Cost management accounting and control 6e by hansen mowen guan chapter 19

COST MANAGEMENT
Accounting & Control
Hansen▪Mowen▪Guan

Chapter 19
Pricing and Profitability
Analysis
COPYRIGHT © 2009 South-Western Publishing, a division of Cengage Learning.
Cengage Learning and South-Western are trademarks used herein under license.

1


Study Objectives
1. Discuss basic pricing concepts.
2. Calculate a markup on cost and a target cost.
3. Discuss the impact of the legal system and ethics on
pricing.
4. Calculate measures of profit using absorption and
variable costing.
5. Determine the profitability of segments.
6. Compute the sales price, price volume, contribution
margin, contribution margin volume, sales mix, market
share, and market size variances.
7. Describe some of the limitations of profit measurement.
2


Basic Pricing Concepts
Market Structure and Price
• Perfect Competition: Many buyers and

sellers; no one of which is large enough to
influence the market.
• Monopolistic Competition: Has both the
characteristics of both monopoly and
perfect competition.
• Oligopoly: Few sellers.
• Monopoly: Barriers to entry are so high
that there is only one firm in the market.
3


Market Structure and Price

4


Pricing Policies
• Cost-based pricing
– Established using “cost plus markup”

• Target costing and pricing
– Determine the cost of a product or service
based on the price (target price) that
customers are willing to pay
– Effectively used in conjunction with marketing
decisions
• Penetration pricing
• Price skimming
5

Pricing Policies
Cost-Plus Pricing
AudioPro Company sells and installs audio
equipment in homes, cars, and trucks.
AudioPro’s income statement for last year is as
follows:
Revenues
Cost of goods sold:
Direct materials
Direct labor
Overhead
Gross profit
Selling and administrative expenses
Operating income

$350,350
$122,500
73,500
49,000

245,000
$105,350
25,000
$ 80,350
6


Pricing Policies
Cost-Plus Pricing

The firm wants to earn the same amount of profit on each
job as was earned last year:
Markup on COGS =

(Selling and administrative expenses
+ Operating income) ÷ COGS

Markup on COGS =

($25,000 + $80,350) ÷ $245,000

Markup on COGS =

0.43 or 43%

7


Pricing Policies
Cost-Plus Pricing
The markup can be calculated using a variety of bases.
The calculation for markup on direct materials is as follows:
Markup on DM =

(Direct labor + Overhead + Selling and
administrative expense + Operating
income) ÷ Direct materials

Markup on DM =

($73,500 + $49,000 + $25,000 +
$80,350) ÷ $122,500

Markup on DM =

1.86 or 186%

8


Pricing Policies
Cost-Plus Pricing
AudioPro wants to expand the company’s product line to
include automobile alarm systems and electronic car door
openers. The cost for the sale and installation of one
electronic remote car door opener is as follows:
Direct materials (component and two remote controls)
Direct labor (2.5 hours x $12)
Overhead (65% of direct labor cost)
Estimated cost of one job
Plus 43% markup on COGS
Bid price

9

$ 40.00
30.00
19.50
$ 89.50
38.49

$127.99


Pricing Policies
Target Costing and Pricing
• Determine the cost of a product or service based on the
price that the customers are willing to pay.
Other installers price the remote car door opener at $110.
Possible actions:
Direct materials (component and two remotes)
$ 40.00
Include one remote instead of two
$35.00
Direct labor (2.5 hours x $12)
30.00
Train workers to reduce time (2 hours x $12)
24.00
Overhead (65% of direct labor cost)
Bid price is 19.50
now
Reduce overhead (50% of direct labor
cost) markup
competitive;
12.00
preserved
Estimated cost of one job
$ 89.50
10
Revised cost of one job

$


The Legal System and Pricing
• Predatory pricing
– The practice of setting prices below cost for
the purpose of injuring competitors and
eliminating competition

• Dumping
– Predatory pricing on the international market
– Companies sell below cost in other countries;
the domestic industry is injured.
11


The Legal System and Pricing
• Price discrimination
– Charging different prices to different
customers for essentially the same product.
– Robinson-Patman Act of 1936 prohibits
• Manufacturers or suppliers are covered by the act
• Price discrimination is allowed if
– If the competitive situation demands it and
– If costs (including costs of manufacture, sale, or delivery)
can justify the lower price

12

The Legal System and Pricing
Cobalt, Inc. manufactures vitamin supplements that costs
an average of $163 per case. Cobalt sold 250,000 cases
last year as follows:
Customer

Price per Case

Cases Sold

Large drug store chain

$200
125,000
Small local pharmacies
232
100,000
Individual health clubs
250
25,000

Cobalt is practicing price discrimination
… is it justifiable?
13


The Legal System and Pricing

$200  $178.40
 10.8%

$200

$232  $208.52
 10.1%
$232

$250  $222
 11.2%
$250
Profits vary within a narrow 1 percent range. The cost differences
among the three classes of customer appear to explain the price
14differences.


Measuring Profit
Absorption Costing
– Also referred to as full costing
– Required for external financial reporting
– Assigns all manufacturing costs, direct
materials, direct labor, variable overhead, and
a share of fixed overhead to each unit of
product
– Each unit of product absorbs some of the
fixed manufacturing overhead in addition to
the variable costs incurred to manufacture it.
15


Measuring Profit
Absorption-Costing

Lasersave, Inc., a company that recycles used toner
cartridges for laser printers. During August the firm
manufactured 1,000 cartridges at the following costs:
Direct materials
Direct labor
Variable overhead
Fixed overhead
Total manufacturing cost

$ 5,000
15,000
3,000
20,000
$43,000

During August, these cartridges were sold at $60
each. Variable marketing cost was $1.25 per unit.
Fixed expenses were $12,000.

16


Measuring Profit
Absorption-Costing

1,000 units produced; 1,000 units sold

*Direct materials ($5 x 1,000) $ 5,000
Direct labor ($15 x 1,000)

15,000

Variable overhead ($3 x 1,000)
Fixed overhead

3,000
20,000

Total manufacturing overhead
and cost of goods sold

$43,000

17


Measuring Profit
Absorption-Costing
1,250 units produced; 1,000 units sold

*Direct materials ($5 x 1,250) $ 6,250
Direct labor ($15 x 1,250)

18,750

Variable overhead ($3 x 1,250)

3,750

Fixed overhead ($16 per unit)

20,000

Total manufacturing overhead $48,750
Add: Beginning inventory
Less: Ending inventory
Cost of goods sold

0
(9,750)
$39,000

Production exceeded sales by 250
units; fixed overhead of $16 per unit is
carried in inventory thus reducing cost
of goods sold and increasing net
income
18


Measuring Profit
Variable-costing

• Also referred to as direct costing
• Assigns only unit-level variable
manufacturing costs to the product
– Direct materials
– Direct labor
– Variable overhead

• Fixed overhead is treated as a period cost
19


Measuring Profit

*Direct materials

$ 5,000

Direct labor

15,000

Variable overhead
Total variable manufacturing expenses
Add: Variable marketing expenses
Total variable expenses

3,000
$23,000
1,250
$24,250

20


Measuring Profit

*1,300 × $39 = $50,700

21


Measuring Profit

22


Profitability of Segments
Profit by Product Line
Alden Company manufactures two products: basic
fax machines and multi-function fax machines. The
multi-function fax uses more advanced technology;
therefore, it is more expensive to manufacture.
Basic
Number of units
Direct labor hours
Price
Prime cost per unit
Overhead per unit

20,000
40,000
$200
$55
$30

Multi-Function
10,000

15,000
$350
$95
$22.50

23


Profitability of Segments
Profit by Product Line

24


Profitability of Segments
Profit by Product Line

25