ACCA Applied Skills · Performance Management

Make-or-Buy and Other Short-Term Decisions for ACCA PM

Short-term decisions use relevant costing: you include only future, incremental cash flows and ignore sunk and non-cash items. For make-or-buy, compare the relevant cost of making with the buy price. With a scarce resource, rank products by contribution per unit of the limiting factor. Then test shut-down and special orders the same way.

What this chapter covers

This chapter teaches you how to choose between options when time is short and the facts are fixed. Should you make a component or buy it? Which products should use a scarce resource? Should you accept a one-off order at a low price? Should you close a division? Every one of these is answered with the same tool: relevant costing.

The chapter has five parts. Relevant costing gives you the rule for what to include. Make-or-buy applies it to an outsourcing choice. Limiting factor analysis applies it when one resource is scarce. Shadow prices and linear programming constraints extend that to several scarce resources and tell you what an extra unit of a resource is worth. Shut-down and special order decisions apply the same rule to closing activities and pricing one-off deals.

This chapter links to much of the rest of PM. It builds on cost classification and marginal costing, and it feeds into pricing, budgeting and performance measurement. You will meet these ideas in Section A, in Section B cases and in Section C written questions, where you must calculate and also give a reasoned recommendation, including non-financial factors.

Decision-making is a core area of the PM syllabus and appears in all three sections of the exam. Objective questions on relevant cost, limiting factors and shadow prices are short, but they are marked all or nothing, so one slip in what to include costs you the whole answer. In constructed response questions, a clear layout and a sensible recommendation earn marks even if one number is wrong. The method is the same every time, so effort here repays you quickly.

Make-or-buy and other short-term decisions: topics in the order to study them

1Relevant Costing PrinciplesEvery other topic in the chapter uses its rule, so learn it first.
2Make-or-Buy DecisionsIt is the simplest application of relevant costs: one choice, two options, and you compare costs.
3Limiting Factor AnalysisIt adds one scarce resource to the make-or-buy logic and introduces contribution per unit of scarce resource.
4Shadow Prices and Linear Programming ConstraintsIt needs limiting factor ideas first, because a shadow price is the value of one extra unit of a scarce resource.
5Shut-Down and Special Order DecisionsIt brings everything together: you apply relevant costs, spare capacity and opportunity cost to a full decision.

How to prepare Make-or-buy and other short-term decisions

Work from the rule to the exam question. Practise each topic with numbers, then practise writing the recommendation.

Learn the relevant cost test: a cost counts only if it is future, incremental and a cash flow. Sunk costs, committed costs, depreciation and general fixed overheads are out.
For each resource in a question, ask how it would be obtained: bought in specially, taken from stock, or diverted from other work. This decides the relevant cost, including any opportunity cost.
Practise make-or-buy by comparing relevant cost of making with the buy price per unit, then check for a limiting factor and for fixed costs that can be avoided.
Rank products by contribution per unit of the scarce resource, allocate the resource in that order, and check demand limits. Then do problems with more than one constraint and learn what a shadow price tells you.
Write shut-down and special order answers in a fixed layout: relevant revenue, relevant costs, net effect, then non-financial points and a recommendation.
Do timed objective questions on each topic, then a full Section C question. Review every wrong answer and note which item you wrongly included or left out.

Common mistakes in Make-or-buy and other short-term decisions

Including sunk or committed costs in the decision
Fix: Test every figure: is it future, incremental and cash? If not, leave it out and say why.
Ranking products by contribution per unit instead of per unit of the scarce resource
Fix: Divide contribution by the scarce resource used per unit, then rank on that figure.
Treating all fixed overheads as relevant in make-or-buy or shut-down questions
Fix: Include only fixed costs that can actually be avoided. Absorbed or allocated overheads that continue are irrelevant.
Forgetting opportunity cost when a resource is fully used
Fix: If the resource is scarce, add the contribution lost from diverting it to the relevant cost.
Ignoring non-financial factors in written answers
Fix: Add points such as supplier reliability, quality, staff morale and customer reaction, then give a clear recommendation.
Misreading what a shadow price means
Fix: Remember it is the extra contribution from one more unit of a binding constraint, and it holds only within a limited range.

Last-day revision: Make-or-buy and other short-term decisions

Relevant costs are future, incremental cash flows.
Ignore sunk costs, depreciation and non-cash items.
Fixed overheads are relevant only if they change because of the decision.
Material already in stock: if it is regularly used and would be replaced, the relevant cost is its replacement cost. If it is not needed and would not be replaced, the relevant cost is the higher of its resale value and its value in the next best alternative use. If it has no other use and no resale value, the relevant cost is zero.
Labour with spare capacity costs nothing extra; labour at full capacity costs pay plus lost contribution.
Make-or-buy: compare relevant cost of making with the buy-in price.
Limiting factor: rank by contribution per unit of the scarce resource, not per product.
With one scarce resource, fill the best-ranked product first, up to its demand.
A shadow price is the extra contribution from one more unit of a scarce resource.
A resource with spare capacity has a shadow price of zero.
Shut-down: compare contribution lost with fixed costs avoided, then add non-financial factors.
Special order: accept if the extra revenue exceeds relevant costs, including any lost sales.

Make-or-buy and other short-term decisions practice questions

Make-or-buy and other short-term decisions in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Make-or-buy and other short-term decisions: frequently asked questions

What is relevant costing in ACCA PM?

It is the method of including only future, incremental cash flows that change because of a decision. You exclude sunk costs, committed costs and non-cash items such as depreciation. It is the basis of all short-term decisions.

How do I solve a make-or-buy question?

Work out the relevant cost per unit of making, including only avoidable costs and any opportunity cost. Compare it with the buy-in price. If a resource is limited, compare the extra cost of buying per unit of the scarce resource saved.

What does a shadow price tell me?

It shows how much total contribution would rise if you had one more unit of a scarce resource. It applies only to a constraint that is fully used, and only within a limited range. A resource with spare capacity has a shadow price of zero.

Do I need to write answers for these topics or only calculate?

You need both. Objective questions test the calculation and the rule. Section C questions usually ask for a recommendation too, so give a clear layout, state your assumptions and add relevant non-financial points.