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

2. Managing activities (Strategy and planning)
Chapter 4
Management Accounting McWatters, Zimmerman, Morse 2 2

3. 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
Management Accounting McWatters, Zimmerman, Morse

4. Strategic Decisions Strategic DecisionOR
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 OR
Management Accounting McWatters, Zimmerman, Morse

5. Strategic Decisions 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
Management Accounting McWatters, Zimmerman, Morse

6. 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
Management Accounting McWatters, Zimmerman, Morse

7. 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
Management Accounting McWatters, Zimmerman, Morse 19 19

8. 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
Management Accounting McWatters, Zimmerman, Morse

9. 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
Management Accounting McWatters, Zimmerman, Morse

10. 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
Activity
Cost (£)
Cost of best competitor
Purchasing
5,000,000
6,000,000
Shipping to Liverpool
3,000,000
2,000,000
Receiving
500,000
600,000
Warehousing
Web page maintenance
800,000
Order processing
4,000,000
4,500,000
Shipping to customer
Three activities are not on the value chain. Those activities could be replaced by shipping directly to the customer
Management Accounting McWatters, Zimmerman, Morse

11. 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
Management Accounting McWatters, Zimmerman, Morse 3 3

12. Product Life Cycle and Costs
Stage
2000
2001
2002
2003
2004
Totals
Design
100,000
50,000
150,000
Marketing
20,000
40,000
30,000
10,000
200,000
Engineering
80,000
Production
800,000
700,000
1,700,000
Customer Service
120,000
Total Product Cost
2,370,000
Costs of the later stages are heavily influenced by the decisions made during the earlier stages
Percentage of Life Cycle Costs
Committed Costs
Incurred Costs
Planning Design & Production Customer Engineering Service
100% 0%
50%
Management Accounting McWatters, Zimmerman, Morse

13. Target Cost = Target Selling Price – Target Profit
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
Management Accounting McWatters, Zimmerman, Morse

14. 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
Management Accounting McWatters, Zimmerman, Morse

15. 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
Management Accounting McWatters, Zimmerman, Morse

16. 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
Management Accounting McWatters, Zimmerman, Morse

17. 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)
Management Accounting McWatters, Zimmerman, Morse

18. 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
Management Accounting McWatters, Zimmerman, Morse

19. 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
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?
Management Accounting McWatters, Zimmerman, Morse

20. 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
Management Accounting McWatters, Zimmerman, Morse

21. Pricing to Maximize Organizational Value –Numerical Example
A schedule of quantities and prices for kayaks showing changing demand with changing prices
Kayaks sold
Price per unit (£)
Total Revenue (£)
100
900
90,000
150
800
120,000
200
700
140,000
300
600
180,000
400
500
200,000
480
192,000
As the price drops, the units sold increase
Management Accounting McWatters, Zimmerman, Morse

22. 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
Kayaks sold
Price (£)
Total revenue (£)
Total cost (£)
Added Value
100
900
90,000
80,000
10,000
150
800
120,000
95,000
25,000
200
700
140,000
110,000
30,000
300
600
180,000
40,000
400
500
200,000
170,000
480
192,000
194,000
-2,000
230,000
-50,000
Management Accounting McWatters, Zimmerman, Morse

23. 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
Management Accounting McWatters, Zimmerman, Morse

24. 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
Management Accounting McWatters, Zimmerman, Morse

25. 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
Management Accounting McWatters, Zimmerman, Morse

26. Pricing a product below its cost reduces the value of the organization
Cost-Based Pricing
Pricing a product below its cost reduces the value of the organization
Two Exceptions
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
Management Accounting McWatters, Zimmerman, Morse

27. MANAGEMENT ACCOUNTING Managing activities (Strategy and planning)
End of Chapter 4
Management Accounting McWatters, Zimmerman, Morse