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CHAPTER 9

Relevant Costs and Product Planning Decisions

© 2009 Cengage Learning

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Introduction

How does a manager decide:

•The selling price of a product?

•Whether to accept a special order?

•Whether to add or drop a product?

•Which products to put on the shelves?

•Whether to hire an employee or outsource?

•Whether to make or buy a product?

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Special Orders

Special order decisions are

•Short-run pricing decisions

•Affected by

•Excess production capacity

•Relevant costs associated with each specific special order

•Qualitative factors

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Special Orders

Should Sunset provide 150 seats (for corporate executives attending a

convention in San Diego) for $125 instead

of the normal fare of $275?

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Special Orders

What information do we have?•Full cost per passenger is $137.61•BUT… what costs are relevant to this decision?•Consider only variable costs not fixed costs.•Variable costs are only the cost of meals ($6.50).•NEXT… consider capacity, do they have excess seats?•THEN… consider qualitative factors•AND… make decision.

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Special Orders

The price of a special order must be higher than

the additional variable costs incurred in

accepting the special order plus any opportunity

costs incurred.

Key Concept

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Outsourcing and Other Make-or-Buy Decisions

•Outsourcing is using another company to provide labor or produce a component rather than using

company employees•For example contracting with another company to provide janitorial and repair services instead

of using employees of the company

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Factors Affecting Outsourcing Decisions

•Impact of taxes

•Payment of fringe benefits to salaried employees

•Impact on the attitude of the remaining work force

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Vertical Integration

Vertical Integration Accomplished when a company is involved in multiple steps of the value chain.

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Make-or-Buy Decision

•Birdie Maker currently makes all golf clubs in the set but is considering acquiring the putter from Ace Putters, a manufacturer of custom putters

Cost to make: $26.50Cost to buy: $34.50

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The Make-or-Buy Decision

Based on Information Given:

Continue making putters IF they believe they can manufacture a putter of acceptable quality and

keep up with technological changes.

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Make-or-Buy with Relevant Fixed Costs

With Relevant Fixed Costs

Due to a change in fixed costs (leased equipment being returned)

Cost to make: $26.50

Cost to buy: $29.00

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Make-or-Buy with Relevant Fixed Costs

With Relevant Fixed Costs

Make internally considering:

•Quality of the putter

•Changing technology

•Dependability of the supplier

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Make-or-Buy with Relevant Opportunity

Costs

With Relevant Opportunity Costs

Opportunity CostsRent out the factory space now being used to make the putters, adding $10 opportunity costs per

putter

Cost to make: $36.50Cost to buy: $24.50

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Make-or-Buy With Relevant Opportunity

Costs

With Relevant Opportunity Costs

Buy the putter

Considering qualitative factors

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Make-or-Buy Decisions

A product should continue to be made internally and labor

incurred internally if the avoidable costs are less than the additional costs that will

be incurred by buying or outsourcing.

Key Concept

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The Decision to Drop a Product or a

Service

•One of the most difficult decisions a manager can make

•Must analyze relevant costs

•Must also consider qualitative factors

•Must consider contribution margin

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The Decision to Drop a Product or a

Service

A product should be dropped when the fixed

costs avoided are greater than the

contribution margin lost.

Key Concept

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Resource Utilization Decisions

Constraint: The capacity to manufacture a product or provide a service is limited in some manner.•Examples include skilled craftspeople, special machinery, and limited space often times are short-run constraints.

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Resource Utilization Decisions

Resource utilization decisions hinge on an

analysis of the contribution margin

earned per unit of the limited resource.

Key Concept

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Theory of Constraints

Identifies bottlenecks in the production process.

Bottlenecks limit throughput: the number of finished goods that result

from the production process.

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Decision to Sell or Process Further

A Furniture Manufacturer Can Sell its Furniture:

•Unassembled and Unfinished

•Assembled and Unfinished

•Assembled and Finished

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Decision to Sell or Process Further

A product should be processed further if the

additional revenue is greater than the additional cost.

Key Concept

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ABC and Relevant-Cost Analysis

•Uses multiple cost drivers to trace costs directly to products

•Focuses on changes in costs associated with a variety of different activities

•Helps managers identify what costs are really avoidable in a relevant-cost analysis