Decision Making - Cost Accounting

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Decisions Involving Alternative Choices
Structure:
13.1 Introduction
Objectives
13.2 Decision Making
13.3 Types of Costs
13.4 Types of Choices Decisions
13.5 Make or Buy Decisions
13.6 Addition / Discontinuance of a Product line
13.7 Sell or Process Further
13.8 Operate or Shut down
13.9 Exploring New Markets
13.10 Maintaining a desired level of profit
13.11 Summary
13.12 Terminal Questions
13.13 Answers to SAQs and TQs
13.1 Introduction
In the previous unit we learnt about Marginal Costing. Marginal costing is the ascertainment of marginal cost and of the effect on profit of changes in volume by differentiating between fixed costs and variable costs. Marginal cost is the amount at any given volume of output by which aggregate costs are changed if the volume of output is increased or decreased by one unit. Marginal costing is a very useful tool for management because of its applications. It is used in providing assistance to the management in vital decision-making both short term and long term. Differential analysis is the process of estimating the consequences of alternative actions that a decision maker may take. It is used both for short term and long term decisions. Short term decisions relates to fixing price for the product, selecting a suitable product mix, diversification of the product etc while long term deals with capital budgeting decisions. Objectives

After studying this unit, you should be able to:
· Explain the steps involved in decision making process
· Know various types of decision choices
· Analyze and interpret various decision choices
13.2 Decision Making
Decision making is the process of evaluating two or more alternatives leading to a final choice known as alternative choice decisions. Decision making is closely associated with planning for the future and is directed towards a specific objective or goal. Decision model contains the following decision-making steps or elements: 1. Identify and define the problem

2. Identify alternative as possible solutions to the problem. 3. Eliminate alternatives that are clearly not feasible
4. Collect relevant data (costs and benefits) associated with each feasible alternative 5. Identify cost and benefits as relevant or irrelevant and eliminate irrelevant costs and benefits from consideration. 6. Identify to the extent possible, non-financial advantage and disadvantage about each feasible alternative. 7. Total the relevant cost and benefits for each alternative 8. Select the alternative with the greatest overall benefits to make a decision 9. Implement or execute the decision

10. Evaluate the results of the decision made.
13.3 Types of Costs
A decision involves selecting among various choices. Non routine types of decisions are crucial and critical to the firm as it involves huge investments and involve much uncertainty. Short term decision making is based on relevant data obtained from accounting information. · Relevant Cost are costs which would change as a result of the decision. · Opportunity costs are monetary benefits foregone for not pursuing the alternative course. When a decision to follow one course of action is made, the opportunity to pursue some other course is foregone. · Sunk costs are historical cost that cannot be recovered in a given situation. These costs are irrelevant in decision making. · Avoidable costs are costs that can be avoided in future as a result of managerial choice. It is also known as discretionary costs. These costs are relevant in decision making. · Incremental / Differential costs are costs that include variable costs and additional fixed costs resulting from a particular decision. They are helpful in finding out the profitability of increased output and give a better measure than the average cost. Self Assessment Questions:

1. Relevant Costs are costs which would _________as a result of the decision. 2. ___________ are historical cost that cannot be recovered in a given situation. 3. Opportunity...
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