Ch19 Guan hansen mowen

8/10/2019 Ch19 Guan hansen mowen

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COST MANAGEMENT

Guan Hansen Mowen

COPYRIGHT 2009 South-Western Publishing, a division of Cengage Learning.Cengage Learning and South-Western are trademarks used herein under license. 1

Chapter 19

Pricing and ProfitabilityAnalysis


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Study Objectives1. 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 andvariable costing.

5. Determine the profitability of segments.

6. Compute the sales price, price volume, contributionmargin, contribution margin volume, sales mix, marketshare, and market size variances.

7. Describe some of the limitations of profit measurement.


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Basic Pricing Concepts

Market Structure and Price Perfect Competition: Many buyers and

sellers; no one of which is large enough toinfluence the market.

Monopolistic Competition: Has both thecharacteristics 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.


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Market Structure and Price


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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) thatcustomers are willing to pay

Effectively used in conjunction with marketingdecisions

Penetration pricing Price skimming


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Cost-Plus Pricing AudioPro Company sells and installs audioequipment in homes, cars, and trucks.

AudioPros income statement for last year is as

follows:Revenues $350,350Cost of goods sold:

Direct materials $122,500

Direct labor 73,500Overhead 49,000 245,000Gross profit $105,350Selling and administrative expenses 25,000Operating income $ 80,350

Pricing Policies


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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%

Cost-Plus Pricing

Pricing Policies


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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 andadministrative expense + Operatingincome) Direct materials

Markup on DM = ($73,500 + $49,000 + $25,000 +$80,350) $122,500

Markup on DM = 1.86 or 186%

Cost-Plus Pricing

Pricing Policies


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AudioPro wants to expand the companys product line toinclude automobile alarm systems and electronic car dooropeners. The cost for the sale and installation of oneelectronic 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 $ 89.50

Plus 43% markup on COGS 38.49Bid price $127.99

Cost-Plus Pricing

Pricing Policies


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Target Costing and Pricing

Pricing Policies

Determine the cost of a product or service based on theprice that the customers are willing to pay.

Direct materials (component and two remotes) $ 40.00Include one remote instead of two $35.00

Direct labor (2.5 hours x $12) 30.00Train workers to reduce time (2 hours x $12) 24.00

Overhead (65% of direct labor cost) 19.50Reduce overhead (50% of direct labor cost) 12.00

Estimated cost of one job $ 89.50Revised cost of one job $ 71.00

Plus 43% markup on COGS 38.49 30.53Bid price $127.99 $101.53

Other installers price the remote car door opener at $110.Possible actions:

Bid price is nowcompetitive; markup

preserved


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The Legal System and Pricing

Predatory pricing The practice of setting prices below cost for

the purpose of injuring competitors andeliminating competition

Dumping Predatory pricing on the international market

Companies sell below cost in other countries;the domestic industry is injured.


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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 a n d If costs (including costs of manufacture, sale, or delivery)

can justify the lower price


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Cobalt, Inc. manufactures vitamin supplements that costsan average of $163 per case. Cobalt sold 250,000 caseslast year as follows:

Customer Price per Case Cases Sold

Large drug store chain $200 125,000Small local pharmacies 232 100,000Individual health clubs 250 25,000

Cobalt is practicing pricediscrimination is it

justifiable?



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$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 differences.


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Measuring Profit

Absorption Costing Also referred to as full costing Required for external financial reporting

Assigns all manufacturing costs, directmaterials, direct labor, variable overhead, anda share of fixed overhead to each unit ofproduct

Each unit of product absorbs some of thefixed manufacturing overhead in addition tothe variable costs incurred to manufacture it.


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Lasersave, Inc., a company that recycles used tonercartridges for laser printers. During August the firmmanufactured 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 $60each. Variable marketing cost was $1.25 per unit.Fixed expenses were $12,000.

Absorption-CostingMeasuring Profit


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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


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*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 $48,750

Add: Beginning inventory 0Less: Ending inventory (9,750)

Cost of goods sold $39,000

Measuring ProfitAbsorption-Costing

Production exceeded sales by 250units; fixed overhead of $16 per unit iscarried in inventory thus reducing costof goods sold and increasing netincome

1,250 units produced; 1,000 units sold


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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


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*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

Measuring Profit


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Measuring Profit

*1,300 $39 = $50,700


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Measuring Profit


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Alden Company manufactures two products: basicfax machines and multi-function fax machines. Themulti-function fax uses more advanced technology;

therefore, it is more expensive to manufacture.

Profit by Product Line

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

Profitability of Segments


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Profitability of SegmentsProfit by Product Line


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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

Profitability of SegmentsDivisional Profit


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Profitability of Segments

Customer profitability

Companies that assess the profitability ofvarious customer groups can moreaccurately target their markets andincrease profits.

1) Identify the customer

2) Determine which customers add value to thecompany


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Analysis of Profit-RelatedVariances

Overall Sales Variance[actual vs. expected revenue]

Sales Price Variance Price Volume Variance


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Sales price Actual Expected Quantity= -variance price price sold

Price volume Actual Expected Expected= -variance volume volume priceThe sales price and price volume variances are labeled favorable ifthe variance increases profit above the amount expected. They are

labeled unfavorable if the variance decreases profit below the amountexpected.


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Contribution Margin Variance[actual vs. expected contribution margin]

Sales Mix Variance Contribution MarginVolume Variance


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P1 actual units P1 budgeted CM- P1 budgeted units - Budgeted average unit CM P2 actual units P2 budgeted CM+- P2 budgeted units - Budgeted average unit CM

Sales Mix Variance =

The sales mix variance is favorable if the sales mix is weighted to themore profitable products.

BudgetedContribution Actual Budgetedaverage unitmargin volume = quantity - quantity contributionvariance sold sold margin

The contribution margin volume variance gives management informationabout gained or lost profit due to changes in the quantity of sales.


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contribution margin variance$14,375 $13,500 = $875 favorable

sales mixvariance

contribution marginvolume variance

(2,000 1,875) $6.75

= $1,718.75 favorable = $843.75 unfavorable

1,250 $4.00- 1,500 - $6.75

625 $15.00+ - 500 - $6.75

Birdwell, Inc.:


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Actual Budgeted Actual Budgeted industry averagemarket share - market share sales unitpercentage percentagein units CM

Market share variance =

Budgeted Budgeted Actual Budgeted market averageindustry sales - industry sales share unitin units in units percentage CM

Market size variance =


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Limitations of Profit Measurement

Limitations of profitability analysis Focus on past performance Emphasis on quantifiable measures Impact on behavior

Successful firms measure far more thanaccounting profit.


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COST MANAGEMENT

Guan Hansen Mowen

COPYRIGHT 2009 South-Western Publishing, a division of Cengage Learning.C L i d S h W d k d h i d li 38

End Chapter 19

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