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Dear sir,
I wanted understand why Apportioned costs are not relevant in case of relevant costing. Because apportioned costs would be allocated to other existing products and not shared by the new product (unless of course it is accepted). this clearly means that incidence of cost bearing would be would be higher on existing products (excluding new product) than if they were shared by the new product as well. this clearly means that even apportioned costs are relevant for decision making purposes.
So can you pls shed light on this sir?
And i also do acknowledge the fact that regardless of the way fixed costs are apportioned the fact remains that they are constant and do not increase with an additional product being introduced. However, sir it is also undeniable to say that burden on existing products increases in the absence of new product which affects the pricing and ultimately sales derived from existing products(which is cash flow).
so apportioned costs should be relevant. I want you sir to counter my argument and help me understand where am going amiss.
What matters when considering the relevant cost of a new contract is the effect on the profits of the company as a whole of doing the contract.
As you have stated, the total fixed costs of the company will remain the same whether we do the contract or not and therefore have no effect on the total profit (unless, of course, we are specifically told that the total fixed costs will change, in which case the amount of the change is relevant).
Clearly if the overheads are apportioned/shared differently between different products then the profit on individual products will change, but the profit of the company as a whole will not change.
(Appreciate that even if there is no new contract, a company can apportion fixed overheads between different products in any way they like. How they choose to apportion will change the profitability of individual products (think about, for example, the difference between using traditional absorption and using ABC) but will have no effect on the total profit of the company.)
Have you watched my free lectures on relevant costing? The lectures are a complete free course for Paper PM and cover everything needed to be able to pass the exam well.
May be i was not able to explain my point well to you sir. Actually my point is if the apportioned costs get divided among ‘n+1′(products we are currently making+1 additional product planning to introduce) instead of usual ‘n’ products then those ‘n’ products get cheaper by some amount as a consequence of which their prices also fall(given the company has a fixed margin or mark-up percentage per unit). this has potential to increase the sales of ‘n’ products and hence profits from them soar. And this is the theory because of which I feel apportioned costs should be relevant.
and even in the short run(or because of the contract being one-off) if the company cannot reduce its selling price(apportioned costs reduce as the new product shares the burden) the fact remains that their per unit profits increase, and given constant sales of units, profits rise(incremental cash flow).
this clearly makes apportioned costs relevant costing decision.
Apportioned costs are not relevant costs!!
Relevant flows are those that change as a result of the new contract. If total fixed overheads do not change (which is what we always assume unless the question says otherwise) then simply apportioning them differently makes no difference.
Certainly if the question says that selling prices and/or demand change for any reason then they are relevant flows, but that is a completely separate issue. Most companies do not apply a fixed mark-up when determining the selling price and they are only likely to reduce prices if there was a resulting big enough increase in sales. That may or may not be the case and is independent of how the overheads are apportioned. If a lower price were to mean that sales would soar then they would already have lowered the price!!
Have you not watched my free lectures on pricing?
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