Chapter 5
Relevant Information
and Decision Making:
Marketing Decisions
5-1
Learning Objective 1
Discriminate between relevant
and irrelevant information
for making decisions.
5-2
The Concept of Relevance
What information is relevant?
It depends on the decision being made.
Decision making essentially involves
choosing among several courses of action.
5-3
The Concept of Relevance
What is the accountant’s role in decision making?
It is primarily that of a technical expert on
financial analysis.
The accountant helps managers focus on the
relevant information.
5-4
Relevant Information
Relevant information is the predicted
future costs and revenues that will
differ among the alternatives.
5-5
Learning Objective 2
Use the decision process to
make business decisions.
5-6
The Decision Process
(A)
(1)
(2)
(3)
(4)
Historical Information
(B)
Other Information
Prediction Method
Decision Model
Predictions as Inputs
to Decision Model
Decisions by Managers
with Aid of Decision Model
Implementation and Evaluation
Feedback
5-7
The Decision Process
Step 1
Gather relevant information using
historical accounting information and other
information from outside the accounting system.
5-8
The Decision Process
Step 2
Using the information gathered in Step 1,
formulate predictions of expected future
revenues or expected future costs.
Step 3
The predictions formulated in Step 2
to the decision model.
5-9
The Decision Process
Step 4
The decisions made by managers, with the aid of
the decision model, are implemented and evaluated.
Feedback is used to make future adjustments
to the decision process.
5 - 10
Decision Model Defined
A decision model is any method used for
making a choice, sometimes requiring
elaborate quantitative procedures.
5 - 11
Accuracy and Relevance
In the best of all possible worlds,
information used for decision
making would be perfectly
relevant and accurate.
5 - 12
Accuracy and Relevance
The degree to which information is
relevant or precise often depends
on the degree to which it is...
Qualitative
Quantitative
5 - 13
Learning Objective 3
Decide to accept or reject a
special order using the
contribution margin
technique.
5 - 14
Special Sales Order Example
Solo Company is offered a special order of
$13 per unit for 100,000 units.
 Should Solo accept the order?
 The first step is to gather relevant
information from Solo Company’s financial
statements.

5 - 15
Special Sales Order Example
Solo Company
Income Statement
Year Ended December 31, 2002 (dollars 000)
Sales (1,000,000 units)
Less: Variable expenses
Manufacturing
$12,000
Selling and administrative
1,100
Contribution margin
$20,000
13,100
$ 6,900
5 - 16
Special Sales Order Example
Solo Company
Income Statement
Year Ended December 31, 2002 (dollars 000)
Contribution margin
Less: Fixed expenses
Manufacturing
$3,000
Selling and administrative 2,900
Operating income
$6,900
5,900
$1,000
5 - 17
Special Sales Order Example
Only variable manufacturing costs are
affected by the particular order, at a rate
of $12 per unit ($12,000,000 ÷ 1,000,000
units).
 All other variable costs and all fixed costs
are unaffected and thus irrelevant.

5 - 18
Special Sales Order Example
Special order sales price/unit
Increase in manufacturing costs/unit
Additional operating profit/unit
$13
12
$ 1
Based on the preceding analysis, should
Solo accept the order?
5 - 19
Learning Objective 4
Decide to add or delete
a product line using
relevant information.
5 - 20
Avoidable and Unavoidable Costs
Avoidable costs are costs that will not continue
if an ongoing operation is changed or deleted.
Unavoidable costs are costs that continue even
if an operation is halted.
5 - 21
Department Store Example

1
2
3
Consider a discount department store that
has three major departments:
Groceries
General merchandise
Drugs
5 - 22
Department Store Example
Department
General
(000)
Groceries
Mdse. Drugs
Sales
$1,000
$800
$100
Variable expenses
800
560
60
Contribution margin $ 200
$240
$ 40
Total
$1,900
1,420
$ 480
5 - 23
Department Store Example
Department
General
(000)
Groceries Mdse. Drugs
Contribution margin $200
$240
$40
Fixed expenses:
Avoidable
$150
$100
$15
Unavoidable
60
100
20
Total
$210
$200
$35
Operating income
$ (10) $ 40
$ 5
Total
$480
$265
180
$445
$ 35
5 - 24
Department Store Example
For this example, assume first that the only
alternatives to be considered are dropping
or continuing the grocery department,
which shows a loss of $10,000.
 Assume further that the total assets invested
would be unaffected by the decision.
 The vacated space would be idle and the
unavoidable costs would continue.

5 - 25
Dropping Products,
Departments, Territories
Total Before Change
Sales
Variable expenses
Contribution margin
Avoidable fixed expenses
Contribution to common
space and unavoidable costs
Unavoidable fixed expenses
Operating income
$1,900,000
1,420,000
480,000
265,000
$ 215,000
180,000
$ 35,000
5 - 26
Dropping Products,
Departments, Territories
Effect of Dropping Groceries
Sales
$1,000,000
Variable expenses
800,000
Contribution margin
200,000
Avoidable fixed expenses
150,000
Contribution to common
space and unavoidable cost
$ 50,000
5 - 27
Dropping Products,
Departments, Territories
Total After Change
Sales
Variable expenses
Contribution margin
Avoidable fixed expenses
Contribution to common
space and unavoidable costs
Unavoidable fixed expenses
Operating income
$900,000
620,000
280,000
115,000
$165,000
180,000
$ (15,000)
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Learning Objective 5
Compute a measure of product
profitability when production
is constrained by a scarce
resource.
5 - 29
Optimal Use of Limited
Resources
A limiting factor or scarce resource restricts
or constrains the production or sale of a
product or service.
 The order to be accepted is the one that
makes the biggest total profit contribution
per unit of the limiting factor.

5 - 30
Product Profitability Example
Constrained by a Scarce Resource

Assume that a company has two products:
a plain cellular phone and a fancier cellular
phone with many special features.
5 - 31
Product Profitability Example
Constrained by a Scarce Resource
Plant workers can make 3 plain phones
in one hour or 1 fancy phone.
Product
Plain
Fancy
Per Unit
Phone
Phone
Selling price
$80
$120
Variable costs
64
84
Contribution margin
$16
$ 36
Contribution margin ratio 20%
30%
5 - 32
Product Profitability Example
Constrained by a Scarce Resource
Which product is more profitable?
If sales are restricted by demand for only
a limited number of phones, fancy
phones are more profitable.
Why?
5 - 33
Product Profitability Example
Constrained by a Scarce Resource
The sale of a plain phone adds
$16 to profit.
The sale of a fancy phone adds
$36 to profit.
5 - 34
Product Profitability Example
Constrained by a Scarce Resource
Now suppose annual demand for phones of
both types is more than the company can
produce in the next year.
 Productive capacity is the limiting factor
because only 10,000 hours of capacity are
available.

5 - 35
Product Profitability Example
Constrained by a Scarce Resource
Which product should the company emphasize?
Plain phone:
$16 contribution margin per unit × 3 units per hour
= 48 per hour
Fancy phone:
$36 contribution margin per unit × 1 unit per hour
= $36 per hour
5 - 36
Learning Objective 6
Discuss the factors that influence
pricing decisions in practice.
5 - 37
Pricing Decisions

–
–
–
–
Among the many pricing decisions to be
made are:
setting the price of a new or refined product
setting the price of products sold under
private labels
responding to a new price of a competitor
pricing bids in both sealed and open bidding
situations
5 - 38
The Concept of Pricing
In perfect competition, a firm can sell as
much of a product as it can produce,
all at a single market price.
In imperfect competition, the price a firm
charges for a unit will influence the
quantity of units it sells.
5 - 39
The Concept of Pricing
Marginal cost is the additional cost resulting
from producing one additional unit.
Marginal revenue is the additional revenue
resulting from the sale of one additional unit.
Price elasticity is the effect of price changes
on sales volume.
5 - 40
Influences on Pricing

–
–
–
Several factors interact to shape the market
in which managers make pricing decisions:
legal requirements
competitors’ actions
customer demands
5 - 41
Learning Objective 7
Compute a target sales price
by various approaches and
compare the advantages
and disadvantages of
these approaches.
5 - 42
Role of Costs in Pricing
Decisions

1
2
Two pricing approaches used by companies
are:
Cost-plus pricing
Target costing
5 - 43
Target Sales Price

1
2
3
4
There are four popular markup formulas
for pricing:
As a percentage of variable manufacturing
costs
As a percentage of total variable costs
As a percentage of full costs
As a percentage of total manufacturing cost
5 - 44
Relationships of Costs to
Same Target Selling Prices
Target sales price
Variable costs:
Manufacturing
Selling and administrative
Unit variable cost
Fixed costs:
Manufacturing
Selling and administrative
Unit fixed costs
Target operating income
$20.00
$12.00
1.10
13.10
$ 3.00
2.90
5.90
$ 1.00
5 - 45
Relationships of Costs to
Same Target Selling Prices
Markup percentages
% of variable
manufacturing
costs:
($20.00 – $12.00) ÷ $12.00
= 66.67%
% of total
variable
costs:
($20.00 – $13.10) ÷ $13.10
= 52.67%
5 - 46
Costing Techniques
Target costing sets a cost before the
product is created or even designed.
Value engineering is a cost-reduction
technique, used primarily during design.
Kaizen costing is the Japanese word for
continuous improvement.
5 - 47
Learning Objective 8
Use target costing to decide
whether to add a new product.
5 - 48
Target Costing and
Cost-Plus Pricing Compared
Suppose that ITT Automotive receives an
invitation to bid from Ford on the anti-lock
braking systems.
 The current manufacturing cost is $154.
 ITT Automotive’s desired gross margin rate
is 30% on sales.
 The market conditions have established a
sales price of $200 per unit.

5 - 49
Target Costing and
Cost-Plus Pricing Compared
What is the bid price using cost-plus pricing?
Bid price = Cost ÷ Cost % = $154 ÷ 0.7
Bid price = $220
5 - 50
Target Costing and
Cost-Plus Pricing Compared
What is the bid price using target costing?
Target cost = Market price × Cost %
= $200 × 0.7
Target cost = $140
Bid price = Market price = $200
5 - 51
Learning Objective 9
Understand how relevant
information is used when
making marketing decisions.
5 - 52
Marketing Decisions
Market Price = $200
Accountants and managers must have a thorough
understanding of relevant information, especially
costs, when making marketing decisions.
5 - 53
End of Chapter 5
5 - 54