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2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton
Chapter 9
Relevant Information
and Decision Making:
Marketing Decisions
2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton
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Learning Objective 1
Discriminate between relevant
and irrelevant information
for making decisions.
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The Concept of Relevance
What information is relevant?
It depends on the decision being made.
Decision making essentially involves
choosing among several courses of action.
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The Concept of Relevance
What is the accountants role in decision making?
It is primarily that of a technical expert on
financial analysis.
The accountant helps managers focus on the
relevant information.
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Relevant Information
Relevant information is the predicted
future costs and revenues that will
differ among the alternatives.
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Learning Objective 2
Use the decision process to
make business decisions.
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The Decision Process
Historical Information Other Information
Prediction Method
Decision Model
Implementation and Evaluation
Predictions as Inputs
to Decision Model
Decisions by Managers
with Aid of Decision Model
Feedback
(1)
(2)
(3)
(4)
(A) (B)
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The Decision Process
Gather relevant information using
historical accounting information and other
information from outside the accounting system.
Step 1
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The Decision Process
Using the information gathered in Step 1,
formulate predictions of expected future
revenues or expected future costs.
The predictions formulated in Step 2
to the decision model.
Step 3
Step 2
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The Decision Process
The decisions made by managers, with the aid of
the decision model, are implemented and evaluated.
Feedback is used to make future adjustments
to the decision process.
Step 4
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Decision Model Defined
A decision model is any method used for
making a choice, sometimes requiring
elaborate quantitative procedures.
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In the best of all possible worlds,
information used for decision
making would be perfectly
relevant and accurate.
Accuracy and Relevance
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The degree to which information is
relevant or precise often depends
on the degree to which it is...
Accuracy and Relevance
Quantitative Qualitative
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Learning Objective 3
Decide to accept or reject a
special order using the
contribution margin
technique.
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Special Sales Order Example
Solo Company is offered a special order of
$13 per unit for 100,000 units.
Should Solo accept the order?
The first step is to gather relevant
information from Solo Companys financial
statements.
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Special Sales Order Example
Solo Company
Income Statement
Year Ended December 31, 2002 (dollars 000)
Sales (1,000,000 units) $20,000
Less: Variable expenses
Manufacturing $12,000
Selling and administrative 1,100 13,100
Contribution margin $ 6,900
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Special Sales Order Example
Solo Company
Income Statement
Year Ended December 31, 2002 (dollars 000)
Contribution margin $6,900
Less: Fixed expenses
Manufacturing $3,000
Selling and administrative 2,900 5,900
Operating income $1,000
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Special Sales Order Example
Only variable manufacturing costs are
affected by the particular order, at a rate
of $12 per unit ($12,000,000 1,000,000
units).
All other variable costs and all fixed costs
are unaffected and thus irrelevant.
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Special Sales Order Example
Special order sales price/unit $13
Increase in manufacturing costs/unit 12
Additional operating profit/unit $ 1
Based on the preceding analysis, should
Solo accept the order?
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Learning Objective 4
Decide to add or delete
a product line using
relevant information.
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Avoidable and Unavoidable Costs
Avoidable costs are costs that will not continue
if an ongoing operation is changed or deleted.
Unavoidable costs are costs that continue even
if an operation is halted.
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Department Store Example
Consider a discount department store that
has three major departments:
1 Groceries
2 General merchandise
3 Drugs
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Department Store Example
Department
General
(000) Groceries Mdse. Drugs Total
Sales $1,000 $800 $100 $1,900
Variable expenses 800 560 60 1,420
Contribution margin $ 200 $240 $ 40 $ 480
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Department Store Example
Department
General
(000) Groceries Mdse. Drugs Total
Contribution margin $200 $240 $40 $480
Fixed expenses:
Avoidable $150 $100 $15 $265
Unavoidable 60 100 20 180
Total $210 $200 $35 $445
Operating income $ (10) $ 40 $ 5 $ 35
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Department Store Example
For this example, assume first that the only
alternatives to be considered are dropping
or continuing the grocery department,
which shows a loss of $10,000.
Assume further that the total assets invested
would be unaffected by the decision.
The vacated space would be idle and the
unavoidable costs would continue.
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Dropping Products,
Departments, Territories
Total Before Change
Sales $1,900,000
Variable expenses 1,420,000
Contribution margin 480,000
Avoidable fixed expenses 265,000
Contribution to common
space and unavoidable costs $ 215,000
Unavoidable fixed expenses 180,000
Operating income $ 35,000
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Dropping Products,
Departments, Territories
Effect of Dropping Groceries
Sales $1,000,000
Variable expenses 800,000
Contribution margin 200,000
Avoidable fixed expenses 150,000
Contribution to common
space and unavoidable cost $ 50,000
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Dropping Products,
Departments, Territories
Total After Change
Sales $900,000
Variable expenses 620,000
Contribution margin 280,000
Avoidable fixed expenses 115,000
Contribution to common
space and unavoidable costs $165,000
Unavoidable fixed expenses 180,000
Operating income $ (15,000)
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Learning Objective 5
Compute a measure of product
profitability when production
is constrained by a scarce
resource.
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Optimal Use of Limited
Resources
A limiting factor or scarce resource restricts
or constrains the production or sale of a
product or service.
The order to be accepted is the one that
makes the biggest total profit contribution
per unit of the limiting factor.
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Product Profitability Example
Constrained by a Scarce Resource
Assume that a company has two products:
a plain cellular phone and a fancier cellular
phone with many special features.
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Plant workers can make 3 plain phones
in one hour or 1 fancy phone.
Product
Plain Fancy
Per Unit Phone Phone
Selling price $80 $120
Variable costs 64 84
Contribution margin $16 $ 36
Contribution margin ratio 20% 30%
Product Profitability Example
Constrained by a Scarce Resource
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Product Profitability Example
Constrained by a Scarce Resource
Which product is more profitable?
If sales are restricted by demand for only
a limited number of phones, fancy
phones are more profitable.
Why?
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Product Profitability Example
Constrained by a Scarce Resource
The sale of a plain phone adds
$16 to profit.
The sale of a fancy phone adds
$36 to profit.
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Product Profitability Example
Constrained by a Scarce Resource
Now suppose annual demand for phones of
both types is more than the company can
produce in the next year.
Productive capacity is the limiting factor
because only 10,000 hours of capacity are
available.
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Product Profitability Example
Constrained by a Scarce Resource
Which product should the company emphasize?
Plain phone:
$16 contribution margin per unit 3 units per hour
= 48 per hour
Fancy phone:
$36 contribution margin per unit 1 unit per hour
= $36 per hour
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Learning Objective 6
Discuss the factors that influence
pricing decisions in practice.
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Pricing Decisions
Among the many pricing decisions to be
made are:
setting the price of a new or refined product
setting the price of products sold under
private labels
responding to a new price of a competitor
pricing bids in both sealed and open bidding
situations
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The Concept of Pricing
In perfect competition, a firm can sell as
much of a product as it can produce,
all at a single market price.
In imperfect competition, the price a firm
charges for a unit will influence the
quantity of units it sells.
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The Concept of Pricing
Marginal cost is the additional cost resulting
from producing one additional unit.
Marginal revenue is the additional revenue
resulting from the sale of one additional unit.
Price elasticity is the effect of price changes
on sales volume.
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Influences on Pricing
Several factors interact to shape the market
in which managers make pricing decisions:
legal requirements
competitors actions
customer demands
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Learning Objective 7
Compute a target sales price
by various approaches and
compare the advantages
and disadvantages of
these approaches.
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Role of Costs in Pricing
Decisions
Two pricing approaches used by companies
are:
1 Cost-plus pricing
2 Target costing
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Target Sales Price
There are four popular markup formulas
for pricing:
1 As a percentage of variable manufacturing
costs
2 As a percentage of total variable costs
3 As a percentage of full costs
4 As a percentage of total manufacturing cost
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Relationships of Costs to
Same Target Selling Prices
Target sales price $20.00
Variable costs:
Manufacturing $12.00
Selling and administrative 1.10
Unit variable cost 13.10
Fixed costs:
Manufacturing $ 3.00
Selling and administrative 2.90
Unit fixed costs 5.90
Target operating income $ 1.00
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Relationships of Costs to
Same Target Selling Prices
Markup percentages
% of variable
manufacturing
costs:
($20.00 $12.00) $12.00
= 66.67%
% of total
variable
costs:
($20.00 $13.10) $13.10
= 52.67%
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Costing Techniques
Target costing sets a cost before the
product is created or even designed.
Value engineering is a cost-reduction
technique, used primarily during design.
Kaizen costing is the Japanese word for
continuous improvement.
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Learning Objective 8
Use target costing to decide
whether to add a new product.
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Target Costing and
Cost-Plus Pricing Compared
Suppose that ITT Automotive receives an
invitation to bid from Ford on the anti-lock
braking systems.
The current manufacturing cost is $154.
ITT Automotives desired gross margin rate
is 30% on sales.
The market conditions have established a
sales price of $200 per unit.
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Target Costing and
Cost-Plus Pricing Compared
What is the bid price using cost-plus pricing?
Bid price = Cost Cost % = $154 0.7
Bid price = $220
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Target Costing and
Cost-Plus Pricing Compared
Target cost = Market price Cost %
= $200 0.7
Target cost = $140
Bid price = Market price = $200
What is the bid price using target costing?
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Learning Objective 9
Understand how relevant
information is used when
making marketing decisions.
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Marketing Decisions
Accountants and managers must have a thorough
understanding of relevant information, especially
costs, when making marketing decisions.
Market Price = $200
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2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton
End of Chapter 5