International Conference on Humanities, Economics 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
AbstractGlobalisation and liberalization has caused markets to
become more competitive. It is a well known fact that Pricing
Decisions are market driven. The Indian automobile Industry is
currently enjoying the best time for last 20 years. This also puts
pressure on the manufacturers to adopt costing techniques/methods
that suits market trend. Today Scrap of products are sold at fully
competitive price which is driven by competitive market, but a new
product is not sold at market driven price as the cost consist of many
irrelevant cost contents. The purchase price of new products is highly
unrealistic and tending to higher in which so many un-real factors are
involved like, Depreciation by SLM (i.e. straight line method)/WDV
(Written down Value) method, advertisement cost, foreign currency
conversion losses, losses due to managerial inefficiency, sometimes
abnormal losses also. Because of this, Indian automobile
manufacturers are not in a position to compete at international level
although India is one of the largest markets of the world. Advantages
like economy of scale, low manufacturing cost, natural wealth,
climatic balance, etc., can be extracted quite easily, but because of
inaccurate pitch of costing decision making process of Indian
Automotive industry, feasibility of aforesaid advantages are far-away
from the hands of Indian Automakers. The current research presents
a concept that bring pragmatic solution to the problem that persists
because of wrong costing decisions.
KeywordsCosting Decision, Relevant Cost, Automobile
Industry.
I. INTRODUCTION
G LOBALISATION, Intense competition and pricing
pressure will continue. In the end, cost leadership will be
decisive in Indian automotive industry, even more than
innovation thereof. Managers find themselves being pulled in
many direction and struggling to do more with less. Growing
volumes in developing markets and increased competition
from emerging economies are putting pressure on prices and
margins. The cost of everything must be controlled strictly.
Customers, of course, have ever increasing expectations for
quality, speed and flexibility (www.sap.com/contactsap,
2010). The automotive industry is a classic example of an
industry with fierce competition and sharing margins where
cost and reliability are distinct. It is also becoming common
practice in auto industry for supplier contracts to offer 3 to 5%
Sachchidanand Pachori, Chartered Accountant , Associate Professor,
Sanghvi Institute of Management and Science,Indore, Madhya Pradesh,
Mobile: +91-9827269325 (Email: spachori@rediffmail.com)
Dr. Karunesh Saxena, Professor, Faculty of Management Studies,
Mohanlal Sukhadiya University, Udaipur, Rajasthan (Email:
karuneshsaxena@gmail.com).
217
annual price cut. The only way suppliers can meet these
challenges are by using innovative ways to reduce material
and production cost. Therefore, the concept of relevant cost
has become most relevant costing decision technique in the
automobile industry, because it eliminates unnecessary cost
that could otherwise complicate the decision making process
and may affect adverselyIn managerial accounting, this term is
synonymous with avoidable cost and differential cost.
Relevant cost is differential or quantifiable future cost that
must be considered in making a particular decision. Relevant
costs are defined as the costs which are affected and changed
by a decision. If a cost increases, decreases, appears,
disappears as different alternatives are concerned, it is
relevant cost (Lal, 2005). In case of relevant cost concepts,
one is to compare relevant revenues with relevant cost and
ignore historic sunk and past cost, from decision making
process so that decision can be protected from being mislead.
Relevant revenues and relevant cost are considered as:
Relevant Revenue > Relevant costs = Decision is
recommended to be accepted and vice versa. Relevant
revenue/cost means the revenue/cost which is influencing the
decision criteria. It is vital to note that relevant costs are
always future cost.
A. Irrelevant Cost
Those costs which neither influence a decision nor are
influenced by the decision are irrelevant costs (Mittal, 2004).
Irrelevant revenue/cost means the revenue/cost which is not
giving any impact on decision criteria. An irrelevant cost or
benefit is one that will not affect the rational decision or
decision making process of the business.
B. Indian Automobile Industry
Since the first car rolled out on the streets of Mumbai in
1898, the automobile industry of India has come a long way
covering distinct road. During its early stages, the auto
industry was overlooked by the Government and the policies
were also not favorable. The liberalization policies and
various tax relieves by the Government of India in recent
years has made remarkable impacts on Indian automobile
industry. Indian auto industry, which is currently growing at
the speed of around 18% per annum, has become a hot
destination for global auto players like, Volvo Motors,
General Motors, Ford Motors, BMW, Honda Siel, Hyundai
Motors, Mercedes Benz, Nissan Motors, Skoda Auto, Suzuki
Motorcycle, Toyota Kirloskar, etc. A well developed
 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 Management accounting, it is
vehicles. Indias 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-utility
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:
will be better, if the costs are not only relevant but also Total Material Origina Realizabl
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
but it can be relevant (Varshney, 2008). Relevant information (per
nt (Kgs.) (Kgs) (Rs. (Rs. Per
is the predicted future costs and revenues that will differ Kg)
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
C 15,000 14,000 4.00 2.50 4.00
costs are those which would remain unaffected by the
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 cash flows and not with historic or sunk cost or with non cash
used (Rs.) expenses 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 firms 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 profit. 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 goods 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 As. 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.)
Variable Cost Per 49.00 ------- 49.00 -------
Particulars Product Product
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 income statement 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 expense 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 assets, 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 opportunity cost, 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
Marginal cost concept is also applicable in relevant cost
concepts, as it is already in use in the industry hence not being
covered under the study.

REFERENCES
[1] Arora, M.N. (2008). Cost Accounting. Noida: Vikas Publication House.
[2] Atkinson, Anthony A., Kaplan Robert S., Young Mark S. (2008).
Management Accounting. New Delhi: Prentice Hall of India.
[3] Bhattacharya, S.K. and Dearden, John (2005). Costing for Management.
New Delhi: Vikas Publication House.
[4] Dr. Probst Klaus, CEO Leoni A.G., www.content.spencerstuart.com
(2011).
[5] Horngren, Charles T., Sedan, G.L., Stratton (2006). Introduction to
Management Accounting. New Delhi: Prentice Hall of India.
[6] Horngren, Charles T.,and Datar, Shrikant M. (2008). Cost Accounting.
Delhi: Dorling Kindersley.
[7] ICFAI University (2004). Work book on Management Accounting and
Control System. Hyderabad: ICFAI University.
[8] http://www.accountingformanagement.com (2009).
http://www.investopedia.com/terms/b/bookvalue.asp (2011)
[9] Khan, M.Y. and Jain, P. k. (2004). Cost Accounting and Financial
Management. New Delhi: Tata Mcgraw Hill Publishing.
[10] Khan, M.Y. and Jain, P. K. (2008). Management Accounting. New
Delhi: Tata Mcgraw Hill Publishing.
[11] Lal, Jawahar (2007). Managerial Accounting; Delhi: Himalay
Publication House.
[12] Mattes Bernhard, CEO of Ford Germany, www.
content.spencerstuart.com (2011).
[13] Mittal D.K. (2004). Cost Accounting. New Delhi: Galgotiya Publishing
Company.
[14] Sinha, Pradeep Kumar. Accounting and Costing For Management. New
Delhi: Excel Books.
[15] Tulsian P.C. (2006). Costing. New Delhi: Vikas Publication House.
[16] Varshney, J.C. (2008). Management Accounting. Delhi: Wishdom
Publication.
[17] Williums, Jan R., Haka, Susan F., Bettner, Mark S. (2007). Financial and
Management Accounting. New Delhi: Tata Mcgraw Hill Publishing.

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 (MDPs) 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

221