You are on page 1of 29

BYABHIJEET RASGOTRA ADITYA SAXENA ALISHA CHOPRA AMAN BANSAL

Alternative Choices Decisions


Process of evaluating two or more alternatives leading to a final choice

COMPONENTS OF DECISION MAKING


Relevant Information Relevant Revenues Relevant Costs Qualitative Factors

Relevant Information Historical costs may be helpful in making predictions. Analyzing differences between expected future revenues and costs. Relevant Revenues They are expected future revenues.

Relevant Costs Relevant Costs are expected future costs Production capacity to manufacture components. Qualitative Factors Perception regarding possible future price changes. Nature of the work to be subcontracted

TYPES OF CHOICE DECISIONS


MAKE or BUY(Outsourcing Decision) ADD or DROP PRODUCTS SELL or PROCESS FURTHER OPERATE or SHUTDOWN SPECIAL ORDERS REPLACE or RETAIN

MAKE OR BUY DECISION


Following alternatives are considered under make or buy decisions
To buy certain raw materials from outside suppliers. To use available capacity to produce the items within the company.

It determines economically most desirable alternative. Differential cost analysis is considered.

AN ILLUSTRATION
Spare parts Ltd. has an annual production of 50,000 units for component X. The components cost structure is as below: Rs. Materials 250 per unit Labour (25% fixed) 180 per unit Expenses: Variable 90 per unit Fixed 135 per unit Total 675 per unit

The purchase manager has an offer from a supplier who is willing to supply the component at Rs.540. Should the component be purchased and production stopped?

ADD OR DROP PRODUCTS


It is a decision to eliminate an UNPROFITABLE PRODUCT. MOST IMPORTANT FACTOR IN THE DECISION:
To add or drop a product-whether it will increase or decrease the future income of the business.

AN ILLUSTRATION
XYZ Ltd. is considering to drop Product B from its line because accounting statements show that product B is being sold at a loss. INCOME STATEMENT
PRODUCT A Sales Revenue 50,000 7500 15,000 7500 30,000 20,000 12,500 PRODUCT B 7500 1000 2000 1000 4000 3500 4500 PRODUCT C 12,500 1500 2500 1250 5250 7250 4000 TOTAL 70,000 10,000 19,500 9750 39,250 30,750 21000

Cost of Sales:
Direct Material Direct Labour Indirect Manufacturing Cost TOTAL COST Gross Margin on sales Selling and administrative

Additional Information: Factory overhead costs : Fixed Costs-Rs.5850 and Variable Costs-Rs.3900. Variable costs by products are: A-Rs.3000,B-Rs.400,C-Rs.500. No change in Fixed Costs and expenses, if product B is eliminated Variable selling and administrative expenses to the extent of Rs.11000.By products: A-Rs.7500,BRs.1500,C-Rs.2000. Fixed selling and administrative expenses are Rs.10,000. No change in sales of Product A and Product C after Product B is dropped.

PARTICULARS Sales Revenue Less: Variable production Costs: Direct Mat. Direct Labour Factory OH

PRODUCT A 50,000

PRODUCT B 7500

PRODUCT C 12,500

TOTAL 70,000

7500 15000 3000

1000 2000 400

1500 2500 500

10,000 19500 3900

S & D Expenses 7500


Total Costs Contribution Margin Less: Fixed Costs: Factory OH S & D Expenses Total Fixed Costs 33,000 17000

1500
4900 2600

2000
6500 6000

11000
44,400 25,600

5850 10,000 15850

Operate Or Shutdown
Need to determine about the short run firms. Management should consider all the investments. Loss incurred if the firm is shut down. Cost incurred while shutting down.

Numerical
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. Management is concerned that the further drop in sales volume will create a loss and has consideration that the operations will be suspended, until better market conditions prevail and also a better selling price. At which point company should be shutdown? Sales revenue(10,000@Rs 3 ) Rs 30,000 (-) Variable costs@ Rs 2 per unit Rs 20,000 Fixed costs Rs 10,000 Net Income 0

Cont..
Units produced
Shutdown Sales revenue@ Rs 3 0 Variable cost@ Rs 2 0 Contribution
Fixed cost Loss

2000 4000 6000 8000 10,000 6000 12000 18000 24000 30,000 4000 8000 12000 16000 20,000 2000 4000 6000 8000 10,000

0
4000 (4000)

10,000 10,000 10,000 10,000 10,000 (8000) (6000) (4000) (2000) 0

Shutdown is desirable at the point at which the operating losses exceed the shutdown cost..

PRODUCT M Sales (-) Profit Cost of Sales (-) Selling & Dist. Expenses 2,00,000 50,000 1,50,000 6,280

PRODUCT B1 1,20,000 24,000 96,000 12,560

PRODUCT B2 80,000 12,000 68,000 12,560

Cost of Production (-) After split off cost


Joint cost apportioned

1,43,720 20,000
1,23,720

83,440 15,000
68,440

55,440 10,000
45,440

2) If B1 is not processed further Sales of product B1 (-) Share in joint cost Profit Rs 1,00440 Rs 68,440 32,000

Sell Or Process Further


The decision whether a product should be sold or processed further is taken by the manufacturer. Additional value adds value to a product and increases its selling price..

Numerical
Modern & Mills Ltd. Manufactures certain grades of products known as M whose by product are B1 and B2.the joint expense of manufacture amount to Rs 2,37,600.
PRODUCT M SALES COST INCURRED Rs 2,00,000 Rs 20,000 PRODUCT B1 1,20,000 15,0000 PRODUCT B2 80,000 10,0000

PROFIT % ON SALES

25

20

15

Total fixed selling expenses are 10% of total cost of sales which are in ratio of 20:40:40 1) Prepare a statement showing apportionment of joint costs to the product. 2) If the product B1 is not subject to further processing and is sold at the point of separation, for which there is a market of Rs 1,00440 without incurring any selling expenses. Would you advise its disposal at this stage

PRODUCT M Sales (-) Profit Cost of Sales (-) Selling & Dist. Expenses 2,00,000 50,000 1,50,000 6,280

PRODUCT B1 1,20,000 24,000 96,000 12,560

PRODUCT B2 80,000 12,000 68,000 12,560

Cost of Production (-) After split off cost


Joint cost apportioned

1,43,720 20,000
1,23,720

83,440 15,000
68,440

55,440 10,000
45,440

2) If B1 is not processed further Sales of product B1 (-) Share in joint cost Profit Rs 1,00440 Rs 68,440 32,000

Special Orders
It is made when a company has excess production capacity. Possibility of selling it at lower price. Provided it doesnt affect the sales of the same product. Pricing can be done using the cost analysis technique. Fixed costs are not considered when deciding the pricing of special orders. Only variable costs are considered.

A manufacturing company produces 20,000 units by operating at 60% of the capacity and sells at a price of Rs. 30/unit. The figures for the year 2003 are:Production Raw material@ Rs. 4.25 Direct labour @ Rs. 5.75 Variable factory overhead @ 7.75 Fixed factory overhead Variable selling costs 2.75% of selling price Rs . 85,000 1,15,000 1,55,000 1,25,000

Fixed selling and administrative costs

72,500

The company receives a special order for 10,000 units from a firm. The company wants to earn a profit of Re 1.00 per unit and no selling expenses are to be incurred for the special order. The pricing of special order:Variable costs to be incurred: (Rs.)

Raw materials
Direct labour Variable overhead

4.25
5.75 7.75 17.75

Desired profit
Minimum price

1.00
18.75

Increase in sales= 10,000* 18.75= Rs. 1,87,500

Income Statement
Without special order Special order
Sales 6,00,000 Raw materials 85,000 1,87,500 42,500

With special order


7,87,500 1,27,500

Less: Variable costs

Direct labour
Variable overhead

1,15,000
1,55,000

57,500
77,500

1,72,500
2,32,500

Variable selling cost(2.75% of S.P)


Total Variable cost Less: Fixed costs: Fixed factory overhead Fixed selling and admin cost Total fixed costs

16,500
3,71,500 1,25,000 72,500 1,97,500

1,77,500 -

5,49,000 1,25,000 72,500 1,97,500

Total costs
Net Income

5,69,000
31,000

1,77,500
10,000

7,46,500
41,000

A company currently operating at 80% capacity has the following particulars:


Rs. Sales Direct materials Direct labour Variable overheads Fixed overheads 32,00,000 10,00,000 4,00,000 2,00,000 13,00,000

An export order has been received that would utilize half the capacity of factory. Order must be executed at 10% below the normal domestic prices. The alternatives available to the management are: 1. Reject the order and continue with the domestic sales only( as at the present); or 2. Accept the order, split capacity between overseas and domestic sales and turn away excess domestic demand i.e. (50% for domestic sales + 50% for export).

Comparative Profitability Statement


Domestic Sale only at 80% capacity Rs.
Domestic sales Export sales Total sales (a) Direct material Direct Labour Variable Overheads Total variable cost Fixed Cost Total Cost(b) Profit (a) (b) 32,00,000 32,00,000 10,00,000 4,00,000 2,00,000 16,00,000 13,00,000 29,00,000 3,00,000

50% for Domestic + 50% for Export Rs.


20,00,000 18,00,000 38,00,000 12,50,000 5,00,000 2,50,000 20,00,000 13,00.000 33,00,000 5,00,000

Replace or Retain
To replace or retain plant and equipment. Differential costs involved are:1. Change in fixed overhead charges. 2. Loss on sale of old equipment. 3. Related costs such as rate of return and interest. Differential benefits involved are:1. Higher production and increased sales 2. Savings in operating costs 3. Realizable value of old machine.

Suppose a company has purchased a plant for Rs. 1,00,000 five years ago which has a life of 10 years with no salvage value. The present book value is Rs. 50,000. Management is considering the replacement of this plant with new plant costing Rs. 80,000 having a life of 5 years with no scrap value at the end of its life. The costs of operating present plant and the proposed plant are as follows:
Present plant Variable costs: (Rs.) Proposed plant (Rs.)

Labour, supplies, power, etc.

80,000

48,000

Fixed costs: insurance, taxes, 10,000 etc.

12,000

Depreciation

10,000 1,00,000

16,000 76,000

It appears that new plant would result into savings of Rs. 24,000. But the book value of the present equipment is a sunk cost and not relevant in the decision.
Present plant Variable costs: (Rs.) Proposed plant (Rs.)

Labour, supplies, power, etc.


Fixed costs: insurance, taxes, etc.

80,000

48,000

10,000

12,000

Depreciation

0 90,000

16,000 76,000

THANK YOU

You might also like