Chapter 19 Information for tactical decisions 19-1 Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-Smith Prepared by Kim Langfield-Smith

Outline The management accountant’s role in decision making Characteristics of relevant information Accept or reject a special order Make or buy a product Outsourcing decisions Add or delete a product or department Joint products: sell or process further Implications of ABC analysis for decisions Incentives for decision makers Pitfalls to avoid when using accounting data for decisions 19-2 Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-Smith Prepared by Kim Langfield-Smith

The management accountant’s role in decision making To provide relevant information to managers and teams who make the decisions Tactical decisions –Do not require significant or permanent resource commitments –Can be changed or reversed quickly Long-term decisions –Tend to be more strategic in nature –May involve increases or decreases in capacity-related resources –More difficult to reverse and effects may extend over longer time periods 19-3 Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-Smith Prepared by Kim Langfield-Smith

A model of the decision-making process 1.Clarify the problem 2.Identify alternative courses of action 3.Collect relevant cost and benefits 4.Compare the costs and benefits of each possible course of action 5.Select a course of action 19-4 Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-Smith Prepared by Kim Langfield-Smith

Characteristics of relevant information Different under competing courses of action –May include opportunity costs  The potential benefit given up when one course of action is chosen over another Relates to the future –Sunk costs are ignored  Costs that have already been incurred and are irrelevant to any future decisions –Prediction of future costs may be based on past data 19-5 (cont.) Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-Smith Prepared by Kim Langfield-Smith

Characteristics of relevant information (cont.) Timeliness versus accuracy –Information available in time to be used in the decision- making process –As accuracy increases, timeliness may decrease Quantitative or qualitative –Quantitative information can be expressed in numeric terms, such as dollars –Qualitative information cannot be expressed easily in numerical terms 19-6 Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-Smith Prepared by Kim Langfield-Smith

The importance of providing only relevant information Generating information is a costly process Supplying irrelevant data can result in a waste of managerial resources Information overload decreases the effectiveness of decision making 19-7 Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-Smith Prepared by Kim Langfield-Smith

Information for unique versus repetitive decisions Unique decisions –Arise infrequently or only once –Relevant information will often be found both inside and outside the organisation –Relevant information is harder to generate Repetitive decisions –Made at regular or irregular intervals –May draw on a large amount of historical data –Relevant information is readily available 19-8 Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-Smith Prepared by Kim Langfield-Smith

Information for decisions: terminology Incremental revenue –The additional revenue that will be gained as a result of choosing one course of action over another Incremental costs –The additional costs that arise from choosing one course of action over another 19-9 Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-Smith Prepared by Kim Langfield-Smith (cont.)

Information for decisions: terminology (cont.) Avoidable costs –Costs that will not be incurred in the future if a particular decision is made Unavoidable costs –Costs that will continue to be incurred no matter which decision alternative is chosen –Irrelevant to the decision Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-Smith Prepared by Kim Langfield-Smith

Accept or reject a special order Whether or not to supply a customer with a single, one-off order for goods or services, at a special price Spare capacity occurs where equipment, labour or other inputs to production are not being utilised and, hence, are available for other purposes –If incremental revenues are greater than incremental costs, the order should be accepted, on financial grounds –Allocated fixed costs should not be included –Assumes that there are no alternative uses for the spare resources Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-Smith Prepared by Kim Langfield-Smith (cont.)

Accept or reject a special order (cont.) If there is no spare capacity – The analysis should take account of opportunity costs associated with the use of the limited capacity If the decision is not a one-off decision –Pricing may need to be reviewed to cover facility costs –If capacity is limited, then it may need to be increased to ensure that all profitable business can be accommodated Strategic issues –Long-term strategic issues may include whether the decision to accept the special order will impact on the business’ reputation or relationships with existing customers Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-Smith Prepared by Kim Langfield-Smith

19-13 Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-Smith Prepared by Kim Langfield-Smith

Make or buy a product Involves the choice of whether to produce a product, or purchase it from an external supplier Consider avoidable versus unavoidable costs Opportunity costs are often relevant –Lost profits from using capacity to make the product Strategic issues may include –Quality of the purchased product –Delivery responsiveness, technical capabilities, labour relations and financial stability of the supplier –Ability of the supplier to respect confidential information Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-Smith Prepared by Kim Langfield-Smith

19-15 Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-Smith Prepared by Kim Langfield-Smith

19-16 Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-Smith Prepared by Kim Langfield-Smith

Outsourcing decisions Outsourcing occurs when part of a manufacturing process, or another function normally undertaken within an organisation, is contracted to an outside business Tends to be a long-term decision rather than a tactical “make or buy” decision Difficult and costly to reverse Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-Smith Prepared by Kim Langfield-Smith

Add or delete a product, service or department Consider which costs and benefits will change if the decision is taken Has long-term implications Conventional accounting data that contains cost allocations should be treated with care Strategic issues –If we delete a product, will this affect sales of other products? Will we loose customers? Will it impact capacity? –Deleting a department may impact on employee morale Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-Smith Prepared by Kim Langfield-Smith

19-19 Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-Smith Prepared by Kim Langfield-Smith

Joint products: sell or process further Joint products –Two or more products produced simultaneously from the one production process –Cannot be separated prior to split-off Split-off point –The stage in the production process when the joint products are identifiable as separate products Joint cost –All manufacturing costs incurred in the production of joint products Relative sales method –A method of allocating joint cost to joint products in proportion to their sales value at the split-off point Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-Smith Prepared by Kim Langfield-Smith

19-21 Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-Smith Prepared by Kim Langfield-Smith

19-22 Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-Smith Prepared by Kim Langfield-Smith

Implications of activity-based cost analysis for decisions Identification of relevant costs, incremental costs, opportunity costs, sunk costs and avoidable costs Costs may be more accurately assigned to products or departments Leads to the identification of precise cost implications of various decision alternatives Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-Smith Prepared by Kim Langfield-Smith

19-24 Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-Smith Prepared by Kim Langfield-Smith

Incentives for decision makers Managers typically make decisions that will maximise their reported performance and rewards Cost systems may be designed explicitly to encourage certain biases in decision making To encourage managers and employees to make certain decisions, systems must be designed with this in mind Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-Smith Prepared by Kim Langfield-Smith

Pitfalls to avoid in using accounting data for decisions 1.Ignore sunk costs 2.Beware of unitised fixed costs in decision making 3.Beware of allocated fixed costs; identify the avoidable costs 4.Pay special attention to identifying and including opportunity costs in a decision analysis Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-Smith Prepared by Kim Langfield-Smith

Summary Tactical decisions do not require significant changes in capacity and can be changed if better opportunities arise Relevant information will include quantitative and qualitative information, as well as strategic issues In decision analysis, incremental revenues and costs are usually the focus, and in some cases so are avoidable costs Identifying whether there is spare capacity is important in special orders and make or buy decisions, as opportunity costs become relevant where there is no spare capacity Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-Smith Prepared by Kim Langfield-Smith (cont.)

Summary (cont.) Adding or deleting a product/department involves consideration of avoidable and unavoidable costs Processing joint products further requires consideration of incremental revenue and costs ABC system may provide more accurate information than costs generated from conventional costing systems Management incentives can sometimes distort the collection and analysis of information in decisions Accounting data should be used carefully in decision analysis as it can be problematic Copyright  2009 McGraw-Hill Australia Pty Ltd PowerPoint Slides t/a Management Accounting 5e by Langfield-Smith Prepared by Kim Langfield-Smith