Financial and managerial accounting 2nd kimel kieso willey chapter 22

22-1 22 Pricing Learning Objectives Compute a target cost when the market determines a product price Compute a target selling price using cost-plus pricing 22-2 Use time-and-material pricing to determine the cost of services provided Determine a transfer price using the negotiated, cost-based, and market-based approaches LEARNING OBJECTIVE Compute a target cost when the market determines a product price The price of a good or service is affected by many factors Illustration 22-1 Pricing factors Regardless of the factors involved, the price must cover the costs of the good or service as well as earn a reasonable profit 22-3 LO Pricing Goods for External Sales The price of a good or service is affected by many factors  Company must have a good understanding of market forces  Where products are not easily differentiated from competitor goods, prices are not set by the company, but rather by the laws of supply and demand – such companies are called price takers  Where products are unique or clearly distinguishable from competitor goods, prices are set by the company 22-4 LO Management Insight Google The Only Game in Town? Pricing plays a critical role in corporate strategy For example, almost 50% of tablet computer users say that they use them to read newspapers and magazines And since Apple’s iPad tablet computer at one time represented 75% of the tablets being sold, Apple felt like it had the newspaper and magazine publishers right where it wanted them So it decided to charge the publishers a fee of 30% of subscription revenue for subscriptions sold at Apple’s App Store Publishers were outraged, but it didn’t take long for somebody to come to their rescue Within day of Apple’s announcement, Google announced that it would only charge a fee of about 10% of subscription revenue for users of its Android system That might at least partially explain why Sports Illustrated provided an app to run on Android tablets before it provided one for iPads, even though at that time Android tablets only had a small share of the market Source: Martin Peers, “Apple Risks App-lash on iPad,” Wall Street Journal Online (February 17, 2011) 22-5 LO Target Costing 22-6  Laws of supply and demand significantly affect product price  To earn a profit, companies must focus on controlling costs  Requires setting a target cost that will provide the company’s desired profit LO Target Costing  Target cost: Cost that provides the desired profit when the market determines a product’s price Illustration 22-2 Target cost as related to price and profit  22-7 If a company can produce its product for the target cost or less, it will meet its profit goal LO Target Costing  First, company should identify its market niche where it wants to compete  Second, company conducts market research to determine the target price – the price the company believes will place it in the optimal position for the target consumers 22-8  Third, company determines its target cost by setting a desired profit  Last, company assembles a team to develop a product to meet the company’s goals LO Management Insight Wal-Mart Stores, Inc Wal-Mart Says the Price Is Too High “And the price should be $19 per pair of jeans instead of $23,” said the retailer Wal-Mart Stores, Inc to jean maker Levi Strauss What happened to Levi Strauss is what happens to many manufacturers who deal with Wal-Mart Wal-Mart often sets the price, and the manufacturer has to figure out how to make a profit, given that price In Levi Strauss’s case, it revamped its distribution and production to serve Wal-Mart and improve its overall record of timely deliveries Producing a season of new jeans styles, from conception to store shelves, used to take Levi 12 to 15 months Today, it takes just 10 months for Levi Strauss signature jeans; for regular Levi’s, the time is down to 1/2 months As the chief executive of Levi Strauss noted, “We had to change people and practice It’s been somewhat of a D-Day invasion approach.” Source: “In Bow to Retailers’ New Clout, Levi Strauss Makes Alterations,” Wall Street Journal (June 17, 2004), p A1 22-9 LO 1 Target Costing Fine Line Phones is considering introducing a fashion cover for its phones Market research indicates that 200,000 units can be sold if the price is no more than $20 If Fine Line decides to produce the covers, it will need to invest $1,000,000 in new production equipment Fine Line requires a minimum rate of return of 25% on all investments Determine the target cost per unit for the cover The desired profit for this new product line is $1,000,000 x 25% = $250,000 Each cover must result in profit of $250,000 ÷ 200,000 units = $1.25 Market price $20 22-10 Desired profit - $1.25 Target cost per unit = $18.75 per unit LO Absorption-Cost Pricing Illustration 22A-1 Step 1: Compute the unit manufacturing cost Computation of unit manufacturing cost Illustration 22A-2 Illustration 22A-2 Other information 22-59 LO Absorption-Cost Pricing Step 2: Compute the markup percentage Illustration 22A-3 Markup percentage— absorption-cost pricing Solving, we find: MP = ($40 + $38) ÷ $87 = 89.66% 22-60 LO Absorption-Cost Pricing Step 3: Set the target selling price Illustration 22A-4 Computation of target price— absorption-cost pricing Because of fixed costs, if more than 10,000 units are sold, the ROI will be greater than 20% and vice versa 22-61 LO Absorption-Cost Pricing Proof of 20% ROI—absorption-cost pricing Illustration 22A-5 22-62 LO Absorption-Cost Pricing Most companies that use cost-plus pricing use either absorption cost or full cost as the basis Reasons: 22-63 Information readily available – cost effective Use of only variable costs may result in too low a price – suicidal price cutting Most defensible base for justifying prices LO Variable-Cost Pricing  Cost base consists of all variable costs associated with a product – manufacturing, selling, administrative  Since fixed costs are not included in base, markup must provide for fixed costs (manufacturing, selling, administrative) and the target ROI  Useful for making short-run decisions because variable and fixed cost behaviors are considered separately 22-64 LO Variable-Cost Pricing Steps: 22-65 Compute the unit variable cost Compute markup percentage Set target selling price LO Variable-Cost Pricing Step 1: Compute the unit variable cost Illustration 22A-6 22-66 LO Variable-Cost Pricing Step 2: Compute the markup percentage Illustration 22A-7 22-67 LO Variable-Cost Pricing Step 3: Set target selling price Illustration 22A-8 Using the $165 target price produces the desired 20% ROI at a volume level of 10,000 units 22-68 LO Proof of 20% ROI—contribution approach 22-69 Illustration 22A-9 LO Variable-Cost Pricing Avoids blurring effects of cost behavior on operating income Reasons: 22-70 More consistent with CVP analysis Provides data for pricing special orders by showing incremental cost of accepting one more order Avoids arbitrary allocation of common fixed costs to individual product lines LO LEARNING OBJECTIVE APPENDIX 22B: Explain issues involved in transferring goods between divisions in different countries Illustration: Alberta’s Boot Division is located in a country with a corporate tax rate of 10%, and the Sole Division is located in a country with a tax rate of 30% The following illustrates the after-tax contribution margin per unit under transfer prices of $18 and $11 Illustration 22B-1 22-71 LO LEARNING OBJECTIVE APPENDIX 8B: Explain issues involved in transferring goods between divisions in different countries Illustration 22B-1 The after-tax contribution margins differ because more of the contribution margin is attributed to the division in the country with the lower tax rate 22-72 LO Copyright “Copyright © 2015 John Wiley & Sons, Inc All rights reserved Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc The purchaser may make back-up copies for his/her own use only and not for distribution or resale The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.” 22-73 ... parts and materials and a material loading charge for related overhead Widely used in service industries, especially professional firms such as public accounting, law, and engineering 22- 26 LO... Time and Material Pricing Illustration: Assume the following data for Lake Holiday Marina, a boat and motor Illustration 22- 13 repair shop Total annual budgeted time and material costs 22- 27... disadvantage is that managers may set the price too low and fail to cover fixed costs 22- 21 LO Cost-Plus Pricing Question Cost-plus pricing means that: 22- 22 a Selling price = variable cost + (markup percentage