1. Accounting Information, Relevant Costs, and Decision Making
Chapter 7
Accounting Information, Relevant Costs, and Decision Making

2. Topics An Introduction to Pricing Pricing of Products and Services
Target Pricing
Cost Plus Pricing
Time and Material Pricing
Value Pricing
Legal and Ethical Issues in Pricing

3. Introduction How does a manager decide:
The selling price of a product?
Whether to accept a special order?
Whether to add a new product or drop an old one?
Which products to put on the shelves?
Whether to hire an employee or outsource?
Whether to make or buy a product?

4. Introduction
All decisions require relevant, timely accounting information.
The following discussion includes some of the tools managers can use to make these decisions.

5. Pricing of Products and Services
Objective:
Discuss the factors and issues affecting the pricing of goods and services.

6. Pricing of Products and Services
Determining the selling price of a product is one of the most important decisions management will be required to make. $ $

7. Hotel Chains and Airlines
Use sophisticated yield management computer software which adjusts rates based on factors such as expected occupancy.

8. Agriculture
The market determines the selling price.

9. VCRs, CD Players
The demand for products at different stages in their life cycle affects pricing.

10. The Selling Price of a Product or a Service
Must be sufficient to cover the “cost” of the product and provide a profit.

11. Target Pricing
Used to determine the maximum cost that can be incurred in order to earn a desired target profit.

12. Computers
Target Cost =
Target Price - Target Profit

13. Cross Functional Application
Target pricing requires the cooperation of marketing, engineering, production, accounting and finance managers in multi-disciplinary teams.

14. Cost Plus Pricing
Target Selling Price =
Cost + (Markup % x Cost)

15. Cost Plus Pricing Markup Percentage
Must cover costs not included in the product cost
Must produce an acceptable profit

16. Time and Material Pricing
In service industries such as CPA firms, prices are often set based on time and material used.

17. Value Pricing
Value Pricing is based on the perceived or actual value of the service provided to a customer.
Ex. Consulting Business

18. Legal and Ethical Issues in Pricing
Predatory Pricing
Price Discrimination
Price Gouging
Ethical Issues in Pricing Pharmaceutical Products

19. Legal and Ethical Issues in Pricing
Pause and reflect
Do you think value pricing is ethical?

20. More Topics for Discussion
Special Orders
Outsourcing
Make or Buy
Add or Drop a Product, Product Line or Service
Resource Utilization
Theory of Constraints
Sell or Process Further
ABC and Relevant Cost Analysis

21. Special Orders Objectives
Analyze and determine the pricing of a special order.

22. Special Order Decisions
Short-run decisions
Excess production capacity
Relevant costs associated with each specific special order

23. Sunset Airlines Special Order
Do we provide 150 seats to San Diego for corporate executives attending a convention for $150 instead of the normal fare of $275?

24. Sunset Airlines Step 1: Define the Problem
Should Sunset Airlines sell 150 tickets at a reduced price of $150 per ticket?

25. Sunset Airlines Step 2: Identify Objectives
To maximize income in the short run without reducing income in the long run.

26. Sunset Airlines Step 3: Identify and analyze available options
Accept the order (sell) the tickets at $150
Let the market place determine the level of sales at the $275 price
Sell the tickets at another price

27. Sunset Airlines The cost per passenger is $175.14
Step 3: Identify and analyze available options
The cost per passenger is $175.14

28. Sunset Airlines Step 4: Select the Best Option
The special order price of $150 per ticket is $25.14 less that the total costs per passenger, so decline the special order. Or should we?

29. Sunset Airlines Step 3: Identify and analyze available options
Determine the relevant costs, which are only $3.25 for meals and drinks if the flight has excess capacity (empty seats).

30. Sunset Airlines Step 4: Select the Best Option
Accept the special order as the order price $150 is higher than the additional variable costs ($3.25).

31. Sunset Airlines
Step 3: Identify and analyze available options
What if Sunset did not have any excess capacity? Then the special order would involve opportunity cost.

32. Sunset Airlines Step 4: Select the Best Option
Do not accept a special order for less than $275 per ticket.

33. Special Orders Key Concept
In general, the price of a special order must be higher than the additional variable costs incurred in accepting the special order plus any opportunity costs incurred.

34. Outsourcing / Make or Buy Decisions
Objectives
Analyze a decision involving the outsourcing of labor or making or buying a component.

35. Outsourcing
Contracting with another company to provide janitorial and repair services instead of using employees of the company.

36. Factors Affecting Outsourcing Decisions
Impact of taxes
Payment of fringe benefits to salaried employees
Impact on the attitude of the remaining work force

37. Vertical Integration
Vertical Integration is accomplished when a company is involved in multiple steps of the value chain.
Advantages
Disadvantages

38. Make or Buy Decision Birdie Maker Golf Company
Currently they make all golf clubs in the set but are considering acquiring the putter from Flutter Putter, Inc., a manufacturer of custom putters.

39. Birdie Maker Golf Company
Step 1: Define the Problem
Continue making the putter or purchase it from Flutter Putter, Inc.

40. Birdie Maker Golf Company
Step 2: Identify Objectives
Maximize income by producing or buying the putter at the lowest cost
Quality of the putter
Impact of the putter on the sales of other clubs

41. Birdie Maker Golf Company
Step 3: Identify and analyze available options
Case I
Cost to make: $26.50
Cost to buy: $34.50

42. Birdie Maker Golf Company
Step 4: Select the Best Option
Case I
Continue making putters IF they believe they can manufacture a putter of acceptable quality and keep up with technological changes.

43. Birdie Maker Golf Company
Step 3: Identify and analyze available options
Case II
Due to a change in fixed costs (leased equipment being returned)
Cost to make: $26.50
Cost to buy: $29.00

44. Birdie Maker Golf Company
Step 4: Select the Best Option
Case II
Make internally considering:
Quality of the putter
Changing technology
Dependability of the supplier

45. Birdie Maker Golf Company
Step 3: Identify and analyze available options
Case III
If volume drops to 500 sets of clubs, fixed costs per putter increase
Cost to make: $36
Cost to buy: $33

46. Birdie Maker Golf Company
Step 4: Select the Best Option
Case III
Purchase the putter

47. Birdie Maker Golf Company
Step 3: Identify and analyze available options
Case IV
Opportunity Costs
Rent out the factory space now being used to make the putters, adding $10 opportunity costs per putter
Cost to make: $36.50
Cost to buy: $34.50

48. Birdie Maker Golf Company
Step 4: Select the Best Option
Case IV
Buy the putter.

49. Make or Buy
Key Concept
In general, a product should continue to be made internally and labor incurred internally if the avoidable costs are less than the additional costs that will be incurred by buying or outsourcing.

50. Add or Drop a Product, Product Line or Service
Objectives
Analyze a transaction dealing with adding or dropping a product, product line or service.

51. Add or Drop a Product, Product Line or Service
One of the most difficult decisions a manager can make
Must analyze relevant costs
Must also consider qualitative factors
Must consider contribution margin

52. Add or Drop a Product, Product Line or Service
Key Concept
In general, a product should be dropped when the fixed costs avoided are greater than the contribution margin lost.

53. Resource Utilization Decisions
Objectives
Analyze a decision dealing with scarce or limited resources.

54. Resource Utilization Decisions
Constraint: The capacity to manufacture a product or provide a service is limited in some manner.

55. Resource Utilization Decisions
Key Concept
Resource utilization decisions require an analysis of relevant costs and relevant qualitative factors and hinge on an analysis of the contribution margin earned per unit of the limited resource.

56. Resource Utilization Decisions
Examples
Skilled craftspeople, special machinery and limited space often times are short-run constraints

57. Theory of Constraints
Identifies bottlenecks in the production process.
Bottlenecks: limit throughput, the number of finished goods that result from the production process.

58. Theory of Constraints Steps for Resolution Identify the bottleneck
Manage the bottleneck
Relieve the bottleneck

59. Sell or Process Further Decisions
Furniture Manufacturer Example
Sell furniture:
Unassembled and Unfinished
Assembled and Unfinished
Assembled and Finished

60. Sell or Process Further Decisions
Key Concept
Assuming sufficient demand, a product should be processed further if the additional revenue is greater than the additional cost.

61. ABC and Relevant Cost Analysis
Uses multiple cost drivers to trace costs directly to products
Focuses on changes in costs associated with a variety of different activities
Helps managers identify what costs are really avoidable in a relevant cost analysis

62. End of Chapter 7
Uses multiple cost drivers to trace costs directly to products
Focuses on changes in costs associated with a variety of different activities
Helps managers identify what costs are really avoidable in a relevant cost analysis