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Basic concepts of relevant costing and related issues.


Relevant cost Cost to be incurred for A1 Cost to be incurred for A2 10000 20000 Sunk cost sunk cost must be ignored for every selection means out here Rs.100000 downpayment.

Note: a. Irrelevant cost is to be ignored for the purpose of selection kyunki unse koi fark toh padta hai hi nahi. b. Yeh dekhe ki kaunsa kaam kare toh bekar hai lekin yeh dekhe ki kaam kiya jaye ya na kiya jaye toh yeh usefull hai. c. We have two types of descion kaunse kaunse descion hai sunk relevant irrlevant Desion of selection ignore consider consider either to do or not to do the act

relevant cost woh hoti hai jo har alternative par alag hai aur kisi kaam na kare toh nahi lagegi. Q1) 1. 2. 3. 4. what do u mean by opportunity cost? Ek alternative chodh kar jo benefit loose karte ho dusre ke liye, woh opp cost kehlata hai. Dhyaan rahe jab aap ek loss karke dusre ko karte ho tab aati hai opp. Cost ki baat nahi toh agar mera kisi chiz mein koi loss hi nahi ho raha hai toh woh opp. Cost kaise hoga. Cost sirf woh hi nahi hota jo jaa raha hai, woh bhi toh hota hai jo nahi aa raha hai. Opp. Cost ki baat tab aata hai jab mutually exclusive chizo ki baat hai, means ek ko karne ke liye aapko baaki sab ko chodhna padega.

Eg. Mere paas capital hai 10 lac ki Toh mere paas do option hai pehla ki main usko bank mein laga dun @10000 pm Dusra mutual fund mein laga dunga @140000 pa Cost of capita mere paas ho gayi 140000 Product Sp Vc X 10 6 Y 12 9 Z 12 7

Demand Capacity Fc

3000 2000 30000

2000 3000 30000

1000 900 30000

What is the opportunity cost. Solution: opportunity cost for each product Particulars X Cont. Pu 4 Total contri =2000*4=8000 Opp cost 6000

Y 3 2000*3=6000 8000

Z 5 5*900=4500 8000

Note: The concept of opp. Cost should be applied only when we have mutually exclusive events

Concepts of relevant cost


Relevant cost of material: A company has a material M1 purchased 4 yrs ago @ Rs.100 for an offer Now the material is in godown from last 4 years hence the nature of material is to be declared as a obsolete (taking logics from AS-2 which says that stock of the year shall be valued). Then company decides to remove the material from the stocks, it has no scrap value, before removing the material, the company receives an offer which will utilize such material (requirement = availability) Current purchase price of material M1 is Rs. 120, what should be the relevant cost for material M1 in respect of new offer. Sol: Statement of relevant cost Cost to be incurred due to acceptance of offer: Benefit to be lost due to acceptance of offer : Minimum price :

nill nill nill

1. Original cost of Rs.100 to be known as sunk cost due to past cost. 2. Current purchase price of Rs.120 has no relevance on the decision because there is no question to purchase the material which we have already lying in our godown Case 2: When scrap value of the material is given Suppose in above case, the scrap value of M1 material is Rs.20 and other fact remain same then what should be the RELEVANT COST of M1 in respect of new offer. Sol.: Statement of relevant cost

Cost to be incurred due to acceptance of offer: nill Benefit to be lost due to acceptance of offer : 20 Minimum cost :20 Case 3: Where the scrap value is given by different people and and different parts are sold differently.

scooter
purchase price:40000 less: depriciat -40000 y takes the stock after repair cost for Rs.6000

x takes the scooter at as it is @ 4000/y says that ki stapney nahi lunga and stapney value400

what will be the relevant cost of scoter

Statement of relevant cost Cost to be incurred due to acceptance of offer: 6000 Benefit to be lost due to acceptance of offer : 4000 Benefit to be achieved due to acceptance of offer : (400) Minimum cost :9600

Case 4: The company has one material purchased for Rs.100, 4 years ago for an offer. The nature of material is toxic and is obsolete as well. Current purchase price of M1 is 150. The company decides to remove such material by incurring extra cost of Rs.60. before removing the material the company receives an offer which will require such material , what should be the relevant cost of material M1 for the utilization of such material in respect of offer? Statement of relevant cost Cost to be incurred due to acceptance of offer: nill Benefit to be lost due to acceptance of offer : nill Benefit to be achieved due to acceptance of offer : (60) Minimum cost : (60)

Case 5: the company has a material M1 purchased some years ago at a cost of Rs.100 for REGULAR activities but such material is lying in godown as it is since the date when it was purchase hence is obsolete now and of no use , it has 2 alternatives Ist : It can be sold as srap @ Rs.90 OR IInd : It can be utilized in the place of M2 for an offer (to make a table) which has been accepted Current purchase price of material M1 is Rs.200 and material M2 is Rs.120 and now the company receives another offer for the manufacture of chair which would require M1 material What should be the relevant cost of M1 material for the offer.

If we had not accepted the offer then benefits would have been in the following manner from M1 a. Sale it @ Rs,.90 OR b. Substitute use in table of Rs.120(this the cost of amount saved from buying the material M2) Thus the Maximum benefit would have been 120 from M1 But due to acceptance of offer , such benefit would have to be lost and henceforth the same must be charged from the offer. Statement of Relevant Cost Cost to be incurred Add :Benefit to be lost Minimum price to be charged

nill 120 (this is the cost saved by not buying M2) 120

Case6 : Suppose in above case M1 can be utilized in place of M2 after incurring some extra cost of Rs.10 (expenses of painting and others) and other facts remaining the same Solution: In this case the net benefit of cost saving in substitute ways would be 120-10=110 which is the maximum benefit and hence the relevant cost of M1 would be Rs.110/-. If say in above the current purchase price of M1 is 70 then its better to purchase M1 from the market instead of utilizing existing material and the relevant cost would be Rs.70

Case6: Regular Use


If a company has 600 cement bags in godown which are of regular nature and purchased at the rate of Rs.400. now the company receives an offer which will require 600 bags ,current purchase price of material would be Rs.420/-. What should be the relevant cost of such material for the offer? In order to complete the offer , it is not possible to utilize the existing material which are of regular nature and hence we should purchase from the market for the offer And the relevant cost will be the COST TO BE INCURRED i.e. 600 bags* Rs.420= Rs.252000/-. Now say that the supplier only supplies the cements ate fixed lot of 800 bags per transaction Then you will have to buy the whole lot of 800*420 i.e. Rs.336000 and then transfer the rest of 200 bags to the regular stock and the remaining would be the relevant cost of the material used for offer.

RELEVANT COST OF LABOUR


Casual labours: These labours can be appointed and retrenched as when required and payment is made as per their work. Permanent labours: These labours cant be terminated / retrenched due to an agreement with the management. Payment will be made irrespective of working. Short Supply: When its not possible to appoint extra labour from the market for next period . Busy: They are not idle and are engaged in regular activity and providing some contribution to the company.

Case1:Casual and not busy (not in short supply)

M/s XYZ and co, is a sanitary store has a casual worker X with Rs.500 for the each day he works, the company anticipates that due to some reason he has no work to do for the next 4 days. Now the company receives an offer which will require such labour for next 4 days. Statement of relevant cost Cost to be incurred due to acceptance of offer (500*4) : Rs.2000/Case2: Permanent and not busy (not in short supply) Suppose in above case the nature of labour is permanent and not busy and salary amount will be 15000 p.m. other facts remaining same, compute the relevant cost of the labour. Statement of relevant cost Cost to be incurred due to acceptance of offer

: nil

Logic: The relevant cost of the labour is nil because the existing labour cost would continue to occur with the same amount irrespective of acceptance of offer. Case3: Casual and busy (in short supply) Suppose M/s XYZ co. A sanitary store has a worker X with the wages of Rs.500 per day at present management can estimate the benefit would be derived from the utilization of such labour for next 4 days in the following manner . Revenue 10000 Less : Mat cost (1500) Less: labour cost (2000) Contribution 6500 The company receives an offer for next 4 days which will require such labour . What should be the relevant cost of labour for the offer? Statement of relevant cost Cost to be incurred due to acceptance of offer (500*4) Add: benefit to be lost due to acceptance of offer Price Case4: Permanent and busy (in short supply) M/s XYZ co. has a labour Mr. X with the salary of 15000p.m. Management predicts that the profits would be 55000 for the next month from regular activities with the utilization of such labour i.e. Revenue 100000 Less : Mat cost (30000) Less: labour cost (15000) Contribution 55000 The company receives a offer which would require such labour for the next moth then what should be the relevant cost of labour for the offer. Statement of relevant cost The labour cost of Rs.15000 is knwn as sunk costand henceforth it must be ignored and than the benefit to be lost ignoring the benefit should bethe amount which should be charged from the offer. If we had not accepted the offer then sunk cost would have been recovered i.e. Rs.15000 along with the profit of Rs.55000/- and both will have to be sacrificed due to acceptance of offer and it should be charged from the offer i.e. non recovery of sunk cost and loss of profit.

2000/6500/8500/-

Amount to be charged from the offer Price

70000/70000/-

Sales Less: variable cost Contribution Less: avoidable fixed cost Benefits Less: unavoidable fixed cost Profits

** ** $$ ** $$ ** $$

RELEVANT COST OF LABOUR


Types Casual Permanent Not busy/no shot supply Labour cost Nil Busy & short supply Labour cost ** +contri ** Benefit to be lost ignoring the labour cost.

RELEVANT COST OF OVERHEAD


Overhead are of two type 1. Variable overhead: variable overhead is always called relevant cost because variable overhead is always to be incurred during productive hours. 2. Fixed overhead: Avoidable FO: this means the overhead which continue to occur only when offer is to be accepted i.e. always relevant like extra supervisors salary or extra rent of machinery. Unavoidable FO: They would continue to occur in totality irrespective of acceptance of offer hence called sunk cost like factory rent, electricity and depreciation of existing machine. These expenses may be called general overheads.

Change in apportionment doesnt change the outflow and are always referred to as sunk cost.

Case1
Suppose a company has a machine and the nature of machine is obsolete means such machines cannot be utilized in regular production and hence management decides to resale such machine for Rs.10000, just before selling the machine as scrap, the company receives an offer for next 6 months which would require such machines, the resale value at the end of 6 months would be Rs.8000, what should be the relevant cost of the machine for the offer.

Relevant cost Benefit to be lost due to acceptance of offer :10000 Less: Benefit to be achieved due to acceptance of offer :(8000) Difference of re sale value Relevant cost 2000

Case2
suppose a construction company has a machine or machines for regular activities .the company receives an offer for the construction of guest house which will require the machine for next 6 months. Current purchase price of the machine is 100000 and the market price hence 6 months would be 80000, then what should be the relevant cost of the machine. In order to complete the order we must purchase a machine from the market rather than utilising the machine from the regular use and regular work be stopped for the same purpose. But after completing the offer the released machine should be transferred to regular stock instead of selling them as scrap in the scrap price. Statement of relevant cost Cost to be incurred due to acceptance of offer :100000 Benefit to be achieved due to acceptance of offer :(80000) Relevant cost of the machine 20000

In the absence of any instruction we should follow the following presumptions Resources Presumptions Material Obsolete Machine Obsolete Fixed overhead Unavoidable fixed cost Labour Casual In the following cases we should consider the nature of labour to be permanent Case1: Such labour cannot be retrenched or retrenched. Case2: They are employees. Case3: They get idle wages (they are underutilised). Do question no.6
We have three type of decisions in hand they are-:

Situation 1

If we have only one offer or revenue ka amount and cost amount are given. Then in that case we should prepare statement of cost benefit.

Statement of cost benefit Revenue Cost Material Labour Overheads Benefits


Situation 2

**

** **

If we have only one offer and only cost amounts are given. Then in that case we should prepare statement of cost benefit. Statement of cost benefit Material ** Labour ** Overheads ** ** Minimum price **
Situation 2

If we have more than one offer and revenue amount and cost amounts are given respectively. Then in that case we should prepare statement of COMPARATIVE cost benefit. Statement of COMPARATIVE cost benefit REVENUE PARTICULARS REVENUE Total (a) COST Material Labour Overhead Total (b) Benefit (a-b)

A1 ** ** ** ** ** ** ** **

A2 ** ** ** ** ** ** ** **

A3 ** ** ** ** ** ** ** **

COST Material Labour Overheads

** ** **

** Minimum price **
If we have more than one alternatives with different amount of benefits , then in that case we should not consider the benefit of one alternative as an opportunity cost for the other alternatives in the descion of comparison However in the decision of quotation of minimum price for the selected alternative, we should consider the higher benefit to be lost in favour of selected alternative as an opportunity cost.

Profit centre
the unit company of the group which always makes profit . they are always a profit centre of the company. We are not the one to decide that which unit is profit making and cost making. Profit centre means profit making unit or department , in other words we can say any department or company is to be considered profit centre when profit occurs in that division on regular basis with substantial amounts. Normally we can say profit would occur when actual output would be higher than breakeven level but substantial profit on regular basis would be achieved only when actual output becomes closer to the capacity In the abscense of instruction , always we should presume actual output would be equall to the capacity, which means 100% capacity utilization exist in the factory .

Cost centre
The original name was loss making unit and is shortly called is cost centre In other words we can say loss exist when actual output becomes closer to the breakeven point , which indicate spare capacity always exist Hence we can say that minimum price will be variable cost for the acceptance of any offer In the absence of any information of nature of any centre or department, it shall be assumed that the particular department is a cost centre

Summary for relevant cost


material

MAKE OR BUY

Make or buy decision relates with component of a product. Component here means a part of the product but not an integral part. E.g. Empty bottle is a component in Soft Drink Company. And bicycle chain in the bicycle. If the decision relates with product for purchase or manufacture then that is to be known as SUB

CONTRACTING OR OUTSOURCING
What is the non costing factor to be considered in make or buy factor. 1. The quality if the component must be standard and sub standard component must not be purchased. 2. The delivery of the component should be on scheduled time. 3. The delivery of the component should be on regular basis with constant price. What is the costing factor to be considered in make or buy factor. 1. Purchase cost of the component should be compared with cost to be incurred due to MANUFACTURING THE COMPONENT. 2. Cost to be incurred includes a. Variable cost and avoidable fixed cost 3. Unavoidable fixed cost(general overhead) should not be considered in the decision of make or buy due to sunk cost.(change in apportionment does not amount to change in cash flow). 4. The above decision can be analysed by preparing statement of comparative cost Statement of comparative cost Manufacture Cost to incurred Material Labour Variable o/h Avoidable f/o Total Purchase cost Purchase

Total

AND SELECT THE OPTION WHICH HAS THE LEAST COST.

THE above decision can be analysed by preparing two statements or one statement in the following manner.

First:
Statement of comparative cost Manufacture Cost to incurred 130 Material Labour Variable o/h Avoidable f/o 20 Total 150 Statement of cost benefit Loss on purchase Purchase Purchase cost 180

Total

180

30000

Benefits from released capacity 50000 Total benefit 20000

Second:
Statement of comparative cost (on the basis of relevant cost) Cost to be incurred 130+20=150 Add: benefit to be lost due to rental income 50 Total relevant cost 200 Purchase cost (if purchased) 180

Total benefit to be lost if manufactured is Rs.20 Thus buying the component is beneficial