Mgt Accnting Project-Decision Making

8/2/2019 Mgt Accnting Project-Decision Making

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Acknowledgement

I would like to thank our college for giving us the opportunity to

deal with project as a part of B.COM (H) curriculum.

I would like to take this opportunity to express our humble gratitude

to our respected professors, for the creative support and motivation

we received from them.

It was very reflective learning with them and I am sure it will be

very helpful in my further studies and fields of work. I am grateful

to them as they helped me in all necessary requirements of myproject. Thus, this is my sincere thanks to the professor for the

guidance and support and for imparting me with great knowledge.

I also extend my heartfelt thanks to my family and well wishers.

Thanking you

Surabhi jain


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CONTENTS

INTRODUCTION

RELEVANT COSTS AND BENEFITS

SIX STEPS IN DECISION MAKING

PROCESS

RELEVANT COSTS

IRRELEVANT COSTS

VARIABLE COSTING AND DECISION

MAKING

EXAMPLES


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INTRODUCTION

When you have a choice between two or more alternatives and youhave to select one, you are making a decision. If there is no choice,

you will have to simply follow or obey. So a decision implies a

selection, a choice, a verdict or a nod.

In everyday life, decisions are made. A personal decision affects an

individual but organizational decisions cause a change, good or bad,

to a lot many people known as stakeholders. So decision making in

an organization must be systematic and not off the cuff. A good

executive must be good at decision making.

Decision making can be regarded as an outcome of mental

processes leading to the selection of a course of action among

several alternatives. Every decision making process produces a final

choice. The output can be an action or an opinion of choice.

It may be noted that every decision involves a certain degree of risk.

Very few decisions are made with absolute certainty. So a good

decision would be to choose a solution with the highest probabilityof success and in accordance with the goals, desires, lifestyle and

values etc.

RELEVANT COST AND

BENEFITS

Relevant means linked or concerned. If an event has nothing to do

with a situation, it is not relevant. Marble processing units at

Karachi may suffer because of unrest in a far-off area like Swat. It

would be relevant as Swat supplies marble rocks. But turmoil in


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Hyderabad, a town much near to Karachi than Swat, would be

irrelevant for the marble units.

Any decision must be evaluated under cost-benefit criteria. The

benefits must be more than the cost except in social projects where

benefits may be equal to cost. Benefits can be in the form of cashreturn, perks, advantages, customers satisfaction or reputation of a

company. While cost means value, worth or sacrifice made.

A management accountant is a member of cross functional team

and, having un-restricted access to MIS, makes a contribution by

providing facts and figure which bring objectivity to the report.

Besides, a management accountant would ensure that theinformation must be relevant (pertinent to the decision

problem); accurate (precise); and timely (arrive in time for the

decision to be made). Companies will occasionally trade-off

accuracy for timeliness.

SIX STEPS IN DECISION

MAKING PROCESS AND

MA ROLE

1. Clarify the decision problem. One must be clear about the

problem. One must look for the root cause or hidden problem

rather than the apparent problem.

2. Specify the criteria . After clarifying a problem, criteria must

be specified for decision-making. What is the objective:maximize profit, increase market share or social service.

3. Identify alternatives. Explore all alternatives, their pros and

cons. This is a critical step in the decision making process.

4. Develop a decision model. This is a simplified version of the

problem. No irrelevant information, only factors relevant to the


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problem is highlighted. It brings together all elements of a

problem like the criteria, the constraints, and the alternative.

5. Collect the data. Relevant data must be collected to

incorporate objectivity in the process. It may be primary data or

secondary data. But it must be up-to-date, timely and accurate.6. Select an alternative. One all formalities are completed,

requisite information obtained and processed, a most suitable or

appropriate choice should be selected.

RELEVANT COSTS

In order to qualify for relevancy, a cost must meet two criteria: (i)

They affect the future and (ii) they differ among alternatives.

Normally, the following are relevant Costs:

DIFFERENTIAL COST:

A differential cost is the difference in cost items under two or more

decision alternatives specifically two different projects or situations.Where same item with the same amount appears in all alternatives, it

is irrelevant. For example, a plot of land can be used for a shopping

mall or entertainment park. The plot is irrelevant since it would be

used in both the cases. Similarly, future costs and benefits that are

identical across all decision alternatives are not relevant.

INCREMENTAL OR MARGINAL COST:

Where as differential cost is a difference between the cost of twoindependent alternatives, incremental or marginal cost is a cost

associated with producing an additional unit. In case of a university,

it could be cost of admitting another student. Even operating a

second shiftis an example of incremental cost. It would be noted


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that the two decisions are not independent as second shift depends

upon first shift.

OPPORTUNITY COST:

It is cost of opportunity foregone. Farhana is a fresh graduate from a

business university. She got two offers, one of Rs.25,000 from an

investment bank and another of Rs.15,000 for a teaching-assistant in

a university. Another of her class-fellow, Shabana got the same offer

from the same university. While Shabana would be happy to join the

university, Farahan would not as she would lose an opportunity to

serve at the bank for Rs.25,000.

IRRELEVANT COSTS

Sunk costs are past costs. These cannot be changed with any future

decision. Suppose, a piece of land has already been purchased by acompany for a sum of Rs.30 million. Also suppose, the company is

consider covering it with a wall which would cost Rupees two

million. While the sum of Rs.30 million is a sunk cost, the other of

Rs.2 million is a future cost or out of pocket expenses. It is relevant

to decision: whether to erect a wall now or postpone it for the next

month, whether it should be two-meter or three-meter high. Whether

a wall is erected or not and, if erected, whether it is 2 or 3 meter, the

sum of Rs.30 million for land would remain the same. It is a sunkcost and therefore irrelevant to the decision.

Similarly, a cost which is identical in all decisions is irrelevant.


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VARIABLE COSTING AIDS IN

DECISIONS SUCH AS:

1.)FIXATION OF SELLING PRICE

Under marginal costing, fixed costs are ignored and price is

determined on the basis of variable costs (marginal). In normal

business conditions, the price fixed must cover full costs otherwise

firm will incur losses. In certain circumstances like trade depression,

dumping, seasonal fluctuation in demand, highly competitive market

etc. pricing is fixed with the help of marginal costing rather than full

costing.

During trade depression, the price may go down even below the full

cost of the product. In such case, the management has to decide

whether to close down the production activities until the recession is

over or continue the production activities. In case, the production

activities are closed down, the firm will incur loss equal to its fixed

cost or un-escapable costs. The main emphasis of management is to

minimise its losses. The firm should continue its production

activities so long as the selling price is more than the marginal costsbecause any contribution earned will help in recovery of the fixed

costs which results in reduction of loss.

Dumping means selling the product in foreign market at a price less

than its total cost. The firm recover its fixed cost from the domestic

market and marginal cost of the product becomes the basis for price

fixation. Similarly if the firm produces product of seasonal demand

or perishable goods marginal costing is more useful technique than

full costing.

EXAMPLE:

Fixed Cost Rs. 100000

Variable Cost Rs. 7 per unit

Current market price Rs. 8 per unit


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Output 50000 units

Should company sell or not?

Solution:

Variable Cost (50000 units@ Rs. 7) Rs. 350000Fixed Cost 100000

Total Cost 450000

Cost per unit = Rs. 450000/50000 units = Rs. 9

Although the selling price does not cover the total cost, yet it is wise

to continue to produce and sell because such a step will reduce the

loss (on account of fixed cost) that will be incurred if production isstopped.

If production is stopped, the loss would be Rs. 100000 (the amount

of fixed cost), but if production is continued the loss will be as

follows:

Sales (50000 units @ Rs. 8) Rs. 400000

Less: Total cost (Marginal cost+Fixed cost) Rs. 450000

Loss Rs. 50000

Thus, by continuing to produce and sell at below total cost, the loss

is reduced by Rs. 50000, i.e, from Rs. 100000 to Rs. 50000.

2.) EXPLORING NEW MARKETSSometimes, a company is not able to fully utilize plant

capacity when selling at total cost plus profit basis. In such

a case, it may explore new markets and find opportunitiesto receive additional bulk order or export order at a price

which may be below total cost but above variable cost so

that the price makes a contribution. The entire amount of

contribution form such sales is profit because fixed cost is

already recovered from current sales at total cost plus profit


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basis. Such additional sales at below total cost is possible

only because in accepting bulk orders and export sales,

price discrimination is possible. In this way spare plant

capacity can be utilized to earn additional profit.

Additional Order for Utilizing Spare Capacity:

When a company has a spare (or idle) capacity which it is not

able to utilize because of sales constraint and it receives a bulk

order at below normal selling price, such an order should be

accepted, and provided existing sales are not affected by price

discrimination. It will earn the company additional profit, by

utilizing spare capacity.

Export Sales:

Additional orders may be accepted from a foreign market at

below normal price or below total cost but above marginal cost.

Export sales yield additional contribution when such sales are at a

price which is above variable cost.

While determining profitability of accepting export orders, thefollowing additional factors should be considered.

Export sales may result in additional costs like special

packing cost, additional quality checks, freight and

insurance charges etc..., if not borne by importer. These

costs should be deducted from contribution to determine

profit from export order.

Export sales may result in certain cost benefits like exportsubsidy from government , exemption or concessions in

excise duty or duty drawbacks, etc.. In determining profit

from export order, these items should be deducted from

cost or added in contribution.


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EXAMPLE:

Indo-British Company has a capacity to produce 5000 articles but

actually produces only 2000 articles for home markets at the

following costs.

Rs.

Materials 40000

Wages 36000

Factory Overheads -Fixed 12000

-Variable 20000

Administration Overheads -Fixed 18000

Selling and Distribution -Fixed 10000Overheads -Variable 16000

Total Cost 152000

The home market can consume only 2000 articles at a selling price

of Rs. 80 per article. An additional order for the supply of 3000

articles is received from a foreign country at Rs.65 article. Should

this order entails an additional packing cost of Rs.3000.

Solution:

Statement of Marginal Cost and

Contribution

(Of 3000 articles for export)

Rs.


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Materials @ Rs. 20 per article 60000

Wages @ Rs. 18 per article 54000

Variable Overheads Factory @Rs. 10 per

Article 30000

-Selling and dist. @ Rs. 8per article 24000

Marginal Cost of sales 168000

Sales (3000 articles @ Rs. 65) 195000

Contribution 27000

Less: Additional Packing Cost 3000

Additional profit 24000

Acceptance of this export order results in additional profit of Rs.24000 and thus the order should be accepted.

3.) MAKE OR BUY DECISIONSThe make-or-buy decision is the act of making a strategic choice

between producing an item internally (in-house) or buying it

externally (from an outside supplier). The buy side of the decisionalso is referred to as outsourcing. Make-or-buy decisions usually

arise when a firm that has developed a product or partor

significantly modified a product or partis having trouble with

current suppliers, or has diminishing capacity or changing demand.

Make-or-buy analysis is conducted at the strategic and operational

level. Obviously, the strategic level is the more long-range of the

two. Variables considered at the strategic level include analysis of

the future, as well as the current environment. Issues like

government regulation, competing firms, and market trends all have

a strategic impact on the make-or-buy decision. Of course, firms

should make items that reinforce or are in-line with their core

competencies. These are areas in which the firm is strongest and

which give the firm a competitive advantage.


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An enterprise may decide to purchase the product rather than

producing it, if is cheaper to buy than make or if it does not have

sufficient production capacity to produce it in-house. With the

phenomenal surge in global outsourcing over the past decades, the

make-or-buy decision is one that managers have to grapple withvery frequently.

Factors that may influence a firm's decision to buy a part rather than

produce it internally include lack of in-house expertise, small

volume requirements, desire for multiple sourcing, and the fact that

the item may not be critical to its strategy. Similarly, factors that

may tilt a firm towards making an item in-house include existing

idle production capacity, better quality control or proprietary

technology that needs to be protected.

The make-or-buy question represents a fundamental dilemma faced

by many companies. Today's global competition forces

manufacturing companies to re-evaluate their existing processes,

technologies, manufactured parts and services in order to focus on

strategic activities. However, companies have finite resources andmay not be able to afford to have all activities in-house.

This has resulted in an increasing awareness of the importance of

the make-or-buy decision, the dilemma organizations face when

deciding between keeping technologies/processes in-house or

purchasing them from an outside supplier the ability to make such

decisions in a structured and rational manner is likely to improve a

company's overall performance.

EXAMPLE:


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Rani and Co. manufactures automobile accessories and parts. The

following are the total

processing costs for each unit.

(Rs.)

Direct material cost 5,000Direct labour cost 8,000

Variable factory overhead 6,000

Fixed cost 50,000

The same units are available in the local market. The purchase price

of the component is Rs. 22,000 per unit. The fixed overhead would

continue to be incurred even when the component is bought from

outside, although there would be reduction to the extent of Rs. 2,000per unit. However, this reduction does not occur, if the machinery is

rented out.

Required:

(A) Should the part be made or bought, considering that the present

capacity when released

would remain idle?

(B) In case, the released capacity can be rented out to anothermanufacturer for Rs. 4,500 per

unit, what should be the decision?

Solution:

(A) The present capacity when released would be remain

idle


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Statement showing the cost to make or buy

Cost Element per unit Make Buy

Direct Material 5000

Direct Labour 8000

Variable Factory

Overheads

6000 19000

Purchase Price 22000

Reduction in Fixed Cost

per unit

19000

(2000)

20000

Since the cost to make is less than the price to buy, it is desirable to

manufacture the component as the idle capacity is not, alternatively,

used.

(B) Statement showing costs of two alternatives, when released

capacity is rented out

Cost Element per unit Make Buy

Relevant cost to make 19000

Purchase Price 22000

Related Income from

alternative use per unit

(4500)

Total Relevant Cost 19000 17500


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In the above situation, the decision is in favour of buying from

outside.

4.) PRODUCT MIX DECISIONSThe product mix of a company, which is generally defined as the

total composite of products offered by a particular organization,

consists of both product lines and individual products. A product

line is a group of products within the product mix that are closely

related, either because they function in a similar manner, are sold to

the same customer groups, are marketed through the same types of

outlets, or fall within given price ranges. A product is a distinct unit

within the product line that is distinguishable by size, price,

appearance, or some other attribute. For example, all the courses a

university offers constitute its product mix; courses in the

marketing department constitute a product line; and the basic

marketing course is a product item. Product decisions at these three

levels are generally of two types: those that involve width (variety)

and depth (assortment) of the product line and those that involve

changes in the product mix occur over time.

The discussion on selection of most profitable product mix may be

discussed in two parts:

(a) when there is no key factor

(b) when there is a key factor

(a) When there is no key (limiting) factor:

When there is no key factor, the product mix that provides thehighest amount of contribution is considered as the most

profitable sales mix. This holds good when fixed cost does not

change due to changes in sales mix.

However, when changes in sales mix are associated with changes

in fixed cost, then that sales mix which provides the highest profit


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is considered as the most profitable sales mix. In other words,

relative profitability of mixes will be evaluated on the basis of

their profit and not on the basis of their contribution when a

change in product mix is associated with change in fixed cost.

EXAMPLE:

The following production/sales mixes are capable of achievement in

a factory:

(i) 2000 units of product A and 2000 units of product C.

(ii) 4000 units of product B

(iii) 1000 units of product A, 2000 units of product B and

1600 units of product C.

Cost per units is as follows:

A B C

Direct Materials (Rs.) 20 16 40Direct Wages (Rs.) 8 10 20

Fixed Cost is Rs. 20000 and variable overheads per unit of A, B and

C are Rs.2, Rs.4 and Rs. 8 respectively. Selling Prices of A, B and C

are Rs. 36, Rs. 40 and Rs.100 per unit respectively.

Determine the marginal contribution per unit of A, B and C and the

profits resulting from product mixes (i), (ii) and (iii).

Solution: Marginal Cost Statement Per unit of products


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A B C

(Rs.) (Rs.) (Rs.)

Selling price (S) 36 40 100

Direct Material 20 16 40

Direct Wages 8 10 20

Variable overhead 2 4 8

Variable cost (V) 30 30 68

Contribution (S V) 6 10 32

Statement Showing Comparative Profitability

Sales Contribution Total Fixed Profit

Contribution Cost

(i) A 2000units 12000

C 2000

units 64000 76000 20000 56000

(ii) B 4000

Units 40000 40000 20000 20000

(iii) A 1000

Units 6000

B 2000

Units 20000

C 1600

Units 51200 77200 20000 57200Conclusion: The sales mix (iii) is the most profitable as it yields the highest amount of

contribution and profit.

(b) When there is a key factor


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When a key factor is operating, selection of the most profitable

sales mix is based on contribution per unit of key factor. The

product which makes the highest amount of contribution per unit

of key factor is the most profitable one and its production is

pushed up. The second preference is to be given to product whichyields the second highest contribution per unit of key factor and

so on and in the end that product should be produced which

yields least contribution per unit of key factor and to the extent of

availability of the key factor.

In case a number of key factors are operating simultaneously, the

basic principle remains the same but problem becomes more

mathematical in nature and one has to resort to Linear

Programming to determine the optimal product mix.

EXAMPLE:

A company manufactures three products. The budgeted quantity,

selling prices and unit costs are as under:

A B C

(Rs.) (Rs.) (Rs.)

Raw materials 80 40 20(@Rs. 20per kg)

Direct Wages 5 15 10

(@Rs. 5 per hour)

Variable Overheads 10 30 20

Fixed Overheads 9 22 18


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Budgeted Production(in units) 6400 3200 2400

Selling price per unit 140 120 90

Required:

(i) Present a statement of budgeted profit

(ii) Set optimal product mix and determine the profit, if the

supply of raw materials is restricted to 18400 kg.

Solution:

(i) Statement of budgeted profit

A B C Total Rs.Budgeted production (units)

Selling Price (Rs,)

Sales (S)

Raw materials

Direct Wages

Variable Overheads

Total Variable Cost (V)

Contribution (S-V)Less: fixed cost*

PROFIT

6400

140

896000

512000

32000

64000

608000

288000

3200

120

384000

128000

48000

96000

272000

112000

2400

90

216000

48000

24000

48000

120000

96000

1496000

1000000

496000171200

324800

*Calculation of fixed cost:


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A=6400 units* Rs.9 = Rs. 57600

B=3200 units*Rs.22 70400

C=2400 units* Rs.18 43200

Total fixed cost Rs. 171200

(ii) When raw material is the key factor

A B C

Raw material per unit of output 4 kg 2 kg 1 kg

Total raw material consumed (kg) 6400*4 3200*2 2400*1=25600 =6400 =2400

Rs.288000 Rs. 112000 Rs.96000

25600 kg 6400 kg 2400 kg

Rs. 11.25 Rs.17.50 Rs. 40

III II I

Ranks:*Contribution per kg of raw material is calculated as:

Total contribution/Total raw materials consumed

Suggested sales mix (raw material is the key factor)

Rank I Product C- 2400 units * 1 kg =2400 kg

Rank II Product B- 3200 units * 2 kg = 6400 kg

Rank III Product A- 2400 units * 4 kg (balance) = 9600 kg

Total materials available 18400 kg

Thus the suggested product mix is: A-2400 units, B- 3200 units and C- 2400

units

Mgt Accnting Project-Decision Making

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