CMA USA Part 2 study material

 

CMA USA Part-2 Section-C

Marginal analysis applications:

1.      Sell or further decision process:

When a single production process leads to the production of two or more products. then that production process is called joint production.

The main product is called join product or main product and it has more value than by product.

Split of the point:

It is a point at which the product is separately identified.

Joint cost:

The cost incurred up to the split of the points is called the join cost.

Ø   Separable cost or further processing cost:

The cost incurred after the split of the points is called separable cost.

By product:

It is a low-value product when compared to a joint product.

Joint product: it is a high-value product when compared to a joint product.

Note: the difference between a by-product and a joint product is its market value.

Sell or further process  decision

: In decision-making of further process or sell at the split of point, the joint cost is not relevant because it is sunk cost.

If marginal revenue > marginal cost = further processing

If MR < marginal cost = no further processing

Or sell at split off.

[Example in Youtube.]

Ø  Absolute inventory:

The original cost of absolute inventory is a sunk cost and that is not relevant.

Ø  Relevant cost:

Relevant cost give relevant in decision-making relevant costs are relevant if

1.      There occur in the future

2.      The difference between or among the various alternative.

Ø  Irrelevant cost:

It is not relevant in decision-making.

Example:

Sunk cost, common cost, etc.

 

Ø  Make or buy decision:

management of a company must sometimes decide whether it wants to a produce particular product. [in-house]or purchase it from outside vendors.

Such a choice is known as a make-or-buy decision. Only avoidable costs are relevant.

In decision-making, unavoidable costs are not relevant.

Avoidable costs include,

• 1.      Avoidable variable cost
• 2.      Avoidable fixed cost

The maximum price the company is willing to pay is an avoidable cost.

If the external price is greater than the avoidable cost, the company will make the product internally.

If the external price is less than the avoidable cost, the company will buy externally from vendors [ suppliers].

[Example on youtube]

Ø  Dis-investment decisions:

It is the action of selling or liquidating an asset. Such as a product or product line or a segment of the business such as a subsidiary.

Certain fixed costs may be continued even after dis investment.

Eg: such as CEO salary, allocated common cost, etc.

It is an unavoidable cost that is not relevant to decision-making.

 

Ø  Dis-investment decisions include,

1.      Identify all unavoidable variables and fixed costs that would continue even if the product or segment terminated.

2.      Identify all variable and fixed avoidable costs that will be incurred only if the division continues its operations.

3.      If CM > avoidable fixed cost = continue

If CM < avoidable fixed cost = discontinue/disinvestment

Common costs and sunk costs are not relevant in decision-making.

The company is considering eliminating the early living product line because of losses over the past year.

Note: marginal product or marginal and physical product

 

The additional output that is produced by adding is additional input.

 
Ø  Marginal revenue product:

The changes in total revenue arise from using one additional unit of resources.

Ø  Special order decision:

In a special order situation, a company asked to produce a special one-time order.

Before accept in the special order, the company must decide the minimum price to charge.

Two factors must be considered,

1.      The direct cost production:

The cost directly incurred is the cost that would be avoidable if the company didn’t produce the order.

2.      Level of capacity:

Case1. Companies operating at less than full capacity:

If the company operating below full capacity and company has access capacity to fulfill the order, then the minimum price is the additional cost to fulfill the order [ avoidable cost]

Case2. If the company operating at full capacity:

If a company operates at full capacity it needs to recover the additional cost of that special order and the opportunity cost of canceling its existing order.