variablecost
A
40 200
240
B
80 60 140
C
20 20 40
indifference Point
difference
in
fined cost
difference invariablecost
IP ARB
45000 15000
300 reports
240140
IP BIC
125000 45000
800 reports
140 40
IP
ACC
125
5000
sso reports
Up
to 300
reports
Method
Ais
mosteconomical
dueto
low
fixed
costs
Between
300800 reports
Method
B isthe
bestchoice
Above 800 reports
Method
C is
bestchoice duetolowve
for
high
volumes
Taiing
Lie
applies
to
firstasoounitsafter
which time is
constant
y
and
1000 25
0322
hours
total
time
for
batches 25 354.2 8855 hours
time
for
25 ᵗʰbatch total
time
for
batches
totaltime
for
batches
hours
totaltime
for
batches
26 to
so 25
5735 hours
Total
time
5735
8855 14590 hours
computation
of
total
costs
directlabour
cost 14590 6
87540
variablecost
5000 19
i
fixed
cost
total
costs
222540
Total
Revenue
required
cost
target
profit
222540 80000 302,
Revenue
from
4500 units
4500
64
288,
Revenueneeded
from
5000 4500
500 units
302540
288000
14540
Augselling
Price
for
soounits
19890
1
The
product iscurrently in the
introduction
phaseusing
skimming pricing high
initial
prices
Life cyclestage
impact onunitselling
Price impacton unit
Production
cost
growth
decrease
pricesare
lowered to
Decrease costs
falldueto
economies
of
respond tonew
competitors
entering
scale
increased productionvolumes
the
market
attract
new
customers increased
efficiency from
the learning
curve
Maturity
Decrease
prices
are
reduced
tothe
stabilize
atlow
level while
costs
are
going
rateto
stay
competitivein a at
theirminimum further
reductions
a
saturated market defend
market
unlikelydue to learningprocess
share plateaus
I
demandfunction
P a be
for
bogies
BD a
320000
b
10000
30
p
320000 333.
for wagons
ND
a 1710000
b 50000
2
25000
P
1710000 250000
MC
220000 vc
Mc
480000 4
220000 1300000
MR
B
320000 21333.3319 320000
MRW
1710000 2125000
1710000
500000
MR MC
220000 320000
1300000 1710000 sooooo
sounits
Profit.gg yimuing
Q
7 units
p
320000
150 270000
BogiesSP
p
1710000
25000 7
1535000
wagons
SP
