The application of linear

programming to management
accounting

After studying this chapter, you should be able to:

formulate the linear programming model and calculate marginal rates of substitution and opportunity
costs using the graphical approach;
construct the initial tableau using the Simplex method;
explain the meaning of the entries in each column of the final tableau;
describe how linear programming can be used in decision-making, planning and control;
formulate the linear programming model that will maximize net present value;
identify the major deficiencies of linear programming.

In the previous chapters we have seen that there
is an opportunity cost for scarce resources that
should be included in the relevant cost
calculation for decision-making and variance
calculations. Our previous discussions, however,
have assumed that output is limited by one scarce
resource, but in practice several resources may
be scarce. The opportunity costs of these scarce
resources can be determined by the use of linear
programming techniques. Our objective in this
chapter is to examine linear programming
techniques and to consider how they can be
applied to some specific types of decisions that a
firm may have to make.

In Chapter 10 we considered how accounting information should be used to ensure

that scarce resources are efficiently allocated. We established that where a scarce Single-resource
resource exists, that has alternative uses, the contribution per unit should be calcu-
lated for each of these uses. The available capacity for this resource is then allocated
constraints
to the alternative uses on the basis of contribution per scarce resource. A typical
problem is presented in Exhibit 24.1.
If we follow the procedure suggested in Chapter 10, we can ascertain the con-
tribution per unit of the scarce resource. Product Y yields a contribution of 14 and
uses 6 scarce labour hours. Hence the contribution is 2.33 per labour hour. Simi-
larly, the contribution per labour hour for product Z is 2. The company should
therefore allocate scarce labour hours to the manufacture of product Y. Sales of
product Y, however, are limited to 420 units, which means that 2520 labour hours
(420 units at 6 hours per unit) will be used. The remaining 360 hours will then be
allocated to product z. As one unit of product Z requires 8 labour hours, the total
output of product Z will be 45 units.
Profits will be maximized when the firm manufactures 420 units of product Y and
45 units of product Z. This will give a total contribution of 6600, which is calculated
as follows:

SINGLERESOURCE CONSTRAINTS - - - - - - - - - - - - - - - - - - - - - - - - - - - - - 695

C. Drury, Management and Cost Accounting
J.C. Drury 1992
 Exhibit 24.1
A single resource LP is a manufacturing company which currently produces two products. The standards per unit of
constraint problem product are as follows:

Product Y () () Product Z () ()
Standard selling price 38 Standard selling price 42
Less Standard cost: Less Standard cost:
Materials {8 units at 1) 8 Materials (4 units at 1) 4
Labour (6 hours at 2) 12 Labour {8 hours at 2) 16
Variable overhead Variable overhead
(4 machine hours at 1) 4 (6 machine hours at 1) 6
24 26
Contribution 14 Contribution 16

During the next accounting period, it is expected that the availability of labour hours will be
restricted to 2880 hours. The remaining production inputs are not scarce, but the marketing manager
estimates that the maximum sales potential for product Y is 420 units. There is no sales limitation for
product Z.

()
420 units of Y at a contribution of 14 per unit 5880
45 units of Z at a contribution of 16 per unit 720
6600
Where more than one scarce resource exists, the optimum production programme
Two-resource cannot easily be established by the process previously outlined. Consider the situ-
ation in Exhibit 24.1, where there is an additional scarce resource besides labour. Let
constraints us assume that both products Y and Z use a common item of material and that the
supply of this material in the next accounting period is restricted to 3440 units.
There are now two scarce resources - labour and materials. If we apply the proce-
dure outlined above, the contributions per unit of scarce resource would be as
follows:
Product Y Product Z

Labour 2.33 2.00
Material 1. 75 (14/8) 4.00 (16/4)
This analysis shows that product Y yields the largest contribution per labour hour,
and product Z yields the largest contribution per unit of scarce materials, but there
is no clear indication of how the quantity of scarce resources should be allocated to
each product. In such circumstances there is a need to resort to higher-powered
mathematical techniques to establish the optimal output programme.

Linear programming is a powerful mathematical technique that can be applied to

Linear the problem of rationing limited facilities and resources among many alternative
programming uses in such a way that the optimum benefit can be derived from their utilization. It
seeks to find a feasible combination of output that will maximize or minimize the
objective function . The objective function refers to the quantification of an objective,
and usually takes the form of maximizing profits or minimizing costs. Linear pro-
gramming may be used when relationships can be assumed to be linear and where
an optimal solution does in fact exist.
To comply with the linearity assumption, it must be assumed that the contri-
bution per unit for each product and the utilization of resources per unit are the
same whatever quantity of output is produced and sold within the output range
being considered. It must also be assumed that units produced and resources
allocated are infinitely divisible. This means that an optimal plan that suggests we
should produce 94.38 units is possible. However, it will be necessary to interpret the
plan as a production of 94 units.

696 - - - - - - - - - - - - - - - - - - - - - APPLICATION OF LINEAR PROGRAMMING TO MANAGEMENT ACCOUNTING