CHAPTER 10

Short-Run Decision Analysis

REVIEWING THE CHAPTER

Objective 1: Describe how managers make short-run decisions.
1. Short-run decision analysis is the systematic examination of any decision whose effects will be
felt over the course of the next year. To perform this type of analysis, managers need both
historical and estimated quantitative and qualitative information. The information should be
relevant, timely, and presented in a format that is easy to use in decision making.
2. Short-run decision analysis is an important component of the management process.
a. Analyzing short-run decisions in the planning stage involves discovering a problem or need,
identifying alternative courses of action to solve the problem or meet the need, analyzing the
effects of each alternative on business operations, and selecting the best alternative. Short-
run decisions should support the company’s strategic plan and tactical objectives and take
into consideration not only quantitative factors, such as projected costs and revenues, but
also qualitative factors, such as the competition, economic conditions, social issues, product
or service quality, and timeliness.
b. In the performing stage, managers make and implement many decisions that affect their
organization’s profitability and liquidity in the short run. For example, they may decide to
outsource a product or service, accept a special order, or change the sales mix. All these
decisions affect operations in the current period.
c. When managers evaluate performance, they analyze each decision to determine if it
produced the desired results, and, if necessary, they identify and prescribe corrective action.
d. Throughout the year managers prepare reports related to short-run decisions. In addition to
developing budgets and compiling analyses of data that support their decisions, they issue
reports that communicate the effects their decisions had on the organization.
Objective 2: Define incremental analysis, and explain how it applies to short-run decision making.
3. Incremental analysis (also called differential analysis) is a technique that helps managers
compare alternative courses of action by focusing on differences in the projected revenues and
costs. Only data that differ among the alternatives are included in the analysis. A cost that differs
among alternatives is called a differential (or incremental) cost.
4. The first step in incremental analysis is to eliminate irrelevant revenues and costs—that is, those
that do not differ among the alternatives. Also eliminated are sunk costs. A sunk cost is a cost that
was incurred because of a previous decision and cannot be recovered through the current decision.
Once all irrelevant revenues and costs have been identified, the incremental analysis can be
prepared using only projected revenues and expenses that differ for each alternative. The
alternative that results in the highest increase in net income or cost savings is the one that
managers generally choose.
5. Incremental analysis simplifies the evaluation of a decision and reduces the time needed to choose
the best course of action. However, it is only one input to the final decision. Managers also need
to consider other issues, such as opportunity costs, which are the benefits forfeited or lost when
one alternative is chosen over another.
Objective 3: Perform incremental analysis for outsourcing decisions.
6. Outsourcing is the use of suppliers outside the organization to perform services or produce goods
that could be performed or produced internally. Make-or-buy decisions are decisions about
whether to make a part internally or to buy it from an external supplier. Such decisions may also
be concerned with the outsourcing of operating activities.
7. To focus their resources on their core competencies (i.e., the activities they perform best), many
companies outsource nonvalue-adding activities, especially those that involve relatively low
levels of skill (such as payroll processing or storage and distribution) or highly specialized
knowledge (such as information management).
8. Incremental analysis of the costs and revenues of outsourcing a product or service as opposed to
producing or performing it internally helps managers identify the best alternative.
Objective 4: Perform incremental analysis for special order decisions.
9. Special order decisions are decisions about whether to accept or reject special orders at prices
below the normal market prices. A special order should be accepted only if it maximizes operating
income. Like all short-run decisions, a special order decision should support the organization’s
strategic plan and tactical objectives and be based on the relevant costs and revenues, as well as
qualitative factors.
10. One approach to analyzing a special order decision is to compare its price with the costs of
producing, packaging, and shipping the order to see if a profit can be generated. Another approach
is to prepare a bid price by calculating the minimum selling price for the special order; the bid
price equals the relevant costs plus an estimated profit.
11. Qualitative factors that can influence a special order decision are the special order’s impact on
sales to regular customers, its potential to lead the company into new sales areas, and the
customer’s ability to maintain an ongoing relationship with the company that includes good
ordering and paying practices.
Objective 5: Perform incremental analysis for segment profitability decisions.
12. The objective of analyzing a decision about segment profitability is to identify segments that have
a negative segment margin. A segment margin is a segment’s sales revenue minus its direct costs
(direct variable costs and direct fixed costs traceable to the segment). These direct costs are
avoidable costs because if management decides to drop the segment, they will be eliminated;
because they vary among segments, they are relevant to the decision. If a segment has a positive
segment margin (i.e., if the segment’s revenue is greater than its direct costs), the segment should
be kept. If a segment has a negative segment margin (i.e., if its revenue is less than its direct
costs), it should be dropped. Certain costs will occur regardless of the decision; because these
costs are unavoidable and are common to all alternatives, they are excluded from the calculation
of the segment margin.
13. An analysis of segment profitability includes the preparation of a segmented income statement
using variable costing to identify variable and fixed costs.
Objective 6: Perform incremental analysis for sales mix decisions involving constrained
resources.
14. Sales mix decisions arise when limited resources, such as machine time or labor, restrict the types
or quantities of products that a company can manufacture or the services it can deliver. The
objective of a sales mix decision is to select the alternative that maximizes the contribution
margin per constrained resource, as well as operating income.
15. Incremental analysis of a sales mix decision involves two steps:
a. Calculate the contribution margin per unit for each product or service line affected by the
constrained resource. The contribution margin per unit equals the selling price per unit less
the variable costs per unit.
b. Calculate the contribution margin per unit of the constrained resource. The contribution
margin per unit of the constrained resource equals the contribution margin per unit divided
by the quantity of the constrained resource required per unit.
Objective 7: Perform incremental analysis for sell or process-further decisions.
16. A sell or process-further decision is a decision about whether to sell a joint product or service at
the split-off point or to sell it after further processing. Joint products are two or more products or
services composed of a common material or process that cannot be identified as separate during
some or all of the production process. Only at a specific point, called the split-off point, do joint
products or services become separate and identifiable. At that point, a company may decide to sell
the product or service as is, or it may decide to process it into another form for sale to a different
market. The objective of a sell or process-further decision is to select the alternative that
maximizes operating income.