NAGA COLLEGE FOUNDATION, INC.

M.T. Villanueva Avenue, Naga City

College of Accountancy and Finance
Strategic Cost Management

Lecture Handout
SHORT-TERM NON-ROUTINE DECISIONS

OVERVIEW

Decisions are made to make things happen or not happen. Decisions are made in all facets of our life
and same apply to business or organization.

Decisions may be strategic, tactical or operational. It is the process of studying and evaluating two or
more available alternatives leading to a final choice. For business entities, management usually
chooses the option that maximizes company profit. Right decisions are vital in ensuring the success of
a company or organization.

LEARNING OBJECTIVES
At the end of the lesson, students should be able to:
1. Differentiate routinary from non-routinary
2. Classify relevant from irrelevant costs in decision making
3. Give examples of short-term non-routine decisions
4. Present relevant cost and quantitative analysis in different situations involving short-term non
routine decisions.

DISCUSSION

DECISION MAKING

DECISION MAKING – is the process of making choices from at least two alternatives by identifying
a problem, gathering information and evaluating alternative solutions. For business entities,
management usually chooses the option that maximizes company profit.

FACTORS CONSIDERED IN DECISION MAKING

1. Qualitative Factors – factors that cannot be expressed in money or other numerical units.
Examples: customer satisfaction, suppliers and employee morale
2. Quantitative Factors – factors that can be expressed in money or other numerical units. The two
quantitative approaches to decision making are:
✓ TOTAL approach: Total revenues and costs are determined for each alternative, and the results
are compared to serve as a basis for the decision to make.
✓ DIFFERENTIAL approach (a.k.a. incremental analysis): Only the differences or changes in costs
and revenues are considered.

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 TYPES of COSTS COMMONLY ASSOCIATED WITH DECISION MAKING

RELEVANT COSTS Future costs that are different among alternatives.

DIFFERENTIAL Increases or decreases in total costs resulting from choosing one option
COSTS over another.
AVOIDABLE COSTS Costs that will be saved or those that will not be incurred if a certain
decision is made.
OPPORTUNITY Benefit foregone or highest income sacrificed when an option is chosen
COSTS over another.
OUT-OF-POCKET Costs required for immediate or near future cash outlays based on a
COSTS particular decision.
SUNK COSTS Historical or past costs that cannot be avoided regardless of what decision
is made.

SHORT-TERM NON-ROUTINE DECISIONS

Short-term non-routine decisions are not covered by standard operating policies (SOPs) of an
organization which are normally codified in a manual. Repetitive or routinary transactions are the
ones covered by SOPs. Examples are policies on expense approval, collections, issuance of
checks, receipts of purchases, warehousing of inventories, selecting, hiring, and training of
personnel, and many other regular, ordinary, repetitive transactions.

NOTE: Differential (incremental) costs, avoidable costs, opportunity costs and out-of-pocket costs are usually considered
relevant in decision making while sunk and unavoidable costs are considered irrelevant.

TYPES of SHORT-TERM NON-ROUTINE DECISIONS

NATURE of ALTERNATIVES DESCRIPTION DECISION-MAKING GUIDELINES

1. MAKE or BUY Should a product or material be
a product or material internally manufactured (‘insource’)
(Outsourcing Decision) or bought from outside supplier
(‘outsource’)?
2. ACCEPT or REJECT Should a special order that requires
a special order a price lower than the regular
selling price be accepted or
rejected?
3. CONTINUE or Should a business segment (e.g.,
SHUTDOWN product line, division, department or
a business segment branch) be continued (‘keep’) or
discontinued (‘drop’)?
4. SELL or PROCESS Should a product, after undergoing
FURTHER the joint process, be sold at the
a product split-off point or be processed
further beyond the split-off point?
5. SCRAP or REWORK Shall be a substandard or obsolete
a product product be sold as scrap (‘junk’) or
be reworked (‘modify’)?
6. BEST PRODUCT Which product(s) should be given
COMBINATION priority in production, given limited
(Optimal Use of Scarcity) resources and/or market
limitations?
7. CHANGE IN PROFIT Should any of the profit factors such
FACTORS as selling price, unit sales, variable
(CVP Analysis in MAS-42C) cost, fixed cost and sales mix be
manipulated to increase profit?
Choose the option that has the lower
cost. In most cases, fixed costs are
irrelevant. Consider if there is any
opportunity costs.
Accept the order if the additional
revenue exceeds additional cost. In
most cases, fixed costs are irrelevant.
Continue if avoidable revenue is
greater than its avoidable costs. Any
allocated fixed cost to the segment is
usually considered irrelevant.
Process further if additional revenue
from processing further is greater than
further processing costs. Joint costs
are considered sunk costs and
irrelevant.
Rework if additional revenue after
rework is higher than rework costs.
The original cost or carrying value is
considered irrelevant.
Identify and measure constraint(s).
Allocate limited resources to products
from highest to lowest CM per unit of
limited resources.
Change the profit factor if it will cause
an improvement on the company’s
over-all profit position.

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OTHER TERMINOLOGIES ASSOCIATED WITH SHORT-TERM NON-ROUTINE DECISIONS

SHUTDOWN COSTS* Costs that will remain to be incurred even if a segment is

discontinued. [Irrelevant]
JOINT COSTS** Costs incurred in processing joint products until the split-off point.
[Irrelevant]
SPLIT-OFF POINT** The production stage where joint products are split into separate
and distinct products.
FURTHER PROCESSING Costs incurred in processing separate products beyond the split-
COSTS** off point. [Relevant]
BOTTLENECK Any particular operation where the capacity is less than the
RESOURCES*** demand placed upon it.
* connected with No. 3 above ** connected with No. 4 above *** connected with No. 6 above

• MAKE OR BUY
A part may be outsourced from a supplier based on the following reasons:
o Lack of technology, man labor hours, machine hours, systems expertise and financing
money
o Unprofitable operations
o Savings

The total relevant cost of each option should be taken when deciding to make or buy a part.
Whichever option gives a lower relevant cost would be a better alternative, assuming no
other quantitative factors are to be considered.

SAMPLE PROBLEM:
HYBE Corporation must decide whether it must continue to produce an engine component or buy it
from PLEDIS Philippines for P 2,500 each. The demand for the coming year is 20 units. The costs of
producing a single unit of the engine component are as follows:

Direct materials P 1,400

Direct labor 600
Factory Overhead (70% 1,000
fixed)
P 3,000

If HYBE buys the components, the facility now used to make the components can be rented out to
another firm for P 9,000.

REQUIRED:
A) Should BMW make or buy the components?
COST MAKE COST BUY
Price per
Direct materials 1,400.00 2,500.00
unit
Total cost
Direct labor 600.00 for 20 50,000.00
units
Factory Overhead Additional
300.00 9,000
(1000*30%) Income

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 Total relevant cost per unit 2,300.00 Net 41,000.00
Unit Cost
Total cost for 20 units
46,000.00 per unit 2,050.00

BMW should just buy the engine component from third party. The effect of buying the
component on company’s profitability is greater than if the entity will continue producing the
component.

• ACCEPT OR REJECT SPECIAL ORDER

In deciding whether to accept or reject a special order, the paramount consideration is incremental
profit.

If regular sales are lost due to the acceptance of special order, the lost contribution margin should be
deducted from incremental profit which may be determined as

Incremental revenue (inflows) P xx

Less: Incremental Cost xx
Incremental profit(loss) P xx

If there is no alternative use of the capacity, the incremental profit (loss) is the difference between
incremental sales and incremental costs and expenses.

The incremental profit (loss) from the special sales should be compared with the best benefit that may
be derived from the alternative use of the capacity to get the net advantage or disadvantage from
accepting the special sales order.

SAMPLE PROBLEM
The manufacturing capacity of JK Corporations facilities is 50,000 units of a product a year. A
summary of operating results for the year end December 31,2023 is as follows.

Total Per unit

Sales (38,000 units) 3,800,000.00 100.00
less: Variable costs and
expense 2,090,000.00 55.00
Contribution margin 1,710,000.00 45.00
less: Fixed costs and
expenses 900,000.00
Operating Income 810,000.00

A distributor company has offered to buy 12,000 units at 90 per unit during 2023. Assume that
all of the corporation’s costs would be at the same levels and rates in 2023 as to 2022.

Required: Should JK Corporation accept or reject the special order?

(Consider the ff cases independently)

a. The company has no alternative use for the idle capacity

Answer:
Incremental Sales( 12,000 x 90) 1,080,000.00

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 Incremental Cost (12,000*55) 660,000.00
Incremental Profit 420,000.00

The company should accept the special order since there is incremental profit.
Note: Fixed costs and expenses are irrelevant

b. The corporation can rent out the idle capacity for 200,000
Answer:
Incremental CM) 420,000.00
Rent Income 200,000.00
Incremental Profit 220,000.00

Since the incremental income from the accepting the special order is greater than
renting out the facility, the company should accept the special order.

c. The corporation can use the idle capacity to produce a new product that could contribute
600,000 in the contribution margin.
Answer:
Incremental Profit 420,000.00
Contribution Margin of New
product 600,000.00
Net Advantage of rejecting the
order -180,000.00

Reject the order and continue producing the new product.

• CONTINUE OR DROP A BUSINESS SEGMENT

A business segment represents a division, product line, department or business unit. The
profitability of a segment is measured by its segment margin.
▪ If segment margin is positive and contributes to the overall profitability of the
enterprise the segment shall be continued, assuming that there is no alternative use
if the segment is discontinued.
▪ If there is an alternative, compute the net benefit of the alternative

Segment margin is determined as follow:

Contribution margin Px
Less: avoidable fixed costs and expenses x
Segment margin x

Sales x
less: Variable costs x
Manufacturing Margin x
Less: Variable expenses x
Contribution Margin x
Less: Controllable direct fixed cost and
expenses x
Controllable Margin x
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 Less: Non controllable direct fixed cost and
expenses x
Segment Margin x
Less: Indirect (allocated) fixed cost and
expenses x
Operating Income x

SAMPLE PROBLEM
Jin company plans to discontinue a division with a P 200,000 contribution margin. Overhead allocated
to the division is P500,000, of which P50,000 cannot be eliminated. Should Francis Company
discontinue the division?

Answer:
The controllable margin is computed as follows:
Contribution Margin P200,000.00
Less: Avoidable cost (500,000-50,000) 450,000.00
Controllable Segment Margin 250,000.00

The segment should be discontinued. Doing such the loss will be eliminated and the profit will
increase by 250,000.

• SELL AT IS OR PROCESS FURTHER

Focus on incremental profit. If incremental costs of further process are greater than the incremental
cost then process the product further. The joint cost and all other cost of preceding process shall be
irrelevant.

SAMPLE PROBLEM
Tarlac Corporation produces three main products. Its production and costs data are given below:

X Y Z
Units sales price after further processing 300.00 550.00 220.00
Units sales price before further processing 250.00 530.00 190.00
Cost of further processing 120,000.00 65,000.00 190,000.00
Units produced and sold 2,000.00 4,000.00 7,500.00
Total joint cost 140,000.00

What product/s should be processed further?

Answer:
X Y Z
Units sales price after further processing 300.00 550.00 220.00
Units sales price before further processing 250.00 530.00 190.00
Cost of further processing 120,000.00 65,000.00 190,000.00
Units produced and sold 2,000.00 4,000.00 7,500.00
Additional unit price 50.00 20.00 30.00

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 Incremental Sales 100,000.00 80,000.00 225,000.00
Incremental Cost 120,000.00 65,000.00 190,000.00
Increase/Decrease in profit -20,000.00 15,000.00 35,000.00

Only produce product y and z.

• CONTINUE OPERATION OR SHUTDOWN (TEMPORARY)

Demands for products vary due to seasonal, cyclical or random variations. Products for
Christmas may not be saleable in other months. If operations are shut down the business will
still lose because of shut down cost-cost incurred even after operations temporarily stopped.
Business will also incur restart up cost once it resumes operations such as rehiring and
retraining personnel. Technically, if continuing the operations will result to sales greater than the
shutdown point, it is better to continue operating and be spared of more losses from
discontinuing operation. Shutdown point is the level of operations where the loss from
continuing is equal to the loss from discontinuing.

SAMPLE PROBLEM:
SVT Company produces and sells 140,000 units monthly except for the month of July and
August when the number of sales declines to 10,000 per month. If the management temporarily
shut down the following will be incurred:
▪ Security and maintenance amounting to 220,000 per month
▪ Restarting the business operation will cost 300,000
▪ The business incur 24M fixed cost annually and is allocated per month. This fixed
cost is expected to drop by 60% during the months that the operation is shutdown.

Other sales and costs are the following

Unit Price P300
Unit Variable Cost 140
Unit Variable Expenses 40

Required:
a. How much is the total shut down cost?

Answer:
Allocated fixed Cost 1,600,000.00 24,000,000*(2/12)*0.4
Security and insurance 440,000.00 220,000*2
Restart up Cost 300,000.00
2,340,000.00

b. What is the shutdown point?

Answer:
Fixed Cost less
Quantity Sold = Shutdown Cost
Unit Contribution
Margin

Quantity Sold = 1,660,000.00 ((24,000,000*2/12)-

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 2,340,000)
120
= 13833.33333

To check:
Contribution Margin = 1,660,000.00 (13,833.3333333333*120)
Less: Fixed Cost and
Expenses 4,000,000.00
loss from continuing -2,340,000.00
Shut down Cost 2,340,000.00

Note: Shutdown point is where loss from continuing equals the shutdown cost

c. Continue or Shutdown?

Contribution Margin (10,000*2*120) 2,400,000.00

less:Fixed Cost 4,000,000.00
Loss from Continuing business -1,600,000.00
less:Shut down cost -2,340,000.00
Advantage of continuing operation 740,000.00

SVT should continue because there is ad advantage of continuing the business. The loss to
be incurred if the operation will shutdown is greater than the loss if the operation will
continue.

• SCRAP OR REWORK
There are products that do not meet the standard production specifications. In deciding whether to
sell as a scrap or rework, the profit from reworking should be compared with the profit of selling as
a scrap without regard to the past costs of producing the product.

SAMPLE PROBLEM:
A company has 5,000 obsolete cutting supplies carried in inventory at a manufacturing cost of P 40
per unit. If the toys are reworked for P8 per unit, they could be sold for P12 per unit. If the toys are
scrapped, they could be sold for a total of P15,800.

Required:
1. Should the company sell the cutting supplies as scrap or rework?

Answer: REWORK

Incremental profit from reworking

(12-8*5,000) = 20,000.00
Incremental profit from selling as
scrap = 15,800.00
Net advantage of working 4,200.00

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 Note: The manufacturing cost of P40 per unit is a sunk cost.

• OPTIMAZATION OF SCARCE RESOURCES

Resources will always be limited. To optimize scarce resources, sales, and production should be
allotted to a product that gives the highest profit per scarce resource.

Contribution Margin per hour= Unit Contribution Margin/ Hours per Unit

SAMPLE PROBLEM
Kapos Company produces products A, B and C. One machine is used to produce the products. The sales
demands, contribution margins and time on the machine (in hours) are as follows:

Market Limit Unit Contribution Hours on Machine

Margin
A 100 units P 20 10 per unit
B 80 units P 18 5 per unit
C 150 units P 25 10 per unit

There are 2,400 hours available on the machine during the week. Total fixed cost is P 3,000.

REQUIRED
What is the best product combination that maximizes the weekly contribution?
a. 90 units of A; 0 unit of B; 150 units of C
b. 50 units of A; 80 units of B; 150 units of C
c. 100 units of A; 80 units of B; 100 units of C
d. 100 units of A; 80 units of B; 150 units of C

Market Unit Contribution Hours on CM per No of

Total hours
Limit Margin Machine Hr Units
A 100 units 20 10 per unit 2.00 500 50
B 80 units 18 5 per unit 3.60 400.00 80
C 150 units 25 10 per unit 2.50 1,500.00 150
2,400.00

Answer:

50 units of A; 80 units of B; 150 units of C

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