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Acc408 Short Run Decisions 1 22 Material

The document outlines the principles of short run decision making in accounting, emphasizing the characteristics and factors involved in making such decisions. It includes case studies for calculating optimum product mixes and contributions for various products, while also discussing the implications of special orders. Key concepts include identifying relevant costs and revenues, establishing marginal relationships, and considering both financial and non-financial factors in decision making.

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2 views6 pages

Acc408 Short Run Decisions 1 22 Material

The document outlines the principles of short run decision making in accounting, emphasizing the characteristics and factors involved in making such decisions. It includes case studies for calculating optimum product mixes and contributions for various products, while also discussing the implications of special orders. Key concepts include identifying relevant costs and revenues, establishing marginal relationships, and considering both financial and non-financial factors in decision making.

Uploaded by

spencerstrasmo
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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MIDLANDS STATE UNIVERSITY

FACULTY OF BUSINESS SCIENCES


DEPARTMENT OF ACCOUNTING SCIENCES
MATERIAL FOR ACC408-SHORT RUN DECISION MAKING 1/22
Introduction
Short run decisions generally tend to have the following characteristics:
 They are usually made at operational level and do not impact long term goals of the entity
 They can easily be changed or reversed without a significant impact on operations.
 They primarily involve variable costs and variable revenue and may result in either
marginal income or a marginal cost.
 They generally do not distort the fixed cost pattern currently enjoyed by the entity
 They are usually initiated and completed within a short period of time…within a year.
 They do not require substantial resources’ commitment; decisions can be varied at short
notice without disrupting routine operations
Several instances arise which call for short run decision-making. The list is not exhaustive but
merely serves as a guide on the approach to be adopted to reaching a decision. The quantitative
approach is first adopted but in every case, non-financial considerations must also be considered
before the final decision is made.
Cases may point towards recommending the optimum product mix, accepting or rejecting a
special order, ‘sell as it is’ or ‘process further’, make or buy, continue to operate or shut down
temporarily.
Basic principles
 Identify relevant revenues and relevant costs associated with the decision to be made.
 Establish the marginal revenue and marginal cost relationship; when MR exceeds MC,
accept the option; when MC exceeds MR, reject the option; when MR matches MC the
decision may be influenced by qualitative factors.
 The variable costing approach or the contribution margin approach is adopted in the
layout of the statement to show the working.
 When an option yields contribution, it is worth pursuing in the short run.
Optimum product mix
Since resources are scarce relative to the demand for them, every effort must be made in
decision-making to get the most out of them. This applies to goods and services. Such a decision
calls for recommending the best combination of goods or services given the constraints on the
ground. The four factors of production are limitations to growth and can be constraints in one
form or another. These are land, labour, capital and entreprenuarial skills.
Given the following data for Bee ltd which produces 2 products-Axe & Wye:

1
Axe Wye
Direct materials-2kgs @$2,5 each 5,00
3 kgs @$2,5 each 7,50
Direct labour-3 hours @$2 each 6,00
3,5 hours @$2 each 7,00
Unit selling price $16 $20,50
Market demand 250 units 200 units

Total direct materials available are 900kgs.


Required
a)Calculate unit contribution per product
b)Confirm whether it is true that there is a limiting factor.
c)Calculate the contribution per unit of the limiting factor
d)Calculate the optimum product mix
e)Calculate how much profit would arise from the result in (d) above.
Solution:
Set out work in Variable costing format
a)Unit contribution
Axe Wye
Unit selling price $16 $20,50
Less VC:D/Materials (2kgs @2,50) ( 5)
(3 kgs@2,50) (7,50)
D/Labor(3 hrs @2,00) (6)
(3,5 hrs @2,00) (7,00)
Unit contribution 5 6

b)Confirming the limiting factor


Available direct materials 900 kgs
Less Anticipated demand: Axe 250 @ 2 kg 500kgs
Wye 200 @ 3kg 600 kgs 1 100 kg
Deficit (200kgs)

2
c)Contribution per unit of the limiting factor
-Unit contribution/limiting factor Axe: $5/2kg……..$2,50 per kg
Wye: $6/3kg…..$2,00per kg.
d)Calculation of Optimum product mix
Available direct materials 900kg
i)Axe:250 units @2kg (500kg)

ii)Wye:(400/3kg)…133 units @3 kgs (399kg)


slack 1 kg

Optimum product mix: 250 units of Axe & 133 units of Wye.
e)Profit from d)
250 of Axe @$5=$1 250 and 133 units of Wye @$6 give a total of $2 048
As a Consolidation exercise, using the same details in the table above and having 1 200 direct
labor hours at the disposal of Bee ltd. Establish the Optimum product mix.

Given two constraints.


A manufacturer produces 2 products-K and P in the cutting and assembly departments of his
factory.
The following data is available:
K P
Unit selling price $600 $1 000
Unit variable costs 250 400
Machine hours-Cutting department 2 hours 4 hours
Assembly department 3 hours 2 hours
Total hours available-Cutting department-80 hours
Assembly department-60 hours

Required
a)Calculate the unit product contribution
b)Formulate the objective function
c)Formulate the limiting factors’ relationships
d)Calculate the Optimum product mix

3
c)Based on c), graphically solve for K and P.

Solution to the case on 2 constraints


a)Unit contribution; K….$350; P…..$600
b)Objective function:
Let the units to be manufactured be K & P; Objective becomes: 350K + 600P=largest
contribution
c)Limiting factors: 2K + 4P =80
3K + 2P=60 Note that production cannot be negative and has to be equal to
zero or greater than zero.
d)Optimum product mix must be bounded by the limiting factors
The two equations are simultaneous in nature and have to be solved;
K=10 whilst P=15.
Produce 10 units of K and 15 units of P.

e)Graphically solving the 2 simultaneous equations leads to 2 linear graphs intersecting yielding
the same results if drawn to scale. The point of intersection of the two linear graphs gives the
values for K and P.

Consolidation case
Jay ltd manufactures two products, Aye and Bee in the Handicraft and Manufacturing
Department. The unit selling prices for Aye and Bee are $300 and $350 respectively whilst their
unit variable costs are $180 and $200 respectively.
In the handicraft department, Aye requires 4 hours whilst Bee requires 2 hours; in the machining
department, Aye needs 3 hours whilst Bee needs 2 hours. The handicraft department enjoys 160
hours whilst the machining department enjoys 140 hours. At least both products must be
available on the market.
Required
a)Formulate the objective function.
b)Formulate the ‘constraints relationship’.

4
c)Solve for the optimum products for Aye & Bee to be produced and be sold.
d)By how much would the entity be better off after adopting the units in c).

Special Order
This is a one-time order not considered to be part of the entity’s normal order. This should not
interfere with the normal sales.
The following pre-requisites must be assessed before accepting such an order:
 Production capacity must be available
 Current selling price must not be affected by the acceptance of a special order.
 Fixed costs must remain fixed
At times the special order may exceed idle capacity. There is need to consider
 Operating overtime within the confines of the law
 Consider engaging casual labor to make up for direct labor hours’ deficit. Consider
outsourcing the supply as the last resort as this may compromise quality.
The layout of the statement showing workings for the special order is as follows:
Additional revenue on the special order xxxxxxxx
Less Incremental costs: Variable costs:D/Materials xxxxxx
D/Labor xxxxxx
Variable manufacturing xxxxxx xxxxxxxx
Contribution xxxxxxxx
Less any special fixed costs(Once-off) xxxxxxxx
Profit/Loss on the special order xxxx

Dee ltd manufactures hand alarms. It is operating at 80% plant capacity producing and selling 12
000 units. Arms Security has made a special order request for 3 800 units which must be met in
full if accepted.
The following data is available per unit:
Unit selling price, $15; Direct material cost, $5; Direct labor cost, $4. Arms security is
requesting for a preferential price of $12 per unit.
For units in excess of plant capacity, overtime labor rates at a premium of 25% now apply.
Direct materials would also be sourced at a premium of 10%
A special machine costing $700 would be acquired and be used to stick a logo on the hand alarm.
It would be sold back to the seller for cash at $630.

5
Required
a)Advise whether Dee Ltd should accept or reject this order.
b)What other non-financial factors must be considered by Dee ltd before finalizing on this order.

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