Chapter 13

Question 1

How companies price a product or service ultimately depends on

Answer 1

on the demand and supply for it.

Question 2

Three influences on demand and supply are:

Answer 2

–Customers
–Competitors
–Costs

Question 3

Customers influence

Answer 3

price through their effect on the demand for a product or service, based on factors such as product features and quality.

Question 4

Competitors influence

Answer 4

price through their technologies, plant capacities, and operating strategies which affect their costs.

Question 5

Costs influence

Answer 5

prices because they affect supply. The lower the cost of producing a product, the greater the quantity a firm is willing to supply

Question 6

Short-run pricing decisions have a time horizon of

Answer 6

less than one year and include decisions such as:
•Pricing a one-time-only special order with no long-run implications
•Adjusting product mix and output volume in a competitive market.

Question 7

Long-run pricing is a strategic decision designed to

Answer 7

build long-run relationships with customers based on stable and predictable prices. Managers prefer a stable price because it reduces the need for continuous monitoring of prices, improves planning and builds long-run buyer–seller relationships.

Question 8

indirect costs of a particular cost object are costs that are related

Answer 8

to that cost object but cannot be traced to it in an economically feasible (cost-effective) way

Question 9

Cost allocations and product profitability analyses affect the products

Answer 9

promoted by a company. To increase profits, managers focus on high-margin products.

Question 10

How should managers use product cost information to price their products? There are two different approaches for pricing decisions:

Answer 10

The MARKET-BASED APPROACH asks: Given what our customers want and how competitors will react to what we do, what price should we charge?
•The COST-BASED APPROACH asks: Given what it costs us to make this product, what price should we charge that will recoup our costs and achieve a target return on investment?

Question 11

Before setting prices under any approach, managers need to understand customers and competitors for three reasons:

Answer 11

Lower-cost competitors continually restrain prices.
•Products have shorter lives, which leaves companies less time and opportunity to recover from pricing mistakes, loss of market share and loss of profitability.
•Customers are more knowledgeable because they have easy access to price and other information online and demand high-quality products at low prices.

Question 12

Market-based Approach: Target Costing for Target Pricing

Answer 12

Starts with a target price which is the estimated price for a product or service that potential customers are willing to pay

Question 13

The target price is estimated based on

Answer 13

An understanding of customers’ perceived value for a product or service, and
2.How competitors will price competing products or services.

Question 14

FOUR STEPS IN DEVELOPING TARGET PRICES AND TARGET COSTS

Answer 14

Develop a product that satisfies the needs of potential customers.
•Choose a target price.
•Derive a target cost per unit by subtracting target operating income per unit from the target price.
•Perform value engineering to achieve target cost

Question 15

VALUE ENGINEERING

Answer 15

Value engineering is a systematic evaluation of all aspects of the value chain, with the objective of reducing costs and achieving a quality level that satisfies customers.
•Value engineering entails improvements in product designs, changes in materials specifications, and modifications in process methods.
•To implement value engineering, managers must distinguish value-added activities and costs from non-value-added activities and costs.

Question 16

Value-added costs is

Answer 16

a cost that, if eliminated, would reduce the actual or perceived value or utility (usefulness) customers experience from using the product or service

Question 17

Non-value-added costs are costs that

Answer 17

if eliminated, would not reduce the actual or perceived value or utility (usefulness) customers gain from using the product or service. It is a cost the customer is unwilling to pay for

Question 18

Cost incurrence

Answer 18

describes when a resource is consumed (or benefit foregone) to meet a specific objective.

Question 19

Locked-in costs (designed-in costs)

Answer 19

are costs that have not yet been incurred but will be incurred in the future based on decisions that have already been made

Question 20

The best opportunity to manage costs is before

Answer 20

they are locked in.

Question 21

To summarize, the key steps in value-engineering are:

Answer 21

Understanding customer requirements and value-added and non-value added costs.

2. Anticipating how costs are locked in before they are incurred.
3. Using cross-functional teams to redesign products and processes to reduce costs while meeting customers needs

Question 22

Unless managed properly, value engineering and target costing can have undesirable effects:

Answer 22

Employees may feel frustrated if they fail to attain targets.
•The cross-functional team may add too many features just to accommodate the different wishes of team members.
•A product may be in development for a long time as the team repeatedly evaluates alternative designs.
•Organizational conflicts may develop as the burden of cutting costs falls unequally on different business functions in the company’s value chain.

Question 23

To avoid those possible undesirable effects, target-costing efforts should always:

Answer 23

Encourage employee participation and celebrate small improvements toward achieving the target cost.

2. Focus on the customer.
3. Pay attention to schedules.
4. Set cost-cutting targets for all value-chain functions to encourage a culture of teamwork and cooperation.

Question 24

Instead of using the market-based approach for long-run pricing decisions, managers sometimes use a cost-based approach.

Answer 24

The general formula for setting a cost-based selling price adds a markup component to the cost base.
•Usually, it is only a starting point in the price-setting process.
•Markup is somewhat flexible, based partially on customers and competitors.
•Because a markup is added, cost-based pricing is

Question 25

Cost-plus pricing can be determined several ways:

Answer 25

Choose a markup to earn a target rate of return on investment, which is the target annual operating income divided by invested capital
•Computing the specific amount of capital invested in a product is challenging because it requires difficult and arbitrary allocations of investments in equipment and buildings to individual products.

Question 26

Because computing the specific amount of capital invested in a product is challenging, sometimes managers use alternate cost bases to set prospective selling prices:

Answer 26

Variable manufacturing cost
–Variable cost
–Manufacturing cost
–Full cost

Question 27

Many managers use full cost for their cost-based pricing decisions because:

Answer 27

It allows for full recovery of all costs of the product.
It allows for price stability.
It is a simple approach.