Doubt - Cap. Bud. (Fin. Mgmt)

The company is utilizing only 80% of its prod. Capacity. Isn’t it??

Then why cant you accept the offer when another 20% remains idle?

Without considering the level of output you have to pay 2,20,000 as FC (Rs5.50*40000units) Its not going to make any difference even if you produce additional 10,000.

You have already allocated 2,20,000 to 40000 units (remember that allocation is made on the basis of budgeted cost and not on the basis of sunk cost. So 2,20,000 will remain unchanged irrespective of the quantum of output. What had been ascertained first in respect of FC is the total FC (Rs.2,20,000) and not Rs.5.50 p.u. Once you had budgeted your FC, you allocated it to your budgeted production ie.40000 units).

From the 40001th product you are incurring only var cost. It is clear from the quest that it is assumed that there is only market for 40000 units; otherwise, you might produce more as there is idle capacity. So u r not going to fetch a buyer for the 40001th unit onwards, other than the current one. As your total FC will be fully covered with the budgeted output itself ie 40,000 units, why are you worried abt FC from the 40001th unit onwards??

Even now, if you are worried about the cost p.u, then see this

 So you can accept the offer!

Originally posted by : Krishna
	Question :   A customer has offered you Rs. 15.00 per unit for 5,000 units of your product. You normally sell your product for Rs. 25.00 per unit. Should you accept this offer?   You currently produce and sell 40,000 units with a maximum capacity of 50,000 units. Total manufacturing costs are Rs. 18.00 per unit, consisting of Rs. 12.50 variable and Rs. 5.50 fixed.   --------------------------------------------------------------------------------------------------------------------   Solution:   Change in Revenues Rs. 75,000 (5,000 x Rs. 15.00) Change in Expenses (62,500) (5,000 x Rs. 12.50) Net Change Rs. 12,500     Conclusion: You should accept the special offer since it results in Rs. 12,500 of additional income.   ------------------------------------------------------------------------------------------------------------------------   Doubt :   How is it possible?? While the same product can be sold at Rs. 25, then why should I select special offer by customers. Nevertheless, if we ignore fixed costs as a sunk cost we will be in loss too.

AT PRESENT PROFIT:

(40000*25)      1000000

(40000*12.5)   (500000)

(50000*5.5)     (275000)

                      .............................

PROFIT         225000

                 ...................................            

AT THIS STAGE , WE HAVE RECOVERED OUR ENTIRE FIXED COST............NOW IF WE PRODUCE AND SELL PRODUCT ADDITIONAL AND IT IS GENERATING POSITIVE REVENUE THEN IT IS ADVISABLE TO ACCEPT OFFER FOR THAT.............

CONTRIBUTION ITSELF WILL BECOME PROFIT AND OUR PROFIT WILL INCREASE BY RS. 12500/-......

SO ACCEPT THE OFFER FOR ANY PRICE ABOVE RS.12.50/- I.E. VARIABLE COST...IT CONTRIBUTES TO PROFIT...........

Thank you so much for your valuable time that you have spent to make such a wonderful explanation and I am really greatful to you.