Chapter 15 – Target Costing and Cost Analysis for Pricing Decisions
15-1
CHAPTER 15
Target Costing and Cost Analysis for Pricing
Decisions
ANSWERS TO REVIEW QUESTIONS
15-1 In the long run, every organization must price its product or service above the total
15-2 The statement that prices are determined by production costs is too simplistic.
15-3 Four major influences on pricing decisions are as follows:
(1) Customer demand: Management must consider customers’ demand for their
15-4 It is crucial to define the firm’s product when considering the reaction of
competitors, so that the competitors can be identified. For example, is a firm that
15-2
15-5 In most industries, both market forces and cost considerations heavily influence
prices. No organization can price its products below their production costs in the
15-6 The profit-maximizing price is the price for which the associated quantity is
15-7 (a) Total revenue: Price multiplied by quantity sold.
15-9 Three limitations of the economic, profit-maximizing model of pricing are as follows:
15–10 Determining the best approach to pricing requires a cost-benefit trade-off. While the
Chapter 15 – Target Costing and Cost Analysis for Pricing Decisions
15-3
15–11 The general formula for cost-plus pricing is as follows:
15–12 The four cost bases commonly used in cost-plus pricing are the following:
absorption manufacturing cost, total cost, variable manufacturing cost, and total
15–13 Four reasons often cited for the widespread use of absorption cost as the cost base
in cost-plus pricing formulas are as follows:
(1) In the long run, the price must cover all costs and a normal profit margin.
15–14 The primary disadvantage of absorption-cost or total-cost pricing formulas is that
15–15 Three advantages of pricing based on variable cost are as follows:
(2) Variable-cost data do not require allocation of common fixed costs to individual
product lines.
15-4
fixed costs.
15–17 Return-on-investment pricing is an approach under which the price is set so that it
15–18 Price-led costing refers to the process under target costing of first determining the
15–19 To be successful at target costing, management must listen to the company’s
15–20 Value-engineering is a cost-reduction and process-improvement technique used to
15–21 Tear-down methods can be used in a service-industry firm just as they are used in
15–22 Under time-and-material pricing, the price includes a cost-based charge for labor, a
15–23 When a firm has excess capacity, there is no opportunity cost in accepting an
additional production job. Therefore, it is not necessary to reflect such an
15-5
15–24 The decision to accept or reject a special order and the selection of a price for a
special order are similar decisions. If a price has been offered for a special order,
15–25 (a) Skimming pricing: Setting a high initial price for a new product in order to reap
(c) Target costing: Conducting market research to determine the price at which a
15–26 (a) Unlawful price discrimination: Quoting different prices to different customers for
15–27 Traditional, volume-based product-costing systems often overcost high-volume and
relatively simple products while undercosting low-volume and complex products.
Chapter 15 – Target Costing and Cost Analysis for Pricing Decisions
15-6
SOLUTIONS TO EXERCISES
EXERCISE 15-28 (25 MINUTES)
q*
Total cost
Total revenue
Chapter 15 – Target Costing and Cost Analysis for Pricing Decisions
15-7
EXERCISE 15-29 (30 MINUTES)
1. Tabulated price, quantity, and revenue data:
(1)
Quantity
Sold per
Month
(2)
Unit
Sales
Price
(3)
Total
Revenue
per
Month*
(4)
Changes
in Total
Revenue†
20
…………………………..
$500
…………………………..
$10,000
40
…………………………..
…………………………..
60
…………………………..
…………………………..
80
…………………………..
…………………………..
15-8
EXERCISE 15-29 (CONTINUED)
2. Total revenue curve:
$ 5,000
$25,000
$20,000
$15,000
Dollars
$40,000
$35,000
•
•
$30,000
$10,000
•
•
15-9
EXERCISE 15-30 (30 MINUTES)
1. Tabulated cost and quantity data:
(1)
Quantity
Produced
and Sold per
Month
(2)
Average
Cost per
Unit
(3)
Total
Cost per
Month*
(4)
Changes
in Total
Cost†
20
…………………………..
$450
…………………………..
$ 9,000
40
…………………………..
…………………………..
60
…………………………..
…………………………..
80
…………………………..
…………………………..
Chapter 15 – Target Costing and Cost Analysis for Pricing Decisions
15–10
EXERCISE 15-30 (CONTINUED)
2. Total cost curve:
$15,000
$10,000
$ 5,000
Total cost increases
at an increasing rate
Dollars
$45,000
$40,000
$30,000
$25,000
$20,000
•
Chapter 15 – Target Costing and Cost Analysis for Pricing Decisions
15–11
EXERCISE 15-31 (40 MINUTES)
1. Tabulated revenue, cost, and profit data:
(1)
Quantity
Produced
and Sold
per Month
(2)
Sales
Price
per Unit
(3)
Total
Revenue
per
Month*
(4)
Total
Cost
per
Month†
(5)
Profit
per
Month**
20
…………………………..
$500
…………………………..
$10,000
$ 9,000
…………………………..
$1,000
40
…………………………..
…………………………..
19,000
17,000
…………………………..
60
…………………………..
…………………………..
27,000
24,600
…………………………..
80
…………………………..
…………………………..
34,000
34,400
…………………………..
Chapter 15 – Target Costing and Cost Analysis for Pricing Decisions
15–12
EXERCISE 15-31 (CONTINUED)
2. Total revenue and cost curves:
$40,000
•
•
$10,000
•
$25,000
Dollars
$30,000
$20,000
$15,000
•
•
Chapter 15 – Target Costing and Cost Analysis for Pricing Decisions
15–13
EXERCISE 15-32 (30 MINUTES)
1. Price = total unit cost + (markup percentage total unit cost)
Allocated fixed
selling and
administrative cost
=
total
unit
cost
–
all
manufacturing
costs
–
variable
selling and
administrative cost
Cost-Plus Pricing Formula
2.
a.
Variable manufacturing cost …………………………..
$275
$495 = $275 + (80% $275)*
Applied fixed manufacturing cost …………………………..
Variable manufacturing cost …………………………..
**($495 – $341) ÷ $341 = 45.16% (rounded)
15–14
EXERCISE 15-33 (15 MINUTES)
1.
Profit on sales of 60,000 units:
Sales revenue (60,000 9.00p) ……………………………………….
540,000p
Less: Variable costs:
Contribution margin ………………………………………………………
Less: Fixed costs (90,000p + 7,500p) ………………………………
Profit …………………………………………………………………………….
2. Required price on special order:
Unit contribution margin
required on special order
=
order special in volumesalesunit
profit additional target
=
Chapter 15 – Target Costing and Cost Analysis for Pricing Decisions
15–15
EXERCISE 15-34 (25 MINUTES)
Cost-Plus Pricing Formula
$600 = $300 + (100% $300)a
Applied fixed manufacturing cost …………………………..
(2)
Absorption manufacturing cost …………………………..
$405
$600 = $405 + (48.15% $405)b
Variable selling and administrative cost …………………………
(3)
Total cost
$525
Variable manufacturing cost …………………………..
Variable selling and administrative cost …………………………
Chapter 15 – Target Costing and Cost Analysis for Pricing Decisions
15–16
EXERCISE 15-35 (30 MINUTES)
Markup percentage
applied to cost base in
cost-plus
pricing formula
=
profit required to
achieve target ROI
+
total annual costs not
included in cost base
annual
volume
cost base per unit
used in cost-plus
pricing formula
15–17
EXERCISE 15-35 (CONTINUED)
In the preceding formula:
$60,000
=
target profit (given)
480
=
annual volume of Wave Darter production and sales (from Exhibit 15-5)
=
variable manufacturing cost per unit (from Exhibit 15–5)
$50
=
variable selling and administrative cost per unit (from Exhibit 15-5)
=
applied fixed manufacturing cost per unit (from Exhibit 15-5)
=
allocated fixed selling and administrative cost per unit (from Exhibit 15-5)
2.
Markup percentage
=
*$650 480
costs tiveadministra
andselling total
$60,000
+
=
42.31% (rounded)
Thus the Wave Darter’s price would be set equal to $925, where
Chapter 15 – Target Costing and Cost Analysis for Pricing Decisions
15–18
EXERCISE 15-36 (15 MINUTES)
1. Material component of time and material pricing formula:
handling material
material
material
2. Material component of price, using formula developed in requirement (1):
New price to be quoted on yacht refurbishment:
Total price of job = time charges + material charges
EXERCISE 15-37 (30 MINUTES)
Answers will vary widely, depending on the company and the product chosen. The answer
Chapter 15 – Target Costing and Cost Analysis for Pricing Decisions
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SOLUTIONS TO PROBLEMS
PROBLEM 15-38 (45 MINUTES)
1. The order will boost Heartland’s net income by $13,950, as the following calculations
show.
Sales revenue ……………………………………………..
$82,500
Less: Sales commissions (10%) …………………..
8,250
$74,250
Less manufacturing costs:
$14,600
8,400
Income before taxes ……………………………………
Income taxes (40%) ……………………………………..
2. Yes. Although this amount is below the $82,500 full-cost price, the order is still
profitable. Heartland can afford to pick up some additional business, because the
company is operating at 75 percent of practical capacity.
Sales revenue …………………………………………………..
$63,500
Less: Sales commissions (10%) ………………………..
6,350
$57,150
Less manufacturing costs:
$14,600
8,400
Income before taxes …………………………………………
$ 6,150
Income taxes (40%) …………………………………………..
2,460