Alternative Choices And Decisions

7/30/2019 Alternative Choices And Decisions

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BY-

ABHIJEET RASGOTRA

ADITYA SAXENA

ALISHA CHOPRA

AMAN BANSAL


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Alternative Choices Decisions

Process of evaluating two or more alternatives

leading to a final choice


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COMPONENTS OF DECISION MAKING

Relevant Information

Relevant Revenues

Relevant Costs

Qualitative Factors


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Relevant Information

Historical costs may be helpful in making

predictions.

Analyzing differences between expected

future revenues and costs.

Relevant Revenues

They are expected future revenues.


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Relevant Costs

Relevant Costs are expected future costs

Production capacity to manufacture

components.

Qualitative Factors

Perception regarding possible future price

changes. Nature of the work to be subcontracted


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TYPES OF CHOICE DECISIONS

MAKE or BUY(Outsourcing Decision)

ADD or DROP PRODUCTS

SELL or PROCESS FURTHER OPERATE or SHUTDOWN

SPECIAL ORDERS

REPLACE or RETAIN


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MAKE OR BUY DECISION

Following alternatives are considered undermake or buy decisions

To buy certain raw materials from outside

suppliers. To use available capacity to produce the items

within the company.

It determines economically most desirable

alternative.

Differential cost analysis is considered.


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AN ILLUSTRATION

Spare parts Ltd. has an annual production of 50,000 units forcomponent X. The components cost structure is as below:

Rs.

Materials 250 per unit

Labour (25% fixed) 180 per unit

Expenses:

Variable 90 per unit

Fixed 135 per unit

Total 675 per unit

The purchase manager has an offer from a supplier who is willing tosupply the component at Rs.540.

Should the component be purchased and production stopped?


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ADD OR DROP PRODUCTS

It is a decision to eliminate an UNPROFITABLE

PRODUCT.

MOST IMPORTANT FACTOR IN THE DECISION:

To add or drop a product-whether it will increase or

decrease the future income of the business.


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AN ILLUSTRATION XYZ Ltd. is considering to drop Product B from its line

because accounting statements show that product B isbeing sold at a loss.

INCOME STATEMENT

PRODUCT A PRODUCT B PRODUCT C TOTAL

Sales Revenue 50,000 7500 12,500 70,000

Cost of Sales:

Direct Material 7500 1000 1500 10,000

Direct Labour 15,000 2000 2500 19,500

Indirect

Manufacturing Cost

7500 1000 1250 9750

TOTAL COST 30,000 4000 5250 39,250

Gross Margin on

sales

20,000 3500 7250 30,750

Selling andadministrative 12,500 4500 4000 21000


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Additional Information:

Factory overhead costs : Fixed Costs-Rs.5850 andVariable Costs-Rs.3900. Variable costs by products

are: A-Rs.3000,B-Rs.400,C-Rs.500. No change in Fixed Costs and expenses, if product

B is eliminated

Variable selling and administrative expenses to the

extent of Rs.11000.By products: A-Rs.7500,B-Rs.1500,C-Rs.2000.

Fixed selling and administrative expenses areRs.10,000.

No change in sales of Product A and Product Cafter Product B is dropped.


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Sales Revenue 50,000 7500 12,500 70,000

Less: Variable

production

Costs:

Direct Mat. 7500 1000 1500 10,000

Direct Labour 15000 2000 2500 19500

Factory OH 3000 400 500 3900

S & D Expenses 7500 1500 2000 11000

Total Costs 33,000 4900 6500 44,400

Contribution

Margin

17000 2600 6000 25,600

Less: Fixed Costs:

Factory OH 5850

S & D Expenses 10,000

Total Fixed

Costs

15850


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Operate Or Shutdown

Need to determine about the short run firms.

Management should consider all the

investments.

Loss incurred if the firm is shut down.

Cost incurred while shutting down.


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Numerical

A company operating below 50% of its capacity expects that the volume

of sales will drop below the present level of 10,000 units per month.Management is concerned that the further drop in sales volume willcreate a loss and has consideration that the operations will besuspended, until better market conditions prevail and also a better

selling price.

At which point company should be shutdown?

Sales revenue(10,000@Rs 3 ) Rs 30,000

(-) Variable costs@ Rs 2 per unit Rs 20,000

Fixed costs Rs 10,000

Net Income 0


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Cont..

Units produced

Shutdown 2000 4000 6000 8000 10,000

Sales revenue@ Rs 3 0 6000 12000 18000 24000 30,000

Variable cost@ Rs 2 0 4000 8000 12000 16000 20,000

Contribution 0 2000 4000 6000 8000 10,000

Fixed cost 4000 10,000 10,000 10,000 10,000 10,000

Loss (4000) (8000) (6000) (4000) (2000) 0

Shutdown is desirable at the point at which the operating losses exceedthe shutdown cost..


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PRODUCT M PRODUCT B1 PRODUCT B2

Sales 2,00,000 1,20,000 80,000

(-) Profit 50,000 24,000 12,000

Cost of Sales 1,50,000 96,000 68,000

(-) Selling & Dist. Expenses 6,280 12,560 12,560

Cost of Production 1,43,720 83,440 55,440

(-) After split off cost 20,000 15,000 10,000

Joint cost apportioned 1,23,720 68,440 45,440

2) If B1 is not processed further

Sales of product B1 Rs 1,00440

(-) Share in joint cost Rs 68,440

Profit 32,000


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Sell Or Process Further

The decision whether a product should be

sold or processed further is taken by the

manufacturer.

Additional value adds value to a product and

increases its selling price..


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Numerical

Modern & Mills Ltd. Manufactures certain grades of products known as

M whose by product are B1 and B2.the joint expense of manufacture

amount to Rs 2,37,600.


SALES Rs 2,00,000 1,20,000 80,000

COST INCURRED Rs 20,000 15,0000 10,0000

PROFIT % ON

SALES

25 20 15

Total fixed selling expenses are 10% of total cost of sales which are in ratio of20:40:40

1) Prepare a statement showing apportionment of joint costs to the product.

2) If the product B1 is not subject to further processing and is sold at the

point of separation, for which there is a market of Rs 1,00440 without

incurring any selling expenses. Would you advise its disposal at this stage


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Sales 2,00,000 1,20,000 80,000

(-) Profit 50,000 24,000 12,000

Cost of Sales 1,50,000 96,000 68,000

(-) Selling & Dist. Expenses 6,280 12,560 12,560

Cost of Production 1,43,720 83,440 55,440

(-) After split off cost 20,000 15,000 10,000

Joint cost apportioned 1,23,720 68,440 45,440

2) If B1 is not processed further

Sales of product B1 Rs 1,00440

(-) Share in joint cost Rs 68,440

Profit 32,000


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Special Orders

It is made when a company has excess production capacity.

Possibility of selling it at lower price.

Provided it doesnt affect the sales of the same product.

Pricing can be done using the cost analysis technique.

Fixed costs are not considered when deciding the pricing of special

orders.

Only variable costs are considered.


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A manufacturing company produces 20,000 units by

operating at 60% of the capacity and sells at a price

of Rs. 30/unit. The figures for the year 2003 are:-

Production

Raw material@ Rs. 4.25 Rs . 85,000

Direct labour @ Rs. 5.75 1,15,000

Variable factory overhead @ 7.75 1,55,000

Fixed factory overhead 1,25,000

Variable selling costs 2.75% of selling price

Fixed selling and administrative costs 72,500

Th i i l d f 10 000


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The company receives a special order for 10,000

units from a firm. The company wants to earn a

profit of Re 1.00 per unit and no selling expenses are

to be incurred for the special order. The pricing ofspecial order:-

Increase in sales= 10,000* 18.75= Rs. 1,87,500

Variable costs to be incurred: (Rs.)

Raw materials 4.25

Direct labour 5.75

Variable overhead 7.75

17.75

Desired profit 1.00

Minimum price 18.75


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Income StatementWithout special order Special order With special order

Sales 6,00,000 1,87,500 7,87,500

Less: Variable costsRaw materials 85,000 42,500 1,27,500

Direct labour 1,15,000 57,500 1,72,500

Variable overhead 1,55,000 77,500 2,32,500

Variable sellingcost(2.75% of S.P)

16,500 - -

Total Variable cost 3,71,500 1,77,500 5,49,000

Less: Fixed costs:

Fixed factory

overhead

1,25,000 - 1,25,000

Fixed selling and

admin cost

72,500 - 72,500

Total fixed costs 1,97,500 - 1,97,500

Total costs 5,69,000 1,77,500 7,46,500

Net Income 31,000 10,000 41,000


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A company currently operating at 80% capacity has thefollowing particulars:

An export order has been received that would utilize halfthe capacity of factory. Order must be executed at 10%below the normal domestic prices. The alternativesavailable to the management are:

1. Reject the order and continue with the domestic salesonly( as at the present); or

2. Accept the order, split capacity between overseas anddomestic sales and turn away excess domestic demand

i.e. (50% for domestic sales + 50% for export).

Rs.

Sales 32,00,000

Direct materials 10,00,000

Direct labour 4,00,000

Variable overheads 2,00,000

Fixed overheads 13,00,000

C ti P fit bilit St t t


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Comparative Profitability Statement

Domestic Sale only at 80%

capacity

50% for Domestic + 50% for

Export

Rs. Rs.

Domestic sales 32,00,000 20,00,000

Export sales - 18,00,000

Total sales (a) 32,00,000 38,00,000

Direct material 10,00,000 12,50,000

Direct Labour 4,00,000 5,00,000

Variable Overheads 2,00,000 2,50,000

Total variable cost 16,00,000 20,00,000

Fixed Cost 13,00,000 13,00.000

Total Cost(b) 29,00,000 33,00,000

Profit (a) (b) 3,00,000 5,00,000


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Replace or Retain

To replace or retain plant and equipment.

Differential costs involved are:-

1. Change in fixed overhead charges.

2. Loss on sale of old equipment.

3. Related costs such as rate of return and interest. Differential benefits involved are:-

1. Higher production and increased sales

2. Savings in operating costs

3. Realizable value of old machine.

Suppose a company has purchased a plant for Rs 1 00 000


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Suppose a company has purchased a plant for Rs. 1,00,000

five years ago which has a life of 10 years with no salvage

value. The present book value is Rs. 50,000. Management is

considering the replacement of this plant with new plant

costing Rs. 80,000 having a life of 5 years with no scrap valueat the end of its life. The costs of operating present plant and

the proposed plant are as follows:

Present plant Proposed plant

Variable costs: (Rs.) (Rs.)

Labour, supplies, power, etc. 80,000 48,000

Fixed costs: insurance, taxes,

etc.

10,000 12,000

Depreciation 10,000 16,000

1,00,000 76,000


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It appears that new plant would result into savings of

Rs. 24,000.

But the book value of the present equipment is a

sunk cost and not relevant in the decision.

Present plant Proposed plant

Variable costs: (Rs.) (Rs.)

Labour, supplies, power,

etc.

80,000 48,000

Fixed costs: insurance,

taxes, etc.

10,000 12,000

Depreciation 0 16,000

90,000 76,000


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THANK YOU

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Alternative Choices And Decisions