Short-run decision making consists of choosing among alternatives with an immediate or limited end in view. Short-term decisions sometimes are referred to as tactical, or relevant, decisions because they involve choosing between alternatives with an immediate or limited time frame in mind.
Suppose that a product can be sold at split-off for $5,000 or processed further at the cost of $1,000 and then sold for $6,400. Should the product be processed further?
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Some decisions tend to be short-run in nature, but when making decisions, an individual ought to note that tactical decisions usually have long-run consequences. In order to make an informed decision, one is required to use a decision model. Decision models help individuals structure their decision-making processes (Mowen, Hansen, & Heitger, 2009). More to this, decision models help individual organization information in order to make informed decisions. Generally, before making a decision, one needs to define the problem, outline all alternatives and eliminate the ones that are not feasible and identify the advantages and disadvantages associated with each feasible alternative (Mowen, Hansen, & Heitger, 2009). Based on the costs and benefits, the decision maker can eliminate irrelevant alternatives. The next step involves estimating the relevant costs and benefits associated with the remaining alternatives and assessing qualitative factors for each alternative (Mowen, Hansen, & Heitger, 2009). Based on the qualitative factors, an individual can make an informed by selecting the alternative with the greatest overall net benefit.
In the case provided, there are two alternatives –to sell the product at split-off for $5,000 or process the product further at the cost of $1,000, after which the product can be sold for $6,400. In this case, ought to determine if processing the product can increase the net profit or not. The incremental cost of processing the product further is $1,000, and the incremental revenue is $1,400. Processing the product further creates a net benefit of $400. Therefore, the product should be processed further.
Brandt Gardner, the owner-manager of a small firm that manufactures feed processing equipment and round-hay bailers, is unhappy with the latest report on financial performance in the Kansas City, Missouri, plant. The company had recently installed a standard cost system in the Kansas City plant to control manufacturing costs. The performance report for the year ended revealed that the variances for materials, labor, and variable overhead were all within the desired ranges, but the fixed overhead spending and volume variances were both significantly unfavorable. Brandt wanted an explanation of the fixed overhead variances and a recommendation.
Which do you think is more important for control of fixed overhead costs: the spending variance or the volume variance? Explain
Fixed overhead costs are capacity costs and are divided into two categories –actual fixed overhead and applied fixed overhead (Mowen, Hansen, Heitger, Sands, Winata, & Su, 2019). The difference between the two categories mentioned above is termed as the total fixed overhead variance. Fixed overhead variances are further divided into two categories, which include fixed overhead spending variance and fixed overhead volume variance (Mowen, Hansen, Heitger, Sands, Winata, & Su, 2019). The fixed overhead spending variance is the result of comparing or finding the difference between actual fixed overhead and the budgeted fixed overhead. On the other hand, the fixed overhead volume is the result of the difference between budgeted fixed overhead and applied fixed overhead. It can be interpreted as a measure of capacity utilization.
Fixed overhead spending costs are not affected by changes in production. In fact, they are mainly affected by long-run decisions (Mowen, Hansen, Heitger, Sands, Winata, & Su, 2019). For this reason, budget variance tends to be small. On the other hand, fixed overhead spending variance comprises numerous individual items, including materials, labor, and production. For this reason, it provides more information regarding the causes of spending variance. Therefore, volume variance is more important for control of fixed overhead costs.
Explain why firms choose to decentralize and give an example.
Typically, many organization centralizes authority. This means that leaders higher in the hierarchical system, such as the Chief Executive Officer (CEO), the board of directors, or senior-level executives, make a decision in the organization (Quain, 2019). In other words, in centralized organizations, power is concentrated in leadership. However, in recent years, there has been a push towards decentralized organizations. Decentralized organizations allow managers at mid or low levels to make and implement critical decisions (Quain, 2019). Many firms choose to decentralized for many reasons, including to increase overall efficiency, to train and motivate local managers, and to free higher-level managers from day-to-day operating activities.
The essence of decentralization is to provide decision-making freedom in an organization. This gives mid and lower levels managers the freedom to make and implement decisions in their areas of responsibilities (Quain, 2019). Local managers can use local information to make informed decisions. This can increase the overall efficiency of a firm. More to this is that they can also provide a more timely response to changing conditions (Quain, 2019).
In the case of a large organization or multinational companies, it is difficult to find a central manager that has a full understanding of the product and markets of the organization. This makes it difficult for them to make informed decisions in certain areas or departments. Thus, such organizations need to be decentralized. Additionally, firms choose to decentralize in order to train and motivate mid and low-level managers (Quain, 2019). More to this, the firm also decentralizes in order to free top management from day-to-day operating conditions. This can help the central managers spend time on more long-range activities.
Explain why NPV is generally preferred over IRR when choosing among competing or mutually exclusive projects. Why would managers continue to use IRR to choose among mutually exclusive projects?
The process of selecting projects to implement requires much analysis. There are a number of evaluation techniques that can be used to determine whether to accept or reject a project. Choosing a project to implement can be complicated if a choice is required to be made between projects that are mutually exclusive. In such cases, the projects are ranked based on various evaluation techniques such as the Net Present Value (NPV) and Internal Rate of Return (IRR) (Rich, Jones, Heitger, Mowen, & Hansen, 2012). The NPV and IRR are techniques that are commonly used to ranks projects. However, the NPV method is better for evaluating projects when compared to IRR.
The NPV is a discounting model of capital investment decisions (Rich, Jones, Heitger, Mowen, & Hansen, 2012). It is the difference between a project projected cash inflow and outflows. Projects with positive NPV are usually accepted as they increase the wealth of the firm (Rich, Jones, Heitger, Mowen, & Hansen, 2012). If the NPV of both projects is positive, the one with NPV that is more positive is chosen. The IRR method ranks investment projects based on the rate of return on an investment (Rich, Jones, Heitger, Mowen, & Hansen, 2012). Basically, the IRR of an investment project is calculated by finding the discount rate that equates the PV of the project's future cash inflows.
In order to know why the NPV method is preferred over IRR, one needs to analyze the reinvestment assumptions for each evaluation technique. The NPV model assumes that cash flows will be reinvested near or at the project's current cost of capital (Rich, Jones, Heitger, Mowen, & Hansen, 2012). On the other hand, the IRR method assumes that the firm can reinvest cash flows at the project’s IRR (Rich, Jones, Heitger, Mowen, & Hansen, 2012). The assumption made in the NPV model is more realistic than the assumption made in the IRR technique. NPV is preferred over IRR when a project has non-normal cash flows. Non-normal cash flows lead to multiple IRRs. For this reason, this technique cannot be employed in such cases. Generally, the NPV method is a better technique for the evaluation of investment projects than the IRR method. This is because the model correctly identifies the best investment alternative (Rich, Jones, Heitger, Mowen, & Hansen, 2012). The IRR method may choose an inferior project.
Explain how a company can report a positive net income and yet still have a negative net operating cash flow.
A firm can have a positive net income while reporting a negative cash flow. A common explanation for this is if a firm uses the accrual method of accounting (Way, N.d). Under this method, non-cash revenues can increase the net income of a company without affecting the cash flows of the firm, whereas cash flow can be decreased by actual payouts, asset increase, and liability decrease that may not be considered expense deductions for net income (Way, N.d). Because of this, the company can report positive net income and at the same time, report negative net operating cash flow.
What is the most important reason for an organization to use enterprise risk management?
Enterprise risk management (ERM) is a way to effectively manage risks in a firm (Kreiser, 2013). This is achieved by utilizing the common risks management framework. The framework used may vary from one organization to another but typically involves people, rules, and tools. ERM often provide a combination of both quantitative and qualitative benefits. However, the most important benefit that ERM provides is the creation of a more risk-focused culture for the organization (Kreiser, 2013). Implementing ERM in an organization increases the focus on risk in the organization resulting in a cultural shift in the organization, which allows risk to be considered and discussed openly. This allows better insight and decision making with regard to risk management. Other benefits of ERM include standardized risk reporting, improved focus, and perspective on risk, efficient use of resources, and effective coordination of regulatory and compliance matters (Kreiser, 2013).
When a company participates in a stock buyback program, it means that the company is buying shares of its own stock and taking them off the market. With this simple definition in mind , how would a company's stock buyback program affect its Earnings per Share?
A stock buyback occurs when a firm buys shares of its own stock from the marketplace (Janssen, 2019). This reduces the number of outstanding shares on the market. Through this, the ownership of the stakeholders is increased. Firms usually buy back shares from the marketplace if it believes the market has discounted its shares too steeply Janssen, 2019). The other reason that makes companies buyback stocks is if it wants to invest in itself or if the company wants to improve its financial ratios.
One of the main goals of a company is to maximize return for shareholders, and typically, buyback of stocks from the marketplace increases shareholder value Janssen, 2019). Secondly, a company may buy back its own stock to improve its financial ratios as it reduces the number of shares outstanding and reduces the number of assets on the balance sheet. As a result, the return on assets increase. Moreover, buyback improves the company's price-earnings ratio Janssen, 2019).
References
Janssen, C. (2019). Stock buybacks: a breakdown. [Online]. Retrieved from: https://www.investopedia.com/articles/02/041702.asp . Accessed October 6, 2019.
Kreiser, J. (2013). Five benefits of enterprise risk management. [Online]. https://www.claconnect.com/resources/articles/five-benefits-of-enterprise-risk-management . Accessed October 6, 2019.
Mowen, M., Hansen, D., & Heitger, D. (2009). Cornerstones of managerial accounting. Mason: USA. South-Western Cengage Learning.
Mowen, M., Hansen, D., Heitger, L. Sands, J., Winata, L., & Su, S., (2019). Managerial accounting. Asia-Pacific Edition. Cengage Learning Australia Pty Limited.
Quain, S. (2019). Advantages and disadvantages when companies decentralize. [Online]. Retrieved from: https://smallbusiness.chron.com/advantages-disadvantages-companies-decentralize-11938.html . Accessed October 6, 2019.
Rich, J., Jones, J., Heitger, D., Mowen, M., & Hanse, D. (2012). Cornerstones of financial and managerial accounting. Southern-Western Cengage Learning.
Way, J. (N.d). Can a company have a positive net income but a negative cash flow for the same year? [Online]. Retrieved from: https://www.sapling.com/12091506/can-company-positive-net-income-but-negative-cash-flow-same-year . Accessed October 6, 2019.
