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

Basic Pricing ConceptsMarket Structure and PricePerfect 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.

Market Structure and Price

Pricing PoliciesCost-based pricingEstablished using cost plus markupTarget costing and pricingDetermine the cost of a product or service based on the price (target price) that customers are willing to payEffectively used in conjunction with marketing decisionsPenetration pricingPrice skimming

Pricing PoliciesCost-Plus PricingAudioPro Company sells and installs audio equipment in homes, cars, and trucks. AudioPros income statement for last year is as follows:

Pricing PoliciesThe 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) $245,000Markup on COGS =0.43 or 43%Cost-Plus Pricing

Pricing PoliciesThe 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) $122,500Markup on DM =1.86 or 186%Cost-Plus Pricing

Pricing PoliciesAudioPro wants to expand the companys 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)$ 40.00Direct labor (2.5 hours x $12)30.00Overhead (65% of direct labor cost) 19.50Estimated cost of one job$ 89.50Plus 43% markup on COGS 38.49 Bid price$127.99Cost-Plus Pricing

Pricing PoliciesDetermine the cost of a product or service based on the price that the customers are willing to pay.Target Costing and PricingDirect materials (component and two remotes)$ 40.00Include one remote instead of two$35.00Direct labor (2.5 hours x $12)30.00Train workers to reduce time (2 hours x $12)24.00Overhead (65% of direct labor cost) 19.50Reduce overhead (50% of direct labor cost)12.00Estimated cost of one job$ 89.50Revised cost of one job$ 71.00Plus 43% markup on COGS 38.4930.53 Bid price$127.99$101.53Other installers price the remote car door opener at $110. Possible actions:Bid price is now competitive; markup preserved

The Legal System and PricingPredatory pricingThe practice of setting prices below cost for the purpose of injuring competitors and eliminating competitionDumpingPredatory pricing on the international marketCompanies sell below cost in other countries; the domestic industry is injured.

The Legal System and PricingPrice discriminationCharging different prices to different customers for essentially the same product. Robinson-Patman Act of 1936 prohibitsManufacturers or suppliers are covered by the actPrice discrimination is allowed ifIf the competitive situation demands it andIf costs (including costs of manufacture, sale, or delivery) can justify the lower price

The Legal System and PricingCobalt, Inc. manufactures vitamin supplements that costs an average of $163 per case. Cobalt sold 250,000 cases last year as follows:Cobalt is practicing price discrimination is it justifiable?

The Legal System and PricingProfits vary within a narrow 1 percent range. The cost differencesamong the three classes of customer appear to explain the price differences.

Measuring ProfitAbsorption CostingAlso referred to as full costingRequired for external financial reportingAssigns all manufacturing costs, direct materials, direct labor, variable overhead, and a share of fixed overhead to each unit of productEach unit of product absorbs some of the fixed manufacturing overhead in addition to the variable costs incurred to manufacture it.

Measuring ProfitLasersave, Inc., a company that recycles used toner cartridges for laser printers. During August the firm manufactured 1,000 cartridges at the following costs:Absorption-Costing

Measuring ProfitAbsorption-Costing*Direct materials ($5 x 1,000) $ 5,000Direct labor ($15 x 1,000) 15,000Variable overhead ($3 x 1,000) 3,000Fixed overhead 20,000Total manufacturing overheadand cost of goods sold $43,000

1,000 units produced; 1,000 units sold

Measuring Profit*Direct materials ($5 x 1,250) $ 6,250Direct labor ($15 x 1,250) 18,750Variable overhead ($3 x 1,250) 3,750Fixed overhead ($16 per unit) 20,000Total manufacturing overhead $48,750Add: Beginning inventory 0Less: Ending inventory (9,750)Cost of goods sold $39,000Absorption-CostingProduction exceeded sales by 250 units; fixed overhead of $16 per unit is carried in inventory thus reducing cost of goods sold and increasing net income1,250 units produced; 1,000 units sold

Measuring ProfitVariable-costingAlso referred to as direct costingAssigns only unit-level variable manufacturing costs to the productDirect materialsDirect laborVariable overheadFixed overhead is treated as a period cost

Measuring Profit*Direct materials $ 5,000Direct labor 15,000Variable overhead 3,000Total variable manufacturing expenses $23,000Add: Variable marketing expenses 1,250Total variable expenses $24,250

Measuring Profit*1,300 $39 = $50,700

Measuring Profit

Profitability of SegmentsAlden 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.Profit by Product Line

Profitability of SegmentsProfit by Product Line

Profitability of SegmentsProfit by Product Line

Profitability of SegmentsProfit by Product Line

Profitability of SegmentsProfit by Product Line

Profitability of Segments Alpha Beta Gamma Delta TotalSales$ 90$ 60$ 30$120$300Cost of goods sold 35 20 11 98 164Gross profit$ 55$ 40$ 19$ 22$136Division expenses-20-10-15-20-65Corporate expenses -3 -2 -1 -4 -10 Operating income (loss)$ 32$ 28$ 3$ -2$ 61Divisional Profit

Profitability of SegmentsCustomer profitabilityCompanies that assess the profitability of various customer groups can more accurately target their markets and increase profits.Identify the customerDetermine which customers add value to the company

Analysis of Profit-Related Variances

Sales Price VariancePrice Volume Variance

Analysis of Profit-Related VariancesThe sales price and price volume variances are labeled favorable if the variance increases profit above the amount expected. They are labeled unfavorable if the variance decreases profit below the amount expected.

Analysis of Profit-Related Variances

Sales Mix VarianceContribution Margin Volume Variance

Analysis of Profit-Related VariancesThe sales mix variance is favorable if the sales mix is weighted to the more profitable products.The contribution margin volume variance gives management information about gained or lost profit due to changes in the quantity of sales.

Analysis of Profit-Related Variances

Analysis of Profit-Related VariancesBirdwell, Inc.:

Analysis of Profit-Related Variances

Limitations of Profit MeasurementLimitations of profitability analysisFocus on past performanceEmphasis on quantifiable measuresImpact on behaviorSuccessful firms measure far more than accounting profit.

COST MANAGEMENTAccounting & ControlHansenMowenGuan

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