Page 119 - DMGT514_MANAGEMENT_CONTROL_SYSTEMS

Management Control Systems

Notes Less: Revenue for leasing and facilities ` 29,000
Net cost (benefit) to the company as a whole (` 9,000)

Example: A company is organized on decentralized lines, with each manufacturing
division operating as a separate profit centre. Each division manager has full authority to decide
on sale of the division’s output to outsiders and to other divisions.

Decision C has always purchased its requirements of a component from Division A. But when
informed that Division A was increasing its selling price to ` 150, the manager of Division C
decided to look at outside suppliers.
Division C can buy the component from an outside supplier for ` 135. But Division A refuses to
lower its prices in view of its need to maintain its return on the investment.

The top management has the following information:
C’s annual purchase of the component 1000 units
A’s variable costs per unit ` 120
A’s fixed cost per unit ` 20
Required:
1. Will the company as a whole benefit, if Division C bought the component at ` 135 from an
outside supplier?
2. If A did not produce the material for C, it could use the facilities for other activities
resulting in a cash operating savings of ` 18,000. Should C then purchase from outside
sources?
3. Suppose there is no alternative use of A’s facilities and the market price per unit for the
component drops by ` 20, should C buy from outside?
Solution:
1. Company will not benefit if C buys from outside:
Purchase cost from outside – 1000 units  ` 135 ` 135,000

Less saving in cost (variable) by reducing divisional
A output (1000  ` 120) ` 120,000
Net cost (benefit) to the company as whole ` 15,000
2. Company will benefit if C purchased from outside:
Purchase cost 1000  ` 135 ` 135,000
Less savings in variable cost 1000  120 120,000
Savings due to A’s equipment used for Other operations 18,000

` 138,000
Net cost (benefit) to the company (3000)
3. Company will benefit if C purchased from outside:
Purchase cost 1000  115 ` 115,000
Less savings in variable cost 1000  120 ` 120,000

Net cost (benefit) to the company (5000)

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