Relevant Information and Decision Making: Marketing Decisions

1
Introduction to Management Accounting
2
Introduction to Management Accounting
Chapter 5

• Relevant Information for
• Decision Making with a Focus
• on Pricing Decisions

3
The Concept of Relevance
Learning Objective 1
Relevant information depends on the decision
being made.
Decision making is choosing among several
courses of action.
Relevant information is the predicted future
costs and revenues that differ among the
alternatives.
4
The Concept of Relevance
Accountants should use two criteria to determine
whether information is relevant
1. Information must be an expected revenue or
cost and...
2. it must have an element of difference among
the alternatives.
5
Decision Process and Role of Information
Learning Objective 2
6
Decision Model
A decision model is any method used for making
a choice, sometimes requiring elaborate
quantitative procedures.
A decision model may also be simple.
7
Accuracy and Relevance
In the best of all possible worlds, information
used for decision making would be
perfectly relevant and accurate.
8
Accuracy and Relevance
The degree to which information is relevant or
precise often depends on the degree to which it
is
Quantitative
Qualitative
9
Relevance of Alternate Income Statements
Learning Objective 3
Cordell Company makes and sells 1,000,000 seat
covers.
Total manufacturing cost is 30,000,000, or 30
per unit.
Direct Material Costs are 14,000,000 Direct-labor
costs are 6,000,000
10
Absorption Approach
Schedule 1 Variable Costs (in thousands of
dollars) Supplies (lubricants, expendable tools,
coolants, sandpaper 600 Materials-handling
labor (forklift operators) 2,800 Repairs on
manufacturing equipment 400 Power for
factory 200 4,000 Schedule 2 Fixed
Costs Managers salaries in factory
400 Factory employee training 180 Factory
picnic and holiday party 20 Factory
supervisory salaries 1,400 Depreciation,
plant and equipment 3,600 Property taxes on
plant 300 Insurance on plant 100
6,000 Total indirect manufacturing
costs 10,000
11
Absorption Approach
Schedule 3 Selling Expenses (in thousands of
dollars) Variable Sales Commission 1,400 Ship
ping Expenses for products sold
600 2,000 Fixed Advertising
1,400 Sales salaries
2,000 Other 600 4,000 Total
Selling Expenses
6,000 Schedule 4 Administrative
Expenses Variable Some clerical wages
160 Computer time rented 40
200 Fixed Office supplies 200 Other
salaries 400 Depreciation on office
facilities 200 Public accounting
fees 80 Legal
fees 200 Other
720 1,800 Total indirect manufacturing
costs 2,000
12
Contribution Approach
Sales (in thousands of dollars) 40,000 Less
Manufacturing costs of good sold Direct
Materials 14,000 Direct Labor
6,000 Indirect Manufacturing (Schedule 1 plus
2) 10,000 30,000 Gross Margin or Gross
Profit 10,000 Selling expenses (Schedule 3)
6,000 Administrative expenses (Schedule
4) 2,000 Total selling and
administrative expenses 8,000
Operating income 2,000
Internal (management accounting) reporting that
emphasizes the distinction between variable
and fixed costs for the purpose of
better decision making.
13
Contribution Approach
14
Special Sales Orders
Learning Objective 4
Cordell Company makes and sells 1,000,000 seat
covers.
Total manufacturing cost is 30,000,000, or 30
per unit.
Cordell is offered a special order of 26 per
unit for 100,000 units.
15
Special Sales Order
Accepting the special order
1. would not affect Cordells regular business.
2. would not raise any antitrust issues.
3. would not affect total fixed costs.
4. would not require additional variable selling
and administrative expenses.
5. would use some otherwise idle manufacturing
capacity.
16
Special Sales Order
Only variable manufacturing costs are affected by
this particular order, at a rate of 24 per unit
(24,000,000 1,000,000 units).
All other variable costs and all fixed costs are
unaffected and thus irrelevant.
17
Special Sales Order
Special order sales price/unit 26 Increase in
manufacturing costs/unit 24 Additional
operating profit/unit 2
Based on the preceding analysis, should Cordell
accept the order?
Yes
2 100,000 200,000 additional profit
18
Special Sales Order
19
Activity-Based Costing, Special Orders, and
Relevant Costs
Cordell examined its 24 million of variable
manufacturing costs and discovered two
significant activities and related cost drivers
21million of processing activity that varies
directly with units produced (14 million of
direct materials, 6 million of direct labor, and
1 million of variable manufacturing overhead) at
a rate of 21 per unit and 3 million of setup
activity that varies with the number of
production setups.
20
Activity-Based Costing, Special Orders, and
Relevant Costs
Assume that processing the additional 100,000
units will require only 5 set-ups.
What is the additional variable cost Using ABC
costing?
Additional unit-based variable manufacturing
cost, 100,000 21 2,100,000 Additional
setup-based variable manufacturing cost, 5
6,000 30,000 Total additional
variable manufacturing cost 2,130,000
21
Pricing Decisions
Learning Objective 5
1. Setting the price of a new or refined product
2. Setting the price of products sold under
private labels 3. Responding to a new price of a
competitor 4. Pricing bids in both sealed and
open bidding situations
22
The Concept of Pricing
In perfect competition, all competing firms sell
the same type of product at the same price.
Marginal cost is the additional cost
resulting from producing and selling one
additional unit.
Marginal revenue is the additional
revenue resulting from the sale of one additional
unit.
23
The Concept of Pricing
In imperfect competition, the price a
firm charges for a unit will influence
the quantity of units it sells.
The firm must reduce prices to generate
additional sales.
Price elasticity is the effect of price changes
on sales volume.
24
Pricing and Accounting
Accountants seldom compute marginal revenue
curves and marginal cost curves.
They use estimates based on judgment.
They examine selected volumes, not the range of
possible volumes.
25
General Influences on Pricing in Practice
Learning Objective 6
Legal requirements
Competitors actions
Customer demands
26
Cost-Plus Pricing
Setting prices by computing an average cost and
adding a markup (the amount by which sales price
exceeds cost).
Target prices can be based on a host of different
markups that are in turn based on a host of
different definitions of cost.
27
Advantages of Contribution Margin Approach
The contribution margin approach offers more
detailed information.
This approach is sensitive to cost-volume-profit
relationships.
This approach allows managers to prepare price
schedules at different volume levels.
Target pricing with full costing presumes a given
volume level.
28
Advantages of Absorption-Cost Pricing
The absorption-cost approach assumes all costs
are variable (even if some are fixed in the
short run).
This approach meets the cost-benefit test. It is
too expensive to conduct cost-volume-tests on
all products.
This approach copes with the uncertainty of the
demand curve.
Target pricing with full costing presumes a given
volume level.
29
Target Sales Price
Learning Objective 7

• as a percentage of variable manufacturing costs

• as a percentage of total variable costs

• as a percentage of full costs

• as a percentage of total manufacturing cost

30
Relationships of Costs toSame Target Selling
Prices
Alternative Markup Percentage
to Achieve Same Target Sales
Price Target sales price 20.00 (20.00
12.00) 12.00 66.67 Variable
costs Manufacturing 12.00 Selling and
administrative 1.10 Unit variable cost
13.10 (20.00 13.10) 13.10 52.67 Fixed
costs Manufacturing 3.00 Selling and
administrative 2.90 Unit fixed costs
5.90 (3) Full Costs 19.00 (20.00 19.00)
19.00 5.26 Target operating income 1.00

31
Advantages of Absorption-Cost Approaches
1. In the long run, a firm must recover all costs
to stay in business.
2. It may indicate what competitors might charge.
3. It meets the cost-benefit test.
4. It copes with uncertainty.
32
Advantages of Absorption-Cost Approaches
5. It tends to promote price stability.
6. It provides the most defensible basis for
justifying prices to all interested parties.
7. It simplifies pricing decisions.
33
Target Costing
Learning Objective 8
Target costing sets a cost before the product is
created or even designed.
Value engineering is a cost-reduction technique,
used primarily during design.
Kaizen costing is the Japanese word for
continuous improvement.
34
Target Costing
Successful companies understand the market in
which they operate and use the most
appropriate pricing approach.
35
The End
End of Chapter 5