ADVANCED MANAGEMENT ACCOUNTING

OPERATIONAL DECISION MAKING

Putu Nita Winidiantari (2281611033/8)

Lecturer :
Ni Putu Sri Harta Mimba, SE.,M.Si.,Ph.D.,Ak,CA,CMA

PROGRAM MAGISTER AKUNTANSI

FAKULTAS EKONOMI DAN BISNIS
UNIVERSITAS UDAYANA
2022
 OPERATIONAL DECISION MAKING

1. The Decisions Making Process

Information produced by management accountants must be judged in the light of its ultimate
effect on the outcome of decisions. It is therefore important to have an understanding of the
decision-making process. The first four stages represent the decision-making or planning
process. The final two stages represent the control process, which is the process of measuring
and correcting actual performance to ensure the alternatives that are chosen and the plans for
implementing them are carried out. We will now examine the stages in more detail.

1.1 Identifying objectives

Before good decisions can be made there must be some guiding aim or direction that will enable
the decision-makers to assess the desirability of choosing one course of action over another.
Hence, the first stage in the decision-making process should be to specify the company’s goals or
organizational objectives. This is an area where there is considerable controversy. Economic
theory normally assumes that firms seek to maximize profits for the owners of the firm or, more
precisely, the maximization of shareholders’ wealth, is equivalent to the maximization of the
present value of future cash flows. Various arguments have been used to support the profit
maximization objective. There is the legal argument that the ordinary shareholders are the
owners of the firm, which therefore should be run for their benefit by trustee managers. Another
argument supporting the profit objective is that profit maximization leads to the maximization of
overall economic welfare. That is, by doing the best for yourself, you are unconsciously doing
the best for society. Moreover, it seems a reasonable belief that the interests of firms will be
better served by a larger profit than by a smaller profit, so that maximization is at least a useful
approximation. Some writers believe that many managers are content to find a plan that provides
satisfactory profits rather than to maximize profits. Cyert and March (1969) have argued that the
firm is a coalition of various different groups – shareholders, employees, customers, suppliers
and the government – each of whom must be paid a minimum to participate in the coalition. Any
excess benefits after meeting these minimum constraints are seen as being the object of
bargaining between the various groups. In addition, a firm is subject to constraints of a societal
nature. Maintaining a clean environment, employing disabled workers and providing social and
recreation facilities are all examples of social goals that a firm may pursue. Clearly it is too
simplistic to say that the only objective of a business firm is to maximize profits. Some managers
seek to establish a power base and build an empire. Another common goal is security, and the
removal of uncertainty regarding the future may override the pure profit motive. Organizations
may also pursue more specific objectives, such as producing high quality products or being the
market leader within a particular market segment. Nevertheless, the view adopted in this book is
that, broadly, firms seek to maximize future profits. There are three reasons for us to concentrate
on this objective:
1. It is unlikely that any other objective is as widely applicable in measuring the ability of the
organization to survive in the future.
2 It is unlikely that maximizing future profits can be realized in practise, but by establishing the
principles necessary to achieve this objective you will learn how to increase profits.
3 It enables shareholders as a group in the bargaining coalition to know how much the pursuit of
other goals is costing them by indicating the amount of cash distributed among the members of
the coalition.

1.2 The search for alternative courses of action

The second stage in the decision-making model is a search for a range of possible courses of
action (or strategies) that might enable the objectives to be achieved. If the management of a
company concentrates entirely on its present product range and markets, and market shares and
profits are allowed to decline, there is a danger that the company will be unable to survive in the
future. If the business is to survive, management must identify potential opportunities and threats
in the current environment and take specific steps now so that the organization will not be taken
by surprise by future developments. In particular, the company should consider one or more of
the following courses of action:
1 developing new products for sale in existing markets;
2 developing new products for new markets;
3 developing new markets for existing products.
The search for alternative courses of action involves the acquisition of information concerning
future opportunities and environments; it is the most difficult and important stage of the
decision-making process.
1.3 Select appropriate alternative courses of action
In order for managers to make an informed choice of action, data about the different alternatives
must be gathered. For example, managers might ask to see projected figures on:
1. the potential growth rates of the alternative activities under consideration;
2. the market share the company is likely to achieve;
3. projected profits for each alternative activity.
The alternatives should be evaluated to identify which course of action best satisfies the
objectives of an organization. The selection of the most advantageous alternative is central to the
whole decision-making process and the provision of information that facilitates this choice is one
of the major functions of management accounting.

1.4 Implementation of the decisions

Once the course of action has been selected, it should be implemented as part of the budgeting
and longterm planning process. The budget is a financial plan for implementing the decisions
that management has made. The budgets for all of the various decisions a company takes are
expressed in terms of cash inflows and outflows, and sales revenues and expenses. These budgets
are merged together into a single unifying statement of the organization’s expectations for future
periods. This statement is known as a master budget and consists of budgeted profit and cash
flow statements. The budgeting process communicates to everyone in the organization the part
that they are expected to play in implementing management’s decisions.

1.5 Comparing actual and planned outcomes and responding to divergencies from plan
The final stages in the process involve comparing actual and planned outcomes and responding
to divergencies from plan. The managerial function of control consists of the measurement,
reporting and subsequent correction of performance in an attempt to ensure that the firm’s
objectives and plans are achieved. To monitor performance, the accountant produces
performance reports and presents them to the managers who are responsible for implementing
the various decisions. These reports compare actual outcomes (actual costs and revenues) with
planned outcomes (budgeted costs and revenues) and should be issued at regular intervals.
Performance reports provide feedback information and should highlight those activities that do
not conform to plans, so that managers can devote their limited time to focusing mainly on these
items. This process represents the application of management by exception. Effective control
requires that corrective action is taken so that actual outcomes conform to planned outcomes.
Alternatively, the plans may require modification if the comparisons indicate that the plans are
no longer attainable. The process of taking corrective action or modifying the plans if the
comparisons indicate that actual outcomes do not conform to planned outcomes, is indicated by
the arrowed lines. These arrowed lines represent ‘feedback loops’. They signify that the process
is dynamic and stress the interdependencies between the various stages in the process. The
feedback loop between stages 6 and 2 indicates that the plans should be regularly reviewed, and
if they are no longer attainable then alternative courses of action must be considered for
achieving the organization’s objectives. The second loop stresses the corrective action taken so
that actual outcomes conform to planned outcomes.

1.6 The Role Of Cost Information In Pricing Decisions

Most organizations need to make decisions about setting or accepting selling prices for their
products or services. In some firms prices are set by overall market supply and demand forces
and the firm has little or no influence over the selling prices of its products or services. This
situation is likely to occur where there are many firms in an industry and there is little to
distinguish their products from each other. No one firm can influence prices significantly by its
own actions. For example, in commodity markets such as wheat, coffee, rice and sugar, prices
are set for the market as a whole based on the forces of supply and demand. Also, small firms
operating in an industry where prices are set by the dominant market leaders will have little
influence over the price of their products or services. Firms that have little or no influence over
the prices of their products or services are described as price takers. In contrast firms selling
products or services that are highly customized or differentiated from each other by special
features, or who are market leaders, have some discretion in setting prices. Here the pricing
decision will be influenced by the cost of the product, the actions of competitors and the extent to
which customers value the product. We shall describe those firms that have some discretion over
setting the selling price of their products or services as price setters. In practice, firms may be
price setters for some of their products and price takers for others. Where firms are price setters,
cost information is often an important input into the pricing decision. Cost information is also of
vital importance to price takers in deciding on the output and mix of products and services to
which their marketing effort should be directed, given their market prices. For both price takers
and price setters the decision time horizon determines the cost information that is relevant for
product pricing or output mix decisions. We shall therefore consider the following four different
situations:

1. A price-setting firm facing short-run pricing decisions;

Companies can encounter situations where they have temporary unutilized capacity and are faced
with the opportunity of bidding for a one-time special order in competition with other suppliers.
In this situation only the incremental costs of undertaking the order should be taken into account.
It is likely that most of the resources required to fill the order will have already been acquired
and the cost of these resources will be incurred whether or not the bid is accepted by the
customer. Typically, the incremental costs are likely to consist of:
• extra materials that are required to fulfil the order;
• any extra part-time labour, overtime or other labour costs;
• the extra energy and maintenance costs for the machinery and equipment required to complete
the order.
The incremental costs of one-off special orders in service companies are likely to be minimal.
For example, the incremental cost of accepting one-off special business for a hotel may consist
of only the cost of additional meals, laundering and bathroom facilities. Bids should be made at
prices that exceed incremental costs. Any excess of revenues over incremental costs will provide
a contribution to committed fixed costs that would not otherwise have been obtained. Given the
short-term nature of the decision, long-term considerations are likely to be non-existent and,
apart from the consideration of bids by competitors, cost data are likely to be the dominant factor
in determining the bid price.

2. A price-setting firm facing long-run pricing decisions;

In this section we shall focus on three approaches that are relevant to a price-setting firm facing
long-run pricing decisions. They are:
a. Pricing customized products/services;
Customized products or services relate to situations where products or services tend to be unique
so that no comparable market prices exist for them. Since sales revenues must cover costs for a
firm to make a profit, many companies use product costs as an input to establish selling prices.
Product costs are calculated and a desired profit margin is added to determine the selling price.
This approach is called cost-plus pricing
b. Pricing non-customized products/services;
With highly customized products or services sales are likely to be to a single customer with the
pricing decision being based on direct negotiations with the customer for a known quantity. In
contrast, a market leader must make a pricing decision, normally for large and unknown volumes
of a single product, that is sold to thousands of different customers. To apply cost-plus pricing in
this situation an estimate is required of sales volume to determine a unit cost, which will
determine the cost-plus selling price. This circular process occurs because we are now faced with
two unknowns that have a cause-and-effect relationship, namely selling price and sales volume.
In this situation it is recommended that cost-plus selling prices are estimated for a range of
potential sales volumes.

3. A price-taking firm facing short-run product mix decisions;

Price-taking firms with a temporary excess capacity may be faced with opportunities of taking on
short term business at a market-determined selling price. In this situation the cost information
that is required is no different from that of a price-setting firm making a short-run pricing
decision. In other words, accepting short-term business where the incremental sales revenues
exceed incremental short-run costs will provide a contribution towards committed fixed costs
that would not otherwise have been obtained. However, such business is acceptable only if the
same conditions as those specified for a price-setting firm apply. You should remember that
these conditions are:
• sufficient capacity is available for all resources that are required from undertaking the business
(if some resources are fully utilized, opportunity costs of the scarce resources must be covered by
the selling price);
• the company will not commit itself to repeat longer-term business that is priced to cover only
short term incremental costs;
• the order will utilize unused capacity for only a short period and capacity will be released for
use on more profitable opportunities.
Besides considering new short-term opportunities organizations may, in certain situations,
review their existing product-mix over a short-term time horizon. Consider a situation where a
firm has excess capacity which is being retained for an expected upsurge in demand. If
committed resources are to be maintained then the product profitability analysis of existing
products should be based on a comparison of incremental revenues with short-term incremental
costs. The same principle applies as that which applied for accepting new short-term business
where spare capacity exists. That is, in the short term products should be retained if their
incremental revenues exceed their incremental short-term costs.

4. A price-taking firm facing long-run product mix decisions.

When prices are set by the market a firm has to decide which products or services to sell given
their market prices. In the longer term a firm can adjust the supply of resources committed to a
product. Therefore the sales revenue from a product should exceed the cost of all the resources
that are committed to it. Hence there is a need to undertake periodic profitability analysis to
distinguish between profitable and unprofitable products in order to ensure that only profitable
products are sold.
 REFERENCES

Drury, Colin. 2012. Management and Cost Accounting. 8th Edition. Cengage Learning.