24Solutions
PRICING CHAPTER DECISIONS, INCLUDING TARGET COSTING
AND TRANSFER PRICING
Chapter 24, SE 1.
Jason Kellam has broken the following rules of pricing:
1.
Prices must be equal to or lower than the competition's price. Pizza restaurants
in New York City are not his competition; others in the Flora, Alabama, area are.
2.
Prices must be acceptable to the customer. Kellam never checked to see what
Flora customers would be willing to spend on a large pizza.
3.
Prices must recover costs and return a profit. Kellam's price will probably exceed
his costs and return a profit, but only if someone buys the pizzas.
Chapter 24, SE 2.
External market factors such as the following must also be considered:
1.
Is there sufficient demand for the new product?
2.
What are the competing products, and what are their prices?
3.
Do customers in this market prefer high- or low-quality products?
4.
What will be customers' overall reaction to this product? (This will require market testing.)
Chapter 24, SE 3.
The 4,000-unit level is preferable. Given that the same total profit will be made at
both the 4,000- and the 9,000-unit levels, it does not make economic sense to produce the additional 5,000 units. Total profit is maximized at the 6,000-unit level (the
point where marginal revenue equals marginal cost). Each additional unit produced
after the 6,000-unit mark will lose money. All of the profit gained from the 4,000- to
the 6,000-unit levels is lost between the 6,000- and the 9,000-unit levels. The ideal
targeted sales level would be 6,000 units unless the same production facilities
could make a product with a greater return. Then the 4,000-unit level would be more
appropriate.
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Ch24 SE1 to SE3
Chapter 24, SE 4.
Desired Profit + Total Selling,
General, and Administrative Expenses
Markup Percentage =
Total Production Costs
$67,400
=
+
$112,600
$300,000
= 60%
Gross MarginBased Price = Total Production Costs per Unit
+ (Markup Percentage
x Total Production Costs per Unit)
= $50
+
( 60% x
$50 )
= $80
Chapter 24, SE 5.
Total billing price:
Replacement wood
$ 650
Deck screws and supplies
Labor (
12 hours @
112
$14 per hour )
Total direct costs
Service overhead
168
$ 930
(
$930 x
40% )
Total billing price for this job
372
$1,302
Chapter 24, SE 6.
No, the company should not proceed with the new product until the committed cost
estimates are below the target cost. Committed costs are costs that are anticipated
because they have been engineered into the product during its design stage. If the
product is manufactured according to engineering specifications, the committed
costs will be incurred.
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Ch24 SE4 to SE6
Chapter 24, SE 7.
The company should not market the new product. The target cost for the product is
$1,311* ($1,600 1.22). The engineer's projected cost is $1,380, or $69 above the
amount needed to earn the desired profit.
*Rounded.
Chapter 24, SE 8.
Premier Castings is a good candidate for using transfer prices. Each process's costs
plus a profit factor could be charged to the next process. In that way, each process
would "sell" its output to the next process. Fairness has to be a part of the development of the transfer prices, however. The seventh and eighth processes could be
left holding the bag. If too much cost is attached by the previous processes, there
will be no room for profit at the end of the chain.
Chapter 24, SE 9.
Premier Castings should probably use cost-based transfer prices for many of the
early processes because there are no comparable market prices. The fourth process
has market prices to use, so the fifth process may negotiate a price with the fourth
process. The final two or three processes will probably need to negotiate even
though only cost-based transfer prices are present. The profit percentage will probably be low by the time the eighth process receives the castings. All eight processes
should probably take part in an overall negotiation on the profit percentage to use.
Chapter 24, SE 10.
In addition to the traditional approaches of transferring the product from one process to the next at variable or full cost, management should consider the following
three options when setting the transfer price for the plastic base:
Cost plus profit:
$27.40 + ( $27.40 x 20% ) = $32.88
Market price: $38.00
Negotiated price: Any price between $32.88 and $38.00
Managers of the Molding Process have the option of selling the process's output to
the outside company and earning more than the 20 percent minimum return. They
should also be able to earn more than 20 percent internally. A price within the $33.50
to $34.00 price range seems to be fair.
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Ch24 SE7 to SE10
Chapter 24, E 1.
The pricing policy objectives of Old Denim, Ltd., are:
a.
Be customer-driven. To appeal to customers, Old Denim maintains an image of
quality clothes for less money.
b.
Adhere to a pricing strategy. Prices are set low to draw customers away from
competitors, and discounted sales are a regular practice.
c.
Maximize profits. Buyers are trained to seek out quality goods at inexpensive
purchase prices.
d.
Maintain or gain market share. Sales have been targeted to increase 5 percent
per year.
e.
Maintain stated rate of return. All sales are expected to yield a 15 percent return
on assets.
Note: Seeing that employees dress appropriately and that the stores are clean and
well organized are operational objectives, not pricing policy objectives.
Copyright Houghton Mifflin Company. All rights reserved.
Ch24 E1
Chapter 24, E 2.
1.
Unit selling prices computed
Gripper
Roadster
One tire
Four tires
One tire
Four tires
$125
$460
$110
$400
20
80
20
80
$105
$105
$380
$ 95
$ 90
$ 90
$320
$ 80
Selling price
Less installation cost
Net selling price
Unit selling price
2.
Influence of cost on sales price discussed
The Gripper tire costs $30 more than the Roadster tire, yet there is only a $15 difference between the two selling prices. The low cost of the Roadster enables it to
be sold at a significantly lower price than the higher-cost Gripper. Therefore, customers perceive the Roadster to be a better purchase value than the Gripper. The
company is not using cost as a major consideration in its pricing decisions.
3.
Other pricing factors identified
Other pricing considerations include:
a.
Local competitors
b.
Quality versus price
c.
Demand for the tires
d.
Selling the Gripper as a loss leader
Copyright Houghton Mifflin Company. All rights reserved.
Ch24 E2
Chapter 24, E 3.
1.
Graph of total revenue and total cost curves drawn
$30, 000
2 5,0 00
Total rev enu e
2 0,0 00
D o l l a rs
18,7 50
1 5,0 00
Tota l c os t
1 0,0 00
5, 000
550 units
4,0 00
0
2.
1 00
2 00
300
4 00
5 00
60 0
U n its
700
8 00
900
1,0 00
Unit selling price calculated
$18,750
550 units
=
$34.09 * per unit
*Rounded.
Chapter 24, E 4.
Innovative websites like Priceline.com and eBay.com are continuously updating
their features to better serve their customers. Both contain the goods offered for
sale, ratings for products and sellers, buying and selling procedures, and assurances of having a secure website. Students should list each site's features, compare the sites, and support their website preference.
Copyright Houghton Mifflin Company. All rights reserved.
Ch24 E3 to E4
Chapter 24, E 5.
1. Unit cost computed
Cost Categories
Total
Projected
Costs
Variable production costs
$1,110,000
Fixed overhead
540,000
Total production costs
$1,650,000
Selling expenses
$ 225,000
General and administrative expenses
350,000
Total selling, general, and administrative expenses
$ 575,000
Total costs and expenses
$2,225,000
Units produced
250,000
$
8.90
Total cost per unit
2. Markup percentage and unit selling price computed, using gross margin pricing
Desired Profit + Total Selling,
General, and Administrative Expenses
Total Production Costs
Markup Percentage =
$250,000
=
+
$575,000
$1,650,000
= 50.0%
Gross MarginBased Price = Total Production Costs per Unit
+ (Markup Percentage
x Total Production Costs per Unit)
=
(
$1,650,000
x ( $1,650,000
=
250,000 ) + [ 50.0%
250,000 )]
$9.90
3. Unit selling price computed using return on assets pricing
Return on AssetsBased Price =
$8.90 + 10%
=
$8.90 + $0.40
=
$9.30
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Ch24 E5
x
(
$1,000,000
250,000 )
Chapter 24, E 6.
1.
Projected cost per head computed
Total
Projected
Costs
Cost Categories
Variable service costs
Direct service labor
$ 525,000
Variable service overhead
250,000
Fixed service overhead costs
225,000
Total service costs
$1,000,000
Selling expenses
$ 142,500
General and administrative expenses
157,500
Total selling, general, and administrative expenses
$ 300,000
Total costs and expenses
$1,300,000
250,000
$
5.20
Units inspected
Total cost per head
2.
Inspection charge determined using gross margin pricing
Desired Profit + Total Selling,
General, and Administrative Expenses
Total Production Costs
Markup Percentage =
$120,000
=
+
$300,000
$1,000,000
= 42.0%
Gross MarginBased Price = Total Production Costs per Unit
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+ (Markup Percentage
x Total Production Costs per Unit)
=
(
$1,000,000
x ( $1,000,000
=
$5.68
Ch24 E6
250,000 ) + [
250,000 )]
42.0%
Chapter 24, E 6. (Continued)
3.
Inspection charge computed using return on assets pricing
Return on AssetsBased Price = Total Costs and Expenses per Unit
+ [Desired Rate of Return
x (Total Cost of Assets Employed
Anticipated Units to Be Produced)]
Desired Rate of Return = 16.00%
Return on AssetsBased Price =
Copyright Houghton Mifflin Company. All rights reserved.
$5.20
+ 16.0% x ( $750,000
= $5.68
Ch24 E6 (2)
250,000 )
Chapter 24, E 7.
1.
Projected cost per transaction computed
Cost Categories
Variable processing costs
$ 50,000,000
Fixed processing costs
36,000,000
Selling expenses
10,000,000
General and administrative expenses
4,000,000
Total costs and expenses
$100,000,000
Number of transactions
10,000,000,000
Projected cost per transaction
2.
$0.01
Transaction charge determined using gross margin pricing
Markup Percentage =
$3,000,000,000
+ ( $10,000,000
+
$4,000,000
)
$50,000,000 + $36,000,000
= 3505%
Gross Margin
Based Price
= [ ( $50,000,000
+ [ 3505%
x(
$36,000,000 ) 10,000,000,000 ]
$86,000,000 10,000,000,000 ) ]
+
= $0.31
3.
Transaction charge determined using return on assets pricing
Return on Assets =
Based Price
$0.01
+
6% x ( $10,000,000,000
10,000,000,000 )
= $0.07
Chapter 24, E 8.
Materials and parts
Markup (
Labor
$600
( 5 hours
Markup (
$200
$ 600
x
50%
)
300
x
$40
)
200
100% )
200
$1,300
x
Total price for job
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Ch24 E7 to E8
Chapter 24, E 9.
The price quoted should be computed as follows:
Cost
Overhead
Markup
Total
Cost
Materials
( 60% markup)
$12,700
$7,620
$20,320
Labor
( 40% markup)
7,900
3,160
11,060
Total cost
Profit markup
$31,380
(
25% )
7,845
$39,225
Total price for job
Chapter 24, E 10.
Target cost computed:
Target cost:
$90.00
1.25
= $72.00
Projected unit cost of the product calculated:
Direct materials cost
$15.00
Manufacturing labor
(
1.2 hours
x
$12.00 )
14.40
Assembly labor
(
1.5 hours
x
$10.00 )
15.00
Overhead costs
Materials handling overhead
( $15.00
x
$1.30 )
19.50
Production overhead
( 2 machine hours
x
$3.00 )
Product delivery overhead
6.00
5.50
$75.40
Projected total unit cost
Production decision calculations:
Target unit cost
$72.00
Less projected unit cost
75.40
($ 3.40)
Difference
The fireplace screen should not be marketed. Because the actual cost exceeds the
target cost, the company will not earn the desired profit.
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Ch24 E9 to E10
Chapter 24, E 11.
Target cost computed:
Target cost:
$90.00
1.10
= $81.82
Projected unit cost of the product calculated:
Direct materials cost
$15.00
Manufacturing labor
(
1.2 hours
x
$12.00 )
14.40
Assembly labor
(
1.5 hours
x
$10.00 )
15.00
Overhead costs
Materials handling overhead
( $15.00
x
$1.30 )
19.50
Production overhead
( 2 machine hours
x
$3.00 )
Product delivery overhead
6.00
5.50
$75.40
Projected total unit cost
Production decision calculations:
Target unit cost
$81.82
Less projected unit cost
75.40
$ 6.42
Difference
The fireplace screen should be marketed. Because the actual cost is less than the
target cost, the company will earn at least the desired profit.
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Ch24 E11
Chapter 24, E 12.
Target cost computed:
Target cost:
$100
1.30
= $76.92
Projected unit cost:
Alternative Alternative
A
B
Direct materials cost
$35.00
$20.00
Manufacturing labor
12.00 *
24.00 *
$71.00
16.00 **
40.00 **
$76.00
Target unit cost
$76.92
$76.92
Less projected unit cost
71.00
$ 5.92
76.00
$ 0.92
1
2
Overhead costs
Projected total unit cost
Difference
Ranking
Both are under the target cost, although Alternative A is more attractive by $5.00.
* Alternative A: labor (1 x $12.00); overhead (200% x $12.00)
** Alternative B: labor (2 x $8.00); overhead (2 x $20.00)
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Ch24 E12
Chapter 24, E 13.
1.
Target cost computed
Target cost =
2.
$7,500
1.25
= $6,000
Projected unit cost of AutoDrill computed
Direct materials cost
$1,620
Purchased parts cost
840
Manufacturing labor
Assembly labor
(
6 hours x
( 10 hours
x
$14 )
84
$15 )
150
Activity-based costs
Materials handling
Engineering
( 5%
( $300
Production and assembly
x
x
$2,460
*)
1)
( $50
123
300
x
30
)
1,500
Delivery
( $570
x
1)
570
Marketing
( $400
x
1)
400
$5,587
Projected total unit cost
* $1,620
3.
+
$840
= $2,460
Production decision discussed
Production decision calculations:
Target unit cost
$6,000
Less projected unit cost
5,587
$ 413
Difference
Management should produce the AutoDrill as soon as possible. The projected cost
of the AutoDrill is $413.00 below its target cost, which means that the company
would be making more than the desired 25 percent profit on the product.
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Ch24 E13
Chapter 24, E 14.
1.
Cost-plus transfer price developed
Cost Categories
Cost per
Unit
Direct materials
$ 5.20
Direct labor
2.30
Variable overhead
1.30
Fixed overhead
2.60
Total production cost
$11.40
Target profit ( 20% of cost )
2.28
$13.68
Cost-plus transfer price
2.
Transfer price discussed
The transfer price could be as low as the variable costs of $8.80 ($5.20 + $2.30 +
$1.30) or as high as the cost-plus price of $13.68. More practically, the transfer price
could be a negotiated price between the $13.00 market price and the $13.68 costplus price. However, because of the large profit factor in the cost-plus price, the
$13.00 market price should be used because it reflects the reality of the external
market.
Chapter 24, E 15.
1.
Market-based transfer price
$25
2.
Minimum transfer price
$10
3.
Cost-plus transfer price
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( $10
+ [ 40% x $10 ] )
Ch24 E14 to E15
$14
Chapter 24, P 1.
1. Schedule of total projected costs and unit costs prepared
Total
Projected
Costs
Cost Categories
Unit*
Cost
Direct materials
Toaster casings
$
960,000
$ 1.60
2,244,000
3.74
3,648,000
6.08
780,000
1.30
1,740,000
2.90
Total production costs
$ 9,372,000
$15.62
Selling expenses
$ 1,536,000
$ 2.56
General operating expenses
840,000
1.40
Administrative expenses
816,000
1.36
$ 3,192,000
$12,564,000
$ 5.32
$20.94
Electrical components
Direct labor
Variable indirect assembly costs
Fixed indirect assembly costs
Total selling, general, and
administrative expenses
Total costs and expenses
*Based on
600,000 units.
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Ch24 P1
Chapter 24, P 1. (Continued)
2.
Selling price computed using gross margin pricing
Desired Profit + Total Selling,
General, and Administrative Expenses
Markup Percentage =
=
Total Production Costs
$1,260,000
+
$3,192,000
$9,372,000
= 47.50%
Gross MarginBased Price = Total Production Costs per Unit
+ (Markup Percentage
x Total Production Costs per Unit)
=
$15.62
+(
=
$23.04
47.50%
x
$15.62 )
*
*Rounded.
3.
Manager Insight: Selling price recommended
Sales
Level
Unit
Price
Unit
Cost*
Unit
Profit
Total
Profit
600,000
$22.64
$20.94
$1.70
$1,020,000
540,000
22.84
$20.94
1.90
1,026,000
480,000
23.04
$20.94
2.10
1,008,000
The company will maximize profits if it uses the $22.84 price, but it will not make its
desired profit of $1,260,000.
* Unit costs would change as volume changes. With limited information, unit cost
was assumed to stay constant.
4.
Manager Insight: Selling price reevaluated
The price could be raised significantly with limited competition and the same demand for the product because the sales level would not drop as a result of a price
increase.
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Ch24 P1 (2)
Chapter 24, P 2.
1.
Cost analysis prepared
Tone
Book
Tyme
Book
Klay
Book
Total
Projected
Costs
$146,250
$243,750
$ 97,500
$ 487,500
Royalty costs
36,000
60,000
24,000
120,000
Printing costs
74,580
124,300
49,720
248,600
Supplies
10,260
17,100
6,840
34,200
Variable production costs
42,600
71,000
28,400
142,000
Fixed production costs
58,800
67,200
42,000
168,000
Total production costs
$368,490
$583,350
$248,460
$1,200,300
Distribution costs
$ 58,200
$ 97,000
$ 38,800
$ 194,000
Marketing costs
61,670
90,060
42,270
194,000
General and administrative costs
18,340
20,960
13,100
52,400
$138,210
$506,700
$208,020
$791,370
$ 94,170
$342,630
$ 440,400
$1,640,700
$101,340
$158,274
$ 68,526
$ 328,140
Cost Categories
Direct labor
Total selling, general, and
administrative costs
Total costs
Desired profit
(
20% of cost )
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Ch24 P2
Chapter 24, P 2. (Continued)
2.
Selling prices computed using gross margin pricing
Desired Profit + Total Selling,
General, and Administrative Costs
Total Production Costs
Markup Percentage =
Gross MarginBased Price = Total Production Costs per Unit
+ (Markup Percentage
x Total Production Costs per Unit)
Tone Book:
Markup Percentage =
Gross MarginBased Price =
$101,340
+
$138,210
$368,490
(
$368,490
26,000
x ( $368,490
=
= 65.01%
) + [ 65.01%
26,000 )]
$23.39
Tyme Book:
Markup Percentage =
Gross MarginBased Price =
$158,274
+
$208,020
$583,350
(
$583,350
x ( $583,350
=
32,000
= 62.79%
) + [ 62.79%
32,000 )]
$29.68
Klay Book:
$68,526
Markup Percentage =
Gross MarginBased Price =
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+
$94,170
$248,460
(
$248,460
x ( $248,460
=
$20.56
Ch24 P2 (2)
20,000
= 65.48%
) + [ 65.48%
20,000 )]
Chapter 24, P 2. (Continued)
3.
Manager Insight: Competition's influence on price discussed
If the quality of Klay's book is comparable to that of the competition, the president
may consider raising the price. Rosenbek is making a 20 percent profit at a unit price
of $20.56. At a unit price of $21.50, the markup would increase to more than 25 percent and Rosenbek's price would still be enough lower than that of the competition
to be competitive.
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Ch24 P2 (3)
Chapter 24, P 3.
Billing prepared
Materials and parts
Spark plugs
(
24 x $3.40
)
$
81.60
Oil, quarts
(
20 x $2.90
)
Hoses
(
12 x $11.60
Water pump
(
Coolant, quarts
(
30 x $6.50
)
195.00
Clamps
(
18 x $5.90
)
106.20
Distributor cap
(
1 x $128.40
)
128.40
Carburetor
(
1 x $214.10
)
214.10
Tires
(
4 x $820.00
)
3,280.00
58.00
)
1 x $764.00
139.20
)
764.00
Total materials and parts
Materials overhead
$ 4,966.50
(
$4,966.50
x
130% )
6,456.45
Mechanic
(
42 hours
x
$18.20
)
$ 764.40
Assistant mechanic
(
54 hours
x
$12.00
)
648.00
Direct labor
Total direct labor cost
Direct labor overhead
1,412.40
(
$1,412.40
x
140% )
Total billing
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Ch24 P3
1,977.36
$14,812.71
Chapter 24, P 4.
1.
Target costs computed
Speed-Calc 4:
$98.00
1.25
= $78.40
Speed-Calc 5:
$110.00
1.25
= $88.00
2.
Projected total unit cost determined
Speed-Calc Speed-Calc
4
5
Direct materials cost
$ 5.50
$ 7.50
Computer chip cost
10.60
11.70
$16.10
$19.20
Total direct materials and parts cost
Production labor
Speed-Calc 4
Speed-Calc 5
Assembly labor
( 1.2 hours
( 1.3 hours
x
x
$16.00 )
$16.00 )
19.20
Speed-Calc 4
( 0.6 hour
x
$12.00 )
7.20
Speed-Calc 5
( 0.5 hour
x
$12.00 )
20.80
6.00
Activity-based costs
Materials/parts handling
Speed-Calc 4
( $16.10
x
$1.20
)
Speed-Calc 5
( $19.20
x
$1.20
19.32
)
23.04
Production
Speed-Calc 4
(
1 machine hour x
$8.00
)
$8.00
8.00
)
Speed-Calc 5
(
1.2 machine hours x
9.60
Marketing/delivery
Speed-Calc 4
4.40
Speed-Calc 5
$74.22
Projected total unit cost
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Ch24 P4
6.20
$84.84
Chapter 24, P 4. (Continued)
3.
Production decision discussed
Speed-Calc Speed-Calc
4
5
Target unit cost
$78.40
$88.00
Less projected unit cost
74.22
$ 4.18
84.84
$ 3.16
Difference
Both Speed-Calc 4 and Speed-Calc 5 should be produced because their anticipated
costs are low enough for them to yield more than the desired profit.
Copyright Houghton Mifflin Company. All rights reserved.
Ch24 P4 (2)
Chapter 24, P 5.
1.
Transfer price recommended
Cost Categories
Cost materials
$ per
Unit
Direct 3.50
Direct labor
2.30
Variable overhead and shipping costs
(
$7.50
Avoidable fixed costs
20,000 )
(
$30,000
+
$1.20 )
8.70
1.50
Total controllable costs
$16.00
Target profit
3.20
$19.20
( 20% of cost)
Cost-plus transfer price
Since Glass Division does not sell to outside customers and the cost-plus transfer
price allows Glass Division to cover controllable costs and earn a 20 percent profit,
the $19.20 price should be used. The corporate overhead should not be included because it is not controllable and therefore is not involved in performance evaluation
procedures, which is the main reason for using transfer prices.
2.
Manager Insight: Transfer price reevaluated
If Glass Division were able to sell to an outside customer, the situation would
change. Glass Division would be able to earn greater profits selling the containers
for $20. However, Instrument Division, without its internal source of supply, would
have to buy at greater costs, thus hurting overall company profits. If there are no
external restrictions on demand or supply, the external cost of $20.00 may be preferred. However, it is more likely that a negotiated price between the cost-plus price
of $19.20 and the market price of $20.00 would be used.
3.
Other factors considered
Management should consider that transfer pricing is an artificial or created price.
Depending on the transfer price used, a manager's performance evaluation can be
affected.
Copyright Houghton Mifflin Company. All rights reserved.
Ch24 P5
Chapter 24, P 6.
1. Schedule of total projected costs and unit costs prepared
Total
Projected
Costs
Unit
Cost*
$ 432,400
$ 1.84
545,200
2.32
1,151,500
4.90
1,598,000
6.80
Variable indirect assembly costs
789,600
3.36
Fixed indirect assembly costs
338,400
1.44
Total production costs
$4,855,100
$20.66
Selling expenses
$ 493,500
$ 2.10
General operating expenses
183,300
0.78
Administrative expenses
126,900
0.54
$ 803,700
$5,658,800
$ 3.42
$24.08
Cost Categories
Direct materials
Casing
Battery chamber
Electronics
Direct labor
Total selling, general, and administrative expenses
Total costs and expenses
*Based on
235,000 units.
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Ch24 P6
Chapter 24, P 6. (Continued)
2.
Selling price computed using gross margin pricing
Desired Profit + Total Selling,
General, and Administrative Expenses
Markup Percentage =
=
Total Production Costs
$846,000
+
$803,700
= 33.98%
$4,855,100
Gross MarginBased Price = Total Production Costs per Unit
+ (Markup Percentage
x Total Production Costs per Unit)
= $20.66 + (
33.98%
$20.66
x
)
= $27.68
3.
Manager Insight: Selling price recommended
Sales
Level
Unit
Price
Unit
Cost*
Unit
Profit
Total
Profit
235,000
$25.68
$24.08
$1.60
$376,000
180,000
26.68
24.08
2.60
468,000
125,000
27.68
24.08
3.60
450,000
The company will maximize profits if it uses the $26.68 price.
* Unit costs would change as volume changes. With limited information, unit cost
was assumed to stay constant.
4.
Manager Insight: Selling price reevaluated
If there were limited competition and the same demand for the product, the price
could be raised significantly because the sales level would not drop as a result of
the price increase.
Copyright Houghton Mifflin Company. All rights reserved.
Ch24 P6 (2)
Chapter 24, P 7.
1.
Target cost computed
Product Y14:
$650.00
Product Z33:
$750.00
2.
1.25 = $520.00
1.25 = $600.00
Projected unit cost of each product determined
Product
Y14
$ 50.00
Total direct materials and parts cost
70.00
$115.00
Purchased parts cost
$ 60.00
65.00
Direct materials cost
Product
Z33
$130.00
Manufacturing labor
Y14 (
6.2 hours
Z33 (
7.4 hours
Assembly labor
x
x
$14.00 )
$14.00 )
86.80
55.20
Y14 (
4.6 hours
x
$12.00 )
Z33 (
9.2 hours
x
103.60
$12.00 )
110.40
Activity-based costs
Materials handling
Y14
(
$115.00
x
$1.30 )
149.50
Z33
(
$130.00
x
$1.30 )
Y14
(
14 machine hours x
$4.40 )
Z33
(
16 machine hours x
$4.40 )
169.00
Production
61.60
70.40
Product delivery
Y14
34.00
Z33
$502.10
Projected total unit cost
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Ch24 P7
40.00
$623.40
Chapter 24, P 7. (Continued)
3.
Production decisions discussed
Product
Y14
Product
Z33
Target unit cost
$520.00
$600.00
Less projected unit cost
502.10
$ 17.90
623.40
($ 23.40)
Difference
Product Y14 can be produced below its target cost, so the company should plan to
market it. Product Z33 either should be redesigned at a lower cost or dropped as a
potential product. In its current form it cannot generate the target profit.
Copyright Houghton Mifflin Company. All rights reserved.
Ch24 P7 (2)
Chapter 24, P 8.
1.
Cost computed
Cost Categories
Budgeted
Total Costs
Materials and parts
$ 2,600,000
$ 6.50
1,920,000
4.80
Supplies
100,000
0.25
Indirect labor
580,000
1.45
Other variable overhead costs
200,000
0.50
Fixed overhead, SDBs
1,840,000
4.60
Variable selling expenses, SDBs
1,480,000
3.70
$ 8,720,000
$21.80
$
560,000
$ 1.40
Fixed selling expenses, corporate
520,000
1.30
General corporate operating expenses
880,000
2.20
Corporate administrative expenses
680,000
1.70
$ 2,640,000
$ 6.60
Total projected costs and expenses
$11,360,000
$28.40
Profit markup
2,272,000
$13,632,000
5.68
Direct labor
Total production costs
(
Cost per Unit
400,000 units )
Costs allocated from corporate office
Other fixed overhead, corporate
Total allocated costs
(
20% of cost )
Total costs, expenses, and transfer profit
$34.08
Cost-plus transfer price
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Ch24 P8
Chapter 24, P 8. (Continued)
2.
Manager Insight: Transfer price recommended and discussed
The minimum transfer price could be the variable cost of $17.20 ($21.80 $4.60), or
the cost-plus transfer price of $34.08 could be used. In addition, the market price of
$35 must be taken into consideration. Thus, a negotiated price between the market
price of $35 and the cost-plus price may be more practical. If R & D insists on selling
the board to internal customers at the $35 market price, those departments may decide to shop around for a cheaper price or a better-quality board. While R & D can
sell its boards to outside customers for $35, the demand is limited. Without internal
sales, R & D would be faced with excess capacity and a higher cost per unit (reduced
sales revenue to cover fixed costs results in a higher unit cost). However, R & D can
cover its costs and earn a 20 percent profit at a price of $34.08.
Copyright Houghton Mifflin Company. All rights reserved.
Ch24 P8 (2)
Chapter 24, C 1.
Students enjoy discussing this case. Their memos usually take the approach that
establishing the brand name is the most important aspect of product differentiation.
But some will go into consumer psychology and talk about ways of influencing
consumer behavior. Maytag Corporation not only has incorporated quality into its
production process, but also has embedded the concept of product quality in the
minds of its customers. The commercials imply that a Maytag product does not
need repairs because it is of such high quality to begin with. No repairs means that
the lifetime cost of a Maytag product is lower than the costs of competing products,
even though the initial price may be higher. Product differentiation is the creation
of features that distinguish a product in customers' minds. The features could include product quality, special packaging, product durability, or special distribution.
Products such as Coca-Cola, Tylenol, Crest, Seiko, Mercedes, and Gillette have
thrived because of their differentiation. The only role that product cost has in such
a strategy is to serve as a benchmark. The company must make sure that the amount
spent on product development, production, and differentiation does not exceed the
price in the long run, although it may initially.
Chapter 24, C 2.
E*TRADE and Ameritrade must take many internal and external factors into consideration when setting the price of trades. Among the external factors are the total demand for trading services, the number and quality of competing brokers, transaction
processing time, current prices of competing products, and customers' preferences
for personal service versus price. Among the internal factors that must be considered are the cost of providing the service, the amount of investment that is required,
the number of employees and amount of training required to offer the service, and
the amount of capacity or service that can be offered.
Online companies require very large investments in computer equipment, software,
and people. However, once those expenditures have been made, the marginal cost
of handling additional customers and trades is very low because the trades are all
handled electronically. To maximize revenues and achieve an adequate return on
investment, online companies must generate large numbers of customers. In contrast, traditional brokers, such as Merrill Lynch, have a much higher marginal cost
than online brokers because they have retail offices and employ brokers to personally handle trades for customers. E*TRADE may have a lower price than Ameritrade
because it has a lower marginal cost or a lower investment than Ameritrade.
Copyright Houghton Mifflin Company. All rights reserved.
Ch24 C1 to C2
Chapter 24, C 3.
1.
Based on the arguments presented, the $2.50 selling price seems better. The
division manager is very familiar with the pricing variables relevant to his specific market. Because the information provided by Cabral is very important in
pricing decisions, Borner, Inc., should let the Brazilian Division set the selling
price for laundry detergent in the future.
Corporate headquarters should set prices if:
a.
b.
inflation is low,
c.
government regulations are minimal, or
d.
2.
headquarters' pricing expertise is greater than the pricing expertise of the
managers in the division,
the corporation's pricing policy dictates a single image worldwide. This
means that the corporation would want a uniform price to be offered
throughout all markets.
Because the market for laundry detergent in Brazil is highly competitive, target
costing would be more appropriate. The corporation is under pressure to contain costs. Corporate and division managers must consider ways to reduce
costs to keep the selling price competitive and still earn a desirable profit. The
direct materials, the production process, or other operating activities can be
changed to reduce costs.
Copyright Houghton Mifflin Company. All rights reserved.
Ch24 C3
Chapter 24, C 4.
1.
Selling prices calculated
a.
Electric stapler (return on assets pricing):
Return on AssetsBased Price = Total Costs and Expenses per Unit
+ [ Desired Rate of Return
x ( Total Costs of Assets Employed
Anticipated Units to Be Produced ) ]
=
( $14 + $3
16,000 ) ]
) + [ 20% x ( $160,000
= $19
b.
Electric pencil sharpener (gross margin pricing):
Markup Percentage =
=
Desired Profit + Total Selling,
General, and Administrative Expenses
Total Production Costs
$240,000
+
$720,000
$1,440,000
= 66.67%
Gross MarginBased Price = Total Production Costs per Unit
+ ( Markup Percentage
x Total Production Costs per Unit )
Copyright Houghton Mifflin Company. All rights reserved.
=
$15 +
= $25
Ch24 C4
( 66.67% x $15 )
Chapter 24, C 4. (Continued)
2.
Use of return on assets pricing assessed
No, a selling price for the electric pencil sharpener cannot be calculated using return
on assets pricing because sufficient information is not available. Return on assets
pricing adds a percentage of assets employed in manufacturing an item to the full
cost of the item. The selling and administrative expenses for the sharpener are not
available, which precludes the determination of full cost. In addition, the assets employed are not available.
3.
Two pricing methods evaluated
In pricing decisions, as in most decisions, additional relevant information increases
the usefulness of the decision method and the probability of an optimum decision.
The return on assets method is more appropriate for decision analysis because it
uses more information in calculating potential selling prices than does the gross
margin method. Return on assets pricing enables a multi-product firm such as
Fastener to use as much information as is available to a single-product firm in calculating potential selling prices.
The survival of a firm depends on its ability to price its products to achieve a longrun return on investment adequate to compensate investors for the use of their
funds. The return on assets method of pricing is a more appropriate method because
it recognizes an amount that would be equivalent to the return needed to attract and
compensate investors.
4.
Additional steps to be taken discussed
Additional steps Carol Watson is likely to take in setting an actual selling price for
each of the two products include the following:
Ascertain the prices of competing products and forecast any price changes.
Perform or refer to market research to determine demand and market acceptance
of the product.
Perform a risk analysis that includes cost-volume-profit analyses at various
prices.
Copyright Houghton Mifflin Company. All rights reserved.
Ch24 C4 (2)
Chapter 24, C 5.
1.
Transfer price discussed
This is an excellent case for class discussion. If the Cabinet Division is not operating at full capacity, it should sell to the Electronics Division at any price that exceeds the incremental cost per unit of producing and selling. Variable costs of producing and selling one unit are $68, assuming that variable selling expenses of $9
apply to intracompany sales. Some of the fixed costs may be incremental in nature
with regard to intracompany sales volume, but this information is not given. Even at
$110 per unit, it is clear that the Cabinet Division will earn a profit. The $110 price is
not necessarily fair, because the Electronics Division must incur additional inventory management costs if it purchases cabinets from an outside supplier. From the
corporation's overall viewpoint, cabinets should not be purchased from the outside
supplier. Between the divisions, the prices of $92.40 and $109.20 are unrealistic, because they are below the discount price available from outsiders. Any transfer price
between $110 and $120 would be realistic and beneficial to each division and to
total company operations.
2.
Transfer price reevaluated
If the Cabinet Division can sell all of its output to outside customers at $120, it
should not decrease its price to satisfy intracompany demand. The Electronics Division should buy from outsiders at $110 as long as the increased storage costs do
not push the unit cost over $120.
Copyright Houghton Mifflin Company. All rights reserved.
Ch24 C5
Chapter 24, C 6.
1.
Target cost computed
Target cost =
2.
$590.00
1.25
= $472.00
Projected unit cost of product CX35 computed
Direct materials cost
$ 56.00
Purchased parts cost
37.00
Manufacturing labor
( 4.5 hours
x
$14.00 )
63.00
Assembly labor
( 5.2 hours
x
$15.00 )
78.00
Activity-based costs
Materials handling
( 10% x $93.00
*)
9.30
Engineering
( $13.50 x
1)
13.50
Production
( $ 8.20 x 26 )
213.20
Product delivery
( $24.00 x
1)
24.00
Marketing
( $ 6.00 x
1)
6.00
$500.00
Projected total unit cost
*
3.
$56.00
+
$37.00
=
$93.00
Product cost calculations reworked
a. Cut product quality, which will reduce direct materials cost by 20 percent and
parts costs by 15 percent:
Direct materials cost
( 0.80 x
$56.00 )
$ 44.80
Purchased parts cost
( 0.85 x
$37.00 )
31.45
Manufacturing labor
( 4.5 hours
x
$14.00 )
63.00
Assembly labor
( 5.2 hours
x
$15.00 )
78.00
Activity-based costs
Materials handling
(
10%
x
$76.25
Engineering
( $13.50 x
1)
13.50
Production
( $ 8.20 x 26 )
213.20
Product delivery
( $24.00 x
1)
24.00
Marketing
( $ 6.00 x
1)
6.00
$481.58
Projected total unit cost
*
$44.80
+
$31.45
Copyright Houghton Mifflin Company. All rights reserved.
=
$76.25
Ch24 C6
*)
7.63
Chapter 24, C 6. (Continued)
b.
Increase the quality of direct materials, which will increase direct materials cost
by 20 percent but will reduce machine hours by 10 percent, manufacturing labor
hours by 16 percent, and assembly labor hours by 20 percent:
Direct materials cost
(
1.20 x
$56.00 )
Purchased parts cost
$ 67.20
37.00
Manufacturing labor
(
3.78 hours x
$14.00 )
52.92
Assembly labor
(
4.16 hours x
$15.00 )
62.40
Activity-based costs
Materials handling
( 10%
Engineering
x
$104.20 * )
10.42
( $13.50
x
1)
13.50
Production
( $ 8.20
x
23.4 )
191.88
Product delivery
( $24.00
x
1)
24.00
Marketing
( $ 6.00
x
1)
6.00
$465.32
Projected total unit cost
* $67.20
4.
+
$37.00
= $104.20
Management should choose the second alternative offered by the design engineers in part 3. It results in a projected cost of $465.32 per unit, which is below
the target cost for the product, and it increases the quality level, which will
please the customers.
Chapter 24, C 7.
This is an excellent case for class discussion. Even though Kwan Cho was following a common business practice in her area of the world, the practice is not condoned in the United States, and Harriet Makay should not keep the "gift" secret from
her company. She should report the incident to her supervisor. Barnes Company
officials may decide to let Makay keep the gift, but only at that point is it ethically
hers. The $500 is really part of the lost sales revenuethe $7 per product negotiated
away during the discussions with Kwan Cho.
Copyright Houghton Mifflin Company. All rights reserved.
Ch24 C6 (2) to C7
Chapter 24, C 8.
Target costing is a pricing method that (1) identifies the price at which a product
will be competitive in the marketplace, (2) defines the desired profit to be made on
the product, and (3) computes the target cost for the product by subtracting the desired profit from the competitive market price. Target costing is very useful for developing products like PDAs because the market is very competitive and prices are
low relative to cost. If the product is going to be successful, it must be priced competitively. Actual selling prices tend to be less than the list, or retail, price suggested
by the manufacturer. Website searches are very helpful for companies using target
costing because they provide the actual retail prices in competitive markets. Students should choose a price at the low end of the available prices because that is
the price the company must meet. The chosen retail price is then divided by 1.25 to
find the target cost. At that point, the company must determine whether it can produce the competing product for a total cost equal to or less than the target cost. If
the company cannot accomplish that objective, it may decide it cannot produce a
competing PDA at a competitive price.
Chapter 24, C 9.
This assignment is designed to develop the students' research and fact-gathering
skills as well as their writing and speaking skills. Students will find a variety of articles that address many different issues. Some of the areas of controversy include
types of transfer prices, fairness of the prices, the Internal Revenue Service's allowance of transfer prices, usefulness of the prices, and benefits and disadvantages of
transfer prices. As groups report on their discussions, list the issues discovered
and ask groups to identify their sources.
Copyright Houghton Mifflin Company. All rights reserved.
Ch24 C8 to C9
Chapter 24, C 10.
1 and 2.
Performance reports prepared
Golf-Brell Company
Divisional Performance Reports
Champions
Division
Tournament
Division
Company
Totals
$ 700,000
$1,720,000
$2,420,000
900,000
3,300,000
4,200,000
$1,600,000
$5,020,000
$6,620,000
$1,600,000
$1,600,000
Costs Controllable by Manager
Sales
Regular
Deluxe
Total sales
Cost of Goods Sold
Direct materials
Fabric tops
$
Cloth
360,000
360,000
Aluminum
660,000
660,000
Closing mechanisms
1,560,000
1,560,000
480,000
540,000
1,020,000
90,000
240,000
330,000
150,000
210,000
360,000
$1,080,000
$4,810,000
$5,890,000
$ 520,000
$ 210,000
$ 730,000
$ 132,000
$ 372,000
$ 504,000
84,000
108,000
192,000
Direct labor
Overhead
Variable
Fixed divisionalavoidable
Total controllable costs
Controllable income
Costs Uncontrollable by Manager
Selling and general operating
expenses
Company administrative expenses
Total uncontrollable costs
Operating income (loss)
Copyright Houghton Mifflin Company. All rights reserved.
$ 216,000
$ 304,000
Ch24 C10
$ 480,000
($ 270,000)
$ 696,000
$ 34,000
Chapter 24, C 10. (Continued)
3. Rates of return computed
Champions
Division
$ 520,000
Controllable income
Total controllable division costs
Rate of return on controllable division costs
Operating income (loss)
Tournament
Division
$ 210,000
1,080,000
48.15%
$ 304,000
Total division costs
1,296,000
23.46%
Rate of return on total division costs
4,810,000
4.37%
($ 270,000)
5,290,000
-5.10%
4. Assessment of director's statement made
The director of the Tournament Division is correct. The Champions Division is earning over 48 percent on its controllable costs and more than 23 percent on total
costs. Because of the high transfer prices, the Tournament Division's profit margin
is being squeezed, and the division ends up losing money.
5. Procedures recommended
The board of directors should direct the manager of the Champions Division to
negotiate a fair and equitable transfer price with the manager of the Tournament
Division. The current overall company rate of return on controllable costs is 12.4
percent.*
*
$730,000
$5,890,000
= 12.4%
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Ch24 C10 (2)