HiltonPlatt 11e TB Ch15

Chapter 15 - Target Costing and Cost Analysis for Pricing Decisions
Chapter 15
Target Costing and Cost Analysis for Pricing Decisions
Answer Key

True / False Questions

1. Setting prices requires a balance between cost considerations and market forces.
TRUE
AACSB: Reflective Thinking

AICPA BB: Critical Thinking
AICPA FN: Research
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 15-01
Feedback True: Correct! It is true that setting prices requires a balance between cost considerations and market forces.
Feedback False: It is true that setting prices requires a balance between cost considerations and market forces.
2. Due to cost-based pricing, an organization or industry can price its products below their
production costs indefinitely.
FALSE

AICPA FN: Research
Blooms: Remember
Difficulty: 1 Easy
Feedback True: No organization or industry can price its products below their production costs indefinitely.
Feedback False: Correct! No organization or industry can price its products below their production costs indefinitely.
3. The revenue curve shows the relationship between the sales price and quantity sold.
FALSE

AICPA FN: Research
Blooms: Remember
Difficulty: 1 Easy
Feedback True: A revenue curve does not show the relationship between sales price and quantity sold, but a demand curve does.
Feedback False: Correct! A revenue curve does not show the relationship between sales price and quantity sold, but a demand curve does.

15-1
4. The marginal revenue curve shows the relationship between the change in total revenue that
accompanies a change in quantity sold.
TRUE

AICPA FN: Research
Blooms: Remember
Difficulty: 1 Easy
Feedback True: Correct! This is the definition of the marginal revenue curve.
Feedback False: This is the definition of the marginal revenue curve.
5. If a company uses a cost-plus approach to pricing, it will find that there are several different
definitions of cost and the higher the cost, the higher the markup percentage.
FALSE

AICPA FN: Research
Blooms: Understand
Difficulty: 2 Medium
Feedback True: This statement is incorrect.
Feedback False: Correct! This statement is incorrect.

6. A firm typically uses only one of the three cost-plus pricing formulas.
FALSE

AICPA FN: Research
Blooms: Understand
Feedback True: There are four alternative cost-plus pricing formulas.
Feedback False: Correct! There are four alternative cost-plus pricing formulas.
15-2
7. Penetration pricing is a pricing strategy in which a new product's initial price is set
relatively low in order to gain a large market share.
TRUE

AICPA FN: Measurement
Blooms: Remember
Difficulty: 1 Easy
Feedback True: Correct! This statement correctly describes penetration pricing as a pricing strategy.
Feedback False: This statement correctly describes penetration pricing as a pricing strategy.

8. Skimming pricing is another name for penetration pricing.
FALSE

Blooms: Remember
Difficulty: 1 Easy
Feedback True: Skimming pricing is where prices are set high and short-term profits are reaped on a new product, whereas penetration
pricing sets prices low to gain a large market share.
Feedback False: Correct! Skimming pricing is where prices are set high and short-term profits are reaped on a new product, whereas
penetration pricing sets prices low to gain a large market share.
9. Matton Corporation manufactures a single product that has a cost of $350. The company
uses a 70% markup on cost to arrive at a selling price of $595, which results in a price that
virtually always exceeds that of the market leaders. If Matton changes to the approach known
as target costing, the company will first undertake a thorough study of competitors' prices.
TRUE

AICPA BB: Marketing
Blooms: Understand
Feedback True: Correct! Target costing requires a thorough study of competitor prices.
Feedback False: Target costing requires a thorough study of competitor prices.
15-3
10. Target costing involves four key principles.
FALSE
AICPA BB: Marketing
Blooms: Understand
Feedback True: Target costing involves seven key principles.
Feedback False: Correct! Target costing involves seven key principles.
11. When a computer-integrated manufacturing (CIM) system is used, the process of target
costing sometimes is computerized.
TRUE

AICPA BB: Marketing
Blooms: Understand
Feedback True: Correct! Target costing is sometimes computerized through the integration with a CIM system.
Feedback False: Target costing is sometimes computerized through the integration with a CIM system.
12. When activity-based costing is integrated with target costing, a product’s projected costs
always go up.
FALSE
AICPA BB: Marketing
Blooms: Understand
Feedback True: Since cost is the target, ABC allows a focus on key activities that reduce projected costs.
Feedback False: Correct! Since cost is the target, ABC allows a focus on key activities that reduce projected costs.
15-4
13. In many cases, traditional, volume based product costing may overcost low-volume and
complex products, while undercosting high-volume and relatively simple products.
FALSE

AICPA BB: Marketing
Blooms: Understand
Feedback True: Distortion usually occurs in the opposite manner.
Feedback False: Correct! Distortion usually occurs in the opposite manner. In many cases, traditional, volume based product costing may
undercost low-volume and complex products, while overcosting high-volume and relatively simple products.
14. Cost distortion can occur under the target-costing approach.
TRUE

AICPA BB: Marketing
Blooms: Understand
Feedback True: Correct! Distortion can occur even when trying to set prices competitively under the target-costing approach, if traditional,
volume based product costing is incorporated.
Feedback False: Distortion can occur even when trying to set prices competitively under the target-costing approach, if traditional, volume
based product costing is incorporated.
15. Value engineering is an outgrowth of target costing.
FALSE

AICPA BB: Marketing
Blooms: Understand
Feedback True: Target costing was actually an outgrowth of value engineering.
Feedback False: Correct! Target costing was actually an outgrowth of value engineering.
15-5
16. Much of the historical development of the target-costing approach has taken place in
German industry.
FALSE

AICPA BB: Marketing
Blooms: Understand
Feedback True: Much of the historical development of the target-costing approach has taken place in Japanese industry.
Feedback False: Correct! Much of the historical development of the target-costing approach has taken place in Japanese industry.
17. Under the time and material pricing approach, the company determines one charge for the
labor used on a job, another charge for the materials, and then averages the two to apply one
charge for everything.
FALSE

AICPA BB: Marketing
Blooms: Understand
Feedback True: Under time and material pricing, the company determines one charge for the labor used on a job and another charge for the
materials; no averaging takes place.
Feedback False: Correct! Under time and material pricing, the company determines one charge for the labor used on a job and another
charge for the materials; no averaging takes place.
18. Time and material pricing is used widely by construction companies.
TRUE

AICPA BB: Marketing
Blooms: Understand
Feedback True: Correct! Construction companies use time and material pricing as do printers, repair shops, and professional firms, such as
engineering, law, and public accounting firms.
Feedback False: Construction companies use time and material pricing as do printers, repair shops, and professional firms, such as
engineering, law, and public accounting firms.
15-6
19. In a competitive bidding situation where all of the companies submitting bids offer a
roughly equivalent product or service, the amount of variable overhead becomes the sole
criterion for selecting the contractor.
FALSE

AICPA BB: Marketing
Blooms: Understand
Feedback True: Variable overhead is not the sole criterion; it is usually the lowest bid.
Feedback False: Correct! Variable overhead is not the sole criterion; it is usually the lowest bid.
20. When a firm has excess capacity, a price that covers the incremental costs incurred
because of the job will contribute toward covering the company’s fixed cost and profit.
TRUE

AICPA BB: Marketing
Blooms: Understand
Feedback True: Correct! When a firm has excess capacity, a price that covers the incremental costs incurred because of the job will
contribute toward covering the company’s fixed cost and profit.
Feedback False: When a firm has excess capacity, a price that covers the incremental costs incurred because of the job will contribute
toward covering the company’s fixed cost and profit.
21. The law prohibits price discrimination of quoting different prices to different customers
for the same product or service, but it permits predatory pricing to establish initial markets.
FALSE

AICPA BB: Marketing
Blooms: Understand
Feedback True: Predatory pricing is also outlawed because it involves temporarily cutting a price to broaden demand for a product with the
intention of later restricting the supply and raising the price.
Feedback False: Correct! Predatory pricing is also outlawed because it involves temporarily cutting a price to broaden demand for a
product with the intention of later restricting the supply and raising the price.
15-7
22. One of the Congressional acts that restricts certain types of pricing behavior is the
Robinson-Patman Act.
TRUE

AICPA BB: Marketing
AICPA FN: Decision Making
Blooms: Remember
Difficulty: 1 Easy
Feedback True: Correct! The Robinson-Patman Act, along with the Clayton Act and the Sherman Act, restrict certain types of pricing
behavior.
Feedback False: The Robinson-Patman Act, along with the Clayton Act and the Sherman Act, restrict certain types of pricing behavior.
15-8
Multiple Choice Questions

23. Which of the following can influence a company's pricing decisions?

A. Manufacturing costs.
B. Competitors.
C. Customer demand.
D. Pricing laws.
E. All of the answers are correct.

Blooms: Remember
Difficulty: 1 Easy
Feedback A: Although this factor can influence a company’s pricing decisions, there is a better answer choice.
Feedback B: Although this factor can influence a company’s pricing decisions, there is a better answer choice.
Feedback C: Although this factor can influence a company’s pricing decisions, there is a better answer choice.
Feedback D: Although this factor can influence a company’s pricing decisions, there is a better answer choice.
Feedback E: Correct! All of these factors can influence a company’s pricing decisions.
24. Which of the following choices correctly denotes factors that can influence a company's
pricing practices for goods and services?
Market Conditions Costs Customer Demand
A. No Yes Yes
B. No Yes No
C. Yes Yes Yes
D. Yes Yes No
E. Yes No Yes

Blooms: Remember
Difficulty: 1 Easy
Feedback A: This answer combination is incorrect.
Feedback B: This answer combination is incorrect.
Feedback C: Correct! All of these factors can influence a company’s pricing decisions.
Feedback D: This answer combination is incorrect.
Feedback E: This answer combination is incorrect.
15-9
25. Which of the following is not a major influence on pricing decisions?

A. Planning and control policies of the firm.
B. Customer demand.
C. Costs.
D. Competitors.
E. Political, legal, and image-related issues.

Blooms: Remember
Difficulty: 1 Easy
Feedback A: Correct! This factor does not have a major influence on pricing decisions.
Feedback B: This factor has a major influence on pricing decisions.
Feedback C: This factor has a major influence on pricing decisions.
Feedback D: This factor has a major influence on pricing decisions.
Feedback E: This factor has a major influence on pricing decisions.
26. Consider the following statements about pricing:

I. Prices are often determined by the market, subject to the constraint that costs must be
covered in the long run.
II. Prices are often based on costs, subject to the constraint that customers and competitors
will exert an influence.
III. A balance of market forces and cost is important when making pricing decisions.
Which of the above statements is (are) true?

A. I only.
B. II only.
C. I and III.
D. II and III.
E. I, II, and III.

Blooms: Remember
Difficulty: 1 Easy
Feedback A: While this statement is true, there is a better answer choice.
Feedback B: While this statement is true, there is a better answer choice.
Feedback C: While these statements are true, there is a better answer choice.
Feedback D: While these statements are true, there is a better answer choice.
Feedback E: Correct! All of these statements are true.

15-10
27. The curve that shows the relationship between the sales price and quantity sold is called
the:
A. marginal revenue curve.
B. average cost curve.
C. profit curve.
D. demand curve.
E. revenue curve.

AICPA FN: Research
Blooms: Remember
Difficulty: 1 Easy
Feedback A: This curve does not show the relationship between the sales price and quantity sold.
Feedback B: This curve does not show the relationship between the sales price and quantity sold.
Feedback C: This curve does not show the relationship between the sales price and quantity sold.
Feedback D: Correct! The demand curve shows the relationship between the sales price and quantity sold.
Feedback E: This curve does not show the relationship between the sales price and quantity sold.
28. The curve that shows the relationship between the total sales revenue and quantity sold is
called the:
C. profit curve.
D. demand curve.
E. revenue curve.

AICPA FN: Research
Blooms: Remember
Difficulty: 1 Easy
Feedback A: This curve does not show the relationship between the total sales revenue and quantity sold.
Feedback B: This curve does not show the relationship between the total sales revenue and quantity sold.
Feedback C: This curve does not show the relationship between the total sales revenue and quantity sold.
Feedback D: This curve does not show the relationship between the total sales revenue and quantity sold.
Feedback E: Correct! The revenue curve shows the relationship between the total sales revenue and quantity sold.

15-11
29. On a graph where the horizontal axis represents quantity sold and the vertical axis
represents selling price, the basic demand curve in a competitive market can be graphed:
A. as a horizontal line.
B. as a vertical line.
C. as a downward sloping line to the right.
D. as an upward sloping line to the right.
E. in the same manner as the total revenue curve.

AICPA FN: Research
Blooms: Understand
Feedback A: This is incorrect for the basic demand curve.
Feedback B: This is incorrect for the basic demand curve.
Feedback C: Correct! The basic demand curve in a competitive market can be graphed as a downward sloping line to the right.
Feedback D: This is incorrect for the basic demand curve.
Feedback E: This is incorrect for the basic demand curve.
30. The curve that shows the change in total revenue that accompanies a change in quantity
sold is called the:
C. profit curve.
D. demand curve.
E. revenue curve.

AICPA FN: Research
Blooms: Remember
Difficulty: 1 Easy
Feedback A: Correct! This correctly describes the marginal revenue curve.
Feedback B: This curve is incorrect.
Feedback C: This curve is incorrect.
Feedback D: This curve is incorrect.
Feedback E: This curve is incorrect.

15-12
31. The curve that shows the change in total cost that accompanies a change in quantity
produced and sold is called the:
B. marginal cost curve.
C. profit curve.
D. average revenue curve.
E. revenue curve.

AICPA FN: Research
Blooms: Remember
Difficulty: 1 Easy
Feedback A: This curve is incorrect.
Feedback B: Correct! This description correctly describes the marginal cost curve.
Feedback C: This curve is incorrect.
Feedback D: This curve is incorrect.
Feedback E: This curve is incorrect.
32. From an economic perspective, a company's profit-maximizing quantity is found where:

A. the total cost curve intersects with the marginal cost curve.
B. the total revenue curve intersects with the average revenue curve.
C. the marginal revenue curve intersects with the demand curve.
D. the marginal revenue curve intersects with the marginal cost curve.
E. the marginal cost curve intersects with the demand curve.

AICPA FN: Research
Blooms: Understand
Feedback A: This description does not describe the profit maximizing quantity.
Feedback B: This description does not describe the profit maximizing quantity.
Feedback C: This description does not describe the profit maximizing quantity.
Feedback D: Correct! The profit maximizing quantity is where the marginal revenue curve intersects with the marginal cost curve.
Feedback E: This description does not describe the profit maximizing quantity.

15-13
33. If the volume sold reacts strongly to changes in price, demand:

A. has no elasticity.
B. has negative elasticity.
C. is inelastic.
D. is elastic.
E. is unrealistic.

AICPA FN: Research
Blooms: Understand
Feedback A: This statement about demand is incorrect.
Feedback B: This statement about demand is incorrect.
Feedback C: This statement about demand is incorrect.
Feedback D: Correct! Demand is elastic.
Feedback E: This statement about demand is incorrect.

34. Under which of the following condition(s) are prices said to be elastic?
Price Change Change in Sales Volume

A. Increase Sizable increase
B. Increase Sizable decrease
C. Decrease Sizable increase
D. Decrease Sizable decrease
E. Either increase or decrease Either sizable increase or decrease

AICPA FN: Research
Blooms: Remember
Difficulty: 1 Easy
Feedback C: This answer combination is incorrect.
Feedback E: Correct! Prices are elastic when price changes either increase or decrease; prices are elastic when change in sales volume
either have sizable increase or decrease.
15-14
35. Which of the following statements regarding price elasticity is false?

A. The concept of price elasticity is an extension of the economic pricing model.
B. Demand is elastic if a price change has a large negative impact on sales volume.
C. Demand is elastic if price changes have no impact on sales volume.
D. Measuring price elasticity is an important objective of market research.
E. Demand is relatively inelastic if price changes have little impact on sales quantity.

AICPA FN: Research
Blooms: Understand
Feedback A: This is a true statement.
Feedback B: This is a true statement.
Feedback C: Correct! It is false that demand is elastic if price changes have no impact on sales volume.
Feedback D: This is a true statement.
Feedback E: This is a true statement.
36. Prices are said to be inelastic under which of the following conditions?
Price Change Change in Sales Volume

A. Increase Sizable decrease
B. Increase Little impact
C. Decrease Sizable increase
D. Decrease Little impact
E. Either increase or decrease Either sizable increase or little/no impact

AICPA FN: Research
Blooms: Remember
Difficulty: 1 Easy
Feedback E: Correct! Prices are inelastic when price change is either increasing or decreasing; prices are inelastic when change in sales
volume either has a sizable increase or little or no impact.

15-15
37. Consider the following statements regarding the economic pricing model:

I. The economic model is limited in use because a firm's demand curve is difficult to
determine.
II. The marginal revenue and marginal cost model is valid for all forms of market
organization (perfect competition, oligopoly, and so forth).
III. Cost accounting systems are not designed to measure the marginal changes in cost
incurred as production and sales increase.

A. I only.
B. III only.
C. I and III.
D. II and III.
E. I, II, and III.

AICPA FN: Research
Blooms: Remember
Feedback A: This statement is true, but there is a better answer choice.
Feedback B: This statement is true, but there is a better answer choice.
Feedback C: Correct! Both statements I and III are true.
Feedback D: One of these answers is false.
Feedback E: One of these answers is false.
38. In a typical business, the firm's overall demand would be influenced by interactions of
pricing policies and:
A. the company's reputation.
B. the quality of goods and services offered.
C. competing goods and services.
D. advertising and promotional campaigns.
E. All of these factors.

AICPA FN: Research
Blooms: Remember
Difficulty: 1 Easy
Feedback A: Overall demand is influence by interactions of pricing policies and this factor; however, there is a better answer choice.
Feedback B: Overall demand is influence by interactions of pricing policies and this factor; however, there is a better answer choice.
Feedback C: Overall demand is influence by interactions of pricing policies and this factor; however, there is a better answer choice.
Feedback D: Overall demand is influence by interactions of pricing policies and this factor; however, there is a better answer choice.
Feedback E: Correct! All of these factors are correct.

15-16
39. Consider the following statements about why prices are often based on product costs:
I. Companies sell many products and services, and cost-based approaches provide a simple
and direct pricing method.
II. The cost of a product or service provides a lower limit or floor, below which price should
not be set in the long run.
III. Determining a company's demand and marginal revenue curves is difficult, costly, and
time consuming.

A. I only.
B. III only.
C. I and III.
D. II and III.
E. I, II, and III.

AICPA FN: Research
Blooms: Understand
Feedback A: This statement is true, but there is a better answer choice.
Feedback B: This statement is true, but there is a better answer choice.
Feedback C: These statements are true, but there is a better answer choice.
Feedback D: These statements are true, but there is a better answer choice.

40. Which of the following represents the cost-plus pricing formula?

A. Price = cost + (markup percentage  cost).
B. Price = cost + markup percentage.
C. Price = markup percentage  cost.
D. Price = cost  markup percentage.
E. Price = cost + (markup percentage + cost).

AICPA FN: Research
Blooms: Remember
Difficulty: 1 Easy
Feedback A: Correct! This is the correct cost-plus pricing formula.
Feedback B: This formula is incorrect.
Feedback C: This formula is incorrect.
Feedback D: This formula is incorrect.
Feedback E: This formula is incorrect.

15-17
41. If a company uses a cost-plus approach to pricing, it will find:

A. there are several different definitions of cost and the higher the cost, the higher the markup
percentage.
B. there are several different definitions of cost and the higher the cost, the lower the markup
percentage.
C. there is one definition of cost, and there is no relationship between cost and the markup
percentage used.
D. there is one definition of cost, and there is no markup percentage with the cost-plus
approach.
E. it is in violation of generally accepted accounting principles (GAAP).

AICPA FN: Research
Blooms: Understand
Feedback A: This statement is false regarding the cost-plus approach to pricing.
Feedback B: Correct! This statement is true regarding the cost-plus approach to pricing.
Feedback C: This statement is false regarding the cost-plus approach to pricing.
Feedback D: This statement is false regarding the cost-plus approach to pricing.
Feedback E: This statement is false regarding the cost-plus approach to pricing.
42. In a cost-plus approach to pricing:

A. there is an inverse relationship between the magnitude of the cost basis and the markup
percentage.
B. there is a direct relationship between the magnitude of the cost basis and the markup
percentage.
C. the cost basis used must include fixed manufacturing overhead.
D. "plus" refers to the addition of allocated administrative overhead to the direct
manufacturing costs.
E. "plus" refers to the addition of allocated fixed manufacturing overhead to the variable
manufacturing costs.

AICPA FN: Research
Blooms: Remember
Feedback A: Correct! This statement is true regarding the cost-plus approach to pricing.
Feedback B: This statement is false regarding the cost-plus approach to pricing.
Feedback C: This statement is false regarding the cost-plus approach to pricing.
Feedback D: This statement is false regarding the cost-plus approach to pricing.
Feedback E: This statement is false regarding the cost-plus approach to pricing.
15-18
43. Patterson and Clay Companies both use cost-plus pricing formulas and arrived at a selling
price of $1,000 for the same product. Patterson uses absorption manufacturing cost as the
basis for computing its dollar markup whereas Clay uses total cost. Which of the following
choices correctly denotes the company that would have (1) the higher cost basis for deriving
its dollar markup and (2) the higher markup percentage?
Cost Basis Markup Percentage
A. Patterson Patterson
B. Patterson Clay
C. Clay Patterson
D. Clay Clay
E. More information is needed to judge.

AICPA FN: Research
Blooms: Understand
Feedback C: Correct! Clay would have the higher cost basis and Patterson would have the higher markup percentage.
Feedback E: This answer is incorrect.

44. Durango Industries employs cost-plus pricing formulas to derive selling prices for its
various products. If the formulas are all used correctly, which of the following cost bases will
result in the highest selling price?
A. Variable manufacturing cost.
B. Absorption manufacturing cost.
C. Total variable cost.
D. Total cost.
E. None of these because if the formulas are applied correctly, all should result in the same
selling price through the use of varying markups.

AICPA FN: Research
Blooms: Understand
Feedback A: This is incorrect.
Feedback B: This is incorrect.
Feedback C: This is incorrect.
Feedback D: This is incorrect.
Feedback E: Correct! None of these result in the highest selling price because all should result in the same selling price through the use of
varying markups.
15-19
45. Consider the following statements about absorption-cost pricing formulas:

I. Absorption-cost formulas consider a company's fixed manufacturing costs when
establishing a selling price.
II. Absorption-cost formulas are often justified on the grounds that a company must cover all
of its costs in the long run.
III. Absorption-cost data are the type that managers need when facing certain pricing
decisions, such as whether or not to accept a special order.

A. II only.
B. I and II.
C. I and III.
D. II and III.
E. I, II, and III.

AICPA FN: Research
Blooms: Understand
Feedback B: Correct! Both statements I and II are true.
Feedback C: Only one of these statements is true.
Feedback D: Only one of these statements is true.
Feedback E: One of these statements is false.

46. The difference between absorption manufacturing cost and total cost with respect to
product pricing is caused by:
A. variable manufacturing cost.
B. applied fixed manufacturing cost.
C. variable selling and administrative cost.
D. allocated fixed selling and administrative cost.
E. both variable selling and administrative cost and allocated fixed selling and administrative
cost.

AICPA FN: Research
Blooms: Remember
Difficulty: 1 Easy
Feedback A: This is incorrect.
Feedback B: This is incorrect.
Feedback C: While this is one statement that causes the difference, there is a better answer choice.
15-20
Feedback D: While this is one statement that causes the difference, there is a better answer choice.
Feedback E: Correct! Both of these cause the difference.

47. Collins Company uses cost-plus pricing and has calculated total variable manufacturing
cost, total absorption manufacturing cost, and total cost for one of its products. Which of these
costs would be the smallest?
A. Total variable manufacturing cost.
B. Total absorption manufacturing cost.
C. Total cost.
D. There is no difference between total absorption manufacturing cost and total cost.
E. More information is needed to correctly answer the question.

AICPA FN: Research
Blooms: Understand
Feedback A: Correct! This cost would be the smallest.
Feedback B: This cost would not be the smallest.
Feedback C: This cost would not be the smallest.
Feedback D: This statement is incorrect.
Feedback E: Sufficient information is given to select one of the costs listed.

48. Which of the following formulas represents the markup percentage on total cost?
A. Target profit  annual volume.
B. Target profit  (annual volume  total cost per unit).
C. (Annual volume  total cost per unit)  target profit.
D. Target profit  variable cost.
E. (Target profit  total cost per unit)  annual volume.

AICPA FN: Research
Blooms: Understand
Feedback A: This formula is incorrect.
Feedback B: Correct! This is the correct formula.
Feedback C: This formula is incorrect.

15-21
49. When determining the markup to be used in a cost-plus pricing formula, many companies
base the markup on a target:
A. return on investment.
B. sales margin.
C. capital turnover.
D. earnings per share.
E. debt-to-equity ratio.

AICPA FN: Research
Blooms: Understand
Feedback A: Correct! Many companies base the markup on a target return on investment.
Feedback B: This is typically not the target used.
Feedback C: This is typically not the target used.
Feedback D: This is typically not the target used.
Feedback E: This is typically not the target used.
50. The following costs relate to Tower Company: Variable manufacturing cost, $30; variable
selling and administrative cost, $8; applied fixed manufacturing overhead, $15; and allocated
fixed selling and administrative cost, $4. If Tower uses absorption manufacturing-cost pricing
formulas, the company's markup percentage would be computed on the basis of:
A. $30.
B. $38.
C. $45.
D. $57.
E. None of the answers is correct.

AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard
Feedback A: This amount is incorrect.
Feedback B: This amount is incorrect.
Feedback C: Correct! Markup percentage would be computed on manufacturing costs of $30 + $15= $45.
Feedback D: This amount is incorrect.
Feedback E: This answer is wrong, because there is a correct answer choice listed.
15-22
51. The following costs relate to Tower Company: Variable manufacturing cost, $30; variable
selling and administrative cost, $8; applied fixed manufacturing overhead, $15; and allocated
fixed selling and administrative cost, $4. If Tower uses total-cost pricing formulas, the
company's markup percentage would be computed on the basis of:
A. $30.
B. $38.
C. $45.
D. $57.

AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard
Feedback C: This amount is incorrect.
Feedback D: Correct! Total cost pricing markup percentage would be computed on the basis of all the costs(manufacturing and selling): $30
+ $15 + $8 + $4 = $57.

15-23
52. The following data pertain to Laramie Enterprises:
Variable manufacturing cost $60

Variable selling and administrative cost 10
Applied fixed manufacturing cost 30
Allocated fixed selling and administrative cost 5
What price will the company charge if the firm uses cost-plus pricing based on total cost and a
markup percentage of 60%?
A. $63.
B. $168.
C. $175.
D. $280.

AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard
Feedback B: Correct! This would be 60% of the total costs (manufacturing and selling) or 60% x ($60 + $30 + $10 + $5) = $105 + (60% x
$105) = $168.

15-24
53. The following data pertain to Ronaldo Enterprises:

What price will the company charge if the firm uses cost-plus pricing based on absorption
manufacturing cost and a markup percentage of 110%?
A. $84.
B. $147.
C. $210.
D. $231.

AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard
Feedback D: Correct! $70 + $40 = $110; $110 + ($110 x 1.1) = $231.

15-25
54. The following data pertain to Frontier Enterprises:

What price will the company charge if the firm uses cost-plus pricing based on variable
A. $84.
B. $147.
C. $210.
D. $231.

AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard
Feedback B: Correct! $70 + ($70 x 1.1) = $147.

15-26
Use the following information to answer Questions 55-58.
The Pines Company, which manufactures office equipment, is ready to introduce a new line
of portable copiers. The following copier data are available:


55. What price will the company charge if the firm uses cost-plus pricing based on variable
A. $396.00
B. $495.00
C. $576.00
D. $643.50

AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard
Feedback C: Correct! $180 + ($180 x 220%) = $180 + $396 = $576.00

56. What price will the company charge if the firm uses cost-plus pricing based on total
A. $150.
B. $384.
C. $390.
D. $624.

AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard
Feedback D: Correct! $180 + $60 = $240 total manufacturing costs; $240 + ($240 x 1.6) = $624.

15-27
57. What price will the company charge if the firm uses cost-plus pricing based on total
variable cost and a markup percentage of 120%?
A. $420.
B. $459.
C. $594.
D. $672.

AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard
Feedback C: Correct! $180 + $90 = $270; $270 + ($270 x 1.2) = $594.
58. What price will the company charge if the firm uses cost-plus pricing based on total cost
and a markup percentage of 40%?
A. $462.
B. $513.
C. $567.
D. $594.
AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard
Feedback C: Correct! Total cost = $180 + $90 + $60 + $75 = $405; $405 + ($405 x 40%) = $567.

15-28
59. Musik Corporation uses a 140% markup on total cost and recently computed a selling
price of $1,560 for a particular product. On the basis of this information, the product's total
cost is:
A. $650.00.
B. $910.00.
C. $1,114.29.
D. $2,184.00.

AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard
Feedback A: Correct! Price = Cost + (Markup percentage × Cost); $1,560 = X + (1.4X); X = $650.

60. Fantasy Transport Company has average invested capital of $800,000 and a target return
on investment of 15%. The total cost per unit is $20 based on a volume level of 25,000 units.
Fantasy’s markup percentage on total cost is:
A. 9.375%.
B. 24.0%.
C. 47.5%.
D. 62.5%.

AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard
Feedback B: Correct! $800,000 x 15% = $120,000 return; $120,000 ÷ 25,000 = $4.80; $4.80 ÷ $20 = 24%
15-29
61. If the target profit is $60,000 for a volume of 480 units, fixed costs are $168,000, and the
variable cost per unit is $450, then the markup percentage on variable cost would be:
A. 104.56%.
B. 105.56%.
C. 106.00%.
D. 106.45%.

AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard
Feedback B: Correct! $450 x 480 = $216,000; $168,000 + $60,000 = $228,000 ÷ $216,000 = 105.56%.

15-30
Use the following information to answer Questions 62 – 64.
Longwood, Inc. manufactures various lines of computer equipment and is planning to

introduce a new line of laptops. Current plans call for the production and sale of 1,000 units,
with estimated costs as follows:
Variable costs:
Manufacturing $450,000
Selling and Administrative 100,000
Total variable costs $550,000
Fixed costs:
Manufacturing $300,000
Selling and Administrative 180,000
Total fixed costs 480,000
Total costs $1,030,000
The average amount of capital invested in the laptop product line is $900,000 and
Longwood’s target return on investment is 18%.
62. What price must Longwood charge if the company uses cost-plus pricing based on total
cost?
A. $868.
B. $900.
C. $1,000.
D. $1,192.

AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard
Feedback D: Correct! $1,030,000 + ($900,000 x 18%) = $1,192,000; $1,192,000 ÷ 1,000 = $1,192.

15-31
63. If Longwood uses cost-plus pricing based on absorption cost, the markup percentage the
company must use would be:
A. 15.72%.
B. 21.64%.
C. 29.56%.
D. 58.93%.

AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard
Feedback D: Correct! Manufacturing costs = $450,000 + $300,000 = $750,000; $750,000 x (1 + X) = $1,192,000; X = 58.93%.

64. What price must Longwood charge if the company uses cost-plus pricing based on total
variable cost?
A. $712.
B. $900.
C. $1,030.
D. $1,192.

AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard
Feedback D: Correct! $1,030,000 + ($900,000 x 18%) = $1,192,000; $1,192,000 ÷ 1,000 = $1,192.

15-32
65. Which of the following terms describes a pricing strategy in which a new product's initial
price is set high and then eventually lowered to appeal to a broader range of customers?
A. Penetration pricing.
B. Price skimming.
C. Customer pricing.
D. Designed pricing.
E. Market-share pricing.

Blooms: Remember
Difficulty: 1 Easy
Feedback A: This is not the correct term.
Feedback B: Correct! This is the correct definition of price skimming.
Feedback C: This is not the correct term.
Feedback D: This is not the correct term.
Feedback E: This is not the correct term.

66. What is price skimming?

A. The initial price is set low and kept constant.
B. The initial price is set low and then raised.
C. The initial price is set high and later lowered.
D. The initial price is set high and kept constant.
E. The initial price is set high and then raised.

Blooms: Remember
Difficulty: 1 Easy
Feedback A: This statement is incorrect.
Feedback B: This statement is incorrect.
Feedback C: Correct! This is the correct definition of price skimming.
Feedback D: This statement is incorrect.
Feedback E: This statement is incorrect.
15-33
67. Which of the following terms describes a pricing strategy in which a new product's initial
price is set relatively low in order to gain a large market share?
B. Price skimming.
C. Customer pricing.
D. Designed pricing.

Blooms: Remember
Difficulty: 1 Easy
Feedback A: Correct! This is the correct definition of penetration pricing.
Feedback B: This is not the correct term.
Feedback C: This is not the correct term.
Feedback D: This is not the correct term.
Feedback E: This is not the correct term.
68. Company A uses a pricing approach where the initial price for a product is set high and
then lowered, and Company B uses an approach where initial prices are set low in an effort to
gain market share. What terms best describe these practices?
Company A Company B
A. Predatory Skimming
B. Penetration Predatory
C. Skimming Penetration
D. Skimming Predatory
E. Predatory Penetration

Blooms: Remember
Difficulty: 1 Easy
Feedback C: Correct! Company A is using price skimming and Company B is using penetration pricing.
15-34
69. Charlene Company, which desires to enter the market with a new product, will perform
the following tasks:
1—Design and engineer the product.
2—Determine the product's cost.
3—Determine the desired profit margin.
4—Determine the suggested selling price.
If Charlene uses target costing, which task would the company perform first?
A. 1.
B. 2.
C. 3.
D. 4.

Blooms: Understand
Feedback A: This is not the first step.
Feedback B: This is not the first step.
Feedback C: This is not the first step.
Feedback D: Correct! Charlene should first determine the suggested selling price.
15-35
70. The four tasks that follow take place with the concept known as target costing:
1—Value engineering.
2—Establish a target selling price.
3—Establish a target cost.
4—Establish a target profit.
Which of the following choices depicts the correct sequence of these tasks?
A. 1, 3, 4, 2.
B. 3, 1, 4, 2.
C. 2, 4, 3, 1.
D. 2, 3, 1, 4.
E. Some other sequence not listed.

Blooms: Understand
Feedback A: This is the correct sequence.
Feedback B: This is not the correct sequence.
Feedback C: Correct! This is the correct sequence.
Feedback D: This is the correct sequence.
Feedback E: This answer is wrong because there is a correct sequence listed.

71. Charter Corporation manufactures a single product that has a cost of $350. The company
uses a 70% markup on cost to arrive at a selling price of $595, which results in a price that
virtually always exceeds that of the market leaders. If Charter changes to the approach known
as target costing, the company will first:
A. reduce its 70% markup rate.
B. trim its $350 cost.
C. attempt to re-engineer its product.
D. undertake a thorough study of competitors' prices.
E. change the markup so that it is based on sales rather than based on cost.

AICPA BB: Marketing
Blooms: Understand
Feedback A: This statement is incorrect.
Feedback C: This statement is incorrect.
Feedback D: Correct! The company will undertake a thorough study of competitors’ prices when switching to target costing.
Feedback E: This statement is incorrect.
15-36
72. Which of the following features is typically absent in target costing?

A. An approach that begins with the determination of a product or service's target cost.
B. An approach that begins with the determination of a product or service's target selling
price.
C. A focus on the customer.
D. A focus on product design.
E. A focus on process design.

AICPA BB: Marketing
Blooms: Remember
Difficulty: 1 Easy
Feedback A: Correct! This feature is typically absent in target costing.
Feedback B: This feature is not absent in target costing.
Feedback C: This feature is not absent in target costing.
Feedback D: This feature is not absent in target costing.
Feedback E: This feature is not absent in target costing.
73. Which of the following is (are) a key feature of target costing?

A. The use of cross-functional teams.
B. A focus on the customer.
C. A focus on product design.
D. A focus on process design.
E. All of the answers are correct.

AICPA BB: Marketing
Blooms: Remember
Difficulty: 1 Easy
Feedback A: While this is a key feature of target costing, there is a better answer choice.
Feedback B: While this is a key feature of target costing, there is a better answer choice.
Feedback C: While this is a key feature of target costing, there is a better answer choice.
Feedback D: While this is a key feature of target costing, there is a better answer choice.
Feedback E: Correct! All of these are key features of target costing.
15-37
74. Flagler Electronics currently sells a camera for $240. An aggressive competitor has
announced plans for a similar product that will be sold for $205. Flagler’s marketing
department believes that if the price is dropped to meet competition, unit sales will increase
by 10%. The current cost to manufacture and distribute the camera is $175, and Flagler has a
profit goal of 20% of sales. If Flagler meets competitive selling prices, what is the company's
target cost?
A. $41.
B. $48.
C. $164.
D. $175.
E. $192.

AACSB: Analytic
AICPA BB: Marketing
Blooms: Apply
Difficulty: 3 Hard
Feedback C: Correct! Target cost should be $205 x 80% = $164.
Feedback E: This amount is incorrect.
75. Miami Industries currently sells an industrial mixer for $900 that market leaders sell for
$820. The current costs to manufacture and distribute the mixer total $645, and the company
has a profit goal of 30% of sales. Miami uses target costing in its efforts to be a leader in the
marketplace. On the basis of this information, (1) what should Miami consider to be the initial
driver of the target-costing process and (2) what amount of cost reduction is needed for the
company to achieve its goals?
Initial Driver Cost Reduction
A. Current price of $900 $15
B. Current price of $900 $71
C. Market leaders’ price of $820 $15
D. Market leaders’ price of $820 $71
E. Market leaders’ price of $820 Some other amount
AACSB: Analytic
AICPA BB: Marketing
Blooms: Understand
Feedback D: Correct! The company should meet the market leaders’ price of $820, which would mean a targeted cost reduction of $71,
calculated as: [$645 – ($820 x 70%)] = $645 - $574 = $71.
15-38
76. Rudy Enterprises currently sells a piece of luggage for $200. An aggressive competitor
has announced plans for a similar product that will be sold for $170. Rudy’s marketing
department believes that if the price is dropped to meet competition, unit sales will increase
by 10%. The current cost to manufacture and distribute the luggage is $130, and Rudy has a
profit goal of 30% of sales. If Rudy meets competitive selling prices, what must happen to the
company's manufacturing and distribution cost?
A. Nothing, because the costs are within defined ranges and can actually increase by $10.
B. Nothing, because the costs are within defined ranges and can actually increase by $23.
C. Costs must decrease by $11.
D. Costs must decrease by $39.
AACSB: Analytic
AICPA BB: Marketing
Blooms: Apply
Difficulty: 3 Hard
Feedback C: Correct! (1 – 0.3)$170 = $119; $130 - $119 = $11 drop in costs to meet profit goals.
77. Delmar Enterprises produces bicycles in a highly competitive market. During the past
year, the company has added a 30% markup on the $250 manufacturing cost for one of its
most popular models. A new competitor manufactures a similar model, has established a $300
selling price, and is seriously eroding Delmar’s market share. Management now desires to use
a target-costing approach to remain competitive and is willing to accept a 20% return on sales.
If target costing is used, which of the following choices correctly denotes (1) the price that
Delmar will charge and (2) company's target cost?

Selling Price Target Cost
A. $300 $240
B. $300 $250
C. $325 $240
D. $325 $250
E. Some other combination of selling price and target cost.
AACSB: Analytic
AICPA BB: Marketing
Blooms: Apply
Difficulty: 3 Hard
Feedback A: Correct! The competitive selling price is $300 and the amount of the target cost is (1 - 0.2) x $300 = $240.
15-39
78. Consider the following statements about activity-based costing and its use in pricing:
I. A company that uses target costing generally would have little need for activity-based
costing.
II. Companies that use cost-plus pricing methods would have little need for activity-based
costing.
III. The use of activity-based costing will often lead to better pricing decisions by managers.

A. I only.
B. II only.
C. III only.
D. I and III.
E. I, II, and III.

AICPA BB: Marketing
Blooms: Understand
Feedback A: This statement is not true.
Feedback B: This statement is not true.
Feedback C: Correct! Only Statement III is true.
Feedback D: Only one of these statements is true.
Feedback E: Only one of these statements is true.
79. Which of the following management tools is a key component of target costing?

A. Management simulation.
B. Linear programming.
C. Value engineering.
D. Goal programming.
E. Performance reporting systems.

AICPA BB: Marketing
Blooms: Remember
Difficulty: 1 Easy
Feedback A: This is not the correct tool.
Feedback B: This is not the correct tool.
Feedback C: Correct! Value engineering is a key component of target costing.
Feedback D: This is not the correct tool.
Feedback E: This is not the correct tool.

15-40
80. Which of the following cost-reduction and process-improvement techniques is often used

in conjunction with target costing?
A. Linear programming.
B. Deterministic simulations.
C. Cost allocation.
D. Budgetary padding.
E. Value engineering.

AICPA BB: Marketing
Blooms: Remember
Difficulty: 1 Easy
Feedback A: This is not the correct technique.
Feedback B: This is not the correct technique.
Feedback C: This is not the correct technique.
Feedback D: This is not the correct technique.
Feedback E: Correct! This statement is correct regarding value engineering.

81. Consider the following statements about time and material pricing:

I. The time charge includes the direct cost of an employee's time.
II. The time charge includes an amount to cover various overhead costs.
III. The material charge includes a handling charge for material.

A. I only.
B. I and II.
C. I and III.
D. II and III.
E. I, II, and III.

AICPA BB: Marketing
Blooms: Understand
Feedback B: While these statements are true, there is a better answer choice.
15-41
82. Under the time and material pricing method, a customer would be charged for:
Material Costs Labor Costs Overhead Costs Profit Margin
A. Yes No No No
B. Yes Yes No No
C. Yes Yes Yes No
D. Yes Yes No Yes
E. Yes Yes Yes Yes

AICPA BB: Marketing
Blooms: Remember
Difficulty: 1 Easy
Feedback E: Correct! Under the time and material pricing method, a customer would be charged for all of these.

83. With the time and material pricing method, the hourly time charge is typically set equal
to:
A. the hourly labor cost.
B. the hourly labor cost + annual overhead.
C. the hourly labor cost + an hourly overhead charge + an hourly charge to cover the profit
margin.
D. annual overhead + an hourly charge to cover the profit margin.
E. the hourly labor cost + an hourly charge to cover the profit margin.

AICPA BB: Marketing
Blooms: Understand
Feedback A: This formula is incorrect.
Feedback B: This formula is incorrect.
Feedback C: Correct! With the time and material pricing method, this is the correct formula for the hourly time charge.
15-42
84. Inse Corporation uses time and material pricing. The repair department expects 20,000
direct labor hours of activity and has the following selected data:
Labor and fringe benefit costs $800,000

Overhead Costs (excludes material handling and storage) 480,000
Target profit 220,000
The company's time charge per hour is:

A. $11.
B. $24.
C. $40.
D. $64.
E. $75.

AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard
Feedback E: Correct! $800,000 + $480,000 + $220,000 = $1,500,000; $1,500,000 ÷ 20,000 = $75

15-43
Use the following information to answer Questions 85 - 87.
Ralph’s Auto Repair uses time and material pricing. The body shop, which anticipates 10,000
direct labor hours of activity, has the following data:
Annual overhead costs:

Material handling and storage $15,000
Other overhead costs 75,000
Annual cost of materials used 187,500
Labor rate per hour, including fringe benefits 18
Hourly charge to achieve profit margin 11
85. The time charge per hour is:

A. $19.50.
B. $27.00.
C. $29.00.
D. $36.5036.75.

AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard
Feedback D: Correct! The time charge is $18 + ($75,000187,500 ÷ 10,000) +$11 = $36.5036.75 per hour.
15-44
86. Assuming there is no profit markup on material cost, the amount to be added to each
dollar of material cost to obtain the total material charge is:
A. $0.06.
B. $0.08.
C. $0.10.
D. $0.13.

AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard
Feedback B: Correct! $15,000 ÷ $187,500 = $0.08

87. If a particular job takes 20 hours of labor and $800 of materials, the price charged for the
job is:
A. $1,380.
B. $1,444.
C. $1,530.
D. $1,5949.

AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard
Feedback D: Correct! ($36.5036.75 x 20 hr.)+ $800 + (800 x $0.08) = $1,5949

15-45
88. Consider the following statements about competitive bidding:

I. The higher the price that a company bids, the greater the profit if the firm gets the contract.
II. Bidding a higher price increases the probability of obtaining a contract.
III. A company that bids low to ensure acceptance of a contract may actually wind up bidding
too low to make an acceptable profit.

A. I only.
B. II only.
C. III only.
D. I and III.
E. I, II, and III.

AICPA BB: Marketing
Blooms: Understand
Feedback C: While this statement is true, there is a better answer choice.
Feedback D: Correct! Both statements I and III are true.
Feedback E: One of these statements is incorrect.

89. If a company has excess capacity, which of the following is a sensible bidding strategy?
A. Set a price to cover all costs.
B. Base the bid on the incremental costs incurred because the job will contribute toward the
company's profit.
C. Base the bid solely on direct labor hours.
D. Downplay the potential impact of competitors.
E. Allocate common fixed costs to individual jobs before preparing the bid.

AICPA BB: Marketing
Blooms: Remember
Difficulty: 1 Easy
Feedback A: This bidding strategy is incorrect.
Feedback B: Correct! This is the correct bidding strategy.
Feedback C: This bidding strategy is incorrect.
Feedback D: This bidding strategy is incorrect.
Feedback E: This bidding strategy is incorrect.
15-46
90. If a firm has no excess capacity, which of the following is a sensible bidding strategy?
A. Set a price to cover all costs.
B. Base the bid on the incremental costs incurred because the job will contribute toward the
company's profit.
C. Base the bid solely on direct labor hours.
D. Downplay the potential impact of competitors.
E. Try to minimize the company's tax liability.

AICPA BB: Marketing
Blooms: Remember
Difficulty: 1 Easy
Feedback A: Correct! This is the correct bidding strategy.
Feedback B: This bidding strategy is incorrect.
Feedback C: This bidding strategy is incorrect.
Feedback D: This bidding strategy is incorrect.
Feedback E: This bidding strategy is incorrect.
91. Harlen Company is involved in a competitive bidding situation. The following costs are
anticipated for a project to be bid with the City of Crimson:
Direct material $340,000

Direct labor 610,000
Allocated variable overhead 420,000
Allocated fixed cost 110,000
Which of the following cost figures should be used in setting a minimum bid price if Harlen
has excess capacity?
A. $530,000.
B. $950,000.
C. $1,370,000.
D. $1,480,000.

AACSB: Analytic
AICPA BB: Marketing
Blooms: Apply
Difficulty: 3 Hard
Feedback C: Correct! Since there is excess capacity, all variable costs are included: $340,000 + $610,000 + $420,000 = $1,370,000.
15-47
92. Gypsum Park Recreation is exploring a competitive bidding situation. The firm, which
currently has no excess capacity, estimates the following costs for a project to be performed
for the Talent School District:

Direct labor 130,000
Which of the following cost figures would be used in determining a minimum price if
Gypsum Park decides to bid on the Talent project?
A. $131,000.
B. $350,000.
C. $441,000.
D. $481,000.

AACSB: Analytic
AICPA BB: Marketing
Blooms: Apply
Difficulty: 3 Hard
Feedback D: Correct! All the costs would be used for determining the minimum price where there is no excess capacity, or $220,000 +
$130,000 + $91,000 + $40,000 = $481,000.
15-48
93. Polson Pool Company is involved in a number of competitive bidding situations. The

following costs are anticipated for a project to be bid for Terrance Manufacturing:

Direct labor 2,450,000
Which of these costs would be treated differently if Polson had either excess capacity or no
excess capacity?
A. Direct materials used, $680,000.
B. Direct labor, $2,450,000.
C. Allocated variable overhead, $570,000.
D. Allocated fixed cost, $230,000.
E. None of these, as all four costs are considered in both situations.
AACSB: Analytic
AICPA BB: Marketing
Blooms: Apply
Difficulty: 3 Hard
Feedback D: Correct! The allocated fixed cost of $230,000 would be treated differentially.
15-49
94. Emporia Shipping Company is involved in a competitive bidding situation. Variable costs

related to the project total $520,000, and allocated fixed cost is $95,000. Which of the
following cost figures should be used in setting a minimum bid price if Emporia has (1)
excess capacity and (2) no excess capacity?
Excess Capacity No Excess Capacity

A. $0 $0
B. $520,000 $520,000
C. $520,000 $615,000
D. $615,000 $520,000
E. $615,000 $615,000
AACSB: Analytic
AICPA BB: Marketing
Blooms: Apply
Difficulty: 3 Hard
Feedback C: Correct! Excess capacity = $520,000; No excess capacity = $520,000 + 95,000 = $615,000

95. Consider the following statements about pricing and the law:
I. American antitrust laws restrict certain types of pricing behavior.
II. The term "price discrimination" involves charging different prices to different customers
for the same goods and services.
III. Charging different prices to different customers for the same goods is permissible if price
differences are based on cost differences of producing and/or selling the good.

A. I only.
B. II only.
C. I and II.
D. II and III.
E. I, II, and III.

AICPA BB: Legal
Blooms: Remember
Feedback B: While this statement is true, there is a better answer choice.

15-50
96. Which of the following pricing practices is illegal?

B. Price skimming.
C. Predatory pricing.
D. Cost-based pricing.

AICPA BB: Legal
AICPA FN: Research
Blooms: Remember
Difficulty: 1 Easy
Feedback A: This pricing practice is not illegal.
Feedback B: This pricing practice is not illegal.
Feedback C: Correct! This pricing practice is illegal.
Feedback D: This pricing practice is not illegal.
Feedback E: This pricing practice is not illegal.

15-51
Essay Questions

97. The following data pertain to Arctic Company's commercial snow thrower:

Required:
For each of the following cost bases, determine the appropriate percentage markup that will
result in a price of $980 for the snow thrower. (Round percentages to nearest one-hundredth
of a percent.)
A. Variable manufacturing cost.
B. Absorption manufacturing cost.
C. Total cost.
D. Total variable cost.
Solution:
A. Variable manufacturing cost per unit $400

Markup ($400 x 145%) 580
Price $980
B. Absorption manufacturing cost ($400 + $160) $560

Markup ($560 x 75%) 420
Price $980
C. Total cost ($400 + $160 + $60 + $25) $645

Markup ($645 x 51.94%) 335
Price $980
D. Total variable cost ($400 + $60) $460

Markup ($460 X 113.04%) 520
Price $980
AACSB: Analytic
AICPA BB: Marketing
Blooms: Apply
Difficulty: 3 Hard

15-52
98. The following data pertain to Tannebaum Corporation's residential humidifier:

Allocated fixed selling and administrative cost ?
To achieve a target price of $450 per humidifier, the markup percentage on total unit cost is
12%.
Required:
A. Calculate the fixed selling and administrative cost allocated to each humidifier.
B. For each of the following bases, determine the appropriate percentage markup on cost that
will result in a target price of $450 per humidifier: (1) variable manufacturing cost, (2)
absorption manufacturing cost, and (3) total variable cost. (Round percentages to the nearest
one-hundredth of a percent.)
Solution:
A. Price = total unit cost + (markup percentage  total unit cost)

$450 = X + (0.12  X)
$450 = 1.12X
$401.79 = X
Because the total unit cost is $401.79, the allocated fixed selling and administrative cost
would be $21.79 ($401.79 - $240.00 - $80.00 - $60.00).
B.
Method Price Cost Basis Markup Markup

Percent
1.Variable manufacturing cost $450 $240 $210 87.50%
2. Absorption manufacturing cost 450 320 130 40.63%
3. Total Variable cost 450 300 150 50.00%
AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard

15-53
99. Alpine, Inc. sells a single product. The following information relates to the year just
ended:
Number of units sold: 40,000
Variable cost per unit: $200
Total fixed cost: $2,400,000
Operating income: $3,800,000
Required:
A. Compute the company's selling price.

B. Compute the percentage markup on total cost. Round your answer to two decimal places.
C. Assume that Alpine desired to change its practice of computing a markup on total cost to a
markup on variable cost. If the company wants to hold selling price constant, would the
markup percentage increase or decrease? By how much?
Solution:
A. The company's total cost is $10,400,000 [(40,000 units  $200) + $2,400,000], resulting in
sales revenue of $14,200,000 ($10,400,000 + $3,800,000). The selling price is therefore $355
($14,200,000  40,000 units).
B. The total cost per unit is $260 [$200 + ($2,400,000  40,000 units)], resulting in a $95
markup ($355 - $260). Each unit is thus marked up by 36.54% of total cost ($95  $260).
C. Because the base for computing the markup is smaller, the percentage markup must
increase to produce the same sales price. The markup on variable cost must equal $155 to
derive a $355 selling price ($355 - $200), or 77.5% ($155  $200). The net result is a hike of
40.96% (77.50% - 36.54%).

AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard

15-54
100. Astro, Inc. uses target costing and will soon enter a very competitive marketplace in
which it will have limited influence over the prices that are charged. Management and
consultants are working to fine-tune the company's sole service, which hopefully will
generate a 12% return (profit) on the firm's $24,000,000 asset investment. The following
information is available:
Hours of service to be provided: 34,000
Anticipated variable cost per service hour: $30
Anticipated fixed cost: $2,560,000 per year
Required:
A. How much profit must Astro produce to achieve a 12% return?

B. Calculate the revenue per hour that Astro must generate to achieve a 12% return.
C. Assume that prior to entering the marketplace, management conducted a planning exercise
to determine whether a 14% return could be attained in year no. 2. Can the company achieve
this return if (a) competitive pressures dictate a maximum selling price of $195 per hour and
(b) service hours, variable cost per service hour, and fixed costs are the same as the amounts
anticipated in year no. 1? Show calculations.
D. If your answer to part "C" is "no," suggest and briefly describe a procedure that Astro
might use to achieve desired results.
Solution:
A. Astro’s target profit is $2,880,000 ($24,000,000  12%).

B. Total revenues must be sufficient to cover costs and produce the target profit. Thus,
revenues equal $6,460,000 [(34,000 hours  $30) + $2,560,000 + $2,880,000]. The revenue
per hour must be $190 ($6,460,000  34,000 hours).
C. Astro’s target profit is $3,360,000 ($24,000,000  14%). Total revenues must equal
$6,940,000 [(34,000 hours  $30) + $2,560,000 + $3,360,000], and the revenue per hour must
be $204.12 ($6,940,000  34,000 hours).
No. A 14% return requires that Astro produce revenue per service hour of $204.12, which is
in excess of the $195 maximum market price.
D. To achieve a 14% return and a $195 revenue-per-hour figure, the company must trim its
costs. Astro could use value engineering, a technique that utilizes information collected about
a service's design and associated processes. The goal is to examine the design and processes
and then identify improvements that would produce cost savings.

AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard

15-55
101. Rollins and Associates develops hotels in resort locations. The company is exploring the
construction of a new facility that would have significant meeting and banquet space for
conventions and conferences, and sleeping rooms that average 850 square feet. The
accounting department estimates that land and building costs will amount to $60 and $120 per
square foot of floor area, respectively. Other expenditures during construction for interest, real
estate taxes, and general overhead are expected to total 35% of land and construction cost.
Once basic construction is completed, Rollins anticipates per-room initial expenditures for:
Sleeping room furnishings and accessories $16,000

Supplies 1,900
Marketing 5,500
The accounting department suggests that 10% be added to the total of all preceding costs to
allow for estimation errors. Construction is anticipated to take two years.
Rollins’ pricing policy is consistent with that of industry leaders, namely, to set a room rate
equal to .1% (.001) of cost. Upon completion, comparable facilities are expected to charge
$240 per day.
Required:
A. Compute the total cost of a sleeping room at the new facility.

B. Is the company's room rate competitive? Briefly explain.
C. Rollins desires to enter this market by adhering to the industry standard and charging a
competitive room rate. If needed, the firm will look for ways to cut expenditures. Briefly
explain the difference between cost-plus pricing and target costing.
D. Other than operating costs and room revenues, what else should Rollins consider before a
final decision is made about the facility?
15-56
Solution:
A.
Land: 850 square feet x $60 $51,000

Construction: 850 sq. ft. x $120 102,000
Subtotal $153,000
Interest, taxes, and overhead: $153,000 x 35% 53,550
Furnishings and accessories 16,000
Supplies 1,900
Marketing 5,500
Subtotal $229,950
Estimation errors: $229,950 x 10% 22,995
Total $252,945
B. The rate may or may not be competitive, depending on whether the estimation errors
materialize. The going market rate is $240 per day, while Rollins’ rate will range between
$229.95 and $252.95.
C. With target costing, a firm first determines a competitive market price to charge for its
good or service and then subtracts an appropriate profit margin. The result is a targeted cost
figure, which may require that a process be redesigned through an approach known as value
engineering. In contrast, cost-plus pricing begins with a company's costs and adds a markup to
arrive at the selling price.
D. The facility is being designed to accommodate conferences and conventions, meaning that
significant added revenues and income may result. For example, audio-visual rentals and
large-scale dining and liquor sales commonly arise from such events. Furthermore, many
things can change during the two-year construction period (e.g., economic downturns and new
competitors) that could alter the company's analysis and construction decisions.

AACSB: Analytic
AICPA BB: Marketing
Blooms: Apply
Difficulty: 3 Hard

15-57
102. Trailrider Corporation manufactures part no. 67, which is used in the production of
mountain bikes. Per-unit information about part no. 67 follows.
Prevailing market price $33

Direct materials 14
Direct labor 6
Manufacturing overhead 7
Selling and administrative expenses 3
Trailrider has traditionally used a 20% markup on total cost to arrive at a reasonable selling
price. The company, though, has noticed a sizable drop in sales volume during the last few
quarters, which it attributes to new entrants in the marketplace.
Required:
A. Compute the current selling price of part no. 67.

B. If management desired to meet the prevailing market price and maintain the current rate of
profit on sales, what must happen to the company's total manufacturing costs? By how much?
Solution:
A. The current selling price is $36: ($14 + $6 + $7 + $3 = $30; $30  120% = $36).
B. The company's markup is $6 ($36 - $30), which is 16.67% of the current $36 selling price
($6  $36). To achieve a 16.67% markup on a $33 selling price, Morrow must reduce its costs
by $2.50.
Prevailing market price $33.00

Less: 16.67% markup ($33 x 16.67%) 5.50
Target cost $27.50
Current cost $30.00

Less: Target cost 27.50
Required cost reduction $2.50

AACSB: Analytic
AICPA BB: Marketing
Blooms: Apply
Difficulty: 3 Hard

15-58
103. For many years, Oxmoor Corporation has used a straightforward cost-plus pricing
system, marking its goods up approximately 20% of total cost. The company has been
profitable; however, it has recently lost considerable business to foreign competitors that have
become very aggressive in the marketplace. These firms appear to be using target costing.
An example of Oxmoor’s woes is typified by item no. 710, which has the following unit-cost
characteristics: direct materials, $50; direct labor, $90; manufacturing overhead, $40; and
selling and administrative expenses, $20. The going market price for an identical product of
identical quality is $210, which is below what Oxmoor is charging.
Required:
A. Contrast cost-plus pricing and target costing.

B. What is Oxmoor’s current selling price for item no. 710?
C. If Oxmoor used target costing for item no. 710, what must happen to costs if the company
desired to meet market prices and maintain its current rate of profit on sales? By how much?
Solution:
A. Cost-plus pricing begins by computing an item's cost and then adds a markup. The result is
the item's selling price. In contrast, target costing begins by determining an appropriate selling
price. A target profit is next subtracted from that price to yield the cost (i.e., the "target cost")
that must be achieved.
B. The current selling price is $240: ($50 + $90 + $40 + $20 = $200; $200  120% = $240).
C. Oxmoor’s markup is $40 ($240 - $200), which is 16.67% of the current $240 selling price
($40  $240). To achieve a 16.67% markup on a $210 selling price, the company must reduce
its costs by $25.
Selling price $210

Less: 16.67% markup ($210 x 16.67%) 35
Target cost $175
Current cost $200

Less: Target cost 175
Required cost reduction $ 25
AACSB: Analytic
AICPA BB: Marketing
Blooms: Apply
Difficulty: 3 Hard

15-59
104. Buffington, Inc. produces a number of components that are used in home theater
systems. Mike Boston, head of the company's market research department, has identified the
need for a new component that will most likely sell for $75. Projected volume levels are
anticipated to reach 28,000 units in the first year, as several firmly entrenched competitors
will be introducing a similar product in the not-too-distant future.
Conversations with Buffington’s engineers and reviews of cost accounting data related to
similar products that the company manufactures resulted in the following cost estimates for
the new component:
Direct materials $18

Direct labor 36
Manufacturing overhead 16
Selling and administrative 5
Buffington currently uses cost-plus pricing and adds a 20% markup on total production cost to
arrive at what is normally a competitive selling price.
Required:
A. What is the anticipated selling price of the new component if Buffington uses its current
pricing policy? What difficulties, if any, might the company face in the marketplace?
B. Assume that Buffington decides to switch to target costing. What price would the company
charge for the new component?
C. With the switch to target costing, what would Buffington have to do to the component's
manufacturing cost to achieve the normal profit margin on sales? Be specific and show
calculations.
15-60
Solution:
A. The total production cost is $70 ($18 + $36 + $16), and the addition of a 20% markup
yields an $84 selling price ($70  120%). Unless the new component has some extra features
that consumers find attractive, overall sales might suffer because $84 exceeds the expected
competitive price of $75.
B. $75 (the expected competitive selling price)
C. Buffington’s markup is $14 ($84 - $70), which is 16.67% of the current $84 selling price
($14  $84). To achieve a 16.67% markup on a $75 selling price, the company must reduce its
production costs by $7.50.
Selling price $75.00

Less: 16.67% markup ($75 x 16.67%) 12.50
Target cost $62.50
Current cost $70.00

Less: Target cost 62.50
Required cost reduction $ 7.50
D. Buffington can use value engineering, which focuses on cost reduction and process
improvement. Information is collected about a product's design and manufacturing processes,
and attempts are made to identify areas of change and where general improvements in
efficiency are possible.

AACSB: Analytic
AICPA BB: Marketing
Blooms: Apply
Difficulty: 3 Hard

15-61
105. Allred Furniture manufactures easy-to-assemble wooden furniture for home and office.
The firm is considering modification of a bookcase, and the company's marketing department
surveyed potential buyers regarding five proposed changes (A-E). The buyers' responses, in
order of preference, along with Allred’s related unit costs for the modifications, follow.
Order of Preference Change Cost

1 A $7.50
2 D 5.00
3 B 4.00
4 C 1.50
5 E 5.50
The bookcase currently costs $81 to produce and distribute, and Allred’s selling price for
this unit averages $108. An analysis of competitive products in the marketplace revealed a
variety of features, with some models having all of the changes that Allred is considering
and other models having only a few. The current manufacturers' selling prices on these
bookcases average $120.
Required:
A. Why is there a need in target costing to (a) focus on the customer and (b) have a
marketing team become involved with product design?
B. Management desires to earn approximately the same rate of profit on sales that is being
earned with the current design.
1. If Allred uses target costing and desires to meet the current competitive selling price,
what is the maximum cost of the modified bookcase?
2. Which of the modifications should Allred consider?
C. Assume that Allred wanted to add a modification or two that you excluded in your
answer to requirement "B2." What process might management adopt to allow the company
to make its target profit for the bookcase? Briefly explain.
15-62
Solution:
A. Target costing is market driven, beginning with a determination of the selling price that
customers are willing to pay. That price is dependent on the product they purchase and the
product's associated features. It is only natural that a marketing team becomes heavily
involved in this process, as much of what is done here is based on customer feedback.
B. 1. Allred currently earns a $27 profit on each bookcase sold ($108 - $81), which translates
into a 25% markup on sales ($27  $108). The current competitive market price is $120,
which means that if Allred maintains the 25% markup, it will earn $30 per unit. The
maximum allowable cost is therefore $90 ($120 - $30).
2. Allred can add $9 of modifications ($90 - $81), giving rise to several options. Customers
feel most strongly about change A, which can be adopted either by itself or in conjunction
with change C ($7.50 + $1.50 = $9.00). Alternatively, changes D and B can be selected, also
adding $9 to total cost ($5.00 + $4.00 = $9.00).
C. Allred might use value engineering to study the design and production process of both the
bookcase as currently manufactured as well as the proposed new features. The goal is to
identify improvements and associated reductions in cost that may allow the company to add
previously rejected options.

AACSB: Analytic
AICPA BB: Marketing
Blooms: Apply
Difficulty: 3 Hard

15-63
106. The controller for Rich Photographic Supply has established the following cost pools and
cost drivers:
Activity Cost Pool Budgeted Cost Driver Budgeted Pool Rate

Overhead Level for
Cost Driver
Machine setups $200,000 Number of setups 100 $2,000 per setup
Material handling 100,000 Pounds of raw material 50,000 $2 per pound
Hazardous waste control 50,000 Pounds of hazardous 10,000 $5 per pound
chemicals
Quality control 75,000 Number of inspections 1,000 $75 per inspection
Other overhead costs 200,000 Machine hours 20,000 $10 per machine hr.
Total $625,000
An order for 1,200 boxes of film-development chemicals has the following production
requirements:
Machine setups 8
Pounds of raw materials 16,000
Pounds of hazardous chemicals None
Inspections 4
Machine hours 400
Direct materials and labor cost $24,000
Rich established a target price by adding a 40% markup to total manufacturing cost.
Required:
A. Determine the order's target price by using the activity-cost pools.

B. Assume that Rich used a single, combined overhead rate based on weight of raw materials.
1. Determine the predetermined overhead rate.
2. Determine the expected cost of the order.
3. Determine the target price.
C. Which approach above ("A" or "B") seems to be a more reasonable method to establish
target prices? Explain.
15-64
Solution:
A. Activity Cost Pool Number Rate Cost

Machine setups 8 $2,000 $16,000
Pounds of raw material 16,000 2 32,000
Pounds of hazardous 0 5 ---
chemicals
Inspections 4 75 300
Machine hours 400 10 4,000
Subtotal $52,300
Direct materials and labor 24,000
Total cost $76,300
Markup at 40% 30,520
Target price $106,820
B. 1. Total budgeted overhead ÷ pounds of raw material

$625,000 ÷ 50,000 = $12.50 per pound
2. Materials and labor $24,000

Overhead ($12.50 x 16,000 pounds) 200,000
Expected cost of the order $224,000
3. Expected cost of the order $224,000

Markup at 40% 89,600
Target Price $313,600
C. The activity-based approach ("A") makes more specific use of the order's characteristics
(and cost drivers). While this order would represent 32% of the expected direct materials
usage, the order would require only 8% of the setups, 0% of the hazardous waste, 0.4% of the
inspections, and 2% of the machine hours. No overhead application method based on any
single variable can reflect all this diversity in resource consumption.

AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard

15-65
107. Shocker Electrical, which installs sophisticated electronic-control systems in new homes,

prices jobs by using the time-and-materials method. The following data apply to a job for
ABC Builders:
Labor hours: 180
Materials cost: $48,000
The following predictions, based on 30,000 direct labor hours, pertain to the company's
operations for the year:
Annual overhead costs:

Material handling and storage $ 40,000
Other overhead costs 360,000
Annual cost of materials used 500,000
Labor rate per hour, including fringe 34
benefits
Shocker Electrical adds a markup of $15 per hour on its time charges, but there is no profit
markup on material costs.
Required:
Calculate the price for the ABC Builders' job.
Solution:
Time charges: $34 + ($360,000  30,000 hours) + $15 = $61 per hour
Material handling: $40,000  $500,000 = 8% of material cost
Price quotation for ABC Builders:

Labor: 180 hours x $61 $ 10,980
Material: $48,000 x 108% 51,840
Total $62,820
AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard

15-66
108. Exquisite Exteriors installs stucco on high-priced custom homes, using the time-and-
materials method to price jobs for individual builders. Exquisite anticipates using $250,000 of
materials during the year and will incur $15,000 for material handling and storage. Other
overhead costs, which are driven by the company's 18,000 direct labor hours, will total
$360,000. Exquisite pays construction crews $17 per labor hour and adds a markup of $19 per
hour on its time charges. There is no profit markup on material cost.
During the first quarter of the year, Exquisite performed 24 jobs for Don Henderson Builders,
using 3,100 labor hours and $72,000 of materials.
Required:
Calculate the amount that Exquisite would bill Don Henderson Builders for work performed.
Solution:
Time charges: $17 + ($360,000  18,000 hours) + $19 = $56 per hour
Material handling: $15,000  $250,000 = 6% of material cost
Billing for Don Henderson Builders:

Labor: 3,100 hours x $56 $ 173,600
Material: $72,000 x 106% 76,320
Total $249,920
AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard

15-67
109. Aerial Roofing performs roofing services for commercial clients. The company recently
submitted a bid of $371,000 to the Ponca School System, computed as follows:
Construction materials $80,000

Labor costs 170,000
Total direct costs $250,000
Construction overhead – 30% of labor 51,000
Allocated administrative overhead 20,000
Total cost $321,000
Aerial adds a 20% profit margin to all jobs, computed on the basis of total direct cost. In
Ponca’s case the profit margin amounted to $50,000 ($250,000  20%), producing a bid price
of $371,000. Assume that 60% of construction overhead is fixed.
Required:
A. If Aerial had excess capacity, what would be the lowest cost total that the company should
use when figuring its bid for the district? How can High justify this amount?
B. If Aerial had no excess capacity, what would be the lowest price that the company should
charge?
C. What is the primary benefit and problem of approaching a competitive bid situation with a
low-bid philosophy?
Solution:
A. The cost total would be the incremental cost associated with the job, or $270,400 [($80,000
+ $170,000 + ($51,000  40%)]. The company has excess capacity; thus, any amount it can
receive in excess of $270,400 will provide a positive contribution toward covering the fixed
costs and boosting profit. Note: The fixed construction overhead and allocated administrative
overhead are ignored here, as these costs will be incurred regardless of whether Aerial gets
the job.
B. No excess capacity indicates a very strong market, with Aerial likely having a steady
backlog of work. The company should cover all of its costs, producing a bid of $371,000.
C. A low-bid philosophy will likely translate into additional business, as a company will often
be successful in its bidding efforts. Unfortunately, if the bids are too low, the firm might not
be able to cover its costs.
AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard

15-68
110. Frontage Corporation, which has a maximum labor capacity of 30,000 hours per month,
has considerable flexibility with its customers when it comes to project completion dates.
Management is considering the submission of a bid for a job to be performed for the city of
Carthage. Costs for the job are as follows:
Raw materials $ 140,000

Labor costs 330,000
Variable overhead (20% of labor) 66,000
Fixed overhead (45% of labor) 148,500
Allocated administrative cost 48,000
Total cost $732,500
Frontage’s labor force is paid an average of $22 per hour and if the company wins the bid,
it will have three months to complete the work. Management adds a 30% profit margin to
all jobs, computed on the basis of total variable cost.
Required:
A. Compute the lowest total cost that the company would use when figuring its bid,
assuming that Frontage has excess capacity.
B. Compute Frontage’s bid if the company has no excess capacity.
C. Assume that Frontage is currently working at 85% of capacity. Does the firm have
sufficient time to complete the job? If not, what could the company do if it desires to do
business with Carthage?
15-69
Solution:
A. The lowest total cost is the variable cost associated with the job, or $536,000 ($140,000 +
$330,000 + $66,000).
B. No excess capacity indicates a very strong market, meaning that Frontage should submit a
bid that reflects all of its costs. The markup is $160,800, which is based on raw materials,
labor, and variable overhead ($140,000 + $330,000 + $66,000 = $536,000; $536,000  30% =
$160,800). Thus, the bid should be $893,300 ($732,500 + $160,800).
C. Frontage has a maximum labor capacity of 90,000 hours (30,000  3) during the three
months needed for completion of Carthage’s work. However, only 15% of this total, or
13,500 hours, is available.
Carthage’s job will require 15,000 hours ($330,000  $22), so the firm lacks sufficient time
but not by much. Given that Frontage has significant flexibility with existing customers when
it comes to project completion, management might possibly delay an existing job's finish date,
freeing hours that could be allocated to Carthage. Another possibility might involve overtime
or perhaps hiring some temporary workers.

AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard

15-70
111. Riverview Manufacturing, which produces electrical components, is contemplating

submitting a bid for 30,000 units of item no. 54. The bid's cost will be follows:

Direct Labor 120,000
Manufacturing overhead 150,000
Additional set-up costs 3,000
Special device 5,000
Allocated administrative overhead 12,000
Total cost $365,000
The special device will be purchased for this job and once the job is completed, the device
will be discarded.
Riverview applies total manufacturing overhead of $5 to each unit (0.5 machine hours at $10
per hour). This figure is based, in part, on budgeted yearly fixed overhead of $1,440,000 and
an anticipated volume of 480,000 machine hours (40,000 per month). Riverview is presently
working at 85% of capacity, and the client needs the order in two months.
Required:
A. Is Riverview’s current operating environment one of excess capacity or no excess

capacity? Briefly explain.
B. If Riverview had excess capacity, what would be the lowest cost total that the company
should use when figuring its bid for the order?
C. Can Riverview produce this order in the required time frame of two months? Explain.
D. Suppose that Riverview is in marginal financial health. Explain the benefits and problems
of approaching the bidding procedure with (1) a low bid or (2) a high bid.
15-71
Solution:
A. Riverview currently has excess capacity, as it is working at 34,000 machine hours per
month (40,000 hours  85%).
B. Riverview should cover the incremental costs associated with the order, which are
computed as follows:

Direct Labor 120,000
Variable manufacturing overhead * 105,000
Additional set-up cost 3,000
Special device 5,000
Total cost $308,000
*Fixed manufacturing overhead is $3 per machine hour ($1,440,000  480,000 hours). Thus,
variable overhead is $7 per hour ($10 - $3), giving rise to $105,000 (30,000 units  0.5 hours
 $7).
C. No, there is insufficient machine time. Riverview has a 40,000-hour capacity each month
and has two months to complete the order. Available machine hours total 12,000 (40,000  2
 15%), and the order requires 15,000 hours (30,000 units  0.5).
D. A low-bid philosophy will likely translate into additional business, as a firm will probably
be successful in its bidding efforts. Unfortunately, if the bids are too low, the firm might not
be able to cover its costs. In contrast, a high-bid philosophy will assist a company in covering
more of its costs if the company wins the bid. Obviously, there is a greater chance for lost
business with this approach. In either case, the marginal financial health of the organization
may or may not improve.

AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard

15-72
112. The following questions explore the relationships between total and marginal functions
in the economic profit-maximizing (EPM) model:
Required:
A. The total revenue function rises over the range of operating activity portrayed in the text.
Why does the marginal revenue function decrease?
B. What is the behavior of the marginal cost curve?
C. In the EPM model, where is the profit-maximizing volume level? Explain.
Solution:
A. The total revenue function is increasing at a decreasing rate; consequently, the rate of
change in marginal revenue is negative.
B. The marginal cost curve decreases initially, reflecting economies of scale achieved at
relatively low levels of activity. However, at relatively high levels of activity, the marginal
cost curve increases because of diseconomies of scale (law of diminishing returns).
C. The profit-maximizing volume level is at the intersection of the marginal cost and marginal
revenue curves.

Blooms: Understand

15-73
113. When pricing products, many companies use target costing and/or cost-plus pricing
methods.
Required:
A. Briefly explain how target costing is applied to new products.

B. How does target costing differ from cost-plus pricing?
C. Can an activity-based costing system be used with target costing? Explain
Solution:
A. Target costing begins with the likely market price for the new product and subtracts an
acceptable profit margin to arrive at the manufacturing cost necessary to achieve the target
margin. Then, to achieve the target cost, the product may need to be redesigned and/or re-
engineered.
B. In cost-plus pricing, cost is the starting point. An acceptable profit margin is then added to
arrive at the desired selling price. In target costing, the manufacturing cost is the target,
determined by starting with market price and subtracting a profit margin.
C. Yes. Activity-based costing helps to focus on the various activities required to manufacture
a product and the costs of those activities. Hence, it is more useful than traditional volume-
based costing systems that spread overhead rather than base overhead assignment on the
utilization of specific activities. Generally speaking, the end result is improved costing of
goods and/or services.
Activity-based costing can also help focus attention on non-value-added activities that
consume resources and increase a product's cost. Reduction or elimination of these activities
can help achieve the product's target cost.

Blooms: Remember

15-74
114. When introducing new products, some companies use price skimming whereas others
use penetration pricing.
Required:
A. Distinguish between price skimming and penetration pricing.

B. Is price skimming a viable alternative for most new products? Explain.
Solution:
A. Price skimming is designed to obtain a high price per unit at relatively low levels of sales.
As the product becomes known and interest in it grows, the price is lowered, thus stimulating
sales volume. Penetration pricing, on the other hand, seeks to generate a relatively high level
of sales initially in order to achieve a high market share. Such penetration is accomplished
through an initial price that is relatively low.
B. Price skimming is probably not viable for most products. The skimming strategy requires a
small core of customers for whom price is unimportant compared to other characteristics of
the product—which might be the case with wealthy buyers and/or luxury goods. These
customers are willing to pay just about any price to secure the product.

Blooms: Remember

15-75
115. Austin Company, which experiences considerable seasonal variation in its activity and
has a high level of fixed costs, is preparing a bid for a project. This particular project will be
done during a slack period of the year.
Required:
A. How should the fixed costs be handled in the bidding approach to this project?
B. Assume that the company wins the bid and performs the job on a profitable basis,
consistent with the results as projected in the bid. Several months later, the customer contacts
Austin and requests a bid to do another job. This project, however, must be done during a
peak season. How should Austin’s management respond? How do you think the customer will
respond?
Solution:
A. Fixed costs should not receive the same emphasis that would be given if the project were
to be done during a peak time. Any contribution that this project can make in excess of the
direct incremental costs will boost the profit of the company.
B. The bid for the second project cannot be prepared on the same basis as the bid for the first
project because of timing. The requirement to perform the job during a peak season means
that the job must provide a sufficient return to make it more attractive than other jobs. In other
words, fixed costs should be considered, and the bid price would be higher.
The customer is likely to be unhappy about the considerable change in bid from the first
project. However, if the customer understands the seasonal nature of Austin’s business, then
perhaps the customer will change its schedule and better "time" its purchases to occur in
Austin’s slow season.

Blooms: Remember

15-76
116. A number of antitrust laws have been enacted that affect product pricing.
Required:
A. Define price discrimination and predatory pricing.

B. Assume that a company has been charged with price discrimination. What role can cost
information play in defending the firm's pricing practices?
Solution:
A. Price discrimination involves charging different prices to different customers for the same
goods and services when the price differences are not based on variations in production,
selling, and/or distribution cost. Predatory pricing, on the other hand, is the practice of
reducing a price for a short time in order to enhance demand and then raising the price
sharply, often with restricted supply.
B. Such information can be used to show differences in costs of providing a product or service
to customers. For example, a customer that places a few large orders having low quality
requirements can be served less expensively than another customer that places many small
orders with tight delivery times and exacting quality specifications.

AICPA BB: Legal
Blooms: Remember

15-77

HiltonPlatt 11e TB Ch15

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Chapter 15 - Target Costing and Cost Analysis for Pricing Decisions

True / False Questions

AACSB: Reflective Thinking

AACSB: Reflective Thinking

AACSB: Reflective Thinking

AACSB: Reflective Thinking

AACSB: Reflective Thinking

AACSB: Reflective Thinking

AACSB: Reflective Thinking

8. Skimming pricing is another name for penetration pricing.

AACSB: Reflective Thinking

10. Target costing involves four key principles.

AACSB: Reflective Thinking

AACSB: Reflective Thinking

14. Cost distortion can occur under the target-costing approach.

AACSB: Reflective Thinking

15. Value engineering is an outgrowth of target costing.

AACSB: Reflective Thinking

AACSB: Reflective Thinking

AACSB: Reflective Thinking

18. Time and material pricing is used widely by construction companies.

AACSB: Reflective Thinking

AACSB: Reflective Thinking

AACSB: Reflective Thinking

AACSB: Reflective Thinking

Multiple Choice Questions

23. Which of the following can influence a company's pricing decisions?

25. Which of the following is not a major influence on pricing decisions?

26. Consider the following statements about pricing:

Which of the above statements is (are) true?

32. From an economic perspective, a company's profit-maximizing quantity is found where:

33. If the volume sold reacts strongly to changes in price, demand:

Price Change Change in Sales Volume

35. Which of the following statements regarding price elasticity is false?

36. Prices are said to be inelastic under which of the following conditions?

Price Change Change in Sales Volume

37. Consider the following statements regarding the economic pricing model:

Which of the above statements is (are) true?

Which of the above statements is (are) true?

40. Which of the following represents the cost-plus pricing formula?

41. If a company uses a cost-plus approach to pricing, it will find:

42. In a cost-plus approach to pricing:

Cost Basis Markup Percentage

AACSB: Reflective Thinking

AACSB: Reflective Thinking

45. Consider the following statements about absorption-cost pricing formulas:

Which of the above statements is (are) true?

AACSB: Reflective Thinking

AACSB: Reflective Thinking

AACSB: Reflective Thinking

52. The following data pertain to Laramie Enterprises:

Variable manufacturing cost $60

53. The following data pertain to Ronaldo Enterprises:

Variable manufacturing cost $70

54. The following data pertain to Frontier Enterprises:

Variable manufacturing cost $70

Use the following information to answer Questions 55-58.

Variable manufacturing cost $180

Use the following information to answer Questions 62 – 64.

Longwood, Inc. manufactures various lines of computer equipment and is planning to

66. What is price skimming?

AACSB: Reflective Thinking