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Managerial Accounting and Decision Making

Managerial Accountant Decision-Making

Steps in Decision-making Process:

1. Clarify the decision problem − Identify the problem.
2. Specify the criterion – Specify the criteria intended for decision-making, i.e., profit maximization or cost
minimization.
3. Identify alternatives – A decision involves selecting between two or more alternatives.
4. Develop a decision model – This is a simplified representation of a choice problem.
5. Collect the data – The managerial accountant collects the data to be used in decision making.
6. Select an alternative – When all the criteria and decision model are considered, management then needs
to select an alternative.
7. Evaluate the decision effectiveness – The management must provide appropriate feedback if the
alternative chosen meets the objective of management.

Qualitative and Quantitative Characteristics

Managerial accountants considers both qualitative and quantitative characteristics when trying to provide support
for decision-making.

Qualitative characteristics Quantitative characteristics

• Supplier relationship • Contribution margin

• Customer relationship per unit
• Quality of inputs • Differential costs
• Opportunity costs

Obtaining information
What criteria should the management accountant use to provide information necessary for decision-making.
1. Relevant – Information should be related and pertinent to the problem.
2. Accuracy – The information should be accurate as much as possible to be useful for decision-making.
3. Timeliness – Relevant and accurate data are only useful if they are provided at the right time.

Relevant Information
Information is considered to be relevant when it:
1. Affects the future costs and benefits.
2. Differs among alternatives.

Unique versus Repetitive Decisions

Unique decisions arise very infrequently or once. Repetitive decisions are usually done on a daily or periodic basis.
Information needed to make unique decisions are usually harder to generate since they happen very infrequently.
On the other hand, repetitive decisions are usually predictable due to decisions being made on a regular basis.
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Identifying Relevant Costs and Benefits

Sunk costs – These are costs that already been incurred. They do not affect any future cost and cannot by any
current or future action. Sunk costs are irrelevant to decision-making. Examples are as follows:

1. Book value of equipment – ABC company purchased an equipment for P100,000 at the beginning of 2020.
With a useful life of 4 years. The company incurs P30,000 in variable operating costs to run the equipment.

The company is considering to replace the equipment with a new one. The old equipment will be sold for
P10,000. The new equipment will make the company more efficient, the annual variable operating costs will be
reduced to P9,000.

The details of the new equipment are as follows:

a. P120,000
b. Useful life – 10 years

Particulars Replace the Do not replace the Differential costs

equipment (A) equipment (A – B)
(B)
Depreciation of old P− P25,000 (P25,000)
equipment
Write-off carrying value 25,000 − 25,000
of old equipment
Proceeds (10,000) − (10,000)
Depreciation of new 12,000 − 12,000
equipment
Operating costs 9,000 30,000 (21,000)
Total costs P36,000 P55,000 P19,000
Decision Replace

The relevant costs are as follows:

• Depreciation of new equipment.
• The decrease in variable costs.
• The proceeds from selling the old equipment.

Differential costs – these are the costs of under the alternatives.

2. Cost of Inventory on Hand – ABC Corporation has spare parts that are unusable that costs P20,000. The
managerial accountant is thinking whether to dispose or modify and use the parts.

The spare parts can be sold for P5,000 in its current condition. Modifying the parts will cost P12,000.

Particulars Modify and use the Sell the inventory Differential costs
inventory (B) (A – B)
(A)
Carrying value of the old P20,000 P20,000 P−
equipment
Proceeds from disposal − (5,000) 5,000
Cost to modify 12,000 − 12,000
Total costs P32,000 15,000 P17,000
Decision Sell
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Irrelevant Future costs and Benefits

There are times that even though there are future cash flows, they might not be different among alternatives.
Making them irrelevant.

Example: Danielyna Corporation has a restaurant. Danielyna currently wants to add a dish to their menu. The
following are the costs and expected revenues comparing if the new dish will be introduced or not:

Particulars Introduce a new Don’t change Differential

dish the menu costs
(A) (B) (A – B)
Relevant Ingredients for P35,000 P20,000 P15,000
cooking
Relevant Chef wages 37,000 35,000 2,000
Irrelevant Waiter salaries 12,000 12,000 −
Irrelevant Utility fees 3,000 3,000 −
Irrelevant Kitchen inspection 15,000 15,000 −
Relevant Expected revenue (150,000) (100,000) (50,000)
per month
Irrelevant Charges to (100) (100) −
customer
Total Costs (P152,000) (P115,000) (P33,000)
Decision Introduce

Opportunity Costs
An opportunity cost is a benefit foregone, or in in a sense − income not realized. For example, a company is
deciding whether to accept a special order or rent out the vacant facility. If the company chooses to accept the
special order it will not be able to rent out its facility, and vice versa.

Although opportunity costs might not involve out-of-pocket costs, this is still considered to be a relevant cost.
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Specific Decision-Making
Aside from the general decision-making made by management, there are certain nonroutine decisions that must be
considered during the discussion of relevant costs and revenues.

1. Accept or reject an offer – These are scenarios where an entity is deciding whether to accept producing
at a special price (mostly lower than usual) or not. Consider the following scenario:

AratNa Company is a travel agency in the Philippines. They have multiple branches and offer travel
packages around the Philippines. Business has not been very strong during the past few months due to the
ongoing pandemic. Mr. Arturito, came to Mrs. Soledad, the manager of AratNa, inquiring about travel
packages from Iloilo to Cebu. Mr. Arturito offered to pay P90,000 for the said trip. Given that the
company’s usual rates and fees for a trip to Cebu and Iloilo is P150,000. Thus, Mrs. Soledad needs to
perform a special analysis.

Soledad obtained the revenue and cost information for a typical travel package from Cebu to Iloilo:

Revenue
Tour package (10 pax) P120,000
Handling fee P30,000
Total P150,000

Expenses
Meals (variable costs) P10,000
Fuel (variable costs) P8,000
Misc. fees (variable costs) P5,000
Tickets (variable costs) P50,000
Salary of tour guide P17,000
Depreciation of Van P10,000
Total P100,000

Profit P50,000

If Soledad did not understand management accounting,

Special price P90,000

Total cost of the tour (P100,000)
Loss from the special offer (P10,000)

Soledad would reject the offer. Fortunately, Soledad knows that only variable costs in this scenario are
relevant costs. Since the fixed costs (Salary and depreciation) would be incurred regardless if there are
tours or none. Also, there would be a 10% discount in ticket pricing due to the pandemic.

Special price P90,000

Variable costs P73,000
Less: Savings in tickets (5,000)
Total variable costs P68,000 (P68,000)
CM from the special offer P22,000 ACCEPT
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What if there is no excess capacity? Let us assume the following scenario:

Mr. Arturito is the manager of Maneyhays Inc. which produces shoes in Marikina. Lebron James, an
American basketball player, recently came to the Philippines. Lebron saw the shoes sold by Maneyhays
and he instantly fell in love with them. He wanted to order 100 pairs of shoes and was also asking if he
could get a discount due to the number of pairs he would be buying. Unfortunately, there were no sizes
that fit Lebron.

Arturito is considering whether to produce the special order for Lebron. One problem is that all of the
warehouse of the company is already operating at full capacity. He would need to stop temporarily the
production of a certain product line to produce the order.

The product line that would be temporarily stopped currently produces 100 pairs, the cost and revenue
information are as follows:

Selling price P800

Variable costs per pair

Leather P120
Rubber P50
Foam P40
Direct labor P30
Variable overhead P60
Utilities (variable portion) P30
Fixed costs per pair
Depreciation allocated P90
Utilities (fixed portion) P130

(Assume all units are immediately sold after production)

If the special order will be made, VOH will decrease by P30 since it will not be using some tools in
relation to Lebron’s order.

The analysis should be as follows:

Selling price P800
Variable cost of the product line (P330)
Contribution margin per unit P470 Minimum acceptable price
x (number of pairs produced and sold) x 100
Opportunity cost P47,000

If Lebron offered the following price per pair:

Particulars @750 @770 @780

Sales @ 100 units P75,000 P77,000 P78,000
Less: Variable costs (30,000) (30,000) (30,000)
(330 – 30) x 100
Less: Opportunity cost (47,000) (47,000) (47,000)
(CM foregone)
Incremental/(Decremental) (P2,000) P− P1,000
Contribution Margin
Decision Reject Accept Accept
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2. Make-or-Buy – The entity is deciding whether to produce a product in-house using its own resources or
simply purchasing (e.g., outsource) it from an outside supplier. Consider the following scenarios:

Scenario A:
Jollibubuyog Company is a Filipino-owned and incorporated corporation. It has expanded its operations
abroad. It is considering to transfer all of its customer service operations to another entity. The monthly
costs of Jollibubuyog’s CSR department are as follows:

Total expenses
Salaries of agents P250,000
Salaries of supervisors P120,000
Salaries of manager P50,000
Utilities (all variable costs) P20,000
Allocated depreciation to P170,000
the CSR department*
Total P610,000

*the space occupied by the CSR department will be used by another department if they are
outsourced.

The company inquired with various business process outsourcing entities, the following were the three
different monthly quotes: P610,000, P440,000, P400,000.

Particulars In-house @610,000 @440,000 @400,000

Variable costs P20,000 P− P− P−
Direct fixed costs
Salaries of agents 250,000 − − −
Salaries of 120,000 − − −
supervisors
Salaries of 50,000 − − −
managers
Total Relevant 440,000 − − −
Costs
Outsource price − P610,000 P440,000 P400,000
Decision In-house Outsource Outsource

Minimum acceptable price

Although fixed costs, such as salaries of the personnel, are generally sunk costs, there are instances such
as this case that fixed costs are direct to a particular segment which will be outsourced. Since another
entity will be performing the CSR process of the company, the salaries of its employees in the CSR
department will not be incurred anymore. Since the depreciation is allocated they will still be incurred
regardless if the company outsources or not (e.g., irrelevant costs).
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Scenario B:
MasterBaker Company, sells bread and other pastry products. The company currently produces its own
products. A start-up company approached MasterBaker and is offering to produce its bread and pastry
products for a monthly cost of P400,000.

If the company outsources its production, it would save P30,000 in monthly salaries of supervisors. Also,
the monthly kitchen depreciation of P50,000 would also not be incurred. Lastly, utilities will not be
incurred anymore.

The average product cost information of MasterBaker are as follows:

Variable costs Average

monthly cost
Direct materials P150,000
Direct labor P65,000
Variable overhead P36,000
Utilities (variable portion) P7,000

Fixed costs

Depreciation P90,000
Salaries of supervisor P40,000
Utilities (fixed portion) P20,000

The analysis is as follows:

Particulars Make Buy Differential costs

(A) (B) (A – B)
Direct materials P150,000 P− P150,000
Direct labor 65,000 − 65,000
Variable overhead 36,000 − 36,000
Utilities (variable 7,000 − 7,000
portion)
Fixed costs:
Depreciation 90,000 40,000 50,000
Salaries of 40,000 10,000 30,000
supervisor
Utilities 20,000 − 20,000
Cost of purchasing − 400,000 (400,000)
Total costs P408,000 P450,000 (P42,000)
Decision MAKE
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3. Keep-or-Drop a Segment – This decision-making usually involves assessing whether a segment or product
line is still contributing to the profit of the company as a whole. Just like the introduction of direct fixed
costs in the Make-or-Buy decision, it is important that we understand these two costs:
a. Unavoidable costs – these are expenses that will be incurred regardless if the segment is
removed or not.
b. Avoidable costs – these are expenses that are direct to a particular segment or department, that
will not be incurred when the segment is eliminated.

To illustrate:
McDonald is the senior manager of 24-Hour Chicken, Inc. Due to the ongoing pandemic, He is assessing if
unprofitable product lines should be dropped. Currently, the company has 2 product lines. Chicken and
Burgers.

The contribution margin statement for the year ending December 31, 2020 is as follows:

Particulars Chicken Burgers Total

Sales P500,000 P250,000 P750,000
Variable expenses:
Direct materials (120,000) (60,000) (180,000)
Direct labor (50,000) (40,000) (90,000)
Variable overhead (30,000) (20,000) (50,000)
Contribution margin P300,000 P130,000 P430,000

Fixed expenses:
Depreciation (250,000) (80,000) (330,000)
Administrative salaries (40,000) (20,000) (60,000)
Rent − (60,000) (60,000)
General overhead (50,000) (10,000) (60,000)
(allocated)
Operating Income / (P40,000) (P40,000) (P80,000)
(Loss)

Other information:
• The allocated depreciation per segment is:
o P200,000 for Chicken
o P10,000 for Burgers
• If the Chicken segment would be dropped, P10,000 administrative salaries would not be
incurred.
• 50% of the administrative salaries of the Burger segment is allocated.
• Currently the Burger segment rents out its own warehouse. The warehouse has no other use.

The questions are as follows:

a. What is the opportunity cost if the Chicken segment is dropped? If the Burger segment is
forgone?
b. How much profit will increase (decrease) if Chicken is dropped? If Burger is dropped?
c. Which segment should we keep?
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The following is the analysis:

Particulars Chicken Burgers

Contribution margin P300,000 P130,000
Opportunity Cost
Direct Fixed expenses:
Depreciation (50,000) (70,000)
Administrative salaries (10,000) (10,000)
Rent − (60,000)
General overhead − −
(allocated)
Segment Income / P240,000 (P10,000)
(Loss) Change in profit
Decision Keep Drop

To answer the questions:

1. The opportunity cost is the contribution margin of each segment. Since this contributes towards
the profit of the segment.

If the Chicken segment is dropped, P300,000 would be the opportunity cost; while P130,000 is
the opportunity cost the Burger segment.

2. The segment income affects the profitability of the whole firm.

If Chicken will be dropped, there will be a decrease in P240,000 profit. Thus, it would be better
off to keep the Chicken segment. If Burgers were dropped, profit will increase by P10,000 since
it only contributes losses to the company.

See analysis below for the proof:

If the Chicken segment was kept; Burger segment was dropped:

Particulars Chicken Unavoidable costs Total

Contribution margin P300,000 − 300,000

Fixed expenses:
Depreciation (250,000) (10,000) 260,000
Administrative salaries (40,000) (10,000) 50,000
Rent − − −
General overhead (50,000) (10,000) (60,000)
(allocated)
Operating Income / (P40,000) − (P70,000)
(Loss)

Previous loss (P80,000)

Loss if Burger was dropped (70,000)
Increase in profit P10,000
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If the Burger segment was kept:

Particulars Burger Unavoidable costs Total

Contribution margin P130,000 P− P130,000

Fixed expenses:
Depreciation (80,000) (200,000) (280,000)
Administrative salaries (20,000) (30,000) (50,000)
Rent (60,000) − (60,000)
General overhead (10,000) (50,000) (60,000)
(allocated)
Operating Income / (P40,000) − (P320,000)
(Loss)

Previous loss (P80,000)

Loss if Chicken was dropped (320,000)
Decrease in profit (P240,000)
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4. Sell or Process Further – In a manufacturing setting, there are products which undergo a join production
process. This results into two or more products, which is called joint products. A typical example is the
processing of Milk into butter, cheese or cream.

There will be a point during the production process that joint products become separable. This point is
known as the split-off point.

Consider the following diagram:

Purchasing cost –
P800 per 20 Liter
batch

Joint processing cost

– P700 per 20 liter
batch
Split-off point

2,000 grams of
cheese is
produced. Selling
Price of cheese –
P85 per 50 grams.

Sales value −
P3,400 (2,000 /
50 x P85) 5,000 grams of butter is
produced. The selling price of
butter is P50 per 100 grams.
Additional
processing
Sales value – P2,500 (5,000 /
cost – P400
100 x 50)

2,000 grams of cheese powder was

produced. The selling price was P40
per 20 grams. Sales value – P4,000
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The analysis of the preceding example is as follows:

Particulars Process further Sell at Split- Incremental

(A) off Benefit
(B) (A – B)
Sales
Butter P2,500 P2,500 −
Cheese − 3,400 (3,400)
Cheese powder 4,000 − 4,000

Less: Total costs

Joint costs (1,500) (1,500) −
Additional (400) − (400)
Processing costs
Profit P4,600 P4,400 P200
Decision Process further

Another way of viewing the sell or process further is when the contribution margin would increase if the
product will be processed further as compared to selling as it is.
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5. Decisions Involving Limited Resources – During our study of economics, we learned that every entity has
to allocate their scarce resources to achieve their goals. Knowing this, when a firm operates, they must
maximize every opportunity and prioritize which orders to fill or which product should be made. Thus,
knowing which products contributes most to profit is crucial in this particular analysis.

Going back to what we have discussed during our first lesson, we remember that the modern
manufacturing environment focuses on reducing waste and being more efficient. One way to being more
efficient is to identify the bottlenecks of the process. This is known as the theory of constraints, which
calls for identifying the limiting factors and finding ways to go around them.

There are many ways to ease the bottlenecks, below are some examples:
• Outsourcing
• Working overtime
• Hiring more workers
• Investing in additional equipment
• Reducing or eliminating any non-value adding activities

Consider the scenario below:

PlemaCola, Inc. who is famous for its tagline: “PlemaCola, Sarap Sipsipon”, sells two kinds of products;
Cola and Juice. The following are the contribution margin per unit of the two products:

Particulars Cola Juice

Selling price P25 P21

Less: Variable costs:

Direct materials (6) (2)
Direct labor (2) (4)
Variable overhead (3) (2)
Variable selling (3) (1)

Contribution margin P11 P12

per unit
Direct labor hour 0.5 hours 0.8 hours
per unit

Considering the information above, the juice product line looks to be contributing more to the company’s
profit. This is true if the company has no restraints and can produce any number of cola and juice.

Unfortunately, PlemaCola is still in its start-up phase and thus, lacking in manpower. The company only
has 165 hours available per month.

Since the company cannot produce all the cola and juice it wants, it needs to prioritize which products to
produce first based on the contribution margin per direct labor hour.
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The analysis of the scenario above is as follows:

Particulars Cola Juice

Contribution margin P11 P12
Divide by: Direct labor hours 0.5 hours 0.8 hour
needed per unit
CM per DLH P22 P15
Decision Produce Cola First*

*We should keep on producing Cola first if the demand for Cola is unlimited.

What if: Monthly demand for cola is 250 units, while monthly demand for Juice is 100 units. The available direct
labor hours per month is still 165. How many Cola and Juice in units would be produced?

Since cola has the highest contribution margin per DLH, we should be prioritize producing and selling it.

Total available direct labor hours 165 hours

Less: Number of cola that can be produced 125 hours(250 units x 0.5 DLH)
Remaining hours allotted for Juice 40 hours

Number of cola in units: 250 units

Number of juice in units: 50 units (40 / 0.8)

What if: Monthly demand for cola is 350 units, while monthly demand for Juice is 150 units. The available direct
labor hours per month is still 165. How many Cola and Juice in units would be produced?

Demand for cola 350 units

Times: DLH 0.5
Req’d DLH 175*

Total demand cannot be supplied by the company due to limited capacity.

Total available direct labor hours 165 hours

Less: Number of cola that can be produced 165 hours(330 units x 0.5 DLH)
Remaining hours allotted for Juice −

Number of cola in units: 330 units (165 hours / 0.5)

Number of juice in units: none
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6. Operate or Shutdown – There are products that are cyclical in nature, causing demand for the said
product to be seasonal as well (e.g., ice cream and winter, winter clothing and summer and the like).
There are also situations, when there are fortuitous events that causes the business to make a decision
whether they should temporarily shutdown or not (e.g., natural disasters, environmental conditions,
economic slowdowns, etc.).

During the situations mentioned above, the company might be operating at a loss due to volume of sales
not being enough to cover costs. Thus, management might consider to temporarily stop operations.
Temporarily shutting down does not mean zero costs or zero losses. When a company shuts down, it
might incur one-time costs to close and reopen, while also incurring recurring shutdown costs (e.g.,
salaries, utilities, rent, etc.).

Thus, when management is deciding whether to operate or shutdown, it should consider the least amount
of loss.

Loss of continuing = CM – FC
Loss of discontinuing = 0 – shutdown costs

The shutdown point is the point were continuing or shutting down is indifferent:
CM – FC = Shutdown costs

To illustrate:

Birdie Airlines, has seen a decline in flights since March 2020 due to the pandemic. During March and
April, the company recorded 20 flights, which is a far cry from its normal flights of 200 per month.
Management is considering to temporarily shutdown the business during the month of May 2020.

If the company temporarily shuts down, only the salaries of their skeletal workforce would be incurred
amounting to P800,000 per month, instead of P1,700,000 per month. It will also lay-off some employees if
they temporarily shutdown, the expected costs of severance payments would be P300,000. Reopening the
business would need mobilization and advertising fees of P200,000.

The company also incurs other fixed costs amounting to P9,000,000 per month. These costs are expected
to decrease by 80% when operations are stopped.

Other pertinent information are as follows:

Revenue per flight P300,000

Variable costs per flight
Landing fees P30,000
Flight crew expenses 50,000
Fuel 100,000
Variable advertising 20,000
Expected flights starting May 20 flights
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The analysis of the above scenario is as follows:

Particulars Operate Shutdown

Sales P6,000,000 P−
Less: Variable costs
Landing fees 600,000 −
Flight crew expenses 1,000,000 −
Fuel 2,000,000 −
Variable advertising 400,000 −

Contribution Margin P2,000,000 P−

Less: Fixed Costs

Salaries (P1,700,000) (P800,000)
Others (9,000,000) (1,800,000)

Less: Other shutdown costs

Mobilization and advertising − (P200,000)
Severance payments − (300,000)

Operating Income/(Loss) (P8,700,000) (P3,100,000)

Decisions Shutdown

The shutdown costs are as follows:

1. Severance payments P300,000
2. Mobilization and advertising (cost of reopening) 200,000
3. Unavoidable fixed costs during shutdown 1,800,000
4. Unavoidable salaries during shutdown 800,000
3,100,000

The shutdown point is as follows (CM – FC = Shutdown Costs):

CM is computed as CM/unit x number of units or CM% x Sales, the shutdown point is expressed in number of
units or sales.

Shutdown in units:
=QTY x P100,000/flight – P10,700,000 = P3,100,000
=QTY x P100,000/flight = P3,100,000 + P10,700,000
=QTY x P100,000/flight = P13,800,000
=QTY = P13,800,000 / P100,000/flight
=QTY = 138 flights

Shutdown in Re:
=Sales x 33.33% – P10,700,000 = P3,100,000
=Sales x 33.33% = P3,100,000 + P10,700,000
=Sales x 33.33% = P13,800,000
=Sales = P13,800,000 / 33.33%
=Sales = P41,400,000
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Other Issues Related to Decision Making

Decision making is often related to the manager’s performance evaluation. The manager should have the incentive
to meet the goal of the organization when making decisions. The organization should make sure that proper
performance evaluations are in place so that the manager will make optimal decisions.

The topic we’ve discussed is focused more on short-term decision making. Which the manager makes on a day-to-
day basis. Long-term decision making will be discussed more in strategic business analysis. Although the relevant
costs will remain the same whether the decision is for a short or long horizon, one key difference would be the
incorporation of time value of money in long-term decisions.

The managerial accountant should be wary of the following, when identifying relevant costs:
1. Sunk costs
2. Unit fixed costs
3. Allocated fixed costs
4. Opportunity costs
5. Avoidable and unavoidable costs.