International Conference on Humanities, and Geography (ICHEG'2012) March 17-18, 2012 Bangkok

Relevant Costing; A Concept For Costing Decisions In Indian Automotive Industry

Sachchidanand Pachori and Dr. Karunesh saxena

annual cut. The only way suppliers can meet these Abstract—Globalisation and liberalization has caused markets to challenges are by using innovative ways to reduce material become more competitive. It is a well known fact that Pricing and production cost. Therefore, the concept of relevant cost Decisions are driven. The Indian automobile Industry is has become most relevant costing decision technique in the currently enjoying the best time for last 20 years. This also puts automobile industry, because it eliminates unnecessary cost pressure on the manufacturers to adopt costing techniques/methods that suits market trend. Today Scrap of products are sold at fully that could otherwise complicate the decision making process competitive price which is driven by competitive market, but a new and may affect adverselyIn managerial , this term is product is not sold at market driven price as the cost consist of many synonymous with avoidable cost and differential cost. irrelevant cost contents. The purchase price of new products is highly Relevant cost is differential or quantifiable future cost that unrealistic and tending to higher in which so many un-real factors are must be considered in making a particular decision. Relevant involved like, by SLM (i.e. straight line method)/WDV costs are defined as the costs which are affected and changed (Written down ) method, advertisement cost, foreign conversion losses, losses due to managerial inefficiency, sometimes by a decision. If a cost increases, decreases, appears, abnormal losses also. Because of this, Indian automobile disappears as different alternatives are concerned, it is manufacturers are not in a position to compete at international level relevant cost (Lal, 2005). In case of relevant cost concepts, although India is one of the largest markets of the world. Advantages one is to compare relevant with relevant cost and like economy of scale, low manufacturing cost, natural wealth, ignore historic sunk and past cost, from decision making climatic balance, etc., can be extracted quite easily, but because of process so that decision can be protected from being mislead. inaccurate pitch of costing decision making process of Indian Automotive industry, feasibility of aforesaid advantages are far-away Relevant revenues and relevant cost are considered as: from the hands of Indian Automakers. The current research presents Relevant > Relevant costs = Decision is a concept that bring pragmatic solution to the problem that persists recommended to be accepted and vice versa. Relevant because of wrong costing decisions. revenue/cost means the revenue/cost which is influencing the decision criteria. It is vital to note that relevant costs are Keywords—Costing Decision, Relevant Cost, Automobile always future cost. Industry. A. Irrelevant Cost I. INTRODUCTION Those costs which neither influence a decision nor are LOBALISATION, Intense and pricing influenced by the decision are irrelevant costs (Mittal, 2004). Gpressure will continue. In the end, cost leadership will be Irrelevant revenue/cost means the revenue/cost which is not decisive in Indian automotive industry, even more than giving any impact on decision criteria. An irrelevant cost or innovation thereof. Managers find themselves being pulled in benefit is one that will not affect the rational decision or many direction and struggling to do more with less. Growing decision making process of the business. volumes in developing markets and increased competition B. Indian Automobile Industry from emerging economies are putting pressure on and Since the first car rolled out on the streets of Mumbai in margins. The cost of everything must be controlled strictly. 1898, the automobile industry of India has come a long way Customers, of course, have ever increasing expectations for covering distinct road. During its early stages, the auto quality, speed and flexibility (www.sap.com/contactsap, industry was overlooked by the Government and the policies 2010). The automotive industry is a classic example of an were also not favorable. The liberalization policies and industry with fierce competition and sharing margins where various tax relieves by the Government of India in recent cost and reliability are distinct. It is also becoming common years has made remarkable impacts on Indian automobile practice in auto industry for supplier contracts to offer 3 to 5% industry. Indian auto industry, which is currently growing at the speed of around 18% per annum, has become a hot Sachchidanand Pachori, Chartered , Associate Professor, destination for global auto players like, Volvo Motors, Sanghvi Institute of Management and Science,Indore, Madhya Pradesh, Mobile: +91-9827269325 (Email: [email protected]) General Motors, Ford Motors, BMW, Honda Siel, Hyundai Dr. Karunesh Saxena, Professor, Faculty of Management Studies, Motors, Mercedes Benz, Nissan Motors, Skoda Auto, Suzuki Mohanlal Sukhadiya University, Udaipur, Rajasthan (Email: Motorcycle, Toyota Kirloskar, etc. A well developed [email protected]).

217 International Conference on Humanities, Economics and Geography (ICHEG'2012) March 17-18, 2012 Bangkok transportation system plays a key role in the development of by a decision being made. Management should consider only an economy and India is no exception to it. With the growth future costs and revenues that will differ under each of transportation system the automotive industry of India is alternative (Arora, 2008). Relevant costs are expected future also growing at rapid speed, occupying an important place on costs and relevant revenues are expected future revenues that the canvas of Indian economy. Today, Indian automotive differ among the alternative course of action being considered industry is fully capable of producing various kinds of (Hongren and Datar, 2008). In , it is vehicles. India’s automotive industry is concentrated across concerned with relevant cost. One characteristic of relevant three major regions – the national capital region with original cost is that they are future costs which have not been incurred. equipment manufacturers (OEMs) such as Maruti, Hero Hence the cost of material is relevant cost as long as the Honda, Honda-SIEL, Yamaha, etc.; The Chennai, Hosur, material not purchased because by deciding whether or not to Bangalore region, with OEMs such as Hyundai, Mitsubishi, purchase the material, one is to choose to incur the cost or Toyota, Ford, Ashok Leyland, TVS, etc.; and the Pune, avoid it. Hence, all relevant costs are future costs (ICFAI Nashik, Aurangabad region, with OEMs such as Tata Motors, University, 2004). Whether particular costs and revenues are Bajaj Auto, Bajaj Tempo, Ford, Kinetic Engineering, etc. The relevant for decision making depends on decision context and automobile industry has strong backward and forward the alternatives available. When choosing among different linkages and hence, provides employment. Thus, the role of alternatives, manager should concentrate only on the costs and the industry can not be overlooked in Indian economy. revenues that differ across the decisions alternatives; these are Indian automobile industry includes the manufacture of relevant cost/revenues (Atkinson, et al, 2008). earth movers, trucks, buses, passenger cars, defense vehicles, three-wheelers, auto-rickshaws, two-wheelers, mopeds, etc. III. RESEARCH METHODOLOGY The automobile industry can be broadly divided into the car The Present research is an exploratory research. The manufacturing, heavy vehicle manufacturing and two-wheeler objective of the research is to explore the possibility of manufacturing. The major car manufacturers are Hindustan application of relevant cost concepts in automobile industry. Motor Ltd., Maruti Udyog Ltd., Fiat India Automobile Ltd., Different managerial decision making criteria were found out, Ford India Pvt. Ltd., General Motors India Pvt. Ltd., Honda where the relevant cost concepts affect the rational decisions Siel Cars India Ltd., Hyundai Motors India Ltd., Skoda Auto making process. With help of caselets the application of India Pvt. Ltd., Toyota Kirloskar Motor Pvt. Ltd., Tata Motors relevant cost concepts favoring to the automobile industry has Ltd., etc. The heavy motor vehicles like earth movers, buses, been explored and explained. trucks, defense vehicles, auto rickshaws and other multi- vehicles are manufactured by L and T Case Pvt. Ltd., Tata A. Applicability of Relevant Cost Concepts Motors Ltd., Ashok Leyland Ltd., Eicher Motors Ltd., Material Requirement Decision Mahindra and Mahindra Ltd., Man Force Motors Truck Pvt. According to relevant cost concept, if material is purchased Ltd. (Bajaj Tempo), etc. specially for the project, the relevant cost is the purchase (www.business.mapsofindia.com/automobile, 2010). Major price. If the material is already in stock and is used regularly, two wheelers manufacturers are Hero Honda Motors Ltd., the relevant cost is replacement price. If material is no more Bajaj Auto Ltd., Honda Motorcycle and Scooter India (P) useful than the relevant cost is realizable value/scrap value. Ltd., Suzuki India Ltd., TVS Motor Company Ltd., Kinetic However, it can be used for another project and is in short Motor Company Ltd., Yamaha Motors India Ltd., Royal supply than the relevant cost is the contribution sacrificed Enfield Ltd., Majestic Auto Ltd., etc. (www.accounting-fianancial-tax.com, 2011). Caselet-I II. LITERATURE REVIEW Asian Motors Ltd. India has been approached by a Chinese The relevant costs are pertinent to decision. Costs are customer who wants to place a special order and is willing to relevant, if they guide the executive towards the decision. It pay Rs. 1,65,000. The order requires material shown below: Total Material Origina Realizabl will be better, if the costs are not only relevant but also Replace Material in l e Value accurate. Relevance and accuracy are not identical concepts. ment Materi Purchas /Scrap Costs may be accurate and irrelevant, costs may be inaccurate Price al Requireme Stock e Price Value (per but it can be relevant (Varshney, 2008). Relevant information nt (Kgs.) (Kgs) (Rs. (Rs. Per Kg) is the predicted future costs and revenues that will differ Per Kg) Kg) among the alternatives relevant information (Horngren, et al, A 7,500 ------6.00 2006). Relevant costs are the costs which would change as a B 10,000 6,000 3.50 2.50 5.00 result of the decision under consideration, where as irrelevant costs are those which would remain unaffected by the C 15,000 14,000 4.00 2.50 4.00 decision. There for only relevant cost would be included in the D 3,000 5,000 7.00 6.00 9.00 analytical framework (Khan and Jain, 2008). Material A would have to be purchased specially for it. A relevant cost is a cost whose magnitude will be affected Material B is used regularly; every consumption of it would force to reorder. Material C is surplus to requirement and has

218 International Conference on Humanities, Economics and Geography (ICHEG'2012) March 17-18, 2012 Bangkok no other use. Material D is also surplus but can be used as If full cost method is followed to take decision than the firm substitute for Material E which cost Rs. 8 per Kg. at other would have suffered a loss of Rs. 40,000 per month, as having project. taken decision to buy the auto part from open market. Decision Equipment Replacement Decision Mat Cost Price Applied Relevant Regular The use of relevant cost in the decision to replace plant and e Calculation for Relevant Cost Cost Ge- equipment, once again is concerned with future incremental rial Cost (Rs.) nerally flows and not with historic or or with non cash used (Rs.) as depreciation (www.accounting-fianancial- 7,500 Kgs. Replacement 45,000 45,000 tax.com, 2011). A @ 6.00 Price Making the Best Use of Scarce Resources 10,000 Kgs. Replacement 50,000 42,000 B @ 5.00 Price In general, the emphasis on products with higher 14,000 Kgs. Scrap value 35,000 56,000 contribution margin maximizes a firm’s total net income, even C @ 2.50 per kg. though total sales may decrease. This is not true, however, 1,000 Kgs. Replacement 4,000 4,000 where there are constraining factors and scarce resources. The @ 4.00 Price constraining factor is the key factor that restricts or limits the 3,000 Kgs. Cost for 24,000 21,000 production or sale of a given product. As per relevant cost D @ 8.00 Material E concept, in the presence of these constraining factors, Total 1,58,000 1,68,000 maximizing total profits depends on getting the highest Conclusion contribution margin per unit of the factor rather than the By application of relevant cost concept not only market is highest contribution margin per unit of product output. The getting extended to china but the firm also has satisfaction to presence of only one limited resource is unrealistic. Virtually, earn a . However, as per regular cost concept, it does not all firms encounter multiple constraints: restrictions on look sound to accept the offer and extension of market materials, labor inputs, and demand for each product, remains mere a dream. warehouse space, and display space, etc. The solution of the Make v/s Buy Decision product mix problem with multiple constraints is considerably Sub-contracting or outsourcing has dominated business in more complex and resolved with linear programming. recent years as the cost of providing and services in Caselet III house is increasing as compared to the price of purchasing Parakram Ltd. India produces products A and B with the goods from the open market. The make or buy decisions are following contribution margins per unit: based on which alternative is less costly on a relevant cost Particulars Product A Product B basis (Rs.) (Rs.) Caselet-II Sales Rs. 8 Rs. 24 The cost of in house production of an Auto-part is Rs. 49 Less: Variable Cost Rs. 6 Rs. 20 per part averaging 10,000 units of production per month and Contribution Rs. 2 Rs. 4 outer packing being Rs. 2 per part. There is a Rs. 20,000 Margin charge of depreciation from head office for furniture and As indicated by Contribution Margin per unit, profit of fittings. Rs. 60,000 per month as management salary is Product B is higher than A’s. Assuming that the firm has required to be shared, Where as, the auto-part is available in limited capacity of 10,000 labor hours, Further, assuming that the market at Rs. 55. Product A requires two labor hours to produce and Product B Decision requires five labor hours per unit. This limited capacity is Relevant Cost Normal Cost explained by determining the contribution margin per labor Based Decision Based Decision hour. Description Make Buy Make Buy Decision (Rs.) (Rs.) (Rs.) (Rs.) Particulars Product Product Variable Cost Per 49.00 ------49.00 ------Unit A B Outer-packing Per 02.00 ------02.00 ------Contribution Margin Unit Per unit Rs. 2.00 Rs. 4.00 Share of ------02.00 ------Labor hours required 2 5 Depreciation of - Per unit Head Office Marginal Rs. 1.00 Rs. 0.80 Management ------06.00 ------Contribution per Salary Per Unit - Labor Hour Cost of Buying Per ------55.00 ------55.00 Conclusion Unit Since Product A returns the higher Contribution Margin, it Total cost per unit 51.00 55.00 59.00 55.00 should be produced and Product B should be dropped or be Conclusion

219 International Conference on Humanities, Economics and Geography (ICHEG'2012) March 17-18, 2012 Bangkok given the second priority to the extent possible to sale the revenues and costs very carefully to make a profit product A. (Content.spencerstuart.com, 2011). While automotive To Add or Drop a Product Line executives recognize the challenges posed by globalization, The decision of whether to drop an old product line or add a many companies are struggling to adequately respond and new one must take into account both qualitative and quote real, competitive and market driven prices of the quantitative factors. Ultimately, any final decision should be products. Relevant cost concepts based decisions now has taken on the impact the decision will have on contribution become very important because every transaction has become margin or net income. monotonous and unique due to different thinking, choice, Caselet III environment, living standard, culture and fashion and style to Man Truck Ltd. has three major product lines: Truck1, use and have Auto-vehicles in this global market. Where Truck2, and Truck3. The company is considering dropping Automakers and suppliers continue to look for opportunities the Truck2 because the shows it is being to streamline production and impose flexible cost structures sold at a loss. that allow them to respond quickly to shifts in demands. (Figures in Rs.) Automotive leaders must possess strong cost and financial Particulars Truck Truck Truck Total acumen to be in the position to identify these opportunities. 1 2 3 When making decisions, businesses should only take into Sales 10,00 15,00 25,00 50,000 account those costs and revenues which are relevant to the Less: 0 0 0 26,000 decision. These principles underpins virtually all of the said Variable 6,000 8,000 12,00 typical decisions could relate to the minimum price to tender cost 0 24,000 for a new contract or a piece of work. Whether to shut down a Contribution 4,000 7,000 division or keep it open. The minimum price to accept from a Margin 13,00 12,500 customer who requires a product which will require transfer of Less: Fixed 2,000 6,500 0 resources away from more profitable uses. Whether a Cost 5,000 manufacturing company should make for itself or buy a (Direct) 1,000 1,500 4,000 component used in production of a product in its product Fixed Cost range. (Allocated) 2,500 Net Income 1,000 - 6,500 V. GENERALIZED FINDINGS 1,000 6,500 Items of income or are only relevant to the decision Decision if they make the business richer or poorer when the business (Figures in Rs.) goes ahead with the decision. For example, non-cash items are Particulars Truck Truck Truck Total irrelevant, such as depreciation of fixed , since to 1 2 3 become richer the business must receive cash as a result of Sales 10,00 15,00 25,00 50,000 their decision and to become poorer the business must spend Less: 0 0 0 26,000 cash. This would also help to explain the concept of Variable 6,000 8,000 12,00 , where another opportunity is foregone if the cost 0 24,000 business goes ahead with the decision under consideration. Contribution 4,000 7,000 The amount by which they would be poorer is relevant and is Margin 13,00 12,500 called the opportunity cost. Less: Fixed 2,000 6,500 0 Implications: The implication of the study suggests that, Cost Irrelev relevant cost concept is a newer concept which suggests (Direct) Irrele Irrele 4,000 ant decisions differently from one situation to another. It grows Fixed vant vant indeed possibilities on the field of impossibilities. It suggests Cost Irrele different measures to expand business, increase profits. It (Allocated) vant suggests taking decisions relevantly and ignoring irrelevant Net Income 500 11,500 cost, which seems to be important though they are not. Not 2,000 9,000 only in case of automobile industry but incase of other Conclusion manufacturing industry also, where ever above mentioned As per relevant cost concept there is no need to drop decision criteria are laid before management, the relevant cost Truck2 because it will not only incur a loss of Rs.500 per concepts helps the management to think differently and take truck but also drop a type of customer together decision favoring to the organization. Relevant cost is applicable especially to unique product line and where special IV. OVERALL CONCLUSION orders are issued and taken like Job Costing, Batch Costing, Contract Costing etc. relevant cost concepts must be applied Consumers are more and more demanding, looking for when, product line is extended, projects are diversified, everything at a very attractive price. The firms have to master

220 International Conference on Humanities, Economics and Geography (ICHEG'2012) March 17-18, 2012 Bangkok expansions are undertaken, or when departmentation is done. 2005in India. He has also entered in the realm of research and waiting to be awarded Ph.D. Book Titled “Corporate Law and Secretarial Practice” has recently got published and many other books and Research Papers are in VI. SUGGESTIONS pipeline. It is suggested that Indian automakers should use relevant cost concepts in there decision making process specially in the area of material requirement decision, make v/s buy decision, equipment replacement decision, accept/reject special order decision, making the best use of scarce resources, and to add or drop a product line, etc. they should take decisions so as to improve profitability to reduce the cost to ensure the proper use of raw material, equipments, plants, and machines. And to increase the compatibility of the business and to get increased market share to drive opportunity profit.

VII. LIMITATIONS concept is also applicable in relevant cost concepts, as it is already in use in the industry hence not being covered under the study.

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Prof. Karunesh Saxena is currently working as Director of College Development Council Mohanlal Sukhadia University, Udaipur. He has published 4 books and 1 monograph. Along with this he has published/ presented about 100 research papers in various reputed journals of the field. He has acted as chairman of many international Conferences in India and Abroad. He has recorded more than 100 higher educational films made for UGC center for Educational Consortium (CEC) Countrywide Classroom Programme. He has conducted more than 50 Management Development Programs (MDP’s) for various companies. CA Sachchidanand Pachori possesses an academic experience of 7 years in the Collegiate Education and in practice as a Chartered Accountant since

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