The Use of Cost Information in Managerial Decision- Making Process

A decision is defined as a conscious choice between a large number of alternatives to achieve an objective or numbers of objectives.

Decision making is simply the process of choosing the most appropriate alternative. Additionally, decisionmaking is the total of physical and mental activities presented while choosing the right choice among all various alternatives.

The qualities of a good decision is being effective, efficient, practical and being taken on time.

Decision-making problem basically involves three stages:

• Introducing all alternatives that may be the basis of the decision,
• Sorting alternatives through their significance,
• Selecting and evaluating the most optimal alternative

It is possible to classify administrative decisions into two categories:

• Programmed (routine) decisions: Programmed decisions are routinely repeated decisions. 
• Non-programmed (nonroutine) decisions: Non-programmed decisions are special decisions that will affect the profitability of businesses in future periods.

Decisions which are taken in businesses can be classified into three categories: top-level management, mid-level management, low-level management.

• Strategic Decisions: Strategic decisions are  non-routine decisions.  Decisions taken by top management in case of mergers, acquisitions, takeovers or offering to the public are examples of strategic decisions.
• Managerial Decisions: These are the decisions which are mostly related to business management. Evaluating the current resources of the business in maximum performance, organizational structure, work-flow, chain of distribution are examples of managerial decisions.
• Operational Decisions: Decisions related to the implementation of general plans and programs are called operational decisions. Low-level managers take these decisions.

There are three types of decision-making conditions:

• Decision making under certainty,
• Decision making under risk,
• Decision making under uncertainty

Cost accounting system primarily aims at determining, defining, measuring and analyzing the various components of direct and indirect costs of the products and services which are produced and sold. Another purpose of cost accounting is to provide both financial and non-financial information to the management during the planning, controlling and monitoring the process.

Information provided by cost accounting system can be divided into two groups:

• cost information (related to the balance sheet and income statement)
• management information (related to utilization in the decision making process

Costs for decision making can be classified as follows:

• Relevant cost
• Sunk cost
• Opportunity cost
• Marginal cost
• Differential cost

Relevant costs are related to future decisions and they can change according to these decisions. Main features of relevant cost are as follows:

• are related to future
• can be changed among the alternatives
• are affected by the decisions

All costs that do not qualify as relevant costs are called sunk costs. Main features of sunk costs are that they are not related to future decisions and they do not change between various alternatives.

Opportunity cost is the value of benefit sacrificed in favor of an alternative course of action.

Marginal cost is the additional cost incurred when making or producing (of a good or service) one additional unit. In other words, the change in total cost that arises from the quantity changes by one unit is called marginal cost.

Differential cost is the increase in total cost in case one alternative is chosen among various alternatives. In other words, the differential cost is defined as the change in costs caused by the prediction of a change within the volume of activity.

We can list the essential factors that have a role in making a profit as follows

• Price of the product (service) per unit
• Sales amount of the product (service)
• Variable cost of the product (service) per unit
• Total amount of fixed cost of the product (service)

Cost – Volume – Profit (CVP) Analysis is a method that is used by the management to make profit planning. This method analyzes the changes in profits in accordance with sales volume and changes between the cost of a product or service and its sales revenue. In other words, it is determining the effects of changes in the sales price, in variable and fixed costs on the activities of a business.

“Break-even point” which is also called “dead point” is the analysis of the level at which the business will make a profit. Break-even point refers to the amount of production that does not result in profit or loss as a result of the activities of the business.

Pricing can be expressed as the process of determining the value of sales during the exchange of products and services that the business produces and sells.

Factors affecting pricing decisions can be listed as follows:

• Customer demands
• Impacts of the competitors
• Costs
• Political and legal regulations

Objectives of pricing decisions are:

• Maximizing profits
• Maintaining or increasing market share
• Determining socially responsible prices
• Maintaining the minimum return on investment rate
• Being customer focused
• Maximizing sales revenues

Pricing strategies are based on one of the three important factors which are cost, demand, and competition. Perceptions that form pricing strategies due to their basic factors can be divided into three groups such as cost-based pricing, competition-based pricing and value-based pricing.

Cost information can be useful in the following areas:

• Investment decisions
• Decision of ceasing or breakdown of a product
• Decision of producing new products
• While accepting a special sales price
• Determining the appropriate product mix
• Decisions of outsourcing

Contribution (Margin) is the difference between the unit sales price and the unit variable cost.