MAS - 1305

MANAGEMENT ADVISORY SERVICES

DECISION MAKING – means choosing from at least two alternative courses of action.

Short term, non-routine decision making cases:

1. Accept or reject a special order or a business proposal
2. Sell or process further a product line
3. Make or buy a part, subassembly or product line
4. Continue operating or close a business segment
5. Product combination
6. Utilization of scarce resources
7. Change in profit factors

QUALITATIVE AND QUANTITATIVE FACTORS

QUALITATIVE FACTORS – are those that cannot easily and accurately be expressed in terms of
money or any other numerical unit of means.
QUANTITATIVE FACTORS – are those that can more easily be expressed in terms of money or
other units of measure.

APPROACHES IN SOLVING DECISION MAKING PROBLEMS

1. Total Approach
2. Differential analysis

TOTAL APPROACH – under this type of analysis, the total revenues and costs are determined for
each alternative and the result are compared to serve as bases for making decisions.
DIFFERENTIAL ANALYSIS – under this approach, only the differences or changes (increases and
decreases or increments and decrements) in revenues and costs are considered.

TYPES OF COSTS USED IN DECISION MAKING

RELEVANT COSTS – are future costs that are expected to be different under each alternative
course of action.
DIFFERENTIAL COST – refer to the increases (increments) or decreases (decrements) in total
costs between two alternatives.
AVOIDABLE COSTS – are costs that will be saved or those that will not be incurred if a certain
decision is made.
OUT-OF-POCKET COSTS – are costs that require current or near future cash outlays or
incurring of a liability for a decision at hand.
POSTPONABLE COSTS – are costs that may be deferred or shifted to a future date or period
of time without adversely affecting current operations.
OPPORTUNITY COSTS – refer to the income or benefit sacrificed or foregone when an
alternative is chosen.
IMPUTED COSTS – are assumed or hypothetical costs representing the cost or value of
resources that is utilized for a specific purpose.
SUNK COSTS – refer to the non-recoverable costs incurred in the past.
JOINT COSTS – are usually encountered in ‘process further of sell-as-is’ problems. They
involve the costs incurred in simultaneously processing or manufacturing two or more
products which are difficult to identify individually as separate types of products until a
certain processing stage known as the point of separation or split-off point.

MAS 1305 – Page 1

 Dao-il Company, which sells a chemical product called Fallurin, received a special order for 1,000
liters of Fallurin from a valued customer. Because of the large volume of this order, the customer is
asking for a discount of 40% off the regular selling price of P25 per liter.
Pertinent data about product Fallurin are as follows:

Normal plant capacity 5,000 liters

Present sales volume – regular customers 3,500 liters
Production costs:
Materials P 3.00 per liter
Labor 2.00 per liter
Factory overhead:
Variable 3.00 per liter
Fixed 7,500 per month
Selling and administrative:
Variable 2.00 per liter
Fixed 11,250 per month

It was ascertained that the special order will not require additional selling and administrative costs
and that the same will not affect regular sales.
Dao-il Company wants to make a decision on whether to accept or reject the special order.

DECISION INVOLVING ALTERNATIVE CHOICES

MAKE OR BUY

Lingkod Company, a manufacturer of furniture sets, is considering to purchase the seat cushions
needed for its chairs. The expected purchase price of these seat cushions is P50 per unit.
Lingkod has been making its own seat cushions since it started operating. If it would continue to
produce these cushions, the company expects to incur the following costs:

Raw materials P 13
Direct labor 15
Variable overhead 5
Fixed overhead (based on the average
production requirement of 10,000 units) 20
Total production cost per unit P 53

Required: 1. Using differential cost analysis, determine whether the company should make or buy
the seat cushions
2. Assuming that 40% of the fixed factory overhead could be eliminated if the
company would discontinue the manufacture of seat cushion, should the company
make or buy the items?
3. Assuming that materials and labor costs are expected to increase by 20% next
period. Factory overhead costs will remain the same, except that 40% of the fixed
overhead will be eliminated in case the company decides to buy the seat cushions
from the other suppliers. Moreover the facilities presently being used in the
manufacture of

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 seat cushions can be utilized to manufacture another part of the main product in
case such facilities become vacant when the company decides to stop producing
the seat cushions. This alternative use of resources would result into cost savings
of P100,000 for Lingkod Company. Assume further that the company’s
requirement for seat cushions is expected to increase by 4,000 units next period.
Prepare an analysis comparing the relevant costs of making and buying the seat
cushions.

ACCEPT OR REJECT A SPECIAL ORDER

Grace Company presently produces and sells 20,000 units of product G which represents only
80% of its normal capacity of 25,000 units. Its regular selling price is P50 per unit and its
manufacturing, selling and administrative costs are as follows:

Materials P 10
Labor 12
Variable overhead 8
Fixed overhead (P60, 000/20,000) 3
Variable selling and administrative costs 7
Fixed selling and adm. cost (P40,000/20,000) 2
Total unit cost P 42

Grace Company received an order from a provincial distributor for 3,000 units. The customer
asks for a special discount of 30%. It is expected that the company will incur no additional selling and
administrative costs.

Required: Determine whether the company should accept or reject the special order.

Kapol Company’s normal capacity is 60,000 units. Since the past few months, it has utilized only
one half of this capacity. For last month, the result of its operation is summarized in the following
statement:
Sales (30,000 units) P 1,500,000
Less: Variable costs 600,000
Contribution margin 900,000
Less: Fixed costs 500,000
Profit P 400,000

Or the variable and fixed costs shown on the statement, 3/4 are manufacturing costs; the balance
represents selling and administrative costs.
This month, a customer submitted a proposal to buy 35,000 units of Kapol Company’s product at
P25 per unit. The only selling cost to be incurred for this order is P4.00 per unit representing freight
charges that will be shouldered by Kapol. If this special order proves to be acceptable, Kapol is willing
to reduce sales to regular customers so as not to exceed its normal capacity.

Required: Should the order be accepted?

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CONTINUE OR DISCONTINUE OPERATING A BUSINESS SEGMENT

Beth Neri Enterprises sells three products, Skinny, Bony and Thinny. Beth, the proprietor, is
concerned about the losses incurred by Thinny, and is considering to discontinue its production and
sales.
Sales and costs data about Beth Neri’s three products are as follows:

Skinny Bony Thinny Total

Sales P 5 P 7 P 9 P 21
Variable cost per unit 2 3 7 12
Contribution margin 3 4 2 9
Fixed cost per unit 1 2 3 6
Profit (loss) per unit P 2 P 2 P( 1) P 3

Fixed costs are allocated among the three products based on the floor area they occupy.
Beth is thinking that if she would eliminate Thinny, its loss of P1 per unit would likewise be
eliminated thereby increasing her total profit per unit from P3 [P2 + P2 - P1] to P4 [P2 + P2]. Is Beth’s
analysis correct?

Rose Descaya operates a chain of bookstore with branches in Manila, Quezon City and Makati.
A summary of operating results of the three branches during a typical month is shown below:

Manila Makati Quezon City Total

Sales P300,000 P400,000 P500,000 P1,200,000
Costs and expenses:
Variable 120,000 160,000 200,000 480,000
Direct fixed costs 50,000 140,000 70,000 260,000
Allocated fixed costs 90,000 120,000 140,000 350,000
Total costs and expenses 260,000 420,000 410,000 1,090,000
Operating profit (loss) P 40,000 P ( 20,000) P 90,000 P 110,000

Like in the previous months, Rose observed that Makati Branch operated at a loss. Due to this,
Rose is considering to close the Makati Branch, hoping that the loss would be eliminated. She
disclosed her plan to her accountant who in turn informed her that if she would push through with her
plan, Makati’s sales, variable costs and direct fixed costs would all be eliminated. However, total
allocated fixed costs would not change; the amount allocated to Makati would just be absorbed by the
other branches.

Required: Should Rose continue operation the Makati Branch despite its operating loss?

TEMPORARY SHUT DOWN

Mr. Rene Villones operates a snack counter selling sandwiches and softdrinks to students of the
school across his store, as well as to his neighbors and passer-by. Each unit sale is composed of a
sandwich and a cup of softdrinks which is sold at a lot price of P15. Variable cost amounts to P8 per
unit. Under normal conditions, Mr. Villones sells an average of 3,000 units per month, during which he
incurs the following fixed costs:

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 Rent P 3,000
Allocated cost of utilities 2,000
Salary of sales clerk 1,500
Janitor’s salary 1,000
Security agency’s billing 2,500
Total P 10,000

A joint strike of teachers and students which started the other day dramatically reduced the sales
of Mr. Villones’ snack counter to only 800 units because his customers now be composed only of his
neighbors and passer-by. Accordingly, the strike would last for about a month. Mr. Villones is
considering to shut down operations for one month to avoid incurring losses due to the reduced sales
volume. He notes that if he shuts down his operation, his share in the allocated cost of utilities would
be reduced to P500, and he could avoid incurring salary of the sales clerk who would be asked to
take a forced leave without pay while the snack counter is closed. All the other fixed costs would be
incurred despite the discontinuance of operations.

Required: should the snack counter be shut down for one month?

SELL OR PROCESS FURTHER

Neth Abogada, Inc. produces a product called Balut. The company buys duck eggs, the materials
needed to make balut, from different suppliers in Pateros at P1.50 each. To convert the eggs into
balut, the same are processed by boiling for about 30 minutes. Processing costs, composed of labor
and factory overhead average at P0.50 per unit. Neth sells the product at P3.00 per unit.
Neth’s product may be sold as Balut, or it may be processed further to come up with another
product called Pritong Balut which actually is fried Balut dipped in bread crumbs or corn starch.
Pritong Balut has proven to be highly salable and commands a price of P3.75 per unit. Materials,
labor and overhead costs required to convert balut into Pritong Balut amounts to P0.40 per unit. Neth
is contemplating to stop selling Balut and instead concentrate on selling Pritong Balut. Should Neth
push through with her plan?

Joint Products

Botjina Paper Products produces chipboard, newsprint and kraft paper from pulp which it buys at
P5 per kilo. On the average, the company uses 100,000 kilos of pulp and incurs conversion cost of
P500,000 per month.
Monthly production and sales price figures for each product are as follows:
Production Sales Price
Chipboard 200,000 sheets P 2.40 per sheet
Newsprint 50,000 reams 20.00 per ream
Kraft paper 30,000 sheets 1.50 per sheet

The total joint cost is allocated based on the weight (in kilos) of the products manufactured during
the month. (Assume that the allocation results are: 17% of the total joint cost is allocated to
chipboard, 80% to newsprint and 3% to kraft paper).
One of the joint products, the kraft paper, may be processed further to produce document
envelopes which can be sold at P2.00 per unit. Each sheet of kraft paper may be converted into one
document envelope at a cost of sixty centavos.

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 Required: Should the kraft paper be sold at the split off point or converted into document
envelope?

PRODUCT COMBINATION/UTILIZATION OF SCARCE RESOURCES

Tisay Company produces and sells three product lines – Labany, Singkamy and Mistisy.
Production and sales data about these three product lines are given as follows:

Labany Singkamy Mistisy

Contribution margin per unit P 5 P 8 P 12
Sales or market limit 10,000 units 20,000 units none
Machine hours required to produce
one unit 1 hr. 4 hrs. 12 hrs.
Total fixed costs P100,000
Total machine hours available 120,000 hrs.

Required: What is the best product combination?

Geling Manufacturing Corp. produces a toy product called Quijote. The company expects a
dramatic increase in the demand for the product in the coming Christmas Season. Estimated
production requirement for that period is 5,000 units.
To produce Quijote, three major parts are needed: Part A, Part B and Part C which all have been
produced by the company using its own facilities.
Production data about the three parts are given below:

NO. OF PARTS
VARIABLE HOURS REQUIRED TO
PART FIXED COST REQUIRED PER
COST PRODUCE 1 UNIT
UNIT OF PRODUCT
A P10 P5 4 hrs. 3
B 15 9 2 2
C 12 8 3 4

Because of the expected increase in production requirement, the company could not afford to
produce all the needed parts because the available hours for parts production is only 100,000 hours.
However, Geling is determined to meet the requirement, so it is contemplating to buy any of the parts
that could not be produced due to limited capacity. The three parts are available in the local market at
the following prices:
Part A - P14
B - 21
C - 18

Required: How many units of each part should be manufactured and which part, if any, should be
purchased from outside suppliers?
How many units of such part should be bought?

MAS 1305 – Page 6

CHANGE IN PROFIT FACTORS

Engot Company manufactures and sells a product called Opaw. The result of operation
during the previous month is summarized below:

Sales (10,000 units) P 150,000

Variable cost 80,000
Contribution margin 70,000
Fixed cost 50,000
Profit P 20,000

Despite the profit of P20,000 earned last month, the company’s President showed
dissatisfaction over the operating result for such period. He instructed the marketing manager to
develop some plans to increase sales and profit figures.
After careful study and consultation with the different departments involved, the marketing
manager proposed an aggressive advertising and promotional program which is expected to
bring about the following:

 50% increase in sales volume

 20% increase in total fixed cost representing promotional and advertising expenses
 P2 increase in variable cost per unit representing the cost of promotional give-aways

Required: What will be the effect of the marketing manager’s plan on the profit position of
Engot Company?

MAS 1305 – Page 7