Chapter 8 Relevant Costs for Short-Term Decisions

Benefits of Outsourcing

- Concentrate on core competencies - Take advantage of other companies' expertise - Reduce risk - Lower cost

If revenue from the special order EXCEEDS the incremental costs of filling the order, you should __________ the order

ACCEPT the special order

When looking at the difference in total operating income when you decide to/not to discontinue a product, what cost will not go away?

Allocated fixed cost! --> management has no control over these costs

Converting Units per Hour to Contribution Margin per Hour

CM/Unit X UNITS/HOUR = CM/Hour

Converting Hours per Unit to Contribution Margin per Hour

CM/Unit ÷ HOURS/UNIT = CM/Hour

If the fixed cost savings exceed the contribution margin lost from discontinuing a product, department, or store

DISCONTINUE THE PRODUCT

If the contribution margin lost from discontinuing a product, department, or store exceeds the fixed cost savings from discontinuing, then ___________

DO NOT DISCONTINUE THE PRODUCT

How are Avoidable fixed costs and Unavoidable fixed costs used to make a major company decision?

Discontinuing a product line; The 2 types of fixed costs are subtracted from Contribution Margin Lost if a product is discontinued to find the Overall Operating Income Lost if Moisturizers are Discontinued

If the incremental costs of making ARE LESS THAN the incremental costs of outsourcing, the company should ___________.

NOT OUTSOURCE

Something you should never do when faced with a Special Order Decision

Never compare the special order sales price with the absorption cost per unit. Rather, use the contribution margin approach.

If revenue from the special order IS LESS THAN the incremental costs of filling the order, you should __________ the order

REJECT the special order

If your current costs are greater than your target costs, your options to solve this are to:

Reduce fixed costs; Reduce variable costs per unit; Branding, product differentiation, adding more products; Accept a lower profit

Added profits from the increase in production resulting from the new machine is relevant or not relevant cost?

Relevant

Cost of the new machine is relevant or not relevant cost?

Relevant

Installation cost of new machine is relevant or not relevant cost?

Relevant

Interest expense on new machine is relevant or not relevant cost?

Relevant

Target Costing

Revenue at market price Less: Desired profit TARGET TOTAL COST

2 types of costs you should avoid considering when making decisions

Sunk costs and Unit costs

Cost-Plus Pricing

Total costs across the value chain Plus: Desired Profit (Profit%*total value of assets) SALES REVENUE DESIRED FOR X UNITS Divided by: Number of units COST-PLUS PRICE PER UNIT

short term decision making

Uses an Incremental Analysis Approach; Ignores irrelevant info; Focuses on relevant revenues, costs, and profits; Uses a Contribution Margin approach

When should you use Unit costs for decision making?

When the Unit costs are PURELY variable

What is valuable about finding the Target Total Cost

You can compare Target Total Cost to Current Total Costs to see how much costs must be reduced to achieve the target profit

Outsourcing

contracting an outside company to produce a product or perform a service

Avoidable fixed costs

fixed costs that can be eliminated as a result of discontinuing a product

Unavoidable fixed costs

fixed costs that will continue to be incurred even if the product line is discontinued

Offshoring

having work performed overseas; can include: Operating own manufacturing plants/call centers overseas or Outsourcing overseas work to another company

Contract manufacturers

only make products for other companies

contribution margin approach

separates variable costs from fixed costs; Part of Short-Term Decision Making

Drawbacks of Outsourcing

- Less control - Employees need to manage oversees relationship - Often results in layoffs

Product Mix Considerations

- What constraint(s) stops us from making or displaying all of the units we can sell? - Which products offer the highest contribution margin per unit of the constraint? - Would emphasizing one product over another affect fixed costs or sales of other products?

Things management must consider when dealing with Special Orders

-Do we have excess capacity to fill the order? -Will the reduced sales price be high enough to cover the incremental costs of filling the order? -Will the special order affect regular sales in the long run?

Special Order

A customer requests a one-time order at a reduced sales price, often for a large quantity

Pitfall to Avoid on Discontinuation decisions

Do not base decision off of a product line income statement that includes the allocation of common fixed expenses. Instead, prepare a segment margin income statement instead

Some things to consider when deciding whether or not to Discontinue a product, department, or store

Does the product provide a positive contribution margin? Are there any fixed costs that can be avoided if we discontinue the product? Will discontinuing the product affect sales of company's other products? What could we do with the freed capacity? (will it be used for a more profitable product?)

Fixed Costs include

Fixed MOH and Fixed operating expenses

Outsourcing Considerations

How do our variable costs per unit compare to the outsourcing cost per unit? Are any fixed costs avoidable if we outsource? What could we do with the freed capacity? What volume do we need?

Things to consider when deciding to sell as is or process further

How much revenue will we receive if we sell the product as is? How much revenue will we receive if we sell the product AFTER processing it further? How much extra will it cost to process the product farther?

Allocated fixed costs

Management has no control over these costs, they are unavoidable and will not go away if the product goes away.

Product based fixed costs

Management is responsible for these costs and they are avoidable/will go away if the product goes away

If the incremental revenue from processing further IS LESS THAN the extra cost of processing further, the company should ________.

Not process further

Accumulated depreciation on old machine is relevant or not relevant cost?

Not relevant

Book value of old machine is relevant or not relevant cost?

Not relevant

Cost of the old machine is relevant or not relevant cost?

Not relevant

Cost per pound of food to be processed by the machinery is relevant or not relevant cost?

Not relevant

Fixed selling costs is relevant or not relevant cost?

Not relevant

Installation cost of old machine is relevant or not relevant cost?

Not relevant

Installation costs of old machine is relevant or not relevant cost?

Not relevant

Maintenance cost of new machine is relevant or not relevant cost?

Not relevant

Sales tax paid on old machine is relevant or not relevant cost?

Not relevant

If the incremental costs of making EXCEED the incremental costs of outsourcing, the company should ___________.

OUTSOURCE

Incremental analysis approach

Part of Short-Term Decision Making; Look only at how operating income would change or differ under each alternative and ignore irrelevant info

Two main characteristics of Relevant Information

Pertains to the future and Differs among alternatives

6 short term decisions

Pricing; Special orders; Discontinuing products, departments, or stores; Product mix when resources are constrained; Outsourcing (make or buy); Selling "as is" or processing further

If the incremental revenue from processing further EXCEEDS extra cost of processing further, the company should ________.

Process further

Characteristics of price-setters

Product is more unique; Product is branded; Less competition; Pricing approach emphasizes cost-plus pricing

Characteristics of price-takers

Product lacks uniqueness; Not a brand name; Heavy competition; Pricing approach emphasizes target costing

Variable selling costs is relevant or not relevant cost?

Relevant

​Trade-in value of old machine is relevant or not relevant cost?

Relevant

Product Line Income Statements

Shows the operating income of each product line, as well as for the company as a whole

Why should sunk costs be ignored when making decisions about future actions?

These costs have already been incurred in the past and cannot change no matter what you do

Cost-plus price formula

Total cost Plus: Desired profit COST-PLUS PRICE

Absorption cost per unit =

Variable MFG cost + (Fixed MOH/Units needed)

Variable costs per unit include

Variable MFG costs (Direct materials, Direct labor, Variable MOH) and Variable Operating expenses (Sales commission and freight out)

To determine at what point you are indifferent to outsourcing or making a product, you need to find the...

Variable cost per unit for outsourcing earbuds

If the company is a price-setter, you should emphasize a __________ approach

cost-plus pricing

If the company is a price-taker, you should emphasize a __________ approach

target costing