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Target Costing and Cost Analysis For Pricing Decisions: Mcgraw-Hill/Irwin
Target Costing and Cost Analysis For Pricing Decisions: Mcgraw-Hill/Irwin
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McGraw-Hill/Irwin
Learning Objective 15-1 – List and describe the four major
influences on pricing decisions.
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15-2
Major Influences on
Pricing Decisions
Customer Political, legal,
demand and image issues
Pricing
Decisions
Competitors Costs
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How are Prices Set?
Costs Market
Forces
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Learning Objective 15-2 – Explain and use the economic,
profit-maximizing pricing model.
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Economic Profit-Maximizing Pricing
Firms
Firms usually
usually have
have flexibility
flexibility in
in setting
setting prices.
prices.
The
The quantity
quantity sold
sold usually
usually
declines
declines as
as the
the price
price is
is increased.
increased.
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Total Revenue Curve
Dollars
Total revenue
Quantity sold
per month
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Demand (or Average Revenue) Curve and
Marginal Revenue Curve
Dollars
per unit
Demand
Revenue per Marginal (or Average
unit decreases revenue Revenue)
as quantity increases Quantity sold
per month
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Total Cost Curve
Dollars
Quantity made
c per month
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Determining the Profit-Maximizing
Price and Quantity (1/3)
Dollars
per unit
p*
Demand
Marginal
cost Marginal Quantity made
revenue
q* and sold
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per month
Determining the Profit-Maximizing
Price and Quantity (2/3)
Dollars
per unit Profit is maximized where
marginal cost equals
marginal revenue, resulting
p* in price p* and quantity q*.
Demand
Marginal
cost Marginal Quantity made
revenue
q* and sold
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per month
Determining the Profit-Maximizing
Price and Quantity (3/3)
Dollars Total cost
Total revenue
Quantity made
q* and sold
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per month
Price Elasticity
The impact of
price changes on
sales volume
The extent to
which a change in
a product’s price affects the
demand for other
substitute products.
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Limitations of the
Profit-Maximizing Model
A firm’s demand and marginal revenue
curves are difficult to discern with precision.
The marginal-revenue, marginalcost
paradigm is not valid for all forms of markets.
Marginal cost is difficult to measure.
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Cost-Benefit Trade-Off in Information
Production
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Role of Accounting
Product Costs in Pricing
Optimal Decisions Suboptimal Decisions
Economic pricing model Cost-based pricing
Sophisticated decision Simplified decision
model and information model and information
requirements requirements
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Cost-Plus Pricing
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Cost-Plus Pricing – Example (1/5)
We
We will
will use
use this
this unit
unit cost
cost information
information toto illustrate
illustrate the
the
relationship
relationship between
between cost
cost and
and markup
markup necessary
necessary to to
achieve
achieve thethe desired
desired unit
unit sales
sales price
price ofof $925.
$925.
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Cost-Plus Pricing – Example (2/5)
Advantages Disadvantage
Does not obscure Fixed costs may be
cost behavior overlooked in
patterns. pricing decisions,
resulting in prices
Does not require that are too low to
fixed cost cover total costs.
allocations.
More useful for
managers.
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Determining the Markup:
Return-on-Investment Pricing (1/6)
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Determining the Markup:
Return-on-Investment Pricing (2/6)
Recall
Recall the
the example
example using
using aa 131.25
131.25 percent
percent markup
markup
on
on variable
variable manufacturing
manufacturing cost.
cost.
Let’s
Let’s solve
solve for
for the
the 131.25
131.25 percent
percent markup.
markup. Invested
Invested
capital
capital is
is $300,000,
$300,000, thethe desired
desired ROI
ROI is
is 20
20 percent,
percent,
and
and annual
annual sales
sales volume
volume is
is 480
480 units.
units.
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Determining the Markup:
Return-on-Investment Pricing (3/6)
Step
Step 1:1: Solve
Solve forfor the
the income
income that
that
will
will result
result in
in an
an ROI
ROI of
of 20
20 percent.
percent.
Income
ROI =
Invested Capital
Income
20% =
$300,000
Income = 20% × $300,000
Income = $60,000
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Determining the Markup:
Return-on-Investment Pricing (4/6)
Step
Step 2:
2: Recall
Recall the
the unit
unit cost
cost information
information below.
below.
Solve
Solve for
for the
the unit
unit sales
sales price
price necessary
necessary to
to
result
result in
in an
an income
income ofof $60,000.
$60,000.
$60,000
Unit sales price − $800 unit cost =
480 units
Unit sales price − $800 unit cost = $125 per unit
Unit sales price = $925
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Determining the Markup:
Return-on-Investment Pricing (6/6)
Step
Step 3:
3: Compute
Compute the
the markup
markup percentage
percentage on
on
the
the $400
$400 variable
variable manufacturing
manufacturing cost.
cost.
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Strategic Pricing of New Products
Uncertainties make pricing difficult.
Production costs
Market acceptance
Pricing Strategies:
Skimming – initial price is high with intent to
gradually lower the price to appeal to a broader
market.
Market Penetration – initial price is low with
intent to quickly gain market share.
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Learning Objective 15-5 – List and discuss the key
principles of target costing.
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Target Costing (1/2)
Market research
determines the price Management computes
at which a new a manufacturing cost that
product will sell. will provide an acceptable
profit margin.
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Target Costing (2/2)
Price led Cross-functional
costing teams
Key
Life-cycle principles Value-chain
costs of target orientation
costing
Focus on Focus on
process product
design Focus design
on the
customer
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Learning Objective 15-6 – Explain the role of activity-based
costing in setting a target cost.
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The Role of Activity-Based
Costing in Setting a Target Cost
Production Process
Component Activities
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Learning Objective 15-7 – Explain how product-cost
distortion can undermine a firm’s pricing strategy.
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Product Cost Distortion
High-volume products
may be overcosted
Low-volume
products
may be undercosted
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Learning Objective 15-8 – Explain the process of value
engineering and its role in target costing.
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Value Engineering
Target Costing and Value Engineering
sting
Target
Target cost
cost information
information
Product
Product design
design
Product
Product costs
costs
Production
Production processes
processes
Value
Value Engineering
Engineering (VE)
(VE)
Cost
Cost reduction
reduction
Design
Design improvement
improvement
Process
Process improvement
improvement
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Learning Objective 15-9 – Determine prices using the time
and material pricing approach.
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Time and Material Pricing (1/2)
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Time and Material Pricing (2/2)
Time charges:
Hourly Overhead Hourly charge Total
labor + cost per + to provide × labor hours
cost labor hour profit margin required
Material Charges:
Total Overhead Total
material per dollar material
cost
+ of material × cost
incurred cost incurred
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Learning Objective 15-10 – Set prices in special-order or
competitive-bidding situations by analyzing the relevant
costs.
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Competitive Bidding (1/2)
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Competitive Bidding (2/2)
Guidelines
Guidelines for
for Bidding
Bidding
• Low bid price
• Any bid price in excess
Bidder has
of incremental costs of
excess capacity job will contribute to
fixed costs and profit.
• High bid price
• Bid price should be full
Bidder has no cost plus normal profit
excess capacity margin as winning bid will
displace existing work.
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Learning Objective 15-11 – Describe the legal restrictions
on setting prices.
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Legal Restrictions On Setting Prices
Price discrimination
Predatory pricing
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End Chapter 15
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