Nội dung

ACCA_C11.qxd 7/08/2007 11:44 CHAPTER Page 372 11 Costing and pricing in a competitive environment Introduction n recent years we have seen major changes in the business world, including deregulation, privatisation, the growing expectations of shareholders and the impact of new technology. These have led to a much more fast-changing and competitive environment that has radically altered the way in which businesses are managed. In this chapter, we consider some of the management accounting techniques that have been developed to help businesses maintain their competitiveness in this new era. We begin by considering the impact of this new environment on the full-costing approach that we considered in Chapter 10. We shall see that activity-based costing, which is a development of the traditional full-costing approach, takes a much more enquiring, much less accepting attitude towards overheads. We shall also examine some recent approaches to costing that can help lower costs and, therefore, increase the ability of a business to compete on price. Management accounting embraces both financial and non-financial measures and, in this chapter, we shall consider the increasing importance of non-financial measures in managing a business. These include the Balanced Scorecard approach, which seeks to integrate financial and non-financial measures into a framework for the achievement of business objectives. We shall go on to consider the idea of shareholder value, which has been a ‘hot’ issue among managers in recent years. Many leading businesses now claim that the quest for shareholder value is the driving force behind strategic and operational decisions. In this chapter we consider what the term ‘shareholder value’ means and we shall look at one of the main methods of measuring shareholder value. Lastly, we shall see how, in theory and in practice, a business can use costing information to aid pricing decisions. This will pick up some of the points on relevant cost and cost–volume–profit relationships that we considered in Chapters 8 and 9. I Learning outcomes When you have completed this chapter, you should be able to: ● Discuss the nature and practicalities of activity-based costing. ● Explain how new developments such as total life-cycle costing and target costing can be used to control costs. ➔ ACCA_C11.qxd 7/08/2007 11:44 Page 373 COSTING AND THE CHANGED BUSINESS ENVIRONMENT ● Discuss the importance of non-financial measures of performance in managing a business and the way in which the Balanced Scorecard attempts to integrate financial and non-financial measures. ● Explain the term ‘shareholder value’ and describe the role of EVA® in measuring and delivering shareholder value. ● Explain the theoretical underpinning of pricing and discuss the issues involved in reaching a pricing decision in real-world situations. Remember to create your own personalised Study Plan Costing and the changed business environment Costing and pricing in the traditional way The traditional and still widely used approach to product costing and pricing was developed around the time of the Industrial Revolution, when industry was characterised by: ● ● ● Direct-labour-intensive and direct-labour-paced production. Labour was at the heart of production. Where machinery was used, it was to support the efforts of direct labour, and the speed of production was dictated by direct labour. A low level of overheads relative to direct costs. Little was spent on power, personnel services, machinery (leading to low depreciation charges) and other areas typical of the overheads of modern businesses. A relatively uncompetitive market. Transport difficulties, limited industrial production worldwide and a lack of knowledge by customers of competitors’ prices meant that businesses could prosper without being too scientific in costing and pricing their output. Customers tended to accept what the supplier offered, rather than demanding precisely what they wanted. Since overheads at that time represented a relatively small element of total costs, it was acceptable and practical to deal with them in a fairly arbitrary manner. Little effort was devoted to controlling the cost of overheads because the benefits of better control were relatively small, particularly compared with the benefits from firmer control of direct labour and material costs. It was also reasonable to charge overheads to individual jobs on a direct labour hour basis. Most of the overheads were incurred directly in support of direct labour: providing direct workers with a place to work, heating and lighting that workplace, employing people to supervise the direct workers, and so on. Direct workers, perhaps aided by machinery, carried out all production. At that time, service industries were a relatively unimportant part of the economy and would have largely consisted of self-employed individuals. These individuals would probably have been uninterested in trying to do more than work out a rough hourly/daily rate for their time and to try to base prices on this. 373 ACCA_C11.qxd 374 7/08/2007 CHAPTER 11 11:44 Page 374 COSTING AND PRICING IN A COMPETITIVE ENVIRONMENT Costing and pricing in the new environment In recent years, the world of industrial production has fundamentally altered. Most of it is now characterised by: ● ● ● Capital-intensive and machine-paced production. Machines are at the heart of much production, including service provision. Most labour supports the efforts of machines, for example technically maintaining them. Also, machines often dictate the pace of production. A high level of overheads relative to direct costs. Modern businesses tend to have very high depreciation, servicing and power costs. There are also high costs of a nature scarcely envisaged in the early days of industrial production, such as personnel and staff training costs. At the same time, there are very low (sometimes no) direct labour costs. Although direct material cost often remains an important element of total cost, more efficient production methods lead to less waste and, therefore, less total material cost, again tending to make overheads more dominant. A highly competitive, international market. Production, much of it highly sophisticated, is carried out worldwide. Transport, including fast airfreight, is relatively cheap. Fax, telephone and, particularly, the internet ensure that potential customers can quickly and cheaply find the prices of a range of suppliers. Markets now tend to be highly price competitive. Customers increasingly demand products custom made to their own requirements. This means that businesses need to know their product costs with a greater degree of accuracy than historically has been the case. Businesses also need to take a considered and informed approach to pricing their output. In the UK, as in many developed countries, service industries now dominate the economy, employing the great majority of the workforce and producing most of the value of productive output. Although there are many self-employed individuals supplying services, many service providers are vast businesses such as banks, insurance companies and cinema operators. For most of these larger service providers, the activities closely resemble modern manufacturing activity. They too are characterised by high capital intensity, overheads dominating direct costs and a competitive international market. Activity-based costing In Chapter 10 we considered the traditional approach to job/batch costing (deriving the full cost of output where one unit/batch of output differs from another). This approach is to collect, for each job/batch, those costs that can be unequivocally linked to, and measured in respect of, the particular job/batch (direct costs). All other costs (overheads) are thrown into a pool of costs and charged to individual jobs/batches according to some formula. As we saw in Chapter 10, survey evidence indicates that this formula has usually been on the basis of the number of direct labour hours worked on each particular job/batch. In the past, overhead recovery rates (that is, rates at which overheads are absorbed by jobs/batches) were typically of a much lower value for each direct labour hour than the rate paid to direct workers as wages or salaries. It is now, however, becoming increasingly common for overhead recovery rates to be between five and ten times the hourly rate of pay, because overheads are now much more significant and the direct ACCA_C11.qxd 7/08/2007 11:44 Page 375 ACTIVITY-BASED COSTING labour input much less so. When production is dominated by direct labour paid, say, £8 an hour, it might be reasonable to have an overhead recovery rate of, say, £1 an hour. When, however, direct labour plays a relatively small part in production, to have overhead recovery rates of, say, £50 for each direct labour hour is likely to lead to very arbitrary costing. Even a small change in the amount of direct labour worked on a job/batch could massively affect the total cost deduced. This is not because the direct worker is very highly paid, but because of the effect of the direct labour change on the overhead loading. Also, overheads are still typically charged on a direct labour hour basis even though those overheads may not be particularly closely related to direct labour. An alternative approach to full costing As a result of changes in the business environment, the whole question of overheads, what causes them and how they are charged to jobs/batches, has been receiving much closer attention. Historically, businesses have been content to accept that overheads exist and, therefore, for product costing purposes they must be dealt with in as practical a way as possible. In recent years, however, there has been an increasing acceptance of the fact that overheads do not just happen; they must be caused by something. To illustrate this point, let us consider Example 11.1. Example 11.1 Modern Producers Ltd has, like virtually all manufacturers, a storage area that is set aside for its inventories of finished goods. The costs of running the stores include a share of the factory rent and other establishment costs, such as heating and lighting. They also include the salaries of staff employed to look after the inventories and the cost of financing the inventories held in the stores. The business has two product lines: A and B. Product A tends to be made in small batches, and low levels of finished inventories are held. The business prides itself on its ability to supply Product B in relatively large quantities instantly. As a consequence, most of the space in the finished goods store is filled with finished Product Bs ready to be despatched immediately an order is received. Traditionally, the whole cost of operating the stores would have been treated as a general overhead and included in the total of overheads charged to batches, probably on a direct labour hour basis. This means that when assessing the cost of Products A and B, the cost of operating the stores has fallen on them according to the number of direct labour hours worked on each one; a factor that has nothing to do with storage. In fact, most of the stores cost should be charged to Product B, since this product causes (and benefits from) the stores cost much more than does Product A. Failure to account more precisely for the cost of running the stores is masking the fact that Product B is not as profitable as it seems to be. It may even be leading to losses as a result of the relatively high stores-operating cost that it causes. So far, much of this cost has been charged to Product A without regard to the fact that Product A causes little of it. 375 ACCA_C11.qxd 376 7/08/2007 CHAPTER 11 11:44 Page 376 COSTING AND PRICING IN A COMPETITIVE ENVIRONMENT What drives the costs? ➔ ➔ Realisation that overheads do not just occur, but that they are caused by activities – such as holding products in stores – that ‘drive’ the costs, is at the heart of activitybased costing (ABC). The traditional approach is that direct labour hours are the cost driver, which probably used to be true. ABC recognises that this is often not the case. There is a basic philosophical difference between the traditional and the ABC approaches. Traditionally we tend to think of overheads as rendering a service to cost units, the cost of which must be charged to those units. ABC sees overheads as being caused by activities, and so it is the cost units that cause the activities that must be charged with the costs that they cause. Activity 11.1 Can you think of any other purpose that identification of the cost drivers serves, apart from deriving more accurate costs? Identification of the activities that cause costs puts management in a position where it may well be able to control them more effectively. It is not always easy to see how and why some overhead costs have arisen. This has traditionally made them more difficult to control than direct labour and material costs. If, however, an analysis of overheads can identify the cost drivers, questions can be asked about whether the activity driving certain costs is necessary at all, and whether the cost justifies the benefit. In Example 11.1, it may well be a good marketing policy that Product B can be supplied immediately from inventories, but this causes a cost that should be recognised and assessed against the benefit. Adopting ABC requires that most overheads can be analysed and the cost drivers identified. This means that it might be possible to gain much clearer insights about the overhead costs that are caused, activity by activity, so that fairer and more accurate product costs can be identified, and costs can be controlled more effectively. Cost pools ➔ Under ABC, an overhead cost pool is established for each cost driver in which all of the costs caused by that driver are placed. So, the business in Example 11.1 would create a cost pool for operating the stores. All costs associated with this activity would be allocated to that cost pool. The total costs in that pool would then be allocated to output (Products A and B, in this case), using the cost driver identified, according to the extent to which each unit of output ‘drove’ those costs. Example 11.2 The management accountant at Modern Producers Ltd (Example 11.1) has estimated that the costs of running the finished goods stores for next year will be £90,000. This will be the amount allocated to the ‘finished goods stores cost pool’. It is estimated that each Product A will spend an average of one week in the stores before being sold. With Product B, the equivalent period is four weeks. ACCA_C11.qxd 7/08/2007 11:44 Page 377 ACTIVITY-BASED COSTING Both products are of roughly similar size and have similar storage needs. It is felt, therefore, that the quantity of each product and the period spent in the stores (‘product weeks’) are the cost drivers. It is estimated that, next year, 50,000 Product As and 25,000 Product Bs will pass through the stores. So the total number of ‘product weeks’ in store will be: Product A (50,000 × 1 week) B (25,000 × 4 weeks) 50,000 100,000 150,000 The stores cost for each ‘product week’ is given by £90,000/150,000 = £0.60 Therefore each Product A will be charged with £0.60 for finished stores costs, and each Product B with £2.40 (that is, £0.60 × 4). Allocating overhead costs to cost pools, as is necessary with ABC, contrasts with the traditional approach, where the overheads are normally allocated to production departments (cost centres). In both cases, however, the overheads are then charged to cost units (goods or services). The two different approaches are illustrated in Figure 11.1. With the traditional approach, overheads are apportioned to product departments (cost centres). Each department would then derive an overhead recovery rate, typically overheads per direct labour hour. Overheads would then be applied to units of output according to how many direct labour hours were worked on them. With ABC, the overheads are analysed into cost pools, with one cost pool for each cost driver. The overheads are then charged to units of output, through activity cost driver rates (for example, £0.60 per ‘product week’ for the stores cost in Example 11.2). These rates are an attempt to represent the extent to which each cost unit is believed to cause the particular part of the overheads. Cost pools are much the same as cost centres, except that cost pools are linked to a particular activity (operating the stores in Examples 11.1 and 11.2), rather than being more general, as is the case with cost centres in traditional product costing. ABC and service industries Much of our discussion of ABC has concentrated on manufacturing industry, perhaps because early users of ABC were manufacturing businesses. In fact, ABC is possibly even more relevant to service industries because, in the absence of a direct material element, a service business’s total costs are likely to be largely made up of overheads. There is certainly evidence that ABC has been adopted more readily by businesses that sell services rather than goods, as we shall see later. Activity 11.2 What is the difference in the way in which direct costs are accounted for when using ABC, relative to their treatment taking a traditional approach to full costing? The answer is no difference at all. ABC is concerned only with the way in which overheads are charged to jobs to derive the full cost. 377 ACCA_C11.qxd 378 7/08/2007 CHAPTER 11 11:44 Page 378 COSTING AND PRICING IN A COMPETITIVE ENVIRONMENT Figure 11.1 Traditional versus activity-based costing With the traditional approach, overheads are first assigned to product cost centres and then overheads are absorbed by cost units based on an overhead recovery rate (using direct labour hours worked on the cost units, or some other approach) for each department. With activitybased costing, overheads are assigned to cost pools and then cost units are charged with overheads to the extent that they drive the costs in the various pools. Source: Adapted from Innes and Mitchell (see reference 1 at the end of the chapter). Example 11.3 provides an example of activity-based costing and brings together the points that have been raised so far. ACCA_C11.qxd 7/08/2007 11:44 Page 379 ACTIVITY-BASED COSTING 379 Example 11.3 Comma Limited manufactures two types of Sprizzer: Standard and Deluxe. Each product requires the incorporation of a difficult-to-handle special part (one of them for a Standard and four for a Deluxe). Both of these products are made in batches (large batches for Standards and small ones for Deluxes). Each new batch requires that the production facilities are ‘set up’. Details of the two products are: Standard Annual sales volume 12,000 units Sales price per unit £65 Batch size 1,000 units Direct labour time per unit 2 hours Direct labour rate per hour £8 Direct material cost per unit £22 Number of special parts per unit 1 Number of set-ups per batch 1 Number of separate material issues from stores per batch 1 Number of sales invoices issued per year 50 Deluxe 12,000 units £87 50 units 21/2 hours £8 £32 4 3 1 240 In recent months, Comma Limited has been trying to persuade customers who buy the Standard to purchase the Deluxe instead. An analysis of overhead costs for Comma Limited has provided the following information. Overhead analysis Set-up costs Special part handling costs Customer invoicing costs Material handling costs Other overheads £ 73,200 60,000 29,000 63,000 108,000 Cost driver Number of set-ups Number of special parts Number of invoices Number of batches Labour hours Required: (a) Calculate the profit per unit and the gross profit margin ratio (gross profit/sales revenue × 100%) for Standard and Deluxe Sprizzers using: (i) the traditional direct-labour-hour-based absorption of overheads; and (ii) activity-based costing methods. (b) Comment on the managerial implications for Comma Limited of the results in (a) above. Solution Using the traditional full (absorption) costing approach that we considered in Chapter 10, the overhead costs are added together and an overhead recovery rate deduced as follows: Overheads Set-up costs Special part handling costs Customer invoicing costs Material handling costs Other overheads £ 73,200 60,000 29,000 63,000 108,000 333,200 ➔ ACCA_C11.qxd 380 7/08/2007 CHAPTER 11 11:44 Page 380 COSTING AND PRICING IN A COMPETITIVE ENVIRONMENT ➔ Overhead recovery rate = = Total overheads Number of direct labour hours 333,200 54,000 = £6.17 per hour The total cost per unit of each type of Sprizzer is calculated by adding the direct costs to the overhead costs per unit. The overhead costs per unit are calculated by multiplying the number of direct labour hours spent on the product (2 hours for each Standard and 21/2 hours for each Deluxe) by the overhead recovery rate calculated above. Hence: Direct costs: Labour Material Indirect costs: Overheads (£6.17 per hour) Total cost per unit Standard £ 16.00 22.00 Deluxe £ 20.00 32.00 12.34 50.34 15.43 67.43 The gross profit margin ratio is calculated as follows: Standard (per unit) £ 65.00 50.34 14.66 22.55% Selling price Total cost (see above) Gross profit Gross profit margin ratio (gross profit/sales revenue) × 100% Deluxe (per unit) £ 87.00 67.43 19.57 22.49% Using the ABC costing approach, the activity cost driver rate will be calculated as follows: Overhead cost pool Set-up Special part Driver Set-ups per batch Special parts per unit (a) Standard driver volume (b) Deluxe driver volume (c) Total driver volume (a + b) (d) Costs £ (e) Driver rate (d/c) £ 12 720 732 73,200 100 12,000 48,000 60,000 60,000 1 Customer invoices Invoices per year 50 240 290 29,000 100 Material handling Number of batches 12 240 252 63,000 250 Other overheads Labour hours 24,000 30,000 54,000 108,000 2 ACCA_C11.qxd 7/08/2007 11:44 Page 381 ACTIVITY-BASED COSTING The activity-based costs are derived as follows: Overhead cost pool Set-up Special part Customer invoices Material handling Other overheads Total overheads (f) Total costs (g) Total costs Unit costs Unit costs Standard (a × e) £ Deluxe (b × e) £ Standard (f/12,000) £ Deluxe (g/12,000) £ 1,200 12,000 5,000 3,000 48,000 72,000 48,000 24,000 60,000 60,000 0.10 1.00 0.42 0.25 4.00 5.77 6.00 4.00 2.00 5.00 5.00 22.00 The total cost per unit is calculated as follows: Direct costs: Labour Material Indirect costs: Overheads (see above) Total cost per unit Standard £/unit Deluxe £/unit 16.00 22.00 20.00 32.00 5.77 43.77 22.00 74.00 The gross profit margin ratio is calculated as follows: Selling price Total cost (see above) Profit Standard £/unit 65.00 43.77 21.23 Deluxe £/unit 87.00 74.00 13.00 Gross profit margin ratio (gross profit/sales revenue) × 100% 32.67% 14.94% The figures show that, under the traditional approach, the gross profit margins are broadly equal between the two approaches. However, the ABC approach shows that the Standard product is far more profitable. Hence, the business should reconsider its policy of trying to persuade customers to switch to the Deluxe product. Criticisms of ABC Critics of ABC argue that analysing overheads in order to identify cost drivers is timeconsuming and costly, and that the benefit of doing so, in terms of more accurate product costing and the potential for cost control, does not justify the cost of carrying out the analysis. This cost–benefit issue is portrayed in Figure 1.2 (page 10). 381