Racy Case 2:
It was another Friday night. The gang was at their usual joint, the Chennai coffee pub. China was having his third mug of coffee. Muscles was attacking his fourth plate of pizza. Wafers was having her nth bite of French fries and was as usual wondering whether it was such a fine thing to have joined CA. She had this morning been taught Decision Making and the good professor was simply beyond her. “Whether to accept a product or reject it?” This funny thing about contribution and that stupid thing about not distributing the fixed cost amongst various products simply beat her.
She was broken out of her thoughts by Rinku. “Lets go for a movie tomorrow”, he screamed. The stringer who always spoke in high decibel was wearing his trademark dirty jeans. “Does he sleep in his jeans” wondered Wafers. “What movie, where and how” asked Muscles eager to be away from hostel so that he need not read Gray’s book on Anatomy, for the test scheduled for Monday. China had no such problems. For him, the Monday’s test on “Strength of Materials” would be a cakewalk. Wafers had no issues at all. Her CA program never required her to take tests. The first examination would be the main examination. Phew.
“Where do we go?” asked Muscles. “Mayajal”, suggested China. Some 30 kms off the heart of Chennai city, on the East Coast Road, away from the monotony of ticking and verifying, would be fun, thought Wafers. “How much would a ticket cost?” asked the scribe. “Rs 100 per head”, said Muscles. “If four of us go it would be Rs 400/- and if five went it would be Rs 500”, added China for effect. For Wafers the coin clicked. Rs 100 per unit irrespective of the number of units. If the number of units is 4, the total variable cost would be Rs 400. If the number of units is 5, the total variable cost would be Rs 500. Wow! “The variable cost per unit is constant. The total variable cost varies with volume”, the good professor had told this morning. “That’s Rule 1”, hastily scribbled Wafers in her notebook. China got into the act. “At the Cineplex we will have to munch. Popcorn. Soft drinks. And then we must have dinner. It would cost us Rs 125 per head.” “If four of us go it would be Rs 500/- and if five of us go it would be Rs 625”, added Dr. Muscles.
“Oh another variable cost” remarked Wafers, excited that Marginal costing wasn’t actually all that Greek. “Mayajal is so far away. How do we travel?” someone asked. “My car” said Rinku. Muscles couldn’t believe his ears. China muttered, “Hey we aren’t going for a press conference that someone would fund our trip”. Rinku ignored the jibe, picked up a scrap of paper and scribbled. 30 kms up and 30 kms down; total 60 kms. Fuel economy 10 Kms per litre. The trip would consume 6 litres. Petrol cost Rs 40 per litre. Rs 240 in all. Toll tax Rs 50 and car parking Rs 10. Total 300/-. He had it all stitched up.
“Rs 300 for us all”, said Muscles. If five of us go it would again be Rs 300. If only two of us went it would still be Rs 300. For Wafers the coin clicked a second time. Rs 300 irrespective of the number of units. In her notebook she hastily wrote in Rule 2, “Fixed costs remain constant irrespective of volume”. That’s what the good professor had told the class that morning. Rinku continued to scribble. Rs 100 per ticket, Rs 125 per head towards snacks and Rs 300 petrol and other fixed costs. For the four of them, it would be (100X4) + (125 X 4) + (300) = 1200. “Who will foot the bill?” asked Muscles. “Not me”, screamed Rinku. “Ask the auditor” said China. Wafers was smart. “We will go Dutch. Rs 1200/4 = Rs 300/- each”, she said. “Great”, agreed all.
Just then Neta (he had always wanted to become a politician) walked in. From Manishankar Aiyer to George W Bush, Neta had an opinion on them all. He wanted to join the “party”. Wafers, joyful in her new understanding of marginal costing did the arithmetic. Tickets; variable cost. Rs 100 per head. Snacks; variable cost. Rs 125 per head. Petrol etc; fixed cost. Rs 300 for all. Total (100X5) + (125 X 5) + (300) = 1425. No of people 5. Dutch cost Rs 1425/5 = 285 per head. From Rs 300 per head then, to Rs 285 per head now. There had been no reduction in cost; then how come the drop wondered Wafers. And she suddenly remembered. “As the number of units go up the fixed cost per unit comes down” the good professor had told this morning. Oh, “Rule 3” she told herself. This business of going for a movie was proving to be quite educative.
Neta zipped out his wallet to count. He had only Rs 250, not Rs 285/-. Wafers did her arithmetic again. Revenue (300 X 4) + Rs 250 = Rs 1450. Total cost Rs 1425. Net gain: Rs 25. Decision: Take Neta along. How come there was a gain when Neta brought in less than the average cost, Wafers wondered? The coin clicked a fourth time. Neta was bringing in Rs 250 as against the variable cost of Rs 225. That’s a contribution of Rs 25. The professor had remarked, “Products with positive contribution should be accepted.” Wafers scribbled that in as Rule 4. What if Neta brought less than Rs 200, she asked herself. Well, he would have to be dropped. The professor had said, “Products with negative contribution should be rejected.” Ha, Rule 5.
Then came the final click. In all her analysis on whether Neta should be in or out, the fixed cost of Rs 300 had been ignored. The decision had been based on contribution only. “Fixed costs which do not change are irrelevant to decision making” the professor had explained that morning. Enter Rule 6. How instructive. Quite a few rules had fallen in place. Marginal costing was no longer giving her sleepless nights. Wafers looked forward to going for the movie in the hope that the travel would help her unravel a few more rules of marginal costing.