Accounting Chapter 18 Homework Budgeted Average Unit Contribution Margin Product Actual

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CHAPTER 18

PRICING AND PROFITABILITY ANALYSIS

DISCUSSION QUESTIONS

1. Price elasticity of demand is measured by

the percentage change in quantity divided

by the percentage change in price. If de-

mand is relatively elastic, a price change of

X percent results in a quantity change of

more than X percent. If demand is relatively

inelastic, a price change of X percent results

2. Perfectly competitive markets are character-

ized by the following: many buyers and

sellers—no one of which is large enough to

influence the market; a homogeneous prod-

uct (one company’s product is virtually iden-

tical to any other company’s product); and

easy entry into and exit from the industry.

3. The markup percentage on cost of goods

4. Target costing is a method of determining

the cost of a product or service based on the

ly. Price skimming is a pricing strategy in

which a higher price is charged at the be-

ginning of a product’s life cycle, and then

lowered at later phases of the life cycle.

6. There are a number of possible reasons;

here are three. First, the price difference

therefore, the price charged may be higher.

Third, the price elasticity of demand for gas-

oline purchased in town may be higher due

to the larger number of competing gas sta-

tions.

7. Price discrimination is the charging of differ-

ent prices to different customers for essen-

tially the same commodity. It is legal in some

firm adheres to government regulations.

Regulated firms must measure profit to en-

9. A segment is any portion of a firm. Seg-

ments may be product lines, divisions, re-

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10. Alpha Company may continue to produce

and sell “Loser” because (a) customers of all

lines prefer to deal with a “full–service” com-

11. Absorption costing differs from variable cost-

ing in that fixed factory overhead is included

in unit cost under absorption costing. The re-

sult is that absorption-costing operating in-

12. Net income must be calculated for external

reporting purposes. An advantage is that net

income is calculated according to GAAP so

outside parties have an understanding of the

Net income also has disadvantages. Net

income does not include the cost of capital

employed to operate the business. As a re-

sult, net income can be positive while the

13. Firms may measure customer profitability

when groups of customers differ in the

14. Sales price and sales volume variances may

be computed from actual and expected rev-

enue amounts. These variances help man-

growth phase, sales increase and so do

profits. The maturity phase is marked by

stable costs and relatively high sales. In the

decline phase of the product life cycle, sales

fall; costs may or may not fall, depending on

maturity phase should lead to stable unit-

level costs. The decline phase, with fewer

units produced, does not enjoy quantity dis-

counts, but unit costs may remain low due to

Setup number and complexity increase, pur-

chasing orders rise, and inspection costs

may increase. Finally, in the decline stage,

batch-level costs again fall as product lines

are streamlined to just a few best-selling

Facility-level costs may or may not be

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CORNERSTONE EXERCISES

Cornerstone Exercise 18.1

1. Markup on COGS = (Selling and administrative expenses + Operating

income)/COGS

2. Job price = $1,655 + (0.27 × $1,655) = $1,655 + $447 = $2,102

3. Markup on direct materials = (Direct labor + Overhead + Selling and adminis-

trative expenses + Operating income)/Direct

Cornerstone Exercise 18.2

1. Supermarkets:

Manufacturing cost per case ……………………………. $52.0000

Special labeling cost ($0.04 × 24) ……………………… 0.9600

Small grocers:

Manufacturing cost per case ……………………………. $52.00

Special handling per case ………………………………… 25.00

Convenience stores:

Manufacturing cost per case ……………………………. $52.00

2. Supermarkets Small Grocers Convenience Stores

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Price per case …………. $58.000 $93.00 $88.00

Less: Cost per case …. 54.285 92.81 83.50

3. The average price per case is $79.67. If this price were charged to all three

customers, the profit percentage for the supermarkets would increase and

the profit percentages to the small grocers and convenience stores would

Cornerstone Exercise 18.3

1. The unit product (manufacturing) cost under absorption costing is:

Direct materials………………………………………………… $ 5.00

Direct labor ……………………………………………………… 3.00

2. Units in ending inventory = Units, beginning inventory + Units produced –

Units sold

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Cornerstone Exercise 18.3 (Concluded)

3. Pattison Products, Inc.

Absorption-Costing Income Statement

For the Month of October

Sales ($24 × 38,400) …………………………………………………………….. $ 921,600

Less: Cost of goods sold ($16.50 × 38,400) …………………………... 633,600

4. Units in ending inventory = Units, beginning inventory + Units produced –

Units sold

Cornerstone Exercise 18.4

1. The unit product (manufacturing) cost under variable costing is:

Direct materials ……………………………………………….. $5.00

Direct labor ……………………………………………………… 3.00

2. Units in ending inventory = Units, beginning inventory + Units produced –

Units sold

18-6

Cornerstone Exercise 18.4 (Concluded)

3. Pattison Products, Inc.

Variable-Costing Income Statement

For the Month of October

Sales ($24 × 38,400) …………………………………………………………………. $ 921,600

Less:

Variable cost of goods sold ($9.50 × 38,400) ………………………… 364,800

4. Units in ending inventory = Units, beginning inventory + Units

produced – Units sold

= 1,600 + 40,000 – 41,000 = 600 units

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Cornerstone Exercise 18.5

2. Sales volume variance = (Actual volume – Expected volume) × Expected price

= [(30,600 – 30,000) × $5.30] = $3,180 F

3. Overall sales variance = Sales price variance + Sales volume variance

= $3,060 U + $3,180 F = $120 F

4. If December sales in pounds were 29,800, there would be a decrease in the

sales price variance, since the actual number of pounds sold decreased.

Cornerstone Exercise 18.6

1. Contribution margin variance = Actual contribution margin – Expected

2. If units sold of the convection oven decrease while everything else stays the

same, the contribution margin variance would increase. On the other hand, if

18-8

Cornerstone Exercise 18.7

1. Budgeted average unit contribution margin

= Budgeted total contribution margin/Budgeted total units

2. Contribution margin volume variance

= (Actual quantity sold – Budgeted quantity sold) × Budgeted average unit

3. If actual units sold of the convection oven decrease while everything else

stayed the same, the contribution margin volume variance would decrease

Cornerstone Exercise 18.8

1. Sales mix variance

= [(Product 1 actual units – Product 1 budgeted units) × (Product 1 bud–

geted contribution margin – Budgeted average unit contribution mar-

2. If actual units sold of the toaster oven (the low contribution margin product)

increase while everything else stays the same, the sales mix variance would

18-9

Cornerstone Exercise 18.9

1. Market share variance

= [(Actual market share percentage – Budgeted market share percentage)

× Actual industry sales in units] × Budgeted average unit contribution

margin

2. Market size variance

= [(Actual industry sales in units – Budgeted industry sales in units) ×

Budgeted market share percentage] × Budgeted average unit contribu-

tion margin

3. If Iliff actually sold a total of 41,000 units, then the actual market share

18–10

EXERCISES

Exercise 18.10

1. The demand for pizza is relatively elastic. This makes sense knowing what we

2. The pizza industry is characterized by monopolistic competition. There are

many pizza parlors, each trying to differentiate itself on some dimension—

Exercise 18.11

1. The flower-growing industry has the characteristics of perfect competition.

There are many buyers and sellers, no one of which has much control over

2. Given the perfectly competitive structure of the industry, Amy should charge

$1.50 per bunch. She can sell all that she wants to at that price. To charge less

18–11

Exercise 18.12

Foster would be ill-advised to charge $75 per hour. There are no doubt many ac-

countants in town; they average $65 per hour for a reason—clients will not pay

much more than that amount. Accounting is a monopolistically competitive in-

dustry. There are many accountants, but they vary somewhat in age, experience,

and preferred type of work (auditing, tax, management advisory services, in-

house bookkeeping for clients). As a result, the price will not vary greatly among

the firms.

Since Foster is new in town, he might adopt a penetration pricing strategy. He is

in the introduction stage of his “service life cycle.” He needs to get some clients

so that he can demonstrate his expertise and start some favorable “word–of–

Exercise 18–13

1. Markup percentage = $1,140,000/$7,600,000 = 0.15, or 15%

2. Bid = $570,000 + (0.15 × $570,000) = $655,500

18–12

Exercise 18.14

a. The markup percentage of 100 percent is typical for department stores. It

must cover all costs of storing and selling the goods, including salaries of

sales personnel; rent or purchase of the building; advertising; hangers and

racks for display; supplies (tags, cleaning supplies, toilet paper for the

restrooms); equipment (e.g., cash registers); and so on. The profit earned is

typically a small proportion of the markup percentage.

b. Like department stores, jewelry store markups include all costs of storing

and selling the goods. In addition, because turnover is much lower in jewelry

Exercise 18.15

1. Absorption unit cost: Variable unit cost:

Direct materials………… $ 6.00 Direct materials ………. $ 6.00

18–13

Exercise 18.15 (Continued)

2. Flaherty, Inc.

Absorption-Costing Income Statement

For the First Year of Operations

Sales (21,300 × $36) ………………………………………………. $766,800

Cost of goods sold (21,300 × $22.50) ……………………… $479,250

Less: Overapplied overhead* ………………………………… 7,000 472,250

* The budgeted fixed overhead rate of $9 per direct labor hour was computed

based on 12,000 direct labor hours. Therefore, budgeted fixed overhead must

have been $108,000. Since actual fixed overhead was $12,000 less than

Both variable and fixed overhead were applied on the basis of direct labor

hours. Since 12,000 hours were worked, total applied overhead amounts to

$180,000. Actual overhead was $173,000 (actual fixed of $96,000 plus actual

variable of $77,000).

18–14

Exercise 18.15 (Concluded)

3. Flaherty, Inc.

Variable-Costing Income Statement

For the First Year of Operations

Sales (21,300 × $36) ………………………………………………. $ 766,800

Variable cost of goods sold (21,300 × $18) …………….. $383,400

Add: Underapplied variable overhead ……………………. 5,000 (388,400)

Variable selling expense (21,300 × $2) …………………… (42,600)

4. IA – IV = Fixed overhead rate × (Production – Sales)

Exercise 18.16

1. Unadjusted cost of goods sold = $546,260 – $2,900 = $543,360

Unit cost = $543,360/38,200 = $14.22408 (rounded)

18–15

Exercise 18.16 (Concluded)

2. Snobegon, Inc.

Variable-Costing Income Statement

For the First Year of Operations

Sales ($20 × 38,200) …………………………………………………………….. $ 764,000

Less: Variable cost of goods sold ($13.47408 × 38,200) ………… 514,710

Exercise 18.17

1. Carina’s labor and profit are embedded in the material prices quoted. For

example, the food preparation includes numerous activities such as recipe

selection, food purchase and preparation, transporting the food to the

2. Carina will need to sit down with Maria and Estefan and determine which

features of the party are most important to them and which are less

3. Carina should remind Mr. Montero that there are many activities involved in

renting and setting up the dance floor. Her rental price for the dance floor in-

18–16

Exercise 18.18

1. The minimum price per blanket that Otero Fibers, Inc., could bid without re-

ducing the company’s net income is $25.03, calculated as follows:

Direct materials (6 pounds × $1.70) …………. $10.20

Direct labor (0.25 hour × $6.50) ……………….. 1.63

2. Using the full-cost criteria and the maximum allowable return specified, Otero

Fibers, Inc.’s, bid price per blanket would be $31.19, calculated as follows:

Relevant costs (from Requirement 1) ………. $25.03

3. Factors that Otero Fibers, Inc., should consider before deciding whether or

not to submit a bid at the maximum acceptable price of $30 per blanket in-

clude the following:

The company should be sure there is sufficient excess capacity to fulfill the

order and that no additional investment is necessary in facilities or equip-

18–17

Exercise 18.19

1. Sales price variance = [($15.00 – $14.80) × 2,500]

2. Sales volume variance = [(2,500 – 1,450) × $15]

3. This product looks like it might be entering the growth phase of the product

life cycle. While price is slightly lower than budgeted, the quantity is much

Exercise 18.20

1. Product R:

Actual volume = $3,075,000/$25 = 123,000 units

Sales price variance = [($26 – $25) × 123,000] = 123,000 U

2. It appears that Eastman is following a penetration pricing strategy for

18–18

CPA-TYPE EXERCISES

Exercise 18.21

Exercise 18.22

Exercise 18.23

Exercise 18.24

Exercise 18.25