Short Term Decision Making: Management Accounting & Control

20
18
WNB
MANAGEMENT ACCOUNTING & CONTROL
SHORT TERM
DECISION MAKING
Learning Outcomes
• At the end of this chapter, students should be able to:

– Explain relevant costs and benefits
– Explain and calculate limiting factors, discontinuing a

segment, special order, make or buy, further processing
decision making
– Explain qualitative factors in decision making
– Explain pricing methods and pricing strategies
WNB_MAF551_Oct2018 2
Chapter’s Outline
Decision Relevant
Limiting
Making Costs and
Factors
Process Benefits
Accept or
Add or Delete
Make or Buy Reject Special
Segments
Order
Sell Now or Qualitative

Pricing
Process Factors in
Decision Making Decision
Further
Introduction
Decision making involves making selection between

alternative courses of action and choosing the best
alternative that will give the highest return or the
maximum profitability to the organization.
• Managers will continuously need to make decisions in running

their business day-to-day activities.
• Management accountants will help managers in making

decisions by providing the relevant quantitative or non-
qualitative information.
Decision Making Process
5 6
3 4 • Provide
feedback &
2
• Review,
monitor rectification
1
• Implement & check
the
• Pick the selected
outcome
best option
• Find options
• Identify options
decision of
problem solutions
Relevant Costs & Benefits
• In decision-making, identifying and considering the relevant
costs will help management pick the right choice, as long as
the net effect is either higher profits or lower costs.
Concept of relevant costs examines expected future

costs and decisions are based on the additional costs
• The
incurred as a result of choosing the particular option.
• The relevance also refers to income, therefore, if there is

additional income gained from choosing an option, this
extra income is considered as relevant and has a bearing on
the decision to be made.
Relevant vs Irrelevant
RELEVANT COST IRRELEVANT COST

& REVENUE & REVENUE
future costs and revenues costs that will not be

that will changed or differs in affected or remain the same
the amount depending on the regardless of which
alternative selected. alternative is chosen.
Example:
Example:
Material X required for the
In order to produce product
production of product A are
A, the company needs to
currently in stock & the
purchase material X that will
manager does not foresee
cost RM 100 per kg.
any other use for the stock.
Relevant Costs in DM
Opportunity cost is the foregone benefit

due to choosing another alternative.
This cost is relevant in decision making, as
choosing one alternative means letting go
OPPORTUNITY of benefits from another alternatives.
COST Example:
Those costs that can be eliminated or

saved by not adopting a given alternative.
This type of cost is relevant as it differs
AVOIDABLE between alternatives.
COST
Example:
Relevant Costs in DM
DIFFERENTIAL Differential cost refers to the difference

COST in costs between options of decisions.
INCREMENTAL Incremental cost is the increase in cost if

COST a particular option is chosen.
Special fixed costs relate to fixed costs

that are incurred as a result of taking the
SPECIAL
option, which otherwise would not have
FIXED COST been incurred.
Irrelevant Costs in DM
Sunk cost is a type of cost that has been

incurred in the past. It is also known as
historical cost.
In decision-making, this is considered as
irrelevant, because whether or not you
take up the option, this particular cost is
SUNK COST past and will not make any difference in
the choice of decision made.
The cost that will remain constant

regardless of the changes in the
productivity.
FIXED COST Irrelevant because it remains the same
between alternatives.
Irrelevant Costs in DM
Costs that have not been incurred but will

be incurred in the future on the basis of
decisions that have already been made.
COMMITTED
COST Example: salary of managers that have
been hired under a contract of one year.
UNAVOIDABLE Costs that cannot be eliminated or saved

COST by not adopting a given alternative.
Limiting
Factors
Accept
vs
Reject
Special
Types of Short Make vs Buy
Order Term Decision
Making
Add vs
Delete
Sell Now vs Segment
Process Further
LIMITING FACTORS
MAF420 June 2012 Integrity Bhd

Limiting Factors
Limiting factors refers to resources that is in short

supply and will restrict the production of a
manufacturing company.
• Even if there is demand for certain product, company

will have to consider the constraint in these
resources.
• What the managers will have to do is to choose the
most profitable product mix using the limited
resources.
Limiting Factors (Quantitative Factors)
STEP 1
Prove that there is really a limiting factor
STEP 2
Calculate the contribution per limiting factor
STEP 3
Determine the most profitable product and give ranking
STEP 4
Calculate the units to be produced for each product
Limiting Factors (Qualitative Factors)
• What is the most profitable product when there is a

limiting factor?
– A product might be the most profitable product based on
the rankings but the company might still decide not to
produce the product because of the following reasons:
To support the government campaign of not using such

product
Fear of bad community reaction to the product
The product might give an effect to the environment
MAKE OR BUY?
MAF420 April 2010 Zaraz

Make or Buy?
• Manufacturers have to often provide the raw materials or

components to either manufacture or assemble parts
respectively, in order to produce a product.
• These can sometimes be outsourced and supplied by
suppliers so that the manufacturers can concentrate on
making their products.
– In this situation, we have a ‘make or buy’ decision problem.
• In a ‘make or buy’ situation, the cost of making and the cost

of buying are compared.
Opportunity cost will exist if there is limited capacity

where the production of a product would displace the
production of another product.
Make or Buy? (Quantitative Factors)
Decision Rule
COST OF MAKING COST OF BUYING

All variable cost Purchase price
Special equipment cost Transportation cost
Incremental cost Modification cost
COST OF MAKING > COST OF MAKING <

COST OF BUYING COST OF BUYING
BUY MAKE
Make or Buy? (Qualitative Factors)
• To make or to buy a component?

– The cost of making a component may be more expensive
than buying from an outside supplier but the company
might still decide to make it because of the qualitative
reasons such as:
To make sure a high quality of product
To be independent and avoid dependency on

another supplier
To provide jobs to the employees and increase

their morale
ACCEPT OR REJECT
SPECIAL ORDER?
MAF551 June 2015 Tunas Ceria
Accept or Reject?
• In a special order situation, a company might have spare

capacity that if they receive an order for a customized
product from a client, the company may be able to
accommodate.
• This is termed as special order.
– Moreover, this would mean extra profit.
• Sometimes, special order situation exists when other company

offers to buy our product in large amount and at a lower price.
Opportunity cost will exist if there is limited capacity

where the production of a product would displace the
production of another product.
Special Order (Quantitative Factors)
In order to make decision, the contribution that will be earned

from the special order will be calculated.
CONTRIBUTION = SALES REVENUES – TOTAL VARIABLE COST
If the contribution is:
Positive = ACCEPT Negative = REJECT
Special Order (Qualitative Factors)
• To accept special order or not?

– A special order gives a negative contribution but the
company might still decide to accept it because of the
following qualitative reasons:
To build business networking
To secure future or other orders
As a social responsibility
ADD OR DELETE
SEGMENT?
MAF420 June 2014 Harraz Bhd
Add vs Delete
• A particular line of service, product or department might

be perceived as not making profits and may itself get
eliminated.
• Businesses often add products to improve generation of
income and be more marketable.
• Whilst doing so, some products may not be profitable and
management must therefore decide whether the line must
be dropped or other products need to be added.
Add vs Delete (Quantitative Factors)
Normally as long as the product or service contributes to

the recovery of fixed overheads, even though it might itself
suffer losses, it should not be dropped.
CONTRIBUTION
Those products and services A particular product or service may
that have negative be added to existing operations, as
contribution, should be long as such a product or service,
dropped as they do not help provides positive contribution and
to cover fixed overheads. supports recovery of overheads.
Add or Delete (Qualitative Factors)
• To delete a segment or continue operation?

– A department might shows a loss but the company still
want to continue its operation because of the following
qualitative reasons:
The loss department can attract the customers to

go to other departments
To make sure the employees can remain working
As a social responsibility because the product produced

by the loss depatment is important to the society
SELL NOW OR
PROCESS FURTHER?
MAF420 Dec 2014 Mawar Wangi
Sell Now vs Process Further
• A manufacturing company that uses a main raw material will

sometimes produce intermediate or joint products that can be
further processed into end products.
• During the first stage of production, the by-products which
are of insignificant value may be produced incidentally and
simultaneously.
In costing, what is important is the recognition of the

joint costs and if further process will incur further
processing costs in order to take the joint products to
a more marketable value.
• For example, when a lamb is slaughtered, the meat and hide

are the main, intermediate or joint products.
• The bones of the lamb are a by-product as they do not have

significant financial value.
Decision Rule:
Incremental Rev > Incremental Rev <

Incremental Cost Incremental Cost
Process further Sell Now
Pricing Decision
Company’s
objective
Price and
Competitor
demand
Pricing
Factors
Product Market &

life cycle season
Pricing Methods
FULL COST MARGINAL MINIMUM

PLUS COST PLUS PRICING
• Allocate all costs • Profit will be • The price will
to products to added to the cost only cover the
ensure that all base in order to variable cost of
costs are get the selling the product plus
covered in the price. additional FC and
cost base opportunity cost
• The cost base (if any)
will only consists
of variable costs.
Pricing Strategies
PENETRATION PRICING SKIMMING PRICING
Occurs when a company launches a Occurs when a company charges a

LOW-PRICED PRODUCT with the HIGH PRICE for early adopters of a
goal of securing market share new product, then gradually
lowering the price to attract
thriftier consumers.
Eg: Kitchenware manufacturer
might charge lower price to lure Eg: Cellphones company might
customers from current launch a new product with an initial
competitors and to discourage new high price, capitalizing on some
competitors from entering the people’s willingness to pay a
industry premium for cutting-edge
technology.
Chapter’s Tutorial
• MAF551 June2018 ZIN RUBBER BHD
• MAF551 Jan 2018 QUPINK SDN BHD
• MAF551 July 2017 THE ALFREDO FURNITURE BHD
• MAF551 Dec 2016 DELTA BHD
• MAF551 June 2016 INTAN BAIDURI SDN BHD
• MAF551 Dec 2015 DIAMANT BERHAD
• MAF551 June 2015 TUNAS CERIA BHD
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20

• At the end of this chapter, students should be able to:

– Explain and calculate limiting factors, discontinuing a

– Explain qualitative factors in decision making

– Explain pricing methods and pricing strategies

Sell Now or Qualitative

Decision making involves making selection between

• Managers will continuously need to make decisions in running

• Management accountants will help managers in making

Concept of relevant costs examines expected future

• The relevance also refers to income, therefore, if there is

RELEVANT COST IRRELEVANT COST

future costs and revenues costs that will not be

Opportunity cost is the foregone benefit

Those costs that can be eliminated or

DIFFERENTIAL Differential cost refers to the difference

INCREMENTAL Incremental cost is the increase in cost if

Special fixed costs relate to fixed costs

Sunk cost is a type of cost that has been

The cost that will remain constant

Costs that have not been incurred but will

UNAVOIDABLE Costs that cannot be eliminated or saved

MAF420 June 2012 Integrity Bhd

Limiting factors refers to resources that is in short

• Even if there is demand for certain product, company

• What is the most profitable product when there is a

To support the government campaign of not using such

Fear of bad community reaction to the product

The product might give an effect to the environment

MAF420 April 2010 Zaraz

• Manufacturers have to often provide the raw materials or

• In a ‘make or buy’ situation, the cost of making and the cost

Opportunity cost will exist if there is limited capacity

COST OF MAKING COST OF BUYING

COST OF MAKING > COST OF MAKING <

• To make or to buy a component?

To make sure a high quality of product

To be independent and avoid dependency on

To provide jobs to the employees and increase

• In a special order situation, a company might have spare

• Sometimes, special order situation exists when other company

Opportunity cost will exist if there is limited capacity

In order to make decision, the contribution that will be earned

CONTRIBUTION = SALES REVENUES – TOTAL VARIABLE COST

If the contribution is:

Positive = ACCEPT Negative = REJECT

• To accept special order or not?

To build business networking

To secure future or other orders

• A particular line of service, product or department might

Normally as long as the product or service contributes to

• To delete a segment or continue operation?

The loss department can attract the customers to

To make sure the employees can remain working

As a social responsibility because the product produced

• A manufacturing company that uses a main raw material will

In costing, what is important is the recognition of the

• For example, when a lamb is slaughtered, the meat and hide

• The bones of the lamb are a by-product as they do not have