Cost management accounting and control 6e by hansen mowen guan chapter 19

Compute the sales price, price volume, contribution margin, contribution margin volume, sales mix, market share, and market size variances.. Pricing Policies • Cost-based pricing – Esta

COST MANAGEMENT

COPYRIGHT © 2009 South-Western Publishing, a division of Cengage Learning.

Cengage Learning and South-Western are trademarks used herein under license 1

Accounting & Control

Hansen▪Mowen▪Guan

Chapter 19 Pricing and Profitability

Analysis

Study Objectives

1 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 and

variable costing.

5 Determine the profitability of segments.

6 Compute the sales price, price volume, contribution

margin, contribution margin volume, sales mix, market share, and market size variances.

7 Describe some of the limitations of profit measurement.

Basic Pricing Concepts

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.

Market Structure and Price

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) that

customers are willing to pay

– Effectively used in conjunction with marketing decisions

• Penetration pricing

• Price skimming

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:

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

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) ÷ $122,500Markup on DM = 1.86 or 186%

Cost-Plus Pricing

Pricing Policies

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) $ 40.00Direct 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

Cost-Plus Pricing

Pricing Policies

Direct materials (component and two remotes) $ 40.00

Include one remote instead of two

$35.00

Direct labor (2.5 hours x $12) 30.00

Train workers to reduce time (2 hours x $12)

24.00

Overhead (65% of direct labor cost) 19.50

Reduce overhead (50% of direct labor cost)

12.00

Estimated cost of one job $ 89.50

Revised cost of one job $ 71.00

Plus 43% markup on COGS 38.49

The Legal System and Pricing

• 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 and

– If costs (including costs of manufacture, sale, or delivery) can justify the lower price

Cobalt, Inc manufactures vitamin supplements that costs

an average of $163 per case Cobalt sold 250,000 cases

last year as follows:

Customer Price per Case Cases Sold

Large drug store chain $200

125,000Small local pharmacies 232

100,000Individual health clubs 250

among the three classes of customer appear to explain the price differences.

Measuring Profit

Absorption Costing

– Also referred to as full costing

– Required for external financial reporting

– Assigns all manufacturing costs, direct

materials, direct labor, variable overhead, and

a share of fixed overhead to each unit of

product

– Each unit of product absorbs some of the

fixed manufacturing overhead in addition to the variable costs incurred to manufacture it.

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 $ 5,000

Variable 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 Profit

Total manufacturing overhead

and cost of goods sold $43,000

1,000 units produced; 1,000 units sold

*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 ($16 per unit) 20,000

Total manufacturing overhead $48,750

Add: Beginning inventory 0

Less: Ending inventory (9,750)

Cost of goods sold $39,000

Measuring Profit

Absorption-Costing

Production exceeded sales by 250 units; fixed overhead of $16 per unit is carried in inventory thus reducing cost

of goods sold and increasing net income

1,250 units produced; 1,000 units sold

Measuring Profit

Variable-costing

• Also referred to as direct costing

• Assigns only unit-level variable

manufacturing costs to the product

*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

Measuring Profit

*1,300 × $39 = $50,700

Measuring Profit

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

Profit by Product Line

Basic Multi-Function

Number of units 20,000 10,000

Direct labor hours 40,000 15,000

Prime cost per unit $55 $95

Overhead per unit $30 $22.50

Profitability of Segments

Profitability of Segments

Profit by Product Line

Profitability of Segments

Profit by Product Line

Profitability of Segments

Profit by Product Line

Profitability of Segments

Profit by Product Line

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 Segments

Divisional Profit

Profitability of Segments

Customer profitability

various customer groups can more

accurately target their markets and

increase profits.

1) Identify the customer

2) Determine which customers add value to the

company

Analysis of Profit-Related

Variances

Overall Sales Variance

[actual vs expected revenue]

Sales Price Variance Price Volume Variance

Analysis of Profit-Related

Variances

The 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

Contribution Margin Variance

[actual vs expected contribution margin]

Sales Mix Variance Contribution Margin Volume Variance

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 the

more profitable products.

Budgeted Contribution Actual Budgeted average unit margin volume = quantity - quantity contribution

variance sold sold margin

Analysis of Profit-Related

Variances

�

Birdwell, Inc.:

Analysis of Profit-Related

Variances

Limitations of Profit Measurement

• Limitations of profitability analysis

– Focus on past performance

– Emphasis on quantifiable measures

– Impact on behavior

• Successful firms measure far more than accounting profit.

COST MANAGEMENT

COPYRIGHT © 2009 South-Western Publishing, a division of Cengage Learning.

Cengage Learning and South-Western are trademarks used herein under license 38

Accounting & Control

Hansen▪Mowen▪Guan

End Chapter 19