hilton maher selto. 13 cost management and decision making mcgraw-hill/irwin © 2003 the mcgraw-hill...
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Hilton • Maher • Selto
13Cost Management and Decision Making
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
13-3
Decision-Making Process
Stage 1Setting Goals &
Objectives
Stage 1Setting Goals &
Objectives
Stage 2Gathering
Information
Stage 2Gathering
Information
Stage 3Evaluating
Alternatives
Stage 3Evaluating
AlternativesStage 4
Planning & Implementation
Stage 4Planning &
Implementation
Stage 5Obtaining Feedback
Stage 5Obtaining Feedback
1122
3344
55
Exh.13-1
13-4
Stage 1: Setting Goals & Objectives
Organizations must set goals to provide clear guidance to
Organizations must set goals to provide clear guidance to
Tangible ObjectivesTangible ObjectivesIntangible ObjectivesIntangible Objectives
Tend to be measureable. They
serve as benchmarks against which to
gauge performance.
Tend to be measureable. They
serve as benchmarks against which to
gauge performance.
Tend to be abstract in nature.
Tend to be abstract in nature.
13-5
Using Target Costing & Setting Tangible Objectives
Determine target selling price per unit Determine target cost, per unit and in
total. Determine Target Profit Deduct target gross margin % Back into target cost
Compare target cost to currently feasible total cost.
The difference it the Cost-Reduction Target
Redesign products and processes to achieve the cost-reduction target.
Determine target selling price per unit Determine target cost, per unit and in
total. Determine Target Profit Deduct target gross margin % Back into target cost
Compare target cost to currently feasible total cost.
The difference it the Cost-Reduction Target
Redesign products and processes to achieve the cost-reduction target.
13-6
Using Target Costing & Setting Tangible Objectives
ExamplePlug-It, Inc. believes it can charge a maximum price of $5 for its 10’ drop cords. They must achieve a gross margin of 40%. Currently, the 10’ drop cords cost $3.25 each to
produce.
ExamplePlug-It, Inc. believes it can charge a maximum price of $5 for its 10’ drop cords. They must achieve a gross margin of 40%. Currently, the 10’ drop cords cost $3.25 each to
produce.
Determine the target cost and the cost-reduction target for Plug-It, Inc.
Determine the target cost and the cost-reduction target for Plug-It, Inc.
Target Cost = Target Price - Target Gross Margin= $5.00 - ($5.00 × 40%)= $5.00 - $2.00 = $3.00
Cost-Reduction Target = Current Feasible Cost - Target Cost
= $3.25 - $3.00 = $.25 or 7.7% (approximately)
Target Cost = Target Price - Target Gross Margin= $5.00 - ($5.00 × 40%)= $5.00 - $2.00 = $3.00
Cost-Reduction Target = Current Feasible Cost - Target Cost
= $3.25 - $3.00 = $.25 or 7.7% (approximately)
13-7
Stage 2: Gathering Information
RelevanceRelevance
Timeliness
Timeliness
Objectivity vs.
Subjectivity
Objectivity vs.
Subjectivity
AccuracyAccuracy
13-8
Identification of Relevant Costs and Benefits
Deciding between alternatives requires
analyzing only “relevant” costs.
Deciding between alternatives requires
analyzing only “relevant” costs.
Only those costs that DIFFER between
alternatives are considered “relevant” to the decision-
making process.
Only those costs that DIFFER between
alternatives are considered “relevant” to the decision-
making process.
Costs incurred in the past are called “sunk costs”. They are not
relevant costs.
Costs incurred in the past are called “sunk costs”. They are not
relevant costs.
13-9
Identification of Relevant Costs and Benefits
Green Ur Enterprises is considering whether to keep its E-Farm internet unit. This year, E-Farm’s projections are:
Sales = $1,200,000
Commissions = $200,000
Salaries = $190,000
Marketing = $480,000
Utilities = $375,000
Allocated Overhead = $685,000
Green Ur Enterprises is considering whether to keep its E-Farm internet unit. This year, E-Farm’s projections are:
Sales = $1,200,000
Commissions = $200,000
Salaries = $190,000
Marketing = $480,000
Utilities = $375,000
Allocated Overhead = $685,000
We have to decide whether to close
the E-Farm Unit. Which of the
following items are “relevant”?
We have to decide whether to close
the E-Farm Unit. Which of the
following items are “relevant”?
Note: The salaries are for employees who will be
transferred to other areas if E-Farm is dropped.
Note: The salaries are for employees who will be
transferred to other areas if E-Farm is dropped.
13-10
Green Ur Enterprises is considering whether to keep its E-Farm internet unit. This year, E-Farm’s projections are:
Sales = $1,200,000
Commissions = $200,000
Salaries = $190,000
Marketing = $480,000
Utilities = $375,000
Allocated Overhead = $685,000
Green Ur Enterprises is considering whether to keep its E-Farm internet unit. This year, E-Farm’s projections are:
Sales = $1,200,000
Commissions = $200,000
Salaries = $190,000
Marketing = $480,000
Utilities = $375,000
Allocated Overhead = $685,000
Identification of Relevant Costs and Benefits
Relevant Costs
Relevant Costs
These all These all disappear if disappear if we close the we close the
E-Farm unit.E-Farm unit.
13-11
Stage 3: Evaluating Alternatives
3. Measure the benefits and costs of each set of outcomes.
3. Measure the benefits and costs of each set of outcomes.
1. Display the decision
alternatives in the order the
decisions will be made.
1. Display the decision
alternatives in the order the
decisions will be made.
2. Trace the path of each
decision to its ultimate
outcome.
2. Trace the path of each
decision to its ultimate
outcome.
13-12
Outsourcing/Make-or-Buy Decision
When the company needs goods or services, should they be “made” internally or “bought”
externally?
When the company needs goods or services, should they be “made” internally or “bought”
externally?
When goods or services are
acquired externally, it is called
“outsourcing”.
When goods or services are
acquired externally, it is called
“outsourcing”.
13-13
Outsourcing/Make-or-Buy Decision
Is it c
heaper to
make or b
uy?
How dependable
is the supplier?
What are the relevant costs?
13-14
Outsourcing/Make-or-Buy Decision
Identify the fixed costs that we could avoid if we outsource.
Identify the fixed costs that we could avoid if we outsource.
Identify the variable costs
that would disappear if we
outsource.
Identify the variable costs
that would disappear if we
outsource.
Identify the new variable costs that we would
incur if we outsource.
Identify the new variable costs that we would
incur if we outsource.
13-15
Outsourcing - Example
Enviro, Inc. is trying to decide whether to house its e-commerce web site on the premises or outsource the
web site management to a third party.
Enviro, Inc. is trying to decide whether to house its e-commerce web site on the premises or outsource the
web site management to a third party.
Annual cost of outsourcing =
$350,000.
Annual cost of outsourcing =
$350,000.
Should we outsource?Should we outsource?Should we outsource?Should we outsource?
13-16
Outsourcing - Example
Since the cost of outsourcing is
$350,000. This is $6,000 less than annual in-house
hosting of the website.
But we must also consider the loss of control, if we
outsource.
Since the cost of outsourcing is
$350,000. This is $6,000 less than annual in-house
hosting of the website.
But we must also consider the loss of control, if we
outsource.
13-17
Decision to Add/Drop a Product, Service or Business Unit
If we shut down the U.S.
operation, we might anger our
American customers.
If we shut down the U.S.
operation, we might anger our
American customers.
. . . Not to mention the bad press!
. . . Not to mention the bad press!
That is why we have to consider
the relevant benefits and the relevant costs
BEFORE making a final decision.
That is why we have to consider
the relevant benefits and the relevant costs
BEFORE making a final decision.
13-18
Green Ur Enterprises is considering whether to keep its E-Farm internet unit. This year, E-Farm’s projections are:
Sales = $1,200,000
Commissions = $200,000
Salaries = $190,000
Marketing = $480,000
Utilities = $375,000
Allocated Overhead = $685,000
Green Ur Enterprises is considering whether to keep its E-Farm internet unit. This year, E-Farm’s projections are:
Sales = $1,200,000
Commissions = $200,000
Salaries = $190,000
Marketing = $480,000
Utilities = $375,000
Allocated Overhead = $685,000
Decision to Drop a Business Unit - Example
Should we close E-Farm?Should we close E-Farm?Should we close E-Farm?Should we close E-Farm?
Determine the impact on Green Ur’s
Net Income if we close the E-Farm unit.
Determine the impact on Green Ur’s
Net Income if we close the E-Farm unit.
13-19
Decision to Drop a Business Unit - Example
Considering ONLY the relevant costs, E-Farm adds $145,000 to corporate profit. Even if we close the E-Farm
unit, we still will incur the overhead and salaries.
Considering ONLY the relevant costs, E-Farm adds $145,000 to corporate profit. Even if we close the E-Farm
unit, we still will incur the overhead and salaries.
We can eliminate the unit level
costs. However, the employees
can be assigned elsewhere and
the facility-level overhead costs are still there.
We can eliminate the unit level
costs. However, the employees
can be assigned elsewhere and
the facility-level overhead costs are still there.
13-20
Adding or Dropping a Business Unit
The term “business unit” can refer to a product, market territory, department, division,
subsidiary, or any other business segment.
The term “business unit” can refer to a product, market territory, department, division,
subsidiary, or any other business segment.
As with the “make or buy” decision, all relevant costs
must be considered.
As with the “make or buy” decision, all relevant costs
must be considered.
13-21
Pricing Decisions
What influences prices?
13-22
Pricing Practices and the Law
13-23
End of Chapter 13