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9 - 12002 Prentice Hall Business Publishing,Introduction to Management Accounting12/e,Horngren/Sundem/Stratton
Chapter 9
Relevant Information
and Decision Making:
Marketing Decisions
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2002 Prentice Hall Business Publishing,Introduction to Management Accounting12/e,Horngren/Sundem/Stratton 9 - 2
Learning Objective 1
Discriminate between relevant
and irrelevant informationfor making decisions.
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2002 Prentice Hall Business Publishing,Introduction to Management Accounting12/e,Horngren/Sundem/Stratton 9 - 3
The Concept of Relevance
What information is relevant?
It depends on the decision being made.
Decision making essentially involveschoosing among several courses of action.
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2002 Prentice Hall Business Publishing,Introduction to Management Accounting12/e,Horngren/Sundem/Stratton 9 - 4
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 therelevant information.
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2002 Prentice Hall Business Publishing,Introduction to Management Accounting12/e,Horngren/Sundem/Stratton 9 - 5
Relevant Information
Relevant information is the predicted
future costs and revenues that will
differ among the alternatives.
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2002 Prentice Hall Business Publishing,Introduction to Management Accounting12/e,Horngren/Sundem/Stratton 9 - 6
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 otherinformation 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 futurerevenues 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 decisionmaking 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
QuantitativeQualitative
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Learning Objective 3
Decide to accept or reject a
special order using thecontribution 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 $12,000Selling 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 $3,000Selling 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 ($12,000,0001,000,000units).
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 usingrelevant information.
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Avoidable and Unavoidable Costs
Avoidablecosts are costs that will notcontinue
if an ongoing operation is changed or deleted.
Unavoidablecosts are costs that continue even
if an operation is halted.
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2002 Prentice Hall Business Publishing,Introduction to Management Accounting12/e,Horngren/Sundem/Stratton 5 - 23
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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2002 Prentice Hall Business Publishing,Introduction to Management Accounting12/e,Horngren/Sundem/Stratton 5 - 24
Department Store Example
Department
General
(000) Groceries Mdse. Drugs TotalContribution margin $200 $240 $40 $480
Fixed expenses:
Avoidable $150 $100 $15 $265
Unavoidable 60 100 20 180Total $210 $200 $35 $445
Operating income $ (10) $ 40 $ 5 $ 35
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2002 Prentice Hall Business Publishing,Introduction to Management Accounting12/e,Horngren/Sundem/Stratton 5 - 25
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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D i P d
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2002 Prentice Hall Business Publishing,Introduction to Management Accounting12/e,Horngren/Sundem/Stratton 5 - 27
Dropping Products,
Departments, Territories
Effect of Dropping Groceries
Sales $1,000,000
Variable expenses 800,000Contribution margin 200,000
Avoidable fixed expenses 150,000
Contribution to common
space and unavoidable cost $ 50,000
D i P d
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2002 Prentice Hall Business Publishing,Introduction to Management Accounting12/e,Horngren/Sundem/Stratton 5 - 28
Dropping Products,
Departments, Territories
Total After ChangeSales $900,000Variable expenses 620,000Contribution margin 280,000Avoidable fixed expenses 115,000Contribution to common
space and unavoidable costs $165,000Unavoidable fixed expenses 180,000Operating income $ (15,000)
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2002 Prentice Hall Business Publishing,Introduction to Management Accounting12/e,Horngren/Sundem/Stratton 5 - 29
Learning Objective 5
Compute a measure of product
profitability when productionis constrained by a scarce
resource.
O i l U f Li i d
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2002 Prentice Hall Business Publishing,Introduction to Management Accounting12/e,Horngren/Sundem/Stratton 5 - 30
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.
P d P fi bili E l
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2002 Prentice Hall Business Publishing,Introduction to Management Accounting12/e,Horngren/Sundem/Stratton 5 - 31
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.
P d t P fit bilit E l
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2002 Prentice Hall Business Publishing,Introduction to Management Accounting12/e,Horngren/Sundem/Stratton 5 - 32
Plant workers can make 3 plain phones
in one hour or1 fancy phone.
Product
Plain Fancy
Per Unit Phone Phone
Selling price $80 $120
Variable costs 64 84Contribution margin $16 $ 36
Contribution margin ratio 20% 30%
Product Profitability Example
Constrained by a Scarce Resource
P d t P fit bilit E l
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2002 Prentice Hall Business Publishing,Introduction to Management Accounting12/e,Horngren/Sundem/Stratton 5 - 33
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?
P d t P fit bilit E l
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2002 Prentice Hall Business Publishing,Introduction to Management Accounting12/e,Horngren/Sundem/Stratton 5 - 34
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.
P d t P fit bilit E l
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2002 Prentice Hall Business Publishing,Introduction to Management Accounting12/e,Horngren/Sundem/Stratton 5 - 35
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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2002 Prentice Hall Business Publishing,Introduction to Management Accounting12/e,Horngren/Sundem/Stratton 5 - 37
Learning Objective 6
Discuss the factors that influence
pricing decisions in practice.
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2002 Prentice Hall Business Publishing,Introduction to Management Accounting12/e,Horngren/Sundem/Stratton 5 - 38
Pricing Decisions
Among the many pricing decisions to bemade 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 biddingsituations
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2002 Prentice Hall Business Publishing,Introduction to Management Accounting12/e,Horngren/Sundem/Stratton 5 - 39
The Concept of Pricing
Inperfectcompetition, 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 firmcharges for a unit will influence the
quantity of units it sells.
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2002 Prentice Hall Business Publishing,Introduction to Management Accounting12/e,Horngren/Sundem/Stratton 5 - 40
The Concept of Pricing
Marginal costis the additional cost resulting
from producing one additional unit.
Marginal revenueis the additional revenue
resulting from the sale of one additional unit.
Price elasticityis the effect of price changes
on sales volume.
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2002 Prentice Hall Business Publishing,Introduction to Management Accounting12/e,Horngren/Sundem/Stratton 5 - 41
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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2002 Prentice Hall Business Publishing,Introduction to Management Accounting12/e,Horngren/Sundem/Stratton 5 - 42
Learning Objective 7
Compute a target sales price
by various approaches andcompare the advantages
and disadvantages ofthese approaches.
Role of Costs in Pricing
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2002 Prentice Hall Business Publishing,Introduction to Management Accounting12/e,Horngren/Sundem/Stratton 5 - 43
Role of Costs in Pricing
Decisions
Two pricing approaches used by companies
are:
1 Cost-plus pricing2 Target costing
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Target Sales Price
There are four popular markup formulas
for pricing:
1 As a percentage of variable manufacturingcosts
2 As a percentage of total variable costs
3 As a percentage of full costs4 As a percentage of total manufacturing cost
Relationships of Costs to
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2002 Prentice Hall Business Publishing,Introduction to Management Accounting12/e,Horngren/Sundem/Stratton 5 - 45
Relationships of Costs to
Same Target Selling Prices
Target sales price $20.00Variable costs:
Manufacturing $12.00Selling and administrative 1.10
Unit variable cost 13.10Fixed costs:
Manufacturing $ 3.00Selling and administrative 2.90Unit fixed costs 5.90Target operating income $ 1.00
Relationships of Costs to
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2002 Prentice Hall Business Publishing,Introduction to Management Accounting12/e,Horngren/Sundem/Stratton 5 - 46
Relationships of Costs to
Same Target Selling Prices
Markup percentages
% of variable
manufacturing
costs:
($20.00$12.00)$12.00= 66.67%
% of totalvariable
costs:
($20.00$13.10)$13.10
= 52.67%
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2002 Prentice Hall Business Publishing,Introduction to Management Accounting12/e,Horngren/Sundem/Stratton 5 - 47
Costing Techniques
Targetcostingsets a cost before the
product is created or even designed.
Value engineeringis a cost-reduction
technique, used primarily during design.
Kaizen costing
is the Japanese word for
continuous improvement.
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2002 Prentice Hall Business Publishing,Introduction to Management Accounting12/e,Horngren/Sundem/Stratton 5 - 48
Learning Objective 8
Use target costing to decide
whether to add a new product.
Target Costing and
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2002 Prentice Hall Business Publishing,Introduction to Management Accounting12/e,Horngren/Sundem/Stratton 5 - 49
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.
Target Costing and
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2002 Prentice Hall Business Publishing,Introduction to Management Accounting12/e,Horngren/Sundem/Stratton 5 - 50
Target Costing and
Cost-Plus Pricing Compared
What is the bid price using cost-plus pricing?
Bid price = CostCost % = $1540.7
Bid price = $220
Target Costing and
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2002 Prentice Hall Business Publishing,Introduction to Management Accounting12/e,Horngren/Sundem/Stratton 9 - 51
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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2002 Prentice Hall Business Publishing,Introduction to Management Accounting12/e,Horngren/Sundem/Stratton 9 - 52
Learning Objective 9
Understand how relevant
information is used whenmaking marketing decisions.
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2002 Prentice Hall Business Publishing,Introduction to Management Accounting12/e,Horngren/Sundem/Stratton 9 - 53
Marketing Decisions
Accountants and managers must have a thorough
understanding of relevant information, especiallycosts, when making marketing decisions.
Market Price = $200
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End of Chapter 5