MANAGEMENT ACCOUNTING

MANAGEMENT ACCOUNTING Cheryl S. McWatters, Jerold L. Zimmerman, Dale C. Morse

Managing activities (Strategy and planning) Chapter 4

Objectives • Select a competitive strategy for an organization • Use activity-based management to reduce the costs of an organization without affecting customer value • Make trade-offs in the product life cycle to reduce overall product costs • Use target costing as a method to select viable products and reduce product cost • Estimate the costs of using different suppliers • Use supply chain management to operate more efficiently and reduce costs • Estimate customer profitability • Make pricing decisions that maximize organizational value • Explain why some organizations use cost-based pricing

OR Strategic Decisions OR To compete through innovative product and service design OR Must excel at understanding customers Strategic Decision To compete through the delivery of high-quality products? Must excel in manufacturing and delivery of customer service To compete through low-cost production Must excel through efficient production

Strategic Decisions Have long-term implications Go beyond the confines of the organization Normally made by leaders of the organization Strategic Decisions Consider how the organization can take advantage of opportunities Consider the strengths and weaknesses of the organization Provide focus and direction

Activity-Based Management and the Value Chain Activity-based costing (ABC) provides an alternative way of tracing costs to products that, in some cases, leads to very different production costs Activity-based management (ABM) extends ABC by analyzing the management of activities, instead of simply retracing the costs of activities. The goal is to provide value to the customer and profit to the shareholders

Activity-Based Management and the Value Chain Delivering the film to theatres ABM achieves the twin goals of achieving customer and shareholder value primarily through the analysis of activities along the value chain Advertising Editing Shooting the film Value Chain for a motion picture Designing sets and costumes The actors Activities that add value to the customer are called value added activities Writing Script

Activity-Based Management and the Value Chain An organization should consider the “best practices” of other organizations to establish a benchmarks for evaluating its own practices An organization should consider whether to “outsource” an activity

Cost Reduction ABM is one approach to reducing costs. The identification and reduction of non-value-added activities can increase profits by lowering costs Product Life Cycle costing is another approach to reducing costs Another approach to reducing costs is Target Costing

Cost ReductionNumerical Example An Internet retailer purchases furnishings from different manufacturers and ships them to the company headquarters from where it distributes the products in its own vehicle fleet Three activities are not on the value chain. Those activities could be replaced by shipping directly to the customer

Product Life Cycle Start Customer Service Design Product life cycle describes the stages of supplying a product or service from its initial conception to the satisfaction of the last customer Marketing Production Engineering

Percentage of Life Cycle Costs 100% Committed Costs 50% Incurred Costs 0% Planning Design & Production Customer Engineering Service Product Life Cycle and Costs Costs of the later stages are heavily influenced by the decisions made during the earlier stages

Target Costing Target Costing is a strategic management process of reducing costs at the early stages of product planning and design Target Cost = Target Selling Price – Target Profit

Target Costing Identify product opportunity Determine price that wouldmake product competitive Determine if product can be made at cost sufficiently low to provide a profit

Supply Chain Management and Costs Supply chain management focuses onrelations with other organizations.Products and services flow into theorganization from external suppliersand products and services flow outto customers

Estimating the Cost of a Supplier Cost of purchasing Timeliness of delivery Treating the Supplier as a cost object will identify whether the supplier is a low-cost option The Cost of a Supplier Packaging of parts or products Quality of supplier’s products

Working with Suppliers to Reduce Costs Use business-to-business e-commerce Reduce warehouse costs by close communication Ways in which suppliers can reduce customers’ costs Enter into long-term relations Implement JIT systems Link computer systems by electronic data interchange (EDI)

Customer Relations and Profitability Customer-related costs are compared with the benefits of having the customer. In some cases, the cost of having a customer is higher than the benefit received

Customer Relations and ProfitabilityNumerical Example James Wilson purchases 1,000 windows annually from Clear Windows for £120,000. The product cost is £80 per window (not including transportation and customer service costs). It costs Clear Windows £10,000 to deliver the windows. Employees at Clear Windows spend 80 hours a year on customer service (cost £20 per hr) Cost of goods sold £80,000 Cost of transportation £10,000 Cost of service £1,600 Total cost £ 91,600 Annual net benefit £120,000 – £91,600 = £28,400 What is the annual net benefit to Clear Windows of having James Wilson as a customer?

Pricing to and Customer Value An important strategic planning decision is the pricing of products and services The pricing decision is complicated and requires knowledge of Customers Competitors (present and potential) Product costs

Pricing to Maximize Organizational Value –Numerical Example A schedule of quantities and prices for kayaks showing changing demand with changing prices As the price drops, the units sold increase

Pricing to Maximize Organizational Value –Numerical Example In order to maximize added value 300 kayaks should be produced at a selling price of £600 per unit Fixed costs are £50,000 and variable costs are £300 per kayak

Pricing in a Competitive Environment Organizations that choose to compete by offering innovative products and services have a more difficult pricing decision because there is no existing price for the new product or service Once competition enters the market, the price of a product becomes squeezed between the cost of the product and the lowest price of a competitor Organizations that produce at a high cost must consider removing that product from their mix

Cost-Based Pricing A recent study reported that firms viewed cost information as an important factor in pricing decisions Cost-based pricing generally uses the average product costs as the base A percentage is added to the average product cost to cover period costs and provide a profit

Cost-Based Pricing Difficulty in estimating customer value and, therefore, demand at different prices Long-run customer goodwill Reasons given for pricing based only on product costs Contracts and regulations Discouraging competition

Cost-Based Pricing Pricing a product below its cost reduces the value of the organization Two Exceptions Lead-losspricing.Selling a particular product at a price below cost to lure customers Predatory pricing.Selling a particular product at a price below cost to drive out competition

MANAGEMENT ACCOUNTING Managing activities (Strategy and planning) End of Chapter 4

MANAGEMENT ACCOUNTING