Use of Cost and Income Data in Strategic Management Accounting (SMA)

Prompt:

A Strategic Management Accountant (SMA) uses cost and income data in a number of different decision making scenarios. Four such scenarios are:
1. Shutting down or keeping open part of the business;
2. Pricing products or services;
3. Product mix and limiting factor analysis; and
4. Make or buy decisions.

For each of the above four scenarios, you are asked to
a) Critically evaluate and discuss what the relevant costs and income would be, to enable the SMA to reach a decision; and
b) Discuss and comment on any qualitative factors that might need to be taken into account in reaching a decision;

Answer:

Strategic Management Accounting utilizes data related to costs and income to arrive at strategic decisions. This part discusses the relevant costs, income and qualitative factors that can be considered when making a decision. Four scenarios will be considered as examples in this analysis and discussion.

  1. Shutting down or keeping open part of the business

In order to decide whether to shut down or keep open part of a business, it is necessary to consider sources of strategic information in terms of costs and income. First, internal costs should be obtained in order to sharpen up existing efficiency reviews (Hanafizadeh et al, 2009). In this case, the current costs of operation should be assessed in order to determine whether they should shut down or keep open part of the business. If the current costs of operation such as administration costs, financing costs, and other internal costs are lower than the income, it will be necessary to continue keeping that part of the business open. On the other hand, if the costs are more than income, it will be better to shut down the part of the business. The cost of shutting down part of business such as administration costs, costs associated with demolition of structures, and costs opportunity costs should also be analysed to determine whether the option of shutting down is a good decision to make. Costs of paying employees for the business if it continues operating and costs of paying the team engaged in shutting down the business should also be considered.

In terms of income, the decision to be made should consider the income generated from the part of business under consideration. In this case, if the current and future income of part of the business is high, it should be kept open. On the other hand, if the part of the business gives only a small amount of income or revenue, it should be shut down. Income can also be achieved in terms of cost saving. Income from the business may include sales revenue from the business, income from continuing operations, and income from other sources related to the part of business being considered (Hanafizadeh et al, 2009). If the business is closed down, it may lead to cost saving which acts as a source of income.

Qualitative factors may also be considered in making this decision. The qualitative factors are non-financial factors which enhance success or failure of the business (Khaled et al, 2011). One of the qualitative factors that should be considered is customer and employee relationship. If shutting down will be against the interests of customers or employees, then the business should be kept operational because if customers will not be satisfied they may quit the entire organisation including other parts of the business. Furthermore, employees who depended on the part of the business for their living may oppose the shutdown; hence causing unrest at the workplace.

  1. Pricing Products or services

Price as one of the key elements of the marketing mix is an important aspect in strategic management accounting. The prices of a company’s products or services determine the amount of revenue to be earned. If the prices are low, the amount of sales revenue will be low; and if the prices of products or services are high, the amount of sales revenue will also be high. The main type of cost to be considered in setting prices for a business is the production cost. This includes the cost of purchasing raw materials and cost of processing the raw material into a desirable output. If the production cost is high, the prices should also be high in order to cover the costs and generate profits (Damodaran, 2012). Other types of costs include transportation costs, financing costs, salaries and wages, taxation costs, administration costs and other expenses that affect the company’s profits. The prices of products or services should cover these costs in order to earn profits for the business. Furthermore, the costs of competitors should be taken into consideration in order to set prices that will enhance competitive advantage in the company. Lifecycle costs should also be considered in setting prices for a product. These costs are the costs incurred throughout the lifecycle of the business (Levy & Sarnat, 1994).

In terms of income, prices can be provided based on the expected income of the product or service (Damodaran, 2012). For instance, if the business produces 100 units of a given product and wants to earn $1000 from the product in terms of revenue, it should set prices at $10 per unit. Income generated from the invested assets should also be considered so that the assets invested can generate the desired income.

Qualitative factors can also be considered when pricing products or services.  One of the factors is schedules and other internal control elements. The prices should meet the standards of the internal control system. Pricing should also consider the relationship with customers. High prices may chase away customers while low prices are favourable for attracting customers. Choices of present and future customers are often affected by the prices of products or services. Therefore, the prices of products and services should be set at levels that customers will accept. Long term profitability also needs to be considered when setting prices of goods and services.  Prices should be made in levels where future profitability will be achievable through customer satisfaction and retention. If high prices are set to meet current profitability needs, the future profitability may be affected negatively because customers may opt to quit the business. Quality of products and services should also be considered when pricing products. High quality products can retain customers and should be given high prices compared to low-quality products.

  1. Product Mix and Limiting Factor Analysis

When making a choice of the product mix to be developed, it is important to consider certain income and cost factors. First, the issue of fixed and variable costs comes in. Fixed costs are the costs incurred whether production takes place or not. For example, the cost of paying rent for an office is incurred whether the product is being produced or not. When choosing the products, it is important to consider products with the lowest fixed costs (Hansen & Mowen, 1997). Variable costs such as production costs change with the amount of products being produced. Products that incur lowest variable costs should be included in the product mix. Costs incurred by competitors should also be considered when choosing the products to be included in the product mix. For instance, if competitors incur high costs in producing a certain product compared to the costs that the company incurs in producing the same product, then the company should include the product in its product mix in order to obtain competitive advantage. The relevant income in this decision includes the expected sales revenue of each product in the product mix. If the sales revenue for a particular product is expected to be high, then the product should be omitted from the product mix. Limiting factors should also consider the sales revenue of each product.

In terms of qualitative factors, products of competitors should be considered. One should consider the products in the product mix which other competitors do not offer in order to minimize competition and reduce the number of substitutes in the market. Another qualitative aspect to be considered is the perceptions of consumers. If the consumers do not have interest or perceive a product negatively, then that product should not be included in the product mix. The chosen products should also be able to retain customers in order to enhance future profitability for the company.

  1. Make or buy decisions

The decision to manufacture a product in-house or purchase it from an external supplier depends on various cost, income and qualitative factors. The cost of production verses the cost of buying should be considered when making a make-or-buy decision (Levy & Sarnat, 1994). If it is cheaper for the product to be bought than to be manufactured in-house, then the decision will be to buy the product. On the other hand, if it is cheaper to manufacture the product in-house than to buy it, then the decision will be to make the product. In terms of income, the make-or-buy decision will consider the direct and indirect income to be earned from the product in both cases. If the income of buying the product is higher, then the product is bought instead of being manufactured in-house.

Quality factors are also considered in this case. First, the production capacity should be considered. If the production capacity is inadequate, then it will be necessary to buy the product instead of producing it in-house. Lack of in-house expertise will also prompt a manager to buy the product despite the associated purchase costs. The need for multiple sourcing and volume requirement should also be considered when making a make-or-buy decision. If the volume required is small, then the decision may be to buy because it will not be economical to make small volumes of the product.

Leave a Reply

Your email address will not be published. Required fields are marked *