Chapter 6 Relevant Information for Special Decisions Pearson Education. All rights reserved

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1 Chapter 6 Relevant Information for Special Decisions 1

2 Learning Objectives 1. Describe and identify information relevant to shortterm business decisions 2. Decide whether to accept a special order 3. Describe and apply different approaches to pricing 4. Decide whether to discontinue a product, department, or store 5. Factor resource constraints into product mix decisions 6. Analyze outsourcing (make-or-buy) decisions 7. Make sell as-is or process further decisions

3 Describe and identify information relevant to short-term business decisions Learning Objective 1

4 How Managers Make Decisions Define business goals Identify alternative courses of action Gather and analyze relevant information Choose best alternative Implement decision Follow-up: Compare actual with anticipated results 4

5 Relevant and Irrelevant Information Relevant Expected future (cost and revenue) data Differs among alternative courses of action Is both quantitative and qualitative Irrelevant Costs that do not differ between alternatives Sunk costs incurred in past and cannot be changed 5

6 Relevant Nonfinancial Information Nonfinancial, or qualitative factors, also play a role in managers decisions. laying off employees outsourcing, reduced control over delivery time and product quality discounted prices to select customers Managers who ignore qualitative factors can make serious mistakes. 6

7 Six Short-Term Special Decisions Special sales orders Pricing Discontinuing products, departments, and stores Product mix Outsourcing (make or buy) Selling as is or processing further 7

8 Keys to Making Short-Term Special Decisions Decisions approach Relevant information approach or incremental analysis approach Two keys in analyzing short-term special business decisions Focus on relevant revenues, costs, and profits Use contribution margin approach that separates variable costs from fixed costs 8

9 Sustainability and Short-term Business Decisions View every decision as having an impact on People Planet Profitability Timberland, doing well and doing good Example: Employees given PTO to volunteer Costly 9

10 Decide whether to accept a special order Learning Objective 2

11 Special Order Considerations A customer requests a one-time order at a reduced sale price, often for a large quantity: DECISION RULE: Do we have excess capacity available to fill this order? Yes No Consider further Reject the special order 11

12 Special Sales Order DECISION RULE: Is the special reduced sales price high enough to cover the incremental costs of filling the order? If revenues are greater than expected cost increase If revenues are less than expected cost increase Accept the special order Reject the special order 12

13 Special Sales Order DECISION RULE: Will the special order affect regular sales in the long run? If no to these questions If yes to these questions Accept the special order Reject the special order 13

14 Incremental Analysis of Special Sales Order, Expected increase in revenues sale of 20,000 oil filters x $1.75 each Expected increase in expenses variable manufacturing costs: 20,000 oil filters $1.20 each $ 35,000 (24,000) Expected increase in operating income $ 11,000 14

15 1. Prepare an incremental analysis to determine whether Collectible Cards should accept the special sales order assuming fixed costs would not be affected by the special order. Variable costs: Direct Materials Direct Labor Variable Overhead $ Total Cost $0.30 Would accept the special order because the cost per part to make it is only $0.30 per part versus the $0.40 per part selling price being offered by the buyer. 15

16 2. Now assume that the Hall of Fame wants special hologram baseball cards. Collectible Cards must spend $5,000 to develop this hologram, which will be useless after the special order is completed. Should Collectible Cards accept the special order under these circumstances? Show your analysis. Expected increase in revenues sale of 57,000 cards x $0.40 each Expected increase in expenses variable manufacturing costs: 57,000 cards x $0.30 each Special hologram cost $ 22,800 (17,100) (5,000) Expected increase in operating income $ 700

17 Describe and apply different approaches to pricing Learning Objective 3

18 Regular Pricing Considerations What is our target profit? How much will customers pay? Are we a price-taker or a price-setter for this product? 18

19 Price-Taker vs Price-Setter Price-Takers Product lacks uniqueness Price-Setters Product is more unique Heavy competition Pricing approach emphasizes target costing Less competition Pricing approach emphasizes cost-plus pricing 19

20 Two potential outcomes when using target costing 1. Actual cost less than target total cost 2. Actual cost greater than target total cost 20

21 Other Strategies Increase sales Use CVP analysis to compute target sales to achieve its target profit. Change or add to its product mix Offer levels of the same product Offer new items to the product mix with high CM Remove items with the lowest CM Differentiate its products (make it unique) Branding Quality Service packs 21

22 Cost-Plus Pricing The opposite of the target-pricing approach Starts with the company s full costs Adds the desired profit to determine a cost-plus price Total cost Plus: Desired profit Cost plus price 22

23 Pricing Decisions DECISION RULE: How to Approach Pricing? If company is a pricetaker for the product: If the company is a price-setter for the product: Emphasize target costing approach Emphasize cost-plus pricing approach 23

24 Decide whether to discontinue a product, department, or store Learning Objective 4

25 Other Short-term Business Decisions Managers Face When to discontinue a product, department, or store How to factor constrained resources into product mix decisions When to make a product or outsource it When to sell as is or process further 25

26 Considerations for Discontinuing Products, Departments or Stores Will the total fixed costs continue to exist even if the product line is discontinued? Can any direct fixed costs of the product be avoided if the product line is discontinued? Can any direct fixed costs of the product be avoided if the product line is discontinued? Use incremental analysis for discontinuing a product 26

27 Discontinuing Products, Departments or Stores DECISION RULE: Discontinue a product, department, or store? If lost revenues from discontinuing a product, department, or store exceed the cost savings from discontinuing: If total cost savings exceed the lost revenues from discontinuing a product, department, or store: Do not discontinue Discontinue 27

28 Factor resource constraints into product mix decisions Learning Objective 5

29 Product Mix DECISION RULE: Which product to emphasize? Emphasize the product with the highest contribution margin per unit of constraint 29

30 Analyze outsourcing (make-or-buy) decisions Learning Objective 6

31 Outsourcing (Make or Buy) Considerations To buy a product or service or produce it in-house The heart of the decisions : how best to use available resources How do our variable costs compare to the outsourcing cost? Are any fixed costs avoidable if we outsource? What could we do with the freed capacity? 31

32 Outsourcing DECISION RULE: Should the company outsource? If the incremental costs of making exceed the incremental costs of outsourcing: If the incremental costs of making are less than the incremental costs of outsourcing: Outsource Do not outsource 32

33 Make sell as-is or process further decisions Learning Objective 7

34 Sell As-Is or Process Further Considerations How much revenue is generated if we sell the product as is? How much revenue is generated if we sell the product after processing it further? How much will it cost to process the product further? 34

35 Sell As-Is or Process Further DECISION RULE: Sell as-is or process further? If extra revenue (from processing further) exceeds extra cost of processing further: If extra revenue (from processing further) is less than extra cost of processing further: Process further Sell as is 35

36 Exercises

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