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Chap 11: Short-term Decisions, Non-financial factors is important here: -…
Chap 11: Short-term Decisions
Relevant Costs:
There are 'costs appropriate to specific management decisions, these are represented by future cash flows whose magnitude will vary depending upon the outcome of the management decisions made'
Future
Cash
Incremental/Specific
Opportunity cost
Avoidable costs
Non Relevant Costs:
Sunk Costs
Committed costs
Notional costs: (non cash items or accountancy entries)
Fixed costs (avoidable FC) would be relevant
Minimum price decisions:
-> for a one off decision is its total relevant costs. This is the price at which the business would break even.
Accept or Reject Decisions:
-> a project with a positive return on a relevant cost basis should be accepted; a negative return should be rejected.
Make or buy decisions:
-> In house production will provide grater control over the work performed but will also use capacity which will give rise to opportunity costs.
Factors to consider:
-How can spare capacity freed up by subcontracting be used most profitably?
-Could the decision to use an outside supplier cause an industrial dispute?
-Would the subcontractor be reliable with delivery times and product quality?
-Does the company wish to be flexible and maintain better control over operations by making everything itself?
With a limiting factor
The optimal decision, based on financial considerations alone, is to arrange internal production and external purchasing in a way that minimises total costs.
Total costs will be minimised if those units bought from the subcontractor have the lowest extra VC per unit of scarce resource saved by buying.
Making the product gives the company more control whereas buying the product gives them access to an organisation with specific expertise.
They will also need to consider what the impact will be on:
The workforce
Customers
Competitors
Outsourcing decisions:
-> is the use of external suppliers for finished products, components or services.
-> also known as contract manufacturing or subcontracting.
Shutdown decisions:
A division of a business that appears to be loss making.
A product of a business that appears to be loss making.
A department of a business that appears to be loss making.
They should focus on relevant costs rather than profitability under absorption costing because absorption costing fails to consider whether overheads will change as a result of the decision.
They should focus on:
Variable costs
Avoidable costs
Directly attributable costs
Timing
Further processing decision:
The costs of the process will need to be apportioned between the products created by the process in order to:
Value inventory
Prepare financial accounts
These costs are not relevant when deciding whether to process any product further because they are:
Sunk
Arbitrarily apportioned
The total joint cost may be relevant for decisions regarding the viability of the process as a whole.
Physical Activity
Relative sales value
Net Realisable value
Qualitative factors:
Assumptions in relevant costing:
Cost behaviour patterns are known with certainty
Costs, prices and volumes are known with certainty.
Objective is to maximise profit/contribution
Information is complete and reliable.
Timescale can also be relevant.
Many fixed costs can be varied, but only in the long term.
Non-financial factors is important here:
Advantages:
Cost Savings
Access to expertise
-Releases capital
Frees up capacity
Disadvantages:
Loss of control
Impact on quality
How flexible, reliable is supplier
Potential loss of confidential information
Loss of in-house skill
Impact on employees' morale.
