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12 Short - Run Decision Making

The document discusses short-run and strategic decision-making in business, focusing on relevant costs, opportunity costs, and sunk costs. It provides examples of make-or-buy decisions, special order decisions, keep-or-drop decisions, and sell-or-process-further decisions, emphasizing the importance of future costs and their impact on these choices. Additionally, it covers cost-based pricing and target costing methods for determining product pricing.

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21 views30 pages

12 Short - Run Decision Making

The document discusses short-run and strategic decision-making in business, focusing on relevant costs, opportunity costs, and sunk costs. It provides examples of make-or-buy decisions, special order decisions, keep-or-drop decisions, and sell-or-process-further decisions, emphasizing the importance of future costs and their impact on these choices. Additionally, it covers cost-based pricing and target costing methods for determining product pricing.

Uploaded by

AUdrey
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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Short – run

Decision
Making
Short – run Decision
Making
–Choosing among alternatives
with an immediate or limited
end in view
Short – run Decision
Making
–Tactical decisions
–Example: accepting a special order
for less than the normal selling
price to utilize idle capacity
Strategic decisions
– Long term in nature
– Involves choosing between different
strategies that attempt to provide a
competitive advantage over a long time
frame
Strategic decisions
Example: producing a component
instead of buying it from suppliers
Relevant costs
–Future costs
–Differ across alternatives
Relevant costs as future
costs
All pending decisions relate
to the future.
Relevant costs differ across
alternatives

If a future cost is the same for more


than one alternative, it has no effect
on the decision.
Example of relevant costs

Consider Targaryen’s make-or-buy alternatives. The cost of


direct labor to produce the additional 20,000 speakers is
$110,000. In order to determine if this $110,000 is a
relevant cost, we need to ask the following:
1. Is the direct labor cost a future cost?
2. Does it differ across two alternatives?
Opportunity cost
– Benefit sacrificed or foregone when one
alternative is chosen over another
– Not an accounting cost; Accountants do not
record the cost of what might happen in the
future.
Sunk cost
– A cost cannot be affected by any future
action
– Ignored by managers for relevant decisions
However, it is human nature to allow sunk
costs to affect relevant decisions.
Common relevant cost
applications
– To make or buy a component
– To keep or drop a segment or product line
– To accept a special order at less than the usual
price
– To further process joint products or sell them at
split-off point
Make-or-buy decisions

–Whether to make a particular


product or to purchase it from
outside supplier
–Internal vs. external production
Make-or-buy decisions

Swasey Manufacturing currently produces an electronic component used in one of


its printers. In one year, Swasey will switch production to another type of printer,
and the electronic component will not be used. However, for the coming year,
Swasey must produce 10,000 of these parts to support the production
requirements for the old printer.
A potential supplier has approached Swasey about the component. The supplier
will build the electronic component to Swasey’s specifications for $4.75 per unit.
The offer sounds very attractive since the full manufacturing cost per unit is $8.20.
Should Swasey make or buy the component?
Make-or-buy decisions

Cost information on internal production includes the following:

Total cost Unit cost


Direct materials $10,000 $1.00
Direct labor 20,000 2.00
Variable overhead 8,000 0.80
Fixed overhead 44,000 4.40
Total $82,000 $8.20
Make-or-buy decisions

Cost information on internal production includes the following:

Total cost Unit cost


Direct materials $10,000 $1.00
Direct labor 20,000 2.00
Variable overhead 8,000 0.80
Fixed overhead 44,000 4.40
Total $82,000 $8.20
Assume that the fixed overhead includes $10,000 of cost that can be avoided if the
component is purchased internally.
Special order decisions

– A company may consider offering a product or


service at a price different from the usual price
– Focus on whether a specially priced order should
be accepted or rejected
– Can be attractive especially when the firm is
operating below its maximum productive capacity
Special order decisions

Leibnitz Company has been approached by a new customer with an offer to


purchase 20,000 units of model TR8 at a price of $9 each. The new customer is
geographically separated from the company’s other customers, and existing sales
would not be affected. Leibnitz normally produces 100,000 units of TR8 per year
but only plans to produce and sell 75,000 in the coming year. The normal sales
price is $14 per unit. Unit cost information for the normal level of activity is as
follows:
Direct materials $3
Direct labor 2.80
Variable overhead 1.50
Fixed overhead 2
Total 9.30
Special order decisions

– Fixed overhead will not be affected by whether or not the special order is
accepted.

Accept Reject
Price 9
Direct materials 3
Direct labor 2.8
Variable overhead 1.5
Increase in 1.7 0 1.7
operating income
Keep-or-drop decisions

– Whether a segment, such as a product


line should be kept or dropped
– Segment’s contribution margin is useful
in evaluation of the performance of the
segments
Keep-or-drop decisions
Shown below is a segmented income statement for Norton
Materials Inc.’s three product lines:

Blocks Bricks Tile Total


Sales revenue 500,000 800,000 150,000 1,450,000
Less: Variable 250,000 480,000 140,000 870,000
expenses
Advertising 10,000 10,000 10,000 30,000
expenses
Salaries 37,000 40,000 35,000 112.000
expenses
Depreciation 53,000 40,000 10,000 103,000
Segment margin 150,000 230,000 45,000 335,000
Keep-or-drop decisions

The two alternatives being considered are to keep


the roofing tile line or to drop it.

Which alternative is more cost effective and by how


much?
Keep-or-drop decisions

The two alternatives being considered are to keep


the roofing tile line or to drop it. Assume further
that dropping the product line reduces sales of
blocks by 10% and sale of bricks by 8%.
Which alternative is more cost effective and by how
much?
Sell-or-process-further decision

Appletime grows apples and then sorts them into one of three
grades, A, B, or C, based on their condition. Appletime must
decide whether to sell the Grade B apples at split-off or to
process them into apple pie filling. The company normally sells
the Grade B apples in 120 five-pound bags at a per-unit price of
$1.25. If the apples are processed into pie filling, the result will
be 500 cans of filling with additional costs of $0.24 per can. The
buyer will pay $0.90 per can.
The use of costs in decision
making

–Cost-based pricing
–Target costing and pricing
Cost-based pricing

–Calculate the product cost and add


the desired profit
–Cost base and a markup
Cost-based pricing
Mark-up

–Percentage applied to the base


cost
Cost-based pricing

Price using markup = Cost per unit


+ (Cost per unit * Markup
percentage)
Target costing and pricing

– Price of the new product as the sum of


the costs and the desired profit.
– Method of determining the cost of a
product or service based on the price
that customers are willing to pay
Target costing and pricing

Digitime manufacturers and wristwatches and is


designing a new watch model that incorporates a
PDA, which Digitime hopes consumers will view as a
valuable design feature. As such, the new PDA
watch has a target price of $200. Management
requires a 15% profit on new product revenues.

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