Unit 3 MA-1 PDF

**[UNIT: 3]** 1. **Marginal cost:** Marginal cost is the change in total production cost that comes from making or producing one more unit. It\'s calculated by dividing the change in production costs by the change in quantity. You can use marginal cost to determine your optimal production volume...

**[UNIT: 3]** 1. **Marginal cost:** Marginal cost is the change in total production cost that comes from making or producing one more unit. It\'s calculated by dividing the change in production costs by the change in quantity. You can use marginal cost to determine your optimal production volume and pricing. marginal cost is the additional cost of producing one more unit of a product or service:  - **Definition**: The change in total production cost when one more unit is produced  - **Formula**: Change in total costs divided by change in quantity  - **Purpose**: Helps businesses optimize production volumes and set prices to maximize revenues  - **Use**: Managers can use marginal cost to make informed decisions about pricing, product mix, and profitability  - **Calculation**: Requires good cost accounting that separates fixed and variable costs  2. **Relevant costs:** In management accounting, relevant cost is a term for costs that are relevant to a specific business decision and can be avoided. Relevant costs are used to eliminate unnecessary data and make the decision-making process more efficient.  Here are some examples of relevant costs: - **Construction firm** A construction firm is deciding whether to continue building an office building after spending \$1 million on it. The firm must consider whether the additional \$0.5 million needed to complete the building is worth it, given that the real estate market has declined and the building is expected to sell for less than the original price.  - **Clothing store** A clothing store is deciding whether to close 50 of its stores and rebrand as a smaller luxury boutique store. The store must consider the costs of closing the stores, such as losing revenue, versus the costs of keeping them open.  - **Special orders** A business may receive a special order from a customer and must decide whether to accept it. The business will consider whether it has the capacity to complete the order, whether the order will cover production costs, and whether it will be profitable in the long run.  3. **Differential Cost** Differential cost refers to the difference between the costs of two alternative decisions. The cost occurs when a business faces several similar options, and a choice must be made by picking one option and dropping the other. Differential cost is the difference between the cost of two alternative decisions, or of a change in output levels.  The concept is used when there are multiple possible options to pursue, and a choice must be made to select one option and drop the others. The concept can be particularly useful in step costing situations, where producing one additional unit of output may require a substantial additional cost. **Here are two examples:** - **Marketing strategy** If a telecom company is deciding between newspaper ads and social media marketing, the differential cost is the difference between the cost of the current strategy and the cost of the new strategy.  **Renovating a hotel space** If a hotel manager is deciding between renovating a space into a guest bedroom or a gift shop, the differential cost is the difference in expected costs between the two options. **Driving to work** If you\'re deciding between driving to work or taking the bus, the differential cost is the difference in variable costs between the two options Types of Differential Costs --------------------------- A differential cost can be a variable cost, a fixed cost, or a mix of the two -- there is no differentiation between these types of costs, since the emphasis is on the gross difference between the costs of the alternatives or change in output. Nonetheless, we make note of all three types of costs below: - *Variable cost*. A variable cost is one that changes in accordance with an associated activity. For example, the cost of commissions will increase as sales increase, and decline as sales decline. There are relatively few types of variable costs in most businesses, usually just direct labor, direct material, credit card fees, and commissions. - *Fixed cost*. A fixed cost is one that stays relatively fixed, irrespective of the activity level of a business. For example, a firm will incur rent expense for its premises, no matter what level of sales it generates. Depending on the business, it may have a relatively large base of fixed costs. - ***Mixed cost*.** A mixed cost is one that contains both a fixed and variable element. This means that there will be a baseline cost, irrespective of the activity level, plus a variable cost that changes to a degree as the activity level changes. 4. **sunk cost** - Management accounting, a sunk cost is a cost that has already been incurred and cannot be recovered. Sunk costs are also known as retrospective costs.  - Sunk costs are fixed costs, but not all fixed costs are sunk costs. For example, equipment is not a sunk cost if it can be returned or resold.  Sunk costs are expenses that have already been incurred and which are unrecoverable. In business, sunk costs are typically not included in consideration when making future decisions, as they are seen as irrelevant to current and future budgetary concerns **Here are some examples of sunk costs:** - **Driving to a concert** If you drive 100 miles to see a musician and then learn they won\'t be there, the 100 miles you already drove is a sunk cost.  - **Buying a movie ticket** If you buy a ticket to a movie and then find out it\'s bad, you shouldn\'t go see it because the ticket is a sunk cost.  - **Spending money on research and development** If you spend money on developing a product and it doesn\'t sell, the money you spent is a sunk cost 5. **Opportunity cost** In accounting, opportunity cost is the value of the best alternative that is not chosen when making a decision. It is a key consideration in business decision-making, and is calculated as part of the cost-benefit analysis (CBA) process. The formula for calculating opportunity cost is: - **Opportunity cost = return on option not chosen - return on option chosen**  Opportunity cost is important because it helps individuals and businesses make informed choices about how to allocate their resources efficiently. For example, a company might consider the opportunity cost of investing in new equipment versus investing in the stock market.  **[SUMS]** **(1)** The cost of manufacturing a part is given below (on the basis or production of 100,000 units) Direct material cost Cost per unit ------------------------------------- --------------- Part purchased from outside 20.00 Other Material 4.00 Direct Wages 6.00 Variable overheads 4.00 Fixed overheads ( total Rs.40 lakh) 40.00 **Total cost** **74.00** The company is operating at rs.80 percent capacity and it will not be making any other use of balance of 20% capacity in future. Hence it contemplates to manufacture a part of the above product, which is purchase from outside; the estimated cost of the part is as under. Direct Material Rs.4 ---------------------------------- -------- Direct Wages Rs.7 Variable overheads 3 Fixed costs (20% of rs.40 lakhs) 8 **Total cost** **22** Should the company make the part or buy it from outside. **(2)** Virat Mfg.Ltd is operating at present at 80 % capacity. Fixed costs are Rs.160; 000.the Company is purchasing its part from the market at factory. At a price of Rs.9.25 per unit. If the part is manufactured in the factory, its cost per unit will be as follows: Material Rs.4.00 ------------------ --------- Wages Rs.3.00 Factory overhead Rs.2.00 If the factory works at full capacity, it can manufacture 80,000 units of that part. The cost accountant of the company has prepared the following statement and presented to the management that the cost of manufacturing will be higher and it will be cheaper to buy it from outside: Cost P.U Total cost -------------------------------- ---------- ------------ Material 4 320,000 Wages 3 2,40,000 Factory Overhead 2 1,60,000 Fixed Costs(20% of total cost) 0.40 32,000 9.40 752,000 Give your opinion on the above statement. **(3) A** company has an opportunity to obtain a machine on monthly lease rental of Rs.2000.however, if this machine is bought, its cost price would be rs.100, and 000.this machine would have useful life of 8 years only. The machine is likely to realise rs.12, 000 at the end of its useful life.if the machine is purchased, and the funds have to be borrowed at 10%, while the same funds can earn 14% returns if invested in business. In such situation, give your opinion whether the machine should be bought or should be taken on lease. **(4)** The directors of AshiLtd.are considering the sales budget for the next budget period. You are required to present to the board a statement showing the marginal cost of each product and to recommend which of the following sales mixes should be adopted: \(1) 450 units of A and 300 units of B. \(2) 900 units of A only. \(3) 600 units of B only. \(4) 600 units of A and 200 units of B. You ascertain the following information. **Product A** **Product B** ------------------------------------- --------------- --------------- Fixed overheads: Rs.10,000 per year Direct Labour at 50 paise per hour 20 hour 30 hour Variable costs: 100% of wages Direct Material Rs.20 Rs.25 Selling Price Rs.60 Rs.100 \(5) The directors of a company intend to prepare a budget for the coming year. You are required to present a marginal cost statement for each product before the board of directors and to determine, which of the following must be adopted. \(1) 600 units of A and 400 units of B. \(2) 1200 units of A only. \(3) 800 units of B only. \(4) 800 units of A and 300 units of B. You ascertain the following information. **Product A** **Product B** ------------------------------------ --------------- --------------- Fixed overheads: Rs.22000 per year Direct Labour at 60 paise per hour 25 hours 35 hours Variable costs: 100% of wages Direct Material Rs.25 Rs.30 Selling Price Rs.80 Rs.140 6. Director of a company are thinking of installing a new machine in place of an existing working in the factory for the last 5 years. From the following information prepare statements to be presented before the board showing the effect of installing a new machine on the costs and profit. The existing machine can be sold at book value. Ignore interest. Particular Existing Machine New Machine ----------------------------- ------------------ ------------- Cost Price 40000 60000 Useful Life 10 Years 10 Years Machine hours-every year 2000 2000 Production per hour (units) 24 36 Wages per hour 3 5 Power annual 2000 4500 Consumable store 6000 7500 Other expanses annual 8000 9000 Material cost per unit 0.5 0.5 Selling price per unit 1.25 1.25 7. Bhgawati Engineeirng co. Has purchases a machine before 5 years. A proposal of installing a new machine in place of that machine is under consideration. The existing machine can be sold at its written down price. From the following information, you are required to recommend to management whether the existing machine should be continued or new machine should be purchased. Particular Existing Machine New Machine ----------------------------- ------------------ ------------- Cost Price 25000 50000 Useful Life 10 Years 10 Years Machine hours-every year 2000 2000 Production per hour (units) 12 18 Wages per hour 1.25 1.25 Power per hour 0.50 2.00 Indirect material-annual 3000 5000 Other expanses annual 12000 15000 Material cost per unit 1 1 Selling price per unit 2 2 Interest will have to be paid at 10% on the additional capital invested.