Class Meeting 9

TACTICAL
DECISION MAKING

Riwayadi
1

LO 1

TACTICAL
TACTICAL DECISION
DECISION MAKING:
MAKING:
Definition
Definition

Consists of choosing among

alternatives with an immediate
or limited end in view.

LO 1

STRATEGIC
STRATEGIC DECISION
DECISION MAKING:
MAKING:
Definition
Definition

Is selecting among alternative

strategies so that long term
competitive advantage is
established.

LO 1

TACTICAL DECISION MODEL

A general approach to tactical decision making
includes:
1. Recognize, define the problem
2. Identify alternatives, eliminating those that are
unfeasible
3. Identify costs & benefits
4. Total relevant costs, benefits of each
alternative
Assess qualitative
qualitativefactors
factors
5. Assess
6. Select alternative with greatest overall benefit
4

LO 1

TIDWELL
TIDWELL PRODUCTS:
PRODUCTS: Background
Background
Tidwell
TidwellProducts
ProductsInc.
Inc.isisfacing
facingexpanded
expanded
production
productionthat
thatisisstraining
strainingthe
thecapacity
capacity
in
infacilities
facilitieswith
with55years
yearsremaining
remainingon
on
their
theirlease.
lease.Two
Twofeasible
feasiblealternatives
alternatives
under
underconsideration
considerationare
area)
a)to
torent
rentan
an
additional
additionalbuilding
buildingfor
forwarehousing
warehousingand
and
b)
b)outsource
outsourceproduction.
production.The
TheCFO
CFOwill
will
prepare
prepareaareport
reportof
ofdetailed
detailedcosts
costsfor
for
these
thesealternatives.
alternatives.
5

LO 1

APPLYING
APPLYING TACTICAL
TACTICAL MODEL
MODEL
Step 1: Define the problem

Increase capacity for warehousing

& production

Step 2: Identify alternatives

1.
2.
3.
4.
5.

Build new facility

Lease larger facility; sublease
current facility
Lease additional facility
Lease warehouse space
Buy shafts & bushings; free
up space

Continued
6

LO 1

APPLYING
APPLYING TACTICAL
TACTICAL MODEL
MODEL
Step 3: Identify costs, benefits

Alt 4: <Costs> + Benefits

Alt 5: <Costs> + Benefits

Step 4: Total relevant costs &

benefits

Alt 4: cost $ 1.000 rent dan make

Alt 5: Cost $ 800 (buy from supplier
Differential cost $ 200 (alt 5 is
chosen)

Step 5: Assess qualitative factors

1.
2.
3.
4.

Product Quality
Reliability of external supplier
Price stability
Labor relations & community
image

Step 6: Make decision

Continue producing & lease

warehouse (alternative 4 is chosen if
assuming qualitative factors are not
7
met))

LO 1

RELEVANT
RELEVANT COSTS:
COSTS: Definition
Definition
Relevant cost is the cost that affects the
decision

Are future costs that differ

across alternatives.
differ across alternatives.

Cost concepts associated with

decision making
Opportunity cost
Benefit (revenue) that is sacrificed because of choosing alternative
Opportunity cost because you choose to study in international program:
salary from working for the company
Opportunity cost is relevan cost

Avoidable and unavoidable cost

Avoidable cost is the cost that will vanish by choosing the alternatives.
For examples are variable production costs and avoidable fixed factory
overhead cost.Avoidable cost is relevant cost
Unavoidable cost is the cost that will still occur whatever alternatives
are chosen. Unavoidable cost is irrelevant cost

Sunk cost
Cost that occurred because of previous decision, for example
depreciation expense
Sunk cost is irrelevant cost

Differential costs (incremental cost or

decremental cost) are the costs that differ
among the alternatives. Differential cost is a
relevant cost.
For example, raw material A Rp 1.000 per kg,
raw material B Rp 800. If raw material B is
chosen, differential cost (decremental cost) is
Rp 200. It means that the company has cost
saving of Rp 200 per kg.

10

LO 1

RELEVANT VS. IRRELEVANT

COSTS
Cost to Make

Cost Not to
Make
---

Differen tial
Cost

Direct labor

$ 150,000

$ 150,000

Depreciation

125,000

$ 125,000

---

Allocated lease

12,000

12,000

---

$ 287,000

$ 137,000

$150,000

Direct labor is the relevant

cost because it differs between
alternatives.
11

Objective to understand the

relevant cost
To simplify the calculation
because only relevant cost is
accounted for

12

APPLICATION OF RELEVANT
COSTS
Make or buy decision
Keep or drop decision
Special order decision
Sell at split off point or process further
decision

13

MAKE OR BUY DECISION

When is this decision made?
When there is a supplier offering the same component
at lower price. Example, manufacturing cost for
component A per unit Rp 1.000, and supplier offers for
Rp 800 per unit, do we accept or reject?

What are relevant costs and irrelevant costs in

this decision
Relevant costs are avoidable costs. Examples are
variable production cost, avoidable fixed factory
overhead cost, and opportunity cost.
Irrelevant costs are unavoidable fixed factory
overhead cost. Examples are depreciation expense of
factory building, and production manager salary
14

Direct Fixed
Costs

Avoidable fixed cost

- Supervisors salary
for particular product

Fixed Costs

Indirect Fixed
Cost
(Common
Fixed Cost)

Unavoidable fixed cost:

- Depr. Exp. Of machine that
is only used for particular
product (direct fixed cost)
-Property tax (indirect fixed cost)
- Depr. Exp. Of factory building

15

When is buy decision made?

When avoidable manufacturing costs is
greater than cost of purchase or cost of
purchase minus opportunity cost

16

ILLUSTRATION
Production costs of componen X at capacity of 1.000 units are as
follows:
Unit cost
Total
Raw material
Rp 500
Rp 500.000
Direct labor
400
400.000
FOH variable
150
150.000
FOH - fixed
450
450.000
Total
Rp 1.500
Rp1.500.000

17

Of total fixed factory overhead cost, included

property tax Rp 50.000, and depreciation
expense of factory building Rp 200.000.
External supplier offers the same component for
Rp 1.350 per unit.
Required:
a. Should we accept the suppliers offering?
Assuming that capacity is idle if the components
are purchased from supplier
b. If idle capacity can be rented to other party for
Rp 150.000, what is your recommendation?
c. What qualitative factors should be considered if
we buy from supplier?
18

Solution
a.
Total production cost
Rp 1.500.000
Unavoidable fixed cost
(property tax & depr.)
(250.000)
Avoidable production cost
Rp 1.250.000
Cost of purchase: 1.000 x Rp 1.350 1.350.000
Cost saving if made internally
Rp 100.000
Decision: it is better to make internally

19

Prove:
Total production cost:
1.000 x Rp 1.500
Rp 1.500.000
Cost of purchase:
1.000 x Rp 1.350
Rp 1.350.000
Unavoidable fixed cost
250.000
Total cost if buy
1.600.000
Cost saving if made internally Rp 100.000

20

b.
Avodiable production costs Rp 1.250.000
Cost of purchase Rp 1.350.000
Rent income
150.000
Net cost of purchase
1.200.000
Cost saving if buy
Rp 50.000
Decision: its better to buy

21

alternative
Avoidable manufacturing cost Rp 1.250.000
Opportunity cost (rent income
sacrificed )
Manufacturing cost
Cost of purchase
Cost saving if buy

150.000
1.400.000
1.350.000
50.000

22

c. Qualitative factors should be considered if we

buy:
1. Quality of products
2. Supplier reliability (timely and availability as
needed)
3. Labor relationship (corporate social
responsibility)
4. Product innovation
23

Class Meeting 10

TACTICAL
DECISION MAKING

Riwayadi
24

KEEP OR DROP DECISION

Keep or drop decision is the decision
about whether or not a segment, such as a
product line, division, or branch should be
kept or dropped.
When is this decision made? When the
segment is getting a loss.
Segmented report prepared on a variable
costing basis provides valuable
information for keep or drop decision.
25

 What are relevant costs and irrelevant costs for this

decision?
Relevant costs are avoidable costs (variable costs and
avoidable fixed costs) and opportunity cost
Irrelevant costs are unavoidable fixed costs

When is drop decision made?

When revenues of dropped segment is lower than their
avoidable costs or when segment has a loss.

Illustration
PT Coca Cola produces three kinds of products: Coca
Cola, Fanta, and Sprite. The accounting manager
has prepared the following estimated income
statement for 200X (in thousands of rupiahs)
26

Coca Cola Fanta Sprite Total

Sales
500
800
150 1.450
Variable expenses
(250)
(480) (120) (850)
Contribution margin
250
320
30
600
Direct fixed expenses:
Advertising
(10)
(10) (10) (30)
Salaries
(17)
(20) (15) (52)
Depreciation
(73)
(60) (30) (163)
Total
(100)
(90) (55) (245)
Segment margin
150
230
(25) 355
Common fixed expenses (40)
(40) (40) (120)
Operating income (loss)
110
190
(65) 235
27

Because the projected performance of sprite product

line shows a negative segment margin, management
of PT Coca Cola is trying to decide to drop the
sprite product line. By dropping the sprite product
line, company can save Rp 65.000 (sprite loss), and
total operating income will increase from Rp
235.000 to Rp 300.000.
Salaries is paid for lines supervisor. Supervisor will
be dismissed and advertising will be eliminated
when product line is dropped. Depreciation expense
and common fixed expenses will still occur even
though the product line is dropped.
28

Required:
a. Do you agree with management decision
to drop the sprite product line? Assuming
the sprite capacity is idle.
b. What is your recommendation if sprite
capacity can be used for expansion of
Fanta product line that can increase
Fantas sales of 20%.
c. What is your recommendation if sprite
capacity can be rented to other party for
Rp 50.000.
d. What qualitative factors should be
considered?
29

Solution
a.
Dropping sprite and the capacity is idle:
Sales revenues
Rp 150.000
Avoidable costs:
Variable expenses
Rp 120.000
Avoidable Fixed cost:
Advertising
10.000
Salaries
15.000
Total avoidable cost
145.000
Segment margin
Rp 5.000
30

Decision:
It is better to keep sprite product line
because it still contributes segment margin
for Rp 5.000. This contribution can be
used to cover unavoidable fixed cost. If
sprite is dropped, total operating income
will decrease by Rp 5.000 or decrease
from Rp 235.000 to Rp 230.000.

31

Prove:
Before dropped

Sales
Variable expenses
Contribution margin
Direct fixed expenses:
Advertising
Salaries
Depreciation
Total
Segmen margin
Common fixed expenses
Operating income

Sprite

1.450
(850)
600

150
(120)
30

(30)
( 52)
(163)
(245)
355
(120)
235

(10)
(15)
(25)
5
5

After Dropped

1.300
(730)
570
(20)
( 37)
(163)
(220)
350
(120)
230
32

b. Dropping Sprite and expand Fanta

Additional sales of Fanta:
20% x Rp 800
Rp 160
Additional variable expenses:
20% x Rp 480
(96)
Additional contribution margin Rp 64
Opportunity cost (sprite margin
that is forgone)
5
Additional income
Rp 59
33

Decision:
It is better to drop Sprite and the idle
capacity is used for expansion of Fanta
because it will increase the operating
income from Rp 235 to Rp 294 (Rp 235 +
59)

34

c. Sprite is dropped and the idle capacity is

rented to other party for Rp 50.000
Rent income
Rp 50.000
Opportunity cost (sprite
margin forgone)
5.000
Additional income Rp 45.000
Decision: Its better to drop Sprite and rent the
idle capacity to other party because it will
increase the total operating income from Rp
235.000 to Rp 280.000 (Rp 235.000 + Rp
45.000)
35

Comparison of Three Alternatives

Total Operating Income
Sprite is dropped and capacity
is idle
Rp 230
Sprite is dropped and capacity
is used for expansion of Fanta
Rp 294
Sprite is dropped and capacity
is rented to other party
Rp 280
Among of the alternatives, alternative 2 is chosen
because it generates the highest total operating
income.
36

d. Qualitative factors that should be

considered:
1. The workers who work for Sprite
(should be lay off or can be transferred
to other segment?)
2. The possibility of redesigning Sprite
(flavor, packaging, etc.)
3. Impact on the two other product lines
4. New competitor
37

SPECIAL ORDER DECISION

This decision is related to accept or reject the
special order from a particular customer
When is this decision made?
When customer wants to buy the product at highly
lower price. For example, regular price is Rp 1.000,
and cost of product is Rp 800, and customer wants to
buy at Rp 600, should we accept?

Special order is the order from potential

customers in markets not ordinarily served or non
regular customers.
Fixed costs will not be assigned to special order
because they have been fully assigned to regular
sales (orders)

38

Illustration
Targeted participants of one-day seminar is 100 persons.
Capacity of seminar room is 120 persons. In this case,
100 participants are regular customers, while the
remaining capacity can be used for special orders.
Seminar fee Rp 100.000 per participant
Variable cost Rp 50.000 per participant
Fixed cost
Rp 20.000 per participant or Rp
2.000.000 in total.
Will you accept if someone wants to joint the one-day
seminar and pay Rp 65.000 using special order?
39

What are relevant costs and irrelevant

costs for this decision?
Relevant costs are variable costs and
additional costs related to special order, for
example, putting a particular label in the
product
Irrelevant costs are fixed cost

When will special order be accepted?

When the price of special order is greater than
variable costs and additional costs related to
special order.
40

Illustration
Ice-cream company is operating
at 80% of its productive
capacity. The company has a
capacity of 20.000 kg. Total
costs and unit cost associated
with producing and selling
16.000 kg are as follows:

41

Total Cost

Unit Cost

Variable Costs:
Dairy Ingredients Rp 11.200.000 Rp 700
Sugar
1.600.000
100
Flavoring
2.400.000
150
Direct labor
4.000.000
250
Packaging
3.200.000
200
Commission
320.000
20
Distribution
480.000
30
Other
800.000
50
Total variable cost Rp 24.000.000 Rp 1.500
42

Fixed Costs:
Salaries
Depreciation
Utilities
Taxes
Other
Total fixed costs
Total costs
Wholesale selling

Total Cost

Unit Cost

Rp

Rp

960.000
320.000
80.000
32.000
160.000
Rp 1.552.000
Rp 25.552.000
Rp 32.000.000

60
20
5
2
10
Rp 97
Rp 1.597
Rp 2.000
43

An Ice-Cream Distributor from Bukittinggi

not normally served by company has
offered to buy 2.000 kg at Rp 1.500 per
kg. The distributor has agreed to pay the
transportation costs. Since the distributor
approached the company directly, there is
no sales commission.
Required:
a. You are as a management accountant,
what recommendation may give to the
manager of the Ice-Cream Company?
b. What qualitative factors should be
considered?
44

Solution
The price of special order
Rp 1.500
Total unit variable cost Rp 1.500
Commission
(20)
Distribution
(30) 1.450
Contribution margin per unit Rp 50
Decision:
It is better to accept the special order because it
will increase the profit for Rp 50 per kg or Rp
100.000 (2.000 kg x Rp 50) in total.
45

Prove:
Sales
VC
CM
FC
Net income

Regular Order Special Order

Total
(16.000 kg)
(2.000 kg) (18.000 kg)
32.000.000
3.000.000 35.000.000
(24.000.000) (2.900.000) (26.900.000)
8.000.000
100.000
8.100.000
(1.552.000)
(1.552.000
6.448.000
100.000
6.548.000
========
======
========

46

Qualitative Factors that should

be considered are:
1.Capacity (any idle capacity or not)
2.Regular customer (will ask the same
price as special order or not)
3.The prospect of special order customer
to be regular customers.

47

SELL AT SPLIT OFF POINT OR

PROCESS FURTHER DECISION
Joint products are two or more products that are
produced through a common process
Joint products can be identified at a split off
point (the point that products are
distinguishable). For example, premium, diesel
fuel, and kerosene are produced from crude oil.
Joint costs are the costs to produce the joint
products

48

 Separable costs are the costs incurred after

products are identifiable or costs to process
further
Sometimes, it is more profitable to process a joint
product further, beyond the split off point.
What are relevant costs and irrelevant costs for
this decision:
Relevant costs are separable costs and opportunity
cost (revenues of split off product foregone because of
processing further) as well as the price after products
are processed further
Irrelevant costs are joint costs
49

 When is process the product further decision

made?
When additional revenue is greater than separable cost
or when sales revenue after products are processed
further is greater than separable costs and opportunity
costs.

Illuatration
Selling price of Crude Palm Oil (CPO) Rp 1.000 per kg
Cost of CPO Rp 400 per kg
Selling price of fried oil Rp 4.000 per kg
Units produced 5.000 kg
Separable cost (cost to process further) Rp 10 million
Should be processed CPO further? What qualitative
factors should be considered?
50

Solution
yes, because it will increase total income
by Rp 5 million as calculated below:
Additional revenue:
(4.000 1.000) 5.000
Separable cost
Additional income

Rp 15.000.000
10.000.000
Rp 5.000.000

51

Another alternative:
Total revenues from fried oil:
5.000 x Rp 4.000
20.000.000
Separable cost
Rp 10.000.000
Opportunity cost:
5.000 x Rp 1.000
5.000.000
Total cost
15.000.000
Additional income
5.000.000

52

CPO
FRIED OIL
SALES 5.000.000 20.000.000
COST:
2.000.000
Cost of CPO
2.000.000
Separable cost
10.000.000
Total cost 2.000.000 12.000.000
Net income 3.000.000
8.000.000
Additional income if processed further will be
Rp 5.000.000
53

Qualitative factors that should

be considered

54