Group 4

LECTURE 5

Short-Run Decision Making

 INTRODUCTION

 One of the important functions of Management Accounting is

decision making.
 Decision-making involves choosing between alternatives.
 Decision making could involve short and long run decisions.
 Short-run decisions involves decisions relating to short-time
horizon and are non-routine in nature.
 Making short-run decisions requires that only those costs and
revenues that are relevant to the alternatives are considered.
 If irrelevant cost and revenue data are included, the wrong
decisions may be made.
 It is therefore essential to identify the relevant costs and
revenues that are applicable to the alternatives being
considered.

Group 4 Participants. Memba 7. Lagos Business School 2-2

 TYPES OF SHORT-RUN DECISIONS

We begin by explaining the concept of relevant cost and

applying this principle to short-run decision making
relating to the following:
1. special selling price decisions;
2. product mix decisions when capacity constraints
exist;
3. decisions on replacement of equipment;
4. outsourcing (make or buy) decisions;
5. discontinuation decisions.

Group 4 Participants. Memba 7. Lagos Business School 2-3

 RELEVANT COSTS & REVENUES

 Relevant Costs & Revenues Concept

The relevant financial inputs for decision-making purposes
are those future cash flows, which will differ between the
various alternatives being considered. In other words, only
differential (or incremental) cash flows should be taken
into account, and cash flows that will be the same for all
alternatives are irrelevant.
 Sunk Cost
Decision-making is concerned with choosing between
future alternative courses of action, and nothing can be
done to alter the past, past costs (also known as sunk
costs) are not relevant for decision-making.

Group 4 Participants. Memba 7. Lagos Business School

 RELEVANT COSTS & REVENUES CONTD.

 Identifying Relevant & Irrelevant Costs

In identifying relevant and irrelevant costs, the
following principles are important
considerations;
• Relevant costs: are future costs that differ
between alternatives;
• Irrelevant costs: consist of sunk costs,
allocated costs and future costs that do not
differ between alternatives.

Group 4 Participants. Memba 7. Lagos Business School 2-5

 DEFINITION OF TERMS

 Sunk costs
These are costs that have been incurred by a decision made in the past and that
cannot be changed by any decision that will be made in the future.
 Relevant costs and revenues
These are future costs and revenues that will be changed by a particular decision,
whereas irrelevant costs and revenues will not be affected by that decision.
 Limiting factors
These are scarce resources that constrain the level of output.
 Opportunity costs
These are costs that measure the opportunity that is sacrificed when the choice of
one course of action requires that an alternative is given up.
 Committed Fixed Costs

 Discretional Fixed Costs

 Opportunity Costs

Group 4 Participants. Memba 7. Lagos Business School 2-6

 OUTSOURCING/MAKE OR BUY DECISIONS

 Outsourcing:
This is the process of obtaining goods or services from outside
suppliers instead of producing the same goods or providing the same
services within the organization.
Decisions on whether to produce components or provide services
within the organization or to acquire them from outside suppliers, are
called outsourcing or ‘make-or-buy’ decisions.
 Decision Criteria:
Choose the lower of; ₦
(A) Suppliers Price xx
₦
(B) Marginal Cost of Producing xx
Opportunity Costs xx
xx
Group 4 Participants. Memba 7. Lagos Business School 2-7
 OUTSOURCING/MAKE OR BUY DECISIONS

Example 1
The management of Dawn Fraser Ltd is considering the next years budget.
One of the intermediate product of the company has a budget as follows:
₦
Direct Material 14
Direct Labour (4hrs @ ₦3) 12
Variable Production Overhead 8
Fixed Production Overhead 20
54
Shane Gould has offered to supply the above unit at 50 per unit.
Required;
Advice the management of Dawn Fraser whether the component be
purchased or produced internally.

Group 4 Participants. Memba 7. Lagos Business School 2-8

 OUTSOURCING/MAKE OR BUY DECISIONS

Group 4 Participants. Memba 7. Lagos Business School 2-9

 DISCONTINUING A PRODUCT LINE

 Deleting a Product Line

The objectives of an organization is often categorized into financial and non-
financials. One of the financial objective of an organization is profit maximization.
Most organizations periodically analyse profits by one or more cost objects, such as
products or services, customers and locations. Periodic profitability analysis can
highlight unprofitable activities that require a more detailed appraisal (sometimes
referred to as a special study) to ascertain whether or not they should be
discontinued.
 Decision Criteria:
₦ ₦
Sales Price xx
Less:
Marginal Cost xx
Discretionary Fixed Cost xx
Opportunity Costs xx xx…...
Accept/(Reject) xx/(xx)
Group 4 Participants. Memba 7. Lagos Business School 2-10
 DISCONTINUING A PRODUCT LINE CONTD.

Example 2
Adabale has three products A, B and C to which the following information
relates:
Products A B C
₦’000 ₦’000 ₦’000
Sales 10,000 12,000 15,000
Variable Costs 3,000 7,000 12,000
Fixed Costs 4,000 3,000 7,000
Profit/(Loss) 3,000 2,000 (4,000)
The Directors of Adabale are considering dropping product C since the product
is unprofitable
a. You have been appointed by the company to help evaluate its decision.
b. What other qualitative factors could the company consider before making its
decision.

Group 4 Participants. Memba 7. Lagos Business School 2-11

 DISCONTINUING A PRODUCT LINE CONTD.

Question 2
Dagunduro is an aluminum fabricating coy which is listed on NYSE. The company recently released its
Q1 results. Extracts on the company’s operating statement by region is shown below:
Region Europe America Africa
$’m $’m $’m
Sales 2,400 3,200 1,800
Variable Costs 1,200 1,800 1,200
Fixed Costs 900 900 1,200
Profit/(Loss) 300 ,500 (600)
The Africa operations fixed costs comprises of 1/3 discretionary fixed costs and 2/3 committed fixed
costs.
Dagunduro is considering shutting down operations in Africa due to poor operating results. If the
company closes its operation in Africa, the factory could be leased to a local competitor at $0.8m
annually.
The Directors of Dagunduro has appointed you as an expert in the field of Management Accounting to
help evaluate its decisions.
a. Should the company discontinue their operations in Africa?
b. What other qualitative factors could the company consider before making its decision.

Group 4 Participants. Memba 7. Lagos Business School 2-12

 SPECIAL PRICING/ACCEPTANCE OF SPECIAL ORDER

 Special Pricing/Acceptance of Special Order

Special pricing decisions relate to pricing decisions outside the main
market. Typically, they involve one-time-only orders or orders at a price
below the prevailing market price.
 Decision Criteria:
₦ ₦
Sales Price (Quoted) xx
Less:
Marginal Cost xx
Opportunity Costs xx xx…...
Accept/(Reject) xx/(xx)

Group 4 Participants. Memba 7. Lagos Business School 2-13

 SPECIAL PRICING/ACCEPTANCE OF SPECIAL ORDER
CONTD.

Example 3
Oribogunje is presently operating at 80% of installed capacity. The company produces
and sell food packs around Onigbongbo. The company currently produces 4,000 food
packs daily. Below is its standard cost card;
₦
Direct Material Cost 200
Direct Labour Cost (3hrs @ ₦40) 120
Variable Production Overhead 80
Fixed Overhead 50
Full Cost 450
Selling Price 520
The company has been approached by Alariwo to take advantage of its spare capacity.
Alariwo is into the supply of food packs to Lagos State Government schools. Alariwo
agreed to pay ₦420 for each food pack.
a. Based on the above data should Oribogunje accept or rejects the offer?
b. What other factors should the company consider beside the quantitative factors?

Group 4 Participants. Memba 7. Lagos Business School 2-14

 LIMITING FACTOR DECISIONS

 Limiting Factor
This refers to any factor that hinders an entity in achieving its set
goals or objectives. Limiting factor could be anything that act as
constraint in the achievement of a desired result. It could either be
internal or external to the organisation. Internal constraints often
involves resources and capacity such as finance, scarcity of
resources, limited storage space, lack of skilled labour, lack of man
hour etc. Externally it could be sales volume, sales value etc.
 Steps in solving limiting factor problems
1. Identify the constraint/ limiting factor
2. Calculate the contribution per product
3. Calculate the limiting factor per product
4. Rank the product based on the limiting factor per product
5. Allocate resources based on the ranking
Group 4 Participants. Memba 7. Lagos Business School 2-15
 LIMITING FACTOR DECISIONS

Example 4
Alagomeji produces and sells three products; A,B and C in a pack. Product A consist of 8
units in a pack, Product B 12 units in a pack and Product C 5 Units in a pack. The
standard cost card of the products are shown below;
Products A B C
Cost Per Pack ₦ ₦ ₦
Direct Material Cost 500 350 400
Direct Wages 200 150 250
Variable Production Cost 120 100 200
Fixed Production Cost 80 50 100
Total Cost/Pack 900 650 950
Selling Price/Pack 1,050 740 1,080
Production Capacity (Monthly) 5,000 8,000 12,000
Due to the recent fire outbreak that consumed one of the three warehouses of the
company, the remaining two warehouses could only store a maximum of 21,000 products
of the company monthly.
As the Management Accountant to the company, prepare a statement which will enable
you to advise management on the most profitable production plan.
Group 4 Participants. Memba 7. Lagos Business School 2-16
 LIMITING FACTOR DECISIONS

Question 3
Akufo produces and sells three products; X,Y and Z. The standard cost card of the
products are shown below;
Products X Y Z
₦ ₦ ₦
Direct Material Cost 20 15 20
Direct Wages 10 15 18
Variable Production Cost 8 11 12
Fixed Production Cost 6 4 10
Total Cost 44 45 60
Selling Price 50 48 65
Monthly Capacity 12,000 15,000 10,000
Aguda has requested for a mix of the companies products (i.e. X,Y and Z) to the tune of
₦1.5m for the next coming month in any order.
As the Management Accountant to the company, prepare a statement which will enable
you to advise management on the most profitable sales plan.

Group 4 Participants. Memba 7. Lagos Business School 2-17

 LIMITING FACTOR DECISIONS

Question 4
Akufo produces and sells three products; X,Y and Z. The standard cost card of the
products are shown below;
Products X Y Z
₦ ₦ ₦
Direct Material Cost 20 15 20
Direct Wages 10 15 18
Variable Production Cost 8 11 12
Fixed Production Cost 6 4 10
Total Cost 44 45 60
Selling Price 50 48 65
Monthly Capacity 12,000 15,000 10,000
Aguda has requested for a mix of the companies products (i.e. X,Y and Z) to the tune of
15,000 units for the next coming month.
As the Management Accountant to the company, prepare a statement which will enable
you to advise management on the most profitable sales plan.
What other factors does the company needs to consider in its decision.
Group 4 Participants. Memba 7. Lagos Business School 2-18
 Group 4

END

LECTURE 5