1. Slides adapted from Langfield-Smith et al., McGraw-Hill
ACC602: Strategic Management Accounting Topic 5: Relevant Costs for Tactical Decision making
Slides adapted from Langfield-Smith et al., McGraw-Hill
Reference Chapter 19 (including appendix) from the recommended textbook

2. LEARNING OUTCOME:
After the completion of this topic, you should be able to:
Interpret the difference between tactical decisions and long term decisions.
Compare contrast the steps in the decision – making process, and the management accountant’s role.
Evaluate all relevant information in make or buy decision, add or delete a product or department, and for special order decisions.
Validate the joint product costs in decisions about whether to sell a product or process it further.
Formulate how incentives can influence the way that managers make decisions.
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3. The management accountant’s role in decision making
To provide relevant information to managers and teams who make the decisions (about how to run their organisation)
Tactical decisions
Do not require significant capacity-related resource commitments (increasing or decreasing the resources such as factory space or equipment)
Can be changed or reversed quickly – to take advantage of better opportunities (impact may be short term)
Example: Accept or reject a one-off production special order
Whether to sell or process further a joint product
Focus on considering incremental revenues and costs that arise from each alternative
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4. Tend to be more strategic in nature
Long-term decisions
Tend to be more strategic in nature
Involve increases or decreases in capacity-related resources
More difficult to reverse and effects may extend over long time periods
Examples:
Closing a business unit
Acquisition of automated computer equipment
Introduction of new product line
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5. A model of the decision-making process
The seven steps involved are: Step 1: Clarify the problem – decision to be made/ problem to be solved - Eg. Should you accept or reject the special order below the normal price
(cont.)
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6. Step 2 Specify the decision criterion
– upon which the decision will be made; often related to specific objective
eg. Maximise profit, increase market share, minimise cost, etc
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7. Step 3 Identify alternative courses of action
– possible (two or more options)
Eg. If machine breaks down – repair, replace, regular maintenance, etc
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8. Step 4 Collect information about relevant costs and benefits
Involves predictions about outcomes (costs and benefits) of various possible courses of action
-need good understanding of what drives costs and factors that influence revenues
The accountant needs to distinguish between relevant and irrelevant data
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9. Step 5
Compare the costs and benefits of each alternative course of action
The accountant will prepare an analysis of the relevant costs and benefits for each possible course of action
Must be matched with respect to decision criterion identified in step 2 (consider whether it is in line with the organisation objectives)
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10. Step 6 Select a course of action
Managers will select the course of actions that best meets the decision criteria identified in Step 2
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11. Step 7 Evaluate the effectiveness of the decision
- Whether the objectives were met or not
-The main objective is to improve the future decisions
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12. Summary Quantitative Analysis - Steps 2-5
Qualitative considerations - Step 6
Primary responsibility of the management accountant – Steps 4 and 5
Management accountant participates (often as part of cross-functional management team) – Steps 1-7
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13. Characteristics of relevant information
Different under competing courses of action
Costs and benefits that are the same across all available courses of action need not be considered (because it will not make any difference in the decision)
Relates to the future
Consequences of decisions affect the future not the past, so only costs and benefits that relate to the future are relevant
Sunk costs are ignored
Costs that have already been incurred cannot be changed and are irrelevant
Prediction of future costs may be based on past data
(cont.)
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14. Characteristics of relevant information
Timeliness versus accuracy
Relevant information is only of value if it is available in time to be used in the decision-making process
A trade-off may need to be made between the accuracy and timeliness of information (accurate information may take longer to produce)
As accuracy improves, timeliness suffers (vice versa)
More accurate information may take more time to produce
Quantitative or qualitative
Quantitative information can be expressed in numeric terms, such as dollars
Qualitative information cannot be expressed effectively in numerical terms
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15. The importance of providing only relevant information
Generating information is a costly process
Requires time and effort
Supplying irrelevant data to managers can lead to managers reading and processing the information, which is a waste of managerial resources
Information overload decreases the effectiveness of decision making.
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16. Information for unique versus repetitive decisions
Unique decisions
Arise infrequently or only once (requires special analysis by the management accountant)
Relevant information will often be found both inside and outside the organisation
Relevant information is harder to generate
Repetitive decisions
Made over and over again
Made at regular or irregular intervals
May draw on a large amount of historical data
readily available
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17. Identifying relevant costs and benefits: terminology (cont.)
Two tests on relevant information:
The cost or benefit relate to the future
The costs or benefits differ between the alternatives
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18. Identifying relevant costs and benefits: terminology
Incremental revenue
The additional revenue that will be gained as a result of choosing one course of action over another
relevant
Incremental costs
The additional costs that arise from choosing one course of action over another
Out-of-pocket costs
Those incremental costs that will be incurred if a particular course of action is selected (relevant)
Sunk costs
Costs that have already been incurred
Irrelevant to any future decisions (do not affect any future cost and cannot be changed by any current or future action)
Irrelevant to decisions
Eg. Carrying amount of equipment, cost of inventory on hand
(cont.)

19. Identifying relevant costs and benefits: terminology (cont.)
Opportunity costs
The potential benefit give up when the choice of one action precludes a different action
relevant
Avoidable costs
Costs that will not be incurred in the future if a particular decision is made (relevant)
Unavoidable costs
Costs that will continue to be incurred no matter which decision alternative is chosen
Irrelevant to the decision
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20. 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
In situations of spare capacity
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
(cont.)
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21. 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’s reputation or relationships with existing customers (qualitative considerations)
(cont.)
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22. Accept or reject a special order (cont.)
Note: Cost savings is a benefit.
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23. Accept or reject a special order (cont.)
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24. Make or buy a product
Involves the choice between whether the organisation produces a product itself, or purchases it from an external supplier
Consider avoidable versus unavoidable costs
Opportunity costs are often relevant
Consider lost profits from using the capacity to make the product
Strategic issues may include (qualitative considerations)
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
(cont.)
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25. Make or buy a product (cont.)
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26. 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
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27. 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 (qualitative considerations)
If we delete a product, will this affect sales of other products? Will we lose customers? Will it impact capacity?
Will deleting a department impact on employee morale?
(cont.)
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28. Add or delete a product, service or department (cont.)
The following costs are avoidable: Food and beverages, wages ($20000), electricity and telephone, depreciation, supervisory salaries, insurance.
The following costs are unavoidable: wages ($20000), and rent
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29. Add or delete a product, service or department
(cont.)
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30. Add or delete a product, service or department
Passengers may choose a different Airline Company if the club is eliminated. Therefore, lost contribution from decreased sale would be an opportunity cost
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31. Joint products: sell or process further
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
(cont.)
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32. Joint products: sell or process further (cont.)
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33. Joint products: sell or process further
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34. Incentives for decision makers
Managers typically make decisions that will maximise their reported performance and rewards
Cost systems may be designed to explicitly encourage certain biases in decision making
To encourage managers and employees to make certain decisions, systems must be designed with this in mind
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35. Pitfalls to avoid in using accounting data for decisions
Ignore sunk costs
Beware of using unitised fixed costs in decision making
Example: Total Fixed cost is $5000, irrespective of whether 1000 units, 2000 units or 4000 units are produced
But unit fixed cost would be as follows:
$5000/1000 = $5 / unit
$5000/2000 = $2.50/ unit
$5000/4000 = $1.25/unit
Beware of allocated fixed costs, but focus on identifying the avoidable costs
Pay special attention to identifying and including opportunity costs in a decision analysis
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36. 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 consideration of strategic issues
In decision analysis, incremental revenues and costs are usually the focus, and in some cases avoidable costs
In special order and make-or-buy decisions, opportunity costs become relevant where there is no or limited spare capacity
(cont.)
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37. 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 systems may provide more accurate information for decisions 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
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38. Reference:
Smith, L. (etal), 6th ed, “Management Accounting 6/e – Information for Managing and Creating Value. McGraw Hill. Australia.Pages
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