SESSION– PROBLEM – DECISION MAKING AND RELEVANT COSTS

Customer Profitability

Allied West, the West zone sales office of Allied Furniture, a wholesaler of specialized furniture, supplies
furniture to three local retailers: Vijay, Amit and Ankush. Expected Revenues and costs of Allied West by
customer for the upcoming year using ABC costing is given below:

Particulars Activity Driver Customer

Vijay Amit Ankush Total
Revenues 50,00,000 30,00,000 40,00,000 1,20,00,000
COGS 37,00,000 22,00,000 33,00,000 92,00,000
Furniture handling Number of units 4,10,000 1,80,000 3,30,000 9,20,000
labor shipped
Furniture handling Assume customer level 1,20,000 40,000 90,000 2,50,000
equip (dep) costs
Rent Warehouse sq. ft space 1,40,000 80,000 1,40,000 3,60,000
reserved
Marketing support Number of sales visits 1,10,000 90,000 1,00,000 3,00,000
Sales order Number of sales orders 1,30,000 70,000 1,20,000 3,20,000
Gen Admin Customer revenue basis 2,00,000 1,20,000 1,60,000 4,80,000
Corp office Customer revenue basis 1,00,000 60,000 80,000 2,40,000
Total costs 49,10,000 28,40,000 43,20,000 1,20,70,000
Op Income 90,000 1,60,000 (3,20,000) (70,000)

Let’s discuss:

1. Should Allied West drop the Ankush account? Analyze the costs in Ankush’s account? What
influence will it have on other costs? What is your decision with respect to Ankush’s account?

2. Should it add a fourth customer Anurag? Imagine Anurag has a customer profile much like
Ankush’s. Allied West’s managers predict revenues and costs of doing business with Anurag to
be the same as the revenues and costs described for Ankush. They have to acquire furniture
handling equipment for the Anurag account costing INR 90,000, with a one-year useful life and
zero disposal value. What influence will it have on other costs?

3. Why do you think depreciation was ignored when considering dropping Ankush’s account and
taken into account while considering adding Anurag’s account?

Prof Divya Aggarwal Management Account Term II

 SESSION– PROBLEM – DECISION MAKING AND RELEVANT COSTS

Make or Buy Decision: Harsh, a management accountant with the Maruti Udyog, is evaluating whether
a component MTR.2000 should continue to be manufactured by Maruti or purchased from Outside
Vendor Company. Outside Vendor has submitted a bid to manufacture and supply the 32,000 units of
MTR.2000 that Maruti Udyog will need for 2019 at a selling price of INR 173. Harsh has gathered the
following information regarding Maruti’s costs to manufacture 30,000 units of MTR-2000 in 2018.

Particulars INR
Direct Materials 19,50,000
Direct Manufacturing Labor 12,00,000
Plant space rental 8,40,000
Equipment Leasing 3,60,000
Other manufacturing overhead 22,50,000
Total manufacturing costs 66,00,000

Harsh has also collected the following information related to manufacturing MTR 2000:

a) Prices of direct materials used in the production of MTR.2000 are expected to increase by 8% in
2019
b) Maruti Udyog’s direct manufacturing labor contract calls for a 5% increase in 2019
c) Maruti Udyog can withdraw from the plant space rental agreement without any penalty. Maruti
Udyog will have no need for this space if MTR.2000 is not manufactured.
d) The equipment lease can be terminated by paying INR 60,000
e) 40% of the other manufacturing overhead is considered variable. Variable overhead changes
proportionately with the number of units produced. The fixed component of other
manufacturing overhead costs is expected to remain the same whether or not MTR.2000 is
manufactured.

Pradeep, plant manager at Maruti Udyog, indicates to Harsh that the current performance of the plant
can be significantly improved and that the cost increases he is assuming are unlikely to occur. Hence, the
analysis should be done assuming costs will be considerably below current levels. Harsh knows that
Pradeep is concerned about outsourcing MTR.2000 because it will mean that some of his close friends
will be laid off.

Harsh believes that it is unlikely that the plant will achieve the lower costs as Pradeep describes. He is
very confident about the accuracy of the information he has collected, but he is also unhappy about
laying off employees.

1. Based on the financial information Harsh has obtained, should Maruti Udyog make MTR.2000 or
buy it in 2019? Show your calculations.
2. What other factors should Maruti Udyog consider before deciding?
3. What should Harsh do in response to Pradeep’s comments?

Prof Divya Aggarwal Management Account Term II