Chapter 9 book: pricing Flashcards
in the long run, what must prices cover?
product costs and eventually earn profit
price takers
firms or buyers that have no influence on the price individually
it is set by the market
target cost
market price - desired profit
includes all product and period costs necessary in order to make and market the product or service
target price
the price firms believe would position it in the best positions for its customers
total cost plus pricing
setting a product price in function of or relative to the cost to produce this product
determining the cost base and then putting a markup
this determines the target selling price
markup per unit
basically profit
selling price - cost = markup
(Desired ROI %) / Units produced = markup
what does the size of the markup depend on?
depends on the return the company hopes to generate on the amount it has invested
competitive and market conditions, political and legal issues, and other relevant factors must all be considered
total cost-plus pricing formula to determine the target selling price
total unit cost + markup percentage · total uni cost = target selling price
ROI
income divided by investment in product tor service
a higher percentage means a greater success in generating profits from the investment
markup percentage
Desired ROI per unit / Total Unit cost = Markup percentage
total cost-plus pricing approach main advantage
simple to calculate
total cost-plus pricing approach main disadvantage
does not consider the demand side
if less units are produced than expected, does the ROI per unit increase or decrease? Does the selling price per unit increase or decrease? why?
ROI per unit increases because the fixed costs per unit now increase
selling price per unit increases because of a bigger ROI per unit
if more units are produced than expected, does the ROI per unit increase or decrease? Does the selling price per unit increase or decrease? why?
ROI per unit decreases because the fixed costs per unit now decrease
selling price per unit decrease because of a smaller ROI per unit
which is more popular between absorption cost-plus pricing and variable cost-plus pricing?
absorption cost-plus pricing
what is excluded in the absorption cost-plus pricing?
variable selling and administrative expenses
fixed selling and administrative expenses
what is the first step of the absorption cost-plus pricing?
calculating the manufacturing cost per unit
how do you find the markup percentage per unit using the absorption cost-plus pricing?
Desired ROI per unit + selling and administrative expenses per unit
=
Markup percentage · Manufacturing cost per unit
Markup percentage = (Desired ROI per unit + selling and administrative expenses per unit) / Manufacturing cost per unit
how do you set the target price using the absorption cost-plus pricing?
Manufacturing cost per unit + (Markup percentage · Manufacturing cost per unit)
= Target Selling Price
how do you find the total markup percentage using the absorption cost-plus pricing?
(net income + selling and administrative expenses) / COGS
why do most companies use absorption cost-plus pricing? when they decide to use cost-plus pricing?
- a company’s cost accounting system provides absorption
variable cost-plus pricing
cost base consists of all the variable costs associated with a product, including variable selling and administrative expenses
in variable cost-plus pricing, what does the markup cover? why?
fixed manufacturing overhead
fixed selling and administrative expenses
the target ROI
because fixed costs are not included in the base
steps to do variable cost-plus pricing
- calculate variable cost per unit
- calculate markup percentage
3 target selling price
how do you calculate markup percentage per unit under variable cost-plus pricing?
Desired ROI + all fixed unit costs = Markup Percentage · all variable unit costs
how do you target the selling variable cost-plus pricing?
all variable unit costs + Markup Percentage · all variable unit costs = Target selling price
how do you calculate overall markup percentage under variable cost-plus pricing?
(Net Income + all Fixed costs) / COGS = Markup percentage
the major disadvantage with variable cost-plus pricing?
managers may set the price too low which will fail to cover fixed costs
in the long run, it will lead to losses
company will reach ROI only if it reaches budgeted sales volume for the period
why would managers use variable cost-plus pricing?
more consistent with volume-profit analysis used to measure the changes in profit with changes in price and volume
provides types of data needed for pricing special orders
avoids arbitrary allocation of common fixed costs
time-and-material pricing
two pricing rates are put in place: labor used on a job and material used on a job
in which industry is time-and-material pricing mostly used?
in the service industry
what are the steps of time-and-material pricing
- calculate the per hour labor charge
- calculate charge for holding and obtaining material
- calculate charges for a particular job
in calculating the labor charge under time-and-material pricing, what does the rate per hour of labor include?
direct labor costs of the employee
selling, administrative, and similar overhead costs
allowance for desired profit or ROI per hour of employee time
in the second step of time-and-material pricing, what does the charge for materials include?
invoice price of any materials used on a job
the costs of purchasing, receiving, handling, and storing material
the desired profit margin on materials themselves
how is the material loading charge expressed?
as a percentage of the total estimated costs of parts and materials over the year
how to find the material loading charge percentage?
- estimating annual costs of purchasing, receiving, handling, and storing material
- dividing previous amount by total estimated costs of parts and materials
- add desired profit margin on materials themselves
under time-and-material pricing, how do you calculate charges for a partial job
sum of labour charge, charge for materials, and material loading charge
transfer price
when companies transfer goods internally from one division to another
what are the objectives a firm’s transfer pricing could accomplish?
promote goal congruence
maintain divisional autonomy
provide accurate performance evaluation
what is the maximum price in transfer pricing that a buying division would pay?
determined by market
the price they would pay from another seller
what is the minimum price in transfer pricing that a selling division would pay under a scenario where they are at maximum capacity?
the variable manufacturing cost per unit + the expected contributed margin
goal congruence
when buying and selling divisions agree on a price that benefit both
what is the minimum price in transfer pricing that a selling division would pay under a scenario where they are at excess capacity?
the price must cover at least the variable manufacturing costs
three possible approaches in determining a transfer price
negotiated transfer price
cost-based transfer price
market based transfer price
negotiated transfer price
price determined through agreement by division managers
are variable costs the same when they are sold internally and externally?
nah bruuuv
which opportunity cost is higher when the amount of units forgone is higher than the amounts of units transferred internally? how do you calculate it?
opportunity cost per unit of units transferred internally is higher than opportunity cost per unit of units foregone
[(Selling Price - Variable Cost) · Units Foregone] / Unites Transferred Internally
= Opportunity cost
which opportunity cost is higher when the amount of units forgone is lower than the amounts of units transferred internally? how do you calculate it?
opportunity cost per unit of units transferred internally is lower than opportunity cost per unit of units foregone
[(Selling Price - Variable Cost) · Units Foregone] / Unites Transferred Internally
= Opportunity cost
cost-based transfer price
basing internal transfer price on the costs to produce
either variable costs alone or both variable and fixed costs
markup can be added
improper transfer price
the cost-based transfer price is wack because although it increases contribution margin for buying division, it leaves the selling division with a contribution margin of 0
it is bad if the company is in max capacity because overall contribution margin will decrease
gyu for company if there is excess capacity because overall contribution margin will increase
disadvantage of cost-based transfer price
does not reflect true profitability
advantage of cost-based transfer price
simple to understand
market-based transfer prices
based on actual market prices of competing goods and services
why is a market-based transfer price system consider the best one?
objective
provides the proper economic incentives
outsourcing
buying from other companies the products you need instead if making them yourself
globalization effect on different divisions
now more than ever, divisions of one single company can be all around the world
