Chapter 9: Pricing

Question 1

What is the objective of target costing?

Answer 1

The objective of target costing is to calculate a cost that ensures a product can be produced at a cost that allows for a reasonable profit margin, given the price determined by the market.

Question 2

What factors influence the establishment of a target cost?

Answer 2

Factors influencing the establishment of a target cost include

market demand,

cost considerations (fixed and variable costs),

pricing objectives like gaining market share or achieving a target rate of return,

and environmental factors like political reaction to prices or patent protection.

Question 3

What is the approach to profitability in industries such as the pharmaceutical industry?

Answer 3

The approach includes heavy investment in research and development, setting high prices, and aggressive marketing to cover substantial financial risks and ensure profitability.

Question 4

What is a ‘price taker’?

Answer 4

A ‘price taker’ is a company that does not set the price of its product; instead, the price is set by the competitive market based on supply and demand. Examples include gasoline retailers like Imperial Oil or Petro-Canada.

Question 5

In what situations might a company set its own prices?

Answer 5

A company sets its own prices when:

The product is specially made for a customer (e.g., custom designer dress by Chanel).

Few or no other producers can manufacture a similar item (e.g., patented computer chips by Intel).

A company successfully differentiates its product or service from competitors (e.g., Starbucks with its coffee).

Question 6

What is the target cost formula in managerial accounting?

Answer 6

Target Cost = Market Price - Desired Profit

This formula helps determine the cost at which a product should be produced to achieve a desired profit margin given its market price.

Question 7

What steps do companies generally follow to establish and use a target cost?

Answer 7

Companies generally:

Choose the market segment to compete in.

Perform market research to determine product features and target price.

Set a target cost by establishing a desired profit (Target Cost = Market Price - Desired Profit).

Assemble a team to design a product that meets quality specs without exceeding the target cost.

Question 8

What does the target cost include in managerial accounting?

Answer 8

The target cost includes all product and period costs that are necessary to make and market the product or service, ensuring it can be sold for a profit.

Question 9

What is total cost-plus pricing?

Answer 9

Total cost-plus pricing is a pricing method where a company determines a cost base for a product or service and then adds a markup to cover the desired profit.

Question 10

What factors should a company consider when determining the optimal markup in total cost-plus pricing?

Answer 10

When determining the optimal markup, a company must consider competitive and market conditions, political and legal issues, and other relevant factors.

Question 11

How do you calculate the target selling price using total cost-plus pricing?

Answer 11

The target selling price is calculated by adding the cost to produce and sell the product (total unit cost) and the markup percentage.

The formula is:

Target Selling Price = Total Unit Cost + (Total Unit Cost x Markup Percentage).

Question 12

How is the markup percentage determined in total cost-plus pricing?

Answer 12

The markup percentage is determined by the desired return on investment (ROI).

For instance, if the desired ROI per unit is $20 and the total unit cost is $112, the markup percentage would be ($20 / $112) * 100%, which equals approximately 17.86%.

Question 13

How does the budgeted sales volume affect the selling price in total cost-plus pricing?

Answer 13

The budgeted sales volume affects the fixed cost per unit.

A lower sales volume increases the fixed cost per unit, thus requiring a higher selling price to achieve the same ROI.

Conversely, a higher sales volume spreads the fixed costs over more units, potentially allowing for a lower selling price.

Question 14

What is the formula for calculating the markup based on desired ROI per unit in total cost-plus pricing?

Answer 14

The markup based on the desired ROI per unit is calculated as:

Markup = (Desired ROI Percentage x Amount Invested) / Units Produced.

Question 15

What are the limitations of total cost-plus pricing?

Answer 15

The limitations of total cost-plus pricing include not considering demand side factors (i.e., what customers are willing to pay) and the impact of sales volume on per-unit costs and pricing.

Question 16

What is absorption cost-plus pricing?

Answer 16

Absorption cost-plus pricing is a pricing approach that includes both variable and fixed manufacturing costs in the cost base but excludes selling and administrative costs.

The selling price is determined by adding a markup that covers both the desired ROI and the selling and administrative expenses.

Question 17

How do you calculate the manufacturing cost per unit in absorption cost-plus pricing?

Answer 17

To calculate the manufacturing cost per unit, sum up the per-unit costs of direct materials, direct labor, variable manufacturing overhead, and fixed manufacturing overhead. Do not include selling and administrative expenses in this calculation.

Question 18

How do you determine the markup percentage in absorption cost-plus pricing?

Answer 18

The markup percentage in absorption cost-plus pricing is determined by adding the desired ROI per unit to the per-unit selling and administrative expenses, and then dividing by the manufacturing cost per unit.

Question 19

What is the formula for setting the target selling price in absorption cost-plus pricing?

Answer 19

The target selling price in absorption cost-plus pricing is set using the formula:

Target Selling Price=Manufacturing Cost per Unit+(Manufacturing Cost per Unit×Markup Percentage)

Question 20

Why might a company choose absorption cost-plus pricing over variable cost-plus pricing?

Answer 20

Companies might choose absorption cost-plus pricing over variable cost-plus pricing because it includes all manufacturing costs, which can make it easier to defend prices to customers and governments.

It also reflects the full cost of producing a product and may align better with financial reporting standards.

Question 21

What is variable cost-plus pricing?

Answer 21

Variable cost-plus pricing is a method where the selling price is based on the sum of all variable costs per unit plus a markup that covers the fixed costs and the desired ROI.

Question 22

What is variable cost-plus pricing?

Answer 22

Variable cost-plus pricing is a method where the cost base includes all variable costs associated with a product, and the markup must cover both the fixed costs and the desired ROI.

It’s used for short-term decisions as it separates variable and fixed cost behaviors.

Question 23

How do you calculate the variable cost per unit in variable cost-plus pricing?

Answer 23

To calculate the variable cost per unit, add up all the variable costs related to producing a unit, including direct materials, direct labor, variable manufacturing overhead, and variable selling and administrative expenses.

Question 24

How is the markup percentage calculated in variable cost-plus pricing?

Answer 24

The markup percentage in variable cost-plus pricing is calculated by adding the desired ROI per unit to the per-unit fixed costs (manufacturing, selling, and administrative), and then dividing this total by the variable cost per unit.

Question 25

What is the formula to calculate the target selling price using variable cost-plus pricing?

Answer 25

The target selling price using variable cost-plus pricing is calculated as:

Target Selling Price = Variable Cost per Unit + (Variable Cost per Unit x Markup Percentage).

Question 26

What are the advantages of variable cost-plus pricing?

Answer 26

Advantages of variable cost-plus pricing include its consistency with cost-volume-profit analysis, the provision of data for pricing special orders, and avoidance of arbitrary allocation of fixed costs to product lines.

Question 27

Why might managers prefer variable cost-plus pricing over absorption costing?

Answer 27

Managers might prefer variable cost-plus pricing because it provides a clearer picture of how costs change with sales volume and does not allocate fixed costs to units, which can blur the effects of cost behavior on operating income.

Question 28

What is time-and-material pricing?

Answer 28

Time-and-material pricing is a method where two pricing rates are set:

one for the labor used on a job and another for the material.

It covers both the direct costs of labor and materials, as well as an allocated portion of overhead costs.

Question 29

What are the components included in the labor rate under time-and-material pricing?

Answer 29

The labor rate includes direct labor costs (hourly rate or salary and benefits), selling, administrative, and overhead costs, and an allowance for desired profit or ROI per hour of employee time.

Question 30

How is the labor charge calculated in time-and-material pricing?

Answer 30

The labor charge is calculated by determining the cost per hour, which includes the direct labor cost, a portion of the total overhead, and the desired profit margin, and then multiplying this rate by the number of hours of labor used on a job.

Question 31

What does the material loading charge cover in time-and-material pricing?

Answer 31

The material loading charge covers the costs of purchasing, receiving, handling, and storing materials, in addition to the desired profit margin on the materials.

Question 32

How do you calculate the material loading charge in time-and-material pricing?

Answer 32

To calculate the material loading charge,

estimate the total annual costs for handling materials,

divide by the total estimated cost of parts and materials,

and add the desired profit margin.

Question 33

What steps are involved in creating a price quotation using time-and-material pricing?

Answer 33

The steps include calculating the labor charge based on the hourly rate and the time required, determining the cost of materials, calculating the material loading charge, and summing these to provide a total price for the job.

Question 34

What is transfer pricing?

Answer 34

Transfer pricing refers to the pricing of goods, services, and intangibles between related business entities within an enterprise.

It is used when divisions within a vertically integrated company transfer goods or services to other divisions.

Question 35

What are the objectives of a transfer pricing policy?

Answer 35

A transfer pricing policy aims to
1) promote goal congruence among divisions,
2) maintain divisional autonomy,
3) provide accurate performance evaluation.

Question 36

What is the general transfer-pricing formula?

Answer 36

The general transfer pricing formula is:

What is the general transfer-pricing formula?

Question 37

How do you calculate the minimum transfer price without excess capacity?

Answer 37

The minimum transfer price without excess capacity is the sum of the variable cost and the opportunity cost. It represents the lowest price at which a selling division should transfer goods to a buying division.

Question 38

How does excess capacity affect transfer pricing?

Answer 38

When a division has excess capacity, the opportunity cost of selling internally versus externally is typically lower.

Therefore, the minimum transfer price may be equal to the variable cost if the alternative is not selling the product at all.

Question 39

What are the three approaches to determining a transfer price?

Answer 39

The three approaches are

1) negotiated transfer prices,
2) cost-based transfer prices,
3) market-based transfer prices.

Question 40

How is the minimum transfer price calculated in a situation with excess capacity?

Answer 40

In the case of excess capacity, the minimum transfer price can be reduced to the variable cost per unit since the opportunity cost is zero.

This means that any price above the variable cost contributes to covering the fixed costs and is preferable to not using the excess capacity.

Question 41

What are the components of variable costs in the context of transfer pricing?

Answer 41

In transfer pricing, variable costs are defined as the variable cost of units sold internally.

This includes all costs that vary with the level of production or service provision, like raw materials and direct labor.

Question 42

How do you determine the minimum transfer price for a special order?

Answer 42

For a special order, the minimum transfer price is the sum of the variable cost of producing the order and the opportunity cost of not selling the product externally at its full capacity.

Question 43

What is the formula for calculating the opportunity cost when units transferred are unequal to units forgone?

Answer 43

Opportunity Cost = [(Selling Price - Variable Cost) x Units Forgone] ÷ Units Transferred Internally

Question 44

What should a firm’s transfer pricing policy aim to accomplish?

Answer 44

A firm’s transfer pricing policy should aim to promote goal congruence, maintain divisional autonomy, and provide accurate performance evaluation.

Question 45

What is the negotiated transfer pricing approach?

Answer 45

The negotiated transfer pricing approach is when the selling division establishes a minimum transfer price, and the buying division establishes a maximum transfer price through negotiations.

Question 46

What are the challenges associated with the negotiated transfer pricing approach?

Answer 46

Challenges with the negotiated approach include the potential lack of market price information, the possibility of negotiations leading to breakdowns, and the costliness and complexity of the process.

Question 47

Why might a company opt for cost-based transfer pricing over market-based or negotiated methods?

Answer 47

Companies may choose cost-based transfer pricing because it’s often simpler to implement when market prices aren’t available or when negotiations between divisions are not feasible.

Question 48

How does the market-based transfer pricing approach work?

Answer 48

Market-based transfer pricing uses market prices of competing goods or services to establish the transfer price.

This method is often seen as providing the right economic incentives and aligning with external market conditions.