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Shortterm Decision Making

The document discusses short-term decision making concepts including determining the appropriate sales mix when there are limiting factors, accepting special orders if the price is higher than the variable cost per unit, dropping loss-making products if they do not contribute, and making or buying decisions based on comparing variable and fixed costs. Several examples and activities are provided to demonstrate how to apply these concepts to make optimal short-term business decisions.

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58 views

Shortterm Decision Making

The document discusses short-term decision making concepts including determining the appropriate sales mix when there are limiting factors, accepting special orders if the price is higher than the variable cost per unit, dropping loss-making products if they do not contribute, and making or buying decisions based on comparing variable and fixed costs. Several examples and activities are provided to demonstrate how to apply these concepts to make optimal short-term business decisions.

Uploaded by

chrystila0307
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOC, PDF, TXT or read online on Scribd
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Short-term Decision Making

Marginal costing and management decisions in short run


Concept of Marginal Costing is very useful in making managerial decisions in the short run.
Determining the appropriate sales mix
a) When there are limiting factors the firm should select the best sales mix by considering those
factors.
Factors which limits indefinite expansion of on organization or earning of profit are called
limiting factors.
e.g. Finance, Sales, Row material, Skilled labour etc.
Steps:
i. Ascertain the contribution
ii. Ascertain the contribution per limiting factor
iii. List the order of preferences

Activity 1
A Company is producing 4 products and planning it’s production mix for the next period.
Estimated cost, sales and production data are given below.
Product W X Y Z
Selling price per unit 20 30 40 36
Labour (2/= per hour) 6 4 14 10
Material (1/= per kg) 6 18 10 12
Maximum demand (units) 5,000 5,000 5,000 5,000

Based on the above data, what is the most appropriate sales mix if;
I. Labour hours are limited to 50,000 hours in a period
II. Materials are limited to 110,000 Kg in a period.

b) Acceptance of a special order


Special order is an order, under terms different from terms for normal sales. Such an order
can be considered only if the organization has not utilized its capacity to the fullest extent.
In this decision the fundamental criteria whether to accept or not, is based on the
comparison of the variable cost with the price in the special offer. If proposed selling price
of the special offer is higher than the variable cost per unit, the order can be accepted.

Activity 2
X Ltd manufacture& market a drink which they sell at Rs.20 per bottle. Current output is
400,000 bottles per month, which represent 80% of capacity. They have the opportunity to
utilize their surplus capacity by selling the drink at Rs.13 per bottle to a super market, which
will sell it as an own labeled product. Total cost for the last month was Rs.5,600,000 out of
which 1,600,000were fixed cost.

Based on the above data, write a report to the Board of Directors stating whether to accept
this special order and the other factors that has to be considered in making the decision.

c) Dropping a loss making product


When a company is producing a range of products, which include a product incurring
losses, business will have to decide whether such product to be discontinued. This decision
can also be taken by comparing variable cost and the selling price. In other words, by
determining whether the product is having a contribution. If the loss making product is
having a contribution, it is profitable to continue the product.
Activity 3
X Company has a range of products of which revenue and cost data are as follows
X (Rs.) Y (Rs.) Z (Rs.)
Sales 32,000 50,000 45,000
Total cost 36,000 38,000 34,000

The total cost comprises of 1/3 of the fixed cost. The Marketing manager of the
Company argues that product X is making losses and hence it should be
discontinued. The Managing Director of the organization seeks your advice on the
issue.

d) Make or Buy Decisions


Frequently the management is faced with the decision whether to make a particular product
or component or whether to buy it from outside. A part from over riding the technical
reason the decision is usually based on an analysis of the cost indicators. Under these types
of decisions the most important factor is that the costs are divided into fixed and variable
cost. Any purchase price payable to an outsider may be compared with any cost which can
be saved unless the production is made.
Activity 4
A firm manufactures component “XL 200” and the cost for the production at current
level of 50,000 units are as follows
Cost per unit (Rs.)
Raw material 2.50
Labour 1.25
Variable O/H 1.75
Fixed O/H 3.50

Component “XL 200” could be bought for Rs.7.75 and if so, the production capacity
utilized at present would be unused. Decide whether “XL 200” to be manufactured or
purchased. Show the effect on profit based on your calculations.

Practice Questions
Acceptance of a Special Order
Alpah Ltd. Manufacturers market a special brand of soap which they sell for Rs.50/= per price.
Current output is 22,500 pieces per month, which represents 75% of full capacity. The total cost
for the last month were Rs.800,000/= out of which Rs.125,000 were fixed cost.
Required:
a) If the average selling price remains the same as it has been in the past, at what level
of activity will the company break-even?
b) Assume that a new customer offers the Alpha Ltd. Rs.35/= per piece for its product.
Provided that there are no effects on sales to old customers and no legal
complications. Should the Alpha Ltd. accept an order for 7,000 pieces of soap. State
two other factors to be considered in making the above decision.

Make or Buy Decisions


Sithumina Ltd. produces product X. Current activity level is 5,000 units, and each unit is sold at
Rs. 150.
The cost structure of the product is given below.
Rs.
Direct material cost 50
Direct labour cost (variable) 30
Fixed overhead cost 40
Cost per unit 120

The company has an opportunity to buy a product of same quality and features at Rs. 100. If the
product is purchased from outside, the fixed cost of Rs. 25,000 can be avoided.
Required:
Decide whether to make the product or buy it from an outside supplier.

Product Mix Decisions


Toyo Lanka PLC (TLP) is a company contracted by a major automobile company to
manufacture four products: R, X, Y, and Z as four major components for their new car. All these
products are manufactured in a semi-automated system and the maximum machine hours
available for production are 19,600 machine hours per week under normal working condition.

The following information is relevant:


Product
Description
R X Y Z

Selling price per unit (Rs) 320 350 500 480

Direct materials per unit (Rs) 90 110 160 130

Direct labour per unit (Rs) 30 30 30 50

Variable overheads per unit


40 40 80 80
(Rs)

Total variable cost per unit (Rs) 160 180 270 260

Machine hours required per unit 3 3 3 5

Max weekly demand (units) 2000 2000 2500 1250


Fixed overheads (Rs) 200,000

According to the contract TLP should supply the following minimum number of products:

Product R X Y Z

Minimum supply (units) 800 800 1000 500

Required:

(i) Find out the optimum production combination that maximizes the profit and calculate the
total profit.
(ii) The managing director of TLP is considering of supplying the maximum demand. Two
mutually exclusive alternatives are available to fulfil the short supply:

Alternative 1: Introducing a night shift to produce only the short supply: As a result,
direct labour cost and variable overheads will go up by 50% for the night
shifts.

Alternative 2: Outsource the short supply products at the following prices:

Product R X Y Z

Outsource price per unit 192 216 324 312

In addition to this purchasing price, TLP needs to repack the products at a


cost of Rs 10 per unit.

Calculate the incremental profit from Alternative 1 and 2, and find out the best alternative that
maximizes the profit.

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