Transcript Chapter 3: CVP Analysis

Cost Management
Measuring, Monitoring, and Motivating Performance
Chapter 13
Joint Management of Revenues and Costs
Prepared by
Gail Kaciuba
Midwestern State University
© John Wiley & Sons, 2005
Chapter 13: Joint Management of Revenues and Costs
Eldenburg & Wolcott’s Cost Management, 1e
Slide # 1
Chapter 13: Joint Management of
Revenues and Costs
Learning objectives
•
Q1: How is value chain analysis used to improve operations?
•
Q2: What is target costing and how is it performed?
•
Q3: What is kaizen costing and how does it compare to target
costing?
•
Q4: What is life cycle costing?
•
Q5: How are cost-based prices established?
•
Q6: How are market-based prices established?
•
Q7: What are the uses and limitations of cost-based and marketbased pricing?
•
Q8: What additional factors affect prices?
© John Wiley & Sons, 2005
Chapter 13: Joint Management of Revenues and Costs
Eldenburg & Wolcott’s Cost Management, 1e
Slide # 2
Q1: Value Chain Analysis
• The value chain is the series of sequential
business processes an organization
completes in order to deliver goods and
services to customers.
• To manage costs, companies analyze the
activities in the value chain.
• Non-value-added activities are those that can
be reduced or eliminated without affecting the
value of the goods to the customer.
• Value-added activities are necessary activities
and support the value of the goods to the
customer.
© John Wiley & Sons, 2005
Chapter 13: Joint Management of Revenues and Costs
Eldenburg & Wolcott’s Cost Management, 1e
Slide # 3
Q2: Target Costing
• In competitive markets, companies may
have no control over selling prices.
• The company’s only method to manage
profits, then, is to manage costs.
• The selling price is used to back into the
target cost of the product.
Target
=
cost
© John Wiley & Sons, 2005
Selling
price
–
Required
profit margin
Chapter 13: Joint Management of Revenues and Costs
Eldenburg & Wolcott’s Cost Management, 1e
Slide # 4
Q2: Target Costing
• Target costing takes place before the
decision to produce the product is final.
• It is most likely to be successful when:
• production and design processes are
complex,
• relationships with suppliers are flexible,
and
• potential customers may be willing to pay
for product attributes that will differentiate
the product from the competition.
© John Wiley & Sons, 2005
Chapter 13: Joint Management of Revenues and Costs
Eldenburg & Wolcott’s Cost Management, 1e
Slide # 5
Q2: Target Costing Example
Ted’s Trailers is considering the design, production, and distribution of a
new motorcycle trailer. The selling price of similar trailers is $1,200. Ted
believes he can sell 10,000 trailers at this price, and he demands a margin
of 25% of selling price on all products. Compute the target cost of the
trailers.
Target cost = $1,200 – ($1,200 x 25%) = $900
© John Wiley & Sons, 2005
Chapter 13: Joint Management of Revenues and Costs
Eldenburg & Wolcott’s Cost Management, 1e
Slide # 6
Q2: Target Costing Example
The estimated production costs for the new trailer are shown below.
Discuss the types of issues that Ted should investigate as he seeks to
reduce these estimated costs to meet the target cost.
Direct materials
$500
Direct labor
210
Variable mfg overhead
50
Fixed mfg overhead
70
Variable selling expenses
40
Fixed selling & admin expenses
70
$940
• Can the product be redesigned so that the
quantity of materials and/or labor can be
reduced?
• Can the purchase price of any of the materials be re-negotiated with the supplier(s)?
• Can the production process be redesigned
so that the quantity of materials and/or labor
can be reduced?
• Can the design of the product be changed to incorporate features that the
customer would be willing to pay for?
• Can variable selling expenses, for example, commissions, be reduced on this
new product?
• Can more than 10,000 units be produced and sold so that the allocation of fixed
costs per unit decreases?
© John Wiley & Sons, 2005
Chapter 13: Joint Management of Revenues and Costs
Eldenburg & Wolcott’s Cost Management, 1e
Slide # 7
Q3: Kaizen Costing
• In kaizen costing, explicit cost reductions
are planned over time.
• Kaizen costing takes place after the
production process has begun.
• Kaizen costing is a continuous improvement
process that takes place over a longer
planning horizon than target costing.
© John Wiley & Sons, 2005
Chapter 13: Joint Management of Revenues and Costs
Eldenburg & Wolcott’s Cost Management, 1e
Slide # 8
Q4: Life Cycle Costing
• Life cycle costing takes the product’s selling
prices and costs over its entire life cycle into
consideration.
• It is useful in industries with products that
are expected to produce losses when first
introduced, but rapid technological changes
and increased volume are expected in
future years.
• Initial production and process design costs
will be viewed as costs to be matched
against the revenues generated over the
product’s entire life.
© John Wiley & Sons, 2005
Chapter 13: Joint Management of Revenues and Costs
Eldenburg & Wolcott’s Cost Management, 1e
Slide # 9
Q5: Cost-Based Pricing
• A selling price that is computed as the
product’s cost plus a markup is known as a
cost-based price.
• The costs included in the base cost can be
variable costs only or variable plus fixed
costs.
• Some companies include only production
costs in the cost base and others include
production, selling, and administrative costs.
© John Wiley & Sons, 2005
Chapter 13: Joint Management of Revenues and Costs
Eldenburg & Wolcott’s Cost Management, 1e
Slide # 10
Q6: Market-Based Pricing
• A product’s selling price depends on the
degree of competition and the degree to
which the company’s product is
differentiated from competitor’s products.
• Market-based prices are based on customer
demand for the product.
• The sensitivity of customer demand to
changes in the selling price is called the
price elasticity of demand.
© John Wiley & Sons, 2005
Chapter 13: Joint Management of Revenues and Costs
Eldenburg & Wolcott’s Cost Management, 1e
Slide # 11
Q6: Market-Based Pricing
• An increase in selling price should decrease
customer demand for the product so that
fewer units are sold.
• When the decrease in units sales offsets the
increased selling price, the price increase
causes total revenue to decrease. This is
known as elastic demand.
• When the decrease in units sales does not
offset the increased selling price, the price
increase causes total revenue to increase. This
is known as inelastic demand.
© John Wiley & Sons, 2005
Chapter 13: Joint Management of Revenues and Costs
Eldenburg & Wolcott’s Cost Management, 1e
Slide # 12
Q6: Market-Based Pricing
Elastic demand:
Total
Revenue
Selling
price
=
Quantity of
units sold
x
Inelastic demand:
Total
Revenue
© John Wiley & Sons, 2005
=
Selling
price
x
Chapter 13: Joint Management of Revenues and Costs
Eldenburg & Wolcott’s Cost Management, 1e
Quantity of
units sold
Slide # 13
Q6: Price Elasticity of Demand
• The price elasticity of demand is calculated
as follows:
Price elasticity
of demand
=
ln(1 + % change in quantity sold)
ln(1 + % change in price)
• This elasticity can be used to compute the
profit-maximizing price:
Profitmaximizing
price
© John Wiley & Sons, 2005
=
Elasticity
Elasticity +1
x
Variable cost
Chapter 13: Joint Management of Revenues and Costs
Eldenburg & Wolcott’s Cost Management, 1e
Slide # 14
Q6: Market-Based Pricing Example
Ted’s Trailers sells horse trailers in a competitive market. The variable
costs of producing the one-horse trailer are $850 per unit. Information
from prior years’ indicates that a 10% increase in the trailer’s selling price
results in a 15% decrease in customer demand. Calculate the price
elasticity of demand and the profit-maximizing price for the one-horse
trailer.
Price elasticity
=
of demand
Profitmaximizing
price
© John Wiley & Sons, 2005
=
ln(1 - 0.15)
ln(1 + 0.10)
-1.70516
-0.70516
-0.16252
=
0.09531
x
= -1.70516
$850 = $2,055
Chapter 13: Joint Management of Revenues and Costs
Eldenburg & Wolcott’s Cost Management, 1e
Slide # 15
Q7: Uses & Limitations of Cost-Based Pricing
• Cost-based pricing is inappropriate in highly
competitive markets.
• If products are priced based on allocated fixed
costs, and the price is too high for the market,
the quantity sold will decrease.
• This decrease in sales will cause an increase in
the fixed costs allocated to each unit.
• The increase in allocated fixed costs will cause
even higher prices and unit sales will decline
even further.
• This is known as the death spiral.
© John Wiley & Sons, 2005
Chapter 13: Joint Management of Revenues and Costs
Eldenburg & Wolcott’s Cost Management, 1e
Slide # 16
Q7: Uses & Limitations of Cost-Based Pricing
• Cost-based pricing is best used when a
company produces highly customized
products.
• However, there can still be problems in
these instances.
• If the determined price is too high the customer
will not buy the customized product.
• The determined price may be lower than the
customer would have paid
© John Wiley & Sons, 2005
Chapter 13: Joint Management of Revenues and Costs
Eldenburg & Wolcott’s Cost Management, 1e
Slide # 17
Q8: Other Factors that Affect Pricing
• In peak-load pricing, companies charge
higher prices when they are at higher
capacities.
• When companies set high prices for newlyintroduced products, and gradually lower
prices to entice customers who would not
have purchased at the higher price, this is
known as price skimming.
• When prices are set unusually high to take
advantage of specific situations, this is
known as price gouging.
© John Wiley & Sons, 2005
Chapter 13: Joint Management of Revenues and Costs
Eldenburg & Wolcott’s Cost Management, 1e
Slide # 18
Q8: Other Factors that Affect Pricing
• Under penetration pricing, companies
charge lower prices for newly introduced
products.
• Companies set prices for the interdepartmental transfer of goods and services
known as transfer prices (chapter 15).
• When this is done to decrease consumer
uncertainty about the new product it is legal.
• When this is done with the intent to eliminate all
competition, it is illegal and is known as
predatory pricing.
© John Wiley & Sons, 2005
Chapter 13: Joint Management of Revenues and Costs
Eldenburg & Wolcott’s Cost Management, 1e
Slide # 19
Q8: Other Factors that Affect Pricing
• When for-profit companies charge different
prices to different customers and it is not
based on differential costs, this is illegal and
is known as price discrimination.
• Not-for-profit companies can legally charge
different prices to customers based on their
ability to pay.
• Collusive pricing, where competitors get
together to determine prices, is not legal.
• Foreign-based companies selling products
at prices lower than in the home country is
known as dumping.
© John Wiley & Sons, 2005
Chapter 13: Joint Management of Revenues and Costs
Eldenburg & Wolcott’s Cost Management, 1e
Slide # 20