Accounting for Decision Making: With and Without Resource Constraints

Decisions are (a) where there are no resource constraints (i.e., an action does not affect other opportunities), (b) there are resource constraints (an action limits the possibility of other choices, requiring a ranking system) and (c) mutually exclusive decisions (one choice means others will be rejected).

Sunk costs are those costs which are already paid or a firm is committeed to. They are irrelevant for future decision making.

Differential costs are the differences between costs and benefits between alternative opportunities available to an organisation. When the number of opportunities are being considered, costs and benefits that are common to these alternative oportunities are irrelevant to the decision.

An avoidable cost is one which does not have to be paid if a firm does not proceed with a decision. An unavoidable costs will be incurred regardless.

An opportunity cost is the maximum benefits that which could be obtained from a resources if it were used for an alternative purpose. An internal opportunity cost relects the cost of using a resource within the organisation itself due to competing opportunities.

Relevant costs and benefits are those costs and benefits that relate to the future. They are additional costs that will be incurred from making a decision. They can include the cost of replacing a resource that was purchased for some other other purpose and the opportunity costs of using a resource that could be used for some other purpose.

Assuming linear cost and sales function, wherethere are no restraints on available resrouces, a firm will accept all projects that produce a positive contribution margin.

Within the contribution margin approach if a firm's income exceeds variable costs the project should proceed. However some variable costs are allocated on a predetermined ration. When a project has fixed costs directly attributable to a project and are avoidable, the approach should be where the income exceeds all costs attributable to the project, that project should be kept (e.g., a project that carries a high proportion of apportioned overhead but is making an overall loss).

When there are resource constriants, the objective should be to establish the optimum output within the constrints to maximise contribution and therefore profits. To determine the optimum output the contribution margin must be dtermined. Then the contribution per unit of the constriant for all those opportunities which yield a positive contribution. These should be ranked according to the contrinbution per unit of the constriant with the highest ranked project the one that yields the highest contribution per unit.

The 'make or buy' decision is when it chooses between using their own resources or purchasing a product or service externally. If there is spare capacity the firm must look at variable and directly attributable fixed costs, plus opportunity costs in relation to capcity that would be available. If there is no spare capacity the firm needs to look at variable and directly attributable fixed costs pluys the loss from the product or service that has been displaced.

Qualitative factors (e.g., reputation, customer goodwill, employee loyalty, legal constraints etc) may also acts as constraints influencing a decision.