CHAPTER 7: MANAGEMENT

DECISION MAKING
INFORMATION AND THE DECISION
PROCESS
 A decision model is a formal method of making a choice,
and it often involves both quantitative and qualitative
analyses
 Management accountants work with managers by
analyzing + presenting relevant data to guide decisions
THE CONCEPT OF RELEVANCE
 Relevant costs are expected future costs and relevant
revenues are expected future revenue that differ among
the alternative courses of action being consider
 Relevant costs and relevant revenue must
 Occur in the future
 Differ among the alternative courses of action
 Qualitative and quantitative relevant information:
 Outcomes of decisions can be quantitative and/or
qualitative
 Quantitative factors: outcomes measured in numerical
terms (revenue, costs, number of units of product…)
 Qualitative factors: outcomes that are difficult to measure
accurately in numerical terms (eg. employee
moral/loyalty, customer satisfaction, company
reputation/image)
ACCEPTING/REJECTING DECISION
 One-Time-Only Special Orders: refer to
accepting/rejecting special orders when there is idle
capacity + the orders have no long-run implications
 If the incremental costs of the order are smaller than the
revenue from the order, the order should be accepted
 In case of full capacity, accepting the order will generate
benefits foregone, ie. opportunity costs of the order. The
order can be accepted if the revenue of the order is
greater than the sum of incremental costs of the order
and the opportunity costs of such order
INSOURCING-VERSUS-OUTSOURCING
AND MAKE-VERSUS-BUY DECISIONS
 Outsourcing and Idle Capacity:
 Outsourcing is purchasing goods + services from
outside vendors rather than insourcing
 If incremental costs (additional cost incurred for an
activity) of insourcing is more than purchasing price
 buy/outsource
 Survey indicate that quality, dependability on
suppliers, and costs are the most important factors in
the make-or-buy decisions
 Sometimes, qualitative factors dominate
 Strategic and Qualitative Factors: affect outsourcing
decisions:
 Outsourcing decisions should be in line with
strategies of the company, should not be in conflict
with strategies
 Qualitative factors (quality of product, time of
delivery, dependency on suppliers, employee
moral…) are of concern
OPPORTUNITY COSTS AND
OUTSOURCING
 Deciding to use a resource in a particular way causes a
manager to forgo the opportunity to use the resource in
alternative ways  this lost opportunity is a cost
 OC is the contribution to operating income that is
forgone by not using a limited resources in its next-best
alternative
 When capacity is constrained, the relevant revenue +
costs of any alternative equal the incremental revenues
and costs plus the OC
 To select an option from many (more than 2) options,
OC will be the highest value of benefits forgone
 OC are not incorporated into formal financial accounting
records, because financial accounting records actual
transactions occurred, not (transactions of) alternatives
rejected
PRODUCT-MIX DECISIONS WITH
CAPACITY CONSTRAINTS
 Product-mix decisions are about which products to sell +
in what quantities
 Managers should choose the product with the highest
contribution margin per unit of the constraint resource
 Constraint resource

 limits/restricts the company from maximizing its

profit
 can be machine, skilled labour, land, capital…
AC LTD. PRODUCES PRODUCTS A & B.
MACHINE HOURS ARE 5000 EACH
MONTH
A B
Quantity 3000 units 2000 units
demanded/month
Selling price $20 $45
Variable cost/unit 12 25
Contribution margin/unit 8 20

Machine hours/unit 1 2
CM/machine hours 8 10
Rank 2 1

Product mix is 1000 units of A + 2000 units of B

CONTINUE/DISCONTINUE A CUSTOMER
 Relevant-Revenue and Relevance costs analysis of dropping a
customer:
 If operating income will be lower because of dropping a
customer, then the customer should not be dropped
 Rent, general-administration, and corporate-office costs are
irrelevant as they do not change if dropping a customer
 Depreciation is irrelevant as depreciation is past costs
 OC of having a customer is relevant
 Relevance-Revenue and Relevance- Costs Analysis of adding
a customer
 if incremental revenues > incremental costs, such customer
should be added
 Rent, general-administration and corporate-office costs are
irrelevant as they do not change
 Cost of new equipment for new customer is relevant
 Depreciation is irrelevant b/c of past costs
 Relevance-Revenue and Relevance - Costs Analysis of
Closing Branch Offices/Segments:
 If revenue loss exceeds cost saving leading to a
decrease in operating income, branch/segment should
not be closed
 Depreciation is a past cost hence irrelevant
 Corporate office costs are irrelevant as they do not
change
 Relevance-Revenue and Relevance - Costs Analysis of
Adding Branch Offices/Segments:
 If operating income increases, office/segment should
be added
 Cost of new equipment is relevant
 Corporate-office costs are irrelevant
EQUIPMENT REPLACEMENT
DECISIONS
 Book value of existing old equipment is a past cost
hence irrelevant
 Current disposal value of old machine is relevant as
it is an expected future benefit that will occur if the
machine is replaced
 Loss on disposal = disposal value – book value, so
each will be considered separately
 Cost of new machine is relevant as it is future
expected cost that occur if the machine is replaced