19-1 HANSEN & MOWEN Cost Management ACCOUNTING AND CONTROL

19-2 Pricing and Profitability Analysis 19

19-3 Economic Pricing Concepts Quantity P* Q* Price Supply Demand Basic Pricing Concepts 1

19-4 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. Basic Pricing Concepts 1

19-5 Characteristics of the Four Basic Types of Market Structure Basic Pricing Concepts 1

19-6 Two Approaches to Pricing 1.Cost-based prices are established using “cost” plus markup. 2.Target prices are influenced by market conditions. Pricing Policies 2

19-7 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: Revenues$350,350 Cost of goods sold: Direct materials$122,500 Direct labor73,500 Overhead 49, ,000 Gross profit$105,350 Selling and administrative expenses 25,000 Operating income$ 80,350 Pricing Policies 2

19-8 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 Cost-Plus Pricing (continued) Pricing Policies 2

19-9 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)/$122,500 Markup on DM =1.86 Cost-Plus Pricing (continued) Pricing Policies 2

19-10 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)$ Direct labor (2.5 hours x $12)30.00 Overhead (65% of direct labor cost) Estimated cost of one job$ Plus 43% markup on COGS Bid price$ Cost-Plus Pricing (continued) Pricing Policies 2

19-11 Target Costing and Pricing Target costing is a method of determining the cost of a product or service based on the price that the customers are willing to pay. Target costing involves much more upfront work than cost- based pricing. However, if the cost-plus pricing turns out to be higher than what customers will accept, additional work or lost opportunity will result. Pricing Policies 2

19-12 Predatory pricing is the practice of setting prices below cost for the purpose of injuring competitors and eliminating competition. Competition Predatory pricing on the international market is called dumping. The Legal System and Pricing 3

19-13 Price discrimination refers to the charging of different prices to different customers for essentially the same product. The Legal System and Pricing 3

19-14 Cobalt, Inc. manufactures vitamin supplements that costs an average of $163 per case. Cobalt sold 250,000 cases last year as follows: Customer Prices per Case Cases Sold Large drug store chain$200125,000 Small local pharmacies232100,000 Individual health clubs25025,000 Cobalt is practicing price discrimination! The Legal System and Pricing 3

19-15 The Legal System and Pricing 3 Analysis of Cobalt, Inc., Customer Class Costs

19-16 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 Direct labor15,000 Variable overhead3,000 Fixed 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 4

19-17 Absorption-Costing Income Statement for Lasersave, Inc., for August Measuring Profit 4

19-18 Absorption-Costing Income Statement for Lasersave, Inc., for September Measuring Profit 4 *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 20,000 Total manufacturing overhead $48,750 Add: Beginning inventory 0 Less: Ending inventory (9,750) Cost of goods sold $39,000

19-19 Variable-Costing Income Statements for Lasersave, Inc. Measuring Profit 4 *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

19-20 Comparative Income Statements for Lasersave, Inc. for the Month of October Measuring Profit 4

19-21 Changes in Inventory under Absorption and Variable Costing Measuring Profit 4

19-22 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. Basic Multi-Function Number of units20,00010,000 Direct labor hours40,00015,000 Price$200$350 Prime cost per unit$55$95 Overhead per unit$30$ Profitability of Segments Profit by Product Line

Profitability of Segments Absorption-Costing Income by Product Line

Profitability of Segments Variable-Costing Income by Product Line

Profitability of Segments Overhead Activities and Drivers

Profitability of Segments Activity-Based Costing Income by Product Line

19-27 Divisional Profit Alpha Beta Gamma Delta Total Sales$ 90$ 60$ 30$120$300 Cost of goods sold Gross profit$ 55$ 40$ 19$ 22$136 Division expenses Corporate expenses Operating income (loss)$ 32$ 28$ 3$ -2$ 61 5 Profitability of Segments

19-28 Sales price variance = Actual price – Expected price x Quantity sold Price volume variance = Actual volume – Expected volume x Expected price 6 Analysis of Profit-Related Variances

19-29 Contribution margin variance = Annual contribution margin – Budgeted contribution margin Contribution margin volume variance = Annual quantity sold – Budgeted quantity sold x Budgeted average unit contribution margin 6 Analysis of Profit-Related Variances

19-30 Data for Birdwell, Inc. 6 Analysis of Profit-Related Variances

19-31 Sales mix variance = [(Product 1 actual units – Product 1 budgeted units) x (Product 1 budgeted unit contribution margin – Budgeted average unit contribution margin)] + [(Product 2 actual units – Product 2 budgeted units) x (Product 2 budgeted unit contribution margin – Budgeted average unit contribution margin)] Birdwell sales mix variance = [($1,250 – 1,500) x ($4.00 – $6.75)] + [(625 –500) x ($15.00 – $6.75)] = $1, Favorable 6 Analysis of Profit-Related Variances

19-32 Market share variance = [(Actual market share percentage – Budgeted market share percentage) x (Actual industry sales in units)] x (Budgeted average unit contribution margin) Market size variance = [(Actual industry sales in units – Budgeted industry sales in units) x (Budgeted market share percentage)] x (Budgeted average unit contribution margin) 6 Analysis of Profit-Related Variances

The Product Life Cycle Product Life Cycle

The Product Life Cycle Impact of the Product Life Cycle on Cost Management

The Product Life Cycle Product Life Cycle Costs in the ABC Categories

Limitations of Profit Measurement Limitations of profit include  focus on past performance  uncertain economic conditions  difficulty of capturing all important factors in financial measures Successful firms measure far more than accounting profit.

19-37 End of Chapter 19