1. C8 - 1 Learning Objectives Power Notes 1.Differential Analysis 2.Setting Normal Product Selling Prices 3.Product Profitability and Pricing Under Production Bottlenecks Chapter M8 C8 Differential Analysis and Product Pricing Differential Analysis and Product Pricing

2. C8 - 2 Differential Analysis Decisions Setting Normal Product Selling Prices Cost-Plus Methods of Product Pricing Production Bottlenecks Slide # Power Note Topics Power Notes 3 16 20 27 Chapter M8 Differential Analysis and Product Pricing Differential Analysis and Product Pricing Note: To select a topic, type the slide # and press Enter.

3. C8 - 3 Differential Analysis 1.Leasing or selling equipment 2.Discontinuing an unprofitable segment 3.Manufacturing or purchasing a needed part 4.Replacing usable fixed assets 5.Processing further or selling an intermediate product 6.Accepting additional business at a special price Differential analysis is used for analyzing:

4. C8 - 4 Proposal to Lease or Sell Equipment June 22, 2003 Differential revenue from alternatives: Revenue from lease$160,000 Revenue from sales100,000 Differential revenue from lease$60,000 Differential cost of alternatives: Repairs, insurance, taxes$ 35,000 Commission expense on sale6,000 Differential cost of lease29,000 Net differential income from leasing$31,000

5. C8 - 5 Proposal to Lease or Sell Equipment June 22, 2003 Revenue from lease$160,000 Revenue from sales100,000 Repairs, insurance, taxes(35,000) Commission expense on sale(6,000) Totals$125,000 $94,000 LeaseSell This alternative format separates the two options into columns. The net benefit is the same.

6. C8 - 6 Proposal to Lease or Sell Equipment June 22, 2003 LeaseSell Revenue from lease$160,000 Revenue from sales100,000 Repairs, insurance, taxes(35,000) Commission expense on sale(6,000) Totals$125,000 $94,000 Net benefit from leasing$31,000 This analysis indicates that it would be better to lease the equipment rather then sell it. What other factors should be considered?

7. C8 - 7 Battle Creek Cereal Co. Condensed Income Statement For the Year Ended August 31, 2003 Bran Corn Toasted Total Flakes Flakes Oats Sales$100,000 $500,000$400,000$1,000,000 Cost of goods sold: Variable costs$ 60,000 $220,000$200,000$ 480,000 Fixed costs20,000 120,00080,000220,000 Total cost of goods sold$ 80,000 $340,000$280,000$ 700,000 Gross profit$ 20,000 $160,000$120,000$ 300,000 Operating expenses: Variable expenses $ 25,000 $ 95,000$ 60,000$ 180,000 Fixed expenses6,000 25,00020,00051,000 Total operating expenses $31,000 $120,000$ 80,000$ 231,000 Income (loss) from operations$ (11,000)$ 40,000$ 40,000$ 69,000 Should Bran Flakes be discontinued?

8. C8 - 8 Battle Creek Cereal Co. Condensed Income Statement For the Year Ended August 31, 2003 Bran Corn Toasted Total Flakes Flakes Oats Differential items Should Bran Flakes be discontinued? Sales$100,000 Sales$100,000 $500,000$400,000$1,000,000 Cost of goods sold: Variable costs$ 60,000 $220,000$200,000$ 480,000 Fixed costs20,000 120,00080,000220,000 Total cost of goods sold$ 80,000 $340,000$280,000$ 700,000 Gross profit$ 20,000 $160,000$120,000$ 300,000 Operating expenses: Variable expenses $ 25,000 $ 95,000$ 60,000$ 180,000 Fixed expenses6,000 25,00020,00051,000 Total operating expenses $31,000 $120,000$ 80,000$ 231,000 Income (loss) from operations$ (11,000)$ 40,000$ 40,000$ 69,000

9. C8 - 9 Battle Creek Cereal Co. Condensed Income Statement For the Year Ended August 31, 2003 Should Bran Flakes be discontinued? Bran Corn Toasted Total Flakes Flakes Oats Differential items Sales$100,000 Sales$100,000 $500,000$400,000$1,000,000 Cost of goods sold: Variable costs$ 60,000 Variable costs$ 60,000 $220,000$200,000$ 480,000 Fixed costs20,000 120,00080,000220,000 Total cost of goods sold$ 80,000 $340,000$280,000$ 700,000 Gross profit$ 20,000 $160,000$120,000$ 300,000 Operating expenses: Variable expenses $ 25,000 $ 95,000$ 60,000$ 180,000 Fixed expenses6,000 25,00020,00051,000 Total operating expenses $31,000 $120,000$ 80,000$ 231,000 Income (loss) from operations$ (11,000)$ 40,000$ 40,000$ 69,000

10. C8 - 10 Battle Creek Cereal Co. Condensed Income Statement For the Year Ended August 31, 2003 Bran Corn Toasted Total Flakes Flakes Oats Differential items Sales$100,000 Sales$100,000 $500,000$400,000$1,000,000 Cost of goods sold: Variable costs$ 60,000 Variable costs$ 60,000 $220,000$200,000$ 480,000 Fixed costs20,000 120,00080,000220,000 Total cost of goods sold$ 80,000 $340,000$280,000$ 700,000 Gross profit$ 20,000 $160,000$120,000$ 300,000 Operating expenses: Variable expenses $ 25,000 Variable expenses $ 25,000 $ 95,000$ 60,000$ 180,000 Fixed expenses6,000 25,00020,00051,000 Total operating expenses $31,000 $120,000$ 80,000$ 231,000 Income (loss) from operations$ (11,000)$ 40,000$ 40,000$ 69,000 If Bran Flakes are discontinued, how would net income be affected?

11. C8 - 11 Battle Creek Cereal Co. Condensed Income Statement For the Year Ended August 31, 2003 Differential items Bran Corn Toasted Total Flakes Flakes Oats Sales$100,000 Sales$100,000 $500,000$400,000$1,000,000 Cost of goods sold: Variable costs$ 60,000 Variable costs$ 60,000 $220,000$200,000$ 480,000 Fixed costs20,000 120,00080,000220,000 Total cost of goods sold$ 80,000 $340,000$280,000$ 700,000 Gross profit$ 20,000 $160,000$120,000$ 300,000 Operating expenses: Variable expenses $ 25,000 Variable expenses $ 25,000 $ 95,000$ 60,000$ 180,000 Fixed expenses6,000 25,00020,00051,000 Total operating expenses $31,000 $120,000$ 80,000$ 231,000 Income (loss) from operations$ (11,000)$ 40,000$ 40,000$ 69,000 If Bran Flakes are discontinued, $15,000 of net income will be lost and overall net income would be reduced to $54,000.

12. C8 - 12 Annual variable costs—present$225,000 Annual variable costs—new equip.150,000 Annual differential decrease in cost$ 75,000 Number of years applicablex 5 Total differential decrease in cost$375,000 Proceeds from sale of present equipment25,000$400,000 Cost of new equipment250,000 Net differential decrease in cost, 5-years$150,000 Annual net differential—new equipment$ 30,000 Proposal to Replace Equipment November 28, 2003

13. C8 - 13 Proposal to Replace Equipment November 28, 2003 PresentNewEquipment This analysis indicates that it would be better to replace the existing equipment. What other factors should be considered? Annual variable costs$ 225,000$150,000 Number of years applicablex 5x 5 Total variable costs$1,125,000$750,000 Cost of new equipment250,000 Less proceeds from sale(25,000) Total costs$1,125,000$975,000 Net total benefit to replace $150,000 Net annual benefit to replace$ 30,000

14. C8 - 14 Differential revenue from further processing per batch: Revenue from sale of gasoline [(4,000 gallons - 800 gallons evaporation) x $1.25]$4,000 Revenue from sale of kerosene (4,000 gallons x $0.80)3,200 Differential revenue$800 Differential cost per batch: Additional cost of producing gasoline650 Differential income from further processing gasoline per batch$150 Proposal to Process Kerosene Further October 1, 2003

15. C8 - 15 Setting Normal Product Selling Prices 1.Demand-based methods 2.Competition-based methods 1.Total cost concept 2.Product cost concept 3.Variable cost concept Cost-Plus Methods Cost-Plus Methods Market Methods Market Methods

16. C8 - 16 Per UnitTotalCost Cost Structure Example (100,000 units) Variable Costs: Direct materials$ 3.00$ 300,000 Direct labor10.001,000,000 Factory overhead1.50150,000 Selling and admin.1.50150,000 Fixed Costs: Factory overhead.5050,000 Selling and admin..2020,000 Total costs$16.70$1,670,000 Product costs$15.00$1,500,000 Variable costs$16.00$1,600,000

17. C8 - 17 Per UnitTotalCost Cost Structure Example (100,000 units) Variable Costs: Direct materials$ 3.00$ 300,000 Direct labor10.001,000,000 Factory overhead1.50150,000 Selling and admin.1.50150,000 Fixed Costs: Factory overhead.5050,000 Selling and admin..2020,000 Total costs$16.70$1,670,000 Product costs$15.00$1,500,000 Variable costs$16.00$1,600,000

18. C8 - 18 Per UnitTotalCost Cost Structure Example (100,000 units) Variable Costs: Direct materials$ 3.00$ 300,000 Direct labor10.001,000,000 Factory overhead1.50150,000 Selling and admin.1.50150,000 Fixed Costs: Factory overhead.5050,000 Selling and admin..2020,000 Total costs$16.70$1,670,000 Product costs$15.00$1,500,000 Variable costs$16.00$1,600,000

19. C8 - 19 Selling Price: Desired profit$ 1.60$ 160,000 Total to markup $ 1.60$ 160,000 Total costs16.701,670,000 Selling price$18.30$1,830,000 Markup Percentage: Markup amount$1.60 Total costs$16.70 Per UnitTotal Total Cost Concept = 9.6% Only the desired profit is covered in the markup. =

20. C8 - 20 Per UnitTotal Selling Price: Desired profit$ 1.60$ 160,000 Total to markup $ 1.60$ 160,000 Total costs16.701,670,000 Selling price$18.30$1,830,000 Markup Percentage: Markup amount$1.60 Total costs$16.70 Total Cost Concept = 9.6% Markup on total cost =

21. C8 - 21 Selling Price: Desired profit$ 1.60$ 160,000 Selling and admin.1.70170,000 Total to markup $ 3.30$ 330,000 Total product costs15.001,500,000 Selling price$18.30$1,830,000 Markup Percentage: Markup amount $3.30 Product costs$15.00 Per UnitTotal Product Cost Concept = 22.0% The desired profit and selling and administrative costs are covered in the markup. =

22. C8 - 22 Per UnitTotal Selling Price: Desired profit$ 1.60$ 160,000 Selling and admin.1.70170,000 Total to markup $ 3.30$ 330,000 Total product costs15.001,500,000 Selling price$18.30$1,830,000 Markup Percentage: Markup amount$3.30 Product costs$15.00 Product Cost Concept = 22.0% Markup on product cost =

23. C8 - 23 Selling Price: Desired profit$ 1.60$ 160,000 Fixed costs.7070,000 Total to markup $ 2.30$ 230,000 Total variable costs16.001,600,000 Selling price$18.30$1,830,000 Markup Percentage: Markup amount$2.30 Variable costs$16.00 Per UnitTotal Variable Cost Concept = 14.4% The desired profit and total fixed costs are covered in the markup. =

24. C8 - 24 Per UnitTotal Selling Price: Desired profit$ 1.60$ 160,000 Fixed costs.7070,000 Total to markup $ 2.30$ 230,000 Total variable costs16.001,600,000 Selling price$18.30$1,830,000 Markup Percentage: Markup amount$2.30 Variable costs$16.00 Variable Cost Concept = 14.4% Markup on variable cost =

25. C8 - 25 TotalProductVariable CostCostCost Cost amount per unit$16.70$15.00 $16.00 Markup percentagex 9.6%x 22.0%x 14.4% Markup amount$ 1.60$ 3.30$ 2.30 Selling price$18.30$18.30$18.30 Product Pricing Using a Cost-Plus Approach The most common method

26. C8 - 26 Products—Unit Analysis SmallMediumLarge WrenchWrenchWrench Sales price$130$140$160 Variable cost4040 40 Contribution margin$ 90$100$120 Profitability Under Production Bottlenecks The process is currently operating at full capacity and is a production bottleneck.

27. C8 - 27 Sales price$130$140$160 Variable cost404040 Contribution margin$ 90$100$120 Bottleneck hours 1 4 8 Products—Unit Analysis SmallMediumLarge WrenchWrenchWrench Profitability Under Production Bottlenecks The number of hours per unit for each product.

28. C8 - 28 Products—Unit Analysis SmallMediumLarge WrenchWrenchWrench Profitability Under Production Bottlenecks Contribution after dividing by the bottleneck hours. Sales price$130$140$160 Variable cost404040 Contribution margin$ 90$100$120 Bottleneck hours 1 4 8 Bottleneck contribution$ 90$ 25$ 15

29. C8 - 29 Products—Unit Analysis SmallMediumLarge WrenchWrenchWrench Sales price$130$140$160 Variable cost404040 Contribution margin$ 90$100$120 Bottleneck hours 1 4 8 Bottleneck contribution$ 90$ 25$ 15 Profitability Under Production Bottlenecks What price for Product C would equate its profitability to Product A?

30. C8 - 30 Products—Unit Analysis SmallMediumLarge WrenchWrenchWrench Sales price$130$140$160$760 Variable cost40404040 Contribution margin$ 90$100$120$720 Bottleneck hours 1 4 88 Bottleneck contribution$ 90$ 25$ 15$ 90 Profitability Under Production Bottlenecks A price of $760 will provide the same contribution as Product A.

31. C8 - 31 Note: To see the topic slide, type 2 and press Enter. This is the last slide in Chapter M8. Power Notes Chapter M8 Differential Analysis and Product Pricing Differential Analysis and Product Pricing