This document discusses various managerial accounting concepts related to cost behavior analysis, decision making, and pricing strategies. It defines three types of cost behavior - fixed costs that do not vary with production, variable costs that vary with production, and mixed costs that have attributes of both. Decision making concepts covered include make-or-buy, keep-or-drop, special order pricing, and product mix decisions. Cost-volume-profit analysis and relevant costing are also summarized. Finally, different pricing strategies such as cost-based pricing, value-based pricing, and strategic pricing are defined.
2. Cost Behavior Analysis
Refers to the way different types of production costs change
when there is a change in level of production.
The reaction of expenses to alterations in the amount of
some business activity. For example, the cost behavior for
aspects of automobile
3. 3 Types of Cost Behavior
Type of Cost Description
Fixed Cost
are business expenses that are not dependent on the level of goods or
services produced by the business. Some of the examples are
Amortization, Depreciation, Insurance, Rent, Salaries, Utilities,
Interest expense, and Property taxes.
Variable Cost
are those costs that vary depending on a company's production volume;
they rise as production increases and fall as production decreases. Some
of the examples are Raw Materials, Labor, Production Supplies, Staff
Wages, and Commissions.
Mixed Cost
are business expense that has attributes of both fixed and variable costs.
In other words, it’s a cost that changes with the volume of production like
a variable cost and can’t be completely eliminated like a fixed cost. Some
of the examples are Equipment Rental, Maid wages, Photocopier
Rental
6. Tactical Decision Making
consists of choosing among alternatives with an immediate or
limited end in view. Accepting a special order for less than the
normal selling price to utilize idle capacity and increase the year’s
profits is an example.
The overall objective of strategic decision making is to select
among alternatives the strategies so that a long-term competitive
advantage is established
7. Relevant Cost
In managerial accounting, refers to the incremental and avoidable cost of
implementing a business decision.
Relevant costing attempts to determine the objective cost of a business
decision. An objective measure of the cost of a business decision is the
extent of cash outflows that shall result from its implementation.
Relevant costing focuses on just that and ignores other costs which do
not affect the future cash flows.
9. Make-or-Buy Decision
The act of choosing between manufacturing a product in-house
or purchasing it from an external supplier.
In a make-or-buy decision, the two most important factors to
consider are cost and availability of production capacity.
is a judgment made by management whether to make a
component internally or buy it from the market. While making
the decision, both qualitative and quantitate factors must be
considered.
10. Keep-or-Drop Decision
A decision whether or not to continue an old product line or
department, or to start a new one is called an add-or-drop
decision. An add-or-drop decision must be based only on
relevant information.
11. Special Order Decision
is a technique used to calculate the lowest price of a product
or service at which a special order may be accepted and
below which a special order should be rejected.
This method of pricing special orders, in which price is set
below normal price but the sale still generates some
contribution per unit, is called contribution approach to special
order pricing. The idea is that it is better to receive something
above variable costs, than receiving nothing at all.
12. Sell-or-Process Decision
A decision whether to sell a joint product at split-off point or to
process it further and sell it in a more refined form is called a
sell-or-process-further decision.
13. Product Mix Decision
refers to the decisions regarding adding a new or eliminating
any existing product from the product mix, adding a new product
line, lengthening any existing line, or bringing new variants of a
brand to expand the business and to increase the profitability.
14. Different Product Mix Decision
Product Line Decision
Product line managers takes product line decisions considering the sales
and profit of each items in the line and comparing their product line with the
competitors' product lines in the same markets. Marketing managers have
to decide the optimal length of the product line by adding new items or
dropping existing items from the line.
Line Stretching
Decision
Line stretching means lengthening a product
line beyond its current range. An organization
can stretch its product line downward, upward,
or both way.
Line Filing Decision
It means adding more items within the present range
of the product line. Line filling can be done to reach
for incremental profits, or to utilize excess capacity.
15. Pricing Strategy
can be used to pursue different types of objectives, such as
increasing market share, expanding profit margin, or driving a
competitor from the marketplace. It may be necessary for a
business to alter its pricing strategy over time as its market
changes.
16. Cost-Based Pricing Strategy
Absorption Pricing
Includes all variable costs, as well as an
allocation of fixed costs.
Breakeven Pricing
The setting of a price at the exact point at which
a company earns no profit, based on an
examination of variable costs and the estimated
number of units to be sold.
Cost-Plus Pricing
Includes all variable costs, an allocation of fixed
costs, and a predetermined markup percentage.
Time and Materials
Pricing
Customers are billed for the labor and materials
incurred by the company, with a profit markup.
17. Value Pricing StrategyThese pricing strategies do not rely upon cost, but rather the perception of customers of the value of the product or service.
Dynamic Pricing
Technology is used to alter prices continuously,
based on the willingness of customers to pay.
Premium Pricing
The practice of setting prices higher than the
market rate in order to create the aura of
exclusivity.
Price Skimming
The practice of initially setting a high price to reap
unusually high profits when a product is initially
introduced.
18. Teaser Pricing StrategyThese strategies are based on the concept of luring in customers with a few low-priced or free products or services,
and then cross-selling them higher-priced items.
Freemium Pricing
The practice of offering a basic service for free,
and charging a price for a higher service level.
High-low Pricing
The setting of a price at the exact point at which
a company earns no profit, based on an
examination of variable costs and the estimated
number of units to be sold.
Loss Leader Pricing
The practice of pricing a few products below the
market rate to bring in customers, and pricing all other
items above the market rate
19. Strategic Pricing StrategyThese strategies involve the use of product pricing to position a company within a market or to exclude competitors from it.
Limit Pricing
The practice of offering a basic service for free,
and charging a price for a higher service level.
Penetration Pricing
The setting of a price at the exact point at which
a company earns no profit, based on an
examination of variable costs and the estimated
number of units to be sold.
Predatory Pricing
The practice of pricing a few products below the
market rate to bring in customers, and pricing all other
items above the market rate
Price Leadership
When one company sets a price point that is adopted
by competitors.
20. Miscellaneous Pricing StrategyThe following pricing strategies are separate pricing concepts not related to the preceding categories
Psychological
Pricing
The practice of setting prices slightly lower than
a rounded price, in the expectation that
customers will consider the prices to be
substantially lower than they really are.
Shadow Pricing
The assignment of a price to an intangible item
for which there is no market price.
Transfer Pricing
The price at which a product is sold from one
subsidiary of a parent company to another.
21. Cost Volume Profit Analysis
is a managerial accounting technique that is concerned with the effect of
sales volume and product costs on operating profit of a business. It deals with
how operating profit is affected by changes in variable costs, fixed costs, selling
price per unit and the sales mix of two or more different products.
23. CVP Analysis Formula
Profit = (P*X) - (V*X) - FC
P = Price Per Unit
V = Variable Cost Per Unit
FC = Fixed Cost
X = Total Units
24. Contribution Margin
is equal to the difference between total sales (S) and
total variable cost or, in other words, it is the amount
by which sales exceed total variable costs (VC). In
order to make profit the contribution margin of a
business must exceed its total fixed costs.
CM = Total Sales - Variable Cost
25. Contribution Margin Ratio
is the difference between a company's sales and
variable expenses, expressed as a percentage. The
total margin generated by an entity represents the
total earnings available to pay for fixed expenses and
generate a profit.
CM Ratio = CM Per Unit / Price Per Unit
26. Breakeven Analysis
is the point at which its sales exactly cover its
expenses. The company sells enough units of its
product to cover its expenses without making a profit
or taking a loss.
Breakeven Point = Fixed Cost / CM Unit
27. Example # 1
Let's say we own a company that manufactures bowling balls. Consider the following
given information on the unit pricing and variable cost for each unit (bowling ball)
that we produce and sell
Sale price per unit PHP10.00
Variable cost per unit
Direct Materials
Direct Labor
Variable portion of manufacturing overhead
Total Variable Cost Per Unit PHP6.00
CM Per Unit = PHP10.00 – PHP6.00
CM Per Unit = PHP4.00
This means that for each unit we produce and sell, we are left with $4 toward our
profit. In other words, for this example, PHP4.00 is how much each bowling ball
contributes to our margin (profit).
CM Ratio = PHP4.00 / PHP10.00
CM Ratio = .40 ; 40%
28. Example # 2
What if this year we produce and sell 1,000 units ?
Sales Revenue (1,000 units * PHP10.00 per unit) = PHP10,000.00
- Variable Cost (1,000 units * PHP6.00 per unit) = (PHP6,000.00)
Contribution Margin Per Unit = PHP10,000.00 – PHP6,000.00
Contribution Margin Per Unit = PHP4,000.00
CM Ratio
= CM per unit / sale price per unit
= PHP4,000.00 / PHP10,000.00
= .40 ; 40%
Notice how the cm ratio remains constant regardless of the number of units we
produce and sell. This is the percentage of sales pesos that "stays in our pocket",
although we still have not deducted our fixed cost.
29. Example # 3
What if this year we produce and sell 1,000,000 units and our total
fixed costs for the year are PHP2,500,000.00
Sales Revenue (1,000,000 units * PHP10.00 per unit) = PHP10,000,000.00
Variable Cost (1,000,000 units * PHP6.00 per unit) = (PHP6,000,000.00)
Contribution Margin Per Unit = PHP10,000.00 – PHP6,000,000.00
Contribution Margin Per Unit = PHP4,000,000.00
Total Fixed Costs = (PHP2,500,000.00)
NET INCOME = PHP1,500,000.00
30. Example #4 (Breakeven)
What if this year we produce and sell 625,000 units and our total
fixed costs for the year are PHP2,500,000.00
Sales Revenue (625,000 units * PHP10.00 per unit) = PHP6,250,000.00
Variable Cost (625,000 units * PHP6.00 per unit) = (PHP3,750,000.00)
Contribution Margin Per Unit = PHP2,500,00.00
Total Fixed Costs = (PHP2,500,000.00)
NET INCOME = PHP0.00
The analysis above shows that if our company sells each unit for PHP10.00,
the variable cost per unit is PHP6.00, and total annual fixed costs are
PHP2,500,000.00, If we sell 625,000 units this year(or PHP6,250,000 in pesos)
our net income will be PHP0.00. This is known as the breakeven point and it tells
us how much we need to sell to just cover our costs