MODULE-1

DECISION MAKING USING COST

CONCEPTS

contents
1.
2.
3.
4.
5.
6.
7.
8.

Definition and meaning of decision making

Features or advantages of decision making
Limitations or problems of decision making
Decision making process or the steps included in
decision making process.
Types of decisions taken;
Decision making using cost concepts.
Areas where managerial decisions are used.
Illustrations

DECISION MAKING
Definition :
Decision making involves the act of selecting one
course of action from among various feasible alternatives
available.
- KHAN AND JAIN
Meaning :
Decision making is the process of selecting the
best from alternatives available after analysing the various
factors efficiently and effectively using different strategies.

FEATURES OF DECISION MAKING

Based on rational thinking :
2. It is the process of selecting the best among various alternatives.
3. It is the evaluation of various alternatives .
4. It is the end product because it is preceeded by discussions and
deliberations .
5. It aims at achieving organisational goals.
6. It involves commitment mgmnt is committed in every decision it takes.
7. Techniques or Basis for decision making are ;
. Intuition: inner feeling of the person.
. facts : present scenario
. experience : past experience
. Considered opinions : experts point of view
. Operation research : systematic technique for problem solving
. Linear programming : it is one of the best technique used to determine
the limited resources for gaining maximum output.
1.

Problems while making decisions

1.

Correctness of decision :- correctness depends on the accuracy of information

and .decision maker ability to visualise all the possible alternative courses of action
in given situation .

2.

The decision environment : The organisation structure , environment condition,

physical that is prevailing in enterprise has the bearing effect .if all have agreed
with decisions they can proceed further or the plann is dropped.

3.

Timing of decision : if the decision are not taken at right time they wont serve to
the purpose. Ex ; introduction of a new product immediately after its launch.

4.

Effective communication of decision : it has to be communicated at right time

with right person at right place without any ambiguity a clear instructions has to be
provided in detail.

5.

Participation of decision making; depends on democratic organisation or

authoritarian firm.

6.

Implementation of decisions : final step of decision making process where lot of

obstacles occur all these has to be solved in order to implement the decision .

DECISION MAKING PROCESS

The different steps involved in decision making process are as follows:
1. Defining the problem : actual cause of the problem or what is the
problem exatly has to be defined correctly .
2. Analysis of the problem : collecting different or various information and
then plan what to do , how to do, where to do , why to do, . And also
should analyse how much risk is involved in doing so. Etc.
3. Alternative course of Action : searching of various solutions is again a
big task , using secondary data and different research techniques.
4. Evaluation of alternatives : all the above possible solution must be
implemented temporirily in order to choose the best course of action .
Under this stage the decision becomes easier .
5. Experience : past experience is the best teacher . With the help of the past
data as well experience one can aim at choosing the right or appropriate
decision.
6. Experimentation : it is implementation of the actual decision taken .
Putting into the practise.

Types of decisions
The decisions may be :
1. Long term decisions : they are non routine types of
decisions . They involve huge investment as well as much
uncertainity is involved .
2. Short term decisions : the level of uncertainity is lesser.
Also known as operating decisions . The information required
for such decision making is called relevant data . The whole
gamut of data that is relevant for decisions like production
related information, demand , sales , technical, legal
implications , market related, availability of inputs etc
in addition to this ,,related costs are also important the
above costs are involved in related costs decisions . The short
term decisions are based on relevant and irrelevant cost .

DECISION MAKING USING COST CONCEPTS

DIFFERENT COST CONCEPTS : To take appropriate decisions a mgmnt
accountant should needs to understand different functions related to costs. The
cost concepts mainly for decision making is broadly classified into relevant and
irrelevant cost .
Relevant cost : As per CIMA relevant cost are those which will be affected by
the decisions being taken. The following below are the different relevant cost
which has the bearing influence in decision making .
1. opportunity costs : is the cost of value of opportunity foregone is taken
into consideration when alternatives is compared . For ex: the opportunity
cost of funds invested in a business is the interest that could have been
earned by investing the funds in bank deposits.
2. notional cost : cost used in product evaluation, decision making and

performance measurement to reflect the use of resources that have no actual

(observable cost) , for ex: notional interest for internally generated funds or
notional rent for use of space .

Types of relevant cost

3. avoidable cost : as per CIMA . Avoidable cost are the specific cost of an activity
or sector of a business that would be avoided if the activity or sector did not exist .
For ex : if a company decision is to discontinue the particular product line then the cost
involved on that is avoidable cost.
4. Historical cost : cost that has been already incurred in the past is called historical
cost. For ex. Amount invested in purchasing of machinery.
5. out of pocket cost : misscelleneous cost such has depreciation that is which
gives rise to the cash expenditure . Mainly used in make or buy decisions .
6. Discretionary costs : those costs which can be changed with the discretion of a
manager or appropriate decision making authority. For ex: maintainance costs, R &D
costs, employees training , advertisements etc.
7. committed costs : are costs which cannot be changed during the budgeted period.
For ex: depreciation of assets , lease rentals and contractual cost .

Types of relevant cost

8. Period cost : are all cost of goods sold and treated as
expense in income statement. For ex: sales expenses,
commission etc.
9. Limiting factor or key factor : is any factor that is in
scarce supply and without that further activities cannot be
performed . For ex: material , labour , machine time etc.
10. Differential cost, Incremental cost and incremental
revenue : it is the difference in the total cost that will arise
from the selection of one alternative instead of another .
Incremental revenue is the cahnge in the total income
resulting from a decision.

Differential ( incremental ) analysis

for example : a company is planning to open one more outlet
.compare the sales and cost and profit
The incremental analysis is done :
Before opening
the sales outlet
RS ;
Total sales
Total cost
Profit

185000
145000
40000

After opening
the sales
outlet ,
RS
350000
275000
75000

Change
(incremental )
Rs.
165000
130000
35000

Incremental analysis is done for both long term and short term
decisions . Short term relating to fixing the price of the product ,
selecting a suitable product mix , diversifying the product . Long term
decisions deal with capital budgeting decsions .

The areas for making managerial decisions

Whether to process a product further or not.
2.
dropping or adding the product.
3.
Acceptance of additional order from a special customer at lower price
4.
opening a new branch or outlet.
5.
Make or buy decisions.
6.
Lease or buy decisions .
7.
Equipment replacement decisions .
8.
Submitting tenders .
9.
Effect of change in price. And fixing price decision.
10. Product mix , sales mix, promotion mix decision.
11. Expand or contract the business.
12. Diversification, and capacity utilisation
1.

based on the above situation the illustrations or

problems are solved .

Irrelevant cost
Irrelevant cost : costs that are neither effected
by the decision nor affect the decision are called
irrelevant costs. For example:
sunk cost : these historical cost cannot be
covered in a given situation . These costs are
irrelevant in decision making .

Factors influencing decision making

Internal and external :
1. The objective of decision making
2. The data and facts required for decision making .
3. the environment in which the decisions required to make

decisions .
4. The decision makers attitude and behaviour.
5. past experience.
6. cognitive biases:it refers to thinking pattern of individuals it varies
from each other based on observation, and generalisation . The
overall decision making gets affected.
7. individual differences ; ability or capacity of work, education , place
all etc differs in their perception of recognising things .
8. Performance evaluation:
9. Time constraints: for ex: certain time limit is provided to complete
the project .

Question paper important question

2 marks:
1.What is meant by differential costing?
Ans .ppt page 11
2. What do you mean by data based decision making?
Ans. The short term decisions are taken through the relevant data which is
obtained from the accounting information with or without modifications .
Related data such has product related info, market related, sales related
technical implications . Refer ppt page no-.10
3. Name some external and internal factors influencing pricing decisions ?
Ans page no 14 ppt
4. Meaning of relevant cost?
Ans page 8

5 and 15 marks questions

5. Describe the process of decision making ? And explain
how the pricing decisions taken in different situation ?
And explain managerial decision areas where marginal
costing principles will be employed ?
Ans. Page no- 12
6. Why is the evaluation of short term pricing and product
mix decisions different from the evaluation of long term
pricing and product mix decisions ?
Ans.Page no-8 to 11.