Chapter 7 Accounting Information Relevant Costs and Decision

Chapter 7 Accounting Information, Relevant Costs, and Decision Making

Topics An Introduction to 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. $ $

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 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 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

Sunset Airlines Step 3: Identify and analyze available options The cost per passenger is $175. 14

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?

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).

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).

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.

Sunset Airlines Step 4: Select the Best Option Do not accept a special order for less than $275 per ticket.

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 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 Step 3: Identify and analyze available options Case I Cost to make: $26. 50 Cost to buy: $34. 50

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.

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

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

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

Birdie Maker Golf Company Step 4: Select the Best Option Case III Purchase the putter

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

Birdie Maker Golf Company Step 4: Select the Best Option Case IV Buy the putter.

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 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