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«Paul M. Collier Aston Business School, Aston University Accounting for Managers Accounting for Managers: Interpreting accounting information for ...»

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ž it is aggregated to the corporate level, whereas managers require information at the business unit level;

ž it is aggregated to annual figures, whereas managers require timely information, at not less than monthly intervals;

ž it is aggregated to headline figures, whereas managers require information in much greater detail;

ž it does not provide a comparison of plan to actual figures to provide a gauge on progress towards achieving business goals.


Consequently, the following chapters are concerned with the disaggregated (to business unit level), more regular (usually monthly) and more detailed information necessary for management decision-making, planning and control.

This chapter and the previous chapter have set financial statements in the context of alternative theoretical frameworks that can provide different perspectives on accounting information. In the words of Bebbington et al. (2001), accounting practice is the result of ‘habit, history, law and expedience, as well as social, political and economic choice’ (p. 8). These alternative perspectives continue throughout the second part of this book.

References Bebbington, J., Gray, R. and Laughlin, R. (2001). Financial Accounting: Practice and Principles.

(3rd edn). London: Thomson Learning.

Blake, J. (1997). Accounting Standards. (6th edn). London: Financial Times/Pitman Publishing.

DiMaggio, P. J. and Powell, W. W. (1983). The iron cage revisited: Institutional isomorphism and collective rationality in organizational fields. American Sociological Review, 48, 147–60.

Edvinsson, L. and Malone, M. S. (1997). Intellectual Capital. London: Piatkus.

Gowthorpe, C. and Blake, J. (eds) (1998). Ethical Issues in Accounting. London: Routledge.

Gray, R. H., Owen, D. L. and Adams, C. (1996). Accounting and Accountability: Changes and Challenges in Corporate Social and Environmental Reporting. London: Prentice Hall.

Griffiths, I. (1986). Creative Accounting: How to Make Your Profits What You Want Them to Be.

London: Waterstone.

Guthrie, J. (2001). The management, measurement and the reporting of intellectual capital.

Journal of Intellectual Capital, 2(1), 27–41.

Jones, T. C. (1995). Accounting and the Enterprise: A Social Analysis. London: Routledge.

Meyer, J. W. (1994). Social environments and organizational accounting. In W. R. Scott and J. W. Meyer (eds), Institutional Environments and Organizations: Structural Complexity and Individuality, Thousand Oaks, CA: Sage, Publications.

Richardson, S. and Richardson, B. (1998). The accountant as whistleblower. In C. Gowthorpe and J. Blake (eds), Ethical Issues in Accounting, London: Routledge.

Scott, W. R. (1995). Institutions and Organizations. Thousand Oaks, CA: Sage Publications.

Smith, T. (1992). Accounting for Growth: Stripping the Camouflage from Company Accounts.

London: Century Business.

Stewart, T. A. (1997). Intellectual Capital: The New Wealth of Organizations. London: Nicholas Brealey Publishing.

Zadek, S. (1998). Balancing performance, ethics, and accountability. Journal of Business Ethics, 17(13), 1421–41.

Marketing Decisions

This chapter considers the use of accounting information in making marketing decisions. It begins with an overview of some of the key elements of marketing theory and introduces cost behaviour: the distinction between fixed and variable costs, average and marginal costs. Decisions involving the relationship between price and volume are covered through the technique of cost–volume–profit (CVP) analysis. Different approaches to pricing are covered: cost-plus pricing; target rate of return; the optimum selling price; special pricing decisions; and transfer pricing.

The chapter concludes with an introduction to segmental profitability.

Marketing strategy Porter (1980) identified five forces that affect an industry: the threat of new entrants, the bargaining power of customers, the bargaining power of suppliers, and the threat of substitute product/services. Against these four forces, the industry is composed of competitors, each of which develops strategies for success. In a later book, Porter (1985) identified three generic strategies that businesses can adopt in order to achieve a sustainable competitive advantage. The alternative strategies were to be a low-cost producer, a higher-cost producer that can differentiate its product/services, or to focus on a market niche. Consequently, the notion of cost is important in marketing decisions, particularly pricing decisions.

Marketing is the business function that aims to understand customer needs and satisfy those needs more effectively than competitors. Marketing can be achieved through a focus on selling products and services or through building lasting relationships with customers (customer relationship management). Marketing texts emphasize the importance of adding value through marketing activity.

Adding value differentiates product/services from competitors, and enables a price to be charged that equates to the benefits obtained by the customer. However, for any business to achieve profitability, customers must be prepared to pay more for the product/service benefit than the benefit costs to provide.

The price customers are willing to pay depends on what Doyle (1998) calls the ‘factors which drive up the utility of an offer’, which he divides into four groups. Product drivers include performance, features, reliability, operating costs and serviceability. Services drivers include ease of credit availability, ordering, delivery, installation, training, after-sales service and guarantees. Personnel drivers


include the professionalism, courtesy, reliability and responsiveness of staff. Image drivers reflect the confidence of customers in the company or brand name, which is built through the other three drivers and by advertising and promotional activity.

Doyle (1998) recognized that each of these value drivers has cost drivers.

The sales mix is the mix of product/services offered by the business, each of which may be aimed at satisfying different customer needs. Businesses develop marketing strategies to meet the needs of their customers in different market segments, each of which can be defined by its unique characteristics. These segments may yield different prices and incur different costs as customers demand more or less of different product/services.

Pricing of product/services is crucial to business success, in terms of increasing the perceived value so as to maximize the margin between price and cost and to increase volume and market share without eroding profits. Pricing strategies may be aimed at penetration – achieving long-term market share – or skimming – maximizing short-term profits from a limited market.

A focus on customer relationship management entails taking a longer-term view than product/service profitability and emphasizes the profits that can be derived from a satisfied customer base. Doyle (1998) describes loyal customers as assets, quoting research that tried to measure the value of a loyal customer.

Doyle says, ‘If managers know the cost of losing a customer, they can evaluate the likely pay-off of investments designed to keep customers happy’ (pp. 51–2).

Doyle explained that the cost of winning new customers is high, loyal customers tend to buy more regularly, spend more and are often willing to pay premium prices. This is an element of the business goodwill, part of the ‘intellectual capital’ that is not reported in financial statements (see Chapter 7).

A further element of marketing is the distribution channel to be used. This may range from the company’s own salesforce to retail outlets, direct marketing and the number of intermediaries between the product/service provider and the ultimate customer.

Marketing texts typically introduce marketing strategy as a combination of the 4 Ps of product, price, place and promotion. The marketing strategy for a business will encompass decisions about product/service mix, customer mix, market segmentation, value and cost drivers, pricing and distribution channel.

Each element of marketing strategy implies an understanding of accounting, which

can help to answer questions such as:

ž What is the volume of product/services that we need to sell to maintain profitability?

ž What alternative approaches to pricing can we adopt?

ž What is our customer, product/service and distribution channel profitability in each of our market segments?

This chapter is concerned with answering these questions. Although information on competitors, customers and suppliers is likely to be limited, strategic management accounting (see Chapter 4) can apply the same tools and techniques in the pursuit of competitive advantage.

MARKETING DECISIONS 105 Cost behaviour Marketing decisions cannot be made in isolation from knowledge of the costs of the business and the impact that marketing strategy has on operations and on business profitability. Profitability for marketing decisions is the difference between revenue – the income earned from the sale of product/services – and cost.

As we saw in Chapter 3, it is the notion of cost that is problematic.

For many business decisions, it is helpful to distinguish between how costs behave, i.e. whether they are fixed or variable. Fixed costs are those that do not change with increases in business activity (such as rent). This is not to say that fixed costs never change (obviously rents do increase in accordance with the terms of a lease) but there is no connection (except sometimes in large retail sites) between cost and the volume of activity. By contrast, variable costs do increase/decrease in proportion to an increase/decrease in business activity, so that as a business produces more units of a good or service, the business incurs proportionately more costs.

For example, advertising is a fixed cost because there is no relationship between spending on advertising and generating revenue (although we may wish there was). However, sales commission is a variable cost because the more a business sells, the more commission it pays out.

A simple example shows the impact of fixed and variable cost behaviour on total and average cost. XYZ Limited has the capacity to produce between 10,000 and 30,000 units of a product each period. Its fixed costs are £200,000. Variable costs are £10 per unit. The example is shown in Table 8.1.

In this example, even if the business produces no units, costs are still £200,000 because fixed costs are independent of volume. Total costs increase as the business incurs variable costs of £10 for each unit produced. However, the average cost declines with the increase in volume because the fixed cost is spread over more units.

Not all costs are quite so easy to separate between fixed and variable. Some costs are semi-fixed, while others are semi-variable. Semi-fixed costs (also called step fixed costs) are constant within a particular level of activity, but can increase when activity reaches a critical level. This can happen, for example, with changes from a single-shift to a two-shift operation, which requires not only additional variable costs but additional fixed costs (e.g. extra supervision). Semi-variable Cost behaviour – fixed and variable costs Table 8.1

–  –  –

costs have both fixed and variable components. A simple example is a telephone bill, which will have a fixed component (rental) and a variable component (calls).

Maintenance of motor vehicles can be both time based (the fixed component) and mileage based (the variable component).

This example introduces the notion of marginal cost. The marginal cost is the cost of producing one extra unit. In the above example, to increase volume from 10,000 to 15,000 units incurs a marginal cost of £50,000 (which in this case is 5,000 additional units at a variable cost of £10 each). However, marginal costs may include a fixed-cost element (in the case of semi-fixed costs).

The notion of cost is therefore quite difficult. Is the cost in the above example the average cost or the marginal cost? If it is the average cost, what level of activity is chosen to determine that average, given fluctuating volumes of sales from period to period?

Cost–volume–profit analysis

A method for understanding the relationship between revenue, cost and sales volume is cost–volume–profit analysis, or CVP. CVP is concerned with understanding the relationship between changes in activity (the number of units sold) and changes in selling prices and costs (both fixed and variable). Typical questions

that CVP may help with are:

ž What is the likely effect on profits of changes in selling price or the volume of activity?

ž If we incur additional costs, what changes should we make to our selling price or to the volume that we need to sell?

CVP is used by accountants in a relatively simplistic manner. While most businesses will sell a wide range of product/services at many different prices (e.g.

quantity discounts), accountants assume a constant product/service mix and average selling prices per unit. The assumption is that these relationships are linear, rather than the curvilinear models preferred by economists that reflect economies and diseconomies of scale. The accountant limits this problem by recognizing the relevant range. The relevant range is the volume of activity within which the business expects to be operating over the short-term planning horizon, typically the current or next accounting period, and the business will usually have experience of operating at this level of output. Within the relevant range, the accountant’s model and the economist’s model are similar.

Profit can be shown as the difference between revenue and costs (both fixed

and variable). This relationship can be shown in the following formula:

–  –  –

Using the example of XYZ Limited, a selling price of £25 for 20,000 units would

yield a net profit of:

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