Name: Hashmi Hareshbhai Sutariya

Subject name: cost and management accounting (subject code-CC 201)

Roll no: 33 MBA – semester (2) Division : A

Institute name: S.K Patel institute of management

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Question:1 explain relevant cost with respect to various decision making areas and give the
examples thereof.

Relevant cost are expected future cost . Relevant costing attempts to determine the objective cost of
a business decision. An objective measure of the cost of a business decision is the extent of cash
outflows that shall result from its implementation. Relevant costing focuses on just that and ignores other
costs which do not affect the future cash flows.

The underlying principles of relevant costing are fairly simple and you can probably relate them to your
personal experiences involving financial decisions.

• Future Cash Flows: Cash expense that will be incurred in the future as a result of a decision is a
relevant cost.
• Avoidable Costs: Only those costs are relevant to a decision that can be avoided if the decision
is not implemented.
• Opportunity Costs: Cash inflow that will be sacrificed as a result of a particular management
decision is a relevant cost.
• Incremental Cost: Where different alternatives are being considered, relevant cost is the
incremental or differential cost between the various alternatives being considered.
Types of decisions

• Make or Buy Decisions • Special Orders • Utilization of a Scarce Resource

• Sell or Process further Decisions

Make or Buy Decisions

A make or buy decision relates to whether an item should be made internally or purchased
from an external supplier.
Special Orders
Special orders are one-time orders that do not affect a company’s normal sales. The profit from
a special order equals the incremental revenue less the incremental costs. As long as the
incremental revenue exceeds the incremental costs and present sales are unaffected, the
special order should be accepted.
Utilization of a Constrained Resource
Whenever demand exceeds productive capacity, a production constraint (bottleneck) exists.
This means that the company is unable to fill all orders and some choices have to be made
concerning which orders are filled and which are not filled. Total contribution margin will be
maximized by promoting those products or accepting those orders that provide the highest unit
contribution margin in relation to the constrained resource In some manufacturing processes,
several intermediate products are produced from a single input. Such products are known as
joint products. The costs associated with making these products.
Sell or Process Further Decisions
up to the point where they can be recognized as separate products (the split-off point) are
called joint product costs.
• A decision often must be made about selling a joint product as is or processing it further.
It is profitable to continue processing a joint product after the split-off point so long as
the incremental revenue from such processing exceeds the incremental processing
costs. In such decisions, the joint product costs incurred before the split-off point are
irrelevant and should be ignored.
Opportunity cost
Relevant costs may also be expressed as opportunity costs. An opportunity cost is the benefit
foregone by choosing one opportunity instead of the next-best alternative.
Example
The relevant costs for decision purposes will be the sum of:
i) 'avoidable outlay costs, i.e. those costs which will be incurred only if the book project is
approved, and will be avoided if it is not
ii) the opportunity cost of the leather (not represented by any outlay cost in connection to the
Project).
This total is a true representation of 'economic cost'.
Cost-volume-profit (CVP) analysis
CVP analysis involves the analysis of how total costs, total revenues and total profits are related
to sales volume, and is therefore concerned with predicting the effects of changes in costs and
sales volume on profit. It is also known as 'break even analysis'.
The technique used carefully may be helpful in the following situations:
a) Budget planning. The volume of sales required to make a profit (breakeven point) and the
'safety margin' for profits in the budget can be measured.
b) Pricing and sales volume decisions.
c) Sales mix decisions, to determine in what proportions each product should be sold.
d) Decisions that will affect the cost structure and production capacity of the company.

Question :2 – what is activity based costing? How it differs from traditional costing? Explain the
benefits and challenges faced while implementing activity based costing?

Activity-based costing ABC is a method for assigning costs to products, services

projects, tasks, or acquisitions, based on:
• The activities that go into them
• Resources consumed by these activities
ABC contrasts with traditional costing (cost accounting), which sometimes assigns costs using
somewhat arbitrary allocation percentages for overhead or the so-called indirect costs. As a
result, ABC and traditional cost accounting can estimate the cost of goods sold and gross
margin very differently for individual products. Contradictory and uncertain cost estimates can
be a problem when management needs to know precisely which products are profitable and
which are selling at a loss.
What Are the Benefits of ABC?
Cost accountants know that traditional cost accounting can hide or distort information on the
costs of individual products and services—especially where local cost allocation rules
misrepresent actual resource usage. As a result, the move to ABC usually motivated by a desire
to understand the "true costs" of individual products and services more accurately. Companies
implement activity-based costing to:
• Identify specific products that are unprofitable.
• Improve production process efficiency.
• Price products appropriately, with the help of accurate product cost information.
• Reveal unnecessary costs that become targets for elimination.
Firms that use ABC consistently to pursue these objectives are practicing activity-based
management ABM.

Traditional method Abc method

Cost pool One or a limited number Many, to reflect different activities

Applied rate Volume based cost drivers Activity-based , non-financial

Suited for Labor-intensive, Capital-intensive, product-diverse,

widely diverse set of operating
Low-overhead companies
activities , variation in number of
production runs ,high –overhead
companies .

Benefits Simple, inexpensive Accurate product costing ,possible

elimination of non-value –added
activities .

Cost Allocate overhead costs first to Assigns overhead costs first to activity
assignment department and second to products or cost pools and second to products or
services. services.

Focus Focuses on managing costs of Focuses on managing processes and

functional departments or activities and solutions of cross-
responsibility centers. functional problems.

What are the various challenges companies face while implementing ABC?
The companies face the following challenges while implementing ABC:
1) A failure to distinguish between fixed and variable costs, and full absorption of cost
that are partially sunk. ABC analysis must be supplemented by additional “cash
flow” studies to determine the incremental effects of various alternatives. However,
ABC is viewed as an “integral calculus” which will narrow the large number of
possible alternatives in a given decision situation to a few which can then be closely
examined using incremental analysis. Incremental analysis typically disregards costs
which are “sunk” with respect to the decision at hand. Therefore ABC might emerge costs
which were sunk costs.
2) Improved technology makes ABC plausible in today's business environment, but
there is a propensity to complicate this system with too many activity cost pools and
cost drivers. The resulting system becomes so complicated that nobody can understand or
efficiently maintain it.
3) Other issues may exist when implementing ABC system, such as a lack of a clear
business purpose, lack of senior management commitment, use of external
consultants who do not understand the organization, and resistance to change.