Accounting for Managers

Module 12: Managerial Decisions

Managerial Decision-Making
Differential Analysis

• Involves looking at all possible scenarios of a decision but ignoring some costs that are not
relevant
• Key terms:
• Differential cost (relevant cost): difference in cost between two choices
• Differential revenue (relevant benefits): difference in revenue between two choices
• Sunk cost: cost that has already occurred and is unavoidable
• Avoidable cost: cost that can be eliminated depending on decision
• Opportunity cost: potential benefit given up if alternative decision is made
• Must look at all costs involved then determine which ones matter for decision we are making
Qualitative Factors

• Affect quality of life rather than your bank account

• less time at home, home office takes up space in home, etc.
• Decision that looks great financially may cause quality changes that make choice less
attractive
• Based more on quality of particular situation as opposed to quantitative decisions that are
mostly about money
Role of Data in Business
Add or Drop Decisions

• Managers must decide which product lines are continued, added, or dropped
• based only on relevant costs involved in process
• Costs can outweigh revenues
• must evaluate and analyze to determine what items to manufacture, offer as services, or stock on shelves
• Variable and direct fixed costs are avoidable costs
Example: Add Drop Decisions Table

• Morrie’s Grocery. Ice Cream Cooler – What Should we Stock?

Cost Vanilla Chocolate Strawberry Neapolitan Butter Pecan

Category (in
USD)
Sales 1,000 1,200 900 700 1,050
Variable 400 720 270 490 577.5
Costs
Contribution 600 480 630 210 472.5
Margin
Direct Fixed 100 180 90 105 105
Costs
Allocated 150 180 135 140 157.5
Fixed Costs
Net Income 350 120 405 -35 210
Additional Managerial Decisions

• Make or Buy decisions

• Sell or Process Further decisions
• Example: Flower Power, Inc.: Sell or Process Further
Cost Category (in Course Flour Fine Flour Bread Flour
USD)
Sales value after all $34,000 $50,000 $31,000
processing
Less: Sales value at $30,000 $40,000 $20,000
the split-point
Incremental revenue $4,000 $10,000 $11,000
from further
processing

Less: cost of bagging $5,000 $5,000 $5,000

Profit (loss) from ($1,000) $5,000 $6,000

bagging the flour
Special Order Decisions

• Special order is a one-time order that is not part of a company’s regular business operation
• Effective analysis must be done to insure that special order will bring additional revenue to a
company
Cost-Plus or Target Costing Decisions

• Cost-plus pricing is when company figures out total cost of product and adds the profit as a
“mark-up” above the cost
• Price-makers: get to decide price
• Target costing involves looking at what company wants for a profit, price for product, and
how to cut costs to reach desired profit
• Price-takers: need to price based on market average or to meet pricing market will bear
• Pressure is put on buyers at company to find lowest priced components in order to lower
costs and create desired profit
Quick Review

Navigating costs will be helpful in your job

Learning how to price product may be important component of your work

Instances where company was losing money with every item sold

Knowing as a manager what products to keep and which processes to outsource can help make
company more profitable