Chapter 10, Short-Run Decision Analysis

Chapter 10

Review of Learning Objectives

LO1 Describe how managers make short-run decisions.

Both quantitative information and qualitative information are important in short-run
decision analysis. Such information should be relevant, timely, and presented in a format
that is easy to use in decision making. When managers plan, they discover a problem or
need, identify alternative courses of action to solve the problem or meet the need,
perform a complete analysis to determine the effects of each alternative on business
operations, and choose the best alternative. As managers perform during the year, they
contract with outside suppliers of goods and services, accept or reject special orders,
examine the profitability of segments, select the appropriate product mix given a resource
constraint, or sell a product as is or process it further. When managers evaluate actual
performance, they review each decision to determine if the forecast results were obtained,
and if they were not, they take corrective action. In reports that managers prepare
throughout the year, they communicate the information they used in making their
decisions, the decisions they made, and the impact of those decision on the organization.

LO2 Define incremental analysis, and explain how it applies to short-run decision

making.
Incremental analysis helps managers compare alternative courses of action by focusing
on the differences in projected revenues and costs. Any data that relate to future costs,
revenues, or uses of resources and that will differ among alternative courses of action are
considered relevant decision information. Examples of relevant information are projected
sales or estimated costs, such as the costs of direct materials or direct labor, that differ for
each alternative. The manager organizes relevant information to determine which
alternative contributes the most to profits or incurs the lowest costs. Only data that differ
for each alternative are considered. Differential or incremental costs are costs that vary
among alternatives and thus are relevant to the decision. Sunk costs are past costs that

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Chapter 10, Short-Run Decision Analysis

cannot be recovered; they are irrelevant to the decision process. Opportunity costs are
revenue or income forgone as a result of choosing an alternative.

LO3 Perform incremental analysis for outsourcing decisions.

Outsourcing (including make-or-buy) decision analysis helps managers decide whether to
use suppliers from outside the organization to perform services or provide goods that
could be performed or produced internally. An incremental analysis of the expected costs
and revenues for each alternative is used to identify the best alternative.

LO4 Perform incremental analysis for special order decisions.

A special order decision is a decision about whether to accept or reject a special order at a
price below the normal market price. One approach is to compare the special order price
with the relevant costs to see if a profit can be generated. Another approach is to prepare
a special order bid price by calculating a minimum selling price for the special order.
Generally, fixed costs are irrelevant to a special order decision because such costs are
covered by regular sales activity and do not differ among alternatives.

LO5 Perform incremental analysis for segment profitability decisions.

Segment profitability decisions involve the review of segments of an organization, such
as product lines, services, sales territories, divisions, or departments. Managers often
must decide whether to add or drop a segment. A segment with a negative segment
margin may be dropped. A segment margin is a segment’s sales revenue minus its direct
costs, which include variable costs and avoidable fixed costs. Avoidable costs are
traceable to a specific segment. If the segment is eliminated, the avoidable costs will also
be eliminated.

LO6 Perform incremental analysis for sales mix decisions involving constrained

resources.
Sales mix decisions require the selection of the most profitable combination of sales
items when a company makes more than one product or service using a common

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Chapter 10, Short-Run Decision Analysis

constrained resource. The product or service generating the highest contribution margin
per constrained resource is offered and sold first.

LO7 Perform incremental analysis for sell or process-further decisions.

Sell or process-further decisions require managers to choose between selling a joint
product at its split-off point or processing it into a more refined product. Managers
compare the incremental revenues and costs of the two alternatives. Joint processing
costs are irrelevant to the decision because they are identical for both alternatives. A
product should be processed further only if the incremental revenues generated exceed
the incremental costs incurred.

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