DECISION INVOLVING ALTERNATE

CHOICE COST ANALYSIS

SUBMITTED TO
DR.DEEPTI KIRAN

PRESENTED BY
NAMITA VAST (109)
 OBJECTIVE

 To Understand:
 Nature of Managerial Decision Making
 Characteristics of Costs for Decision-Making
 Alternative Choice Decisions
 NATURE OF MANAGERIAL DECISION MAKING

 Managerial decision making is the process of choosing effective course of action among various alternatives.
Decision-making is an integral part of all management functions – planning, organization, co-ordination and
control.
 Managers has to spend a considerable amount of time and thought on the decisions
 STEPS IN DECISION MAKING

 Decision making process is complex and not amenable to standardization, the following steps seem useful for
most of the problems:
 Defining the problem
 Developing alternative solutions
 Evaluating the alternatives
 Arrive at a decision.
 CHARACTERISTICS OF COSTS FOR DECISION-MAKING

 All future costs are not necessarily relevant to decision making purposes.
 Expected future costs are the costs that are expected to occur during time period covered by the decision.
 Cost incurred for both the alternatives are same, then they are not relevant.
 Costs incurred for the alternatives are different, then they become relevant costs
 ACCOUNTING DATA FOR DECISION MAKING

 Costs from a Cost Accounting System

 Variable Costs
 Opportunity Costs
 Depreciation
 Fixed Costs
 Cost analysis is the classification of the aggregate costs into relevant types.
 It is essential of controlling cost as well as of decision making.
 For the purpose of decision making and control, costs are distinguished on the basis of their relevance to the
different types of decision and control function.
 Hence expenditure which has taken place and which is irrecoverable in a situation is regarded as sunk cost.
 Cost incurred as a result of post decision which can not be altered by another decision at a subsequent date is
known as sunk cost.
 Hence for decision with future implication, a sunk cost is an irrelevant cost.
 If a decision has to be made whether to replace the existing plant the book value of existing plant is to be regarded
as sunk cost as it is irrelevant to the question of its replacement.
COST
Relevant Cost
 Relevant costs are those expected future costs which
are essential to a decision. The two key aspects of
these costs are as follow.
 They must be expected future cost.
 They must be different among the alternative course
of action.
Opportunity Cost
 Opportunity cost of the value of opportunity forgone
is taken into consideration when alternatives are
compared.
 It is helpful to the management in making
profitability calculation when one or more of the
inputs required by one or more of the alternative
course of action is already available.
MAKE OR BUY DECISION

 The following points are the relevant consideration involved in taking make or buy decision.
 Labour relation.
 Cost of making and purchasing.
 Quality of goods supplied by supplier.
 Availability of labour to make the product.
 Possible use of related capacity and facility as a result of buying instead of making.
 Cost of labour redundancies.
 Whether there is possibility to expand the existing capacity or extra capacity.
SHUT DOWN OR CONTINUE

 If the products are making a contribution towards fixed expenses or in other words if selling price is above the
marginal cost. It is preferable to continue because the losses are minimised.
 By suspending the manufacture certain fixed expenses can be avoided and certain extra fixed expenses may be
incurred depending upon the nature of the industry.
 Decision is based on as to whether the contribution is more than the difference between the fixed expenses
incurred in normal operation and the fixed expenses incurred when the plant is shut down.
 Shut down point can be calculated by using the following formula.
 Shut down point = (Total Fixed Cost – Shut down cost)/contribution per unit
 EXPORT OR LOCAL SALES

 When the firm has the surplus capacity it may think of utilising the same to meet export orders at price lower than
that prevailing in the local market.
 The decision is only made when the local sale is earning a profit.
 i.e. where fixed expenses have already been recovered by the local sales. In such cases if the export price is more
than the marginal cost, it is preferable to enter the export market. Any reduction in the price prevailing the local
market to fulfill surplus capacity capacity may have address effect on the normal local sales.
EXPAND OR CONTRACT

 Whenever a decision is taken as to whether the capacity is to be expanded or not, following points should be kept
in mind.
 Additional fixed expenses to be incurred.
 Possible decrease in selling price due to increase in production.
 Whether the demand is sufficient to absorb the increased production.
 Based on the above points the cost schedule will be worked out. While deciding about the contraction of business,
the segregation in fixed expenses and the marginal contribution cost will have to be taken in to amount.
XYZ ltd. is producing a kitchen equipment from five component three of which are made using general purpose machines
and two by manual labour. The data for the manufacture of the equipment is as follow.

Components A B C D E TOTAL

Machine hours            
required per unit 10 14 12 – – 36

Labor hours            
required per unit – – – 2 1 3
Variable cost per
32 54 58 12 4 160
unit (₹)
Fixed cost per unit 48 102 116 24 26 316

Total component
80 156 174 36 30 476
cost

Assembly cost /  
unit (variable) ₹40
Selling price per
600
unit
The marketing department of the company anticipates 50% increase in the demand during the next period. General
purpose machinery used to manufacture A,B and C is already working to the maximum capacity of 4752 hours and there
is no possibility of increasing this capacity during the next period. But labor is available for making component D and E
and also for assembly according to demand. The management is considering the purchase of one of the components A,B
or C from the market to meet the increase demand.
These components are available in the market at the following prices

Particulars ₹
Component A 80
Component B 160
Component C 125
 REQUIRED :

 Profit made by company from current operation.

 If the company buys any of the components A, B or C what is the extent of additional capacity that can be
created?
 Assuming 50% increase in demand during the next period, which component company should from the market?
 The increase in profit, if any, if the component suggested in point 3 is purchased from the market.
 A B C
Particulars ₹
A – 10 10
B 14 – 14 Sales (132 * 600) 79,200

C 12 12 – Less:- Variable Cost 

(21,120)
26 22 24 (132*160)

            Assembly Cost

(5,280)
(132*40)
Existing units =  4752/36  = 132 Units Contribution 52,800
If we buy A
4752/26 = 183  (up by 51)    = 38.64% Less:- Fixed Cost (132*316) (41,712)
If we buy B
4752/22  = 216 (up by 84)  = 63.64%
Profit 11,088
If we buy C
4752/24  = 198 (up by 66)  = 50%
PROFIT STATEMENT FOR CURRENT SCENARIO

ADDITIONAL CAPACITY
 AS OVERALL DEMAND INCREASE BY 50%, WE CAN NOT SELECT TO BUY A. SO MAKE OR BUY
DECISION REMAINS BETWEEN REMAINS BETWEEN B AND C.

Particulars B C Particulars ₹
Buying cost 160 125 Sales  ( 198*600) 1,18,800
Less:- Variable Less:- Variable cost
(54) (58) (20,196)
cost (198*102)
Excess buying                                   
106 67 (24,750)
cost (A) (198*125)

Hours                            Assembly cost

14 12 (7920)
       (B) (198*40)
Contribution 65,934
                    A/B 7.57 5.58
Less:- Fixed cost (41,712)
Decision Manufacture Buy Profit 24,222

MAKE OR BUY(COST) PROFIT STATEMENT AFTER 50% INCREASE

 G LTD. PRODUCES AND SELLS 95,000 UNITS OF X IN A YEAR AT ITS 80% PRODUCTION CAPACITY. THE SELLING PRICE OF
PRODUCTS IS ₹ 8 PER UNIT. THE VARIABLE COST IS 75% OF SALES PRICE PER UNIT. THE FIXED COST IS ₹ 3,50,000. THE COMPANY
IS CONTINUOUSLY INCURRING LOSSES AND MANAGEMENT PLANS TO SHUT DOWN THE PLANT. THE FIXED COST IS EXPECTED
TO BE REDUCED TO ₹ 1,30,000. ADDITIONAL COST OF PLANT SHUT-DOWN ARE EXPECTED AT ₹ 15,000.
SHOULD THE PLANT BE SHUT-DOWN? WHAT IS THE CAPACITY LEVEL OF PRODUCTION OF SHUT-DOWN POINT?
If Plant is If plant is
Particulars
continued shutdown A comparison of loss figures indicate as above points out that
Sales 7,60,000 – loss is reduced by ₹ 15,000 if plant is shutdown.
Less:- Variable Shut down point  =  3,50,000 – 1,45,000
5,70,000 – 8-6
cost
= 2,05,000
Contribution 1,90,000 – 2
Less:- Fixed =  1,02,500 Units
3,50,000 1,30,000
Cost Capacity level of shut down point
At 100% level production is  95,000/ 0.80 = 1,18,750
Less:-
Additional – 15,000 Capacity level at shut down = 1,02,500
Cost 1,18,750
= 86.32%
Operating
(1,60,000) (1,45,000)
Loss
THANK YOU