Cost Management ACCOUNTING AND CONTROL Pricing and Profitability Analysis

HANSEN & MOWENHANSEN & MOWEN

Cost ManagementCost ManagementACCOUNTING AND CONTROLACCOUNTING AND CONTROL

Pricing and Profitability AnalysisPricing and Profitability Analysis

Economic Pricing ConceptsEconomic Pricing Concepts

Quantity

P*

Q*

Price Supply

Demand

Basic Pricing ConceptsBasic Pricing Concepts 1

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.


Characteristics of the Four Basic Types of Market Characteristics of the Four Basic Types of Market StructureStructure

Characteristics of the Four Basic Types of Market Characteristics of the Four Basic Types of Market StructureStructure


Two Approaches to Pricing

1. Cost-based prices are established using “cost” plus markup.

2. Target prices are influenced by market conditions.

Pricing PoliciesPricing Policies 2

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 $350,350Cost of goods sold:

Direct materials $122,500Direct labor 73,500Overhead 49,000 245,000

Gross profit $105,350Selling and administrative expenses 25,000Operating income $ 80,350


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

Cost-Plus Pricing (continued)


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



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) $ 40.00

Direct labor (2.5 hours x $12) 30.00

Overhead (65% of direct labor cost) 19.50

Estimated cost of one job $ 89.50

Plus 43% markup on COGS 38.49

Bid price $127.99



Target Costing and Pricing

Target costing is a method of determining the cost of a

product or service based on the price that the customers

are willing to pay.

Target costing is a method of determining the cost of a

product or service based on the price that the customers

are willing to pay.

Target costing involves much more upfront work than cost-

based pricing. However, if the cost-plus pricing turns out to be higher than what customers will accept, additional work or lost

opportunity will result.

Target costing involves much more upfront work than cost-

based pricing. However, if the cost-plus pricing turns out to be higher than what customers will accept, additional work or lost

opportunity will result.


Predatory pricing is the practice of setting prices below cost for the purpose of injuring competitors

and eliminating competition.

CompetitionCompetition

Predatory pricing on the international

market is called dumping.

The Legal System and PricingThe Legal System and Pricing 3

Price discrimination refers to the charging of different prices to different customers for essentially the same

product.


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

Customer Prices per Case Cases Sold

Large drug store chain $200125,000

Small local pharmacies 232100,000

Individual health clubs 25025,000Cobalt is practicing price discrimination!Cobalt is practicing price discrimination!



Analysis of Cobalt, Inc., Customer Class CostsAnalysis of Cobalt, Inc., Customer Class CostsAnalysis of Cobalt, Inc., Customer Class CostsAnalysis of Cobalt, Inc., Customer Class Costs

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 $ 5,000Direct labor 15,000Variable overhead 3,000Fixed overhead 20,000 Total manufacturing cost $43,000

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

Absorption-Costing

Measuring ProfitMeasuring Profit 4

Absorption-Costing Income Statement for Absorption-Costing Income Statement for Lasersave, Inc., for AugustLasersave, Inc., for August

Absorption-Costing Income Statement for Absorption-Costing Income Statement for Lasersave, Inc., for AugustLasersave, Inc., for August


Absorption-Costing Income Statement for Absorption-Costing Income Statement for Lasersave, Inc., for SeptemberLasersave, Inc., for September

Absorption-Costing Income Statement for Absorption-Costing Income Statement for Lasersave, Inc., for SeptemberLasersave, Inc., for September


*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 20,000

Total manufacturing overhead $48,750

Add: Beginning inventory 0

Less: Ending inventory (9,750)

Cost of goods sold $39,000

Variable-Costing Income Statements Variable-Costing Income Statements for Lasersave, Inc.for Lasersave, Inc.

Variable-Costing Income Statements Variable-Costing Income Statements for Lasersave, Inc.for Lasersave, Inc.


*Direct materials $ 5,000

Direct labor 15,000

Variable overhead 3,000

Total variable manufacturing expenses $23,000

Add: Variable marketing expenses 1,250

Total variable expenses $24,250

Comparative Income Statements for Lasersave, Inc. Comparative Income Statements for Lasersave, Inc. for the Month of October for the Month of October

Comparative Income Statements for Lasersave, Inc. Comparative Income Statements for Lasersave, Inc. for the Month of October for the Month of October


Changes in Inventory under Absorption Changes in Inventory under Absorption and Variable Costing and Variable Costing

Changes in Inventory under Absorption Changes in Inventory under Absorption and Variable Costing and Variable Costing


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 Multi-Function

Number of units 20,000 10,000Direct labor hours 40,000 15,000Price $200 $350Prime cost per unit $55 $95Overhead per unit $30 $22.50

5Profitability of SegmentsProfitability of Segments

Profit by Product Line


Absorption-Costing Income by Product LineAbsorption-Costing Income by Product LineAbsorption-Costing Income by Product LineAbsorption-Costing Income by Product Line


Variable-Costing Income by Product LineVariable-Costing Income by Product LineVariable-Costing Income by Product LineVariable-Costing Income by Product Line


Overhead Activities and DriversOverhead Activities and DriversOverhead Activities and DriversOverhead Activities and Drivers


Activity-Based Costing Income by Product LineActivity-Based Costing Income by Product LineActivity-Based Costing Income by Product LineActivity-Based Costing Income by Product Line

Divisional Profit

Alpha Beta Gamma Delta Total

Sales $ 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 $ 61


Sales price variance =

Actual price –

Expected price x

Quantity sold

Price volume variance =

Actual volume

– Expected volume

xExpected

price

6Analysis of Profit-Related VariancesAnalysis of Profit-Related Variances

Contribution margin

variance=

Annual contribution

margin–

Budgeted contribution

margin

Contribution margin volume

variance=

Annual quantity

sold–

Budgeted quantity

soldx

Budgeted average unit contribution

margin


Data for Birdwell, Inc.Data for Birdwell, Inc.Data for Birdwell, Inc.Data for Birdwell, Inc.


Sales mix variance = [(Product 1 actual units – Product 1 budgeted units) x (Product 1 budgeted unit contribution margin – Budgeted average unit contribution margin)] + [(Product 2 actual units – Product 2 budgeted units) x (Product 2 budgeted unit contribution margin – Budgeted average unit contribution margin)]

Birdwell sales mix variance = [($1,250 – 1,500) x ($4.00 – $6.75)] + [(625 –500) x ($15.00 – $6.75)] = $1,718.75 Favorable


Market share variance = [(Actual market share percentage – Budgeted market share percentage) x (Actual industry sales in units)] x (Budgeted average unit contribution margin)

Market size variance = [(Actual industry sales in units – Budgeted industry sales in units) x (Budgeted market share percentage)] x (Budgeted average unit contribution margin)


7The Product Life CycleThe Product Life Cycle

Product Life CycleProduct Life CycleProduct Life CycleProduct Life Cycle


Impact of the Product Life Cycle on Cost ManagementImpact of the Product Life Cycle on Cost ManagementImpact of the Product Life Cycle on Cost ManagementImpact of the Product Life Cycle on Cost Management


Product Life Cycle Costs in the ABC CategoriesProduct Life Cycle Costs in the ABC CategoriesProduct Life Cycle Costs in the ABC CategoriesProduct Life Cycle Costs in the ABC Categories

8Limitations of Profit MeasurementLimitations of Profit Measurement

Limitations of profit include

focus on past performance

uncertain economic conditions

difficulty of capturing all important factors in financial measures

Successful firms measure far more than accounting profit.

Documents

Cost Management ACCOUNTING AND CONTROL Pricing and Profitability Analysis