maf420 pbl 2 (2)
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DECISION MAKING
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.
Long term Short term
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
out - of - pocket cost
sunk cost
opportunity cost
potential benefits that the management should give up
- is the cost that already incurred
additional cost that will be incurred in the selected option.
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 :
Elevate the system’s bottleneck
Subordinate everything else to the decision in step 2
If the bottleneck has been broken back to step 1
Decide how to exploit the bottleneck
Identify the constraints
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 BMachine hours / unit 60 20Selling price / unit RM 600 RM 480Variable / unit 300 360Contribution margin RM 300 RM 120c/s ratio 50 % 25 %
Factory capacity is at 600 000 working hours
contribution margin approach
Product A Product B
A B C
Contribution per unit
RM 9 RM 10 RM 7
Hours required 3 5 1
Contribution per margin hour
3 2 7
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 hoursProduct C 4 000Balance 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 year2. 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 costSalary 24 000Utilities 12 040Material 34 000Administrative cost -Maintenance -Equipment 100 000Closing cost ( 20 000)Additional cost saving or profit. 150 040
Comparative approach.Continue Delete
Sales 1 200 000 1 200 000
+ incomeProceed from sales of equipment 100 000
- ExpensesSalary 117 000 93 000Utilities 17 200 12 040Materials 99 500 65 500Maintenance 41 700 41 700Administrative cost 56 200 56 200Closing cost 20 000Net profit 868 400 1 011 560
CLOSE
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
ExampleGiven, AB Sdn BhdProduction : 150 000 units Selling price : RM 100 per unit
Operating expenses Marketing expensesFixed - RM 3 000 000 Fixed – RM 1 500 000Variable – 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 statementWithout SP With SP Difference
150 000 units 170 000 units 20 000 units150 000 x RM 100 150 000 x RM 100
20 000 x RM 80Income RM 15 000 000 RM 16 600 000 RM 1 600 000Variable expenses• Operating
•Marketing
Fixed expenses• Operating• Marketing
[150 000 x 40]RM 6 000 000
[150 000 x 10]RM 1 500 000
RM 3 000 000RM 1 500 000
[170 000 x 40]RM 6 800 000
[150 000 x 10]RM 1 500 000
RM 3 000 000RM 1 500 000
RM 800 000
-
--
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 000Less : variable operating expenses(20 000 x RM 40) RM 800 000Incremental 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 2200DL- 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 statementCost of manufacturing: DM 4 000 DL 800 V. O/H 2 200 Opp. Cost (2500-1500) 1 000 8 000Cost 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 input
Common production
process
Product C
Product B
Product A
Separate processing
Separate processing
Separate processing
Final sales
Final sales
Final sales
Joint product
costs
Split-off points
Joint products
Separate product costs
2 / more products that are produced from a
common input
Point at which the joint products can be
recognized as individual units of
output
Joint product costs & the contribution approach
• 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.
Sell / Further processing decision
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 9.00Selling price (RM) : Before FP After FP
11.0015.00
14.0019.00
13.0020.00
Should further process or not?
Solution
PA PB PCSelling price (RM) : Before FP After FP
11.0015.00
14.0019.00
13.0020.00
Incremental revenueLess: Further processing cost
4.00(5.00)
5.00(3.00)
7.00(9.00)
Incremental contribution
(1.00) 2.00 (2.00)
• 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- Employee’s welfare
- Relationship between suppliers
3. Technology- To improve quality
of products
4. Law & legal- All decisions must
comply the law
2. Surrounding- Image of company
- Quality of environment
5. Competitors & markets expectations of competitor reaction may influence the
price adjustment
4. Product life cycle stages the product life may influence the firm’s pricing
policy (introduction, growth, maturity, saturation &
decline)
1. Organizational goals Selling price must be set to
achieve the goals
2. Product mix if there are multi products, the SP must be set for each
individual product
3. Price / demand relationship
the effect of price elasticity of demand can determine
the optimum price to be set
5. Other pricing strategies
4. Special order pricing
3. Optimum price / output pricing
2. Demand pull pricing
1. Cost & pricing policy
POLICING POLICIES
3. Optimum price / output pricing
4. Special order pricing
For a one off order, where a minimum pricing rule may be applied
Pricing policy where profit is maximized - where MR = MC
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