Short Term Decision Part1

ACCA F5 - Performance Management 

From article "008 Cost types" - Relevancy

Ø  Irrelevant cost

o   Sunk cost - cost already incurred

o   Committed cost - cost committed by company

o   Non cash flow costs - depreciation

Ø  Relevant cost - Future, Incremental & Cash flows

o   Out of pocket cost - all direct and indirect cost

o   Opportunity cost - earning opportunity forgone when selecting one alternative project

Examples:

Material	In stock	In stock	Out of stock
Nature	In regular use and will be replaced	Will not be replaced
Relevant cost	Current purchase price	The opportunity cost	Current purchase price
Labor	Spare capacity	Full capacity	Full capacity
Nature		Can hire more labor	Can't hire more labor
Relevant cost	0	Extra cost for labor	Opportunity cost

Make or Buy = Four Numbers You Should Know:

When you are supposed to make a make-or-buy decision, there are four numbers you need to be aware of. Your decision will be based on the values of these four numbers. Let's have a look at the numbers now. They are quite self-explanatory.

• The volume
• The fixed cost of making (Caution: Only extra fixed cost for making product is relevant for decision making)
• Adjusted per-unit direct cost when making
• Per-unit cost when buying

Now, there are two formulas that use the above numbers. They are 'Cost to Buy' and 'Cost to Make'. The higher value loses and the decision maker can go ahead with the less costly solution.

Cost to Buy (CTB) = Volume x Per-unit cost when buying

Cost to Make (CTM) = Extra fixed costs + (Adjusted per-unit direct cost x volume)

Non-quantifiable issues on make or buy

Quality of product required

Core competency and reliability of supplier vs. in-house competency

Alternative use of resource

Impact on stakeholders (employees, customers, society)

Reaction on stakeholders

The make or buy decision.

CIMA Article: Performance Operation