The Managerial Accountant’s Role in

Decision Making

Managerial
Accountant

Cross-functional
management teams
who make
Designs and implements
production, marketing,
accounting information
and finance decisions
system

Make substantive
economic decisions
affecting operations
14-1
 The Decision-Making Process
1. Clarify the Decision Problem

2. Specify the Criterion

3. Identify the Alternatives

Quantitative
Analysis
4. Develop a Decision Model

5. Collect the Data

6. Make a Decision
14-2
 The Decision-Making Process
1. Clarify the Decision Problem

2. Specify the Criterion

Primarily the
responsibility of the 3. Identify the Alternatives
managerial
accountant.
4. Develop a Decision Model

5. Collect the Data

Information should be:
1. Relevant
2. Accurate 6. Make a Decision
3. Timely
14-3
 The Decision-Making Process
1. Clarify the Decision Problem

2. Specify the Criterion

3. Identify the Alternatives

Qualitative
Considerations 4. Develop a Decision Model

5. Collect the Data

6. Make a Decision
14-4
 The Decision-Making Process
1. Clarify the Decision Problem
Relevant
Pertinent to a
decision problem. 2. Specify the Criterion

Accurate
3. Identify the Alternatives
Information must
be precise.
4. Develop a Decision Model

Timely 5. Collect the Data

Available in time
for a decision
6. Make a Decision
14-5
 Relevant Information
Information is relevant to a decision problem
when . . .
1. It has a bearing on the future,
2. It differs among competing alternatives.

14-6
 Identifying Relevant
Costs and Benefits
Sunk costs
Costs that have already been incurred. They do
not affect any future cost and cannot be
changed by any current or future action.

Sunk costs are irrelevant to decisions.

14-7
 Other Issues in Decision Making

Short-Run
Incentives for Versus
Decision Makers Long-Run
Decisions

14-8
 Analysis of Special Decisions
The Text Book takes you through some special decisions
faced by many businesses:

1. Accept or Reject a special order

2. Outsource a Product or Service
3. Add or Drop a Service, Product or
Department
4. Special Decisions in Manufacturing
5. Decisions Involving Limited Resources
14-9
 Other Issues in Decision Making
Pitfalls to Avoid

Sunk Allocated
costs. fixed costs.

Unitized Opportunity
fixed costs. costs.
14-10
PROBLEM

The electric manufacturing company is engaged in producing a

variety of precision instrument and other specialized electric
components.
The company is presently following a policy of pricing all of its
products at 150% of the total variable cost of producing and selling
them. Recently, the Government has invited tenders for 1,000
electric components to be used at TV stations.
The company’s management is exploring the possibility of the firm
entering the Government Contract. The management accountant
has prepared the following cost estimates for the purpose.

11
Direct Materials 800,000
Direct Labour 550,000
Variable Manufacturing Overheads 225,000
Fixed Manufacturing Overheads 300,000
Production Setup costs 125,000
Special Tools and dyes 300,000
2,300,000

Unit Cost (Rs. 2,300,000/1,000 = Rs. 2,300

12
The Government Contract requires delivery of all 1,000 units within
one year. In order to meet schedules, the company would have to
forego regular sales order of the value of Rs. 2,250,000. Special
tool and dyes will have no sale value after their use.

You are required:

State the lowest price the company could bid on the contract for the
components without sacrificing short-term profit. State your
assumptions, if any.

13
SUGGESTED SOLUTION:

Statement Showing the Lowest Price of the Tender to be

Quoted Increment Costs
Rs.
Direct Materials 800,000
Direct Labour 550,000
Variable Overheads 225,000
Production set-up costs 125,000
Special tools and dyes 300,000
2,000,000

Add: Opportunity Cost (Reduction in Regular sales)

Contribution Sacrificed (2250,000x50/150) 750,000
Total Relevant Costs 2,750,000
14
Thus, Rs. 2,750,000 is the lowest bid price the company should
quote to carry out the contract for supplying 1,000 electric
components.

Assumptions:
(a) Fixed manufacturing overheads are allocated costs and not
incremental costs.
(b) Company would be able to recapture regular sales order of Rs.
2,250,000 now foregone in future years.

15
PROBLEM
A company has been making a machine to order for a customer,
who has since gone into liquidation with no prospects to obtain any
money from winding up of the company.
Costs incurred to date in manufacturing the machine are Rs. 50,000
and progressive payments of Rs. 15,000 had been received from the
customer prior to the liquidation.
The sales department has found another company willing to buy the
machine for Rs. 34,000 once it has been completed.
To complete the work, the following costs would be incurred:
(a) Materials: these have been bought at a cost of Rs. 6,000. they
hare no other user, and if the machine is not finished, they
would be sold for scrap for Rs. 2,000.
(b) Further labour costs would be Rs. 8,000. labour is in short
supply, and if the machine is not finished, the work force would
be switched over to another job, which would earn Rs. 3,000 in
16
 revenue, and incur direct cost of Rs. 12,000 and absorbed
(fixed) overhead of Rs. 8,000.
(c) Consultancy fee Rs. 4,000 will be paid. if the work is not
completed the consultants contract would be cancelled at a cost
of Rs. 1,500.
(d) General overheads of Rs. 8,000 would be added to the cost of
additional work.

You are required:

(i) Should the new customer’s offer be accepted?

(ii) Given reasons of including and excluding the expenses from the
above cost calculation.

17
SOLUTION

Cost of Offer
1 Cost incurred Rs. 50,000
2 Progressive payments Rs. 15,000 Nil
3 Material cost Nil
4 Labour cost 2,000
5 Add: Opportunity cost 8,000
Revenue 30,000
Less: direct cost 12,000
18,000
6 Fixed overheads Rs. 8,000 Nil
7 Consultancy Fee 2,500
8 General overheads 8,000
Cost to complete the machine 38,500
Offer Price 34,000
Loss 4,500
18
(i) The Customer’s offer should not be accepted.
If general overheads are allocated then total cost Rs. 30,500 and
benefit of Rs. 3,500, the offer can be accepted.
(ii) Reasons for inclusion or exclusion:

1. Sunk cost not be included.

2. Irrelevant cost/revenue.
3. Rs. 6,000 is not relevant, past cost only the ne realizable value
is taken.
4. Direct cost.
5. Net contribution loss if the Labour is used in completion.
6. Allocated cost not relevant they are unavoidable.
7. Rs. 4,000 will be paid but only avoidable cost is relevant (4,000
– 1,500) = Rs. 2,500 is because of completing the job.
8. Specifically incurred on additional work (If allocate than
exclude).
19
PROBLEM
Company C wishes to discover how sensitive their new project is to
the adversities that may face it. Due to uncertain economic
conditions there is every possibility that the capital costs are
increased, revenues are decreased and costs increased.
All the information needed for evaluation is given below:
(i) Capital Costs
(a) Initial expenditure Rs. 250,000
(b) Life 10 years.
(c) Scrap value Rs. 25,000
(ii) Revenue (per annum)
(a) Sales Volume 10,000 units
(b) Selling Price Rs. 20 per unit
(iii) Cost
(a) Labour Rs. 4 per unit
(b) Material Rs. 8 per unit
(c) Fixed Rs. 30,000 per annum
20
You are required:

(a) Identify the area which makes the project most vulnerable and
to which the management has to focus their attention.
(b) What further evaluation is Required by the management in that
sensitive area.

21
SOLUTION

Per Total
Sensitive Analysis Unit(Rs.) (Rs.)
Cost of Project 250,000
Sales (10,000) 20 200,000
Variable Cost
Material 8
Labour 4 12 120,000
Contribution 8 80,000
Fixed Cost 30,000
Pre-depreciation Profit 50,000
Depreciation (225,000/10) 22,500
Net Profit: 27,500
Rate of Return (27,500 ÷ 250,000 × 100) 11%

22
1.
Volume reduces by 10%
Decrease in contribution will be (42000 - 22,500)
= 19,500
Return on investment (19,500 ÷ 250,000 × 100) 7.8%

2. Rs.
Drop in selling price by 10% 18
12
Contribution 6
Total contribution (10,000 x 6) 60,000
Fixed Cost 30,000
Depreciation 22,500
Profit 52,500
Return on investment (7,500 ÷ 250,000 × 100) 7,500
3%
23
3.
Increase in variable cost by 10%
Selling Price 20.00
Variable cost (12 x 1.10) 13.20
Contribution 6.80
Total contribution 68,000
Fixed Cost & Depreciation 52,500
16,500
Return on investment 6.2%

24
(a) The area which is most vulnerable is the sale price, dropping
sale price by 10% has greater impact of Return on Investment.
ROCE is reduced from 11% to 3%.
(b)
(i) Demand at various price levels.
(ii) Procedure of setting sale price.
(iii) Company’s history about pricing product.
(iv) Supply and demand forces effecting price of the company’s
product.

25
PROBLEM

The Modern furniture Company Ltd. has got an offer for the
purchase of 5,000 Chairs at price of Rs. 400 per unit. The
management feels that by accepting this offer, there will a saving of
Rs. 10 per unit in material cost on all units manufactures; the fixed
overhead will increase by Rs. 350,000 and overall working hours
efficiency will drop by 2% on all production.
Being a senior financial Cost Analyst you have been requested by
the Chief Executive of the Company to evaluate the proposal / offer
by giving the recommendation as to whether or not the offer should
be accepted.

26
 The Company record presents the following information for the past
year.
Per Total (Rs.)
Unit(Rs.)
Material Costs 100 Rs. 1,200,000
Labour Costs 200 Rs. 2,400,000
Fixed overheads 100 Rs. 1,200,000
Variable Overheads 50 Rs. 600,000
Selling Price Rs. 500 per unit
Units Produced 12,000

Variable Overhead is based on labour working hours.

27
SUGGESTED SOLUTION:

Present Proposal
Condition Accepted
Units Units
Units Produced 12,000 17,000
Rs. '000 Rs. '000
Sales 6,000 8,000
Variable Cost of Sales
Material 1,200 1,530
Labour 2,400 3,468
Variable overhead 600 867
Total Variable Cost of manfg 4,200 5,865
Contribution 1,800 2,135
Fixed Cost 1,200 1,550
Profit 600 585

28
Decision:
The Company should reject the proposal on the basis of
profitability. Other factors should also be considered.
Working Notes:

1 Material Cost = 1,200,000 x 17,000 1,700,000

12,000
Less: Discount on bulk purchase (170,000)
Net Material Cost 1,530,000
2 Labour Cost = 2,400,000 x 17,000 3,400,000
12,000
Add 2% Decrease in efficiency in labour hours 68,000
Net Labour Cost 3,468,000
3 Variable OH = 600,000 x 17,000 850,000
12000
Add 2% Decrease in efficiency in labour hours 17,000
Total variable overhead 867,000
29