RELEVANT COST

TYPES OF DECISIONS
DETERMINATION OF SALES MIX
EXPLORING A NEW MARKET
DISCONTINUATION OF A PRODUCT LINE
MAKE OR BUY DECISIONS
EQUIPMENT REPLACEMENT DECISION
INVESTMENT IN ASSEST
CHANGE VS STATUS QUO
EXPAND OR CONTRACT
SHUTDOWN OR CONTINUE
• EXPAND OR CONTRACT
Illustration: Following Information has been made available from the cost records of
ABC manufacturing spare parts:

Direct Materials Per Unit

X Rs. 8
Y Rs. 6
Direct Wages
X 24 hours@25 paisa per hour
Y 16 hours@25 paisa per hour
Variable overheads 150% of Direct wages
Fixed overheads Rs. 750
Selling Price
X Rs. 25
Y Rs. 20
The directors want to acquainted with the desirability of adopting anyone of the
following alternatives sales mixes in the budget for the next period.
a. 250 Units of X and 250 units of Y
b. 400 units of Y only
c. 400 units of X and 100 units of Y
d. 150 units of X and 350 units of y.
State which of the alternative sales mixes you would recommend to the management.
Illustration: The budgeted results for A company ltd. Includes the following:
Sales Rs. in lakhs Variable cost as % of sales value
Product A 50 60%
Product B 40 50%
Product C 80 65%
Product D 30 80%
Product E 44 75%

Fixed overheads for the period are Rs. 90 lakhs.

You are asked to
a. Prepare a statement showing the amount of loss expected,
b. Recommend a change in sales volume of each product which will eliminate the
expected loss.
Assume that the sale of only one product can be increased at a time.
 EXPLORING THE NEW MARKET

Decision regarding selling goods in a new market

(whether Indian or Foreign)
Illustration: A company annualy manufactures 10000 units of a
product at a cost of 4Rs. Per unit. In the year 1997, there is a fall
in the demand for home market which can consume 10,000 units
only at a sale price of Rs. 3.72 per unit. The analysis of the cost
per 10,000 units is:
Material Rs. 15,000
Wages 11,000
Fixed Overheads 8,000
Variable Overheads 6,000

The foreign market is explored and it is found that this market

can consume 20,000 units of the product if offered at a price
of Rs. 3.55 per unit. It is also discovered that for additional
10,000 units of the product (over initial 10,000 units) that fixed
overheads will increase by 10per cent. Is it worthwhile to ty to
capture the foreign market?
Illustration: A machine tool manufacturing company sell its lathes at Rs. 36,500
each made up as follows:
Direct Materials Rs. 16000
Direct Labour Rs. 2000
Variable Overheads Rs. 5000
Fixed Overheads Rs. 3000
Variable Selling Overheads Rs. 500
Royalty Rs. 1000
Profit Rs.5000
32,500
Central excise Duty Rs. 1000
Sales Tax Rs.3000
36,500

There is enough idle capacity.

a. A firm in Arabia has offered to buy 10 ompany’s lathes at Rs. 28,500 each.
Should the company be interested in the business?
b. It has been decided to sell 5 such lathes to an engineering company under
the same management at bare cost. What price should you charge?
Illustration: A manufacturer is thinking whether he should drop one item from his
product line and replace it with another. Below are given his present cost and output
data:
Product Price Variable Cost per unit Percentage of sales
Book Shelfs 60 40 30%
Tables 100 60 20%
Beds 200 120 50%

Total fixed Cost per year Rs. 7,50,000

Sales Last Year Rs. 25,00,000
The change under consideration consists in dropping in the line of tables in favour of
cabinets. If this dropping and change is made the manufacturer forecasts the following
cost output data:
Product Price Variable Cost per unit Percentage of sales
Book Shelfs 60 40 50%
Tables 160 60 10%
Beds 200 120 40%
Total fixed cost per year Rs. 7,50,000
Sales this year Rs. 26,00,000

Is this proposal to be accepted? Comment.

Illustration: The Managing Director of A Pvt. Ltd., asks for your assistance in arriving at
a decision as to continue manufacturing a component X; or to buy it from an outside
supplier. The component X is used in the finished products of the company. The
following data are supplied:
1. The annual requirement of component X is 10,000 units. The lowest quotation
from an outside supplier is Rs. 8.00 per unit.
2. The Component X is manufactured in the machine shop. If the component X is
bought out, certain machinery will be sold at its book value and the residual
capacity of the machine shop will remain idle.
3. The total expenses of the machine shop for the year ending 31.3.1998 are as
follows:
Material 1,35,000
Direct labour 1,00,000
Indirect Labour 40,000
Power & fuel 6,000
Repair & Maintenance 11,000
Rate, Taxes & insurance 16,000
Depreciation 20,000
Other overhead expenses 29,600
4. The following expenses of the machine shop apply to manufacturing of component
X:
Material 35,000
Direct Labour 56,000
Indirect Labour 12,000
Power & fuel 600
Repair & Maintenance 1,000
The sale of machinery used for the manufacture of component X would reduce.
Depreciation by Rs. 4,000
Insurance by Rs. 2,000
5. If the component X is bought out, the following additional expenses would be
incurred:
Freight Rs. 1 per unit
Inspection Rs. 10,000 per annum

You are required to prepare a report to the managing director showing the
comparison of expenses of machine shop (i) when the component X is made, and (ii)
when bought out
Illustration: A company purchased a machine two years ago at
cost of Rs. 60,000. The equipment has no Salvage value at the
end of its six years, useful life and the company is charging
depreciation according to the straight line method. The
company learns that a new equipment can be purchased at a
cost of Rs. 80,000 to do the same job and having an expected
economic life of 4 years without any salvage value. The
advantage of the new machine lies in its greater operating
efficiency which will reduce the variable operating expenses
from the present level of Rs. 1,65000 to Rs. 1,30,000 per
annum. The sales volume is expected to continue at Rs. 2 lacs
per annum for the next 4years.

You are required to evaluate the usefulness of the proposal.

Illustration: The following details have been furnished to you regarding
two proposals which are for consideration before a firm.
(a) Improvement in the quality of the product, which will result in an
additional sale of Rs. 5,000 units at the existing price. However, this
improvement in quality will result in increase in the variable cost by
10 paise per unit.
(b) Reduction in the selling price of the product by 12 paisa per unit.
This will push up sales by 5000 units.

In both cases the fixed expenses will increase by Rs. 1000.

The present sales of the firm are 10,000 units at the rate of Rs. 2.10 per
unit. The variable cost is Rs. 1.0 per unit and the total fixed costs are
Rs.3,000.

You are required to state whether it will be appropraite for the firm to
select any of the new proposals or should it continue with the existing
scheme.
Illustration: A company is considering
expansion. Fixed costs amount Rs. 420000 and
are expected to increase by Rs. 1,25,000 when
plant expansion is completed. The present plant
capacity is 80,000 units a year. Capacity will
increase by 50% with the expansion. Variable
costs are currently Rs. 6.80 per unit and are
expected to go down by Rs. 0.40 per unit with
the expansion. The current Selling price is rs. 16
pe runit and is expected to remain same under
either alternatives. What are the break even
points under either alternative? Which
alternative is better and why?
A Ltd. S experiencing recessionary difficulties and as a result its directors are
considering whether or not the factory should be closed down till the recession ha
passed. The flexible budget is compiled giving the following details:
 Fixed costs Production capacity (FC+VC)
Close Normal 40% 60% 80% 100%
down
Factory 6000 8000 10000 11000 12000 13000
overheads
Administr 4000 6000 6500 7000 7500 8000
ative
overheads
Selling & 4000 6000 7000 8000 9000 10000
distributio
n
Overhead
s

Miscellan 1000 1000 1500 2000 2500 3000

eous
Direct - - 10000 15000 20000 25000
labour
Direct - - 12000 18000 24000 32000
Material
15000 21000 47000 61000 75000 91000
The following additional information has been suppiled
to you;
a. Present sales at 50% capacity are estimated at Rs
30000 p.a
b. Estimated cost of closing down are rs 4500 . In
addition maintenace of plant and machinery is
expected to amount rs 800
c. Cost of reopening 2000 and traing to personnel 1400
d. Market research investigation reveals that sales
should take an upward swing to around 70% capacity
at prices which would produce revenue of Rs.
1,00,000 in approximately twelve months time.

You are required to advise the directors whether to close

down for twelve months or continue the operations
indefinetly.