 So, dear students, in last session, we were discussing about decision making and various costs related to decision making. If you remember, we have already discussed about relevant costs and sunk costs. Today, we will talk about introduction of new product, we will also talk about closing down a factory temporary, that is shutdown cost and then we will discuss about joint products and whether to process a joint product or no. To take a very brief recap, what do you understand by relevant cost and can you give any example of a relevant cost? Just think over, I think you are getting it right. So, relevant cost is that cost, which is relevant to the decision. In other words, that particular cost really affects the decision making. For example, if company has spent lot of money on R and D of a product, a new product has been developed technologically, market research has also been done. Now, the decision is to be taken about whether to launch a product or no. So, what will be the relevant cost and what will be the sunk cost? Can you think of? So, the cost on R and D, the cost on market research, both are sunk costs, though they are very important, they have already been incurred. So, they should not have any role in deciding whether the product should be commercially launched or no. The decision about launching of the product should solely depend on how much surplus the product will generate on its launching. So, we will look at the cost of the product and the revenues from the product. Because you take a decision of make or buy, which also we have discussed in the last session. So, we are making a particular product at say 15 rupees per unit. There is a offer from the supplier that supplier is willing to supply it at 12 rupees. Shall we go for buying or we should continue to make at 15 rupees? How will you take a call? Again, think of what is a relevant cost and what is a sunk cost. So, what is a relevant cost in this case? Is this 15 rupees? 15 rupees is a total cost of making versus we have 12 rupees as a cost of buying. Is this 15 rupees relevant for a make or buy decision? The answer is no, because we already have facilities. We should not look at the total cost, we should rather look at a variable cost. So, if we break down this 15 and it is told to you that 7 rupees is fixed and 8 is variable and 12 rupees is a cost of buying. So, now what is relevant? 8 rupees which is a cost of variable cost of production is a relevant cost and it should be compared with 12 rupees which is a cost of buying. So, now you can see that 8 rupees becomes relevant for the decision and we may decide that we should make rather than buy at 12 rupees. 7 rupees which is a fixed cost is to be considered as a sunk cost in this case. So, sunk cost is that cost which is already committed or which has already been incurred and is not going to change because of the decision. So, it should not be considered while taking the decision. So, I hope it is clear to you and make or buy decision is also clear to you. So, let us go ahead now. Let us go to shut down costs. Now, many times what happens in a business scenario? It becomes difficult to run a particular product because of the temporary downturn. So, the demand for the product falls and once the demand falls, the product becomes loss making. In such case, company has to decide whether the production should continue or not. So, if so happens that the revenues you are generating are below the total cost. Is it advisable to continue the production? Answer will be yes because we do not look at the total cost. We should rather look at the variable cost. If we continue our example that 7 rupees is a fixed cost, 8 rupees is a variable cost. So, 15 rupees is a total cost. We used to sell the product at say 18 rupees initially. Now, the cost, the selling price of the product comes down to 15. So, we are not making any profit. It further comes down to say 13. Shall we make it? Answer is yes because we are able to produce at 8. So, even if we sell at 13, we at least generate some contribution. We will win loss, but if we close it, the losses will be to the tune of 7 rupees per unit which is the fixed cost. So, since the fixed cost does not change as long as the product contributes to the fixed cost, it may be advisable to make it. But further what may happen is, if we decide to temporarily close the product, close the product line or the production of a particular product, there is some change in the fixed cost. How will you define fixed cost? In the normal cost, we say that fixed cost is that cost which does not change with the level of activity. So, irrespective of you need certain cost like rent, say, maintenance are incurred. But what happens is, if we close down the production facility temporarily, we are not talking of a permanent decision, but when we temporarily close down the production facility, some of the fixed cost may go down. For example, some of the employees working there, we can transfer to other divisions. We may decide to keep the plant off, so our fixed power cost may go down and so on. But some of the fixed cost may increase like we may need more security because even if the plant is closed, some amount of security is required to ensure that plant and machinery is properly secured. So, there might be some changes in the fixed cost. So, what we have to look is the fixed cost which is incurred in case the production is on and fixed cost if we shut down. The difference in this fixed cost also becomes relevant. So, we look at this difference plus the variable cost and that is compared with the revenue for taking a decision on shut down. Now, let us see what is the formula. So, here we can see that if the selling price is above the variable cost, then it is better to continue. But as we discussed, some of the fixed cost also slightly changes. Now, the decision is based on the contribution after adjusting the difference in fixed cost. So, now let us try to do one or two problems on the same, so that it is little more clear to you. So, here you can see in the excel sheet the details of the problem. The fixed cost at 75 percent capacity is rupees 25,000, additional fixed expenses if the factory shut is 10,000 and fixed expenses with the factory shut down is 3,000, production at 75 percent capacity is 15,000 unit, contribution per unit is 2. Now what has happened is demand is very low and company is able to operate at only 40 percent of the capacity. Is it advisable to shut down temporarily? That is the question. So, how will you take a call? Now, here you can see that as long as we are operating at 75 percent capacity, our fixed costs are 25 and as you know fixed cost do not change with the level of activity. So, even if the capacity is 50 percent or 40 percent or 30 percent, the fixed cost will remain the same. But if we completely close down the facility for temporary time, then the fixed cost will come down to just 3,000. Because we may transfer our fixed employees, we may close down our power facility, we may close down some extra cost which are incurred on cleaning of the plant, the time of manager etcetera will get saved. But we have to incur some extra fixed costs which are to the tune of 10,000. Let us first try to look at the profitability in case we continue to operate. So, now you know that the contribution per unit is 2 rupees. Now, let us look at what happens at a different levels of activities. Suppose we work at 75 percent, then how many number of units do we make? They are given that production at 75 percent capacity is 15,000. So, how much contribution do we generate? 15,000 into 2. So, 30,000 comes to the kitty of the company. That is a contribution, I will write in full for more clarity. From this contribution, we have to pay our fixed costs. And how much are the fixed costs? It is given that the fixed costs are 25,000. So, at 75 percent capacity, the unit operates at a profit of 5000. I hope it is clear to everyone. Now, currently they are not able to operate at that capacity. The production is down and it is only at 40 percent. So, first we have to calculate what will be the number of units at 40 percent. So, number of units come to 8,000. Is it right? So, how much will be the contribution? 2000 per unit. So, it comes to 16, correct? What will be the fixed costs? Fixed costs remains at 25. So, the profit is minus 9. Or in other words, there is a loss of 9. Is it right? Now, it is looking like, it is almost impossible to increase the level of activity to a level of taking the plant to profit. So, if you operate at 30 percent, 40 percent or even 50 percent, we are likely to be at loss always, right? So, one option company has is, instead of running the plant, temporary close it down, which will bring down the fixed costs from 25 to 3. But there will be additional fixed costs to the tune of 10. So, how will you decide? Are you able to take a call? So, by closing down, we lose the 2 rupees per unit contribution, but we save on fixed cost, but we also incur 10,000 more on fixed costs. So, let us look at the solution. So, we calculate the revised fixed costs. You know that the total fixed cost currently is 25. It will reduce to 3, right? But extra fixed cost of 10 is incurred. So, essentially we are reducing 7,000 from it. So, 25 minus 10 plus 3, that is 25 minus 13. So, we will continue to incur 12,000 and the contribution per unit is 2 rupees. So, 6,000 units become that level of activity, where whether we operate or not operate, the cost will remain the same, right? So, that is considered as a shutdown point. Are you getting? Now, carefully look at the formula. So, we say that total fixed cost minus shutdown cost. So, what is shutdown cost? Because after the closure, the fixed cost will come down to 3 plus extra fixed cost of 10. So, essentially 13 is a fixed cost on shutdown, 25 is a normal fixed cost. So, we saved 12,000 by taking a decision of closing down and we divided by per unit, which is per unit contribution, which is 2. So, equivalent to 6,000 units, we were able to generate at a 6,000 units, we were able to generate a contribution of 12, which we are saving. We can just go back and check what we have done. Suppose if we take units at 6,000, what will be the profitability? So, at 6,000, what will happen is the contribution will be 12, fixed cost will continue to be 25. So, it leads to a profit of minus 13. In other words, it leads us to a loss of 13. Now, by taking a decision of closure, we have been able to bring down our fixed cost to 3 plus 10, that is 13. So, even if we close, the loss will be 13 and if we continue also the loss will be 13. So, 6,000 units is that level, this is the number of units. So, 6,000 units is a level where we run or not run our losses remain at 13. Suppose our number of units are more than 6, let us say our number of units at 8, then our loss is 9. So, the loss will go on increasing as the number of units fall at 6,000, the loss becomes 13,000. If the number of units fall below 6, then our loss will be more than 13. So, it may be better to keep our plants shut rather than continue to incur losses more than 13,000. So, 6,000 is a shutdown point. In other words, it is that level of activity where we need not have to run the plant, it is better to shut down at that level and below that level. So, only if we feel that demand is likely to be more than 6, then we take a call to continue. Of course, nobody would like to run in loss, this is a temporary measure, the demand is very low. So, only in such cases the decision on shutdown point becomes level. Now, let us look at the next concept, I hope the shutdown point issue is now very clear to you. Now, the next is about introducing of a new product. Now, what happens is after certain time the life cycle of the old product, product is no longer the old product remains profitable for a long time and company has to decide on a launching of a new product. So, what are the factors considered? The first is customer should have interest. So, we will look at the market research and see whether the customers have interest. Second there should be sufficient and sustainable demand because only once in a while customers have interest is not enough, we should have a sustainable demand of such level where we are able to make profit. If both the conditions are made then it make make sense to introduce a new product. This is a very simple decision earlier we have discussed it when we talked about relevant cost and sunk cost. So, I think it will be clear to you. Now, the next concept which we discussed is known as joint products. Many times what happens is from one production process instead of one product coming out two or more products come out and most of them are of similar importance then they are called as joint products. Can you think of any example of one production process giving more than one products? Each one of us operates or uses some vehicle. Vehicle runs on which fuel either petrol or diesel in most cases in some case may be gas. So, where all from we get this petrol, diesel or gas? Of course for us it is from petrol pump, but where does it get manufactured? I think you all know it gets manufactured in a refinery. So, crude oil is refined and we get petroleum products, but is there a separate process for petrol or separate process for diesel? The answer is no. From the crude oil when the refining activity is done simultaneously number of products emerge. They include petrol, they include diesel, they include gas sometime they include other petrochemicals. Of course they may require slight further processing, but basic process is common. So, these are the examples of joint products. Can you think of any other example? So, when one or more product is separated in the course of same processing operation and not that only one product is important, many products are important then it is considered as a joint product. They will generally require further processing. Here is one more example, in coke production, coal becomes a raw material and not just coke usually sulphate of ammonia light oil. So, we get also emerge from the same process, so coke, sulphate of ammonia and light oil all three are considered as joint products. Same process we have already discussed, we get petrol, diesel, gas and joint products. Here pictorially it is shown, so we get crude oil which is extracted from the earth either below the sea or above the sea. So, we get the crude oil then it is refined in the refinery. At the refining up to the split of point some joint costs are incurred in the refinery then we get petrol and diesel and other products like gas then they may require site refining may be it is the ladies taken out some more processes are done and then we get finally sellable form of petrol and diesel. So, we have two set of costs one are the joint costs which are common for petrol diesel gas then on each product separate costs are incurred. So, it becomes necessary that the joint costs which are the costs of refining process are properly charged to petrol and diesel we will see how they are charged. So, after separation point then there is some processing and the products are ready for sell. Now, what happens is sometimes from the same process more than one products emerge, but they are not of equal economic importance. So, one product is very important in such case that one product which is important is called as main product other products also emerge, but they are of subsidiary important they are not so important then those products are called as by products. So, can you think of some example of a by product sometimes main products could be joint products like from refining you get petrol diesel gas they are the main products but you may also get some other products which are not so important economically their prices are much lesser. So, they become by products. So, can you think of any example of a by product if you have seen any machine shop whenever any machining activity is done on lathe or any other equipment usually some scrap gets generated the scrap consists of metal. So, it has a sellable value, but that value is no way comparable to our finish goods it is more like a raw material or more like a scrap to be disposed of at a relatively less value. So, that metallic powder which gets generated is a by product whereas the product which we are making from the lathe is the main product. One more example we were talking of the coke manufacture. So, we discussed that from the while we manufacture coke here we have seen it. So, in coke manufacturing we get sulphate of ammonia and light oil which are considered as joint products, but simultaneously gas and tar also comes out that is not so important. So, it is considered as a by product. In lumber mills you know where the wood is cut lot of saw dust gets generated and it can be sold out that saw dust is a by product. Again in a cotton cleaning process when the cotton is being cleaned the cotton seed is taken out and then from the cotton seed oil is extracted and then the remains become a good food for animal, but that cotton seed which is removed from the cotton in the cotton cleaning process is usually considered as a by products. Same way when the coconut oil is taken then the coca shells which remain they become the by products. So, variety of examples can be given in fact most of the manufacturing processes do give a give some scrap or do give some minor important products they are considered as by products. So, here are some of the important terminologies any process that generates two or more equally or equivalently important products then such are called as joint products and that process is called as joint product process. The cost which are incurred for the joint process before split of point they are considered as joint product cost. So, split of point it is that point where those individual products can be identified and they are separated. So, up to that point you have one process from there the two or three products become separate and some more processing may be done that point is called as split of point. As we were discussing what happens is up to joint product level the cost come together. So, it becomes necessary that that cost is appropriately charged to the joint products it is not possible to identify them on one to one basis we have one joint cost that requires to be extracted. So, what are the different methods the easiest method is physical units. So, if we know that from a refining process let us say petrol and diesel come out only two products come out and we know that petrol say one lakh liters of petrol is manufactured and one lakh thirty thousand liters of diesel is manufactured. Then the total joint product joint cost may be charged in the ratio of one lakh to one lakh thirty thousand to petrol and diesel respectively. This is one method but the problem with this method is that both the products then get the same cost per liter or per unit which may not be fair. So, petrol may be more costly diesel may be less costly we may also get a very refined form of fuel known as aviation fuel which is for airlines that may be even far more costly but physical unit methods methods allocates the cost same cost per unit basis. So, though it is very simple the cost which is charged may not be appropriate considering the economic realities. So, there is another method which is known as relative sale value. So, here the sale value is taken as a base and from the sale value post processing costs or after split off costs are reduced. So, we get the relative sale value sometimes we know sale values at split off point then it is good we can directly charge the cost based on the sale value of split off point when the sale values are not known we may calculate relative sale value. Sometimes relative sale values are also tough to calculate but net realizable value can be found. So, all the three I mean physical units is of course based on the physical units remaining three are based on the sale value of those products. So, here is a little bit of comparison we have already discussed it. So, physical unit methods actually goes by number of liters or weights whereas sale value or relative sale value methods look at the economic value at split off point and then economic value is estimated using either the sale value at split off or calculating the relative sale value at split off. There are also other methods like constant gross profit method. So, we look at the gross profit of the earlier period and that gross profit is reduced from the final sale value to arrive at an estimated sale value. In case of net realizable value what is done is post separation cost since they are known they are removed from the sale value. So, we get that the realizable value at split off point and then that is used as a basis for separation. So, this was about the discussion about joint products. Now, let us look at the some of the problems that will make it more clear to you how are the joint cost charged. Now, here you can see that company produces the following products by using 6000 liters. The raw material cost is 20 per kg and 4 products emerge M row, Bum row, Cam row and Dumb row. The total output you can see is 5000. The total production cost and cost per unit is required to be calculated. Now, here the basis given is only the physical units or the weights in kgs. So, it is very simplistic we can get the total cost and then divide it appropriately based on the output. So, how much is a total RM cost? We will say it is a joint cost so, it is 6000 into 20 or 5000 into 20. So, it is 6000 into 20 because the cost will be incurred on all the units and now this cost of 120 should be charged in the ratio of output. So, these are the number of kgs of output. We know that the total cost is 120,000 for output of 5000. Now, we will try to charge the cost in the proportion of weights. I think there is some problem with the formula numerator should all I should all add the dollar and now we will try to take a sum is it right. So, we are able to charge 30,000, 48,000, 18,000 and 24,000 this is in the proportion of the output in kgs right and this is the cost in rupees. Now, is it a good way of good method or there is some problem with this method? What is the shortcoming of this method? Shortcoming is that per unit cost will be same we will see how much is per unit cost. So, it is 24 rupees for AMRO and you can see that for BAMRO, CAMRO and DAMRO all the products it is exactly same 24 rupees. So, here there is a problem that it might be that a product say AMRO may be more important, but we come out with a cost which is same because we charge it on the basis of number of units or the weights. Let us see another methods also now one more problem here we have two products P 1 and P 2 we are going to use the contribution margin method the joint costs are given marginal cost is 9000 marginal or variable cost fixed cost is 5000. Now, here the two products are there number of units is 200 for P 2 it is 150 per unit price that is the selling price is 50 and 40. Now, let us try to solve it how to solve anyone can think of something first we will try to find out how much is the joint cost. So, we are given that the joint cost is 9 and 5. So, if we make a sum you can readily see it is 14 now the issue is how to charge this 14 one method which we have already seen is going by number of units. So, let us try to see what happens if we go by number of units. So, we know that for the product P 1 the number of units are 200 for P 2 it is 150. So, the easiest way is to charge 14000 on the basis of numbers. So, total is 350 and the total cost is 14000. So, 14000 upon 350 into 200. So, we are able to charge 8000 to P 2 and 6000 to P 1. So, exactly 14000 is allocated, but is it a fair method not so because if we try to go by per unit we can see that per unit cost is 40 P 1 also 40 P 2 also 40 and total is 40. Now, you can see that P 2 selling price is only 40 P 1 the selling price is 50 perhaps P 1 has more economic value, but is not reflected on per unit method. So, we have to do something. So an improvisation is done in the form of what is known as contribution margin method. So, in contribution margin method what is done is what we do is we know separately the marginal cost and variable cost. Now marginal cost that is variable cost and fixed cost. Now marginal cost is more linked to the quantity so marginal cost that is here you can see marginal cost was 9 and fixed cost was 5. So, marginal cost is charged on the basis of number of units which is 250 and 150. So, it is more a raw material cost so 9000 we have divided as 200 by 350. So, you get 5143 and for P 2 you get 3857. And fixed cost instead of apportioning on the basis of number of units it is apportion on the basis of their contribution margin. Now, how will you know the contribution margin you know that it is selling price minus variable cost. So, here there is a working node first we have calculated the revenue of the products. So, revenue we are aware that 200 units are sold at 50. So, if you multiply you will get 10000 here and 150 into 40 you will get 6000. So, for products P 1 and P 2 the sale revenue is 10 and 6 then we have calculated the marginal cost which is charged on the basis of number of units. So, from sale revenue the marginal cost is reduced or the variable cost is reduced which gives us a contribution. Now, here you can see the contribution is 4857 and 3143 the total is 7000. Can we verify this total answer is yes we will just try to verify it right now. So, 10 plus 6 16000 is a total revenue and 9000 is a total marginal cost which was anyway known to us. So, we know that from 16000 9 is a marginal cost. So, 7000 is 16 minus 9 that is 7000 is our contribution. Now, this is a surplus which is coming from each of the products then we will charge it we will take that as a base and based on 4857 and 3127 we will try to allocate the fixed cost which is 5000. So, fixed cost is allocated. Now, let us try to work out the profit. So, if you now calculate the product profitability now we are doing it by so joint costs are charged by contribution margin method which we have just learned. You know how to calculate profitability we do sales minus variable cost that gives us the contribution and contribution less fixed cost gives us the profit. Now, how much is a variable cost of P actually speaking we do not know, but we have worked it out we have estimated. So, we will go by that for P1 and for P2 we have calculated it as 5143 and 3857 and we also know their sales which is 10000 and 6000 we will also do total parallely we have already done it, but I am just showing it more clearly. So, now we get 4857 and 3123 as a contribution from this we will reduce the fixed cost again basically the product fixed cost were joint they were not known individually, but we have worked it out on the basis of ratio which was calculated. So, it is 3469 and 1531 you can see that the more fixed cost is now born by P1. So, now you can know the individual profitability of the product which is 1388 and 618. Now, if we took total we can see the totals which were known to us because from 16000 revenue 9 was the variable cost you can go up and 5 was the fixed cost. So, 16 minus 9, 7 was the contribution minus 5, 2 was the profit. How much profit from each product was not known now by using the contribution method we have calculated the profit from the products. Now, suppose we were to do by the first method how what will be the answer we will also try by the alternate method. So, instead of joint costs charged by contribution method if we charge on physical units method. So, then what will be the answer is anyone of you able to work out? What will be the answer if they are charged by physical units method I will paste the values and then we will change if required. So, in physical units method what will happen is the distinction of total variable and fixed cost would not be there. We will have to take the total joint cost which we have already calculated that our joint cost based on number of units 14000 we will be able to charge 6 and 4. So, now sales is 10 and 6. So, we will charge the total joint cost. So, for P 1 it is in the ratio of 200 to 150. So, for P 1 we got 8000 and for P 2 we had got 6000. The total being 14000 now you can see here what happens is the profit. So, the profit is 2000 for P 1 and nil for P 2 why this happened? Because P 2 you can see here the selling price is much lower it is just 50 rupees. And when we charge on per unit basis we charge 40 rupees for both the products. So, there was a shortage we were not able to charge the same amount I mean we were charging the same amount 40 rupees whereas the selling price of P 2 is also 40. So, the profit was 0 for P 2 all the profit was shown attributable to P 1. So, contribution margin method gives a better way of charging the joint cost than physical unit methods. So, I hope these methods are clear to you. Now there is one more issue what happens sometimes in joint products is at a joint product level at a particular level we get the output we have to decide whether we should further process it or not further process it. Now, how will you take that decision just think over. So, suppose we have this products P 1 and P 2 we know that the joint cost as we have calculated it is known to us. But we have to take a call on processing or not further processing it how that will be done. So, how much is a joint cost let us say we use the physical unit method we know it is 40 rupees. If we use contribution margin method then it comes something else. But right now if we use the physical units method it is 40 rupees. Now there is a offer that we can further process it by spending say 15 rupees. And then the P 1 product in a advance form can be sold at a higher level. Shall we take this call or no how will you decide what are the relevant cost? You will realize that 40 rupees or 43 rupees or 47 rupees which we calculate here is a sunk cost it is not relevant. What is relevant is how much is a further processing cost and how much is a incremental revenue generated by further processing. I will give you an example let us extend this example. So, these facts continue now what is further given is instead of selling P 1 at 50 rupees and P 2 at 40 rupees it is possible to sell the advanced version of P 1 and P 2. So, now it is given I will just specifically write so that it is more clear to you. So, we are adding a further problem we have two products which you know they are P 1 and P 2 current selling price is 50 and 40. Now it is possible to make some advancements some more refinements in those products and then I can perhaps sell them at 70 rupees and 62 rupees. But to make it an advance product I will have to spend on further processing and the further processing costs are given to be 22 rupees and 13 rupees. Now does it make sense to sell or not sell and we already know that the joint costs are 40 and 40 if we use the physical unit method. So, shall we sell or not sell now what happens is for this decision this 40 and 40 is totally irrelevant we should ignore it because this costs are already committed. What is important is the further processing cost and the incremental selling price. So, if we are as this is given that advance product we are able to sell at 70 rupees and advance product P 2 we are sell able to sell at 62 rupees. We will compare this with their original selling prices. So, original selling price is 50 and 40. So, by further processing how much is the incremental revenue we were able to generate it is 20 rupees for P 1 and it is 22 rupees for P 2 and how much is the cost of further processing it is 22 and 13. So, how much is a net incremental revenue it is minus 2 for P 1 and it is 9 rupees for P 2. So, otherwise our P 2 was being sold at 40 rupees after further processing we are able to get 62 rupees. So, 22 rupees of value addition for a extra cost of 13. So, it is very very good to further process P 2 we will get 9 rupees more. Whereas, if we come to P 1 the incremental price was 20 rupees that is from 50 we were able to take it to 70, but the additional processing cost was also very heavy 22. So, the incremental revenue was minus 2. So, we should not further process it. So, this is the decision that in case of P 1 it is not good to go for further processing while for P 2 it is good for further processing. So, I think now the concepts of relevant cost and decision making are clear to you. We have discussed relevant cost, sunk cost, decisions like make or buy decision then we have also discussed shutdown point. We have now discussed the joint products various methods of allocation of joint products cost and in the end we have also seen further processing or not further processing of joint products. So, let us stop here in the next session we will go for budgeting and some more issues. Thank you so much.