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Special order pricing and production planning
Published on September 26, 2018 35 min
Other Talks in the Series: Management Accounting
Hello everyone. I would like to welcome you to this HSTalks lecture series on managerial accounting. My name is Alexander Himme and I'm an assistant professor for managerial accounting at the Kuhne Logistics University in Hamburg, Germany. In this module, we would talk about the concept of relevant information. Relevant information is the only information that should be considered in decision-making. Decision-making is typically a situation that managers have to choose between alternatives. We will apply the idea of relevant information in this module to two very common decisions that managers have to make. The first decision is the decision to accept or not a special price offer from a customer. The second decision is how to determine the optimal product mix into production when resources are limited.
Let us first introduce the idea of relevant information. This topic is very important because one of the most prominent functions of management accounting is the provision of relevant information for decision-making. What is decision-making? Decision-making always involves choosing between alternatives. For example, if a customer asks for a special price for the order, the merger has to choose if he or she accepts a special order or not. Or a manager may have to decide if, for certain reasons, the manufacturing of a certain product should be stopped or not. The further typical decision where a manager has to decide between alternatives is the make or buy decision. That is for certain component needed for production the question is if this component should be produced internally or should be sourced from an outside supplier? What all of these decisions have in common is that they're not routine and that every time, special studies are needed which collect and assess the information needed for making a decision. In other words, there is not a permanent accounting system that would tell us automatically which information is relevant or not. Instead, it is always up to the manager to decide which of the existing information he or she must take into account to make a reasonable decision. Making decisions requires that only those costs and revenues that are relevant to the alternatives are considered. If irrelevant costs and revenue data are included, the wrong decision may be made. It is therefore essential to identify the relevant costs and revenues that are applicable to the alternatives being considered. Special studies focus on whatever pending time arrives the decision-maker considers appropriate for a given situation. However, it is important not to focus excessively on the short-term because the objective is to maximize long-term benefits. So, the relevance of a cost or revenue often depends on the time horizon under consideration. It is therefore important to make sure that the information presented for decision-making relates to the appropriate time horizon. If inappropriate time horizons are selected, there is a danger that misleading information will be presented. Of course, our aim should always be to maximize long-term net cash and flows.