Pricing Products and Services

Appendix A

PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
 Appendix A-2

1. Price Elasticity of Demand

ln(1 + % change in quantity sold)
Єd =
ln(1 + % change in price)

Price elasticity of demand Natural log function

I can estimate the price

elasticity of demand for a
product or service using
the above formula.
 Appendix A-3

2. Total Cost Base

Under the absorption approach to cost-plus
pricing, the cost base is the absorption costing
unit product cost rather than the variable cost.

The cost base includes

direct materials, direct
labor, and variable and
fixed manufacturing
overhead.
 Appendix A-4

Problems with the Absorption Costing

Approach

The absorption costing approach essentially

assumes that customers need the forecasted unit
sales and will pay whatever price the company
decides to charge. This is flawed logic simply
because customers have a choice.
 Appendix A-5

3. Variable Cost Base

Under the variable approach, the cost base is
the variable costing unit product cost.

The cost base includes

direct materials, direct
labor, and variable
manufacturing
overhead.
 Appendix A-6

Problems with the Variable Costing

Approach

The variable costing approach

is applicable only when:
1) The company has excess capacity.
2) Orders will not disturb the current market.
3) There are not dumping prices.
4) Sales and profits will increase when accepting
orders at a lower price, in a different market.
 Appendix A-7

4. Target Costing
Target costing is the process of determining the
maximum allowable cost for a new product and then
developing a prototype that can be made for that
maximum target cost figure. The equation for
determining a target price is shown below:

Target
Target cost
cost == Anticipated
Anticipated selling
selling price
price –– Desired
Desired profit
profit
Once the target cost is determined, the
product development team is given the
responsibility of designing the product
so that it can be made for no more than
the target cost.
 Appendix A-8

Reasons for Using Target Costing

Two characteristics of prices and product costs
include:
1. The market (i.e., supply and demand)
determines price.
2. Most of the cost of a product is determined
in the design stage.
 Appendix A-9

Reference
• Garrison, Noreen & Brewer
• Managerial Accounting
• 15th Edition.

Managerial Chapter 6 9
Accounting