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Cost Accounting for Decision-making

Cost Accounting for Decision-making. Lesson 4. Part III. Different Types of Business Decisions (Hire, Make or Buy) (2). Five Types of Business Decisions. Hire, make or buy Accept or reject an order at a special price Eliminate or retain an unprofitable segment Retain or replace equipment

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Cost Accounting for Decision-making

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  1. Cost Accounting for Decision-making Lesson 4

  2. Part III Different Types of Business Decisions (Hire, Make or Buy) (2)

  3. Five Types of Business Decisions • Hire, make or buy • Accept or reject an order at a special price • Eliminate or retain an unprofitable segment • Retain or replace equipment • Sell or process further

  4. Question If a company does not have enough machine /labour hours to produce all the products, what should the company do?

  5. Solutions: The company may consider to do the following: • Ask the workers to work overtime • Outsource some of the processes or products • Invest in additional machines • Reduce defective units

  6. Managing Constraints Constraint is the limits on resources that a company can provide e.g. Machine hours; labour hours; production capacity. When there are constraints, a company can overcome them either by expanding its production capacity or outsourcing.

  7. Managing Constraints Before making a decision, we have to consider the following: • What constraints are there that hinder the company from producing the quantity demanded? • Which product(s) should be produced by the company and which product(s) should be outsourced?

  8. Decision Rule in Managing Constraints

  9. Example of Managing Constraints The maximum production capacity for a company is restricted to 12,000 machine hours (MH). This year, it canproduce X, Y and/or Z.

  10. Required: • Does the company has any constraint in its production process? • In order to maximise profit, calculate the number of units to be produced for each product and their respective. • The company does not want to lose sales, what will be the maximum acceptable purchase price if the company outsources the remaining shortfall units?

  11. Steps to Follow in Making the Decision • Find out the total required machine hours for the production and see whether the company’s maximum capacity poses a constraint here. • Calculate the respective contribution margin per machine hour for each product. • Rank the order of the products with the highest contribution margin per MH first and so on. • Determine the production plan and calculate the total contribution margin. • Suggest some alternatives to overcome the production shortfall.

  12. Suggested Solution • Since total required machine hours (18,000 hours*) exceeds the company’s maximum capacity (12,000 hours),it poses a constraint to the company in the production process. • *6 x 2,000 + 2 x 2,000 + 1 x 2,000

  13. Steps to determine the number of units to be produced for each product and its respective contributions: Step 1: Calculate the contribution margin per machine hour

  14. Step 2: Rank the order of products for production Step 3: Determine the number of units for each products to be produced

  15. Step 4: Calculate the total contribution margin $6 x 2,000 + $10 x 2,000 + $12 x 1,000 = $44,000 So, to maximize profit, the company should produce 2,000 units of Z, 2,000 units of Y and 1,000 units of X. • The company does not have machine hours to produce the remaining 1,000 units of X. It has to outsource the shortfall units and the maximum acceptable purchase price of X will be $30 per unit which is equal to the selling price of X.

  16. Classwork Elin Company produces and sells three products: A, B, and C. Data relating to the three products is as follows:

  17. Classwork The three products use the same raw materials. The company has only 4,500 kg of raw materials on hand, the cost of which is $10 per kg. It is known that the material will be in shortage and not available in local market for purchase in the next few months. Part A Required: Compute the contribution margin per kg of material used in each product. Which product(s) should the company produce and what is the total contribution from the production?

  18. Classwork Part B Two options are now available for the company to consider in overcoming the production shortfall: (i). The company can buy the materials from oversea at a cost of $15 per kg. (ii). A supplier can supply the products at the prices of $50, $38 and $35 for A, B and C respectively. Advise which option the company should adopt?

  19. Suggested Solution Part A 1.

  20. Suggested Solution • The company should produce C first, then A: The company should produce 1,800 units of C and 375 units of A. The total contribution is $100,800*. *$18,000 + $82,800 = $100,800

  21. Suggested Solution Part B (i). Additional contribution = $54,000 (ii).Contribution from A = $(80 – 50) x 625 = $18,750 Contribution from B = $(56 – 38) x 1,500 = $27,000 Additional contribution = $45,750

  22. Suggested Solution Conclusion: Option (i) should be adopted because it obtains $8,250* more contribution than Option (ii). *$54,000 - $45,750 = $8,250

  23. Homework: Q5

  24. END

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