13.2 Similarities between target and Kaizen costing: Rely on goal setting to achieve cost reduction Focus on product design and the manufacturing process to find ways to reduce cost
Trang 1Chapter 13 Joint Management of Revenues and Costs
LEARNING OBJECTIVES
Chapter 13 addresses the following questions:
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 market-based pricing?
Q8 What additional factors affect prices?
These learning questions (Q1 through Q8) are cross-referenced in the textbook to individual exercises and problems
COMPLEXITY SYMBOLS
The textbook uses a coding system to identify the complexity of individual requirements in the exercises and problems
Questions Having a Single Correct Answer:
No Symbol This question requires students to recall or apply knowledge as shown in the
textbook
e This question requires students to extend knowledge beyond the applications
shown in the textbook
Open-ended questions are coded according to the skills described in Steps for Better Thinking (Exhibit 1.10):
Step 1 skills (Identifying)
Step 2 skills (Exploring)
Step 3 skills (Prioritizing)
Step 4 skills (Envisioning)
Trang 2QUESTIONS
13.1 Just-In-Time (JIT) is an inventory management and manufacturing system where
products are manufactured as demanded and raw materials are delivered just when they are needed in the manufacturing cycle Very little inventory is kept on hand; suppliers deliver small amounts on a regular basis Organizations adopt Just-In-Time systems to keep inventory costs down and also to better manage quality because defects are often monitored more closely with JIT systems Systems such as JIT are known as demand-pull systems, because demand pulls inventory through the system to the point of sales
13.2 Similarities between target and Kaizen costing:
Rely on goal setting to achieve cost reduction
Focus on product design and the manufacturing process to find ways to reduce cost
Encourage organizations to work with suppliers to reduce costs
Use functional teams to determine where costs can be cut
Encourage employees to take an active part in the cost cutting decision making process
Take advantage of the trade-offs among price, functionality, and quality
Focus on continuous improvements in products and processes
Differences between target and Kaizen costing:
Target costing occurs in the design and decision-making phase of product
development Kaizen costing occurs after the product has been manufactured for the first time, and continues throughout the life of the product
Similarities and Difference among life cycle, target, and Kaizen costing
Life cycle costing (LCC) is similar to Kaizen costing in that cost reductions over time are expected LCC is different because there is no goal setting for specific targeted costs and the product is unprofitable in the beginning of the life cycle
In target costing, an unprofitable product is never manufactured, but under life cycle costing the product is expected to make a profit at some time, although not
at the beginning of its life cycle
13.3 Target and Kaizen costing are most appropriate in the following situations:
Product development and design phases are long and complex
The production process is complex
The market is willing to pay for differences in quality or function
The manufacturer can push some cost reductions onto suppliers and
subcontractors
The manufacturer can influence the design of subparts
Students should draw from these characteristics in identifying products for which target and kaizen costing would and would not be appropriate For example, these methods would be appropriate for automobile design and production, heavy equipment
manufacture, camera manufacture, computers, and electronics Some service industries
Trang 3use various forms of target costing practices For example, hospitals are reimbursed by Medicare with a flat-fee per patient by the diagnosis the patient is given Doctors agree
on clinical pathways, that is, the steps taken to treat the average patient with that
diagnosis The clinical pathway is designed to cost less than the reimbursement amount Similarly, a CPA firm may use these methods to evaluate whether services can be
provided to achieve desired profits or whether the firm should continue offering services
to a client Target and kaizen costing are not generally useful for simple product
manufacturing such as small toys or for food and beverages such as colas, cereals, or pasta products
13.4 The value chain cycle follows these processes in an organization, in a continuous manner:
research and development, product or service design, manufacturing process or service delivery design, manufacture or service delivery, marketing, distribution, customer
service Following are some of the benefits from value chain analysis: enhanced
efficiency, cost reduction, improvements in supplier and customer relationships, the ability to identify and eliminate non-value-added activities, reductions in rework, scrap, and waste, production cycle time reductions, and an increased ability to negotiate lower prices with suppliers
13.5 First determine the product’s target price, quality, and functionality Then determine the
target cost Design the product and manufacturing or delivery process to achieve the target cost A pilot project is set up to evaluate the feasibility of the product and process design and operation If the product meets the target criteria, it goes into full production
At each stage decisions are made about whether the product will be able to meet the price, quality, and functionality requirements If these are not met, the product will not
be produced or the requirements will change in response to customer input
13.6 Cost-based pricing is performed by adding a mark-up to some measure of product cost,
such as variable costs or a partially or fully allocated cost For example, if a computer’s variables costs were $300 and the required mark-up 100%, the price would be $600
($300 + 100%*$300)
13.7 Market based prices are determined using some measure of customer demand Managers
identify the amount that customers are willing to pay for a good or service and set the price at that amount With historical information about prices and quantities sold, the price elasticity of demand formula can be used to determine a profit-maximizing price Market research could be conducted and competitors’ prices could be analyzed The Internet is also a source for pricing information
13.8 Supply chain analysis explores the flow of resources from the initial suppliers (inside or
outside the organization) to the delivery of products or services to customers or clients Often, prices of inputs are reduced through negotiations with suppliers and may entail long-term contracts To further reduce costs, the purchasing organization may provide engineering or other kinds of assistance to the supplier
Trang 413.9
Common Advantages:
Use of goal setting encourages better performance
Team approach motivates employee cooperation
Allows a competitive price advantage for a short period of time
Common Disadvantages:
Stress of cost reduction environment can impair employee wellbeing
Encourages organizations to forego some products having long term profit
potential that are not profitable in the beginning
13.10 This problem is called the death spiral because as demand falls, average costs increase
because fewer units are produced This means that price will increase because it is based
on average cost When price increases, demand usually falls, so production will also fall, and average cost will increase, causing prices to increase, causing demand to fall, and
finally the company goes out of business
13.11 Not-for-profit organizations often receive donations and grants to help off-set operating
costs Therefore they do not have to set prices so that their operating costs are recovered They have other organizational objectives, such as providing services to low-income people Hence they may set prices using a sliding scale according to ability to pay They may not charge for some products or services
Trang 5EXERCISES
13.12 Value-Added and Non-Value-Added Activities
A Inspection activities are non-value-added Some organizations have very low defect rates, making it unnecessary to inspect; that is, the product design and manufacturing process insures high quality production The concept of high quality is to ―do it right the first time.‖ Some firms may inspect incoming materials to guarantee high quality during their manufacturing processes, but these costs could be eliminated through contractual arrangements with suppliers that include high penalties for low quality material
deliveries
B Moving materials to work stations could also be either value-added or non-value-added, depending on the circumstance In organizations that use JIT systems, the amount of materials handling is reduced to the minimum level necessary, which reduces costs
C Manufacturing extra inventory to keep employees busy is non-value added if there are no sales for the inventory
13.13 Lickety Split
Percent change in price = ($1.93 - $1.75)/$1.75 = +10%
Percent change in demand = (1,000 – 850)/1,000 = –15%
The elasticity is ln (1 + percent change in quantity sold)/ln(1+percent change in price)
= ln(1–0.15)/ln(1+0.1)
= –0.16252/0.09531 = –1.705 Variable cost = $640/1,000
Variable cost = $0.40
Price = (2.9 x $0.40) + 0.40 = $1.56
Trang 6B The elasticity is ln(1–0.12)/ln(1+0.10
= –0.12783/0.09531 = –1.341 Mark-up = [–1.341/(–1.341+1)] – 1 = 2.93
The formulas indicate that he should increase his current markup, to nearly 300%
However, these formulas are very sensitive to errors in the estimates of price and quantity changes, so they should be used only as guidelines He can slowly begin increasing the mark-up until he reaches the point where contribution margin times quantity sold
maximizes his profits
13.15 Big Bertram
A It is a cellular or kanban system An employee work team manufactures each item in a small workstation using Just-In-Time inventory control methods
B Each employee inspects his own work, and so defects are caught very quickly Inventory
is delivered to each cell just as it is needed and products are made only when they are ordered so inventory costs are minimized Usually there are space savings
C A cellular system succeeds when manufacturing is continuous and the defect rates are low If the supplier has any problems with the software and deliveries are slow, the line cannot manufacture anything If there are any problems with quality, it may take longer
to get these adjusted because the software has already been released materials for
delivery In addition, Big Bertram would want to emphasize the security aspects of the supplier’s access to its inventory levels Firewalls and strong security code systems would be needed to protect the integrity of Bertram’s database and specialized software programs Organizations in competitive industries guard their production information to protect their private information regarding areas of their competitive strengths
13.16 Chrysler
A If Chrysler had used target costing for the P.T Cruiser, the first step would have been to determine a market price for the new model Focus groups and customer surveys would have been conducted Once the market price had been established, the required profit margin would be subtracted, leaving the target cost At this point a team would be
assembled of engineers, accountants, and marketing people to design the product and the manufacturing process If the team is able to do this at the target cost, a pilot production line is implemented If costs come in at the target cost, the P.T Cruiser would go into full production If the target cost cannot be met, at either the design or pilot stage, the whole process is reiterated several times If the Cruiser never came in at the target cost, the marketing department could do more research to see if customers would respond to an increased price or decreased quality or function If the target cost is never met, the
product is dropped
Trang 7B New products such as the P.T Cruiser may be well received, or they may not be
Consumers’ preferences vary across age groups, across geographical locations, across income brackets, across gender lines, and many other characteristics Because of this, the survey and focus group information may not represent the population of consumers needed In addition, economic factors affect the success of a new product None of these can be known for certain ahead of time
13.17 Sea Breeze Taffy
A Elasticity = ln(1+0.20)/ln(1-0.10)
= 0.18232/–0.10536 = –1.730
B Variable cost = $2,400/1,500 = $1.60
Profit maximizing price = [–1.730/(–1.730+1)] x $1.60 = $3.79
C She should drop the price, but in slow increments to determine the point at which the contribution margin times quantity sold maximizes profits
D The following factors could affect her price decision:
Any constraints in the resources and capacity she has available
Competitor’s actions General economic factors, if the economy is down, she may need to lower her price
Weather affects the number of customers and she may need to run sales during slow times to move inventory and ingredients that have a short shelf life
13.18 Oysters Away
[Note: This problem requires knowledge of special order decisions (Chapter 4).]
A Elasticity = ln(1–0.15)/ln(1+0.10)
= –0.16252/0.09531 = –1.705 Variable cost (vc) = $120,000/2,000 = $60
Profit maximizing price = [–1.705/(–1.705+1)]*vc
Trang 8out about this price and demand lower prices Students may think of other relevant factors
Therefore the new target cost is cost = $148.50 – $14.85 = $133.65
C Need to reduce each cost by ($150 – $133.65)/$150 = 10.9%:
Original Amount Target Cost
13.20 Blade Runner (continued)
A Following are the new costs:
B The next step will be to look for more cost savings so that the target cost can be met No savings were mentioned for inspection, so that is one area that could be explored Other departments may have to cut back further to meet the target cost of $133.65 After the
Trang 9target cost has been met, a pilot project would be set up If the scooter can be produced for $133.65 in the pilot project, the product would be manufactured If costs still were too high, the target costing process would be reiterated
C Any changes in suppliers would need to be carefully considered The reliability of the supplier, the timeliness of delivery and quality of products supplied, all need to be
explored If suppliers do not meet required standards, new vendors must be found, and/or the target cost may not be met Productivity gains by labor could reduce quality Any trade-offs in quality or functionality to meet the target cost need to be explored and discouraged The new target cost assumes no reductions in quality or functionality For each category: is the cost reduction actually attainable without affecting quality or
functionality? For marketing, will the cost reduction affect sales volumes? Will cutting inspection costs mean that more defective units are sold? Will direct labor workers feel too much pressure to continually reduce costs and turnover increase? Will the machining department continue to be precise in their work while cutting costs?
D Questions (i.e., uncertainties) about whether the company will be able to achieve its planned cost reductions are listed below Students may think of others
Direct materials – How certain can managers be that the price set by vendors now will
continue over the next accounting period? How certain can they be that no changes in the price of raw materials will occur?
Direct labor – How certain can managers be that labor productivity will continue to
improve? Could labor demand a pay rate increase in the next year?
Machining – How certain can managers be that no new technology will be developed,
making their current machines obsolete?
Inspection – How certain can managers be that inspectors will not demand an increase in
salaries, or that they will continue to provide high quality inspections?
Engineering – How certain can engineers be that any changes will either improve quality
or reduce costs as they anticipate?
Marketing – How certain can managers be that the popular media will not increase prices
for advertising? How certain can they be that appropriate customers are targeted in the advertising campaigns?
Administration – How certain can managers be that administrative costs do not increase,
especially costs for computerized systems and software?
Trang 10PROBLEMS
13.21 Budget Cupboards
[Note: An example is provided in the textbook for students to follow in answering Part A.]
A Here are possible answers to this question; students may think of others
Potential Area for
Administration Outsource functions such as
payroll if it is cheaper to do so
Explore software that would increase efficiency and reduce number of employees needed Changes in quality
or functionality
Identify specialty functions with low volume sales and consider discontinuing them
Identify lower cost materials that would not reduce current quality
B To price more competitively, overall costs need to be reduced without affecting product quality or functionality Value chain analysis and JIT are methods that are used to reduce costs JIT manufacturing reduces inventory storage and insurance costs, and frees up extra space in the manufacturing plant If there are alternative uses for the space, the overall contribution margin should increase Value chain analysis enables managers to categorize activities into value-added and non-value added Then the non-value added activities are eliminated or minimized to save costs The supply chain can be analyzed to determine whether vendors can reduce their costs or provide higher quality goods and services at the same price
13.22 Sandy
A Target and kaizen costing are both market-based pricing techniques Once the market price is established, both methods set cost goals for production However, target costing occurs at the decision-making phase of product development and kaizen costing occurs once the product has be manufactured and price reductions are anticipated Target
costing specifies a particular cost for the product and the product will not be
manufactured unless the target cost is met In contrast, kaizen specifies specific cost reduction goals for the product across its life cycle
Trang 11B
Target Costing
Estimated selling price for a given
design and functionality
How certain can managers be that customers will be willing to pay the estimated price? Will competition drive the price down?
Estimates for sales volume Will competitors’ advertising campaigns affect demand?
How certain are managers that demand will not change if economic conditions change?
Estimated product costs:
Will electricity rates or taxes or insurance rates change? Will salaries for supervisory employees increase? Will other overhead costs increase or decrease?
If the design phase takes very long, how certain can managers be that estimated costs will hold until production begins?
Kaizen Costing
Same information as above Same uncertainties as above
Estimates for cost reductions over
Some costs will likely increase over time, such as property taxes and utilities How certain are managers that other costs can be cut to override any cost
increases and reduce costs further? Can they find activities to eliminate to reduce overhead costs, such
as number of set-ups?
C Managers are able to create biased estimates under any system, by underestimating or overestimating costs and revenues If managers are biased toward producing particular goods or services, they may unintentionally be very optimistic in their estimates of prices and volumes, and overestimate them They may also underestimate costs, not checking with vendors to be certain that quality remains high when direct material costs are
Trang 12reduced In addition, they may ask direct labor employees to estimate time under the best circumstances, not average circumstances Because these analyses rely on the target costing team’s estimates, any bias in the estimates affects the decision, and potentially the success of the product Similarly if managers are biased against products or services, they will underestimate volumes and prices, and overestimate costs In this case, a
decision could be made to forego an otherwise profitable product or service
D Kevin needs to understand that biased estimates affect all types of analyses An
advantage of target costing is that a pilot project is implemented before full production begins At this stage any optimistic biases in estimates are highly likely to be revealed While this method uncovers positive biases, negative biases may not be as easily
discovered However, because target and kaizen costing use teams, individual biases are likely to be minimized with input from a number of different people Both target and kaizen costing focus on market prices, and this information is relatively easy to obtain in many industries, so team members can monitor their own biases with concrete
information from the market place or from customer surveys All methods of making are subject to bias, so managers must continually monitor their own and
decision-colleagues’ tendencies toward bias as plans are developed and decisions made
13.23 Heritage Jewelry Store
A John is probably influenced by traditional pricing methods in this industry The mark-ups may be published in industry trade journals and John knows that his competitors are using similar methods and so feels comfortable using this method
B Elasticity is the sensitivity of demand to changes in price The demand for some products
is greatly affected by any change in price For example, commodities prices are
published daily Demand for these products is considered very elastic (very responsive to price changes) For other products, changes in price lead to little change in demand For example, demand for expensive cars such as a Rolls Royce or Lotus is inelastic; it is not very responsive to small changes in price
C When prices increase, consumers will not buy products for which demand is very elastic For example, if frost has damaged this year’s asparagus crop and the price increases, consumers will substitute other vegetables for asparagus and demand will decrease However, if the weather is perfect for asparagus and the crop is large, prices decrease and demand increases because consumers buy asparagus instead of other vegetables that are similarly priced
D If John has not tracked sales and prices over the years, he does not have accurate data with which to use in the elasticity formulas Therefore he cannot be certain about the accuracy of his estimates These formulas are very sensitive to error, and if they are based on inaccurate estimates, he may set a price that is profit-minimizing instead of maximizing In addition, response to changes in his prices may depend on whether his competitors match his new prices, and John cannot know for certain whether their prices will change