MODULE 3: COMMON

ORGANISATION’S
DECISION MAKING
DR. NUR LAILI AB GHANI
nurlaili@ukm.edu.my
ZCMA6022 MANAGERIAL ACCOUNTING
UKM-GRADUATE SCHOOL OF BUSINESS
SEMESTER 1, SESSION 2022/2023
Highlights
This module provides the understanding
on the thinking processes in decision
making for operational and capital
expenditure in organisation.

Students will be able to prepare, review and present the

strategic proposals using management accounting tools
to establish effective operational and capital expenditure
decision-making relevant to the business plan in
organisation.

DR. NUR LAILI AB GHANI UKM-GSB 2

Topics
Cost-Volume Profit Analysis
Analyse the effects of changes in an organization’s volume
of activity on its costs, revenue & profit.

Decision Making for Operational

Expenditure
Analyse special order or special decision related to
operational expenditure.

Decision Making for Capital

Expenditure
Analysis capital expenditure decision making related to
acquisition or maintenance of fixed assets.

DR. NUR LAILI AB GHANI UKM-GSB 3

COST-VOLUME PROFIT
ANALYSIS

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What kind of
information that we
need for analysis &
decision making in
organisation?

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Relevance
•
•
Bearing on the Future.
Different under
competing alternatives.
Timeliness
• Focus on Relevant costs
& benefits.
• Relevant range:
activities within which
management expects to

•
operate
Knowing the cost Accuracy
behaviour within the
relevant range.

DR. NUR LAILI AB GHANI UKM-GSB 6

Cost-Volume Profit
Analysis
Effects of changes in Effects on profit of
an organization’s changes in selling
Break-even point
volume of activity on prices, service fees,
(BEP)
its costs, revenue & costs, income tax
profit. rates & product mix.

Analysis on Cost
Margin of Safety Structure for
Operating Leverage
(MOS) different
organisation

DR. NUR LAILI AB GHANI UKM-GSB 7

Break-Even Point
Total contribution Total contribution
Volume of activity margin = margin = amount of
where: TOTAL SALES REVENUE revenue to cover FC
REVENUE = COSTS – TOTAL VARIABLE after all VC have been
COSTS covered

Contribution margin
BEP (units) = BEP (dollars) =
ratio =
Fixed costs / Fixed costs /
Unit contribution
Unit contribution Contribution margin
margin /
margin ratio
Unit sales price

DR. NUR LAILI AB GHANI UKM-GSB 8

Graphing the Cost-Volume
Profit Relationship
Cost-Volume Profit Graph
RM250,000

RM200,000
BEP (units) = BEP
8,000 RM150,000
BEP (dollars) =
RM128,000 RM100,000
FC = RM50,000
RM50,000
Relevant Range

RM0
2,000 4,000 6,000 8,000 10,000 12,000 14,000
Sales Total Fixed Cost Total Cost
DR. NUR LAILI AB GHANI UKM-GSB 9
 Assumptions in CVP Analysis

1 2 3 4 5

Behaviour of Behaviour of Efficiency & In In multi-

total revenue total costs is productivity manufacturing product
is linear: linear over the of production firms, organisation,
Prices will not relevant range: process inventory sales mix
change as sales FC constant, VC remain levels at remains
volume varies unchanged as constant. beginning & constant over
within relevant activity changes.
range No. of units end of the the relevant
produced = No. of period are the range.
units sold same DR. NUR LAILI AB GHANI UKM-GSB 10
Margin of Safety
MOS =
How close projected What will happen
Budgeted Sales operations are to the when there is a
Revenue – BEP Sales BEP change in FC?
Revenue

What will happen

What will happen
when there is a
when there is a
change in Unit
change in VC?
Contribution Margin?

DR. NUR LAILI AB GHANI UKM-GSB 11

Operating Leverage
Ability of the firm to Operating Leverage
Extent to which generate an increase Factor =
organization uses FC in net income when
in its cost structure sales revenue Contribution Margin /
increases Net income

Greatest in firms
with:
Large FC
Low VC
High CM ratio

DR. NUR LAILI AB GHANI UKM-GSB 12

Analysis of Cost Structure for
Different Organisation

Retail / Building Manufacturing

Government Contractor Higher FC
Agency Higher VC
Equal VC & FC
DR. NUR LAILI AB GHANI UKM-GSB 13
 125

EXERCISE: REFER 100

TO EXCEL FILE 75

M3 – CVP 50

ANALYSIS
25

0
Item 1 Item 2 Item 3 Item 4 Item 5

DR. NUR LAILI AB GHANI UKM-GSB 14

GROUP EXERCISE
Get into groups, discuss
and analyse the cost
structure for your
organisation based on
the list of costs
identified in Module 2.

DR. NUR LAILI AB GHANI UKM-GSB 15

What kind of
decisions that need
to be made within
organisation’s
business activities
and operations?

DR. NUR LAILI AB GHANI UKM-GSB 16

 A Which car B Quantity of
model to each model & its
produce? selling price?
Decision C How to F How to ensure
manufacture the the quantity &
Making by Car car & its parts? quality of the
Manufacturer Internal or various inputs
outsource? to be used?
Operational & D Advertising, E Which
Capital distribution & investment
Expenditure product projects to
positioning to accept?
sell the cars.

DR. NUR LAILI AB GHANI UKM-GSB 17

 QUANTITATIVE ANALYSIS

01 02 03 04

Clarify the Develop a

Specify the Identify the
decision decision
criterion alternatives
problem model

Decision- Evaluate
Making decision
effectiveness
Make a
decision
Collect the
data
Process
Participate by Managerial 07 06 05
Accountant as part of
cross-functional team QUALITATIVE ANALYSIS DR. NUR LAILI AB GHANI UKM-GSB 18
Example of Decision-Making
Process
STEPS IN DECISION MAKING ACTION NEEDED
Clarify the decision During MCO, receive order more
problem than their maximum capacity.
Specify the criterion What is their objective?
Identify the alternatives Outsource production to
outside?
Develop a decision model Combine the criterion,
constraints and alternatives.
Collect the data Collect data, perform budgeting
and costing analysis.
Make a decision What is the final decision?
Evaluate decision Evaluate the achievement of
effectiveness objective.

DR. NUR LAILI AB GHANI UKM-GSB 19

OPERATIONAL
EXPENDITURE DECISION
MAKING
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What are the
examples of
operational
expenditure
decision to be made
within organisation?

DR. NUR LAILI AB GHANI UKM-GSB 21

Operational
Expenditure Decisions
Outsource a
Accept or No excess
Product or
Reject capacity
Service

Add or Drop a
Sell or Process
Service, Product
Further
or Department

DR. NUR LAILI AB GHANI UKM-GSB 22

 Know the relevant costs & benefit
for your business activities.
Identify the relevant information for
the relevant range.

Important Understand the basis cost

management concept – Product &

Notes for Process Costs, POHR

Operational Identify the cost behaviour.

Expenditure Choose the best costing statement

to reflect your decision.

Decisions Ability to make relevant analysis for

decision making.

DR. NUR LAILI AB GHANI UKM-GSB 23

Other Important Notes

SUNK COSTS OPPORTUNITY

COSTS
• Costs that have already • Potential benefit given up
been incurred. when the choice of one
• Do not affect any future action precludes a
cost and cannot be different action.
changes by any current or
future action.
DR. NUR LAILI AB GHANI UKM-GSB 24
 125

EXERCISE: REFER 100

TO EXCEL FILE 75

M3 – OPEX 50

DECISION MAKING
25

0
Item 1 Item 2 Item 3 Item 4 Item 5

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CAPITAL EXPENDITURE
DECISION MAKING

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What are the
examples of capital
expenditure
decision to be made
within organisation?

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Capital Expenditure
Decisions
Acceptance or Capital-Rationing
Rejection (Worthwhile
Focus on Projects
(Capital projects in limited
Investment) investment funds)

Business
Acquisition &
Expansion
Refurbishment of
(Establish new
Fixed Assets
branch)

DR. NUR LAILI AB GHANI UKM-GSB 28

 How to analyse
capital expenditure
decisions?
Discounted Cash Flow Analysis:
Net Present Value (NPV) &
Internal Rate of Return (IRR)

Alternative Method:
Payback Period &
Accounting Rate of Return

DR. NUR LAILI AB GHANI UKM-GSB 29

Discounted Cash Flow Analysis &
Alternative Methods
Internal Rate
Net Present Choosing the
of Return
Value (NPV) Hurdle Rate
(IRR)

Look at Accounting
Payback
Depreciable Rate of
Period
Asset Return

DR. NUR LAILI AB GHANI UKM-GSB 30

Discounted Cash Flow Analysis
NET PRESENT VALUE (NPV)
• Prepare a table showing the cash
flows during each year of the
proposed investment.
• Compute the PV of each cash flow,
using a discount rate that reflects
the cost of acquiring investment
capital.
• Discount rate = hurdle rate OR
minimum desired rate of return.
• Compute NPV = sum of the present
value of the cash flows.
• DECISION: If NPV ≥ 0, accept the
investment proposal. Otherwise,
reject it.
INTERNAL RATE OF RETURN (IRR)
• True economic return earned by the asset over
its life.
• Discount rate that would be required in a net-
present-value analysis in order for the asset’s
NPV to be exactly zero.
• Prepare a table showing the cash flows during
each year of the proposed investment
(Identical to the NPV analysis).
• Compute the IRR for the proposed investment.
Find the discount rate that yields NPV = 0 for
the proposed investment.
• DECISION: If IRR > Cost of Capital OR Hurdle
Rate, accept the investment proposal.
Otherwise, reject it.
DR. NUR LAILI AB GHANI UKM-GSB 31
 All cash flows are treated as though they
occur at year-end in the PV calculations.
Treat cash flows associated with an
investment project as though they were
Assumptions known with certainty.
Each cash inflow is immediately reinvested in
underlying another project that earns a return for the
organisation.
Discounted NPV: each cash inflow is reinvested at the

Cash Flow same rate used to compute the project’s NPV.

IRR: each cash inflow is reinvested at the

Analysis same rate as the project’s IRR.

Perfect capital market. Money can be
borrowed or lent at an interest rate = hurdle
rate.
DR. NUR LAILI AB GHANI UKM-GSB 32
Other Important Analysis
Choosing the Hurdle Rate
• Determined by management based
on the investment opportunity rate.
• Rate of return the organisation can
earn on its best alternative
investments of equivalent risk.
• The greater a project’s risk is, the
higher the hurdle rate should be.
• Investment decision should be
separated with the decision to
finance the project.
Look at Depreciable Assets
• The acquisition cost of Fixed Asset is allocated
to the time periods in the asset’s life through
depreciation charges.
• We will exclude any depreciation charges in the
discounted cash flow analysis.
• NPV and IRR focus on cash flows. Periodic
depreciation charges are not cash flows.
• Example: Straight-line depreciation OR
Reducing Balance depreciation.
DR. NUR LAILI AB GHANI UKM-GSB 33
Alternative Methods
Payback Period
• The amount of time it will take for
the after-tax cash inflows from the
project to accumulate to an amount
that covers the original investment.
• Formula can be used given an Even
cash inflows throughout the project.
• If the project exhibits an uneven
cash inflows, payback period must
be calculated on a year-to-year
basis.
Payback Period =
Initial Investment / Annual
after-tax cash inflows
Accounting Rate of Return
• Focus on incremental accounting income that
results from a project.
• Accounting income is based on accrual
accounting procedures.
• Revenue is recognized during the period of
sale, not necessarily when cash is received.
• Expenses are recognized during the period they
are incurred, not when they are paid in cash.
Accounting Rate of Return =
[(Average incremental revenue) – (Average
incremental expenses including depreciation &
income taxes)] /
Initial investment
DR. NUR LAILI AB GHANI UKM-GSB 34
Few Disadvantages
Payback Period
• Ignore time value of money.
• Do not consider project’s cash flow
beyond the payback period.
Accounting Rate of
Return
• Simplest way of screening
investment proposal.
• Ignore time value of money.
• Parallel to financial accounting
statements which are using accrual
accounting.
DR. NUR LAILI AB GHANI UKM-GSB 35
 125

EXERCISE: REFER 100

TO EXCEL FILE 75

M3 – CAPEX 50

DECISION MAKING
25

0
Item 1 Item 2 Item 3 Item 4 Item 5

DR. NUR LAILI AB GHANI UKM-GSB 36

Issues in Decision
Making
Incentives for Decision Short-Run vs Long-Run
Makers
Example of Sunk Costs for
replacement of fixed asset
Unitised fixed costs
Sometimes assigned to
individual product for
product-costing purpose.
Better to include total
amount.
Sunk Costs
Decisions Tendency to ignore the
importance of book values
Long Run: affected by time in decision to replace an
value of money asset
Allocated fixed costs
Opportunity costs
across division
Which avoidable costs before
Important in decision
deciding to eliminate
making
unprofitable division.
DR. NUR LAILI AB GHANI UKM-GSB 37
GROUP EXERCISE
Get into groups,
discuss the possible
decision to be made
within your
organisation.

DR. NUR LAILI AB GHANI UKM-GSB 38