BMGT221 G Pfeiffer Chapter 8 1 A How Do Managers Make Decisions o Management accountants help gather and analyze relevant information to compare alternatives a Also help with follow up o How Managers make decisions Identify alternative courses of action a Define Business Goals b c Gather and analyze important information compare alternatives d Choose best alternative e Implement decision f Follow up compare actual results with the results anticipated o Relevant nonfinancial information has the same characteristics as relevant Relevant Information o Relevant Information a Is expected future data b Differs among alternatives o Only Relevant Data affects decisions Relevant Nonfinancial Information financial information a Is expected future data b Differs among alternatives o Examples a Outsourcing b Weather c Laying off employees Keys to Making Short Term Special Decisions o Relevant information approach incremental analysis approach o How operating income would change or differ under each alternative o 6 Kinds of decisions a Special sales orders b Pricing c Dropping products departments and territories d Product mix e Outsourcing f Selling as is or processing further o Two keys to making short term special decisions a Focus on relevant revenues costs and profits b Use a CM approach that separates variables costs from fixed costs Must be analyzed separately because they behave differently B How do Managers Make Special Order and Regular Pricing Decisions Special Sales Orders Decisions o Occur when a customer requests a one time order at a reduced sales price a Usually for larger quantities BMGT221 G Pfeiffer Chapter 8 2 o Special Order Considerations Do we have Capacity available to fill this order Excess capacity is a necessity for accepting a special order True for both service firms and manufacturing companies Will the reduced sales price be high enough to cover incremental costs of filling the order the variable costs and any additional fixed costs Special price MUST exceed the variable costs of filling the order or the company will lose money on the deal must provide a positive contribution margin In some cases other fixed costs may be incurred to fill the special order the sales price must be high enough to generate a positive contribution margin and cover additional fixed costs Will the special order affect regular sales in the long run Will regular customers find out about the special order and demand a lower price or take business elsewhere Will special order customers come back again and again asking for the same reduced price Will the special order price start a price war with competitors o Example a ACDelco sells oil filters for 3 20 each A company has offered them 35 000 for 20 000 filters 1 75 per filter b The sale will Use capacity that would otherwise be idle Not change fixed costs Not require any variable nonmanufacturing expenses Not affect regular sales c The only concern not addressed is the special sales price high enough to cover the variable manufacturing costs associated with the order The CM income statement shows the variable manufacturing cost per unit is 1 20 the special order will have a positive CM of 0 55 per unit o Decision Rule for Special Orders a Accept the Special Order if expected increase in revenues exceeds expected increase in variable and fixed costs b Reject the Special Order if expected increase in revenues is less than expected increase in variable and fixed costs Regular Pricing Decisions a To gain more control over pricing companies use Branding Product Differentiation b Regular Pricing Considerations Do we have Capacity available to fill this order Will the reduced sales price be high enough to cover incremental costs of filling the order the variable costs and any additional fixed costs Will the special order affect regular sales in the long run BMGT221 G Pfeiffer Chapter 8 3 What is our Target Profit How Much will Customers Pay A company s stock price tends to decline if the company doesn t meet their target profits managers must keep costs low while generating enough revenue to meet target profits Managers cant set prices above what customers are willing to pay or sales will decline The amount customers are willing to pay depends on the competition the product s uniqueness the effectiveness of marketing campaigns general economic conditions etc Are we a Price take or a Price setter for this Product Characteristics of Price takers Product lacks uniqueness Heavy competition Pricing approach emphasizes target costing Characteristics of Price setters Product is more unique Less competition Pricing approach emphasizes cost plus pricing o Target Costing a Target Costing the total cost to develop design produce market deliver and service the product Every cost incurred throughout the value chain relating to the product Starts with the market price of the product the price customers are willing to pay and subtracts the company s desired profit to determine the product s target cost b Market price is taken If actual cost is greater than target total cost Accept a lower profit Cut fixed costs Cut variable costs Use other strategies i e increasing sales volume changing or adding the company s product mix strengthen name brand to gain more control over pricing c Calculating Target Full Cost Once the target total cost is known fixed and variable cost components can be analyzed separately Revenue at Market Price Less Desired Profit Target Total Cost Calculations 250 000 units x 3 00 price 10 x 1 000 000 of assets d Calculating Target Fixed Cost Target Total Cost Less Current variable costs Target Fixed Costs Calculations 250 000 units x 1 50 price e Calculating Target Unit Variable Cost Total 750 000 100 000 650 000 Total 650 000 375 000 275 000 What is our Target Profit How Much will Customers Pay Are we a Price take or a Price setter for this Product 4 Total 650 000 325 000 325 000 250 000 1 30 Total 375 000 325 000 700 00 100 000 800 000 250 000 3 20 BMGT221 G Pfeiffer Chapter 8 Target total cost Less Current fixed costs Target total variable costs Divided by number of units Target variable cost per unit o Cost Plus Pricing a Emphasized by companies that are price setters Have more control over pricing but price cant be higher than what customers are willing to pay b Opposite of target pricing approach c Cost plus price Total Cost Desired Profit Calculations 250 000 units x 1 50 price 10 x 1 000 000 of assets Current variable costs Plus
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