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9 - 1©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton
Chapter 9
Relevant Information
and Decision Making:
Marketing Decisions
©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 9 - 2
Learning Objective 1
Discriminate between relevant
and irrelevant information
for making decisions.
©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 9 - 3
The Concept of Relevance
What information is relevant?
It depends on the decision being made.
Decision making essentially involveschoosing among several courses of action.
©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 9 - 4
The Concept of Relevance
What is the accountant’s role in decision making?
It is primarily that of a technical expert onfinancial analysis.
The accountant helps managers focus on therelevant information.
©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 9 - 5
Relevant Information
Relevant information is the predictedfuture costs and revenues that willdiffer among the alternatives.
©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 9 - 6
Learning Objective 2
Use the decision process to
make business decisions.
©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 9 - 7
The Decision Process
Historical InformationHistorical Information Other InformationOther Information
Prediction MethodPrediction Method
Decision ModelDecision Model
Implementation and EvaluationImplementation and Evaluation
Predictions as Inputsto Decision Model
Decisions by Managerswith Aid of Decision Model
Feedback
(1)
(2)
(3)
(4)
(A) (B)
©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 9 - 8
The Decision Process
Gather relevant information usinghistorical accounting information and otherinformation from outside the accounting system.
Step 1
©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 9 - 9
The Decision Process
Using the information gathered in Step 1,formulate predictions of expected futurerevenues or expected future costs.
The predictions formulated in Step 2to the decision model.
Step 3
Step 2
©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 9 - 10
The Decision Process
The decisions made by managers, with the aid ofthe decision model, are implemented and evaluated.
Feedback is used to make future adjustmentsto the decision process.
Step 4
©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 9 - 11
Decision Model Defined
A decision model is any method used for making a choice, sometimes requiring elaborate quantitative procedures.
©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 9 - 12
In the best of all possible worlds,information used for decisionmaking would be perfectlyrelevant and accurate.
In the best of all possible worlds,information used for decisionmaking would be perfectlyrelevant and accurate.
Accuracy and Relevance
©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 9 - 13
The degree to which information isrelevant or precise often dependson the degree to which it is...
The degree to which information isrelevant or precise often dependson the degree to which it is...
Accuracy and Relevance
QuantitativeQuantitativeQualitativeQualitative
©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 5 - 14
Learning Objective 3
Decide to accept or reject a
special order using the
contribution margin
technique.
©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 5 - 15
Special Sales Order Example
Solo Company is offered a special order of $13 per unit for 100,000 units.
Should Solo accept the order? The first step is to gather relevant
information from Solo Company’s financial statements.
©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 5 - 16
Special Sales Order Example
Solo CompanyIncome Statement
Year Ended December 31, 2002 (dollars 000)
Sales (1,000,000 units) $20,000Less: Variable expenses
Manufacturing $12,000Selling and administrative 1,100 13,100
Contribution margin $ 6,900
©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 5 - 17
Special Sales Order Example
Solo CompanyIncome Statement
Year Ended December 31, 2002 (dollars 000)
Contribution margin $6,900Less: Fixed expenses
Manufacturing $3,000Selling and administrative 2,900 5,900
Operating income $1,000
©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 5 - 18
Special Sales Order Example
Only variable manufacturing costs are affected by the particular order, at a rate of $12 per unit ($12,000,000 ÷ 1,000,000 units).
All other variable costs and all fixed costs are unaffected and thus irrelevant.
©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 5 - 19
Special Sales Order Example
Special order sales price/unit $13Increase in manufacturing costs/unit 12Additional operating profit/unit $ 1
Based on the preceding analysis, should Solo accept the order?
©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 5 - 20
Learning Objective 4
Decide to add or delete
a product line using
relevant information.
©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 5 - 21
Avoidable and Unavoidable Costs
Avoidable costs are costs that will not continueif an ongoing operation is changed or deleted.Avoidable costs are costs that will not continueif an ongoing operation is changed or deleted.
Unavoidable costs are costs that continue even if an operation is halted.Unavoidable costs are costs that continue even if an operation is halted.
©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 5 - 22
Department Store Example
Consider a discount department store that has three major departments:
1 Groceries2 General merchandise3 Drugs
©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 5 - 23
Department Store Example
Department General
(000) Groceries Mdse. Drugs TotalSales $1,000 $800 $100 $1,900Variable expenses 800 560 60 1,420Contribution margin $ 200 $240 $ 40 $ 480
©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 5 - 24
Department Store Example
Department General
(000) Groceries Mdse. Drugs TotalContribution margin $200 $240 $40 $480Fixed expenses:Avoidable $150 $100 $15 $265Unavoidable 60 100 20 180Total $210 $200 $35 $445Operating income $ (10) $ 40 $ 5 $ 35
©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 5 - 25
Department Store Example
For this example, assume first that the only alternatives to be considered are dropping or continuing the grocery department, which shows a loss of $10,000.
Assume further that the total assets invested would be unaffected by the decision.
The vacated space would be idle and the unavoidable costs would continue.
©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 5 - 26
Dropping Products,Departments, Territories
Total Before ChangeSales $1,900,000Variable expenses 1,420,000Contribution margin 480,000Avoidable fixed expenses 265,000Contribution to common space and unavoidable costs $ 215,000Unavoidable fixed expenses 180,000Operating income $ 35,000
©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 5 - 27
Dropping Products,Departments, Territories
Effect of Dropping Groceries Sales $1,000,000Variable expenses 800,000Contribution margin 200,000Avoidable fixed expenses 150,000Contribution to common space and unavoidable cost $ 50,000
©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 5 - 28
Dropping Products,Departments, Territories
Total After ChangeSales $900,000Variable expenses 620,000Contribution margin 280,000Avoidable fixed expenses 115,000Contribution to common space and unavoidable costs $165,000Unavoidable fixed expenses 180,000Operating income $ (15,000)
©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 5 - 29
Learning Objective 5
Compute a measure of product
profitability when production
is constrained by a scarce
resource.
©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 5 - 30
Optimal Use of Limited Resources
A limiting factor or scarce resource restricts or constrains the production or sale of a product or service.
The order to be accepted is the one that makes the biggest total profit contribution per unit of the limiting factor.
©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 5 - 31
Product Profitability ExampleConstrained by a Scarce Resource
Assume that a company has two products: a plain cellular phone and a fancier cellular phone with many special features.
©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 5 - 32
Plant workers can make 3 plain phonesin one hour or 1 fancy phone.
Product Plain Fancy Per Unit Phone PhoneSelling price $80 $120Variable costs 64 84Contribution margin $16 $ 36Contribution margin ratio 20% 30%
Product Profitability ExampleConstrained by a Scarce Resource
©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 5 - 33
Product Profitability ExampleConstrained by a Scarce Resource
Which product is more profitable?
If sales are restricted by demand for only a limited number of phones, fancy phones are more profitable.
Why?
©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 5 - 34
Product Profitability Example Constrained by a Scarce Resource
The sale of a plain phone adds$16 to profit.
The sale of a fancy phone adds$36 to profit.
©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 5 - 35
Product Profitability ExampleConstrained by a Scarce Resource
Now suppose annual demand for phones of both types is more than the company can produce in the next year.
Productive capacity is the limiting factor because only 10,000 hours of capacity are available.
©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 5 - 36
Product Profitability Example Constrained by a Scarce Resource
Which product should the company emphasize?
Plain phone:$16 contribution margin per unit × 3 units per hour= 48 per hourFancy phone:$36 contribution margin per unit × 1 unit per hour= $36 per hour
©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 5 - 37
Learning Objective 6
Discuss the factors that influence
pricing decisions in practice.
©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 5 - 38
Pricing Decisions
Among the many pricing decisions to be made are:
– setting the price of a new or refined product– setting the price of products sold under
private labels– responding to a new price of a competitor– pricing bids in both sealed and open bidding
situations
©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 5 - 39
The Concept of Pricing
In perfect competition, a firm can sell asmuch of a product as it can produce,all at a single market price.
In imperfect competition, the price a firmcharges for a unit will influence thequantity of units it sells.
©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 5 - 40
The Concept of Pricing
Marginal cost is the additional cost resultingfrom producing one additional unit.
Marginal revenue is the additional revenueresulting from the sale of one additional unit.
Price elasticity is the effect of price changeson sales volume.
©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 5 - 41
Influences on Pricing
Several factors interact to shape the market in which managers make pricing decisions:
– legal requirements– competitors’ actions– customer demands
©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 5 - 42
Learning Objective 7
Compute a target sales price
by various approaches and
compare the advantages
and disadvantages of
these approaches.
©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 5 - 43
Role of Costs in Pricing Decisions
Two pricing approaches used by companies are:
1 Cost-plus pricing2 Target costing
©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 5 - 44
Target Sales Price
There are four popular markup formulas for pricing:
1 As a percentage of variable manufacturing costs
2 As a percentage of total variable costs3 As a percentage of full costs4 As a percentage of total manufacturing cost
©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 5 - 45
Relationships of Costs to Same Target Selling Prices
Target sales price $20.00Variable costs:
Manufacturing $12.00Selling and administrative 1.10
Unit variable cost 13.10Fixed costs:
Manufacturing $ 3.00Selling and administrative 2.90
Unit fixed costs 5.90Target operating income $ 1.00
©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 5 - 46
Relationships of Costs to Same Target Selling Prices
Markup percentages
% of variablemanufacturingcosts:
($20.00 – $12.00) ÷ $12.00= 66.67%
% of totalvariablecosts:
($20.00 – $13.10) ÷ $13.10= 52.67%
©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 5 - 47
Costing Techniques
Target costing sets a cost before theproduct is created or even designed.
Value engineering is a cost-reductiontechnique, used primarily during design.
Kaizen costing is the Japanese word forcontinuous improvement.
©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 5 - 48
Learning Objective 8
Use target costing to decide
whether to add a new product.
©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 5 - 49
Target Costing and Cost-Plus Pricing Compared
Suppose that ITT Automotive receives an invitation to bid from Ford on the anti-lock braking systems.
The current manufacturing cost is $154. ITT Automotive’s desired gross margin rate
is 30% on sales. The market conditions have established a
sales price of $200 per unit.
©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 5 - 50
Target Costing and Cost-Plus Pricing Compared
What is the bid price using cost-plus pricing?
Bid price = Cost ÷ Cost % = $154 ÷ 0.7
Bid price = $220
©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 9 - 51
Target Costing and Cost-Plus Pricing Compared
Target cost = Market price × Cost %= $200 × 0.7
Target cost = $140Bid price = Market price = $200
What is the bid price using target costing?
©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 9 - 52
Learning Objective 9
Understand how relevant
information is used when
making marketing decisions.
©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton 9 - 53
Marketing Decisions
Accountants and managers must have a thoroughunderstanding of relevant information, especiallycosts, when making marketing decisions.
Market Price = $200