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Special Order Pricing

:
A special order is a job executed against customers specifications as to design,
model, size of the product. For pricing this special order or job, a cost sheet
is prepared on the basis of material requisition, time taken workers and ration
al methods of overhead obsortion. Thus total cost of job is arrived, to which if
we add a reasonal profit as agreed, we will get price of a special order is arr
ived.
Process of product addition and Deletion:
A business may have to decide on adding or dropping a product line. When a new p
roduct line is added, certain costs will go up and vice versa, when a product li
ne is dropped certain costs will not have to be incurred. Such a decision may be
taken by comparing the differential cost and incremental revenue and its effect
on the overall profit position of the company.
Addition OR Expand of a the product:
Expansion of business operations results in economies of scale, greater flexibil
ity, lower fixed costs and greater capacity of the firm to meet the customers, s
pecifications. Expansion also brings with it many organizational and communicati
on problems control and monitoring functions become more complex and designation
of authority and responsibility becomes more confused.
Since profit maximization is a firms primary goal, the expansion of business ope
rations should also be viewed from that angle. Expansion resuls in heavy fixed c
osts. It means sales volumes will have to be increased for meeting such costs th
rough there may be increase in per unit contribution on account of economies of
the scale. The management must therefore make sure that market will absorb the a
dditional volume of required sales.
Illustration - I
A comapnay is considering expansion. Fixed costs amount to Rs. 4,20,200 and are
expected to increase by Rs. 1,25,000 when plant expansion is completed. The pres
ent plant capacity is 80,000 units a year. Capacity will increase by 50% with th
e expansion. Variable costs are currently Rs. 6.80 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 remain same under either alternatuve. What are
the break even points under either alternative> Which is the better and why.
Solution:
Computation of break - even - point under the two alternatives
Particular Present Position After Expansion
Fixed cost Rs. 4,20,000 5,45,000
Capacity 80,000 1,20,000
Selling Price Per Unit 16 16
Variable Cost per Unit 6.80 6.40
Contribution per unit 9.20 9.60
(Sales - VAriable Cost)
B.E.P in Units 4,20,000 / 9.20 5,45,000 / 9.60
45,652 56,771
Assuming that the whole production can be sold the profit under the two alternat
ives will be as under.
Particulars Present Position After Expansion
Sales Rs. 12,80,000 19,20,000
-Variable Cost 5,44,000 7,68,000
Contribution 7,36,000 11,52,000
Fixed Cost 4,20,000 5,45,000
Profit 3,16,000 6,07,000
It is obvious from the above calculations, that profits will be almost doubled a
fter the expansion of the product. Hence the alternative of addition is preferab
le.
Deletion Or Discontinue of a product:
The following factors should be considered before taking a decision about the di
scontinuance of a product line.
1. Fixed costs are apprortioned over different products on some reasonable basis
. Which may not be very much correct. Hence contribution gives a better idea abo
ut the profitability of a product as compared to profit.
2. The capacity utilisation i.e. whether the firm is working to full capacity or
below the normal capacity. In case a firm is having idle capacity, the producti
on of any product which can constribute towards the recovery of fixed cost can b
e justified.
3. The long - term prospects in the market for the product.
4. The effect on sale of other products. In some cases the discontinuance of one
product may result in heavy descline in sale of other products affecting the ov
er all profitability of the firm.
Illustration - II
A manfacturer is thinking whether he should drop one item fom his product line a
nd replace it with another. Below are given his present and ouput data.
Product Price Variable Cost Percentage of sales
Book Shelfs 60 40 30%
Tables 100 60 20%
Beds 200 120 50%
Total Fixed Cost Per Year = Rs. 7,50,000
Sales last Year = Rs. 25,00,000
The change under consideration consists in dropping the line of tables in favour
of cabinets. If this dropping and change is under the manifacturer fore casts t
he following cost and output data.
Product Price Variable Cost Percentage of sales
Book Shelfs 60 40 50%
Cabinets 160 60 10%
Beds 200 120 40%
Total Fixed Cost Per Year = 7,50,000
Sales This Year = 26,00,000
Is this proposal to be accepted?
Solution:
Comparative Profit Statement:
Existing Situation
Book Shelfs Tables Beds Total
Sales 7,50,000 5,00,000 12,50,000
25,00,000
Less
Variable Cost 5,00,000 3,00,000 7,50,000
15,50,000
2,50,000 2,00,000 5,00,000
9,50,000
Less
Fixed Cost 7,50,000
Profit 2,50,000
Proposed Situation:
Book Shelfs Cabinets Beds Total
Sales 13,00,000 2,60,000 10,40,000
26,00,000
Less
Variable Cost 8,66,667 97,500 6,24,000 15,58,16
6
4,33,333 1,62,500 4,16,000
10,11,833
Less
Fixed Cost 7,50,000
Profit 2,61,833
Suggestion:
The above analysis shows that the manufacturer will stand to gain in case he dro
ps the production of tables in preference to cabintes. However the demand for ca
binets should be of permanent nature.
Working Notes:
Variable Cost:
Existing Situation Proposed Situation
Book Shelfs 7,50,000 * 40/60 13,00,000 * 40 / 60
5,00,000 8,66,667
Tables 5,00,000 * 60/100
3,00,000
Cabinets 26,00,000 * 60 / 160
97,500
Beds 12,50,000 * 120 / 200 10,40,000 * 120 / 200
7,50,000 6,24,000
Illustration III:
A comapny annually manifactures 10,000 units of a product at a cost of Rs. 4 per
unit and there is home market for consuming the entire volume of production at
the sale price of Rs. 4.25 per Unit. In the year 2003, there is a fail in the de
mand for home market which can consume 10,000 units only at a sale price of Rs.
3.75 per Unit. The analysis of cost per 10,000 units is:
Materials 15,000
Wages 11,000
Fixed Overheads 8,000
Variables Overheads 6,000
The foriegn market is explored and it is found that this market can consume 20,0
00 units of the product if offered at a sale price of Rs. 3.55 per Unit. It is a
lso discovered that for additional 10,000 units of the product cover initial 10,
000 units. the product overheads will increase by 10%. Is it worth while to try
to capture the foriegn market.
Statement Showing the advisibility of selling goods in foreign market.
Particulars Year 2002 Year 2003 Forien Market Total
10,000 Units 10,000 Units 20,000 Units 30,000 units
Materials 15,000 15,000 30,000 45,000
Wages 11,000 11,000 22,000 33,000
Over Heads
Fixed 8,000 8,000 1,600 9,600
Variable 6,000 6,000 12,000 18,000
Total Cost 40,000 40,000 65,000 1,05,600
Profit / Loss 2,500 (-) 2,800 5,400 2,600
Sales 42,500 37,200 71,000 1,08,200
Suggestion:
From the above analysis it is clear that it is advisible to sell goods in the fo
reign market. It will compensate not only for the loss on account of sale in dom
estic market but will also result in an overall profit of Rs. 2,600.
Working
Notes:
Sales:
Year 2002: 10,000 * 4.25 = 42,500
Year 2003 : Home Market: 10,000 * 3.72 = 37,200
Foriegn Market: 20,000* 3.55 = 35,500
Overall Profit = Foreign Market Profit - Home Market Loss: 5,400 - 2,800 = 2,600
0
Make or Buy Decisions:
Decision to make or buy has to be taken when product being manufactured has a co
mponent part that can either be made within the factory or purchased from an out
side firm. This decision can be arrived at only by comparing the suppliers price
with the marginal cost. For example the toal cost of making a component part co
mes to Rs. 11, consisting of of Rs. 8 as variable cost and Rs. 3 as fixed cost.
Suppose an outside firm is willing to supply the same component part at Rs. 10.
The prime fact conclusion is that it is cheaper to buy the component part. But a
study of cost analysis above shows that each unit of component contributes Rs.
3 towards the recovery of fixed cost. This fixed cost has to be incurred to make
or buy. The real cost in making one unit of component is only Rs. 8 which is it
s variable cost. The offer should, therefore be rejected because acceptance will
mean that the total cost of the purchased part will come to Rs. 13, i.e, Rs. 10
(Purchase Price) plus Rs. 3 (fixed cost which cannot be saved if production is
suspended).
However, in arriving at a final decision