Lecture Managerial accounting: Creating value in a dynamic business environment (10th edition): Chapter 15 - Ronald W. Hilton, David E. Platt

Chapter 15
Target Costing and
Cost Analysis for
Pricing Decisions

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Major Influences on
Pricing Decisions
Customer
demand

Political, legal,
and image issues

Pricing
Decisions

Competitors

Costs
15­2


How Are Prices Set?
Prices are determined by the market, subject
to costs that must be covered in the long run.

Costs

Market
Forces

Prices are based on costs, subject to
reactions of customers and competitors.
15­3


Economic Profit-Maximizing Pricing
Firms
Firms usually
usually have
have flexibility
flexibility in
in setting
setting prices.
prices.
The
The quantity
quantity sold
sold usually
usually
declines
declines as
as the
the price
price is
is increased.
increased.

15­4


Total Revenue Curve
Dollars

Total revenue

Curve is increasing throughout
its range, but at a declining rate
Quantity sold
per month
15­5


Demand Schedule and Marginal
Revenue Curve
Dollars
per unit
Sales price must decrease
to sell higher quantity
Demand
Revenue per
Marginal
unit decreases
revenue
as quantity increases

Quantity sold
per month

15­6


Total Cost Curve
Dollars

Total cost increases
at an increasing rate
Total cost increases
at a declining rate

Quantity made
per month
15­7


Marginal Cost Curve
Dollars
per unit
Marginal
cost
Quantity where
marginal cost
begins to increase

c

Quantity made
per month
15­8

Determining the Profit-Maximizing Price
and Quantity
Dollars
per unit

p*
Demand
Marginal
cost

Marginal Quantity made
revenue
q*

and sold
per month

15­9


Determining the Profit-Maximizing Price
and Quantity

Dollars
per unit

Profit is maximized where
marginal cost equals

marginal revenue, resulting
in price p* and quantity q*.

p*
Demand
Marginal
cost

Marginal Quantity made
revenue
q*

and sold
per month

15­10


Determining the Profit-Maximizing Price
and Quantity
Total cost
Total revenue

Dollars

Total profit at the
profit-maximizing
quantity and price,
q* and p*.
Quantity made

q*

and sold
per month

15­11


Cost-Plus Pricing
Price = cost + (markup percentage ×
cost)
Full-absorption
manufacturing
cost?

Variable
manufacturing
cost?

Total cost,
including selling
and administrative?

Total variable cost,
including selling
and administrative?
15­12


Strategic Pricing of New Products

Uncertainties make pricing difficult.
Production costs.
Market acceptance.

Pricing Strategies:
Skimming – initial price is high with intent to gradually lower

the price to appeal to a broader market.
Market Penetration – initial price is low with intent to quickly
gain market share.

15­13


Target Costing

Market research
determines the price
at which a new
product will sell.

Management computes
a manufacturing cost that
will provide an acceptable
profit margin.

Engineers and cost analysts design a product
that can be made for the allowable cost.
15­14

Target Costing
Price led
costing
Life-cycle
costs
Focus on
process
design

Cross-functional
teams

Key
principles
of target
costing
Focus
on the
customer

Value-chain
orientation
Focus on
product
design
15­15


The Role Of Activity-Based

Costing In Setting A
Target Cost

Production Process

Component Activities
15­16


Product Cost Distortion
High-volume products
may be overcosted

Low-volume products
may be undercosted

15­17


Value Engineering
and Target Costing
Target
Target cost
cost information
information

 Product
Product design
design


 Product
Product costs
costs

 Production
Production processes
processes
Value
Value Engineering
Engineering (VE)
(VE)

 Cost
Cost reduction
reduction

 Design
Design improvement
improvement

 Process
Process improvement
improvement
15­18


Time and Material Pricing
Price is the sum of

labor and material

charges.

Used by construction

companies, printers,
and professional
service firms.

15­19


Time and Material Pricing
Time charges:
Hourly
labor
cost

+

Overhead
cost per
labor hour

+

Hourly charge
to provide
profit margin

×

Total
labor hours
required

Material Charges:
Total
material
+
cost
incurred

Overhead
per dollar
of material
cost

×

Total
material
cost
incurred
15­20


Competitive Bidding
Low probability
of winning bid

High bid
price

High profit if
winning bid

High probability
of winning bid

Low bid
price

Low profit if
winning bid

15­21


Competitive Bidding
Guidelines
Guidelines for
for Bidding
Bidding
Bidder has
excess capacity

Low bid price
Any bid price in excess of
incremental costs of job
will contribute to fixed

costs and profit.

Bidder has no
excess capacity

High bid price
Bid price should be full
cost plus normal profit
margin as winning bid will
displace existing work.
15­22


Legal Restrictions On Setting Prices
Price discrimination
Predatory pricing

15­23