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© Pearson Education Limited 2008 MANAGEMENT ACCOUNTING Cheryl S. McWatters, Jerold L. Zimmerman, Dale C. Morse.

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Presentation on theme: "© Pearson Education Limited 2008 MANAGEMENT ACCOUNTING Cheryl S. McWatters, Jerold L. Zimmerman, Dale C. Morse."— Presentation transcript:

1 © Pearson Education Limited 2008 MANAGEMENT ACCOUNTING Cheryl S. McWatters, Jerold L. Zimmerman, Dale C. Morse

2 4-2 © Pearson Education Limited 2008 Management Accounting McWatters, Zimmerman, Morse Managing activities (Strategy and planning) Chapter 4

3 4-3 © Pearson Education Limited 2008 Management Accounting McWatters, Zimmerman, Morse 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

4 4-4 © Pearson Education Limited 2008 Management Accounting McWatters, Zimmerman, Morse Strategic Decisions To compete through innovative product and service design To compete through low- cost production To compete through the delivery of high- quality products? Strategic Decision OR Must excel at understanding customers Must excel through efficient production Must excel in manufacturing and delivery of customer service OR

5 4-5 © Pearson Education Limited 2008 Management Accounting McWatters, Zimmerman, Morse Strategic Decisions Have long-term implications Consider the strengths and weaknesses of the organization Consider how the organization can take advantage of opportunities Provide focus and direction Normally made by leaders of the organization Go beyond the confines of the organization Strategic Decisions

6 4-6 © Pearson Education Limited 2008 Management Accounting McWatters, Zimmerman, Morse 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

7 4-7 © Pearson Education Limited 2008 Management Accounting McWatters, Zimmerman, Morse Activity-Based Management and the Value Chain ABM achieves the twin goals of achieving customer and shareholder value primarily through the analysis of activities along the value chain Activities that add value to the customer are called value added activities Value Chain for a motion picture Writing Script Designing sets and costumes The actors Shooting the film Advertising Delivering the film to theatres Editing

8 4-8 © Pearson Education Limited 2008 Management Accounting McWatters, Zimmerman, Morse 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

9 4-9 © Pearson Education Limited 2008 Management Accounting McWatters, Zimmerman, Morse 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

10 4-10 © Pearson Education Limited 2008 Management Accounting McWatters, Zimmerman, Morse Cost Reduction Numerical 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 ActivityCost (£)Cost of best competitor Purchasing5,000,0006,000,000 Shipping to Liverpool3,000,0002,000,000 Receiving500,000600,000 Warehousing2,000,000 Web page maintenance800,000600,000 Order processing4,000,0004,500,000 Shipping to customer3,000,0002,000,000 Three activities are not on the value chain. Those activities could be replaced by shipping directly to the customer

11 4-11 © Pearson Education Limited 2008 Management Accounting McWatters, Zimmerman, Morse Product Life Cycle Product life cycle describes the stages of supplying a product or service from its initial conception to the satisfaction of the last customer Design Start Marketing Engineering Production Customer Service Customer Service

12 4-12 © Pearson Education Limited 2008 Management Accounting McWatters, Zimmerman, Morse Product Life Cycle and Costs Percentage of Life Cycle Costs Committed Costs Incurred Costs Planning Design & Production Customer Engineering Service 100% 0% 50% Stage Totals ££££££ Design100,00050,000150,000 Marketing20,00040,000100,00030,00010,000200,000 Engineering80,000100,00010,000 Production100,000800,000700,000100,0001,700,000 Customer Service30,00040,00050,000120,000 Total Product Cost2,370,000 Costs of the later stages are heavily influenced by the decisions made during the earlier stages

13 4-13 © Pearson Education Limited 2008 Management Accounting McWatters, Zimmerman, Morse 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

14 4-14 © Pearson Education Limited 2008 Management Accounting McWatters, Zimmerman, Morse Target Costing Identify product opportunity Determine price that would make product competitive Determine if product can be made at cost sufficiently low to provide a profit

15 4-15 © Pearson Education Limited 2008 Management Accounting McWatters, Zimmerman, Morse Supply Chain Management and Costs Supply chain management focuses on relations with other organizations. Products and services flow into the organization from external suppliers and products and services flow out to customers

16 4-16 © Pearson Education Limited 2008 Management Accounting McWatters, Zimmerman, Morse Estimating the Cost of a Supplier Packaging of parts or products Quality of supplier’s products Timeliness of delivery Cost of purchasing The Cost of a Supplier Treating the Supplier as a cost object will identify whether the supplier is a low-cost option

17 4-17 © Pearson Education Limited 2008 Management Accounting McWatters, Zimmerman, Morse Working with Suppliers to Reduce Costs Link computer systems by electronic data interchange (EDI) Use business-to- business e- commerce Enter into long-term relations Reduce warehouse costs by close communication Implement JIT systems Ways in which suppliers can reduce customers’ costs

18 4-18 © Pearson Education Limited 2008 Management Accounting McWatters, Zimmerman, Morse 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

19 4-19 © Pearson Education Limited 2008 Management Accounting McWatters, Zimmerman, Morse Customer Relations and Profitability Numerical 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 Cost of goods sold £80,000 Cost of transportation £10,000 Cost of service £1,600 Total cost £ 91,600 What is the annual net benefit to Clear Windows of having James Wilson as a customer? Annual net benefit £120,000 – £91,600 = £28,400

20 4-20 © Pearson Education Limited 2008 Management Accounting McWatters, Zimmerman, Morse Pricing to and Customer Value An important strategic planning decision is the pricing of products and services Product costs The pricing decision is complicated and requires knowledge of Competitors (present and potential) Customers

21 4-21 © Pearson Education Limited 2008 Management Accounting McWatters, Zimmerman, Morse 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 Kayaks soldPrice per unit (£)Total Revenue (£) , , , , , , ,000

22 4-22 © Pearson Education Limited 2008 Management Accounting McWatters, Zimmerman, Morse Fixed costs are £50,000 and variable costs are £300 per kayak Pricing to Maximize Organizational Value – Numerical Example Kayaks soldPrice (£)Total revenue (£)Total cost (£)Added Value ,00080,00010, ,00095,00025, ,000110,00030, ,000140,00040, ,000170,00030, ,000194,000-2, ,000230,000-50,000 In order to maximize added value 300 kayaks should be produced at a selling price of £600 per unit

23 4-23 © Pearson Education Limited 2008 Management Accounting McWatters, Zimmerman, Morse 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

24 4-24 © Pearson Education Limited 2008 Management Accounting McWatters, Zimmerman, Morse Cost-Based Pricing Cost-based pricing generally uses the average product costs as the base A recent study reported that firms viewed cost information as an important factor in pricing decisions A percentage is added to the average product cost to cover period costs and provide a profit

25 4-25 © Pearson Education Limited 2008 Management Accounting McWatters, Zimmerman, Morse Cost-Based Pricing Reasons given for pricing based only on product costs Difficulty in estimating customer value and, therefore, demand at different prices Contracts and regulations Long-run customer goodwill Discouraging competition

26 4-26 © Pearson Education Limited 2008 Management Accounting McWatters, Zimmerman, Morse Cost-Based Pricing Lead-loss pricing. 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 Two Exceptions Pricing a product below its cost reduces the value of the organization

27 4-27 © Pearson Education Limited 2008 Management Accounting McWatters, Zimmerman, Morse MANAGEMENT ACCOUNTING Managing activities (Strategy and planning) End of Chapter 4


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