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Relevant Costing

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Relevant Costing

Poor Decision making may result when acceptable prices are determined by adding a fixed percentage to the "full cost" of a product when that "full cost" includes a unitized fixed cost. Any selling price above the contribution margin will add to the wealth of the firm. This being the case , is there a danger in the decision rule that "always accept any offer that has a positive contribution margin?" Please expand on your explanation by giving examples.

Also, what about the issue of capacity? Does it have any impact on the above decision making process if a company operates at full capacity or have idle capacity?

Why is it sometimes important to allocate overhead costs among products, services or some other grouping? Other times the allocations should be disregarded as in this case - why?

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Solution Summary

Your response is 516 words and includes examples of when contribution margin is not going to maximize firm value and when allocating helps or hurts the decision.

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Relevant Costing

Poor Decision making may result when acceptable prices are determined by adding a fixed percentage to the "full cost" of a product when that "full cost" includes a unitized fixed cost. Any selling price above the contribution margin will add to the wealth of the firm. This being the case , is there a danger in the decision rule that "always accept any offer that has a positive contribution margin?" Please expand on your explanation by giving examples.

Yes, there is a danger in blindly using the "always accept any offer that has a positive contribution margin."

One danger is that the offer will create a new pricing structure. While it may give you a positive contribution margin to sell below your normal prices, if customers can routinely get products below published prices just because you get a positive contribution margin from it, you will have trouble selling at full price. Then, your total profits will go down as regular customers "convert" to the "as long as it ...

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Carol Sargent, PhD
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  • BSc, University of Virginia
  • MSc, University of Virginia
  • PhD, Georgia State University
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