Understanding how businesses make decisions paves the way not only to better decision-making processes but potentially to better outcomes. Decisions made by businesses can have short-term effects or long-term impacts, or in some situations, both. Short-term decisions often address a temporary circumstance or an immediate need while long-term decisions align more with permanent problem solving and meeting strategic goals.
Because these two types of decisions require different types of analyses, we will consider short-term decision-making here and long-term decision-making in Capital Budgeting Decision. Accounting distinguishes between short-term and long-term decisions not only because of the difference in the general nature of these decisions but also because the types of analyses differ significantly between short-term and long-term decision categories.
As the time horizon over which the decision will have an impact expands, more costs become relevant to the decision-making process. In addition, when a time element is considered, there will be additional factors such as interest paid or received that will have a greater influence on decisions.
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Table Considering the business challenges facing Gearhead Outfitters , what short-term decisions might the company encounter? Gearhead must carry a certain level and variety of inventory to meet the demands of its customers. The company will have to maintain appropriate accounting records to make proper business decisions to promote sustainability and growth.
How might Gearhead be able to compete with larger chains and remain profitable? Will every sale result in the anticipated profit to the company? Consider what specialized short-term decision-making processes the company may use to meet its goals. Should more of an item than normal be purchased for resale to receive a larger discount from the supplier?
What information about cost, volume, and profit is needed to make a sound business decision in this case? Some items may be sold at a loss or lesser profit to attract customers to the store. What type of information and accounting system is needed to help in this situation? The company requires relevant, consistent, and reliable data to determine the proper course of action. Short-term decision-making is vital in any business. Consider this concept in relation to Centralized vs. Discuss possible short-term issues and decisions, management focuses, and whether or not the centralized versus decentralized style will aid in company flexibility and success.
Also, think in terms of how the decision-making process will be evaluated. Business decision-making can be outlined as a process that is applied by management with each decision that is made. The process of decision-making in a managerial business environment can be summed up in these steps.
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The first step of the decision-making process is to identify the goal. In the decisions discussed in this course, the quantitative goal will either be to maximize revenues or to minimize costs.
The second step is to identify the alternative courses of action to achieve the goal. In the real world, steps one and two may require more thought and research that you will learn about in advanced cost accounting and management courses. This chapter focuses on steps three and four, which involve short-term decision analysis : determining the appropriate information necessary for making a decision that will impact the company in the short term, usually 12 months or fewer, and using that information in a proper analysis in order to reach an informed decision among alternatives.
Step five, which involves reviewing and evaluating the decision, is briefly addressed with each type of decision analyzed. Though these same general steps could be used in long-term decision analyses, the nature of long-term decisions is different. Short-term decisions are typically operational in nature: making versus buying a component of a product, using scarce resources, selling a product as-is or processing it further into a different product.
It is relatively easy to change a short-term decision with minimal impact on the company. Long-term decisions are strategic in nature and typically involve large sums of money. The effects of a long-term decision can have significant financial impact on a company for years.
Examples of long-term decisions include replacing manufacturing equipment, building a new factory, or deciding to eliminate a product line. As stated in the first step of the decision-making process, maximizing revenues is usually one of the goals of an organization. Therefore, making some short-term decisions requires analysis of both costs and revenues.
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In carrying out step three of the managerial decision-making process, a differential analysis compares the relevant costs and revenues of potential solutions. What does this involve? First, it is important to understand that there are many types of short-term decisions that a business may face, but these decisions always involve choosing between alternatives.
Examples of these types of decisions include determining whether to accept a special order; making a product or component versus buying the product or component; performing additional processing on a product; keeping versus eliminating a product or segment; or determining whether to take on a new project. In each of these situations, the business should compare the relevant costs and the relevant revenues of one alternative to the relevant costs and relevant revenues of the other alternative s.
Therefore, an important step in the differential analysis of potential solutions is to identify the relevant costs and relevant revenues of the decision. What does it mean for something to be relevant? In the context of decision-making, something is relevant if it will influence the decision being made. For example, suppose you have two options for a summer job—either flagging traffic for a road crew or working for a landscaping company doing lawn care.
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For either job, you will be required to have industrial grade sound protectors plugs or headphones for your ears. This cost would not be relevant because it is the same under either alternative, so it will not influence your decision between the two jobs; it would be considered an irrelevant cost. You also believe your transportation costs will be the same for either job; thus this would also be an irrelevant cost. However, if you are required to have steel-toed boots for the road work job but can wear any type of work boot for the landscaping job, you would need to consider the difference between the costs, or the differential cost , of these two types of boots.
This difference in cost between the two pairs of boots would be designated as a relevant cost because it influences your decision. The two jobs also may have differences in revenues, called a differential revenue. Because the differential revenue influences the decision, it is also a relevant revenue.
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If both jobs pay the same hourly wage, it would have an irrelevant revenue , but if the road crew job offers overtime for any time worked over 40 hours, then this overtime wage has the potential to be a relevant revenue if overtime is a likely occurrence. Looking only at these differences—of both costs and revenues—between the alternatives, is known as differential analysis. In conducting these types of analyses between alternatives, the initial focus will be on each quantitative factor of the analysis—in other words, the component that can be measured numerically.
Examples of quantitative factors in business include sales growth, number of defective parts produced, or number of labor hours worked.
get link However, in decision-making, it is important also to consider each qualitative factor , which is one that cannot be measured numerically. For example, using the same summer job scenario, qualitative factors may include the environment in which you would be working road dust and tar odors versus pollen and mower exhaust fumes , the amount of time exposed to the sun, the people with whom you will be working working with friends versus making new friends , and weather-related issues both jobs are outdoors, but could one job send you home for the day due to weather?
Examples of qualitative factors in business include employee morale, customer satisfaction, and company or brand image. In making short-term decisions, a business will want to analyze both qualitative and quantitative factors. In short-term decision-making, revenues are often easier to evaluate than costs. In addition, each alternative typically only has one possible one revenue outcome even though there are many costs to consider for each alternative.
How do we know if a cost will have an impact on the decision? The starting point is to understand the various labels that are attached to costs in these decision-making environments. Management must determine if a cost is avoidable or unavoidable because in the short run, only avoidable costs are relevant for decision-making purposes. An avoidable cost is one that can be eliminated in whole or in part by choosing one alternative over another.
For example, assume that a bike shop offers their customers custom paint jobs for bikes that the customers already own. If they eliminate the service, the cost of the bike paint could be eliminated. View update history Read related news Find Community Groups. Share Embed.
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