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CHAPTER SEVEN
Relevant Costs and Product Planning Decisions
This chapter examines a variety of short-term decisions that managers
make. In particular, it examines relevant costs and product planning
Key Concepts
• The price of a special order must be higher than the additional
variable costs plus any opportunity costs incurred in accepting the
special order.
• When faced with a limited resource, a company will maximize profit by
making the product with the highest contribution margin per unit of the
limited resource.
Learning Objectives
LO1— Analyze the pricing of a special order.
LO2— Analyze a decision involving outsourcing labor or making or buying a
component.
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Lecture Outline
A. Introduction
1. The short-term tactical decisions that managers make require
relevant and timely accounting information.
2. Relevant costs are costs that differ among alternatives—that is,
B. Special Orders (LO1)
Special- order decisions are short-run pricing decisions in which
management must decide which sales price is appropriate when customers
place orders that are different from those placed in the regular course of
business.
1. Special-order decisions are affected by whether the company has
excess production capacity and can produce additional units with
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2. The price of a special order must be higher than the additional
variable costs plus any opportunity costs incurred in accepting the
special order.
C. Outsourcing and Other Make-or-Buy Decisions (LO2)
Outsourcing and make-or-buy decisions are short-term decisions to
outsource labor or to purchase components used in manufacturing from
another company rather than to provide services or produce components
internally.
1. Strategic Aspects of Outsourcing and Make-or-Buy Decisions
An analysis of outsourcing and make-or-buy decisions requires an
in-depth analysis of relevant quantitative and qualitative factors and
Key Concept
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2. The Make-or-Buy Decision
o To decide whether to make or buy, the total avoidable
costs need to be compared with the cost of purchase. If the
total avoidable costs are more than the cost of purchase,
D. The Decision to Drop a Product or a Service (LO3)
1. A product or service should be dropped if the avoidable fixed costs
are more than the contribution margin of the product or service. On
Key Concept
A product should continue to be made internally if the avoidable costs are
Making it Real
Onshoring and Outsourcing
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2. Before making a decision qualitative factors (for example what
impact will discontinuing the sale of the product have on sales of
the remaining product lines?) need to be considered.
E. Resource Utilization Decisions (LO4)
1. A resource utilization decision is a short-term decision which
requires an analysis of how best to use a resource that is available
in limited supply (constraint).
2. To maximize profit, managers must focus on the contribution
margin provided by each product per unit of limited resource rather
than on the profitability of each product.
F. The Theory of Constraints (LO5)
The theory of constraints is a management tool for dealing with constraints.
It identifies bottlenecks in the production process. Bottlenecks are
Key Concept
Key Concept
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identified, management must focus its time and resources on relieving the
bottleneck.
G. Decisions to Sell or Process Further (LO6)
1. The key in deciding whether to sell or process further is that all
costs which are incurred up to the point where the decision is made
are sunk costs and therefore not relevant.
2. The relevant costs in a sell or process further decision are the
advisable.
End-of-Chapter Material
Brief exercises, exercises, problems, and cases based on different learning
objectives have been provided at the end of the chapter. These-end-of chapter
Key Concept
A product should be processed further if the additional (incremental) revenue
Key Concept