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Management Accounting And Strategy Notes

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MODULE 2: MANAGEMENT ACCOUNTING & STRATEGY Lecture 1 - Introduction to Management Accounting and Strategy READING 1: Pricing, Target Costing and Customer Profitability Analysis Chapter 12 (Bhimani et al, 2012) Major Influences on Pricing: (1) Customers
- Elasticity of product different for different customers - dynamic pricing
- Increased use of customer profiling and targeted pricing
- Price comparison sites help customers identify prices but unavailable for private offers (2) Competitors
- Higher competition - less influence on price
- Established departments to search out information on competitors
- Reverse engineering of competitors products
- Increasingly need to take global view rather than only considering domestic markets (3) Costs
- Generally price > cost although sometimes have to accept market determined price Product-Cost Categories and Time Horizon Short-Run Pricing (6mth - 1yr): (1) Pricing for a one-off special order with no LT implications (2) Adjusting product mix and output volume in a competitive market Long-Run Pricing (> 1 year): (1) Pricing a product in a major market where price setting has considerable leeway:
- Market based: Given what customers want/competitors do what should we charge?
- Cost-Based (Cost-Plus): Given cost of product what should we charge to recoup costs and produce desired profit?
Target Costing for Target Pricing

* Target Price: Estimated price for a product that potential customers will be willing to pay, based on perceived value for product and competitors' responses

* Target Cost: Estimated LR cost per unit of product that, when sold at target price, enables company achieve target operating profit

* To develop target prices and target costs: (1) Develop product that satisfies needs of potential customers (2) Choose target price based and target operating profit per unit (3) Derive target cost per unit by subtracting operating profit from price (4) Perform value engineering to achieve target costs Cost-Plus Pricing

* General Formula: Cost Based + Mark-Up = Prospective Selling Price

* Mark-up sometimes based on target rate of return on investment

* Firms may choose to mark-up percentages according to full product costs as allows:
- Full product cost recovery
- Price stability (allows for planning)
- Simplicity (no need to break down variable + fixed costs) Life-Cycle Product Budgeting and Costing

* Product Life Cycle: Time from initial R&D to when supports for customer is withdrawn

* Life Cycle Budgeting: Managers estimate revenues and costs attributable to each product for each stage in life cycle

* Life Cycle Costing: Tracks/accumulates actual costs attributable from start to finish

* 3 Important Benefits: (1) Full set of costs associated with each product become visible (2) Differences among products in % TC incurred at early stages in cycle are highlighted (3) Interrelationships among value-chain business function costs are emphasised Customer-Profitability Analysis

* Customer-Profitability Analysis: Reporting and analysis of customer revenues and customer costs - ensures customers contributing sizeably receive appropriate attention

* Customer Revenues: Inflows of assets from customers received in exchange for products/services being provided to those customers (must consider price discounting)
- Discounting can be recognised either by (1) recording list price less the discount or (2) only recording actual prices

* Customer Cost Hierarchy: Categorises costs related to customers into different cost pools on basis of different types of cost drivers or different degrees of difficulty in determining cause-and-effect relationships
- Highlights how some costs can be reliably assigned to individual customers while others can be reliably assigned only to distribution channels or corporate wide efforts

READING 2: Capital Investment Decisions Chapter 13 (Bhimani et al, 2012) Capital Budgeting

* Capital Budgeting: LT planning for proposed capital project (usually longer than one year - capital-budgeting decisions must consider revenues and costs over long periods)

* 6 Stage Process: (1) Identification Stage: Distinguish what types of capex investment will achieve firm's strategy and accomplish organisation objectives (2) Search Stage: Explore several projects which achieve organisations goals (3) Information Acquisition Stage: Consider predicted costs/consequences of options (4) Selection Stage: Choose projects for implementation (5) Financing Stage: Obtain product funding - equity & debt securities (6) Implementation & Control Stage: Put project in motion and monitor performance

* Often need to consider time value of money (i.e. opportunity cost of investment) DCF Methods

* Explicitly includes all projects CFs and time value of money in decisions

* NPV: Calculates expected net monetary gain or loss from project by discounting all expected future cash inflows and outflows to present using require rate of return; accept project if NPV > 0

* IRR: Calculates rate of return at which PV of Cash Inflows = PV of Cash Outflow; accept project if IRR > required rate of return

* NPV and IRR make different assumption about rate which project cash inflows are reinvested - may rank projects differently

* Non-financial & qualitative factors (e.g. effects of investment decisions on employee learning and company's ability to respond faster to market changes) often not explicitly considered in capital-budgeting decisions but can be important

* Should use sensitivity analysis to consider different possible scenarios

* Relevant cash inflows and outflows are ones that differ among the alternatives Payback Method

* Measures time it will take to recoup (in the form of cash inflows) the total amount invested in a project

* Neglects profitability and time value of money Accounting Rate of Return

* Operating profit divided by measure of investment

* Considers profitability but ignores time value of money Income Tax Factors

* 3 factors influence amount of depreciation claimed as a tax deduction: (1) Capital allowance - amount allowable for depreciation (2) The time period over which the asset is to be depreciated (3) Pattern of allowable depreciation Inflation

* 2 internally consistent ways to account for inflation in capital budgeting (1) Predict cash inflows and outflows in nominal terms and use nominal discount rate (2) Predict cash inflows and outflows in real terns and use real discount rate
Both should yield same NPV

READING 3: Strategic Management Accounting (Lord, 2007) Introduction

* Business strategy produces LT plans for business, taking into consideration plans and possible actions of competitors to position the firm so it has a competitive advantage

* Strategic Management Accounting: Must provide managers with internal, financial information and (financial & non-financial) information about the operating environment Strategy and Information Needs

* ~1970s firms started to consider external forces - initially seen as solely negative influence

* Porter (1985): Listed both advantages (absorbing demand fluctuations, serving unattractive segments) and disadvantages (lower prices, less bargaining power) posed by competitors

* Different relationships can exist between firms e.g. co-existence, co-operation

* Shift in view of competitors - concept of strategic management changes i.e. relationships can be cooperative (information sharing), as well as confrontational

* Need for external information other than competitors e.g. 'resources, skills, time availability, lines of credit, geographical sites and characteristics, demand forecasts) Traditional Management Accounting & Strategy (vs. Strategic MA)

Components of Strategic Management Accounting - Several Views: (1) Competitor Information
- Profits arising not from internal efficiency but firm's competitive position
- Simmons (1981): Advocates collecting and estimating cost, volume and price of competitors; determining what stage of life cycle competitors products are in (build/
maintain/harvest); calculating market share
- Bromwich (1990): Costs of barriers to entry (EOS, product differentiation, capital requirement, strategic pricing by incumbents, intensive R&D, excess capacity, vertical integration, existing networks)
- Coad (1996): Information can be obtained through the 'grapevine', former employees, public availably information, analyst reports, trade journals etc.
- Collier & Gregory (1995): Analyses strategic management in hotel sector - SWOT analysis, monitoring cost structure/pricing complies, benchmarking etc.
- Criticised as overemphasis on competitors can lead to mirroring actions rather than innovating; does not recognise possibility of alliances

(2) Strategic Position and MA Emphasis
- Porter (1985): 2 main ways to position firm to gain competitive a advantage (1) differentiate products (2) cost leadership
- Shank (1989): Different MA emphases depending on strategic position (see table)

- Chenhall and Langfield-Smith (1998): Differentiators benefits from balanced PM, employee-based measures, benchmarking, strategic planning techniques; low cost firms benefit from traditional accounting and ABC techniques
- Cooper (1996): Lean enterprises do not compete on differentiation/cost leadership instead 'collide' i.e. introduce products to match competitors
- Miles and Snow (1978): 3 successful strategies: (1) Prospector - emphasises individual creativity & innovation, LT perspective (2) Defender - emphasise formal accounting procedures and cost data (3) Analyser and one unsuccessful (1) Reactor
- Criticised for not questioning what strategy is, how it is formed, how it changes etc; strategies not always a result of strategic planning; even if deliberate strategies are achieve usefulness/validity of components of strategic MA can be questioned (3) Value Chain Perspective
- Value Chain Analysis: Linked set of value-creating activities all the way from basic raw material sources for component suppliers through to the ultimate end-use product delivered into the final consumers' hands'
- Porter (1985): Suggested firms analyse own value chain, identify activities which add value with the firm and associated cost; linkages could be identified to provide opportunities for optimising/coordinating/reconfiguring activities
- Firm's value chain joined to value chains of suppliers &
customers - exploitation of linkages can result in lowers costs - competitive advantage
- Can use ABC to analyse linkages with suppliers and lifecycle costing to determine value chain costs
- Cost Driver Analysis: Porter (1985) & Shank (1989) advocated determining causes of costs for each value activity split into structure and executional drivers: Structural Improvement - cost increase or decrease Executional Improvement - lower costs
- Competitive Advantage Analysis: Can extend VCA to analyse competitors VCs
- Criticised as value chain linkages may be recognised/acted up with out strategic MA

(4) Market-Oriented Information
- Collecting market information on product attributes desired by customers and the producing product at price customer will pay
- Bromwich (1990): CA achieved in market, should consider operating performance, relaibility, warranty arrangement, degree of finish/trim, assurance of supply, after sales service of products
- Can operationalise using target costing Role of the Accountant

* Whether there is a role for the accountant in strategic decision-making has been questioned - few cases of strategic MA highlighting role for accountant

* Debate should be a warning to MAs - unless they can work in teams, contributing strength in data collection/analysis, possible that strategic MA will develop without involvement of accountants Despite research and teaching about strategic MA, it is rarely used in practice and appreciation of meaning is limited

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