DECISION MAKING

Long term Short term

SHORT TERM DECISION OR TACTICAL DECISION

- decision that doesn’t need involvement of
changes in capacity – related resources.
- only relevant data are taken into accounts.
 CHARACTERISTICS OF RELEVANT
INFORMATION
• The costs and benefits are different at different
option
• The costs and benefits are related to the future.
• Timely and accurate
• Qualitative or quantitative
• Cash flow
ITEMS OF RELEVANT INFORMATION
opportunity
cost
potential benefits that the management should give up
out - of - pocket
cost
additional cost that will be incurred in the selected
option.

sunk cost

- is the cost that already incurred

DECISION MAKING PROCESS
Clarify the problem

Identify alternative option from selected

decision

Identify relevant costs and benefits

Compare the costs and benefits form

each option

Select an option
 LIMITING FACTOR DECISION MAKING
1) Optimum production mix
• this approach give guideline to management
how much can every type of products can be
maximize produce in bottle-neck and non-
bottleneck situation.
• this approach based on priority of products
contribution per unit.
• the products are ranking based on its
profitability and reallocate the production for
each type of products
2) Theory of constraints
- is approach to minimize cost and produce high sale.
- involve 5 process :

Identify the constraints

Decide how to exploit the bottleneck

Subordinate everything else to the

decision in step 2

Elevate the system’s bottleneck

If the bottleneck has been broken back

to step 1
3) Throughput cost accounting
- main objective is to make money.
- assume that material is the only variable cost,
the others are fixed.
- throughput here meaning contribution margin
which when sale less material.
-3 ways to increase profits
: increase throughput
: decrease fixed cost
: decrease investment
(usually inventories)
 Example
Details Product A Product B
Machine hours / unit 60 20
Selling price / unit RM 600 RM 480
Variable / unit 300 360
Contribution margin RM 300 RM 120
c/s ratio 50 % 25 %

Factory capacity is at 600 000 working hours

 contribution margin approach

Product A Product B
 A B C
Contribution per RM 9 RM 10 RM 7
unit
Hours required 3 5 1
Contribution per 3 2 7
margin hour
Profitability ranking 2 3 1

- The company have 18 000 capacity hour

- Demand A : 6 000 units
B : 5 000 units
C : 4 000 units
- Allocation of capacity 18 000 hours
Product C 4 000
Balance 14 000
- Product A require 18 000 hours to fulfill demand, but the balance only
14 000
= 14 000
3
= 4 667 units
 DISCONTINUING SEGMENT.
• consideration of to add or to delete any department or
any one of the products.
• benefits for continuing : expenses of shutdown will be
avoided.
: trained employee will be
keep.
: cost open new segment is
avoidable.
• benefit of discontinuing : avoid losses.
: saving in various type of costs.
• there are 2 approaches in comparing the costs and
benefits which is comparative income statement and
incremental approach.
 EXAMPLE ADD OR DELETE SEGMENT.
Cutting department Sewing department Packaging department
Salary 54 000 15 000 48 000
Utilities 8 000 5 500 3 700
Materials 47 000 18 500 34 000
Maintenance 24 000 3 800 13 900
Administrative cost 36 000 8 200 12 000
Depreciation 33 000 30 000 20 000

The management want to close the packaging department. The below information are
also provided :
1. if the department close, they will save one line leader and another one supervisor
salary. They have same salary which is RM 12 000 per year
2. the utilities are expected to reduce by 30 %.
3. all the materials are no longer needed.
4. All of the equipment can be sold at RM 100 000.
5. Maintenance and administrative cost will be apportion to the other 2 departments.
6. Additional cost for closing the department is RM 20 000.
7. The sale is RM 1 200 000
Incremental approach.
Loss from contribution of deleted -
department

+ cost saving / relevant cost

Salary 24 000
Utilities 12 040
Material 34 000
Administrative cost -
Maintenance -
Equipment 100 000
Closing cost ( 20 000)
Additional cost saving or profit. 150 040
Comparative approach. CLOSE
Continue Delete
Sales 1 200 000 1 200 000

+ income
Proceed from sales of equipment 100 000

- Expenses
Salary 117 000 93 000
Utilities 17 200 12 040
Materials 99 500 65 500
Maintenance 41 700 41 700
Administrative cost 56 200 56 200
Closing cost 20 000
Net profit 868 400 1 011 560
 Special order decision
• Management often has to make a decision on whether /
not to accept a special order
• Additional orders must be considered on the basis of:
1. price that must be quoted to enable profit
2. whether the other orders be fulfilled if the contract is
accepted
• Considerations needed:
1. only those costs that will be affected by taking the
order are relevant
2. fixed manufacturing costs are irrelevant
3. should accept the special order if some contribution is
made
 Example
Given, AB Sdn Bhd
Production : 150 000 units
Selling price : RM 100 per unit

Operating expenses Marketing expenses

Fixed - RM 3 000 000 Fixed – RM 1 500 000
Variable – RM 40 per unit Variable – RM 10 per unit

- XY Sdn Bhd offered to buy 20 000 units at RM 80 per

unit. The delivery cost will be incurred by XY Sdn Bhd.
AB Sdn Bhd will not incur any marketing expenses.
 Approach 1 : comparative income statement
Without SP With SP Difference
150 000 units 170 000 units 20 000 units
150 000 x RM 100 150 000 x RM 100
20 000 x RM 80
Income RM 15 000 000 RM 16 600 000 RM 1 600 000
Variable expenses
• Operating [150 000 x 40] [170 000 x 40]
RM 6 000 000 RM 6 800 000 RM 800 000

•Marketing [150 000 x 10] [150 000 x 10]

RM 1 500 000 RM 1 500 000 -
Fixed expenses
• Operating RM 3 000 000 RM 3 000 000 -
• Marketing RM 1 500 000 RM 1 500 000 -

Profits RM 3 000 000 RM 3 800 000 RM 800 000

 Approach 2 : incremental approach

Income (20 000 x RM 80) RM 1 600 000

Less : variable operating expenses
(20 000 x RM 40) RM 800 000
Incremental profit RM 800 000
Qualitative effects to be considered
 Make / Buy decision
• Manufacturing of products may require components to be
incorporated of the products.
• The components can either be manufactured / bought in
from suppliers.
• Cost of making < cost of buying
~ firm should make the components
• Opportunity cost is considered only if there is limited
capacity
example
• Cost of manufacturing Component X:
DM- RM 4000 Variable O/H- RM 2200
DL- RM 800 Fixed O/H- RM 4600

• If production of Component X is undertaken,

production of Component Y would be reduced by
4 000 kg result in loss of revenue of RM 2 500. the
marginal cost of producing 4 000 kg of processed
Component Y is RM 1 500.

• Cost of purchasing Component X : RM 7500

Should the company make / buy Component X ?

Comparison statement
Cost of manufacturing:
DM 4 000
DL 800
V. O/H 2 200
Opp. Cost (2500-1500) 1 000 8 000
Cost of purchasing 7 500

- Company should buy Component X since it is

cheaper than cost of manufacturing.
- The contribution lost from processed Component Y
is part of the cost, thus represents the opportunity
cost.
 Joint product costs & the contribution approach

Product Separate Final

A processing sales
Joint Common
Separate Final
input production Product B
processing sales
process
Separate Final
Product C
processing sales

Joint Joint Separate

product products product costs
costs
Point at which the 2 / more products that
joint products can be Split-off
are produced from a
recognized as points
common input
individual units of
output
 Sell / Further processing decision

• Using incremental analysis to make short-term

'process further' decisions on whether to sell a
product 'as is' or process it further by adding
additional costs.
• Incremental analysis helps focus on the
relevant parts of a decision.
• Based on the differences between the
incremental revenues and the incremental
costs.
example
Cost of producing 3 products = RM 104 000
PA PB PC

Monthly output (kg) 10 000 5 000 8 000

Further processing (RM) 5.00 3.00 9.00
Selling price (RM) :
Before FP 11.00 14.00 13.00
After FP 15.00 19.00 20.00

Should further process or not?

Solution
PA PB PC
Selling price (RM) :
Before FP 11.00 14.00 13.00
After FP 15.00 19.00 20.00
Incremental revenue 4.00 5.00 7.00
Less: Further processing (5.00) (3.00) (9.00)
cost
Incremental (1.00) 2.00 (2.00)
contribution

• Further processing of Product PB is the only further processing

activity which leads to an increase in contribution
• Therefore, should further processing Product PB, but should
sell Product PA & PC without further processing
 Multi limiting factors in decision making
• As a result of limited supply of resources constraint, a
company normally cannot produces as many products as
it wish.
• Limited supply of resources can be in many forms:
- limited cash, labour time, material / machine
availability & others.
• In line with the limited resources, the production
manager therefore needs to plan the production mix in
order to maximize its profit.
• To establish the proper production mix, the rule is to
rank the products according to the:
CONTRIBUTION PER LIMITING FACTOR
 1. Social 2. Surrounding
- Employee’s welfare - Image of company
- Relationship - Quality of
between suppliers environment

3. Technology 4. Law & legal

- To improve quality - All decisions must
of products comply the law
 1. Organizational goals
Selling price must be set to 4. Product life cycle
achieve the goals stages the product life may
influence the firm’s pricing
2. Product mix policy (introduction, growth,
if there are multi products, maturity, saturation &
the SP must be set for each decline)
individual product
5. Competitors & markets
3. Price / demand expectations of competitor
relationship reaction may influence the
the effect of price elasticity price adjustment
of demand can determine
the optimum price to be set
 POLICING POLICIES

1. Cost & pricing

policy 4. Special order
pricing
2. Demand pull
pricing 5. Other pricing
strategies
3. Optimum price
/ output pricing
 3. Optimum price / output pricing
Pricing policy where profit is maximized
- where MR = MC

4. Special order pricing

For a one off order, where a minimum
pricing rule may be applied