Decision Making

While taking decision for this unit, kindly give the attention on several
hints in decision making
 Ignore sunk costs.
 Beware of unitized fixed costs, i.e., the average fixed cost per unit, although
fixed costs do not change in total.
 Beware of allocated fixed costs; identify the avoidable costs. (1)
 Pay special attention to identifying and including opportunity costs in the
analysis of alternatives.

Identify the relevant cost and benefits

Lisa is currently a student in B.COM at Bargarh College and would like to visit a friend in BBSR
over the weekend. She trying to decide whether to drive or take the train. Because she is in
tight budget, she wants to carefully consider the costs of the two alternatives. If one
alternatives is far less expensive than the other, that may be decisive in her choice. By car, the
distance between her hostel at Bargarh and friend’s room in BBSR is 230 miles. Lisa has
compiled the following list of items to consider.

Automobile cost
SL Items Annual cost Cost per mile
Number of fixed items (based on 10000
miles per yr)
(a) Annual straight-line depreciation on car 2800 0.280
(24000 original-10000 esimated resale
value in 5 yes/5 yrs.)
(b) Cost of Gasoline (2.70 per gallon/27 miles 0.100
per gallon)
(c) Annual cost of auto insurance and licence 1380 0.138
(d) Maintenance and repairs 0.065
(e) Parking fees at college (45 per month* 8 360 0.065
months)
(f) Total average cost per mile 0.619
Additional Data
(g) Reduction in the resale value of car due to 0.026 per mile
solely to wear and tear
 (h) Cost of round trip ticket from Bargarh to 104
BBSR
(i) Benefit of relaxing and being able to study ?
during the train ride rather than having to
drive
(j) Benefit of having car available in BBSR ?
city
(k) Hassel of parking the car in BBSR city ?
(l) Cost of parking the car in BBSR city 25 per day

Identify the relevant cost with stating reason. Calculate the differential cost and the option
which is beneficial for her.

Question- (2) Ram Nath Builders has some obsolete (but new) seats that are in the books at
the original cost of ₹58 000. These seats are no longer used in new coaches being built as they
do not comply with NSW seat belt regulations. These seats could be modified to comply with
regulations at an expected cost of ₹24 000, which would give a saving of ₹52 000 on buying
new seats. M Pvt Ltd of Chhattisgarh states still operates coaches that were built with the old
seats and have offered to purchase the entire stock for ₹34 000.

(a) Which cost is a sunk cost?

(b) Which of the figures is not relevant?
(c) What should Ram Nath Coach Builders do—sell the old seats and buy new ones or modify
the old seats? Provide figures to support your answer.
(d) If M Pvt Ltd of Chhattisgarh only offered ₹27 000, would your advice to Ram Nath Coach
Builders be different? Why?
Question (3) D Ltd. is a company that manufactures personal care products. It has three
divisions: hair care, skin care and dental care. Following is an extract from the financial
statements for the year ending 31 December 2017:

Hair Care Skin Care Dental Care

Revenue ₹900 million ₹600 million ₹300 million

Net income/(loss) ₹210 million ₹100 million (₹50 million)

In the board meeting summoned for review of financial statements, a director proposed that
the company should dispose of the dental care division because it is loosing money. The CEO
argued that the board can’t conclude that a segment is losing money just because it generated
net loss for a period. He suggested that the company’s chief financial officer should conduct a
detailed analysis for presentation in the next board meeting. Being the company’s
management accountant, the CFO asked you to identify which of the following costs are
relevant for the decision:

1. CEO’s salary
2. Salaries of Dental Care workers who can be laid-off
3. Salaries of Dental Care workers who can’t be laid-off
4. One-time retirement benefits to be paid to laid-off workers
5. Cost of raw materials consumed by Dental Care division
6. Annual directors’ fee
7. Interest paid on loans raised for Dental Care division
8. Salary of the Dental Care chief operating officer
9. Company-wide quality certification fee
10. License fee paid for the rights to manufacture dental care products
11. Head office rent
12. Audit fee (if it doesn’t depends on the number of divisions)

Make or Buy Decision

Question-1 The Auto ltd. makes steering wheels covers for car. These steering wheels covers
the following cost structure.
Units produced- 5000
Variable cost per unit- Rs 12
Fixed cost per unit- Rs 4
Another Auto ltd. has offered to make the steering wheel covers for Rs 15 each. If offer is
accepted the variable cost will be eliminated, but fixed cost will remain. Should Auto ltd go
accept offer? How much additional income will be realized by taking the offer?
Question-2 The B ltd manufactures the chair. The following cost structure are as follow:
Total unit produced – 10000
Total direct materials- Rs 1, 00,000
Direct labour- Rs 60,000
Variable overhead- Rs 40,000
Total allocated fixed overhead- Rs 55000
The C ltd offers to make the chair for B ltd. for Rs 18. If the offer is accepted the
allocated fixed overhead will have to be re-allocated to other division. Should B ltd.
accept offer? How much additional income will be realised by taking the offer.
Question-3 The D ltd manufactures 6000 units of component part that is used in its
product and incur the following costs.
Direct materials- Rs 35000
Direct Labour Rs 15000
Variable manufacturing overhead Rs 10000
Fixed manufacturing overhead Rs 20000
Total Cost = Rs 80000/6000= Rs 13.33/unit
Another company has offered to sell the same. Component part to the company for
Rs 12 per unit. The fixed manufacturing overhead consists mainly of depreciation on
the equipment used to manufacture the part and would not be reduced if the
component part was purchased from the outside the firm. D ltd has the opportunity to
use the factory equipment to produce another product which is estimated to have a
Contribution margin of Rs 14000. Prepare a report whether company will make or buy.

Question (4)
M Ltd. manufactures computer tables. Recently a supplier has offered the tables of the same
quality @ ₹14 each with an assurance of continued supply. The following is the budget for
4000 units prepared for the quarter ending 28 February 2018:

Variable ₹
Raw materials 20000
Direct wages 18000
Production Overhead:
Variable 12000
Fixed 14000
Distribution cost:
variable 6000
fixed 7500
Administration cost:
variable 5000
Fixed 12500

Required:
(a) Should M Ltd. accept the offer from the supplier?

(b) What would be the decision if the supplier offered the tables at ₹12 each?

Accept or Reject
Question-1
A Ltd makes and sells tiles. The present factory facilities are operating at about 80% capacity,
producing 78 000 square metres of varying tiles. One of the products produced is an antistatic
tiles that can be hot-air welded together to form seamless flooring and wall covering. This is
used in hospitals and laboratories as it is easier to keep germ-free. The normal selling price
throughout Odisha is Rs 8.00 per square metre, excluding freight. A summary of production
costs for making 11 000 square metres of this product in the last six months shows:
 Variable Total (Rs) Per meter (Rs)
Direct raw Materials 9350 0.85
Packing Materials 2750 0.25
Direct Labour 15400 1.40
Variable manufacturing overhead 3300 0.30
Fixed manufacturing overhead 20900 1.90
Fixed selling and administrative overhead 11550 1.05
Total 6.00

An agent in the Chhattisgarh states that he can obtain a contract for the supply of 6000 square
metres of antistatic tiles at Rs 4.20 per square metre. The agent would be entitled to 10%
commission on the sale price. Special export packaging would cost an additional Rs 2400 on
this order. Freight and insurance on this order, not included in the selling price, would cost Rs
1500. Advise management on whether the order should be accepted or rejected.

Question (2)

A company at present operates at 80% of capacity, producing 50 000 units per annum.

A budget for the year is:

Variable Total Per Unit (₹)

sales 500000 10.00
Less: Manufacturing Exp
Variable 100000
Fixed 200000 300000 6.00
Gross Profit 200000 4.00
Less: Selling and administration exp.
Variable 50000
Fixed 50000 100000 2.00
Net Profit 100000 2.00

An order is received from Bihar states manufacturer for 5000 units at ₹5 FOB. Special export
packing will increase manufacturing costs by ₹0.50 per unit on this order. The present variable
selling and administrative costs will be reduced by ₹0.20 per unit on this order. A commission
of 10% on sales price will be payable to the Bihar states manufacturer.

Required

(a) Calculate the increase or decrease in profit if this order is accepted.

(b) Discuss factors other than profit that should be taken into account when considering
 Short-term special order price decisions.

Sell-or-Process-Further Decision

A sell-or-process-further analysis can be carried out in three different ways:

 Incremental (or Differential) Approach calculates the difference between the additional
revenues and the additional costs of further processing. If the difference is positive the product
must be processed further, otherwise not.
 Opportunity Cost Approach calculates the difference between net revenue from further
processed product and the opportunity cost of not selling the product at split-off point. If the
difference is positive, further processing will increase profits.
 Total Project Approach (or the comparative statement approach) compares the profit
statements of both options (i.e. selling or further processing) separately for each product. The
option generating higher profit is chosen.

The following example illustrates the approaches to a sell-or-process-further decision:

Question (1)

Product A and B are produced in a joint process. At split-off point, Product A is complete
whereas product B can be processed further. The following additional information is available:

Product A B
Quantity in Units 5,000 10,000
Selling Price Per Unit:
At Split-Off ₹10 ₹2.5
If Processed Further $5
Costs After Split-Off ₹20,000
Perform sell-or-process-further analysis for product B.
Question (2) ABC Company manufactures three products. In one production batch, the
company incurs ₹25,000 manufacturing costs up to the split off-point (the point in the
manufacturing process when the products can be separately identified). The following
summarizes the further processing costs beyond the split-off point and ultimate sales value.

Product Type Further Processing cost (₹) Expected Sales Revenue (₹)
Product 1 72000 90000
Product 2 12000 28000
Product 3 2000 12000
The company can sell the products at split-off point. The expected sales revenues at split-off
point are: Product 1 - ₹24,000, Product 2 - ₹8,000, Product 3 - ₹7,000. Which products
should be sold at split-off point and which products should be processed further?

Question (3) Sitanath has a farm at Bargarh town which grows and processes chicken. Each
chicken is disassembled into three main parts: breasts, wing and thigh. Every month it
produces 50,000 kgs of breasts, 20,000 kgs of wings and 30,000 kgs of thighs at joint costs
of ₹150,000. The firm currently allocates the joint costs based on the physical measurement
basis. The company is considering whether to further process the joint products by taking a
frying process to sell fried chicken breasts, wings and thighs. The following information is also
provided

Parts Selling price per kg at split-off Further processing Selling price per
point (₹) costs per kg (₹) pound of the fried
Products (₹)

Thighs 15 5 23
Wings 8 3 15
Breasts 15 5 23

Required:

Should the chicken breasts, wings and thighs be further processed?

Profitable product mix

Unlimited Demand

Question (1) A Ltd. makes two types of office desks, Executive and Standing. Both desks
require time in the Painting Department, but there are only 172 hours per month available
currently in that department. The company can sell as many of each desk as it can make. What
is the optimal product mix that would maximize profit each month? The following information
is given in the following tables

Executive (₹) Standing (₹)

Price 150.00 200.00
Variable Cost 70.00 110.00
Contribution Margin 80.00 90.00
Painting Department Time 15 20
required (Minutes)
Limited Demand

Question (2) A Ltd. makes two types of office desks, Executive and Standing. Both desks
require time in the Painting Department, but there are only 172 hours per month available
currently in that department. The company can only sell 500 of each desk per month. What is
the optimal product mix that would maximize profit each month?

Executive (₹) Standing (₹)

Price 150.00 200.00
Variable Cost 70.00 110.00
Contribution Margin 80.00 90.00
Painting Department Time 15 20
required (Minutes)

Hints: When working with optimal product mix, determine which product will give you the
highest contribution margin per hour of constrained resource. Then look to see if there are
other constraints, for example, a limit to the number of units of either product that could be
sold.

Addition or Elimination of Product Line

Question (1)

Advise the management with the following information.

Variable Product (1) (₹) Product (2) (₹) Product (3) (₹) Product (4) (₹)
Sales 15000 22000 35000 42000
Less: Variable 9000 15000 25000 38000
cost
Contribution 6000 7000 10000 4000
margin
Less: Fixed cost
(a) Direct 4000 3500 3000 1000
fixed cost
(b) Allocated 1000 1500 8000 3000
Fixed
cost
Net Income 1000 2000 (1000) (Break-even)

The Company is planning to drop the product line 3 because it has operating loss. Would it be
beneficial for the company? If not advice the management which product line the company
should consider to drop from the product line.