DECISION MAKING

TECHNIQUES
 RELEVANT COST ANALYSIS
Variability Based Element Based Relationship Based Controllability
Time Period Based • Fixed • Material • Direct based

• Current • Variable • Labor • Indirect • Controllable

• Historical • Semi-variable • Expenses • Non-Controlla
• Pre-determined ble
Normality Based
Functional • Normal
• Abnormal
• Production
• Admin COST
Attribute Based
• Selling
• Distribution • Product
• R&D • Period
• Pre-production
Decision making based
• Conversion
Payment • Relevant
Based Cause & Effect Based
• Irrelevant
• Explicit • Engineered
• Implicit • Discretionary
 MATERIAL COST RELEVANCE

Relevance

Material already available Material to be purchased

Regularly used – current Rarely used – NRV Current purchase price i.e out pf
replacement cost as opportunity cost pocket expenses
 LABOUR COST RELEVANCE

relavance

Workers already available Workers to be arranged

Labour in shortage – Out of pocket

General rule – variable Excessive labour – variable cost + costs
and hence relavant committed and irrelevant opportunity cost
 RELEVANCE OF OTHER COSTS

Type Effect
Variable Overheads • Irrelevant if already incurred
• Relevant only if costs are to be incurred in the future
Fixed overheads • Relevent only in the following circumstances
• Specifically incurred
• Incremental in nature
• Avoidable or discretionary
• Opportunity cost
Depreciation Irrelevant as it is only an apportionment of historical cost
However, any fall in asset disposal value becomes relevant
Other departmental costs • Irrelevant if already incurred or apportioned
• Relevant if they are to be incurred specifically
• Relevant costs
• Marginal cost – total variable cost – Prime cost + variable OH.
• Differential costs – change in cost due to change in level or patter of
activity – incremental or decremental cost
• Opportunity costs – Value of sacrifice made, or benefit of opportunity
foregone by selecting one alternative in preference to other alternatives
• Replacement costs – cost at which there could be purchase of asset or
material that is similar or same or identical to the one being replaced or
revalued
• Out of pocket costs – costs that entail current or near future cash outlays
for decision at hand
• Irrelevant costs
• Sunk cost – cost which has already been incurred or sunk in the past
• Committed cost – cost in respect of which decision has already been
taken, such decision cannot be altered
• Absorbed Fixed Cost
 OPPORTUNITY COST
• It is the benefit foregone from an alternative not chosen
• It is the value of sacrifice made or the benefit of opportunity foregone by selecting
one alternative in preference to the other alternative
• It is the cost of opportunity lost by diversion of an input factor from one use to
another

• Opportunity Gain
• It is the incidental, indirect benefit derived out of choosing a particular course of
action from among various options and comprises of
• Savings in costs
• Additional indirect benefits
• Incremental revenue – it is the additional revenue that arises from production or
sale of additional units.
 CVP ANALYSIS

• It is the analysis of 3 variables

• Cost
• Volume
• Profit
• And explores the relationship between the 3
• Aims at measuring variations between the 3 components
• Makes use of marginal costing pronciples for planning and short term
decision making
• Break even point
• Fixed Cost/PV Ratio (Break even Sales) OR
• Fixed Cost/Contribution PU (Break Even Quantity)
• (Fixed Cost – Depreciation)/ Contribution PU [ Cash BEP]
• BEP under the ABC system
• Fixed Cost(+) setup cost* no of setups(+) engg cost*no of engg hours
Sale Price (-) unit variable cost
• Margin of Safety
• Total sales (-) BEP sales (MOS Value) OR
• Profit/PV Ratio (MOS Value) OR
• Profit/ contribution PU (MOS Qty)
• Indifference Point
• Difference in Fixed Cost/ Difference in PV ratio (Indifference Value) OR
• Difference in Fixed Cost/ Difference in Contribution PU (Indifference
Qty)
• Shut down Point
Avoidable Fixed Cost/ PV Ratio (Value)OR
Avoidable Fixed Cost / Contribution PU (Qty)

• SHORT TERM DECISION MAKING

• Effective use of key factor / limiting factor
• Keep or drop decision
• Product mix decision
• Outsourcing decision
• Asset replacement decision
• Sell or further process decision
• Product distribution decision