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Chapter 6

Relevant Information

for Special Decisions

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Learning Objectives

1. Describe and identify information relevant to short-

term 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


Learning Objective 1

Describe and identify information

relevant to short-term business

decisions


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

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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

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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.

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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

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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

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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

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Decide whether to accept a

special order


DECISION RULE: Do we have excess capacity available to fill this order?

Yes

Consider further

No

Reject the special order

A customer requests a one-time order at a reduced sale

price, often for a large quantity:

Special Order Considerations

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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

Accept the special order

If revenues are less than expected cost increase


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Special Sales Order

DECISION RULE: Will the special order affect regular sales

in the long run?

If no to these questions

Accept the special order

If yes to these questions


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Incremental Analysis of Special

Sales Order,

Expected increase in revenues—sale of

20,000 oil filters x $1.75 each $ 35,000

Expected increase in expenses—variable

manufacturing costs:

20,000 oil filters $1.20 each

(24,000)

Expected increase in operating income $ 11,000

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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.

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.

Variable costs:

Direct Materials

Direct Labor

Variable Overhead

$0.13

0.06

0.11

Total Cost $0.30

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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 $ 22,800

Expected increase in expenses—variable

manufacturing costs:

57,000 cards x $0.30 each

Special hologram cost

(17,100)

(5,000)

Expected increase in operating income $ 700



Describe and apply different

approaches to pricing


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?

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Price-Taker vs Price-Setter

Price-Takers Price-Setters

Product lacks uniqueness Product is more unique

Heavy competition Less competition

Pricing approach

emphasizes target costing

Pricing approach

emphasizes cost-plus

pricing

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Two potential outcomes when using

target costing

1. Actual cost less than target total cost

2. Actual cost greater than target total cost

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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

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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

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Pricing Decisions

DECISION RULE: How to Approach Pricing?

If company is a price-taker for the product:

Emphasize target costing approach

If the company is a price-setter for the

product:

Emphasize cost-plus pricing approach

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Decide whether to discontinue a

product, department, or store


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

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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

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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:

Do not discontinue

If total cost savings exceed the lost revenues from discontinuing a product, department, or store:

Discontinue

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Factor resource constraints into

product mix decisions


Product Mix

DECISION RULE: Which product to emphasize?

Emphasize the product with the highest contribution margin per unit of constraint

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Analyze outsourcing (make-or-buy)

decisions


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?

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Outsourcing

DECISION RULE: Should the company outsource?

If the incremental costs of making exceed the incremental

costs of outsourcing:

Outsource

If the incremental costs of making are less than the

incremental costs of outsourcing:

Do not outsource

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Make sell as-is or process further

decisions


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?

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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:

Process further

If extra revenue (from processing further) is less than

extra cost of processing further:

Sell as is

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Exercises

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