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