1.5. Relevant Information for Decision Making with a Focus on Pricing Decisions

Question 1

What is the Absorption Approach for Income Statements?

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2.
3.
4.
5.

Answer 1

• Separates manufacturing costs from nonmanufacturing costs
• First, deduction of manufacturing cost of goods sold from sales to compute a gross margin
• Second, deduction of nonmanufacturing costs to measure operating income
• Well-suited for long-run pricing decisions
• Used for external reporting

Question 2

What is the Contribution Approach for Income Statements?

1.
2.
3.
4.
5.

Answer 2

• seperates fixed costs from variable costs
• first deduction of variable costs from sales to compute a contribution margin
• second, deduction of fixed costs o measure operating income
• useful in situations where decisions affect variable costs differently than they affect fixed costs, such as in short-run pricing decisions
• not allowed by regulators for external financial reporting

Question 3

The Contribution Approach allows to easier understand…

Answer 3

…. impact of changes in sales volume on operating income

Question 4

What is the idea of Cost-Plus Pricing Using Various Approaches?

Answer 4

• setting prices by selecting a cost basis and adding a markup as a percentage of respective cost basis, i.e.
• Price = Cost basis + cost basis x markup = cost basis x (1+ markup)
• i.e. markup = Price / cost basis -1 = (price - cost basis) / cost basis
• key: determine “plus” in cost plus

Question 5

What can be said about the Contribution Approach in Cost-Plus Pricing? (Advantages)

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2.
3.

Answer 5

• price formula allows managers to prepare price schedules at different volume levels
• due to seperation of Variable and Fixed Costs, total uni costs correctly captured
• offers insights into the short term versus long run effect of cutting prices in special orders

Question 6

What is the Maximum and Minimum Price?

Answer 6

• maximum price is not a matter of costs at all; its what you think you can obtain (i.e. what your customer is willing to pay)
• minimum price should equal the total variable costs

Question 7

What is the Concept of Target Costing?

Answer 7

• take the market price of a product as given. now determine the maximum cost the company can spend to make the product and still achieve the desired profitability

Question 8

What is the process of Target Costing?

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Answer 8

• set cost before the product is created or even designed
• improvement in product design and manufacturing process so that product´s cost does not exceed its target cost (Value engineering)
• after product implementation, continuous improvement during manufacturing (kaizen costing)
• use activity based managememt (ABM) to furthe rreduce costs
• use target costing to decide whether to add new product

Question 9

What is….

1. value engineering?
2. kaizen costing?

Answer 9

1. cost reduction technique //during design and development: improvement in product design and manufacturing process so that product´s cost does not exceed its target cost
2. during production: continuous improvement during manufacturing

Question 10

Compare Target Costing vs Cost-Plus Pricing

TC
1.
2.

CPP
1.
2.

Answer 10

Target Costing:
- products market price as starting point
- target product cost to be achieved via value engineering, kaizen costing, activity based management, negotiations with suppliers, …

Cost-Plus Pricing
- products cost as starting point
- market price as markup of cost basis

Question 11

Explain the increasing popularity of target costing

1.
2.
3.

Answer 11

• global market competititon limits the companies influence on market prices
• cost management becomes key to profitability
• target costing forces managers to focus on costs to achieve desired profitability

Question 12

It is misleading to use the absorption costing income statement to predict
the effect of changes in sales volume because ________.

Answer 12

total fixed production costs do not change with small changes
in sales volume

Question 13

Fixed selling expenses affect the calculation of ________ on the
contribution income statement. Fixed selling expenses do NOT affect the
calculation of ________ on the absorption income statement.

Answer 13

operating income; gross margin

Question 14

In the short run, when managers set prices for products, the minimum
selling price should be equal to _______

Answer 14

all variable costs of producing, selling and distributing the good
or service

Question 15

When should the contribution approach be used?

Answer 15

• in situations where decisions affect the variable costs differently than they affect fixed costs, such as in short run pricing decisions

Question 16

When should the apsorption approach be used?

Answer 16

• in long run pricing decisions