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BAAC 221 Chapter 8

Relevant Costs for Short-Term Decisions

Relevant Information Costs and revenues managers use to make decisions; expectorated future data that DIFFERS between alternatives
Sunk Costs costs incurred in the past and irrelevant to decisions
Two keys to analyze short-term special business decisions 1- focus on relevant costs, revenues, and profits 2- use a contribution margin approach to separate variable and fixed costs
Questions to answer before making a SPECIAL DEAL 1- do we have excess capacity available to fill this order? 2- will the reduced sales price be high enough to cover the incremental costs of filling the order? 3- Will this order affect regular sales in the long-run?
Decision Rule: Special Orders ACCEPT if: expected revenues > expected increase in costs
Questions to answer for REGULAR PRICING DECISIONS 1- what is our target profit? 2- How much will customers pay? 3- are we a price-taker or a price-setter?
Characteristics of Price-Takers 1- Production lacks uniqueness 2- Heavy competition 3- Pricing approach emphasizes target costing
Characteristics of Price-Setters 1- Unique production 2- less competition 3- Pricing approach emphasizes cost-plus pricing
Target Costing Equation Revenue at MARKET price - desired profit = target total cost
Cost-Plus Pricing Equation Total cost + desired profit = cost-plus price
Questions to answer before deciding to DISCONTINUE PRODUCTS, DEPARTMENTS, OR STORES 1-Does the product have a positive contribution margin? 2-Are there any fixed costs that can be avoided if we discontinue it? 3-Will discontinuing the product affect sales of the company's other products? 4-What could we do with the freed capacity?
Product Line Income Statement Shoes the operating income of each product line as well as the company as a whole
Avoidable Fixed Costs Costs eliminated from discontinuing; relevant
Unavoidable fixed costs Costs that continue regardless of discontinuation; irrelevant
Decision Rule: DISCONTINUATION Discontinue if: Total cost savings > lost revenues
Common Fixed Expenses expenses that cannot be traced directly to a product line
Segment Margin Income Statements Product line income statement that contains no allocation of common fixed costs. Only direct fixed costs can be traced to a specific product line's contribution margin. All common fixed costs unallocated shown on in total
Segment Margin income resulting from subtracting direct fixed costs from contribution margin.
Constraints Limited resources that restrict production or sale of a product
Questions to ask for PRODUCT MIX DECISIONS 1- What constraints stop us from making,displaying all the units we can sell? 2-Which products offer the highest contribution margin per unit of the constraint? 3- Would emphasizing one product over another affect fixed costs?
Decision Rule: PRODUCT MIX Emphasize the product with the HIGHEST contribution margin per unit of the constraint
Make-or-Buy a name for outsourcing decisions
Outsourcing contracting an outside company to produce a product or perform a service;; domestic or overseas
Offshoring having work performed overseas. Not necessarily outsourced.
Contract Manufacturers Manufacturers who only make products for other companies, not for themselves
Questions to ask for OUTSOURCING 1- How do variable costs compare to outsourcing cost? 2- Are any fixed costs avoidable if we outsource? 3- What could we do with the freed capacity?
Decision Rule: OUTSOURCING Outsource IF: incremental costs of making > incremental costs of outsourcing
Potential Drawbacks of Outsourcing Loss of control, more employees needed to manage relationship, ofter results in laying off employees.
Created by: 1229955762