Session 5:Decision Making

Workshop on
Management Accounting for
non -finance executives

BY: ABDUL RAHIM SURIYA

FCA, FCMA

BUSINESS DECISSION MAKING

o Making decisions is one of the basic functions of a manager.
o Managers are constantly faced with problems of deciding
what products to sell, what services to offer,what price to
quote, whether to make or buy component parts, what channels
of distribution to use,whether to accept special assignment at
special prices, whether to out-source any extra services
required or hire staff and so forth.

BUSINESS DECISSION MAKING

o Decision making is often a difficult task that is complicated
by the existence of numerous alternatives and massive amounts
of data, only some of which may be relevant.
o Every decision involves choosing from among at least two
alternatives.
o In making a decision, the costs and benefits of one alternative
must be compared to the costs and benefits of other
alternatives.
3

WHAT IS DECISION MAKING?

o Decision making is defined as the process

of:
o
o
o
o
o

identifying problems,
considering and evaluating the alternatives,
arriving at a decision,
taking action, and
assessing the outcome.

STEPS IN AN EFFECTIVE
DECISION MAKING PROCESS
o

Decision-making experts note that managers are

more like to be effective decision makers if they
follow the general approach as detailed below.
Identify the problem
1.
2.
3.

Generate alternative solutions

Evaluate and choose an alternative
Implement and monitor the chosen solution

Although these steps do not guarantee all

decisions will have the outcomes desired, they
do increase the likelihood of success.
5

PROBLEMS CLASSIFICATION
o For decision making it is important to understand

the types of problems , decisions and conditions

that managers face .
o Problem can be classified into :
o
o
o

Crisis problem
Non crisis problems, or
Opportunity problems

TYPE OF DECISION
o Programmed Decisions

A manager makes a programmed decision when

a situation occurs so often or is so wellstructured that it can be handled through the use
of preset decision rules.
o Non-Programmed Decisions

Decisions for which predetermined decision

rules are impractical due to novel and/or illstructured situations.
7

DAY TO DAY BUSINESS DECISION

o Managers

come across various

situations in day to day business
activities where decision are required.

o Decision making require accurate data

which of course need to be analyzed

and evaluated properly by decision
maker before reaching at a decision.
8

DECISION MAKING
RELEAVANT AND IRRELEVANT COST
o Distinguishing between relevant and irrelevant cost is critical for

two reasons :
o

First, irrelevant data can be ignored and need not be analyzed. This
can save decision makers tremendous amounts of time and effort.

Second, bad decisions result from erroneously including irrelevant

cost and benefit data when analyzing alternatives.

To be successful in decision making, managers must be able to

recognize the difference between relevant and irrelevant data and
must be able to correctly use the relevant data in analyzing
alternatives.
9

DECISION MAKING
NON-QUANTATIVE FACTORS
Financial and quantitative information is used as a basis for
decision making. It should not be used exclusively. However, in
most decisions there are a number of factors which need to be
balanced and weighed before the final point is reached and the
decision actually made.
Most of the factors are qualitative ones that are not easily
expressed in terms of money.
Example
A decision to close a department or a factory the cost of making
staff redundant can be calculated quite easily. But the effect in
terms of loss of morale of other staff , decrease in productivity
etc cannot be easily measured.
10

Different costs for differing purposes

o

We need to recognise that cost are relevant in one decision situation are not
necessarily relevant in another.

For one purpose , a particular group of cost may be relevant;for another

purpose , an entirely different group cost may be irrelevant.

Thus , in each decision situation the manager must examine the data at
hand and isolate the relevant costs.Otherwise , the manager runs the risk of
being misled by irrelevant data.

Nearly 70 years ago, eminent economist J. Maurice Clarke stated that

Accountants

use different costs because of

their differing objectives.
11

Different costs for differing purposes

o The concept of different cost for different purposes

is basic to managerial accounting.

o The business world has certainly become a lot more

complicated since Professor Clarkes insightful

comment. Management accountants today are
expected to be a lot more conversant and
knowledgeable about business operations. They are
expected to add value to their company by their
ability to bring the right information to bear on a
decision. To do that, management accountants must
be able to identify, analyze, and help solve problems.
12

DIFFERENCIAL COST
o Differential cost is the difference in the cost of
alternative choices.
o It deal with the determination of incremental revenue,
cost, and margins.
o Historical costs drawn from the financial accounting
records generally do not give management the
differential cost information needed to evaluate
alternative courses of action.
13

DIFFERENCIAL COST
o Differential cost is often referred to as marginal or

incremental cost.

o The term marginal cost is widely used by

economists.

o Engineers generally speak of incremental costs as

the added cost incurred when a project or an

undertaking is extended beyond its originally
intended goal.
14

OPPORTUNITY COSTS
o Opportunity costs are the measurable
value of an opportunity or potential
benefits given up when one alternative
is selected over another.
o The opportunity cost is not the usual
outlay of cash rather they represent
economic benefits that are foregone as a
result of pursing another course of
action.
15

OPPORTUNITY COSTS
o Opportunity costs require the measurement of
sacrifices associated with alternatives. If a decision
requires no sacrifice, there is no opportunity cost.
Example 1
o Miss Monica has a part-time job that pays her Rs.
1000 per week while attending college. She would
like to spend a week at the beach during spring break,
and her employer has agreed to give her the time off,
but without pay. The lost wages of Rs 1000 would be
an opportunity cost of taking the week off to be at the
beach.
16

OPPORTUNITY COSTS
EXAMPLE - 2
o An engineer quite his job with INTEL to start his own business. The data
are:
If open an
Independent
Business
Salary income from INTEL
Revenue from business
Total expenses
Net income

If continue
as an INTEL
Employee

Rs. 3.0 Million

Rs. 1.6 Million

Rs. 1.2 Million

Rs. 1.4 Million

Rs. 1.2 Million

The opportunity cost of starting a new business is the Rs. 1.2 million
salary that could be received from INTEL.

17

SUNK COSTS
o A sunk cost is a cost that has already been

incurred and that cannot be changed by

any decision made now or in the future.

o Sunk cost are irrelevant cost for decision

making and should be ignored.

18

CASE STUDY
SUNK COSTS
o Management of the Shaheen Chemical Company is

reviewing a research project that was initiated for the

purpose of developing a new product.
o
o

Expenditures to date on the project total Rs. 252,000.

The Research and Development Department now
estimates that an additional Rs. 48,000 will be required to
produce a marketable product.
Current market estimates indicate a lifetime profit potential
having a present value of Rs. 80,000 for the product,
excluding research and development expenditure.

o Q- Advise Management for spending additional Rs.

48,000.

19

SUNK COSTS
o An understanding of the distinction between future

costs and sunk costs can help avoid confusion and

possible error when management is faced with a
decision involving two material amount of cost that
has been incurred in the past.

o This question typically arises in deciding whether to

continue or to terminate a project already in

progress.

20

MODULES OF DIFFERENCIAL COSTS

o

Various Situations where Differential Cost

Analysis is used by management for decision
making:
o
o
o
o

Pricing decision for a special order.

Price cut in a competitive market.
Pricing in case of full capacity.
Increasing, curtailing, or stopping
production of certain products.
21

MODULES OF DIFFERENCIAL COSTS

o
o
o
o
o
o
o
o
o

Evaluating make-or-buy alternatives.

Expanding or reducing plant capacity.
Cost benefit analyses- spending additional amounts
for sales promotion.
Selecting new sales territories.
Further processing decision
Addition of new machinery vs. putting plant on
double shift/OT.
Utilization of spare capacity
Replacing present equipment with new machinery.
22
Decision to shut down plant.

SPEICAL PRICING FOR SPECIAL ORDERS

o The differential cost aids management in deciding

at the price the company can afford to accept an

additional order for sale of goods or services.
o These additional orders may be for
o
o

Government institutions or
Export etc

23

CASE STUDY- 1
SPEICAL PRICING FOR SPECIAL ORDERS
o A company manufactures 450,000 units. The fixed factory

overhead is Rs. 335,000. The variable cost is Rs. 3.7 per

unit. Each unit sells for Rs. 5.

o The sales department reports that a customer has offered to

pay Rs.4.25 per unit for an additional 100,000 units. To

make the additional units, an annual rental cost of
Rs.10,000 for new equipment would be incurred.

o Q- Advise Management to accept the order or not.

24

SOLUTION TO CASE STUDY- 1

SPEICAL PRICING FOR SPECIAL ORDERS
The traditional accountant may project loss on this order as follows:
Sales (100,000 units @ Rs.4.25)
Cost of goods sold:
Variable cost @ Rs. 3.7
Fixed factory overhead (100,000 units @.*74)

Rs. 425,000
370,000
74,000

NET LOSS ON ACCEPTING OFFER AT Rs. 4.25

44,000
19,000

Based on above management would reject the offer.

Fixed Cost per unit : 335000 / 450000 = 0.74
Alternate : Fixed Cost per unit : 345,000 / 550,000 = 0.627
25

SOLUTION TO CASE STUDY- 1

SPEICAL PRICING FOR SPECIAL ORDERS
Management may decide to evaluate it further based on differential
cost concept:
Sales Prices
425,000
Variable Costs

(4.25 x 100000)
(3.70 x 100000)

Less : Increase in fixed cost

Incremental gain on accepting the offer
o

Rs.
370,000
55,000
10,000
45,000

When a differential cost analysis leads management to accept an

additional order , it is to be ensured that the order is not going to
disturb the market of the existing products.

26

CASE STUDY- 2
SPEICAL PRICING FOR SPECIAL ORDERS
Polaski Company manufactures and sells a single product. Operating at capacity, the
company can produce and sell 30,000 units per year. Costs associated with this level
of production and sales are given below:
Unit
Total
Direct materials Rs.
15
Rs. 450,000
Direct labor
8
240,000
Variable manufacturing overhead.
3
90,000
Fixed manufacturing overhead
9
270,000
Variable selling expense..
4
120,000
Fixed selling expense...
6
180,000
Total cost ...
45
1,350,000
Unit sales price is Rs. 50 each. Fixed manufacturing overhead is constant at Rs.
270,000 per year within the range of 25,000 through 30,000 units per year.
27

CASE STUDY- 2
SPEICAL PRICING FOR SPECIAL ORDERS
Assume that due to a recession, Polaski Company expects to sell only
25,000 units through regular channels next year. A large retail chain has
offered to purchase 5,000 units if Polaski is willing to accept a 16%
discount off the regular price. There would be no sales commissions on this
order; thus, variable selling expenses would be slashed by 75%. However,
Polaski Company would have to purchase a special machine to engrave the
retail chains name on the 5,000 units. This machine would cost Rs. 10,000.
Polaski Company has no assurance that the retail chain will purchase
additional units any time in the future.

Required:
Determine the impact on profits next year if this special order is accepted.
28

SOLUTION TO CASE STUDY- 2

SPEICAL PRICING FOR SPECIAL ORDERS
Existing Fixed expenses are not irrelevant. However Cost of new machine is
relevant and be considered & recovered from this order.
Existing
Sale price
50
Direct Material
15
Direct Labour
8
Variable Overhead
3
Variable Selling
4
Special Machine (10000 5000) 30
Contribution Margin
15

New order
42
15
8
3
1
2
29
13

CONCLUSION: Incremental revenue from new order is 65000 (13*5)

29
Order be accepted at 16% discount provided it will not effect existing sales.

UTILIZATION OF SPARE CAPACITY

o

In cases where production is below capacity,

opportunities may arise for.
o
o
o
o
o

sales at a specially reduced price ,

introducing new products ,
manufacturing under another brand name.
tolling options
biding for Government or export for bulk
supplies

30

CASE STUDY-3
UTILIZATION OF SPARE CAPACITY
SUPRA LTD is operating at 80% of its capacity and produce 8,000 units per month.
The budget is as follows:
Per unit -Rs
Rupees
Sales
10
80,000
Variable costs:
Raw materials
3
24,000
Direct labour
2
16,000
Variable overheads
1
8,000
6
48,000
Fixed costs
3
24,000
Total Costs
9
72,000
Budgeted profit
1
8,000
There is an offer to export 1,000 units per month at a price of Rs. 8/- per unit.
Q - Advise Management, should the offer be accepted?

31

SOLUTION TO CASE STUDY

UTILIZATION OF SPARE CAPACITY
a)

Capacity assessment
The spare capacity available is 20% i.e. 2000 units, so we can consider
this offer.

b)

Increment revenue vs. incremental Cost

Additional revenue (1,000 x 8)
Rs. 8,000
Additional costs
(1,000 x 6)
6,000
Increased profitability (assuming no change in fixed cost) 2,000

c)

Conclusion
Based on above,the contract should be accepted to gain from spare
capacity available as the fixed costs will remain same and have no
relevance here for decision, and therefore not to be considered for this
additional order.
32

MAKE OR BUY DECSION

o A manufacturer may evaluate options to make-or-buy few components

of the product being manufactured.

o This problem arises particularly in connection with the possible use of:
o
o
o

idle equipment
idle space
idle labor

o Make or buy decision are evaluated for outsourcing .An enterprises

despite of available in-house resources might opt for outsourcing.

Examples
o Garment factory --- fusing cutting inside or buy readymade collar
o Catering Business
33

CASE STUDY-4
MAKE OR BUY DECSION
o National Automobile Company produces an assembly used in the production of one of

its product lines.

o The department in which the assembly is produced incurs annual fixed costs of Rs.

500,000.

o The variable cost of production is Rs. 51 per unit.

o The assembly could be bought outside at a cost of Rs. 53 per unit.
o The current annual requirement is for 100,000 assemblies.

Q- Advise Management, should the company continue to make or buy?

34

SOLUTION TO CASE STUDY

MAKE OR BUY DECSION
Per unit

Total

53

5,300,000

VC

51

5,100,000

FC

500,000

Cost to Buy
Cost to Make:

5,600,000

Conclusion
o

A decision to make in house would cost the company extra Rs. 300,000 but
that depend how much fixed cost can be saved if bought from outside.

Therefore in case of buying from outside, the fixed costs of Rs. 500,000
will require analysis to determine what would actually be saved if in-house
production of the assembly were discontinued.
35

MAKE OR BUY DECSION

o

Other factors need to be considered by the Management

1.

Continuity and control of supply. Can the outside company be

relied upon to meet the requirements in terms of quantity, quality,
delivery, timely supply and price stability?

2.

Alternate supplier. Is alternate suppliers available to avoid

monopoly in future

3.

Alternative use of resources. Can the resources used to make this

article be transferred or utilised to another activity which will save
cost or increase revenue?

4.

Social/legal. Will the decision affect contractual or ethical obligations

to employees or business connections?
36

DECISION TO SHUT DOWN

o Differential cost analysis is also used when a business is

confronted with the possibility of a

manufacturing and/or marketing facilities.

shutdown

of

o In the recent years few companies have experienced shut down

of their marketing department and entered into outsourcing

contract to perform its marketing function and in some cases
companies despite of own manufacturing facilities have
preferred to go for Tolling options.

37

EXAMPLES
DECISION TO SHUT DOWN
o Orgnon and Reckitt have shut down their pharmaceuticals

plant completely and are concentrating on marketing function.

Their products are being manufactured by ABBOT AND
MECTOR/GETZ respectively.

o Some companies are getting their few products toll through

other pharmaceutical companies like :

o
o
o
o

WYTH for SPENCER and MECTOR

PHARM EVO for ASIAN PHARMA
SANTE from ELKO
ICI and BYER from GETZ PHARMA

38

DECISION TO SHUT DOWN

o

A shutdown of facilities or a project or a department does

not eliminate all costs. Some expenses like depreciation,
interest, and insurance may continue during complete
inactivity.

If operations continues (even in loss situation), certain

expenses connected with the shutting down of the
facilities would be saved such as costs that would have to
be incurred on shut down when a closed facility is
reopened.

39

DECISION TO SHUT DOWN

o

Other aspect of shutdown:

1.
2.
3.
4.

the loss of established markets.

morale of other employees,
danger of plant obsolescence
training of new employees when project will restart.

In periods of trading difficulty, a business can

continue to operate while marginal contribution
equals fixed expenses i.e. in Breakeven situations.
40

CASE STUDY-5
DECISION TO SHUT DOWN
o

Delta Corporation is considering closing down its plant for one year, after
which time the demand for its product is expected to increase substantially.

o
o
o

At present it is operating at 40% capacity.

o
o
o
o
o
o

Q-

Sales value
Variable costs
Fixed costs

Rs 000
60,000
40,000
50,000

Other data
Fixed costs of Rs18 million will continue to incur even if the plant is
closed.
The cost of closing down operations for one year will be Rs. 14 million.

Advise Management best course of action.

41

SOLUTION TO CASE STUDY

DECISION TO SHUT DOWN
Statement of profit or loss
In case of
Continuing operation
Sales
Variable cost of sales
Contribution margin
Fixed costs
Net loss

In case of
Temporary closure
Rs000
60,000
40,000
20,000
50,000
(30,000)

Rs000
Fixed expenses
18,000
Closing down costs 14,000

(32,000)

CONCLUSION
The company can minimize its losses by not closing down.

42

DISCONTINUE PRODUCT/ SEGMENT

o There may arise circumstances where

management decide to discontinue certain

products or department or segment divisions or
types of customer in case they are yielding
o
o

net loss or
an inadequate profit.

43

FOCUS ON CURRENT PRACTICE

A bakery distributed its products through route
salespersons, each of whom loaded a truck with an
assortment of products in the morning and spent the day
calling on customers in an assigned territory.
Believing that some items were more profitable than
others, management asked for an analysis of product costs
and sales.
The accountants to whom the task was assigned allocated
all manufacturing and marketing costs to products to
obtain a net profit for each product.
44

FOCUS ON CURRENT PRACTICE

The resulting figures indicated that some of the products
were being sold at a loss, and management discontinued
these products.
However, when this change was put into effect, the
companys overall profit declined. It was then seen that by
dropping some products, sales revenues had been reduced
without commensurate reduction in costs because the
common manufacturing costs and route sales costs had to
be continued in order to make and sell the remaining
products.
45

DISCONTINUE PRODUCT/ SEGMENT

IMPACT ON OTHER PRODUCTS
o
In case financial data suggest to discontinue a product or
division it is important to analyze and evaluate the extent to
which sales of other products will be adversely affected.
o

Example
i.

ii.
iii.

a life saving drug if discontinued may directly effect entrance

of Sales officers in doctors clinic, which of course will effect
sales of other products and overall image of the company.
Angised and Digixon of GLAXOWELLCOME
Hospital: If one unit like X Ray not yielding profit even
then management may continue so that business of high yield
division like Laboratory may not be effected.
46

DISCONTINUE PRODUCT/ SEGMENT

o

Classification of fixed cost

o

Separable fixed cost

It exists only because the segment exists; it will be eliminated
if the segment is discontinued. For example salary of a branch
manager or a department.

Joint fixed costs

It remain after the disposal or discontinuing segment and be
absorbed by the remaining segments. For example
Depreciation of factory building, salaries of security and head
office cost etc.
47

CASE STUDY-6
DISCONTINUE PRODUCT/ SEGMENT
o

Citi International a manufacturer of 3 consumer products, is considering dropping

SOAP, which is presently losing money as detailed below:

Sales revenue
Variable costs
Contribution Margin
Fixed costs
Separable
Joint*
Total
Profit (loss)

Shampoo
500,000
270,000
230,000

Soap
300,000
202,000
98,000

Conditioner
400,000
220,000
180,000

Total
1,200,000
692,000
508,000

56,000
100,000
156,000

59,000
60,000
119,000

45,000
80,000
125,000

160,000
240,000
400,000

74,000

(21,000)

55,000

108,000

* Allocated on the basis of total sales value.

48

SOLUTION TO CASE STUDY

DISCONTINUE PRODUCT/ SEGMENT
From the previous slide, it appears that by dropping the SOAP line, Citi
International would save Rs.21,000 a year. However, incremental analysis
leads to quite a different picture:
On Discontinuing Soap:
Decrease in revenue
Less:
Variable costs avoided
Separable fixed costs avoided
Total costs avoided
b
Decrease in net income

a-b

300,000
202,000
59,000
261,000
39,000

CONCLUSION
Profit of Citi International will decrease by Rs. 39,000 if the Soap line were
dropped. Fixed cost Rs. 60,000 will continue to incur inspective of SOAP.
(60,000 21,000 = 39,000 Loss)

49

SOLUTION TO CASE STUDY

DISCONTINUE PRODUCT/ SEGMENT
Alternate working - P/L A/c after discontinuing Soap
Shampoo

Conditioner

Sales revenue
500,000
Variable Cost
Contribution margin
Fixed costs
- Separable
56,000
- Joint*
Total
189,333
Profit
40,667

Previous Profit (3 products) 108,000

New Profit (2 products)
69,000
Decrease in profits by dropping SOAP line

Total
400,000
270,000
230,000

900,000
220,000
180,000

490,000
410,000

45,000
101,000
133,333
106,667
240,000
151,667
341,000
28,333
69,000

39,000

Conclusion :
It is advisable to continue Soap line since overall profit is declining by
Rs 39,000
50

DISCONTINUE PRODUCT/ SEGMENT

o Other non-financial factors
o

On elimination of the SOAP line there be may

considerable effect on the sales of the other
products.

Few consumer may stop buying the shampoo and

conditioner if the Soap is not available and may
switch to competitors products.

51

CASE STUDY-7
RELEVANT COSTS
A merchandising company has two departments, A and B. Monthly income statement
for the company is as follows for a recent month :
Department
Sales Rs.
Less variable expenses
Contribution margin ..
Less fixed expenses
Net operating income (loss) Rs.

Total
A
B
4,000,000 Rs. 3,000,000 Rs. 1,000,000
1,300,000
900,000
400,000
2,700,000
2,100,000
600,000
2,200,000
1,400,000
800,000
500,000 Rs. 700,000 Rs. (200,000)

A study indicates that Rs. 340,000 of the fixed expenses being charged to Department B
are sunk costs or allocated costs that will continue even if B is dropped. In addition, the
elimination of Department B will result in a 10% decrease in the sales of Department A.
Required: What will be the effect on the net operating income of the company as a
whole if Department B is dropped ?
52

SOLUTION TO CASE STUDY

RELEVANT COSTS
Impact on Contribution Margin
Department B
Department A

600,000
210,000
810,000

Saving in fixed cost (800 - 340)

Net decrease in profit if Dept B is closed

460,000
350,000

Alternate working
Dept B - 200,000 340,000

140,000

Dept A - Contribution margin impact

210,000
350,000

53

CASE STUDY
PRODUCT PROCESS EFFICIENCY
o

It is often possible to elevate the constraint at very low

cost.

Western Textile Products makes pockets, waistbands, and

other clothing components. The constraint at the
companys plant in Greenville, South Carolina, was the
slitting machines. These large machines slit huge rolls of
textiles into appropriate widths for use on other machines.
o

Management was contemplating adding a second shift

to elevate the constraint. However, investigation
revealed that the slitting machines were actually being
run
only one hour in a nine-hour shift.
54

CASE STUDY
PRODUCT PROCESS EFFICIENCY
o

The other eight hours were required to get materials, load

and unload the machine, and do setups. Instead of adding
a second shift, a second person was assigned to each
machine to fetch materials and do as much of the setting
up as possible off-line while the machine was running.

This approach resulted in increasing the run time to four

hours. If another shift had be added without any
improvement in how the machines were being used, the
cost
would have been much higher and there would have
been
only a one-hour increase in run time.

55

ADDITIONAL CONTRACT PRICING

LIMITING FACTORS
o

In case a business is operating at full capacity, an additional

orders be considered on the basis of limiting factor so that the
price quoted will at least maintain the existing rate of
contribution per unit of limiting factor.

Limiting factor may be material, labour etc.

CASE STUDY-8
Sitara Ltd manufactures special purpose gauges to customers
specifications. The highly skilled labour force is always
working to full capacity. The budget for the next year shows
following data :
56

CASE STUDY
ADDITIONAL CONTRACT PRICING

Sitara Ltd manufactures special purpose gauges to

customers specifications.
The highly skilled labour force is always working to
full capacity.
The budget for the next year shows following data :

57

CASE STUDY-9
ADDITIONAL CONTRACT PRICING
Rs in 000s

BUDGETED P/L A/C

Sales
Direct materials
Direct wages 3,200 hours @ Rs. 93.75
Contribution margin
Fixed overhead,
Profit

540
40
300
200
100
100

An enquiry is received from Lanka Ltd for a gauge which would use Rs. 600 of direct
materials and 40 labour hours.

Q-1 What is the minimum price to quote to Lanka Ltd when maximum work
hours are 3200.
Q-2 Would the minimum price be different if spare capacity were available but
materials were subject to a quota of Rs. 40,000 per year?

58

SOLUTION TO CASE STUDY

ADDITIONAL CONTRACT PRICING
1.

The limiting factor is Rs. 3,200 labour hours. Budgeted contribution

per hour is Rs.200,000 3,200 hours = Rs. 62.50 per hour.
Minimum price is to be quoted:

Materials
Wages 40 hours @ 93.75
Add: Contribution 40 hours @ 62.5
To Quote Contract price (minimum)

Rs.
600
3,750
4,350
2,500
6,850

Minimum Price quotation should be Rs 6,850 at which

the contract will maintain the budgeted contribution.
59

SOLUTION TO CASE STUDY

ADDITIONAL CONTRACT PRICING
2.

If the limiting factor is materials, budgeted contribution

per rupee of materials is Rs. 5 (. Rs.200,000 Rs.
40,000 )
Rs.
Materials & wages (actual cost)
4,350
Contribution Rs. 600 x 5
3,000
To Quote Contract price (minimum)
7,350
Sitara must aim to earn the maximum profit from its
limited supply .Price quoted should be minimum Rs
7,350 as it will maintain the existing profit by way of
recovering contribution margin plus additional cost
incurred.
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FURTHER PROCESSING DECISION

o

In processing operations, particularly those involving more

than one product, often there is a choice between:
o
Selling a product in an unfinished form, or
o
to further process it into a finished product.

If relevant costs of further processing are re-covered by the

incremental revenue, a product may be further processed, else
not.

Example
o
Textile: Gray Cloth Dying Printing
o
Mining: Oil - Gas

61

CASE STUDY-10
FURTHER PROCESSING DECISION
Shezad Ltd produces three products from a common process.
o
Total joint costs is Rs.104,000 per month
o
Each of the products may be further processed:
o
Selling prices and further processing costs per litre are as follows:

Cost of further processing

Selling price:
o
Before further processing
o
After further processing
Monthly out put

Rs.

(in liters)

A
5.00
11.00
15.00
100.00

Product
B
3.00

C
9.00

14.00
19.00
50.00

13.00
20.00
80.00

Q - Advise Shezad Ltd about further processing any of its products.

62

SOLUTION TO CASE STUDY

FURTHER PROCESSING DECISION
o
o

The incremental costs and revenues be considered.

The common cost is irrelevant for decision to process further or not .
Product
C

A B
Selling price:
o
Before further processing
11.00
o
After further processing 15.00
19.00
Incremental revenue on processing further
4.00
Further processing cost
(5.00)
(3.00)
Incremental contribution
(1.00)
+ 2.00

14.00
20.00
5.00
(9.00)
(2.00)

13.00
7.00

The above calculation shows that the further processing of product B is the only further
processing activity which leads to an increase in contribution.
CONCLUSION
Shezad Ltd may further process product B only, and sell products A and C without further
processing them.

63

CASE STUDY 11
FURTHER PROCESSING DECISION
Wexpro, Inc., produces several products from processing of 1 ton
of clypton, a rare mineral. Material and processing costs total Rs.
60,000 per ton, one-fourth of which is allocated to product X.
Seven thousand units of product X are produced from each ton of
clypton. The units can either be sold at the split-off point for Rs. 9
each, or processed further at a total cost of Rs. 9,500 and then sold
for Rs. 12 each.
Required:
Advise whether product X be processed further or sold at the splitoff point?
64

SOLUTION TO CASE STUDY

FURTHER PROCESSING DECISION
Increment Sales Revenue if
further processed (12 - 9 x 7000 ) = 21,000
Increment Cost
Net incremental income on
further processing

9,500
11,500

CONCLUSION
Product X be processed further
65

CONCEPT REVIEW EXERCISE

Fill in the blank from choices given.
1.

____________ cost are the measurable value of an

opportunity by passed by rejecting an alternative use of
resources.
a) Marginal
b)
Sunk
c)
Opportunity

2. ____________ cost in the difference in the cost of alternative

choices.
a) Opportunity
b)
Sunk
c)
Differential
3.

Differential cost is after referred to as ___________ cost.

a) Marginal
b)
Sunk c)
Opportunity
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THE END

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