Management Accounting Concepts & Techniques for Decision Making

Jazz

RELEVANT COSTING / DIFFERENTIAL COST ANALYSIS

DECISION MAKING – Is the process of choosing a course of action from at least two alternatives
1. Short-term non-routine cases
a. Accept or reject a special order or a business proposal
b. Sell of process further a product line
c. Make or buy a part, subassembly or product line
d. Continue operating or close a business segment
e. Product combination
f. Utilization of scarce resources
g. Change in profit factors

2. Long term cases e.g. capital investment decisions

Decision-Making Process
1. Defining the problem.
2. Specifying the objective and criteria.
3. Identifying the alternative courses of action.
4. Determining and evaluating the possible consequences of the alternatives.
5. Choosing the best alternative and making the decisions.
6. Evaluating the results of the decisions.

Approaches in decision-making:
TOTAL Approach – the revenues and costs are determined for each alternative, and the results
are compared to serve as a basis for decision-making

DIFFERENTIAL Approach – only the differences or changes in costs and revenues are considered

Factors to Consider in decision-making:

QUALITATIVE Factors – those that cannot easily and accurately be expressed in terms of money or
any other numerical unit of measure

QUANTITATIVE Factors – those that can easily be expressed in terms of money or other numerical
unit of measure

TYPES OF COSTS AND TERMINOLOGIES USED IN DECISION-MAKING:

RELEVANT COSTS Future costs that are expected to be different between or among
alternatives.
DIFFERENTIAL COSTS Increases (increments) or decreases (decrements) in total costs that
result from selecting one alternative instead of another.
AVOIDABLE COSTS Costs that will be saved or those that will not be incurred if a certain
decision is made. (relevant)
SUNK COSTS Costs that are incurred already and cannot be avoided regardless of
what decision is made. (irrelevant)
OUT-OF-POCKET COSTS Costs that will require expenditure of cash or incurrence of a liability
as a consequence of a management decision (relevant)
OPPORTUNITY COSTS Income sacrificed or foregone when a certain alternative is chosen
over another alternative (relevant)
JOINT COSTS Costs incurred in simultaneously manufacturing two or more (joint)
products that are difficult to identify individually as separate types of
products until the products reach a certain processing stage known
as the split-off point (irrelevant)
SPLIT OFF POINT A point in manufacturing process where some or all of joints products
can be recognized as distinct and separate products
FURTHER PROCESSING Cost incurred beyond the split off point as separated joint products
COSTS are to be processed further (relevant)
BOTTLENECK RESOURCES Any resource or operation where the capacity is less than the
demand placed upon it
POSTPONABLE COSTS Costs that may be deferred or shifted to a future date or period of
time without adversely affecting current operations
IMPUTED COSTS Assumed or hypothetical costs representing the costs or value of a
resource that is utilized for a specific purpose

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Management Accounting Concepts & Techniques for Decision Making
Jazz
SHORT-TERM DECISION MAKING GUIDELINES
Decision objective: decide in favor of the action that will give the organization the BEST PROFIT POSITION
(highest revenue or lowest costs)
Nature of Alternatives Description
1. MAKE OR BUY Should a part or product be
a part or a product manufactured (in-sourced) or
bought (outsourced) from
outside supplier?
2. ACCEPT OR REJECT Should a special order that
a special order usually requires a price lower
than the regular selling price
be accepted?
3. CONTINUE or Should a business segment,
SHUTDOWN a which may be a product line,
business segment a department or a branch be
continued or discontinued?
4. SELL or PROCESS Should a product, after
FURTHER a product undergoing the joint process,
be sold at the split-off point or
be processed further?
5. PRODUCT Which product(s) should be
COMBINATION produced and sold when
Optimization of there is a given limited
scarce resources resources or bottleneck
operations?
6. CHANGE IN PROFIT Should any of the profit
FACTORS factors such as sales price,
CVP Relationships volume, variable cost, fixed
cost and sales mix be
manipulated to increase
profit?
Decision Guidelines
Choose the option that involves the
lower cost. In most cases, fixed costs
are irrelevant unless it can be
avoided. Consider opportunity costs, if
any.
Accept the special order when the
additional revenue from the special
order exceeds additional cost,
provided the regular market will not
be affected. In most cases, fixed
production costs are irrelevant.
Continue if avoidable revenue of the
segment involved is greater than its
avoidable costs; otherwise, consider
shutting down the segment. Since,
allocated fixed cost is usually
unavoidable, it is considered
irrelevant.
Process further if additional revenue
from the processing further is greater
than further processing costs. Joint
costs, since already incurred, are
considered sunk costs and irrelevant.
Identify and measure the constraint on
the limited resource (s). Rank the
products according to the highest
contribution margin per unit of scarce
resources.
Identify the factor to be changed and
the amount of contemplated change.
Change the profit factor if it will cause
an Improvement on the company’s
over-all profit position.
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Management Accounting Concepts & Techniques for Decision Making
Jazz

EXERCISES:

PROBLEM 1 (Special Order)

PROBLEM 2 (SELL OR PROCESS)

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Management Accounting Concepts & Techniques for Decision Making
Jazz

PROBLEM 3 (Make or Buy)

PROBLEM 4 (Scrap or Rework)