Decision Making - Routine PDF

Decision Making -- it is the determination of a specific action among alternatives which is considered to be the best option. Types of Decisions: 1. Routine Decisions -- ones that is being made on a regular basis. Usually, these are pertaining to the normal operating cycle of an entity wh...

Decision Making -- it is the determination of a specific action among alternatives which is considered to be the best option. Types of Decisions: 1. Routine Decisions -- ones that is being made on a regular basis. Usually, these are pertaining to the normal operating cycle of an entity which occurs on a daily basis, hence there are already set of policies addressing such situation minimizing the discretion of the decision maker. Examples include what to sell, how much to sell, what to buy, how much to buy, etc. 2. Non-Routine Decisions -- these are pertaining to situations that are uncommon and will be made under the discretion of the decision maker. Usually non-routine decisions arise from events that managers have never dealt with before. Scientific Approach in Decision Making 1. Set the Objectives: Usually it is to maximize the benefits and/or minimize the cost 2. Identify the Alternatives: The different options available in order to attain the objectives a. Make or Buy (Outsourcing Decision) b. Accept or Reject (Special Orders) c. Drop or Maintain (Segments) d. Sell or Process Further (Joint Processing of Products) e. Constrained Resources (Environment with Bottlenecks) 3. Gather Data f. Relevant Data -- those that should be considered in the decision making process g. Irrelevant Data -- those that should be ignored and not included in the analysis. 4. Evaluate alternatives based on data gathered: Determination of the advantages and disadvantages for each alternative. 5. Make a Conclusion: Select the alternative that will best achieve the objective. Relevant versus Irrelevant 1. Relevant Revenues and Costs - those expected future revenues and costs that differ among alternatives. a. Differential Revenue and Costs -- those that differ between two alternatives. i. Incremental Revenue and Costs -- are incurred additionally as a result of an activity. ii. Avoidable Revenue and Costs -- a cost that can be avoided if a particular option is selected. It is a cost that would go away. b. Opportunity Costs -- the contribution to income that is forgone by not using a limited resource in its best alternative use. 2. Irrelevant Revenues and Costs -- those that will not differ no matter what alternative will be chosen. c. Sunk Costs - past costs that have already been incurred and nothing can be done to change it. d. Committed Costs -- those future costs and revenues that will remain the same regardless of the decision to be made. ***Make or Buy*** - Also called outsourcing decision - General Objective: Whichever of the two options results in the lower cost - Consideration: the relevant cost to make versus the relevant cost to buy - Issue: The total cost per unit of a product or service includes a *unitized* portion of fixed cost, a cost that may continue even if the item or service is purchased elsewhere at a lower price - Computation of cost: [Cost to Make] [Cost to Buy] ------------------------------------------------------------- ---- --------------------------- ---------------- ---- Direct Materials xx Purchase Price Xx Direct Labor xx Variable Overhead xx Decrease in Fixed Overhead (if any) xx Opportunity Cost (if any -- alternative usage of the space) xx TOTAL xx TOTAL Xx ***Accept or Reject*** - A special order is a one-time order that is not considered part of the company's normal ongoing business. - General Objective: Incremental Revenue (Special selling price) should always be higher than the incremental cost. - Consideration: Discounted selling price versus relevant cost to make and sell. - Issue: Since the existing fixed manufacturing overhead costs would not be affected by the order, they are not relevant. - Computation: Sales xx --------------------------------------------------------------------------------------------- ---- ------ Less: Cost to Make and Sell Direct Materials xx Direct Labor xx Variable Manufacturing Overhead xx Variable Selling and Administrative (if required) xx Special Equipment and other requirements (if any) xx Lost Contribution Margin -- if required to sacrifice regular sales due to lack of capacity. xx (xx) Incremental Income Xx ***Drop or Maintain*** - General Objective: As long as the segment can contribute in covering common cost, it should not be closed. - Consideration: The contribution margin lost from the activity to be dropped versus avoidable costs. - Issues: - The key is the proper handling of fixed costs, particularly allocated common costs, and determination if such amounts are avoidable or unavoidable - Mutually exclusive decisions -- a segment will be affected by decisions made regarding another segment. - Computation: Segment Revenue (Sales) xx ------------------------------------------------------------- ------ Less: Variable Cost (xx) Segment Contribution Margin xx Less: Direct/Traceable Fixed Costs (xx) Segment Margin (if positive = Maintain; if negative = drop) xx Incremental Approach with consideration to additional items: Loss Segment Margin (xx) -------------------------------------------------- ---- ------ Increase in Contribution Margin of other segment xx Decrease in Contribution Margin of other segment (xx) Cost incurred in closing the segment (xx) Increase/(Decrease) in Over-all Operating Income xx ***Shutdown Point*** - Objective: To choose the alternative that will result to the lower loss (choosing the lesser evil) - This is applicable for companies with products that have seasonal, cyclical or random variation in demand. It is also applicable to those companies that are in the process of restructuring its operation. - Consideration: Indifference point when to close and to stay open. - Computation: Shutdown Point (In Units to be Sold): \ [\$\$Shutdown\\ Point = \\frac{Avoidable\\ Fixed\\ Cost - Shutdown\\ Cost}{\\text{Contribution\\ Margin\\ per\\ unit}}\$\$]{.math.display}\ ***Sell or Process Further*** - A ***joint production process*** results in the commingled manufacture of two or more products, called joint products. The products become identifiable from each other at the ***split-off point***. - Objective: When deciding to process a product the goal is always to maximize profit - Consideration: The correct decision is made by comparing the separable cost incurred against the amount of increased sales revenue. - Issue: [Joint costs incurred prior to split-off are not relevant] when making the sell-at-split-off or-process-further decision, because these costs will be incurred regardless of the alternative selected. - Computation: Sales after further processing xx ------------------------------------------------------------- ------ Sales at Split-off point (xx) Incremental Revenue xx Cost to be incurred when process further (Incremental Cost) (xx) Net Incremental Profit = if positive xx Constrained Resources - Constraints -- Limitations or bottlenecks under which a company must operate, such as limited available machine time or raw materials, which restrict the company's ability to satisfy demand. - Objective: To maximize profit in a constrained environment by prioritizing products that will yield the highest. - Consideration: When only one limited resource is present, a company should focus on products that have the greatest amount of contribution margin per unit of the scarce resource. - Computation Guide: - Identify the constraint - Compute the CM/unit for each of the product line - Compute the Contribution margin per constrained resources - Highest CM/constraint would be prioritize or rank 1 - Effects of Market Limitations - If the product line with the highest contribution margin has a maximum market demand limit, other resources may be devoted to the other product line. - If all the product line has a minimum requirement, this should be prioritized regardless of the ranking, then proceed to the ranking based on the contribution margin per constrained resource