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ADMS 3510 (18)


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Administrative Studies
ADMS 3510
Jamison Aldcorn

CHAPTER 11. DECISION MAKING AND RELEVANT INFORMATION A good decision process includes a post implementation assessment and explanation of the key causes of variance. Decisions are made based on forecasted future revenue and cost and not on historical revenue and costs Decision framework: choose only relevant costs Imperfect information-> decisions- > forecast future Sources of data: electronic/hardcopy source documents, relevant stories of past experience, expertise in processes and outcomes, analysis from MIS , about controllable factors and expert advice and forecast. Quantitative data: measured numerically- expressed in financial and non financial terms Relevant data: data that changes between available choices  Analysing risk: - Incorporate risk by quantifying risk( which helps improve mgr’s confidence and align their interest with that of the company) and including it in the forecast. Such measure of risk: probability - Probabilities permit estimation of a range of predicted outcomes and identification of the most likely to occur, the expected value, which is the sum of risk weighted outcomes - Risk weights are measured as probabilities in decimal format while outcomes are usually measured as financial payouts from pursuing a specific course of action. - Fruitful discussion, less emotional - Highly risky decisions: high probability of (near certain) loss, or small probability of a very large loss - High return: either a highly improbable but large upside return or near certain return. - As circumstances change, assumptions, probability change, and negative and positive outcomes and their magnitudes change. - Action must be taken : or face paralysis by analysis: managers decide to wait and wait for more information.  Relevant Vs Irrelevant costs: - Relevant revenue: forecast future revenue that differs because of a decision - Incremental revenue: additional total revenue from one alternative - Differential revenue : difference between the total revenue of two or more alternatives - Relevant cost: cost that differs due to a decision made - Incremental cost/ out of pocket / outlay/ differential cost: difference between two alternative relevant costs - Net relevant cost: incremental saving – incremental cost  Additional relevant considerations: time , tax and qualitative factors - Taxes can increase due to increase in pre-tax income from one tax bracket to the next - Qualitative factors: outcomes that cannot be measured in numerical terms: measured in scales of eg. 1- 5 effective training, employee morale, and incorrect assumptions by top mgt. - Quantifying the qualitative factor into a rough estimate of financial value provides relevant information to assist in the decision making. - Responsible management teams will go to experts outside their enterprise to help them more clearly understand the risk and outcomes. - Managers must give more weight to qualitative or non financial quantitative factors than to financial factors. Change output level: short and long term decisions Short term production output decisions have no capacity management effects, such as accepting or rejecting one time-only special . Fixed costs are irrelevant. - Variable and throughput costing is appropriate for pricing finished goods. - In case of idle capacity, the effect of a special order on operating income depends on the customer accepting the contract, not on full absorption cost recovery as fixed cost is irrelevant. - Fixed cost/ capacity
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