Decision making, performance measurement and management accounting control systems
Domain 4 tests short-term decision making using relevant costing, the ranking of products under a scarce resource, divisional performance measures and the design of management control systems. Questions reward clear identification of relevant cash flows and goal-congruent recommendations.
Relevant costing
- Relevant costs are future, incremental and cash-based. Sunk costs, committed costs, apportioned fixed overhead and non-cash book depreciation are irrelevant.
- Opportunity cost is relevant even when no cash is paid, because using a resource for one purpose forgoes its next best use.
- Typical decisions: special order acceptance, make or buy, shutdown or continuation, further processing and scarce resource allocation.
Scarce resource ranking
- Rank products by contribution per unit of the limiting factor, not by contribution per unit.
- Allocate the scarce resource in rank order, respecting minimum and maximum demand.
- The opportunity cost of diverting a scarce resource from another product is the lost contribution.
Worked example
Product A earns contribution GHS30 and uses 2 kg of material; product B earns GHS24 and uses 1 kg. Available material is 1,000 kg. Demand for B is 600 units; demand for A is unlimited. Contribution per kg: A = GHS15; B = GHS24. Rank B first. B uses 600 kg, leaving 400 kg for 200 units of A. Total contribution = (600 × 24) + (200 × 30) = GHS14,400 + GHS6,000 = GHS20,400. Ranking by unit contribution would make A first: 500 units of A use 1,000 kg and earn GHS15,000, which is GHS5,400 worse. Each kg given to A forgoes GHS24 of B contribution and earns only GHS15.
Performance measurement
- Responsibility centres are cost, revenue, profit and investment centres; apply the controllability principle.
- ROI = divisional profit / divisional investment. RI = profit - (imputed interest rate × investment). ROI can reject projects earning above the cost of capital but below the current divisional ROI; RI encourages goal congruence but is an absolute amount.
- The balanced scorecard uses financial, customer, internal process and learning and growth perspectives, combining financial and non-financial measures.
- Transfer prices may be market-based, cost-plus or negotiated; they should motivate goal-congruent decisions and preserve divisional autonomy.
Control systems
- Feedback compares actual with plan; feed-forward anticipates problems; concurrent controls monitor during operations.
- Reports need relevance, accuracy and timeliness; investigate significant variances and monitor the cost of the control system itself.
Traps
- Including apportioned head office overhead in a make-or-buy decision.
- Ignoring the opportunity cost of scarce capacity.
- Using total profit rather than contribution for a shutdown decision.
- Comparing ROI across divisions of very different sizes.
- Choosing a transfer price that is convenient but not goal-congruent.
- Treating qualitative factors as irrelevant.