chapter 7 accounting information, relevant costs, and decision making

Chapter 7

Accounting Information, Relevant Costs, and

Decision Making

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

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?

Introduction

All decisions require relevant, timely accounting information.

The following discussion includes some of the tools managers can use to make these decisions.

Pricing of Products and Services

Objective:

Discuss the factors and issues affecting the pricing of goods and services.

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.

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Hotel Chains and Airlines

Use sophisticated yield management computer software which adjusts rates based on factors such as expected occupancy.

http://www.omnihotels.com

Agriculture

The market determines the selling price.

VCRs, CD Players

The demand for products at different stages in their life cycle affects pricing.

The Selling Price of a Product or a Service

Must be sufficient to cover the “cost” of the product and provide a profit.

Target Pricing

Used to determine the maximum cost that can be incurred in order to earn a desired target profit.

Computers

Target Cost =

Target Price - Target Profit

Cross Functional Application

Target pricing requires the cooperation of marketing, engineering, production, accounting and finance managers in multi-disciplinary teams.

Cost Plus Pricing

Target Selling Price =

Cost + (Markup % x Cost)

Cost Plus Pricing

Markup Percentage

Must cover costs not included in the product cost

Must produce an acceptable profit

Time and Material Pricing

In service industries such as CPA firms, prices are often set based on time and material used.

Value Pricing

Value Pricing is based on the perceived or actual value of the service provided to a customer.

Ex. Consulting Business

Legal and Ethical Issues in Pricing

Predatory Pricing

Price Discrimination

Price Gouging

Ethical Issues in Pricing Pharmaceutical Products

Legal and Ethical Issues in Pricing

Pause and reflect

Do you think value pricing is ethical?

http://www.merck.com

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

Special Orders

Objectives

Analyze and determine the pricing of a special order.

Special Order Decisions

Short-run decisions

Excess production capacity

Relevant costs associated with each specific special order

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?

Sunset Airlines

Step 1: Define the Problem

Should Sunset Airlines sell 150 tickets at a reduced price of $150 per ticket?

Sunset Airlines

Step 2: Identify Objectives

To maximize income in the short run without reducing income in the long run.

Sunset Airlines

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

Step 3: Identify and analyze available options

Sunset Airlines

The cost per passenger is $175.14

Step 3: Identify and analyze available options

Sunset Airlines

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?

Step 4: Select the Best Option

Sunset Airlines

Determine the relevant costs, which are only $3.25 for meals and drinks if the flight has excess capacity (empty seats).

Step 3: Identify and analyze available options

Sunset Airlines

Accept the special order as the order price $150 is higher than the additional variable costs ($3.25).

Step 4: Select the Best Option

Sunset Airlines

What if Sunset did not have any excess capacity? Then the special order would involve opportunity cost.

Step 3: Identify and analyze available options

Sunset Airlines

Do not accept a special order for less than $275 per ticket.

Step 4: Select the Best Option

Special Orders

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.

Outsourcing / Make or Buy Decisions

Objectives

Analyze a decision involving the outsourcing of labor or making or buying a component.

Outsourcing

Contracting with another company to provide janitorial and repair services instead of using employees of the company.

Factors Affecting Outsourcing Decisions

Impact of taxes

Payment of fringe benefits to salaried employees

Impact on the attitude of the remaining work force

Vertical Integration

Vertical Integration is accomplished when a company is involved in multiple steps of the value chain.

Advantages

Disadvantages

www.gm.com

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.

Birdie Maker Golf Company

Step 1: Define the Problem

Continue making the putter or purchase it from Flutter Putter, Inc.

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

Birdie Maker Golf Company

Case I

Cost to make: $26.50

Cost to buy: $34.50

Step 3: Identify and analyze available options

Birdie Maker Golf Company

Case I

Continue making putters IF they believe they can manufacture a putter of acceptable quality and keep up with technological changes.

Step 4: Select the Best Option

Birdie Maker Golf Company

Case II

Due to a change in fixed costs (leased equipment being returned)

Cost to make: $26.50

Cost to buy: $29.00

Step 3: Identify and analyze available options

Birdie Maker Golf Company

Case II

Make internally considering:

Quality of the putter

Changing technology

Dependability of the supplier

Step 4: Select the Best Option

Birdie Maker Golf Company

Case III

If volume drops to 500 sets of clubs, fixed costs per putter increase

Cost to make: $36

Cost to buy: $33

Step 3: Identify and analyze available options

Birdie Maker Golf Company

Case III

Purchase the putter

Step 4: Select the Best Option

Birdie Maker Golf Company

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

Step 3: Identify and analyze available options

Birdie Maker Golf Company

Case IV

Buy the putter.

Step 4: Select the Best Option

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.

Add or Drop a Product, Product Line or Service

Objectives

Analyze a transaction dealing with adding or dropping a product, product line or service.

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

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.

Resource Utilization Decisions

Objectives

Analyze a decision dealing with scarce or limited resources.

Resource Utilization Decisions

Constraint: The capacity to manufacture a product or provide a service is limited in some manner.

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.

Resource Utilization Decisions

Examples

Skilled craftspeople, special machinery and limited space often times are short-run constraints

Theory of Constraints

Identifies bottlenecks in the production process.

Bottlenecks: limit throughput, the number of finished goods that result from the production process.

Theory of Constraints

Steps for Resolution

Identify the bottleneck

Manage the bottleneck

Relieve the bottleneck

Sell or Process Further Decisions

Furniture Manufacturer Example

Sell furniture:

Unassembled and Unfinished

Assembled and Unfinished

Assembled and Finished

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.

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

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