Accounting Information, Relevant Costs, and Decision Making

1
Chapter 7

• Accounting Information, Relevant Costs, and
  Decision Making

2
Topics
An Introduction to Pricing Pricing of Products
and Services Target Pricing Cost Plus
Pricing Time and Material Pricing Value
Pricing Legal and Ethical Issues in Pricing
3
Introduction
How does a manager decide The selling price of a
product? Whether to accept a special
order? Whether to add a new product or drop an
old one? Which products to put on the
shelves? Whether to hire an employee or
outsource? Whether to make or buy a product?
4
Introduction
All decisions require relevant, timely accounting
information. The following discussion includes
some of the tools managers can use to make these
decisions.
5
Pricing of Products and Services
Objective Discuss the factors and issues
affecting the pricing of goods and services.
6
Pricing of Products and Services
Determining the selling price of a product is one
of the most important decisions management will
be required to make.


7
Hotel Chains and Airlines
Use sophisticated yield management computer
software which adjusts rates based on factors
such as expected occupancy. http//www.omnihotels
.com
8
Agriculture
The market determines the selling price.
9
VCRs, CD Players
The demand for products at different stages in
their life cycle affects pricing.
10
The Selling Price of a Product or a Service
Must be sufficient to cover the cost of the
product and provide a profit.
11
Target Pricing
Used to determine the maximum cost that can be
incurred in order to earn a desired target profit.
12
Computers
Target Cost Target Price - Target Profit
13
Cross Functional Application
Target pricing requires the cooperation of
marketing, engineering, production, accounting
and finance managers in multi-disciplinary teams.
14
Cost Plus Pricing
Target Selling Price Cost (Markup x Cost)
15
Cost Plus Pricing
Markup Percentage Must cover costs not included
in the product cost Must produce an acceptable
profit
16
Time and Material Pricing
In service industries such as CPA firms, prices
are often set based on time and material used.
17
Value Pricing
Value Pricing is based on the perceived or actual
value of the service provided to a customer. Ex.
Consulting Business
18
Legal and Ethical Issues in Pricing
Predatory Pricing Price Discrimination Price
Gouging Ethical Issues in Pricing Pharmaceutical
Products
19
Legal and Ethical Issues in Pricing
Pause and reflect Do you think value pricing is
ethical? http//www.merck.com
20
More Topics for Discussion
Special Orders Outsourcing Make or Buy Add or
Drop a Product, Product Line or Service Resource
Utilization Theory of Constraints Sell or Process
Further ABC and Relevant Cost Analysis
21
Special Orders
Objectives Analyze and determine the pricing of a
special order.
22
Special Order Decisions
Short-run decisions Excess production
capacity Relevant costs associated with each
specific special order
23
Sunset Airlines
Special Order Do we provide 150 seats to San
Diego for corporate executives attending a
convention for 150 instead of the normal fare of
275?
24
Sunset Airlines
Step 1 Define the Problem Should Sunset Airlines
sell 150 tickets at a reduced price of 150 per
ticket?
25
Sunset Airlines
Step 2 Identify Objectives To maximize income in
the short run without reducing income in the long
run.
26
Sunset Airlines
Step 3 Identify and analyze available options
Accept the order (sell) the tickets at 150 Let
the market place determine the level of sales at
the 275 price Sell the tickets at another price
27
Sunset Airlines
Step 3 Identify and analyze available options
The cost per passenger is 175.14
28
Sunset Airlines
Step 4 Select the Best Option
The special order price of 150 per ticket is
25.14 less that the total costs per passenger,
so decline the special order. Or should we?
29
Sunset Airlines
Step 3 Identify and analyze available options
Determine the relevant costs, which are only
3.25 for meals and drinks if the flight has
excess capacity (empty seats).
30
Sunset Airlines
Step 4 Select the Best Option
Accept the special order as the order price 150
is higher than the additional variable costs
(3.25).
31
Sunset Airlines
Step 3 Identify and analyze available options
What if Sunset did not have any excess capacity?
Then the special order would involve opportunity
cost.
32
Sunset Airlines
Step 4 Select the Best Option
Do not accept a special order for less than 275
per ticket.
33
Sunset Airlines
Key Concept In general, the price of a special
order must be higher than the additional variable
costs incurred in accepting the special order
plus any opportunity costs incurred.
34
Outsourcing / Make or Buy Decisions
Objectives Analyze a decision involving the
outsourcing of labor or making or buying a
component.
35
Outsourcing
Contracting with another company to provide
janitorial and repair services instead of using
employees of the company.
36
Factors Affecting Outsourcing Decisions
Impact of taxes Payment of fringe benefits to
salaried employees Impact on the attitude of the
remaining work force
37
Vertical Integration
Vertical Integration is accomplished when a
company is involved in multiple steps of the
value chain. Advantages Disadvantages www.gm.com
38
Make or Buy Decision
Birdie Maker Golf Company Currently they make all
golf clubs in the set but are considering
acquiring the putter from Flutter Putter, Inc., a
manufacturer of custom putters.
39
Birdie Maker Golf Company
Step 1 Define the Problem Continue making the
putter or purchase it from Flutter Putter, Inc.
40
Birdie Maker Golf Company
Step 2 Identify Objectives Maximize income by
producing or buying the putter at the lowest
cost Quality of the putter Impact of the putter
on the sales of other clubs
41
Birdie Maker Golf Company
Step 3 Identify and analyze available options
Case I Cost to make 26.50 Cost to buy 34.50
42
Birdie Maker Golf Company
Step 4 Select the Best Option
Case I Continue making putters IF they believe
they can manufacture a putter of acceptable
quality and keep up with technological changes.
43
Birdie Maker Golf Company
Step 3 Identify and analyze available options
Case II Due to a change in fixed costs (leased
equipment being returned) Cost to make
26.50 Cost to buy 29.00
44
Birdie Maker Golf Company
Step 4 Select the Best Option
Case II Make internally considering Quality of
the putter Changing technology Dependability of
the supplier
45
Birdie Maker Golf Company
Step 3 Identify and analyze available options
Case III If volume drops to 500 sets of clubs,
fixed costs per putter increase Cost to make
36 Cost to buy 33
46
Birdie Maker Golf Company
Step 4 Select the Best Option
Case III Purchase the putter
47
Birdie Maker Golf Company
Step 3 Identify and analyze available options
Case IV Opportunity Costs Rent out the factory
space now being used to make the putters, adding
10 opportunity costs per putter Cost to make
36.50 Cost to buy 34.50
48
Birdie Maker Golf Company
Step 4 Select the Best Option
Case IV Buy the putter.
49
Make or Buy
Key Concept In general, a product should continue
to be made internally and labor incurred
internally if the avoidable costs are less than
the additional costs that will be incurred by
buying or outsourcing.
50
Add or Drop a Product, Product Line or Service
Objectives Analyze a transaction dealing with
adding or dropping a product, product line or
service.
51
Add or Drop a Product, Product Line or Service
One of the most difficult decisions a manager can
make Must analyze relevant costs Must also
consider qualitative factors Must consider
contribution margin www.pg.com
52
Add or Drop a Product, Product Line or Service
Key Concept In general, a product should be
dropped when the fixed costs avoided are greater
than the contribution margin lost.
53
Resource Utilization Decisions
Objectives Analyze a decision dealing with secure
or limited resources.
54
Resource Utilization Decisions
Constraint The capacity to manufacture a product
or provide a service is limited in some manner.
55
Resource Utilization Decisions
Key Concept Resource utilization decisions
require an analysis of relevant costs and
relevant qualitative factors and hinge on an
analysis of the contribution margin earned per
unit of the limited resource.
56
Resource Utilization Decisions
Examples Skilled craftspeople, special machinery
and limited space often times are short-run
constraints
57
Theory of Constraints
Identifies bottlenecks in the production
process. Bottlenecks limit throughput, the
number of finished goods that result from the
production process.
58
Theory of Constraints
Steps for Resolution Identify the
bottleneck Manage the bottleneck Relieve the
bottleneck
59
Sell or Process Further Decisions
Furniture Manufacturer Example Sell furniture
Unassembled and Unfinished Assembled and
Unfinished Assembled and Finished
60
Sell or Process Further Decisions
Key Concept Assuming sufficient demand, a product
should be processed further if the additional
revenue is greater than the additional cost.
61
ABC and Relevant Cost Analysis
Uses multiple cost drivers to trace costs
directly to products Focuses on changes in costs
associated with a variety of different
activities Helps managers identify what costs are
really avoidable in a relevant cost analysis
62
End of Chapter 7
Uses multiple cost drivers to trace costs
directly to products Focuses on changes in costs
associated with a variety of different
activities Helps managers identify what costs are
really avoidable in a relevant cost analysis