Decision Making

Fundamental function of Management

Choice Among Alternatives

Types Routine Cost Classification

• Production scheduling
• Purchase of Material
Types
Strategic/ Long run Short Run/ Operating decisions

• Longer Period of time • Shorter Period of time < Year

• Capacity Related resources can be changed • Capacity Related resources can Non Routine
not be changed • Buying or Making
• No concept of Fixed and variable cost • Concept of Fixed and variable • Accept or Reject special
cost Exist (Short run) order
• Rigid/ Irreversible • Continue or drop product
• Flexible / Can be changed
line
• Time value of money plays critical role while • No role of time value of money
Making decision. in Making decision as time is so
short that value of money remains stable.
 Cost Classification

Relevant cost Irrelevant cost

• Information that changes from alternative to alternatives • Information that remains same among alternatives
• Basis for making decision • Not considered for decision making
Example

Avoidable cost Incremental Cost Opportunity cost

Cost that can be avoided when An approach that focuses on the
• Potential benefit that is given
one alternative Chosen over other. Cost and revenue that differ among
alternatives. up when one alternative Chosen
Cost of Making Outsourcing over other.
Alt -01 Alt-02 Incremental
(Alt 1 Vs Alt 2) • My home first floor is vacant
D/M (500)
D/L Cost A $ 1,000 $ 1,500 So I m loosing say 30,000 P.M
VFoH Cost B 5,000 4,000 1,000
• Potential cost not out of pocket
FFoH Cost C 500 500 ---
Example $ 6,500 $ 6,000 $ 500 Alt 1 cost > Alt 2 cost
• All Variable cost
• Discretionary/ Alt -02 as it cost 500 less than Alt -01
Direct Fixed cost Example
Incremental cost/ Incremental approach
 Cost Classification

Relevant cost Irrelevant cost

• Information that remains same among alternatives
• Not considered for decision making
Example

Committed cost
Sunk cost Unavoidable cost
Cost that has been incurred in past • Cost that will incurred in future
Cost that continue to be incurred
and has no role To play in present irrespective of alternative to be
irrespective of alternative to be
decision making selected
selected
After Bs A&F ( Cost= 500,000) After taking car on 5 Year lease
Rent of Bahria University if
a department is dropped still
Job CA Careem Personal use
Remains same and continue incur

Example Example Example

• Depreciation • Lease Rentals
• Common/ Indirect/ Allocated fixed cost
• Fees you paid for semester
• Prepaid rent
 Cost Classification

Relevant cost Irrelevant cost

• Information that changes from alternative to alternatives • Information that remains same among alternatives
• Basis for making decision • Not considered for decision making
Example Example
Avoidable cost Sunk cost
• Cost that can be avoided when • Cost that has been incurred in past and has no role
one alternative Chosen over other. To play in present decision making
Example Example
• All Variable cost • Depreciation
• Discretionary/Direct Fixed cost • Fees you paid for semester
Relevant cost Unavoidable cost
• An approach that focuses on the • Cost that continue to be incurred irrespective of
Cost and revenue that differ among alternative to be selected
alternatives. Example
Example
Incremental cost/ Incremental approach • Common/ Indirect/ Allocated fixed cost
Committed cost
Opportunity cost • Cost that will incurred in future irrespective of
• Potential benefit that is given up when
alternative to be selected
one alternative Chosen over other.
• Potential cost not actual Example
• Lease Rentals
 Make or Buy Decision
Ex 8-5 :Tiny Toy Company
28.8 *40,000
Cost of Buying ………………………………………………...........................… 1,152,000

Less Avoidable Cost of Making/ Benefits of buying

Relevant Costing
D/M……………………………….. 5.0
D/L……………………………….. 10.0
V FoH ……………………………….. 7.0
75% * 8 6.0
FFoH ………………………………..
28.0 *40,000…………………………….. (1,120,000)
Cost of Buying is > Benefits of Buying …………………………………………… 32,000

Decision

Tiny Toy should reject this offer and continue to make part at his own.
 Make or Buy Decision
Ex 8-6 (1) :Miller Manufacturing
65 *15,000
Cost of Buying ………………………………………………...........................… 975,000
Less Avoidable Cost of Making/ Benefits of buying
D/M……………………………….. 28.0
D/L……………………………….. 10.0
V FoH ……………………………….. 3.0
FFoH (direct)……..…………….. 6.0
47.0 *15,000…………………………….. (705,000)
Cost of Buying is > cost of Making …………………………………………… 270,000

Decision : Miller Company should reject this offer and continue to make Monitors at his own.
Ex 8-6 (2)
Cost of Buying ………………………………………………...........................… 975,000 Decision
Less benefits of buying
Avoidable cost of buying………………………… 705,000 Miller Company should reject this offer
Opportunity cost………………………………………… 250,000 (955,000) and continue to make Monitors at his own
Cost of Buying is > cost of Making …………………………………………… 20,000 As still Cost of Buy > benefits of buying.
 8-21 (a) Henry Horticultural 8-21 (b)
40,000 timers * 32 40,000 timers * 32
Cost of Buying …………………………………………….... 1,280,000 Cost of Buying …………………………………………….... 1,280,000
Less :Avoidable cost of Making / Benefits of buying Less :Avoidable cost of Making / Benefits of buying
D/M………………………. $ 12 D/M…….. $ 12
D/L……………………… 6 D/L……… 6
VFoH…………………….. 3 VFoH…… 3
8*30% 2.4 $ 21 * 40,000 timers….. 840,000
Direct Fixed cost………….
$ 23.4 * 40,000 timers (936,000)
Opportunity cost
Cost of Buying > cost of Making…………………… $ 344,000 (1,240,000)
C.M: (11-7) *100,000………………… 400,000
Decision: Company should reject this offer Cost of Buying > cost of Making…………………… $ 40,000
and make timers at his own
Decision: Company should reject this offer
and make timers at his own as Still
cost of buying is > benefits of buying
Special Order
Glo-Bright Lamp
Benefit of Accepting offer
25,000 *14 350,000
Sales ………………………….

Less Cost of Accepting offer

11 * 25,000 275,000
Variable Manfact cost……………….……..
Incremental shipping cost………………………….. 4,200 (279,200)

Benefits of Accept offer > Cost of Accept offer 70,800

Decision : The company should accept the offer as it will

result in increase in profit by 70,800