Page 257 - DMGT202_COST_AND_MANAGEMENT_ACCOUNTING

Cost and Management Accounting

Notes If the firm wants to introduce Activity-Based Costing system in practice, it must know the various

areas through which it could benefit out of the business intelligence. The areas of decision-making
are as follows:

Pricing Strategy: To fix the reasonable as well as competitive price not only to attract the buyers

but also to earn handsome profit margin out of the activity.

Make or Buy decisions and outsourcing: The firm should identify the right mode of supplying
the goods to the customers either through production or purchase; which is the best alternative
to yield profi t.
This is being effectively applied by the automobile industry. The demand of the accessories and
spare parts are normally met through this method of costing to identify the proper way of supply
at right cost without axing the profi t margin. It is being calculated through the study of nature
and number of activities involved.

Transfer Pricing

Nowadays, most firms process the materials not only for their production process to produce

finished goods, but also to fulfill the industrial demands of many firms through the supply of

work in progress materials.
Molasses, a residue of the sugar-manufacturing process, is considered a new material by farmers,

who use it to enhance the soil’s fertility once in two years. Though not a finished product, it
is considered as a by-product during the process of manufacturing of sugar. The sugar

manufacturing firms are expected to fix appropriate prices during the sale of molasses. It should

be neither overpriced nor underpriced by using scientific determination of price i.e. ABC which
slashes the cost of production.
The cost of the molasses is normally determined through an effective study of activities involved
in the process of production. During the early days, the method of computing the cost for the
work in progress was only on the basis of traditional cost system which mainly erred in the
process of apportionment of overheads.
Capital Budgeting Decisions: It is one of the most important tools of analysis to study the worth of
the long-term investments. The capital investment decisions are irreversible decisions which play
vital role to determine the profi tability of the fi rms. In modern business, every fi rm is required
to study the long-term investment decisions only in the context of proposed cost drivers and
activity drivers for the manufacture of a product. The selection of the best investment proposal
among the available purely depends upon the earning potential over the cost drivers.
Accepting foreign orders: Foreign orders are normally accepted by considering the worth of
manufacturing. The worth of manufacturing is how best the firm makes use of the fi xed cost

of operations. This is being studied through the comparison between the installed capacity and
capacity utilized. If the capacity of utilization is less than that of installed capacity, the fi rm could
think of for accepting the additional or foreign orders. This could be better analysed through
Activity-Based Costing.
Plant close decisions: The plant close decision is normally by all the firms by considering the cost

of resources and activity drivers involved in the process of manufacturing. The following examples

will certainly help us to understand the intricacies faced by the firm not only in the manufacturing
but also in the service industries. Let us discuss with an example from the service industry.

Example: The coach division of TV Sundaram Iyengar & Sons Ltd. Madurai, wound up
its operations due to the dominance of the cost of the resource drivers. The major resource for
the coach division is skilled labour in order to meet the expectations of customers, bus owners,

fleet owners and so on. The greater demand for skilled labour led to a hike in its costs. To fi ll
the absence of skilled labourers, the firm was supposed to carry out the operations, for which

outsourcing was preferred, not considering the quality of unskilled and semi-skilled labourers,
leading to consumption of more hours by them. This finally led to increase in the cost of resource

252 LOVELY PROFESSIONAL UNIVERSITY