Cost Management

ACCOUNTING AND CONTROL

HANSEN & MOWEN

19-1
 19
Pricing and Profitability Analysis

19-2
 Basic Pricing Concepts 1
Economic Pricing Concepts
Price Supply

P*

Demand

Q* Quantity
19-3
Basic Pricing Concepts 1

Market Structure and Price

Perfect Competition—Many buyers and sellers; no
one of which is large enough to influence the
market.
Monopolistic Competition—Has both the
characteristics of both monopoly and perfect
competition.
Oligopoly—Few sellers.
Monopoly—Barriers to entry are so high that there is
only one firm in the market.

19-4
Basic Pricing Concepts 1
Characteristics
Characteristicsof
ofthe
theFour
FourBasic
BasicTypes
Typesof
ofMarket
MarketStructure
Structure

19-5
Pricing Policies 2

Two Approaches to Pricing

1. Cost-based prices are established using

“cost” plus markup.
2. Target prices are influenced by market
conditions.

19-6
Pricing Policies 2
Cost-Plus Pricing
AudioPro Company sells and installs audio equipment in
homes, cars, and trucks. AudioPro’s income statement
for last year is as follows:

Revenues $350,350
Cost of goods sold:
Direct materials $122,500
Direct labor 73,500
Overhead 49,000 245,000
Gross profit $105,350
Selling and administrative expenses 25,000
Operating income $ 80,350

19-7
Pricing Policies 2
Cost-Plus Pricing (continued)
The firm wants to earn the same amount of profit on each
job as was earned last year:

Markup on COGS = (Selling and administrative expenses +

Operating income)/COGS
Markup on COGS = ($25,000 + $80,350)/$245,000
Markup on COGS = 0.43

19-8
Pricing Policies 2
Cost-Plus Pricing (continued)
The markup can be calculated using a variety of bases.
The calculation for markup on direct materials is as follows:

Markup on DM = (Direct labor + Overhead + Selling and

administrative expense + Operating
income)/Direct materials
Markup on DM = ($73,500 + $49,000 + $25,000 +
$80,350)/$122,500
Markup on DM = 1.86

19-9
Pricing Policies 2
Cost-Plus Pricing (continued)
AudioPro wants to expand the company’s product line to
include automobile alarm systems and electronic car door
openers. The cost for the sale and installation of one
electronic remote car door opener is as follows:

Direct materials (component and two remote controls) $ 40.00

Direct labor (2.5 hours x $12) 30.00
Overhead (65% of direct labor cost) 19.50
Estimated cost of one job $ 89.50
Plus 43% markup on COGS 38.49
Bid price $127.99

19-10
Pricing Policies 2

Target Costing and Pricing

Target
Target costing
costing isisaamethod
method of of
determining the
thecost
determiningTarget cost of
of aa involves much
Target costing
costing involves much
product or service
product or service based
based on on
more
more upfront
upfront work
work than
than cost-
cost-
the price that
the price that the customers
the customers
based
based pricing.
pricing. However,
However, ifif the
the
are willing
are willing to pay.
to pay.
cost-plus
cost-pluspricing
pricingturns
turnsout
outto tobebe
higher
higher than
thanwhat
what customers
customerswill will
accept,
accept, additional
additionalwork
workor orlostlost
opportunity
opportunitywillwillresult.
result.

19-11
The Legal System and Pricing 3

Predatory pricing is the practice of setting prices

below cost for the purpose of injuring competitors
and eliminating competition.

Predatory
pricing on the
international
market is called
dumping.
Competition

19-12
The Legal System and Pricing 3

Price discrimination refers to the charging of different

prices to different customers for essentially the same
product.

19-13
The Legal System and Pricing 3

Cobalt, Inc. manufactures vitamin supplements that costs

an average of $163 per case. Cobalt sold 250,000 cases
last year as follows:

Customer Prices per Case Cases Sold

Large drug store chain $200

125,000
Small local pharmacies 232
100,000
Individual health clubs 250
25,000
Cobalt is practicing price discrimination!

19-14
The Legal System and Pricing 3
Analysis
Analysisof
ofCobalt,
Cobalt,Inc.,
Inc.,Customer
CustomerClass
ClassCosts
Costs

19-15
Measuring Profit 4
Absorption-Costing
Lasersave, Inc., a company that recycles used toner
cartridges for laser printers. During August the firm
manufactured 1,000 cartridges at the following costs:

Direct materials $ 5,000

Direct labor 15,000
Variable overhead 3,000
Fixed overhead 20,000
Total manufacturing cost $43,000

During August, these cartridges were sold at $60 each.

Variable marketing cost was $1.25 per unit. Fixed
expenses were $12,000.

19-16
Measuring Profit 4

Absorption-Costing
Absorption-CostingIncome
IncomeStatement
Statementfor
forLasersave,
Lasersave,
Inc.,
Inc.,for
forAugust
August

19-17
Measuring Profit 4

Absorption-Costing
Absorption-CostingIncome
IncomeStatement
Statementfor
forLasersave,
Lasersave,
Inc.,
Inc.,for
forSeptember
September

*Direct materials ($5 x 1,250) $ 6,250

Direct labor ($15 x 1,250) 18,750
Variable overhead ($3 x 1,250) 3,750
Fixed overhead 20,000
Total manufacturing overhead $48,750
Add: Beginning inventory 0
Less: Ending inventory (9,750)
Cost of goods sold $39,000

19-18
Measuring Profit 4

Variable-Costing
Variable-CostingIncome
IncomeStatements
Statements for
for
Lasersave,
Lasersave,Inc.
Inc.

*Direct materials $ 5,000

Direct labor 15,000
Variable overhead 3,000
Total variable manufacturing expenses $23,000
Add: Variable marketing expenses 1,250
Total variable expenses $24,250

19-19
Measuring Profit 4
Comparative
ComparativeIncome
IncomeStatements
Statementsfor
forLasersave,
Lasersave,Inc.
Inc. for
forthe
the
Month
Monthof
ofOctober
October

19-20
Measuring Profit 4
Changes
ChangesininInventory
Inventoryunder
underAbsorption
Absorption
and
andVariable
VariableCosting
Costing

19-21
 Profitability of Segments 5

Profit by Product Line

Alden Company manufactures two products: basic fax machines
and multi-function fax machines. The multi-function fax uses more
advanced technology; therefore, it is more expensive to
manufacture.

Basic Multi-Function
Number of units 20,000 10,000
Direct labor hours 40,000 15,000
Price $200 $350
Prime cost per unit $55 $95
Overhead per unit $30 $22.50

19-22
Profitability of Segments 5
Absorption-Costing
Absorption-CostingIncome
Incomeby
byProduct
ProductLine
Line

19-23
Profitability of Segments 5
Variable-Costing
Variable-CostingIncome
Incomeby
byProduct
ProductLine
Line

19-24
Profitability of Segments 5
Overhead
OverheadActivities
Activitiesand
andDrivers
Drivers

19-25
Profitability of Segments 5
Activity-Based
Activity-BasedCosting
CostingIncome
Incomeby
byProduct
ProductLine
Line

19-26
Profitability of Segments 5
Divisional Profit
Alpha Beta Gamma Delta Total

Sales $ 90 $ 60 $ 30 $120 $300

Cost of goods sold 35 20 11 98 164
Gross profit $ 55 $ 40 $ 19 $ 22 $136
Division expenses -20 -10 -15 -20 -65
Corporate expenses -3 -2 -1 -4 -10
Operating income
(loss) $ 32 $ 28 $ 3 $ -2 $ 61

19-27
Analysis of Profit-Related Variances 6

Sales price Actual Expected Quantity

price –
x
variance = price sold

Price volume Actual Expected Expected

– x
variance = volume volume price

19-28
 Analysis of Profit-Related Variances 6

Contribution Annual Budgeted

margin = contribution – contribution
variance margin margin

Budgeted
Contribution Annual Budgeted average unit
margin volume = quantity – quantity x contribution
variance sold sold margin

19-29
Analysis of Profit-Related Variances 6
Data
Datafor
forBirdwell,
Birdwell,Inc.
Inc.

19-30
Analysis of Profit-Related Variances 6

Sales mix variance = [(Product 1 actual units – Product 1

budgeted units) x (Product 1 budgeted unit contribution margin –
Budgeted average unit contribution margin)] + [(Product 2 actual
units – Product 2 budgeted units) x (Product 2 budgeted unit
contribution margin – Budgeted average unit contribution margin)]

Birdwell sales mix variance = [($1,250 – 1,500) x

($4.00 – $6.75)] + [(625 –500) x ($15.00 – $6.75)] =
$1,718.75 Favorable

19-31
Analysis of Profit-Related Variances 6

Market share variance = [(Actual market share percentage –

Budgeted market share percentage) x (Actual industry sales
in units)] x (Budgeted average unit contribution margin)

Market size variance = [(Actual industry sales in units –

Budgeted industry sales in units) x (Budgeted market share
percentage)] x (Budgeted average unit contribution margin)

19-32
The Product Life Cycle 7
Product
ProductLife
LifeCycle
Cycle

19-33
The Product Life Cycle 7
Impact
Impactof
ofthe
theProduct
ProductLife
LifeCycle
Cycleon
onCost
CostManagement
Management

19-34
The Product Life Cycle 7
Product
ProductLife
LifeCycle
CycleCosts
Costsininthe
theABC
ABCCategories
Categories

19-35
Limitations of Profit Measurement 8

Limitations of profit include

 focus on past performance
 uncertain economic conditions
 difficulty of capturing all important
factors in financial measures

Successful firms measure far

more than accounting profit.

19-36
 End of
Chapter 19

19-37