Managerial accounting 5th jiambalvo ch08

Estimating Demand The most difficult part of determining the profit maximizing price is determining the demand function used  Sales managers in various regions could estimate the tot

Pricing Decisions

 Pricing decisions are often the most

difficult decisions that managers

face

 Pricing decisions examined in this

chapter include

standpoint of economic theory

and activity based pricing

The Profit Maximizing Price

 Economic theory suggests that the

quantity demanded is a function of the price that is charged

 Generally, the higher the price, the

lower the quantity demanded

quantity demanded at various prices, determining the optimal price is straightforward

The Profit Maximizing Price

 To calculate the profit maximizing

price:

price to obtain the contribution margin

by the quantity demanded

profits

profit

Estimating the Profit

Maximizing Price

Estimating the Profit

Maximizing Price

Estimating Demand

 The most difficult part of

determining the profit maximizing price is determining the demand function

used

 Sales managers in various regions

could estimate the total quantity demanded at various prices

 The product could be test marketed

with a number of potential customers at various prices

 Estimates of price and quantity

Find the profit maximizing price

Test Your Knowledge 1

(Price - Variable) X Quantity - Fixed Cost = Profit

(6.95 - 1.50) X 20,000 - 80,000 = 29,000 (5.95 - 1.50) X 25,000 - 80,000 = 31,250

Pricing Special Orders

 Special orders are for goods and

services not considered part of a

company’s normal business

charged in the normal course of business

charging a price that is below full cost

Pricing Special Orders

 The special order decision presents two alternatives

 Reject

 Income from the main business is

the same under both alternatives

be considered in the special order

Pricing Special Orders

 Need to consider incremental

revenues and incremental costs

revenue associated with the special order

Special Orders – Premier Lens

Example

Special Orders – Premier Lens

Example

Should Premier Lens accept special

order of 20,000 lenses to be sold to Blix

Camera for $73 per lens?

Below is the full cost of $75 per lens

Special Orders – Premier Lens

Example

Special Orders – Premier Lens

Example

 Perform incremental analysis

 Fixed costs are not incremental, they

will not change if the order is accepted

Commonwealth Edison

Which of the following is true?

typically are not relevant

typically are relevant

Answer: a

Fixed costs typically are not relevant

Test Your Knowledge 2

Cost-Plus Pricing

 With a cost plus approach, the

company starts with an estimate of

product cost

administrative costs

 Adds a markup to arrive at a price

that allows for a reasonable level of profit

Cost-Plus Pricing

 Advantages

apply

profit if a sufficient quantity can be sold at the specified price

 The approach also has limitations

 Experimentation with different

markups may be necessary

 Inherently circular for manufacturing

firms

 Need to estimate demand to determine

Cost-Plus Pricing

All of the following are limitations of

cost plus pricing except

a Determination of the markup

percentage requires judgment

b Is inherently circular for

manufacturing firms

c Experimentation may be necessary

d Cost plus is simple to apply

Test Your Knowledge 3

Target Costing

difficult to make changes that reduce costs

 80% of a product’s costs cannot be

reduced once it is designed

 Product features drive costs

 Integrated approach to determine

features, price, costs and design to ensure a profit

Target Costing

 The process begins with an analysis of

competing products

 This leads to a specification of

features and price attractive to customers

 The second step is to specify a desired

level of profit

 Then the engineering department with

input from the cost accounting

Target Costing

that are already in production

Test Your Knowledge 4

are assigned to cost pools

 Indirect costs include processing orders, handling returns, and

shipments

customers using cost drivers to

determine customer profitability

 Subtracting these costs and product costs from customer revenue yields a

Customer profitability is measured as:

a Revenue minus cost of goods sold

b Revenue minus indirect manufacturing costs

c Revenue minus cost of goods sold minus indirect service costs

d Revenue minus cost of goods sold minus indirect manufacturing costs

Answer: c

Test Your Knowledge 5

Customer Profitability Measurement System

Customer Profitability Measurement System

Cost Pools and Cost Drivers to

Service Customers

Cost Pools and Cost Drivers to

Service Customers

Customer Profitability Analysis

Cost

A customer profitability measurement

(CPM) system:

a Allocates indirect costs to individual

customers

b Traces revenue to individual customers

c Traces cost of goods sold to individual

Customer Profitability Analysis

Customer Profitability and

Performance Measures

Customer Profitability and

Performance Measures

measures that will drive managers to improve customer profitability

 Percent of customers who are not

profitable

 Dollar loss for customers who are not profitable

 Average profit per customer

 Number of customer service requests per 100 customers

Activity-Based Pricing

 Customers are presented with

separate prices for services they

request in addition to the cost of

goods purchased

the services they request

on the supplier

 Also called menu-based pricing

Activity-Based Pricing

 Customers might object as the

price they pay should cover these

costs

 Lower prices slightly and then encourage customers to make fewer but larger purchases

 Customers could be encouraged to

Pricing Decisions

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