Fundamentals of Management Accounting

Short Term Decision Making

Fundamentals of Management Accounting

Class Slides Ian Wilson

The syllabus expects students to competent with:

Explaining Relevant Costs & Cash Flows

Explaining Make or Buy Decisions

Calculating profit maximising by obtaining the best sales mix using Limiting Factor analysis

What is a Limiting Factor?What is a Limiting Factor?What is a Limiting Factor?What is a Limiting Factor?

In business there are not enough resources available to fulfil ALLALLALLALL the plans of the organisation

The Factor which is in short supply is called a Limiting Factor

When a resource is in short supply, it will have to make decisions based on how best to use those scarce resources.

Examples: Can you think of any?Examples: Can you think of any?Examples: Can you think of any?Examples: Can you think of any?

1. Most obvious.a lack of sales!

2. Materials

3. Labour.skilled/trained

4. Machine Hours

5. Production capacity

6. MoneyCashnot enough of it!

Limiting Factor analysis is a technique used to calculate the mix of products that should be made to maximise the return on a single limiting factor

See the example on page 122 of your notes

Red & Herring!

Which one should the company make to maximise its return on scarce machine hours?

AnswerAnswerAnswerAnswer:

Tempted by Herring?

Higher Contribution - 60 compared to 30

Higher Profit - 40 compared to 10

Still could be wrong decision!

WhyWhyWhyWhy?

1. Profit includes Fixed Costs distorts the picture!

2. Fixed Costs are apportioned Arbitrarily!

Example continued:Example continued:Example continued:Example continued:

Lets assume we have 1000 machine hours available.

A Red takes 1 hour & herring takes 3 hours:

Re-work your thought now see foot of page 122.

Work out the Contribution per Limiting Factor

Red is 30, Herring is 20

Your answer has changed!

Key Stages to followKey Stages to followKey Stages to followKey Stages to follow:

1. If not stated, identify Limiting Factor

2. Find the Contribution per Unit

3. Calculate the Contribution per Limiting Factor

4. Rank in order of priority

5. Prepare Production Schedule

6. Calculate the Total Contribution

7. Deduct Fixed Costs if known/available

A company makes 3 Products:

1. Speedwell

2. Nettle

3. Liatris

Fixed costs 7500

1800 Hours available

How much to produce of each of the three products to MAXIMISE profits for the Company?

A more complex question, 3 products:

A, B & C

Given sales Demand for each product:

No limit on materials

Machine Hours limited to 200,000 hours

Labour hours limited to 50,000 hours

Calculate maximum profits based on best use of limited resources:

Looked at this in Session 1

1. Relevant Costs

2. Avoidable Costs

3. Opportunity Costs

4. Sunk Costs

5. Controllable Costs

6. Uncontrollable Costs

Relevant CostsRelevant CostsRelevant CostsRelevant Costs:

Future cash flows arising as a direct consequence of a decision.

They are:

1. Future Costs

2. Cash Flows

3. Incremental Costs

See page 125See page 125See page 125See page 125:

RequiredRequiredRequiredRequired:

Should the company accept the offer?

Follow page 125:

Summary RulesSummary RulesSummary RulesSummary Rules:

Relevant cash flows are future cash flows:

Relevant cash flows are incremental cash flows:

Committed costs are not relevant:

Relevant costs can be opportunity costs:

Read page 126:

Exercise 4Exercise 4Exercise 4Exercise 4:

Look at the 3 questions here:

Exercise 5Exercise 5Exercise 5Exercise 5:

A,B,C or D?

The decision to make a component in house or buy it in from outside is a tough business decision.

Assume that all fixed costs of manufacturing are general to the business

Only the Marginal costs are relevant therefore

CriteriaCriteriaCriteriaCriteria:

Compare marginal cost of making to the purchase price:

4 products, Make or Buy?

Page 128