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Short Term Decision Making

This chapter covers short-term decision-making in accounting, focusing on marginal and absorption costing methods. It explains how to draft income statements using both methods and applies marginal costing to decisions such as accepting special orders, dropping products, and make-or-buy scenarios. Key concepts include evaluating contributions, capacity, and costs to make informed business decisions.

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Ziningi Dlamini
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15 views23 pages

Short Term Decision Making

This chapter covers short-term decision-making in accounting, focusing on marginal and absorption costing methods. It explains how to draft income statements using both methods and applies marginal costing to decisions such as accepting special orders, dropping products, and make-or-buy scenarios. Key concepts include evaluating contributions, capacity, and costs to make informed business decisions.

Uploaded by

Ziningi Dlamini
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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CHAPTER 14

Short-term decision
making
OUTCOMES
At the end of this chapter students should be able to
• distinguish between marginal and absorption costing
• draft an income statement using the marginal costing
format
• apply marginal costing to short-term decisions.
OBJECTIVE
DETERMINE TOTAL
MANUFACTURING COST
PER UNIT
= TOTAL MANUFACTURING
COSTS
NUMBER OF UNITS
PRODUCED
15.1INTRODUCTION
Income statement – 2 methods:

Marginal costing
(unit cost includes variable cost only)

Absorption costing

(unit cost includes fixed and variable cost

See ILLUSTRATIVE EXAMPLE page 272


Cost per unit
Marginal costing – cost per unit Absorption costing :Cost per Unit

Direct materials (variable) Direct Materials (variable)


Direct Labour (variable) Direct Labour (variable)
Add Variable Manufacturing costs Add Variable Manufacturing costs
(variable) Add Fixed Manufacturing costs
= Cost per unit (variable) = Cost per unit (variable + fixed)
Absorption costing income
statement (variable + fixed)
Sales
Less Manufacturing costs (variable + fixed)

= Gross Profit

Less Selling and Admin Costs (variable + fixed)

= Net Profit
Marginal costing Income
Statement (variable only)
Sales 1 700 000
Less: Variable costs (700 000)
Contribution 1 000 000
Less: Fixed costs 200 000
Net profit 800 000
15.2DECISIONS USING
MARGINAL COSTING
Decision # 1

Special order decisions

Currently producing 20 000 units @ R50-sp

Option to produce 5 000 units @ R30 –sp

DO YOU ACCEPT ????????

See ILLUSTRATIVE EXAMPLE page 274


MARGINAL COSTING

Option to produce 5 000 units @ R30 – DO YOU


ACCEPT ????????

1. Do you have capacity?

2. Calculate variable cost per unit

3. Draft a marginal costing income statement


(determine contribution)

If contribution is POSITIVE, then accept order


If contribution is NEGATIVE, the decline order
Currently producing 20 000 units @ R50

Option to produce 5 000 units @ R30

DO YOU ACCEPT ????????

Step 1 : Do you have capacity?


Currently the company makes 20 000 chocolates (80%
capacity).
Therefore, 100% capacity is 25 000 boxes,

Therefore, SPARE CAPACITY = 20% is 5 000 boxes


Special Order decision
Currently making 20 000 units

Step 2- Calculate variable cost per unit


Variable cost per unit = Total Variable costs
Number of chocs
= R500 000/ 20 000 boxes = R25 per choc.
Total costs- last year for 20 000 R700 000 (given)
chocolates

Fixed costs R200 000 (given)

Variable costs R500 000


Special Order decision

Step 3 – Draft Marginal income statement


• Sales (5000 × R30) R150 000
• Less: Variable costs (5000 × R25) (R125 000)
• Contribution R 25 000

If contribution is positive, the company should accept the


order So yes !! ACCEPT the order!!!
Special Order decision

Calculate the profit after the special order is accepted

Sales revenue ( 5000x R30)+(20 000XR50) 1 150 000


Less: Varaible costs (5000 x R25) + 500 000 (625 000)
Contribution 525 000
Less: Fixed cost (200 000)
Net Profit 325 000
DECISIONS USING MARGINAL COSTIN

Decision # 2
Dropping a product or department
1. Draft a marginal costing Income Statement
2. Look at contribution per product
3. If contribution is POSITIVE, then keep product
4. If contribution is NEGATIVE, the drop product

See ILLUSTRATIVE EXAMPLE page 230


Dropping a product or
department
Co considering dropping Product Bar as Bar is making a loss.
Product Ace Product Bar Product Lace Total

R R R R

Sales revenue 100 000 15 000 25 000 140 000


Less: Total costs (85 000) (17 000) (18 500) (120 500)
Profit 15 000 (2 000) 6 500 19 500

BREAKDOWN OF TOTAL COST Product Ace Product Bar Product Lace

Variable costs 66 000 9 800 13 000 88 800


Direct Materials 15 000 2 000 3 000 20 000
Direct Labour 30 000 4 000 5 000 39 000
Indirect manufacturing costs 15 000 3 000 4 000 22 000
Selling and admin 6 000 800 1 000 7 800

Fixed Costs 31 700


Indirect manufacturing costs 20 000
Selling and admin 11 700

Net income 19 500


Dropping a product or
department

Co considering dropping Product Bar as Bar is making a loss.


Product Ace Product Bar Product Lace Total

R R R R

Sales revenue 100 000 15 000 25 000 140 000


Less Variable costs 66 000 9 800 13 000 88 800
Direct Materials 15 000 2 000 3 000 20 000
Direct Labour 30 000 4 000 5 000 39 000
Indirect manufacturing costs 15 000 3 000 4 000 22 000
Selling and admin 6 000 800 1 000 7 800
Contribution margin 34 000 5 200 12 000 51 200
Less Fixed Costs 31 700
Indirect manufacturing costs + so 20 000
Selling and admin
KEEP!! 11 700

Net income 19 500


DECISIONS USING MARGINAL COSTIN

Decision # 3
Choice of products where a limiting factor
exists

See ILLUSTRATIVE EXAMPLE page 279


The scarce resource is labour. Its limited to 50 000 hours
Demand for each is 5000 units
Product A B C D
Selling price per unit 60 90 120 108

Less Variable costs


Labour (R6 per hour) 18 12 42 30
Material (R3 per hour) 18 54 30 36

CONTRIBUTION 24 24 48 42
Labour (hours) required 3 2 7 5
Material (litres) required 6 18 10 12

To make all the products demanded , we would need


A – 5000 units x 3 hours
B – 5000 units x 2 hours
C – 5000 units x 7 hours
D – 5000 units x 5 hours = 85 000 hours

BUT WE ARE LIMITED TO 50 000 HOURS


The scarce resource is labour. Its limited to 50 000 hours
Demand for each is 5000 units
Product A B C D
Selling price per unit 60 90 120 108

Less Variable costs


Labour (R6 per hour) 18 12 42 30
Material (R3 per hour) 18 54 30 36

CONTRIBUTION 24 24 48 42
Labour (hours) required 3 2 7 5
Material (litres) required 6 18 10 12

Contribution per unit 24 24 48 42

Divided by labour hours 3 2 7 5

Contribution per labour hour R8 R12 R6,86 R8,40

Ranking 3rd 1st 4th 2nd


Labour constrained : B, D, A, C
demand is 500 units each

1st B 10 000 hours


5000 units of B x 2 hours labour
required

2nd D 25 000 hours

5000 units of D x 5 hours labour


required
3rd A 15 000 hours
5000 units of A x 3 hours labour
required

4th C
NOTHING

Total 50 000 hours !!!!


ALL USED UP!!!
DECISIONS USING MARGINAL COSTIN

Decision # 4
Make versus buy
Do we produce internally OR do we buy
externally?
Which is cheaper?

See ILLUSTRATIVE EXAMPLE page 281


Make or Buy
Co currently produces 10 000 units. The cost per unit is

Rands
Direct materials 5,0
Direct labour 2,5
Variable manufacturing overheads 3,5
Fixed manufacturing overheads 7,0
Total Cost 18,0

The component can be purchased from an external supplier at R15,50

Buying in price versus Variable manufacturing cost


R15,50 versus R11 (R5+R2,50+R3,50)
Therefore savings is R4,50 per unit.
Make or Buy
• Savings of R4,50 per unit
• If you make in house, profits will increase R4,50 x 10 000
units = R45 000.
• Before you make a final decision, consider:
- how reliable is the supplier
- How is the quality of the goods
- Will the supplier increase the price in the near future?

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