07/11/2022

ACA: LECTURE IV
Controlling

1. Management accounting
Necessary for: Main characteristics:
 Calculation/pricing  Relevant information  crucial
 Insourcing/outsourcing  Frequently in opposition to the
 Setting the minimum level of prices traditional, short-term-oriented incentive
 … schemes
Task of accounting systems:
1) Information from economic events  useful information for financial statement and
performance reports
2) Managers: accounting information to administer and to coordinate activities or functions
Management Accounting vs. Financial Accounting

Management Accounting Financial Accounting

Purpose of Help managers make decisions to Communicate an organization’s
information fulfill organization’s goal financial position to investors, banks,
regulators and other outside parties
Primary users Internal: managers of the External users: investors, banks,
organization regulators and suppliers
Focus and Future oriented  decision making Past-oriented
emphasis
Rules of  Internal measures Financial statements prepared in
measurement  No accordance with IFRS/GAAP accordance with IFRS/GAAP and by
and reporting external independent auditors
Time span and From hourly information to 15/20 Annual and quarterly financial
types of reports years reports
Behavioral Influence the behavior of managers  Primarily reports economic evens
implications and other employees  Influences behavior because
 Decision influencing role  manager’s compensation is often
achieve target by influencing based on reported financial
 Decision facilitation role  results
information
Strategic Decisions and Management Accounting – Key Success Factors

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Management Accounting Process:

1) Plan 2) Do 3) Check 4) Act

 Define and  Develop detailed  Confirm outcomes  Standardize solution
analyse probelm action plan against plan  Define next issues
 Implement plan  Identifing issues

Key Management Accounting Guidelines:

1) Cost-benefit approach
 to spend resources if they promote decision making that better attains organization goals
in relation to the costs of those resources
2) Full recognition to behavioral as well as technical considerations
 two simultaneous missions for providing information:
1. To help managers make wise economic decisions
2. To help managers and other employees to aim and strive for goals of the organization
3) Use different costs for different purposes: a cost concept used for external reporting is not
appropriate for internal report to managers
… into the Organizational Structure:

Line management Staff management Chief Financial Controller // chief

Officer (CFO) accounting officer (CAO)
directly responsible provide advice overseeing the responsible for both
financial operations of management accounting
an organization and financial accounting
Ethical Principles:

Competence Confidentiality Integrity Credibility Resolution of

ethical conflict

1.1 Types of Costs

Cost accounting:

 = a category of managerial accounting that aims to capture a company's total cost of value
creation.
 one of the central information systems in management accounting.
 provide answers to: How much does the creation of a product or service costs? And what
result was achieved in a certain period or with a specific product
Cost classification (Direct and indirect costs) and Cost-behavior patterns (Variable Costs and Fixed
Costs):

Total cost  cost behavior Total cost  assigned to object

Variable costs Fixed costs Indirect costs Direct cost
Change Unchanged Costs that are common to Costs that are directly related to
Example: Example: salaries several cost objects BUT a cost object and can be traced
manufacturing and depreciation cannot be traced to a in a economically feasible way
material and single one Example: manufacturing
wages Example: salaries and material and wages
rent

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1.2 The Flow of Costs

1) Inventoriable costs
 all costs of a product recorded as an asset on the balance sheet, only expensed as cost
of goods sold in the income statement when a product is sold.
2) Period costs
 all costs in the income statement other than costs of goods sold.
 Companies expect these costs to increase revenues in a specific period.
Flow of Revenue and Costs - Manufacturing Company

 𝑅𝑒𝑣𝑒𝑛𝑢𝑒𝑠 − 𝐶𝑂𝐺𝑆/𝑝𝑟𝑜𝑑𝑢𝑐𝑡 𝑐𝑜𝑠𝑡𝑠 = 𝐺𝑟𝑜𝑠𝑠 𝑚𝑎𝑟𝑔𝑖𝑛 − 𝑝𝑒𝑟𝑖𝑜𝑑 𝑐𝑜𝑠𝑡𝑠 = 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑖𝑛𝑐𝑜𝑚𝑒

Flow of Revenue and Costs - Merchandising Company

 balance sheet is different from

manufacturing
 Merchandising do not produce goods or
services  no positions
 inventoriable costs are recorded in the
BS position “Merchandise Inventory”

𝑅𝑒𝑣𝑒𝑛𝑢𝑒𝑠 − 𝐶𝑂𝐺𝑆 𝑜𝑟 𝑝𝑟𝑜𝑑𝑢𝑐𝑡 𝑐𝑜𝑠𝑡𝑠 = 𝐺𝑟𝑜𝑠𝑠 𝑚𝑎𝑟𝑔𝑖𝑛 − 𝑝𝑒𝑟𝑖𝑜𝑑 𝑐𝑜𝑠𝑡𝑠 = 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑖𝑛𝑐𝑜𝑚𝑒
𝑚𝑒𝑟𝑐ℎ𝑎𝑛𝑑𝑖𝑠𝑒 𝑝𝑢𝑟𝑐ℎ𝑎𝑠𝑒 = 𝑝𝑢𝑟𝑐ℎ𝑎𝑠𝑒 + 𝑓𝑟𝑒𝑖𝑔ℎ𝑡𝑖𝑛 − 𝑑𝑖𝑠𝑐𝑜𝑢𝑛𝑡 − 𝑟𝑒𝑡𝑢𝑟𝑛 𝑎𝑛𝑑 𝑎𝑙𝑙𝑜𝑤𝑎𝑛𝑐𝑒𝑠
𝑏𝑎𝑙𝑎𝑛𝑐𝑒 𝑠ℎ𝑒𝑒𝑡 → 𝑖𝑛𝑡𝑖𝑡𝑖𝑎𝑙 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑎𝑛𝑑 𝑒𝑛𝑑𝑖𝑛𝑔 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦
𝑃𝑒𝑟𝑖𝑜𝑑 𝑐𝑜𝑠𝑡𝑠 = 𝑚𝑎𝑟𝑒𝑘𝑡𝑖𝑛𝑔 + 𝑎𝑑𝑣𝑒𝑟𝑡𝑖𝑠𝑖𝑛𝑔 + 𝑠ℎ𝑖𝑝𝑝𝑖𝑛𝑔 + 𝑑𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 + 𝑎𝑑𝑚𝑖𝑛𝑖𝑠𝑡𝑟𝑎𝑣𝑖𝑣𝑒
𝐶𝑂𝐺𝑆 = 𝑚𝑒𝑟𝑐ℎ𝑎𝑑𝑖𝑠𝑒 𝑝𝑢𝑟𝑐ℎ𝑎𝑠𝑒 − (𝑒𝑛𝑑𝑖𝑔𝑛 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 − 𝑖𝑛𝑖𝑡𝑖𝑎𝑙 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦)
The Need for Uniform Terms:

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2. Calculation and Cost Systems

2.1 Cost-volume Profit analysis / Break-Even-Analysis
Goal: Show relationships between production, sales and profit as well as effects of changes in costs
and revenues on the profit structure of the company
𝐵𝐸 𝑎𝑛𝑎𝑙𝑦𝑠𝑖𝑠 → 𝑝𝑟𝑜𝑓𝑖𝑡 = 𝑠𝑎𝑙𝑒𝑠 − 𝑐𝑜𝑠𝑡𝑠 = 𝑐𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑚𝑎𝑟𝑔𝑖𝑛 − 𝑓𝑖𝑥𝑒𝑑 𝑐𝑜𝑠𝑡𝑠
𝑃𝑟𝑜𝑓𝑖𝑡 = (𝑝𝑟𝑖𝑐𝑒 ∗ 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦) − (𝑣𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑐𝑜𝑠𝑡𝑠 ∗ 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦) − 𝑓𝑖𝑥𝑒𝑑 𝑐𝑜𝑠𝑡𝑠
𝑃𝑟𝑜𝑓𝑖𝑓 = (𝑝𝑟𝑖𝑐𝑒 − 𝑣𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑐𝑜𝑠𝑡𝑠) ∗ 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 − 𝑓𝑖𝑥𝑒𝑑 𝑐𝑜𝑠𝑡𝑠
𝑃𝑟𝑜𝑓𝑖𝑡 = 𝑅𝑒𝑣𝑒𝑛𝑢𝑒𝑠 − 𝑣𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑐𝑜𝑠𝑡𝑠 − 𝑓𝑖𝑥𝑒𝑑 𝑐𝑜𝑠𝑡𝑠
𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑐𝑜𝑠𝑡𝑠 = 𝑟𝑒𝑣𝑒𝑛𝑢𝑒𝑠 − 𝑝𝑟𝑜𝑓𝑖𝑡 − 𝑓𝑖𝑥𝑒𝑑 𝑐𝑜𝑠𝑡𝑠
𝑅𝑒𝑣𝑒𝑛𝑢𝑒 − 𝑣𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑐𝑜𝑠𝑡 = 𝑐𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑚𝑎𝑟𝑔𝑖𝑛
𝑐𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑚𝑎𝑟𝑔𝑖𝑛 = 𝐶𝑀 𝑟𝑎𝑡𝑖𝑜 ∗ 𝑟𝑒𝑣𝑒𝑛𝑢𝑒

𝑓𝑖𝑥𝑒𝑑 𝑐𝑜𝑠𝑡𝑠 𝑓𝑖𝑥𝑒𝑑 𝑐𝑜𝑠𝑡𝑠

𝐵𝐸 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 = 𝑥 = =
𝑐𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑚𝑎𝑟𝑔𝑖𝑛 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 𝑝𝑟𝑖𝑐𝑒 − 𝑣𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑐𝑜𝑠𝑡𝑠
𝐵𝐸 𝑠𝑎𝑙𝑒𝑠 = 𝑝𝑟𝑖𝑐𝑒 ∗ 𝑥
𝑐𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑚𝑎𝑟𝑔𝑖𝑛
𝑐𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑚𝑎𝑟𝑔𝑖𝑛 𝑟𝑎𝑡𝑖𝑜 = =%
𝑟𝑒𝑣𝑒𝑛𝑢𝑒𝑠
𝑐𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑚𝑎𝑟𝑔𝑖𝑛
𝐵𝐸 𝑟𝑒𝑣𝑒𝑛𝑢𝑒𝑠 = → 𝑡ℎ𝑒 𝑛𝑒𝑤 𝑟𝑒𝑣𝑒𝑛𝑢𝑒𝑠 𝑖𝑛 𝑜𝑟𝑑𝑒𝑟 𝑡𝑜 𝑏𝑒 𝐵𝐸
𝑐𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑚𝑎𝑟𝑔𝑖𝑛 𝑟𝑎𝑡𝑖𝑜
𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑖𝑛𝑐𝑜𝑚𝑒 = 𝑟𝑒𝑣𝑒𝑛𝑢𝑒 − 𝑡𝑜𝑡𝑎𝑙 𝑐𝑜𝑠𝑡𝑠
𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑖𝑛𝑐𝑜𝑚𝑒
𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑖𝑛𝑐𝑜𝑚𝑒 𝑚𝑎𝑟𝑔𝑖𝑛 % =
𝑟𝑒𝑣𝑒𝑛𝑢𝑒𝑠
𝑡𝑜𝑡𝑎𝑙 𝑐𝑜𝑠𝑡𝑠
𝑅𝑒𝑣𝑒𝑛𝑢𝑒𝑠 =
1 − 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑖𝑛𝑐𝑜𝑚𝑒 𝑚𝑎𝑟𝑔𝑖𝑛 %
𝑡𝑜𝑡𝑎𝑙 𝑐𝑜𝑠𝑡𝑠 = 𝑓𝑖𝑥𝑒𝑑 𝑐𝑜𝑠𝑡𝑠 + 𝑣𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑐𝑜𝑠𝑡𝑠
𝑟𝑒𝑣𝑒𝑛𝑢𝑒𝑠 = 𝑡𝑜𝑡𝑎𝑙 𝑐𝑜𝑠𝑡𝑠 + 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑖𝑛𝑐𝑜𝑚𝑒

To have the break-even revenue  we need to have 𝑝𝑟𝑜𝑓𝑖𝑡 = 0 , 𝑠𝑜𝑐𝑎𝑙𝑙𝑒𝑑 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑖𝑛𝑐𝑜𝑚𝑒 = 0

𝐵𝐸 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 = 𝐵𝐸 𝑠𝑎𝑙𝑒𝑠 → 𝐵𝐸 𝑝𝑜𝑖𝑛𝑡

 = the critical output quantity x at which the total revenue is just as large as the total cost
 Degree of employment, which covers the total fixed costs and the variable costs attributable
to the quantities sold
 All costs are recorded and dividend into fixed and variable costs
 Selling price and variable costs per units are independent of the quantity
 No warehouse  sales = production
 An increase in the income tax has no effect on the break-even point

2.2 Costing Systems

 A costing system's building blocks consist of: cost object, direct costs, indirect costs, cost
pools, and cost-allocation bases.
 Concept of cost pools = describe the grouping of individual indirect cost items  not every
single cost has to be allocated individually and allow the grouping of indirect costs with the
same cost-allocation base together.

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 Cost-allocation base = serves as an approximation to be the main cost driver of those indirect
costs. (ex: machine hours)

Job Order vs. Process Costing

Job-costing Process-costing systems

For manufactured batches of unique products For companies that produce identical units
or specialized services through a series of processes
 Examples: health care providers,  Examples: coca cola, surfboards,
customized computers, accounting medical equipment. Postal service,
firms, Aircraft manufactured , Newspaper
Engineering  Single product  produced on
 Many different jobs are worked on continuous basis or for long period
during each period, with each job having  All units of product are identical
different production requirements   Accumulates cost of each process
work in progress simultaneously needed to complete the product
 Accumulates cost per batch or job  Used large products of similar goods
 More prevalent with service-based  No simultaneously work in process
companies

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Job order costing:

Calculate – Job Costing:

1) budgeted manufacturing overhead rate =

Budgeted manufacturing overhead costs/
Budgeted machine-hours = 4600000/184000 = 25
2) manufacturing overhead allocated during 2017
= Actual machine-hours * budgeted manufacturing
overhead rate = 180000*25 = 4500000
3) amount of under- or overallocated
manufacturing overhead = Manufacturing overhead
allocated during 2017 - Actual manufacturing
overhead costs =4500000-4830000 = -330000
“Peanut Butter Approach”  indirect costs are used by 3 business divisions in equal measures 
advantage and disadvantages
Potentially errors when using simple overhead allocation methods:
1) Allocation method acceptable when applying to homogeneous products
2) Large allocation errors for heterogeneous products (cause automation)
In a competitive market environment: Prices of products might not be able to compete or margin on
a product might be effectively too low
Traditional Overhead Allocation vs Activity-Based Approach:

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2.3 Activity-Based Costing

Main Characteristics: Steps:

 = a costing system by identifying individual 1) Companies have to identify all
activities and their fundamental cos drivers in activities within the value chain of
a company’s value chain the organization
 Activity = event or task with a specified 2) Compute the costs of individual
purpose activities
 Big effort to allocate every cost driver  3) Costs are then assigned to the
costing information cost object depending on the set of
 companies get high transparency of their activities needed to produce the
entire production processes  optimize parts product or service
of the value chain
 higher production costs
Activity-Based Management:
= describes management decisions that use activity-based costing information to satisfy customers
and improve profits.
Cost reduction and Product pricing and mix Design decisions
process improvement decisions
decisions
 Manufacturing and  ABC gives management  Management can identify
distribution personnel use insights into the cost and evaluate new designs
ABC systems to focus on structures for making and to improve performance by
cost reduction efforts selling diverse products evaluating how product and
 Managers set cost-  It provides more accurate process designs affect
reduction targets in terms product cost information activities and costs
of reducing the cost per and more detailed  Companies can work with
unit of the cost-allocation information on costs of their customers to evaluate
base activities and the drivers of the costs and prices of
those costs alternative design choices

ABC and Department Indirect-Cost Rates:

 Evolved costing system  from a single cost pool to separate indirect-cost rates for each
department, e.g. Design, Manufacturing, Distribution,

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  cost drivers of resources in each department or sub-department differ from the single,
company-wide, cost-allocation base.
 ABC systems  refinement of department costing systems.
 General approach to ABC in the service and merchandising areas is very similar to the
approach in manufacturing

Advantages and Disadvantages of ABC

Advantages Disadvantages/limitations
 Significant amounts of indirect costs are allocated using  Measures necessary to
only one or two cost pools implement the system
 All or most costs are identified as output unit-level costs  ABC systems require
 Products make diverse demands on resources because management to:
of differences in: Volume, Process steps, Complexity  estimate costs of activity pools
 Products that a company is well-suited to make and sell  Identify and measure cost
show small profits while products for which a company drivers for these pools
is less suited show large profits Activity-cost rates need to be
 Complex products  profitable and simple products  updated regularly
losing money (appearance) detailed ABC systems  expensive
 Operating staff have disagreements with the accounting and complex
staff about the costs of manufacturing and marketing
products and services

Costs are divided into homogeneous cost pools and classified as:

 Output unit-level
 Batch level
 Product, or service-sustaining
 Facility sustaining costs
The cost pools correspond to key activities
Costs are allocated to products or customers using activity drivers or cost-allocation bases that have
a cause-and-effect relationship with the cost in the cost pool
Exercise example of ABC:
Objective: calculate cost of two products under existing simple costing systems:
1) Calculate direct costs: direct material costs and direct manufacturing costs
𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦(𝑢𝑛𝑖𝑡𝑠 𝑠𝑜𝑙𝑑) ∗ 𝑑𝑖𝑟𝑒𝑐𝑡 𝑚𝑎𝑡𝑒𝑟𝑖𝑎𝑙 𝑐𝑜𝑠𝑡𝑠 + 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦
∗ 𝑑𝑖𝑟𝑒𝑐𝑡 𝑚𝑎𝑛𝑢𝑓𝑎𝑐𝑡𝑢𝑖𝑛𝑔 𝑐𝑜𝑠𝑡𝑠 (𝑝𝑒𝑟 ℎ𝑜𝑢𝑟 𝑎𝑛𝑑 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡𝑠)
2) Calculation of overhead costs: see cost activity and sum all of them
3) Assign overhead costs using a simple costing system
1. 𝑠𝑢𝑚 𝑜𝑓 𝑚𝑎𝑐ℎ𝑖𝑛𝑒 ℎ𝑜𝑢𝑟𝑠
𝑜𝑣𝑒𝑟ℎ𝑒𝑎𝑑 𝑐𝑜𝑠𝑡𝑠
2. 𝑜𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑐𝑜𝑠𝑡 𝑟𝑎𝑡𝑒 𝑝𝑒𝑟 𝑚𝑎𝑐ℎ𝑖𝑛𝑒 ℎ𝑜𝑢𝑟 =
𝑠𝑢𝑚 𝑜𝑓 𝑚𝑎𝑐ℎ𝑖𝑛𝑒 ℎ𝑜𝑢𝑟𝑠

ACA HSG 8
Valentina Serratore Bachelor BWL 07/11/2022

3. 𝑜𝑣𝑒𝑟ℎ𝑒𝑎𝑑 𝑠𝑢𝑟𝑐ℎ𝑎𝑟𝑔𝑒 𝑝𝑟𝑜𝑑𝑢𝑐𝑡 1

= 𝑚𝑎𝑐ℎ𝑖𝑛𝑒 ℎ𝑜𝑢𝑟 𝑜𝑓 𝑝𝑟𝑜𝑑𝑢𝑐𝑡 1 ∗ 𝑜𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑐𝑜𝑠𝑡 𝑟𝑎𝑡𝑒 𝑝𝑒𝑟 𝑚𝑎𝑐ℎ𝑖𝑛𝑒 ℎ𝑜𝑢𝑟
 do it also for product 2
4) Calculation of total costs
𝑡𝑜𝑡𝑎𝑙 𝑐𝑜𝑠𝑡𝑠 = 𝑜𝑣𝑒𝑟ℎ𝑒𝑎𝑑 𝑐𝑜𝑠𝑡𝑠 + 𝑑𝑖𝑟𝑒𝑐𝑡 𝑐𝑜𝑠𝑡𝑠
𝑡𝑜𝑡𝑎𝑙 𝑐𝑜𝑠𝑡𝑠
𝑡𝑜𝑡𝑎𝑙 𝑐𝑜𝑠𝑡𝑠 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 =
𝑢𝑛𝑖𝑡𝑠
Calculate the costs of an object using ABC:
1) Calculation of the activity cost rate

2) Allocation of overhead costs

3) Calculation of total costs

ACA HSG 9
Valentina Serratore Bachelor BWL 07/11/2022

3. Pricing Decisions and Cost Management

3.1 Pricing Decisions
Major Factors Affecting Price Decisions:

Customers Competitors Costs

through effect on the through technologies, plant  Affect supply.
demand for a product based capacities, and operating The lower the cost of producing a
on factors (features and strategies which affect their product, the greater the quantity a
quality) costs firm is willing to supply

 Weighing Customers, Competitors, and Costs

Costing and Pricing for the Long-Run:

Short-run pricing Long-run pricing

 less than one year  More than one year
 Pricing a one-time-only special order  long-run relationships with customers
with no long-run implications based on stable and predictable prices
 Adjusting product mix and output  reduces the need for continuous monitoring
volume in a competitive market of prices, improves planning and builds long-run
buyer-seller relationships

Purposes of Cost Allocation:

1) To provide information for economic decisions
2) To motivate managers and other employees
3) To justify costs or compute reimbursement amounts
4) To measure income and assets

3.2 Target vs. Cost Plus Pricing

Two different Long-Run Pricing Approaches for pricing decisions:

1) MARKET-BASED APPROACH 2) COST-BASED APPROACH

(Target Costing): (Cost-Plus Pricing):
Given what our customers want and how Given what it costs us to make this product,
competitors will react to what we do, what price what price should we charge, that will recoup
should we charge? our costs and achieve a target return on
investment?
 Starts with a target price which is the  adds a markup component to cost base
estimated price for a product or service that  it is only a starting point in the price-setting
potential customers are willing to pay process
 The target price is estimated based on:  Markup: flexible, based partially on
 understanding of customers’ customers and competitors
perceived value for a product or  the „plus“ refers to the markup component
service  computing the specific amount of capital
 How competitors will price invested in product is challenging 
competing products or services alternate cost bases to set prospective
selling prices: Variable manufacturing
Steps: costs, Variable cost, Manufacturing cost,
1) Develop a product that satisfies the Full cost
needs of potential customer
2) Choose a target price

ACA HSG 10
Valentina Serratore Bachelor BWL 07/11/2022

3) Derive a target cost per unit by
substracting target operating income
per unit from the target price
4) Perform value engineering to achieve
target cost
 Full cost  used for cost-based pricing
decisions: Full recovery of all costs, Allows
price stability, Simple approach

Objective:
- Reducing costs
- Satisfying customers by quality level

Example: Example:

Allowable cost = derived from market research

Target cost  strategic reasoning (higher than
the „pure“ allowable cost)
„Dispersing Process“ of Drifting Cost 
derived Value Engineering to achieve Target
Cost

Target pricing vs. Cost-Plus pricing:

1) The selling prices computed under cost-plus pricing are prospective prices
2) The target-pricing approach reduces the need to go back and forth among prospective cost-
plus prices, customer reactions, and design modifications
3) Target-pricing first determines product characteristics and target price on the basis of
customer preferences and expected competitor responses and then computes a target cost
 Progressive vs. Retrograde Pricing

ACA HSG 11
Valentina Serratore Bachelor BWL 07/11/2022

Target Cost Management:

Pro Contra
 Meaningful addition to traditional cost  Complex and uncertainty-based
accounting determination of market data
 Strengthening cost awareness  Derivation of market prices can contain highly
 Market-determined cost fixing subjective (weighting) elements for
guarantees long-term equivalence calculation (subjective
competitiveness overestimation or underestimation of the
 Identification aid, where exactly cost performance requirements)
reduction measures are necessary  Potential distortion of market prices due to
 Provides market determined cost dumping etc.
budgets  The risk of fictitiousness
 Intervene in the early phases of the  Strong focus on product-related
product life cycle manufacturing costs

3.3 Life-Cycle Product Budgeting

Life-Cycle Product Budgeting and Costing

 Consider target prices and target costs over a multiple-year product life cycle
 In life-cycle budgeting  estimate revenues and business function costs across the entire
value-chain (see product life cycle)
 Life-cycle budgeting and life-cycle costing span several years
 Product life cycle:

Budgeted life-cycle costs = provide useful information for strategically evaluating pricing decisions.
Two features of costs make life-cycle budgeting:
1) R&D and design  long and costly
2) Many costs locked in at the R&D and design stages
Life-Cycle Product Budgeting and Environmental Costs

 Managing environmental cost  application of life-cycle costing and value engineering

 Environmental costs incurred over several years of the product’s life cycle  locked in at
the product- and process-design stage
 Sustainability Accounting Standards Board (SASB)  define standards for environmental,
social, and governance (ESG) performance for different industries
 High relevant ESG ratings, high future profitability and financial performance: customer
loyalty and satisfaction, employee engagement, or brand and reputation

ACA HSG 12
Valentina Serratore Bachelor BWL 07/11/2022

3.4 Non-Cost-Based Pricing Methods

Non-cost-based pricing methods  Opportunities:
Price discrimination Pricing depending on International pricing
occupancy
Different customer pricing for the same Higher pricing for the Purchasing power in
product or service same product depending individual countries,
 Ticket discounts for target groups on occupancy or peak prices are adjusted
 Early bird discount hours.

Tutorial - pricing decision and cost management:

ACA HSG 13