Information for decision making

Trainee accounting technicians need to recognise the limiting factor concept and use this within the decision making process. It is generally accepted that businesses have one or more limiting factors or, as John Sizer states “a factor in the activities of an undertaking which at a particular point in time or over a period will limit the volume of output”.

Within the planning stage of the budgetary cycle it will be apparent that there will be a factor or factors which will limit the organisational activities. This is often referred to as the key factor or principal budget factor, and its effects on the organisational plans must be fully assessed.

Such factors are often referred to as scarce resources which limit volume and may include:

• supply of skilled labour;
• supply of materials;
• factory space;
• finance;
• plant capacity;
• market demand.

It is often the case that a business may face a single constraint situation, however, others may face a multi constraint scenario. Budgetary plans are usually set some months prior to the period to which they relate. Circumstances alter and situations often arise where limits are placed on a resource or series of resources after the plans have been formulated. Where resources can limit capacity, in the short run, a business must decide on the product mix which will secure maximum contribution (and therefore maximum profit).

This is the decision making process faced by the accounting technician in which he or she would use the marginal costing technique focusing on contribution per limiting factor. The following case study illustrates this process. Crescent Animal Feeds Ltd produces three products CA1, CA2 and CA3. It’s budget for the quarter ending June 2002 and the standard cost specifications are shown in Table 1. It’s budgeted operating statement would therefore be as in Table 2.

Shortly before the start of the budget period the firm suffers a major breakdown to one of its mixing machines and the supplier, a foreign machine manufacturer, cannot supply the parts until towards the end of June.

It is estimated that the effect on operating hours will be a reduction of 10% in the budget period. This will not affect the employees’ basic working week as the budgeted activity for the quarter involved overtime working. The operating hours in the current budget are shown in Table 3.

The shortfall will therefore be:
18,500 x 10% = 1,850 hours

Thus revised capacity in hours:
18,500 x 90% = 16,650 hours

The business decides to revise its budget and its product mix, so that in the short run, it can secure maximum profit. The decision- making process involves the following steps:

1. determine the contribution per unit of output / product;
2. determine the contribution per limiting factor – the labour hour;
3. rank the products per the contribution per limiting factor;
4. revise the production and sales mix;
5. revise the budgeted profit.

Refer to Table 4.

Conclusion
This revised production and sales mix is viewed only from a financial perspective. The business may decide to consider alternative strategies to avoid loss of customer satisfaction in not being able to meet the demand for CA3. They may, in the short run, be able to buy in and repackage a similar alternative product as a substitute. However, they may decide to spread the shortfall across all products so as to minimise the adverse effect on customer relations.

Philip E Dunn, Esk Valley Business School, author of texts, study texts and exam kits - Foulks Lynch CAT series