Chapter 19

Describe and identify information relevant to

business decisions
 Define business goals

Identify alternative courses of

action

Gather and analyze relevant

information

Compare alternatives

Choose best alternative

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 Expected future data
Differs among alternatives
Relevant costs
Relevant to a particular decision

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 Do not affect decision
Sunk costs
Occurred in the past
Cannot be changed

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Make special order and pricing decisions
 Will the reduced
Is there excess price cover the
capacity? incremental
costs?

Will special
order affect
sales in the
long-run?

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 Is there excess
capacity?

Yes No

Consider Reject the

further special order
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8
 Consider
Does reduced Yes
fixed costs
price cover
variable
costs? Reject the
No
special order

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 Consider affect on regular sales in the long run

Will special order

Will regular customer
customers find demand lower
out and demand price on a
a lower price? regular basis?

Will special order

start a price war
with
competitors?

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 What is our How much will
target profit? customers
pay?

Are we a
price-taker or
a price-setter?

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 Product lacks Product is more
uniqueness unique
Intense competition Less competition
Pricing approach Pricing approach
emphasizes target emphasizes cost-plus
pricing pricing

Price-takers Price-setters

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Revenue at market price
Less: Desired profit If current cost is
greater than
Equals Target full cost
target cost, the
company needs
to find a way to
Includes product reduce costs.
and period costs

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Full cost
Plus: Desired profit
Equals Cost-plus price

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 DECISION RULE:
How to Approach
Pricing?

Is company a Is company a
price-taker for the price-setter for
product? the product?

Emphasize cost-
Emphasize target
plus pricing
pricing approach
approach

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15
Make dropping a product and product-mix
decisions
Does the product Can any fixed
provide a positive Will fixed costs costs be avoided
contribution continue? if we drop the
margin? product?

Will the sales of What could we

other products be do with the freed
affected? capacity?

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 Two keys
Focus on relevant revenues, costs, and profits
Use a contribution margin approach
Focus now on a decrease in volume

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 If product has a negative contribution margin
DROP
Unavoidable fixed costs are irrelevant
Avoidable, direct fixed costs are relevant
If direct fixed costs decrease more than the decrease in
revenues
DROP
Other considerations:
Lost contribution margins from other products
Will more profitable products be made with excess
capacity?

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 DECISION RULE:
Drop a product,
department, or territory?

Are lost revenues > Are lost revenues <

cost savings? cost savings?

Do not drop Drop

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Expected decrease in revenues $129,000
Expected decrease in variable costs 93,000
Expected decrease in operating income $36,000

DO NOT DROP

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 What constraints Which products
stop us from offer the highest
making all the units contribution margin
we can sell? of the constraint?

Would emphasizing
one product over
another affect fixed
costs?

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 DECISION RULE:
Which product to
emphasize?

The product with the

highest contribution
margin per unit of
constraint
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Make outsourcing and sell as is or process
further decisions
How do variable
Are any fixed
costs compare to
costs avoidable if
the outsourcing
we outsource?
costs?

What would we
do with the freed
capacity?

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 DECISION RULE: Should the company outsource?

If the incremental cost of

If the incremental costs of
making are less than the
making exceed incremental
incremental costs to
costs to outsource
outsource

Do not
Outsource outsource

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26
 The benefit forgone by not choosing an alternative
course of action
Example:
If the company chooses not to outsource, it will lose any
revenue from freed capacity

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 How much How much
revenue will be revenue will be
earned if sold as- earned if
is? processed further?

How much will it

cost to process
further?

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 DECISION RULE: Sell as-is or
process further?

If extra revenue from If extra revenue from

processing further processing further is
exceeds extra cost less than extra cost

Process further Sell as is

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29