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5-step Decision Making Process

Identify the problems and Uncertainties


Obtain Information
Make prediction about future
Make decisions by choosing among alternatives
Implement the decision, evaluate performance and learn
Relevant Cost and Relevant Revenues
Relevant costs are expected future costs and Relevant revenues are
expected future revenues that differ among the alternative courses
of action being considered.
Costs and Revenues that are not relevant are said to be irrelevant.
It is important to recognise that relevant costs and relevant
revenues must:
- occur in the future
- Differ among the alternative courses of action
Relevant cost analysis generally emphasises quantitative factors
that can be expressed in financial terms.
Qualitative factors (employee morale) and quantitative non-
financial factors (reduction in new product development time, % of
on time flight arrival, etc.) are difficult to measure in financial terms
but they are important for managers to consider.
It should be noted that all variable costs are not relevant and all
fixed costs are not irrelevant.
Understanding the factors to be considered in accepting or rejecting
a special order

11.32 Selling Price Rs.100 per unit; Variable Manufacturing Cost:


Rs.45 per unit; Allocated fixed manufacturing cost: Rs.15 p.u.
The firm is having enough idle capacity to accept a one-time
special order of 20000 units at Rs.60 p.u. No additional
marketing cost is required for this special order. What would
be the effect on operating income if special order be accepted
without affecting normal sales?
Special Order Price p.u. Rs. 60
Less: Variable Marketing Cost p.u. Rs.45
Contribution Margin p.u. Rs. 15
Increase in Operating Income: Rs.15 x 20000 units =
Rs.3,00,000
Most Profitable Product Mix
In absence of any constraint (limiting factor),
decision will be based on Contribution Margin
%
If there is constraint (limiting factor), decision
will be based on contribution per unit of
limiting factor.
Adding or Dropping product lines /
business units
Decision will be based on Contribution Margin
of the product lines / business units.
In-sourcing vs. outsourcing decisions
Make or Buy Decisons
Sona Steering manufactures 20,000 units of part no.498, the
manufacturing cost p.u. of which is as follows.
Direct Material Rs.6; Direct Manf. Lab Rs.30; Var. Manf. Overhead Rs.12;Fixed
manf. overhead allocated Rs.16; Total manf. cost Rs.64.
A firm offers to sell 20,000 units of part no.498 at Rs.60 p.u. Sona Steering will
buy from the firm if overall savings becomes at least Rs.25,000.
Furthermore, If Sona Steeting accepts the offer, Rs.9 p.u. of fixed overhead
allocated would be eliminated, and the released facilities could be used to
save relevant costs in the manufacture of another Part no.575. Sona
Steering to achieve an overall savings of Rs.25,000, what would be the
amount of relevant costs that would have to be saved by using the
released facilities in the manufacture of part no. 575?
Cost of buying 20,000 units @ Rs.60 = Rs.12,00,000
For buying from outside, the cost may be saved:
Variable cost + savings in Fixed Cost, Rs. (48 + 9)x20,000= 11,40,000
Extra cost of buying from outside 60,000
Minimum overall saving 25,000
Relevant costs that have to be saved for production of Part No.575 85,000