MANAGEMENT ACCOUNTING
© Pearson Education Limited 2008
Cheryl S. McWatters, Jerold L. Zimmerman, Dale C. Morse
4-2
Managing activities
(Strategy and planning)
Chapter 4
Management Accounting McWatters, Zimmerman, Morse
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4-3
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
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4-4
Strategic Decisions
OR
To compete through innovative
product and service design
Must excel at understanding
customers
Strategic
Decision
To compete through lowcost production
Must excel through
efficient production OR
Management Accounting McWatters, Zimmerman, Morse
To compete through
the delivery of highquality products?
Must excel in
manufacturing and
delivery of customer
service
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4-5
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
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4-6
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
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Activity-Based Management and the
Value Chain
Delivering
ABM achieves the twin goals of
achieving customer and shareholder
value primarily through the analysis
of activities along the value chain
the film to
theatres
Advertising
Editing
Shooting
Designing the film
sets and
costumes
Value Chain
for a motion
picture
The
actors
Writing
Script
Management Accounting McWatters, Zimmerman, Morse
Activities that add value to the
customer are called value added
activities
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4-8
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
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4-9
Cost Reduction
ABM is one approach to reducing costs. The
identification and reduction of non-valueadded 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
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4-10
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
2,000,000
2,000,000
Web page maintenance
800,000
600,000
Order processing
4,000,000
4,500,000
Shipping to customer
3,000,000
2,000,000
Management Accounting McWatters, Zimmerman, Morse
Three activities are
not on the value
chain. Those
activities could be
replaced by shipping
directly to the
customer
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4-11
Product Life Cycle
Start
Customer
Service
Production
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
Engineering
Management Accounting McWatters, Zimmerman, Morse
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4-12
Product Life Cycle and Costs
Stage
2000
2001
2002
2003
2004
Totals
£
£
£
£
£
£
Costs
later stages
are
Design of the 100,000
50,000
Marketing
20,000
40,000
100,000
heavily
influenced
by
the
Engineering
80,000
100,000
10,000
Production
100,000
decisions
made during
the800,000
Customer Service
30,000
earlier
stages
Total Product Cost
150,000
30,000
10,000
200,000
700,000
100,000
1,700,000
40,000
50,000
120,000
10,000
2,370,000
Percentage of Life Cycle
Costs
100%
Committed Costs
50%
Incurred Costs
0%
Planning
Design &
Engineering
Management Accounting McWatters, Zimmerman, Morse
Production
Customer
Service
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4-13
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
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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
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4-15
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
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4-16
Estimating the Cost of a Supplier
Cost of
purchasing
Timeliness of
delivery
Treating the
Supplier as a cost
The will
Costidentify
of a
object
Supplier
whether
the supplier
is a low-cost option
Packaging of
parts or products
Management Accounting McWatters, Zimmerman, Morse
Quality of supplier’s
products
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4-17
Working with Suppliers to Reduce
Costs
Use business-toReduce warehouse
business ecommerce
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
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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
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4-19
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
What is the annual net benefit to Clear Windows of having
Annual net benefit £120,000 – £91,600 = £28,400
James Wilson as a customer?
Management Accounting McWatters, Zimmerman, Morse
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4-20
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
Management Accounting McWatters, Zimmerman, Morse
Competitors
(present and
potential)
Product costs
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4-21
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
400
192,000
600
300
180,000
Management Accounting McWatters, Zimmerman, Morse
As the price
drops, the units
sold increase
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4-22
Pricing to Maximize Organizational
Value –Numerical Example
InFixed
ordercosts
to maximize
are £50,000
added
andvalue
variable
300costs
kayaks
areshould
£300
be produced at a selling
per kayak
price of £600 per unit
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
140,000
40,000
400
500
200,000
170,000
30,000
480
400
192,000
194,000
-2,000
600
300
180,000
230,000
-50,000
Management Accounting McWatters, Zimmerman, Morse
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4-23
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
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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
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Cost-Based Pricing
Difficulty in estimating
customer value and, therefore,
demand at different prices
Contracts and
regulations
Long-run
customer
goodwill
Reasons given for
pricing based only
on product costs
Discouraging
competition
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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
Management Accounting McWatters, Zimmerman, Morse
Predatory pricing.
Selling a particular product
at a price below cost to
drive out competition
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4-27
MANAGEMENT ACCOUNTING
Managing activities
(Strategy and planning)
End of Chapter 4
Management Accounting McWatters, Zimmerman, Morse
© Pearson Education Limited 2008