UNIT-III: DECISION MAKING

Steps in Decision Making Process, Concept of Relevant Costs and Benefits,

Various short -term decision making situations–Profitable product mix, Acceptance
or Rejection of special/ export offers, Make or buy, Addition or Elimination of a
product line, Sell or process further, Operate or shut down, Fixation of selling
price.

INTRODUCTION
Marginal costing is very helpful in managerial decision-making.
Management’s production, cost and sales decision may be affected from
marginal costing. That is why, it is the part of cost control method of cost
accounting. Decision making is also known as Decision models. It is the
process of evaluating two or more alternatives leading to final choice. The
technique of marginal costing is a valuable aid to management in taking
various policy decisions.
CONCEPT OF DECISION-MAKING
Decision making is the essence of management. It means to take the
final step in deliberations. It is the process of choosing action among
alternative courses of action. A decision always involves a prediction.
Management decisions are of crucial and critical nature.
STEPS IN DECISION-MAKING

Defining the Problem

Identifying
Alternatives

Evaluating Qualitative
Steps in Decision-
& Quantitative Factors
Making

Additional Information

Selection of
Alternative

Appraisal of the
results
Defining the problem: The problem should be clearly and precisely
defined, so be obtained. that proper solution may be obtained.
Identifying alternatives: The best possible alternative solutions to the
problem should be identified.

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Evaluating qualitative and quantitative factors: Each alternative is
associated with a number of advantages and disadvantages. The decision
maker should evaluate each factor in qualitative as well as in quantitative
terms to determine the largest net advantage.
Additional Information: The decision maker may obtain additional
information and it is usually possible to obtain such type of information.
Selection of alternative: After identifying and evaluating additional
information, the decision maker can select the alternative.
Appraisal of the results: The decision maker should carry out an
appraisal of the results and it will help in correcting the mistakes and
making better predictions well in time.
CONCEPT OF RELEVANT COSTS
The relevant costs are pertinent to decision making. Costs are
relevant if they guide the executive towards the decision. It will be better
if the costs are not only relevant but also accurate. Relevance and accuracy
are not identical concepts. Costs may be accurate and irrelevant. Costs can
also be inaccurate but relevant.
CHARACTERISTICS OF RELEVANT COSTS
The main characteristics of relevant costs are as under:
Future costs: All future costs are not relevant to alternative choice, but
costs are not relevant unless they are future costs. Data regarding standard
cost is useful only as a basis for estimating future costs.
Difference between alternatives: All future costs are not relevant. Only
such future costs are relevant which may be expected to differ between
alternatives. The cost which will not change between different alternatives
are to be ignored.
VARIOUS SHORT-TERM DECISION-MAKING SITUATIONS
There are a number of managerial decision-making of which some of the
important are discussed below;
a) Profit planning
b) Product mix
c) Acceptance or Rejection of special/ export offers
d) Make or buy
e) Addition or Elimination of a product line
f) Sell or process further
g) Operate or Shutdown
h) Fixation of selling price
PRODUCT MIX
It refers to variety of products a company sells. It also refers to the
total number of product lines that a company offers to its customer.
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 Sometimes when some limiting factors like raw material shortage, labour
shortage etc., situation arise, at that time, management will decide which
product should continue or which product will discontinue. In this context
management will decide to continue such product whose contribution is
maximum. Hence the production which gives less contribution, that
products should be either closed down or its production will reduce.
Illustration 1
A company with overall capacity of 2,00,000 machine hours as so far
been producing a standard mix if 30,000 units of product X, 20,000 units
of product Y and Z each. The total expenditure exclusive of fixed cost is Rs.
4,18,000/- and variable cost ratio among the products approximates
1:1.5:1.75 respectively per unit. The fixed charges came to Rs. 4/- per
unit. When the unit selling prices are Rs. 13.50/- for X, Rs. 15/- for Y and
Rs. 21/- for Z he incurs a loss. He desires to change the product mix as
under;

Product Mix 1 Mix 2 Mix 3

X 36,000 30,000 44,000
Y 24,000 12,000 16,000
Z 14,000 26,000 16,000
As management expert, which mix you will recommend
Solution
a) Calculation of Variable cost per unit
Total variable cost of Rs.4,18,000/- will be distributed among three
products in the following ratio.
Product X (30,000X1) =Rs. 30,000
Product Y (20,000X1.50) = 30,000
Product Z (20,000X1.75) = 35,000
Ratio will be=6:6:7
Hence, total variable cost of each product will be
Product X = 4,18,000X6/19 = Rs.1,32,000
Product Y = 4,18,000X6/19 = 1,32,000
Product Z = 4,18,000X7/19 = 1,54,000
Per unit variable cost will be
Product X = 1,32,000/30,000 = Rs. 4.40/- per unit
Product Y = 1,32,000/20,000 = Rs. 6.60/- per unit
Product Z = 1,54,000/20,000 = Rs.7.70/- per unit
b) Calculation of contribution per unit of each product
Particulars Product X Product Y Product Z
Selling Price 13.50 15.00 21.00
Less: Variable Cost 4.40 6.60 7.70
Contribution 9.10 8.40 13.30
c) It is assumed that the fixed cost of Rs.2,80,000(70,000X4)
remains constant for all proposed mixes.

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 Comparative Study of all product mix
Product Contribu Mix-1 Mix-2 Mix-3
tion per
Units Total Units Total Units Total
unit
X 9.10 36,000 3,27,600 30,000 2,73,000 44,000 4,00,400
Y 8.40 24,000 2,01,600 12,000 1,08,000 16,000 1,34,400
Z 13.30 14,000 1,86,200 26,000 3,45,800 16,000 2,12,800
Contribution 7,15,400 7,19,600 7,47,600
(-)Fixed Cost 2,80,000 2,80,000 2,80,000
Profit 4,35,400 4,39,600 4,67,600
Decision: From the above analysis, it is clear that mix-3 gives maximum
total contribution and gives a net profit of Rs.4,67,600/- after deduction of
fixed cost. Therefore, mix-3 is recommended.
Illustration 2
‘X’ Ltd., produces and sells three products A, B&C. it has an available
machine hour capacity of one lakh hours interchangeable the three
products. Presently the company produces and sells 20,000 units of A and
15,000 units each of B and C. The selling prices per unit of A, B &C are
Rs.25/-, Rs.32/- and Rs.42/- respectively. With this price structure and
aforesaid sales mix, the company is incurring a loss. The total expenditure,
excluding fixed cost, is Rs.13.75 lakhs. The unit cost ratio amongst the
products A, B and C is 4:6:7. Fixed cost per unit is Rs.5/-. Since the
company desires to improve its profitability without changing its cost and
price structure, it is considering the following three mixes so as to be within
the total available capacity.

Product Mix 1 Mix 2 Mix 3

A 20,000 25,000 30,000
B 12,000 15,000 5,000
C 18,000 10,000 15,000
Calculate the loss from the present mix and profit or loss from each of
the proposed mix. Advise the management which mix should be accepted.
Solution

Product Units Produced Unit Cost Equivalent units

ratio
A 20,000 4 80,000
B 15,000 6 90,000
C 15,000 7 1,05,000
Total 50,000 2,75,000
Total Variance Cost=13,75,000/-
Variable Cost per unit=13,75,000 =5/-
2,75,000
Variable Cost of
Product-A: 4X5=20/-; Product-B: 6X5=30/-; Product-C: 7X5=35/-
Contribution per unit;
Product-A: 25-20=5/-; Product-B: 32-30=2/-; Product-C: 42-35=7/-

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 Particulars Amount
(Rs.)
Contribution:
Product-A (20,000X5) 1,00,000
Product-B (15,000X2) 30,000
Product-C (15,000X7) 1,05,000
Total 2,35,000
Less: Fixed Cost (50,000unitsX5) 2,50,000
Loss 15,000

Calculation of Profitability
Particulars Mix-1 Mix-2 Mix-3
Contribution
Product A 1,00,000 1,25,000 1,50,000
Product B 24,000 30,000 10,000
Product C 1,26,000 70,000 1,05,000
Total Contribution 2,50,000 2,25,000 2,65,000
Less: Fixed Cost 2,50,000 2,50,000 2,50,000
Profit - (25,000) 15,000
Decision: The management should opt for Mix-3 because it is only mix,
who give profit of Rs.15,000/-.
ACCEPTANCE OR REJECTION OF SPECIAL ORDER/EXPORT OFFERS
Sometimes management has to take a decision to accept or refuse
an additional order for one of its products at a price which is below the
customary sale price. Such an order can prove attractive when a business
is working below full production capacity and the price offered results in
incremental revenue which is more than differential costs.
Illustration 3
A machine shop in a factory is working to its full capacity and earning
a contribution of Rs.50/- per hour. The management receives a high priority
order which it wants to execute immediately. Material will be supplied by
the customer and the special order will take a minimum of 10 hours. Wages
payable will be Rs.15/- per hour and variable overhead will be 150% of
wages. If the customer is prepared to pay Rs.800/- for the order, should
the order be accepted.
Solution
Calculation of the cost of special order
Particulars Amount (Rs.)
Direct Wages (10hrs x15) 150
Variable Overhead (150% of Rs.150) 225
Loss of Contribution (10hrs x50) 500
Cost of Special Order 875
Price offered by Customer 800
Loss 75
Decision: The order should not be accepted as it would give a loss of Rs.75/-

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Illustration 4 (EXPORT ORDER)
A company selling electric kits at a cost of Rs.6,900/- each, made up
as under;

Particulars Amount (Rs.)

Direct materials 3,200
Direct Labour 400
Variable overhead 1,000
Fixed overhead 200
Depreciation 200
Selling overhead-variable 100
Royalty 200
Profit 1,000
6,300
Central Excise Duty 600
Total 6,900
a. A foreign buyer has offered to buy 200 such kits at Rs.5,000 each. As a
Cost Accountant, would you advise accepting this offer.
b. What price should the company quote for a kit to be purchased by a
company under the same management if it should be at cost.
Solution
a. Variable cost per kit is computed as follows;

Particulars Amount (Rs.)

Direct materials 3,200
Direct Labour 400
Variable overhead 1,000
Royalty (Assumed to be on production) 200
Variable Cost 4,800
Offer price from foreign buyer 5,000
Contribution per kit 200
Offer should be accepted as it results incremental profit of Rs.200/-
per kit and a total profit of Rs.40,000/-(i.e., 200 kits x 200). It is assumed
a) there is spare capacity, and b) selling overhead are not relevant for
export order.
b. For the company under the same management, price to be quoted is
computed as under:

Particulars Amount Amount

(Rs.) (Rs.)
Price (Excluding excise duty) 6,300
Less: Profit 1,000
Variable selling overhead 100 1,100
Price to be quoted 5,200
Note: Excise duty has not been included. It may be added, wherever payable.

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MAKE OR BUY DECISION
A firm has to take decision whether to purchase a product or
manufacture itself. If a firm manufactures a product or part, thereof then
it has to incur some fixed or variable cost and if a firm purchases the same
market, it has to choose the supplier by taking into consideration the
availability of materials, financial soundness, regular supply and reliability
of supplier. The decision should be taken after comparing the cost and
benefit received by two alternatives. If cost purchase is less than marginal
cost of manufacturing then it is advisable to purchase the product from the
market instead of manufacturing it by the firm.
Illustration 5
From the following information of Swasthik Ltd.,

Variable cost of manufacturing component ‘A’ -Rs.10/- per unit; Outside

purchase price-Rs.12/- per unit; Incremental fixed cost in manufacturing-
Rs.5,000/-. Find whether the company should buy or make the component
if its annual requirements are a) 2,000 units and b) 3,000 units. At what
level the company would be indifferent between buying and manufacturing?
Solution

a. Incremental costs of manufacturing

Particulars Amount (Rs.)
Fixed Cost 5,000
Variable Costs (10X2,000) 20,000
Purchase Price (2,000X12) =24,000/-. It is better to buy, since the
purchase cost is lesser than the manufacturing cost.
b. Incremental costs of manufacturing
Particulars Amount (Rs.)
Fixed Cost 5,000
Variable Cost (10X3,000) 30,000
Purchase Price (3,000X12) =36,000/-. It is better to manufacture,
since the manufacturing cost is lesser than the buying cost.
The Break-Even Level
Additional contribution per unit of manufacturing Rs.2/- per unit.
(Outside purchase price-Variable cost of manufacturing)
Break-Even Level= Incremental fixed costs
Additional contribution per unit
= 5,000/2= 2,500 units
Illustration 6
ABC Ltd., has got a Machine No.201. If manufactures product ‘X’ with
its selling price Rs.100/- and Marginal cost Rs.60/-. The machine takes 20
hours to produce it. The company uses a component ‘Y’ that can be
manufactured on machine No.201 in 3 hours at a marginal cost of Rs.5/-.
However, the component ‘Y’ can be bought from the market at a price of
Rs.10/-. Should the component ‘Y’ be made on machine No.201?
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Solution
Contribution from Product ‘X’

Particulars Amount
(Rs.)
Selling Price 100
Less: Variable Cost 60
Contribution 40
Contribution per unit=40/20=2
Cost of Producing Component ‘Y’

Particulars Amount
(Rs.)
Marginal Cost 5
Cost due to loss of contribution from Product ‘X’ (3hrsX2) 6
Contribution 11
Supplier’s Price=Rs.10/-
The above computation shows that purchasing of component ‘Y’ from
the supplier will result in a net gain of Rs.1/- per component as compared
to manufacturing it. Hence, it is better for the company to buy the
component from outside supplier as compared to manufacturing it.
ADDITION OR ELIMINATION OF A PRODUCT
When a firm manufactures more than one product and one product
has to be discontinued, then management should take decision on the basis
of the contribution, effect on sales of other products and plant capacity etc.,
Marginal costing technique helps in management decision making of adding
or dropping a product or product line. The product which gives lesser
contribution should be discontinued.
Illustration 7
ABC Ltd., makes three products X-6000 units, Y-4000 units and Z-2000
units. The cost per unit of each product is as follows;

Particulars Products
X Y Z
Raw Materials 3.00 4.00 5.00
Direct Wages 2.00 5.00 4.00
Variable Overheads 4.00 3.00 2.00
Fixed Expenses 6.00 5.00 7.00
Total Cost 15.00 17.00 18.00
Selling Price 20.00 25.00 22.00
The firm decides to discontinue a product, and by doing so then the
production of other products will go up by 50%. You are required to
compute which product should be discontinued.

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 Solution
Calculation of Total Fixed Expenses

Particulars Amount
(Rs.)
Product ‘X’ (6,000X6) 36,000
Product ‘Y’ (4,000X5) 20,000
Product ‘Z’ (2,000X7) 14,000
Total Fixed Expenses 70,000
Calculation of Contribution per unit

Particulars Per unit

(Rs.)
Product ‘X’ (20-9) 11
Product ‘Y’ (25-12) 13
Product ‘Z’ (22-11) 11
i. If Product ‘X’ is discontinued, Product of Y and Z will be increased by 50%
each. Product of Y and Z would be 6,000 units and 3,000 units
respectively.

Contribution Per unit (Rs.)

Product ‘Y’ (6,000X13) 78,000
Product ‘Z’ (3,000X11) 33,000
Total Contribution 1,11,000
Less: Fixed Cost 70,000
Profit 41,000
ii. If Product ‘Y’ is discontinued, Product of X and Z will be increased by 50%
each. Product of X and Z would be 9,000 units and 3,000 units
respectively.

Contribution Per unit (Rs.)

Product ‘X’ (9,000X11) 99,000
Product ‘Z’ (3,000X11) 33,000
Total Contribution 1,32,000
Less: Fixed Cost 70,000
Profit 62,000
iii. If Product ‘Z’ is discontinued, Product of X and Y will be increased by 50%
each. Product of X and Y would be 9,000 units and 6,000 units
respectively.

Contribution Per unit (Rs.)

Product ‘X’ (9,000X11) 99,000
Product ‘Y’ (6,000X13) 78,000
Total Contribution 1,77,000
Less: Fixed Cost 70,000
Profit 1,07,000
Decision: If Product Z is discontinued then profit will be maximum i.e.,
Rs.1,07,000/-.

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SELLING OR FURTHER PROCESSING
The decision whether to sell the half-finished product right now or to
process it future depends on the incremental gain/loss resulting from
effecting either decision. The incremental revenues from processing are to
be compared with the incremental costs of processing, and if they exceed,
the alternative to process it further may be preferred to selling it
immediately. The incremental revenues are measured by difference
between selling price of the unit after processing and selling price per unit
without further processing, multiplied by the number of units involved.
Incremental revenue=(peater-know) x Units
Where peater stands for selling price per unit after processing further
Where know stands for selling price per unit before processing further
Incremental costs are;
a. Incremental outlay costs of processing and
b. Opportunity costs of using the facilities to process the product
Incremental revenues are based on the increase in selling price after the
product has been processed further.
Illustration 8
A process industry unit manufactures three joint products, A, B &C
but C has no realisable value unless it undergoes further process after the
point of separation. The details of C are as follows;
Particulars Per Unit (Rs.)
Upto point of separation
Marginal Cost 15
Fixed Cost 10
After point of separation
Marginal Cost 6
Fixed Cost 3
Total Cost 34
C can be sold at Rs.18/- per unit and no more. Would you recommend
discontinuing product C? Would you recommendation be different if A, B
and C are not joint products?
Solution
Particulars Amount (Rs.)
Cost upto point of separation 25.00
Cost after separation 9.00
Sales Price 18.00
The loss of Rs.25/- per unit if C is processed is recouped to the extent of:
Sale price less cost after separation i.e., 18-9=9/-
Processing of C is recommended.

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 If A, B and C were not joint products but arose out of the one and the
same process, the cost apportioned to C would be zero, since it will be
treated as either a waste or an unsaleable by-product of no value and the
entire cost of Rs.25/-upto the point of separation would be borne by A and
B. Further processing of C in that case would yield a profit of Rs.18-9=9/-
per unit.
Processing of C would be recommended in that situation as well.
SHUTDOWN OR CONTINUE
A business is sometimes confronted with the problem of suspending
its business operations for a temporary period or permanently closing
down. Permanent closure of the business is very drastic decision and should
be carried out only in extreme circumstances.
Temporary Shut down
The following items of costs and benefits should be considered while
deciding about the temporary shut down of plant.
Items of Cost
The items of cost to be considered are;
i. Effect on fixed overhead costs
ii. Setting up costs
iii. Retrenchment or lay off compensation to workers
iv. Packing & storing of Plant & Equipment costs
v. Loss of goodwill and or market
Items of Benefits
The items of benefits to be qualified are;
i. Avoiding operating losses
ii. Saving in fixed costs
iii. Saving in repairs & maintenance costs
iv. Saving in indirect labour costs
v. Saving in heat & light costs
vi. Saving in other indirect costs
Permanent Closing down
A business is expected to earn a reasonable return on its investment.
In case the business is not earning enough to compensate for the risk
involved it may be closed down permanently. In order to decide whether to
continue operations or abandon the project altogether, a comparison should
be made between the revenues from continued operations and revenues
from complete closing down and sale of plant. The business should be
closed down if the amount of revenue in the event of closing down is more
than the amount of revenue from continued operations of the business.

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Illustration 9
Plant-III budgeted income & cost estimates are follows;
Particulars Amount Amount
(Rs.) (Rs.)
Sales (Annual) 10,00,000
Costs-
Fixed 4,00,000
Variable 3,00,000
Head Office allocated 3,50,00010,50,000
Loss 50,000
Sales of Plant-III is under consideration. What is your recommendation
based on the data given? Justify your recommendation.
Solution
Plant-III: Statement of Profit

Particulars Amount
(Rs.)
Sales 10,00,000
Less: Variable Cost 3,00,000
Contribution 7,00,000
Own Fixed Cost 4,00,000
Profit 3,00,000
Head Office Allocated Fixed Cost 3,50,000
Loss 50,000
Decision: The above statement shows that Plant by itself is giving a profit
of Rs.3,00,000/-. The loss is because of head office allocated expenses of
Rs.3,50,000/-. The head office has to justify charging of such heavy fixed
expenses to the branch. It seems they are either on the higher side or not
properly allocated. Hence, the branch should not be closed down but should
continue its operations.
Illustration 10
A Ltd., is experiencing recessionary difficulties and as a result its
directors are considering whether or not the factory should be closed down
till the recession has passed. A flexible budget is complied giving the
following details;

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 Particulars Fixed Cost Production Capacity
(Fixed Cost+ Variable Cost)
Close Normal 40% 60% 80% 100%
Down
Factory Overheads 6,000 8,000 10,000 11,000 12,000 13,000
Administrative 4,000 6,000 6,500 7,000 7,500 8,000
Overheads
Selling & Distribution 4,000 6,000 7,000 8,000 9,000 10,000
Overheads
Miscellaneous 1,000 1,000 1,500 2,000 2,500 3,000
Direct Labour - - 10,000 15,000 20,000 25,000
Direct Material - - 12,000 18,000 24,000 32,000
15,000 21,000 47,000 61,000 75,000 91,000
The following additional information has been supplied to you;
i. Present sales at 50% capacity are estimated at Rs.30,000/- p.a.
ii. Estimated costs of closing down are Rs.4,500/-. In addition,
maintenance of plant & machinery is expected to amount Rs.800/- p.a.
iii. Cost of reopening after being closing down are estimated to be
Rs.2,000/- for overhauling of machines and getting ready and
Rs.1,400/- for training of personnel.
iv. Market research investigations reveal that sales should take an upward
swing to around 70% capacity at prices which would produce revenue
of Rs.1,00,000/- in approximately in twelve months’ time.
You are required to advise the directors whether to closedown for twelve
months or continue operations indefinitely.
Solution
Statement of Profit or Loss

Particulars Percentage Capacity Levels

0 50 70
(Close Down)
Sales (A) - 30,000 1,00,000
Costs;
Variable Costs - 33,000 47,000
Fixed Costs 15,000 21,000 21,000
Special Shut-Down Costs;
Closing Down 4,500
Plant Maintenance 800
Cost of Reopening & Overhauling 2,000
Training 1,400
Total Costs (B) 23,700 54,000 68,000
Profit (Loss) (23,700) (24,000) 32,000
Decision: the above table shows that loss will be a sum of Rs.300/- more
(i.e., Rs.24,000-Rs.23,700) if the plant is not closed down. The difference
being insignificant, it may be advisable to continue the operations on
account of non-financial consideration.
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Working Notes:
Computation of Variable Costs
i. For 50% Capacity
At 40% capacity the total costs are Rs.47,000
At 60% capacity the total costs are 61,000
Variable Costs for 1% capacity level=Change in Costs
Change in capacity Levels
= 14,000/20=Rs.700/-
For 10% increase in capacity the variable costs will be 7,000
Total Costs at 40% capacity 47,000
Total Costs at 50% capacity (47,000+7,000) 54,000
Fixed Costs as given are 21,000
Hence, Variable Costs at 50% capacity are (Rs.54,000-Rs.21,000) 33,000

ii. For 70% Capacity

Total Costs at 60% capacity Rs.61,000
Variable Costs for 10% capacity 7,000
Total Costs at 70% capacity (61,000+7,000) 68,000
Fixed Costs as given are 21,000
Variable Costs at 70% capacity are (Rs.68,000-Rs.21,000) 47,000

FIXATION OF SELLING PRICE

Fixation of selling price is one of the significant tasks of management.
Prices are generally calculated on the basis of market condition and other
economic aspects. Cost volume profit analysis supports the management
in fixing the selling price under diverse conditions. The pricing decision may
be taken either for long run or short run period. In the long run period, all
enterprises will try to cover both fixed and variable cost otherwise it cannot
be sustained in the market. However, in the short run company may fix the
selling price below the total cost. Moreover, in the situations like stiff
competition, depression, exploring new markets etc., the product may have
to sold at a price below the total cost, to capture the market.
Illustration 11
Ankith limited produces a single product. Its selling price and
production cost per unit are given below;
Particulars Per unit (Rs.)
Material 5.00
Labour 4.00
Variable overhead 3.00
Fixed overhead 4.00
Total cost 16.00
Output 50,000 units

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 Due to depression the company is not able to sell at the existing
selling price of Rs.18/- per unit. However, it is possible to sell the total
output of 50,000 units at Rs. 14/- per unit. You are required to advise
whether the company should sell at Rs. 14/- per unit or drop the product.
Solution

Particulars Amount
(Rs.)
Sales (50,000X14) 7,00,000

Less: Variable Cost (50,000X12) 6,00,000

Contribution 1,00,000
Less: Fixed Cost (50,000X4) 2,00,000
Loss 1,00,000
Decision: If company sells at Rs.14.00/- per unit it will suffer a loss of
Rs.1,00,000/-. However, if the company drops the production, it will suffer
a loss of Rs.2,00,000/- on account of fixed costs which cannot be avoided
during the period of closure of factory. Therefore, it is advised to sell at
Rs.14.00/- per unit even though it is below the total cost of Rs.16.00/- per
unit.
Illustration 12
Prestige Company Private Ltd., manufacturing pressure cookers has
drawn up the following budget for the year 2021-22.

Particulars Amount
(Rs.)
Raw Materials 20,00,000
Labour Stores, Power & Other Variable Cost 6,00,000
Manufacturing Overheads 7,00,000
Variable distribution costs 4,00,000
General Overheads including Selling 3,00,000
Total Cost 40,00,000
Income from Sales 50,00,000
Budgeted Profit 10,00,000
The General Manager suggests to reduce selling prices by 5% and
expects achieve the additional volume of 50%. There is sufficient capacity.
More intensive manufacturing programme will involve additional costs of
Rs.50,000/- for production planning. It will also be necessary to open an
additional sales office at cost of Rs.1,00,000/- per annum.
The Sales Manager, on the other hand, suggests to increase selling
price by 10% which is estimated to reduce sales volume by 10%. At the
same time, saving in manufacturing overheads and general overheads at
Rs.50,000/- and Rs.1,00,000/- per annum respectively is expected on this
reduced volume. Which of these two proposals would you accept and why?
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Solution
Comparative Statement of Budgeted Profit

Particulars Proposal-I Proposal-II

(Rs.) (Rs.)
Sales 71,25,000 49,50,000
Cost of Sales;
Raw Materials 30,00,000 18,00,000
Labour Stores, Power & Other Variable 9,00,000 5,40,000
Cost
Manufacturing Overheads 7,50,000 6,50,000
Variable distribution costs 6,00,000 3,60,000
General Overheads including Selling 4,00,000 2,00,000
Total Cost 56,50,000 35,50,000
Profit (Sales-Cost of Sales) 14,75,000 14,00,000
Conclusion: Proposal-I gives a higher profit of Rs.14,75,000/- and thus
should be accepted.
Working Notes;

Sales: Proposal-I (50,00,000X95/100X150/100) Rs.71,25,000

Proposal-II (50,00,000X110/100X90/100) 49,50,000
Raw Material: Proposal-I (20,00,000+50%) 30,00,000
Proposal-II (20,00,000-10%) 18,00,000
Labour: Proposal-I (6,00,000+50%) 9,00,000
Proposal-II (6,00,000-10%) 5,40,000

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