accounting chapter 25

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1. Short-Term Business Decisions Chapter 25 25-1Copyright 2014 Pearson Education, Inc. publishing as Prentice Hall 2. Learning Objectives 1. Identify information that is relevant for making short-term decisions 2. Make regular and special pricing decisions 25-2Copyright 2014 Pearson Education, Inc. publishing as Prentice Hall 3. Learning Objectives 3. Make decisions about dropping a product, product mix, and sales mix 4. Make outsourcing and processing further decisions 25-3Copyright 2014 Pearson Education, Inc. publishing as Prentice Hall 4. Learning Objective 1 Identify information thatIdentify information that is relevant for makingis relevant for making short-term decisionsshort-term decisions 25-4Copyright 2014 Pearson Education, Inc. publishing as Prentice Hall 5. How Managers Make Decisions Copyright 2014 Pearson Education, Inc. publishing as Prentice Hall 25-5 6. Relevant versus Irrelevant Information Relevant Expected future data Differs among alternatives Irrelevant Does not affect the decision Sunk costs Incurred in the past Cannot be changed regardless of which future action is taken Copyright 2014 Pearson Education, Inc. publishing as Prentice Hall 25-6 7. Relevant Information Financial (quantitative) Nonfinancial (qualitative) Copyright 2014 Pearson Education, Inc. publishing as Prentice Hall 25-7 8. Types of Short-Term Special Decisions Regular and special pricing Dropping unprofitable products and segments, product mix, and sales mix Outsourcing and further processing Copyright 2014 Pearson Education, Inc. publishing as Prentice Hall 25-8 9. Keys in Analyzing Short-term Special Business Decisions 1. Focus on relevant revenues, costs, and profits 2. Use a contribution margin approach that separates variable costs from fixed costs Copyright 2014 Pearson Education, Inc. publishing as Prentice Hall 25-9 10. Doherty Company is considering replacing the individual printers each employee in the corporate office currently uses with a network printer located in a central area. The network printer is more efficient and would, therefore, cost less to operate than the individual printers. However, most of the office staff thinks having to use a centralized printer would be inconvenient. They prefer to have individual printers located at each desk. Identify the following information as financial or nonfinancial and relevant or irrelevant. The first item has been completed as an example. Copyright 2014 Pearson Education, Inc. publishing as Prentice Hall 25-10 11. Financial Nonfinancial Relevant Irrelevant 1. Amount paid for current printers 2. Resale value of current printers 3. Cost of new printer 4. Operating costs of current printers 5. Operating costs of new printers 6. Employee morale Copyright 2014 Pearson Education, Inc. publishing as Prentice Hall 25-11 12. Financial Nonfinancial Relevant Irrelevant 1. Amount paid for current printers 2. Resale value of current printers 3. Cost of new printer 4. Operating costs of current printers 5. Operating costs of new printers 6. Employee morale Copyright 2014 Pearson Education, Inc. publishing as Prentice Hall 25-12 13. Financial Nonfinancial Relevant Irrelevant 1. Amount paid for current printers 2. Resale value of current printers 3. Cost of new printer 4. Operating costs of current printers 5. Operating costs of new printers 6. Employee morale Copyright 2014 Pearson Education, Inc. publishing as Prentice Hall 25-13 14. Financial Nonfinancial Relevant Irrelevant 1. Amount paid for current printers 2. Resale value of current printers 3. Cost of new printer 4. Operating costs of current printers 5. Operating costs of new printers 6. Employee morale Copyright 2014 Pearson Education, Inc. publishing as Prentice Hall 25-14 15. Financial Nonfinancial Relevant Irrelevant 1. Amount paid for current printers 2. Resale value of current printers 3. Cost of new printer 4. Operating costs of current printers 5. Operating costs of new printers 6. Employee morale Copyright 2014 Pearson Education, Inc. publishing as Prentice Hall 25-15 16. Financial Nonfinancial Relevant Irrelevant 1. Amount paid for current printers 2. Resale value of current printers 3. Cost of new printer 4. Operating costs of current printers 5. Operating costs of new printers 6. Employee morale Copyright 2014 Pearson Education, Inc. publishing as Prentice Hall 25-16 17. Learning Objective 2 Make regular andMake regular and special pricingspecial pricing decisionsdecisions 25-17Copyright 2014 Pearson Education, Inc. publishing as Prentice Hall 18. Three Basic Questions to Ask When Setting Regular Prices What is the companys target profit? How much will customers pay? Is the company a price-taker or a price-setter for this product or service? Copyright 2014 Pearson Education, Inc. publishing as Prentice Hall 25-18 19. Price-Takers versus Price-Setters Copyright 2014 Pearson Education, Inc. publishing as Prentice Hall 25-19 Exhibit 25-2 Price-Takers versus Price-SettersExhibit 25-2 Price-Takers versus Price-Setters 20. Target Pricing Formula Copyright 2014 Pearson Education, Inc. publishing as Prentice Hall 25-20 Basic Profit Calculation: Revenues Less: Costs Profits 21. Target Pricing Formula Copyright 2014 Pearson Education, Inc. publishing as Prentice Hall 25-21 Basic Profit Calculation: Rewritten as: Revenues Revenues Less: Costs Less: Profits Profits Costs 22. Target Pricing Formula Copyright 2014 Pearson Education, Inc. publishing as Prentice Hall 25-22 Basic Profit Calculation: Rewritten as: Target pricing formula: Revenues Revenues Revenue at market price Less: Costs Less: Profits Less: Desired profit Profits Costs Target full product cost 23. Smart Touch Learnings Budgeted Income Statement Copyright 2014 Pearson Education, Inc. publishing as Prentice Hall 25-23 24. Target Full Product Cost Copyright 2014 Pearson Education, Inc. publishing as Prentice Hall 25-24 25. Target Full Product Cost Copyright 2014 Pearson Education, Inc. publishing as Prentice Hall 25-25 26. What Options Does Smart Touch Learning Have? 1. Accept the lower operating income of $236,000, which is a 9.44% return ($236,000 operating income/$2,500,000 average assets), not the 10% target return required by stock- holders. 2.Reduce fixed costs by $14,000 or more. 3.Reduce variable costs by $14,000 or more. Copyright 2014 Pearson Education, Inc. publishing as Prentice Hall 25-26 27. What Options Does Smart Touch Learning Have? 4.Attempt to increase sales volume. If the company has excess manufacturing capacity, making and selling more units would only affect variable costs; however, it would mean that current fixed costs are spread over more units. 5.Change or add to its product mix (covered later in this chapter). Copyright 2014 Pearson Education, Inc. publishing as Prentice Hall 25-27 28. What Options Does Smart Touch Learning Have? 6.Attempt to differentiate its tablet computer from the competition to gain more control over sales prices (become a price-setter). 7. A combination of the above strategies that would increase revenues and/or decrease costs by $14,000. Copyright 2014 Pearson Education, Inc. publishing as Prentice Hall 25-28 29. Cost-Plus Pricing Full product cost Plus: Desired profit Cost-plus price Copyright 2014 Pearson Education, Inc. publishing as Prentice Hall 25-29 30. Target Full Product Cost Copyright 2014 Pearson Education, Inc. publishing as Prentice Hall 25-30 31. Decision Rule for Pricing Copyright 2014 Pearson Education, Inc. publishing as Prentice Hall 25-31 DECISION RULE: How to approach pricing? If the company is a price-taker for the product: If the company is a price-setter for the product: Emphasize a target pricing approach Emphasize a cost-plus pricing approach 32. Special Pricing Questions to Consider Does the company have the excess capacity available to fill the order? Will the reduced sales price be high enough to cover the differential costs of filling the order? Will the special order affect regular sales in the long run? Copyright 2014 Pearson Education, Inc. publishing as Prentice Hall 25-32 33. Special Pricing Example Smart Touch Learning normally sells its tablet computers for $500 each. Assume that a company has offered Smart Touch Learning $68,750 for 250 tablets, or $275 per tablet. The special pricing requested is substantially less that the regular sales price. Additional information about this sale includes: Production will use manufacturing capacity that would otherwise be idle (excess capacity). No change in fixed costs. No additional variable nonmanufacturing expenses (because no extra selling or administrative costs are incurred with this special order). No effect on regular sales. Copyright 2014 Pearson Education, Inc. publishing as Prentice Hall 25-33 34. Smart Touch Learnings Budgeted Income StatementTraditional and Contribution Margin Formats Copyright 2014 Pearson Education, Inc. publishing as Prentice Hall 25-34 35. Cost per TabletTraditional Format versus Contribution Format Income Statement Per traditional format income statement = $698,000 COGS / 2,400 tablets = $290.83 per tablet, rounded Per contribution format income statement Copyright 2014 Pearson Education, Inc. publishing as Prentice Hall 25-35 36. Cost per TabletTraditional Format versus Contribution Format Income Statement Per traditional format income statement = $698,000 COGS / 2,400 tablets = $290.83 per tablet (rounded) Per contribution format income statement = $588,000 variable costs / 2,400 tablets = $245 per tablet Copyright 2014 Pearson Education, Inc. publishing as Prentice Hall 25-36 37. Effect on Contribution Margin Effect on contribution margin per tablet = $275 $245 = $30 per tablet Effect on total contribution margin Copyright 2014 Pearson Education, Inc. pu