Solution manual cost accounting a managerial emphasis 13e by horngren ch12

To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com CHAPTER 12 PRICING DECISIONS AND COST MANAGEMENT 12-1 The three major influences on pricing decisions are Customers Competitors Costs 12-2 Not necessarily For a one-time-only special order, the relevant costs are only those costs that will change as a result of accepting the order In this case, full product costs will rarely be relevant It is more likely that full product costs will be relevant costs for long-run pricing decisions 12-3 Two examples of pricing decisions with a short-run focus: Pricing for a one-time-only special order with no long-term implications Adjusting product mix and volume in a competitive market 12-4 Activity-based costing helps managers in pricing decisions in two ways It gives managers more accurate product-cost information for making pricing decisions It helps managers to manage costs during value engineering by identifying the cost impact of eliminating, reducing, or changing various activities 12-5 Two alternative starting points for long-run pricing decisions are Market-based pricing, an important form of which is target pricing The market-based approach asks, “Given what our customers want and how our competitors will react to what we do, what price should we charge?” Cost-based pricing which asks, “What does it cost us to make this product and, hence, what price should we charge that will recoup our costs and achieve a target return on investment?” 12-6 A target cost per unit is the estimated long-run cost per unit of a product (or service) that, when sold at the target price, enables the company to achieve the targeted operating income per unit 12-7 Value engineering is a systematic evaluation of all aspects of the value-chain business functions, with the objective of reducing costs while satisfying customer needs Value engineering via improvement in product and process designs is a principal technique that companies use to achieve target costs per unit 12-8 A value-added cost is a cost that customers perceive as adding value, or utility, to a product or service Examples are costs of materials, direct labor, tools, and machinery A nonvalue-added cost is a cost that customers not perceive as adding value, or utility, to a product or service Examples of nonvalue-added costs are costs of rework, scrap, expediting, and breakdown maintenance 12-9 No It is important to distinguish between when costs are locked in and when costs are incurred, because it is difficult to alter or reduce costs that have already been locked in 12- To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 12-10 Cost-plus pricing is a pricing approach in which managers add a markup to cost in order to determine price 12-11 Cost-plus pricing methods vary depending on the bases used to calculate prices Examples are (a) variable manufacturing costs; (b) manufacturing function costs; (c) variable product costs; and (d) full product costs 12-12 Two examples where the difference in the costs of two products or services is much smaller than the differences in their prices follow: The difference in prices charged for a telephone call, hotel room, or car rental during busy versus slack periods is often much greater than the difference in costs to provide these services The difference in costs for an airplane seat sold to a passenger traveling on business or a passenger traveling for pleasure is roughly the same However, airline companies price discriminate They routinely charge business travelers––those who are likely to start and complete their travel during the same week excluding the weekend––a much higher price than pleasure travelers who generally stay at their destinations over at least one weekend 12-13 Life-cycle budgeting is an estimate of the revenues and costs attributable to each product from its initial R&D to its final customer servicing and support 12-14 in Three benefits of using a product life-cycle reporting format are: The full set of revenues and costs associated with each product becomes more visible Differences among products in the percentage of total costs committed at early stages the life cycle are highlighted Interrelationships among business function cost categories are highlighted 12-15 Predatory pricing occurs when a business deliberately prices below its costs in an effort to drive competitors out of the market and restrict supply, and then raises prices rather than enlarge demand Under U.S laws, dumping occurs when a non-U.S company sells a product in the United States at a price below the market value in the country where it is produced, and this lower price materially injures or threatens to materially injure an industry in the United States Collusive pricing occurs when companies in an industry conspire in their pricing and production decisions to achieve a price above the competitive price and so restrain trade 12- To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 12-16 (20–30 min.) Relevant-cost approach to pricing decisions, special order Relevant revenues, $4.00  1,000 Relevant costs Direct materials, $1.60  1,000 Direct manufacturing labor, $0.90  1,000 Variable manufacturing overhead, $0.70  1,000 Variable selling costs, 0.05  $4,000 Total relevant costs Increase in operating income $4,000 $1,600 900 700 200 3,400 $ 600 This calculation assumes that: a The monthly fixed manufacturing overhead of $150,000 and $65,000 of monthly fixed marketing costs will be unchanged by acceptance of the 1,000 unit order b The price charged and the volumes sold to other customers are not affected by the special order Chapter 12 uses the phrase “one-time-only special order” to describe this special case The president’s reasoning is defective on at least two counts: a The inclusion of irrelevant costs––assuming the monthly fixed manufacturing overhead of $150,000 will be unchanged; it is irrelevant to the decision b The exclusion of relevant costs––variable selling costs (5% of the selling price) are excluded Key issues are: a Will the existing customer base demand price reductions? If this 1,000-tape order is not independent of other sales, cutting the price from $5.00 to $4.00 can have a large negative effect on total revenues b Is the 1,000-tape order a one-time-only order, or is there the possibility of sales in subsequent months? The fact that the customer is not in Dill Company’s “normal marketing channels” does not necessarily mean it is a one-time-only order Indeed, the sale could well open a new marketing channel Dill Company should be reluctant to consider only short-run variable costs for pricing long-run business 12- To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 12-17 (20–30 min.) Relevant-cost approach to short-run pricing decisions Analysis of special order: Sales, 3,000 units  $75 Variable costs: Direct materials, 3,000 units  $35 Direct manufacturing labor, 3,000 units  $10 Variable manufacturing overhead, 3,000 units  $6 Other variable costs, 3,000 units  $5 Sales commission Total variable costs Contribution margin $225,000 $105,000 30,000 18,000 15,000 8,000 176,000 $ 49,000 Note that the variable costs, except for commissions, are affected by production volume, not sales dollars If the special order is accepted, operating income would be $1,000,000 + $49,000 = $1,049,000 Whether McMahon’s decision to quote full price is correct depends on many factors He is incorrect if the capacity would otherwise be idle and if his objective is to increase operating income in the short run If the offer is rejected, San Carlos, in effect, is willing to invest $49,000 in immediate gains forgone (an opportunity cost) to preserve the long-run selling-price structure McMahon is correct if he thinks future competition or future price concessions to customers will hurt San Carlos’s operating income by more than $49,000 There is also the possibility that Abrams could become a long-term customer In this case, is a price that covers only short-run variable costs adequate? Would Holtz be willing to accept a $8,000 sales commission (as distinguished from her regular $33,750 = 15%  $225,000) for every Abrams order of this size if Abrams becomes a long-term customer? 12- To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 12-18 (15-20 min.) Short-run pricing, capacity constraints Per kilogram of hard cheese: Milk (10 liters  $1.50 per liter) Direct manufacturing labor Variable manufacturing overhead Fixed manufacturing cost allocated Total manufacturing cost $15 $29 If Vermont Hills can get all the Holstein milk it needs, and has sufficient production capacity, then, the minimum price per kilo it should charge for the hard cheese is the variable cost per kilo = $15+5+3 = $23 per kilo If milk is in short supply, then each kilo of hard cheese displaces 2.5 kilos of soft cheese (10 liters of milk per kilo of hard cheese versus liters of milk per kilo of soft cheese) Then, for the hard cheese, the minimum price Vermont should charge is the variable cost per kilo of hard cheese plus the contribution margin from 2.5 kilos of soft cheese, or, $23 + (2.5  $8 per kilo) = $43 per kilo That is, if milk is in short supply, Vermont should not agree to produce any hard cheese unless the buyer is willing to pay at least $43 per kilo 12-19 (25–30 min.) Value-added, nonvalue-added costs costs Category Value-added costs Nonvalue-added costs Gray area Examples a Materials and labor for regular repairs b Rework costs c Expediting costs caused by work delays g Breakdown maintenance of equipment Total d Materials handling costs e Materials procurement and inspection costs f Preventive maintenance of equipment Total $ 800,000 $ 75,000 60,000 55,000 $190,000 $ 50,000 35,000 15,000 $100,000 Classifications of value-added, nonvalue-added, and gray area costs are often not clear-cut Other classifications of some of the cost categories are also plausible For example, some students may include materials handling, materials procurement, and inspection costs and preventive maintenance as value-added costs (costs that customers perceive as adding value and as being necessary for good repair service) rather than as in the gray area Preventive maintenance, for instance, might be regarded as value-added because it helps prevent nonvalueadding breakdown maintenance 12- To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Total costs in the gray area are $100,000 Of this, we assume 65%, or $65,000, are value-added and 35%, or $35,000, are nonvalue-added Total value-added costs: $800,000 + $65,000 $ 865,000 Total nonvalue-added costs: $190,000 + $35,000 225,000 Total costs $1,090,000 Nonvalue-added costs are $225,000 ÷ $1,090,000 = 20.64% of total costs Value-added costs are $865,000 ÷ $1,090,000 = 79.36% of total costs Program (a) Quality improvement programs to • reduce rework costs by 75% (0.75  $75,000) • reduce expediting costs by 75% (0.75  $60,000) • reduce materials and labor costs by 5% (0.05  $800,000) Total effect (b) Working with suppliers to • reduce materials procurement and inspection costs by 20% (0.20  $35,000) • reduce materials handling costs by 25% (0.25  $50,000) Total effect Transferring 65% of gray area costs (0.65  $19,500 = $12,675) as value-added and 35% (0.35  $19,500 = $6,825) as nonvalue-added Effect on value-added and nonvalue-added costs (c) Maintenance programs to • increase preventive maintenance costs by 50% (0.50  $15,000) • decrease breakdown maintenance costs by 40% (0.40  $55,000) Total effect Transferring 65% of gray area costs (0.65  $7,500 = $4,875) as value-added and 35% (0.35  $7,500 = $2,625) as nonvalue-added Effect on value-added and nonvalue-added costs Total effect of all programs Value-added and nonvalue-added costs calculated in requirement Expected value-added and nonvalue-added costs as a result of implementing these programs Effect on Costs Classified as ValueNonvalueGray Added Added Area –$56,250 – 45,000 –$ 40,000 –$ 40,000 –$101,250 –$7,000 –12,500 –19,500 –$ 12,675 –$ 12,675 – $ 6,825 – $6,825 + 19,500 $ +$7,500 – $22,000 – 22,000 +$ 4,875 +$ 4,875 – $ 47,800 + 2,625 – $19,375 –$127,450 865,000 225,000 $817,200 $ 97,550 + $7,500 – 7,500 $ If these programs are implemented in 2007, total costs would decrease from $1,090,000 (requirement 2) to $817,200 + $97,550 = $914,750, and the percentage of nonvalue-added costs would decrease from 20.64% (requirement 2) to $97,550 ÷ 914,750 = 10.66% These are significant improvements in Marino’s performance 12- To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 12-20 (2530 min.) Target operating income, value-added costs, service company The classification of total costs in 2009 into value-added, nonvalue-added, or in the gray area in between follows: Value Gray NonvalueTotal Added Area added (4) = (1) (2) (3) (1)+(2)+(3) Doing calculations and preparing drawings 75% × $400,000 $300,000 $300,000 Checking calculations and drawings 4% × $400,000 $16,000 16,000 Correcting errors found in drawings 7% × $400,000 $28,000 28,000 Making changes in response to client requests 6% × $400,000 24,000 24,000 Correcting errors to meet government building code, 8% × $400,000 32,000 32,000 Total professional labor costs 324,000 16,000 60,000 400,000 Administrative and support costs at 40% ($160,000 ÷ $400,000) of professional labor costs 129,600 6,400 24,000 160,000 Travel 18,000 — 18,000 Total $471,600 $22,400 $84,000 $578,000 Doing calculations and responding to client requests for changes are value-added costs because customers perceive these costs as necessary for the service of preparing architectural drawings Costs incurred on correcting errors in drawings and making changes because they were inconsistent with building codes are nonvalue-added costs Customers not perceive these costs as necessary and would be unwilling to pay for them Carasco should seek to eliminate these costs by making sure that all associates are well-informed regarding building code requirements and by training associates to improve the quality of their drawings Checking calculations and drawings is in the gray area (some, but not all, checking may be needed) There is room for disagreement on these classifications For example, checking calculations may be regarded as value added Reduction in professional labor-hours by a Correcting errors in drawings (7% × 8,000) b Correcting errors to conform to building code (8% × 8,000) Total Cost savings in professional labor costs (1,200 hours × $50) Cost savings in variable administrative and support costs (40% × $60,000) Total cost savings Current operating income in 2009 Add cost savings from eliminating errors Operating income in 2009 if errors eliminated 12- 560 hours 640 hours 1,200 hours $ 60,000 24,000 $ 84,000 $102,000 84,000 $186,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Currently 85% × 8,000 hours = 6,800 hours are billed to clients generating revenues of $680,000 The remaining 15% of professional labor-hours (15% × 8,000 = 1,200 hours) is lost in making corrections Carasco bills clients at the rate of $680,000 ÷ 6,800 = $100 per professional labor-hour If the 1,200 professional labor-hours currently not being billed to clients were billed to clients, Carasco’s revenues would increase by 1,200 hours × $100 = $120,000 from $680,000 to $800,000 Costs remain unchanged Professional labor costs Administrative and support (40% × $400,000) Travel Total costs Carasco’s operating income would be Revenues Total costs Operating income 12- $400,000 160,000 18,000 $578,000 $800,000 578,000 $222,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 12-21 (25–30 min.) Target prices, target costs, activity-based costing Snappy’s operating income in 2008 is as follows: Revenues ($4  250,000) Purchase cost of tiles ($3  250,000) Ordering costs ($50  500) Receiving and storage ($30  4,000) Shipping ($40  1,500) Total costs Operating income Total for 250,000 Tiles (1) $1,000,000 750,000 25,000 120,000 60,000 955,000 $ 45,000 Per Unit (2) = (1) ÷ 250,000 $4.00 3.00 0.10 0.48 0.24 3.82 $0.18 Price to retailers in 2009 is 95% of 2008 price = 0.95  $4 = $3.80; cost per tile in 2009 is 96% of 2008 cost = 0.96  $3 = $2.88 Snappy’s operating income in 2009 is as follows: Revenues ($3.80  250,000) Purchase cost of tiles ($2.88  250,000) Ordering costs ($50  500) Receiving and storage ($30  4,000) Shipping ($40  1,500) Total costs Operating income Total for 250,000 Tiles (1) $ 950,000 720,000 25,000 120,000 60,000 925,000 $ 25,000 Per Unit (2) = (1) ÷ 250,000 $3.80 2.88 0.10 0.48 0.24 3.70 $0.10 Snappy’s operating income in 2009, if it makes changes in ordering and material handling, will be as follows: Total for 250,000 Tiles Per Unit (1) (2) = (1) ÷ 250,000 $950,000 $3.80 Revenues ($3.80  250,000) 720,000 2.88 Purchase cost of tiles ($2.88  250,000) 5,000 0.02 Ordering costs ($25  200) 87,500 0.35 Receiving and storage ($28  3,125) 60,000 0.24 Shipping ($40  1,500) 872,500 3.49 Total costs $ 77,500 $0.31 Operating income Through better cost management, Snappy will be able to achieve its target operating income of $0.30 per tile despite the fact that its revenue per tile has decreased by $0.20 ($4.00 – $3.80), while its purchase cost per tile has decreased by only $0.12 ($3.00 – $2.88) 12- To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 12-22 (20 min.) Target costs, effect of product-design changes on product costs costs and Manufacturing costs of HJ6 in 2008 and 2009 are as follows: 2008 Total (1) Direct materials, $1,200 × 3,500; $1,100 × 4,000 $4,200,000 Batch-level costs, $8,000 × 70; $7,500 × 80 560,000 Manuf operations costs, $55 × 21,000; $50 × 22,000 1,155,000 Engineering change costs, $12,000 × 14; $10,000 × 10 168,000 Total $6,083,000 Per Unit (2) = (1) ÷ 3,500 $1,200 160 2009 Per Unit Total (4) = (3) (3) ÷ 4,000 $4,400,000 $1,100 600,000 150 330 1,100,000 275 48 $1,738 100,000 $6,200,000 25 $1,550 Target manufacturing cost Manufacturing cost per unit of HJ6 in 2009 = per unit in 2008 × 90% = $1,738 × 0.90 = $1,564.20 Actual manufacturing cost per unit of HJ6 in 2009 was $1,550 Hence, Medical Instruments did achieve its target manufacturing cost per unit of $1,564.20 To reduce the manufacturing cost per unit in 2009, Medical Instruments reduced the cost per unit in each of the four cost categories—direct materials costs, batch-level costs, manufacturing operations costs, and engineering change costs It also reduced machine-hours and number of engineering changes made—the quantities of the cost drivers In 2008, Medical Instruments used machine-hours per unit of HJ6 (21,000 machine-hours 3,500 units) In 2009, Medical Instruments used 5.5 machine-hours per unit of HJ6 (22,000 machine-hours  4,000 units) Medical Instruments reduced engineering changes from 14 in 2008 to 10 in 2009 Medical Instruments achieved these gains through value engineering activities that retained only those product features that customers wanted while eliminating nonvalue-added activities and costs 12- To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 12-23 (20 min.) Cost-plus target return on investment pricing Target operating income = target return on investment  invested capital Target operating income (25% of $1,000,000) $250,000 Total fixed costs 358,000 Target contribution margin $608,000 Target contribution per room-night, ($608,000 ÷ 16,000) Add variable costs per room-night Price to be charged per room-night Proof Total room revenues ($42  16,000 room-nights) Total costs: Variable costs ($4  16,000) Fixed costs Total costs Operating income $38 $42 $672,000 $ 64,000 358,000 422,000 $250,000 The full cost of a room = variable cost per room + fixed cost per room The full cost of a room = $4 + ($358,000 ÷ 16,000) = $4 + $22.375 = $26.375 Markup per room = Rental price per room – Full cost of a room = $42 – $26.375 = $15.625 Markup percentage as a fraction of full cost = $15.625 ÷ $26.375 = 59.24% If price is reduced by 10%, the number of rooms Beck could rent would increase by 10% The new price per room would be 90% of $42 $37.80 The number of rooms Beck expects to rent is 110% of 16,000 17,600 The contribution margin per room would be $37.80 – $4 $33.80 Contribution margin ($33.80 17,600) $594,880 Because the contribution margin of $594,880 at the reduced price of $37.80 is less than the contribution margin of $608,000 at a price of $42, Beck should not reduce the price of the rooms Note that the fixed costs of $358,000 will be the same under the $42 and the $37.80 price alternatives and hence, are irrelevant to the analysis 12- To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 12-24 (2025 min.) Cost-plus, target pricing, working backwards Investment Return on investment Operating income (20%  $2,400,000) Operating income per unit of RF17 ($480,000  20,000) Full cost per unit of RF17 Selling price ($300 + $24) Markup percentage on full cost ($24  $300) $2,400,000 20% $480,000 $24 $300 $324 8% With a 50% markup on variable costs, Selling price of RF17 = Variable cost per unit of RF17  1.50, so: Variable costs per unit of RF17 = Selling price of RF17 $324 = = $216 1.50 1.50 Fixed cost per unit = $300 – $216 = Total fixed costs = $84 per unit  20,000 units = At a price of $348, sales = 20,000 units  0.90 Revenues ($348  18,000) Variable costs ($216  18,000) Contribution margin ($132  18,000) Fixed costs Operating income $84 $1,680,000 18,000 $6,264,000 3,888,000 2,376,000 1,680,000 $ 696,000 If Waterbuy increases the selling price of RF17 to $348, its operating income will be $696,000 This would be more than the $480,000 operating income Waterbury earns by selling 20,000 units at a price of $324, so, if its forecast is accurate, and based on financial considerations alone, Waterbury should increase the selling price to $348 Target investment in 2009 Target return on investment Target operating income in 2009, 20%  $2,100,000 $2,100,000 20% $420,000 Anticipated revenues in 2009, $315  20,000 Less target operating income in 2009 Target full costs in 2009 Less: total target fixed costs Total target variable costs in 2009 $6,300,000 420,000 5,880,000 1,680,000 $4,200,000 Target variable cost per unit in 2009, $4,200,000  20,000 = $210 12- To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 12-25 Life-cycle product costing Variable cost per unit = Production cost per unit + Mktg and distribn cost per unit = $50 + $10 = $60 Total fixed costs over life of Yew = $6,590,000  $1, 450,000  $19,560,000  5, 242,000  $2, 900,000 = $35,742,000 Fixed costs $35,742,000  BEP in units = = 714,840 units Selling price  Variable cost per unit $110  $60 2a Revenues ($110  1,500,000 units) Variable costs ($60  1,500,000 units) Fixed costs Operating income $165,000,000 90,000,000 35,742,000 $ 39,258,000 Revenues Year ($240  100,000 units) Years & ($110  1,200,000 units) Total revenues Variable costs ($60  1,300,000 units) Fixed costs Operating income $ 24,000,000 132,000,000 156,000,000 78,000,000 35,742,000 $ 42,258,000 2b Over the product’s life-cycle, Option B results in an overall higher operating income of $3,000,000 Before selecting its pricing strategy, Intentical managers should evaluate whether the same pricing policy will be adopted globally Different markets may need different pricing For example, special taxes on imports may mean higher prices in foreign markets Intentical’s pricing strategy must be sensitive to changing customer preferences and reactions of competitors 12- To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 12-26 (30 min.) Relevant-cost approach to pricing decisions Revenues (1,000 crates at $100 per crate) Variable costs: Manufacturing Marketing Total variable costs Contribution margin Fixed costs: Manufacturing Marketing Total fixed costs Operating income $100,000 $40,000 14,000 54,000 46,000 $20,000 16,000 36,000 $ 10,000 Normal markup percentage: $46,000 ÷ $54,000 = 85.19% of total variable costs Only the manufacturing-cost category is relevant to considering this special order; no additional marketing costs will be incurred The relevant manufacturing costs for the 200-crate special order are: Variable manufacturing cost per unit $40  200 crates Special packaging Relevant manufacturing costs $ 8,000 2,000 $10,000 Any price above $50 per crate ($10,000 ÷ 200) will make a positive contribution to operating income Therefore, based on financial considerations, Stardom should accept the 200-crate special order at $55 per crate that will generate revenues of $11,000 ($55  200) and relevant (incremental) costs of $10,000 The reasoning based on a comparison of $55 per crate price with the $60 per crate absorption cost ignores monthly cost-volume-profit relationships The $60 per crate absorption cost includes a $20 per crate cost component that is irrelevant to the special order The relevant range for the fixed manufacturing costs is from 500 to 1,500 crates per month; the special order will increase production from 1,000 to 1,200 crates per month Furthermore, the special order requires no incremental marketing costs If the new customer is likely to remain in business, Stardom should consider whether a strictly short-run focus is appropriate For example, what is the likelihood of demand from other customers increasing over time? If Stardom accepts the 200-crate special offer for more than one month, it may preclude accepting other customers at prices exceeding $55 per crate Moreover, the existing customers may learn about Stardom’s willingness to set a price based on variable cost plus a small contribution margin The longer the time frame over which Stardom keeps selling 200 crates of canned peaches at $55 a crate, the more likely it is that existing customers will approach Stardom for their own special price reductions If the new customer wants the contract to extend over a longer time period, Stardom should negotiate a higher price 12- To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 12-27 (25–30 min.) Target rate of return on investment, activity-based costing Operating Income Statement, April 2009 Revenues (12,000 disks  $22 per disk) Materials (12,000 disks  $15 per disk) Gross margin Ordering (40 vendors  $250 per vendor) Cataloging (20 new titles  $100 per title) Delivery and support (400 deliveries  $15 per delivery) Billing and collection (300 customers  $50 per customer) Operating Income Rate of return on investment ($51,000  $300,000 ) $264,000 180,000 84,000 10,000 2,000 6,000 15,000 $ 51,000 17.00% The table below shows that if the selling price of game disks falls to $18 and the cost of each disk falls to $12, monthly gross margin falls to $72,000 (from $84,000 in April), and this results in a return on investment of 13%, which is below EA’s target rate of return on investment of 15% EA will have to cut costs to earn its target rate of return on investment Operating Income Statement, May 2009 Revenues (12,000 disks  $18 per disk) Materials (12,000 disks  $12 per disk) Gross margin Ordering (40 vendors  $250 per vendor) Cataloging (20 new titles  $100 per title) Delivery and support (400 deliveries  $15 per delivery) Billing and collection (300 customers  $50 per customer) Operating Income Rate of return on investment ($39,000  $300,000 ) $216,000 144,000 72,000 10,000 2,000 6,000 15,000 $ 39,000 13.00% After EA’s workforce has implemented process improvements, its monthly support costs are $31,500, as shown below Monthly support costs after process improvements, May 2009 Ordering (30 vendors  $200 per vendor) $ 6,000 Cataloging (15 new titles  $100 per title) 1,500 Delivery and support (450 deliveries  $20 per delivery) 9,000 Billing and collection (300 customers  $50 per customer) 15,000 Total monthly support costs $31,500 EA now earns $6 ($18 – $12) gross margin per disk Suppose it needs to sell X game disks to earn at least its 15% target rate of return on investment of $300,000 Then X needs to be such that: $6 X – $31,500 >= $300,000  15% = $45,000 $6 X >= $76,500 X >= $76,500  $6 = 12,750 game disks i.e., EA must now sell at least 12,750 game disks per month to earn its target rate of return on investment of 15% 12- To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 12-28 (25 min.) Cost-plus, target pricing, working backward backward In the following table, work backwards from operating income to calculate the selling price Selling price $ 9.45 (plug) Less: Variable cost per unit 2.50 Unit contribution margin $ 6.95 Number of units produced and sold ×500,000 units Contribution margin $3,475,000 Less: Fixed costs 3,250,000 Operating income $ 225,000 a) Total sales revenue = $9.45  500,000 units = $4,725,000 b) Selling price = $9.45 (from above) Alternatively, Operating income $ 225,000 Add fixed costs 3,250,000 Contribution margin 3,475,000 Add variable costs ($2.50 × 500,000 units) 1,250,000 Sales revenue $4,725,000 Sales revenue $4,725,000 Selling price =   $9.45 Units sold 500,000 Operating income $225,000 c) Rate of return on investment =  = 9% Total investment in assets 2,500,000 d) Markup % on full cost Total cost = ($2.50  500,000 units) + $3,250,000 = $4,500,000 $4,500,000 Unit cost = = $9 500,000 units $9.45  $9 Markup % = = 5% $9 $4,725,000  $4,500,000 Or = 5% $4,500,000 New fixed costs New variable costs New total costs New total sales (5% markup) New selling price Alternatively, New unit cost New selling price = $3,250,000 ─ $250,000 = $3,000,000 = $2.50 ─ $0.50 = $2 = ($2  500,000 units) + $3,000,000 = $4,000,000 = $4,000,000  1.05 = $4,200,000 = $4,200,000 ÷ 500,000 units = $8.40 = $4,000,000 ÷ 500,000 units = $8 = $8  1.05 = $8.40 New units sold = $500,000 × 90% = $450,000 units Budgeted Operating Income For the year ending December 31, 20xx Revenues ($8.40  450,000 units) Variable costs ($2.00  450,000 units) Contribution margin Fixed costs Operating income (loss) 12- $3,780,000 900,000 2,880,000 3,000,000 $ (120,000) To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 12-29 (40–45 min.) Target prices, target costs, value engineering, cost incurrence, lockedin cost, activity-based costing Old CE100 Direct materials costs $182,000 Direct manufacturing labor costs 28,000 Machining costs 31,500 Testing costs 35,000 Rework costs 14,000 Ordering costs 3,360 Engineering costs 21,140 Total manufacturing costs $315,000 Cost Change $2.20  7,000 = $15,400 less $0.50  7,000 = $3,500 less Unchanged because capacity same (20%  2.5  7,000) $2 = $7,000 (See Note 1) (See Note 2) Unchanged because capacity same New CE100 $166,600 24,500 31,500 28,000 5,600 2,100 21,140 $279,440 Note 1: 10% of old CE100s are reworked That is, 700 (10% of 7,000) CE100s made are reworked Rework costs = $20 per unit reworked  700 = $14,000 If rework falls to 4% of New CE100s manufactured, 280 (4% of 7,000) New CE100s manufactured will require rework Rework costs = $20 per unit  280 = $5,600 Note : Ordering costs for New CE100 = orders/month  50 components  $21/order = $2,100 Unit manufacturing costs of New CE100 = $279,440 ÷ 7,000 = $39.92 Total manufacturing cost reductions based on new design = $315,000 – $279,440 = $35,560 Reduction in unit manufacturing costs based on new design = $35,560 ÷ 7,000 = $5.08 per unit The reduction in unit manufacturing costs based on the new design can also be calculated as Unit cost of old design, $45 ($315,000 ÷ 7,000 units) – Unit cost of new design, $39.92 = $5.08 Therefore, the target cost reduction of $6 per unit is not achieved by the redesign Changes in design have a considerably larger impact on costs per unit relative to improvements in manufacturing efficiency ($5.08 versus $1.50) One explanation is that many costs are locked in once the design of the radio-cassette is completed Improvements in manufacturing efficiency cannot reduce many of these costs Design choices can influence many direct and overhead cost categories, for example, by reducing direct materials requirements, by reducing defects requiring rework, and by designing in fewer components that translate into fewer orders placed and lower ordering costs 12- To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 12-30 (25 min.) Cost-plus, target return on investment pricing Target operating income = Return on capital in dollars = $13,000,000  10% = $1,300,000 Revenues* Variable costs [($3.50 + $1.50)  500,000 cases Contribution margin Fixed costs ($1,000,000 + $700,000 + $500,000) Operating income (from requirement 1) * solve backwards for revenues $6,000,000 2,500,000 3,500,000 2,200,000 $1,300,000 $6,000,000  $12 per case 500,000 cases Markup % on full cost Full cost = $2,500,000 + $2,200,000 = $4,700,000 Unit cost = $4,700,000 ÷ 500,000 cases = $9.40 per case $12 - $9.40 Markup % on full cost =  27.66% $9.40 Selling price = Budgeted Operating Income For the year ending December 31, 20xx Revenues ($14  475,000 cases*) $6,650,000 Variable costs ($5  475,000 cases) 2,375,000 Contribution margin 4,275,000 Fixed costs 2,200,000 Operating income $2,075,000 * New units = 500,000 cases  95% = 475,000 cases Return on investment = $2,075,000  15.96% $13,000,000 Yes, increasing the selling price is a good idea because operating income increases without increasing invested capital, which results in a higher return on investment The new return on investment exceeds the 10% target return on investment 12- To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 12-31 (20 min.) Cost-plus, time and materials The different markup rates used by Mazzoli for direct materials and direct labor may represent the approximate overheads (plus a profit margin) associated with each: for example, direct materials would incur ordering and handling overhead, and direct labor would incur overheads such as benefits, insurance, etc., and these may be approximately 50% and 100% of costs These markups could also be driven by industry practice and competitive factors As shown in the table below, Bariess will tell White that she will have to pay $270 get the clutch plate repaired and $390 to get it replaced COST Repair option (3.5 hrs  $30 per hr.; $40) Replace option(1.5 hrs  $30 per hr.; $200) Labor Materials Total Cost $105 $ 40 $145 45 200 245 PRICE (100% markup on labor cost; 50% markup on materials) Repair option ($105  2; $40  1.5) Replace option ($45  2; $200  1.5) Labor Materials $210 $ 60 90 300 Total Price $270 390 If the repair and replace options are equally safe and effective, White will choose to get the clutch plate repaired for $270 (rather than spend $390 on a replacement plate) Mazzoli Brothers will earn a greater contribution toward overhead in the replace option ($145 = $390 – $245) than in the repair option ($125 = $270 – $145) If we assume that Mazzoli Brothers earns a constant profit margin on each job, it will earn a larger profit by replacing the clutch plate on Johanna White’s car for $390 than by repairing it for $270 Therefore, Bariess will recommend the replace option to White, which is not the one she would prefer Recognizing this conflict, Bariess may even present only the replace option to Johanna White, or suggest that the repair option will result in a less-than-safe car Of course, he runs the risk of White walking away and thinking of other options (at which point, he could present the repair option as a compromise) The problem is that Bariess has superior information about the repairs needed but his incentives may cause him to not reveal his information and instead use it to his advantage It is only the seller’s desire to build a reputation, to have a long-term relationship with the customer, and to have the customer recommend the seller to other potential buyers of the service that encourages an honest discussion of the options 12- To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 12-32 (25 min.) Cost-plus and market-based pricing California Temps’ full cost per hour of supplying contract labor is Variable costs Fixed costs ($240,000 ÷ 80,000 hours) Full cost per hour $12 $15 Price per hour at full cost plus 20% = $15  1.20 = $18 per hour Contribution margins for different prices and demand realizations are as follows: Price per Hour (1) $16 17 18 19 20 Variable Cost per Hour (2) $12 12 12 12 12 Contribution Margin per Hour (3) = (1) – (2) $4 Demand in Hours (4) 120,000 100,000 80,000 70,000 60,000 Total Contribution (5) = (3) × (4) $480,000 500,000 480,000 490,000 480,000 Fixed costs will remain the same regardless of the demand realizations Fixed costs are, therefore, irrelevant since they not differ among the alternatives The table above indicates that California Temps can maximize contribution margin ($500,000) and operating income by charging a price of $17 per hour The cost-plus approach to pricing in requirement does not explicitly consider the effect of prices on demand The approach in requirement models the interaction between price and demand and determines the optimal level of profitability using concepts of relevant costs The two different approaches lead to two different prices in requirements and As the chapter describes, pricing decisions should consider both demand or market considerations and supply or cost factors The approach in requirement is the more balanced approach In most cases, of course, managers use the cost-plus method of requirement as only a starting point They then modify the cost-plus price on the basis of market considerations—anticipated customer reaction to alternative price levels and the prices charged by competitors for similar products 12- To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 12-33 Cost-plus and market-based pricing Single rate = $1, 262, 460  $11.91 per testing hour 106,000 testing hours Billing rate = $11.91  1.45 = $17.27 Labor and supervision = $ 491,840 = $4.64 per test-hour 106,000 test-hours Setup and facility costs = Utilities = $402,620 = $503.275 per setup hour 800 setup hours $368,000 = $36.80 per MH 10,000 MH Labor and supervision (60%, 40%) Setup and facility cost (25%, 75%) Utilities (50%, 50%) Total cost Number of testing hours (TH)1 Cost per testing hour Markup Billing rate per testing hour 1106,000 HTT $295,104 100,655 184,000 $579,759 ÷63,600 TH $ 9.12 per TH ×1.45 $ 13.22 per TH ACT $196,736 301,965 184,000 $682,701 ÷42,400 TH $ 16.10 per TH ×1.45 $ 23.35 per TH Total $ 491,840 402,620 368,000 $1,262,460 testing hours  60% = 63,600 TH; 106,000 testing hours  40% = 42,400 TH The billing rates based on the activity-based cost structure make more sense These billing rates reflect the ways the testing procedures consume the firm’s resources To stay competitive, Best Test needs to be more efficient in arctic testing Roughly 44% of 301,965 arctic testing’s total cost (  44% ) occurs in setups and facility costs Perhaps the setup 682,701 activity can be redesigned to achieve cost savings 12- To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 12-34 (25–30 min.) Life-cycle costing Projected Life Cycle Income Statement Revenues [$500  (16,000 + 4,800)] Variable costs: Production [$225  (16,000 + 4,800)] Distribution [($20  16,000) + ($22  4,800)] Contribution margin Fixed costs: Design costs Production ($9,000  48 mos.) Marketing [($3,000  32 mos.) + ($1,000  16 mos.)] Distribution [($2,000  32 mos.) + ($1,000  16 mos.)] Life cycle operating income Average profit per desk = $10,400,000 4,680,000 425,600 5,294,400 700,000 432,000 112,000 80,000 $ 3,970,400 $3,970, 400  $190.88 (16,000  4,800) Projected Life Cycle Income Statement Revenues ($400  16,000) Variable costs: Production ($225  16,000) Distribution ($20  16,000) Contribution margin Fixed costs: Design costs Production ($9,000  32 mos.) Marketing ($3,000  32 mos.) Distribution ($2,000  32 mos.) Life cycle operating income $6,400,000 3,600,000 320,000 2,480,000 700,000 288,000 96,000 64,000 $1,332,000 The new desk design is still profitable even if FFM drops the product after only 32 months of $1,332,000 production However, the operating income per unit falls to only $83.25   per desk 16,000 desks Life cycle operating income (requirement 2) $1,332,000 Additional fixed production costs ($9,000  16 mos.) 144,000 Revised life cycle operating income $1,188,000 No, the answer does not change even if FFM continues to incur the fixed production costs for the full 48 months The revised operating income for the new executive desk becomes $1,188,000, $1,188,000 which translates into $74.25 ( ) operating income per desk 16,000 desks 12- To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 12-35 (30 min.) Airline pricing, considerations other than cost in pricing pricing If the fare is $500, a Air Americo would expect to have 200 business and 100 pleasure travelers b Variable costs per passenger would be $80 c Contribution margin per passenger = $500 – $80 = $420 If the fare is $2,000, a Air Americo would expect to have 190 business and 20 pleasure travelers b Variable costs per passenger would be $180 c Contribution margin per passenger = $2,000 – $180 = $1,820 Contribution margin from business travelers at prices of $500 and $2,000, respectively, follow: At a price of $500: $420 × 200 passengers At a price of $2,000: $1,820 × 190 passengers = $ 84,000 = $345,800 Air Americo would maximize contribution margin and operating income by charging business travelers a fare of $2,000 Contribution margin from pleasure travelers at prices of $500 and $2,000, respectively, follow: At a price of $500: $420 × 100 passengers At a price of $2,000: $1,820 × 20 passengers = $42,000 = $36,400 Air Americo would maximize contribution margin and operating income by charging pleasure travelers a fare of $500 Air Americo would maximize contribution margin and operating income by a price differentiation strategy, where business travelers are charged $2,000 and pleasure travelers $500 In deciding between the alternative prices, all other costs such as fuel costs, allocated annual lease costs, allocated ground services costs, and allocated flight crew salaries are irrelevant Why? Because these costs will not change whatever price Air Americo chooses to charge The elasticity of demand of the two classes of passengers drives the different demands of the travelers Business travelers are relatively price insensitive because they must get to their destination during the week (exclusive of weekends) and their fares are paid by their companies A 300% increase in fares from $500 to $2,000 will deter only 5% of the business passengers from flying with Air Americo In contrast, a similar fare increase will lead to an 80% drop in pleasure travelers who are paying for their own travels, unlike business travelers, and who may have alternative vacation plans they could pursue instead Since business travelers often want to return within the same week, while pleasure travelers often stay over weekends, a requirement that a Saturday night stay is needed to qualify for the $500 discount fare would discriminate between the passenger categories This price discrimination is legal because airlines are service companies rather than manufacturing companies and because these practices not, nor are they intended to, destroy competition 12- To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 12-36 (25 min.) Ethics and pricing Baker prices at full product costs plus a mark-up of 10% = $80,000 + 10% of $80,000 = $80,000 + $8,000 = $88,000 The incremental costs of the order are as follows: Direct materials $40,000 Direct manufacturing labor 10,000 30% of overhead costs (30% × $30,000) 9,000 Incremental costs $59,000 Any bid above $59,000 will generate a positive contribution margin for Baker Baker may prefer to use full product costs because it regards the new ball-bearings order as a long-term business relationship rather than a special order For long-run pricing decisions, managers prefer to use full product costs because it indicates the bare minimum costs they need to recover to continue in business rather than shut down For a business to be profitable in the long run, it needs to recover both its variable and its fixed product costs Using only variable costs may tempt the manager to engage in excessive long-run price cutting as long as prices give a positive contribution margin Using full product costs for pricing thereby prompts price stability Not using full product costs (including an allocation of fixed overhead) to price the order, particularly if it is in direct contradiction of company policy, may be unethical In assessing the situation, the specific “Standards of Ethical Conduct for Management Accountants,” described in Chapter (p 16), that the management accountant should consider are listed below Competence Clear reports using relevant and reliable information should be prepared Reports prepared on the basis of excluding certain fixed costs that should be included would violate the management accountant’s responsibility for competence It is unethical for Lazarus to suggest that Decker change the cost numbers that were prepared for the bearings order and for Decker to change the numbers in order to make Lazarus’s performance look good Integrity The management accountant has a responsibility to avoid actual or apparent conflicts of interest and advise all appropriate parties of any potential conflict Lazarus’s motivation for wanting Decker to reduce costs was precisely to earn a larger bonus This action could be viewed as violating the standard for integrity The Standards of Ethical Conduct require the management accountant to communicate favorable as well as unfavorable information In this regard, both Lazarus’s and Decker’s behavior (if Decker agrees to reduce the cost of the order) could be viewed as unethical Credibility The Standards of Ethical Conduct for Management Accountants require that information should be fairly and objectively communicated and that all relevant information should be disclosed From a management accountant’s standpoint, reducing fixed overhead costs in deciding on the price to bid are clearly violating both of these precepts For the reasons cited above, the behavior described by Lazarus and Decker (if he goes along with Lazarus’s wishes) is unethical Decker should indicate to Lazarus that the costs were correctly computed and that determining prices on the basis of full product costs plus a mark-up of 10% are required by company policy If Lazarus still insists on making the changes and reducing the costs of the order, Decker should raise the matter with Lazarus’s superior If, after taking all these steps, there is continued pressure to understate the costs, Decker should consider resigning from the company, rather than engaging in unethical behavior 12- To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 12-37 (30 min.) Target prices, target costs, value engineering Direct materials Direct manufacturing labor ($15 per hr  0.5 hr.) $14  25,000 hrs ) Engineering ( 50,000 units Testing ($12 per hr  0.25 hr.) Full cost per unit of TX40 Markup % = $14.98 7.50 7.00 3.00 $32.48 $40.60  $32.48 = 25% $32.48 These new units will require direct costs and testing, but no additional engineering since there will be no incremental R&D and design costs to produce 10,000 more units Incremental revenues Direct costs ($14.98 + $7.50) Testing costs Contribution margin Increase in units sold Increased contribution margin Less : Advertising costs Operating income (loss) $40.60 22.48 3.00 $15.12 ×10,000 units $151,200 (200,000) $ (48,800) No, the increase in units sold are insufficient to cover the extra advertising costs and incremental costs of production Avery will incur an operating loss on these extra units and should not pursue this strategy Direct costs ($22.48  60,000 units) Engineering ($14  25,000 hrs.) Testing ($3  60,000 units) Advertising Full cost of TX40 Divide by number of units Full cost per unit of TX40 Markup New selling price $1,348,800 350,000 180,000 200,000 $2,078,800 ữ60,000 units $34.65 ì1.25 $43.31 12-25 ... Nonvalue-added costs Gray area Examples a Materials and labor for regular repairs b Rework costs c Expediting costs caused by work delays g Breakdown maintenance of equipment Total d Materials handling costs... income, value-added costs, service company The classification of total costs in 2009 into value-added, nonvalue-added, or in the gray area in between follows: Value Gray NonvalueTotal Added Area added... nonvalue-added, and gray area costs are often not clear-cut Other classifications of some of the cost categories are also plausible For example, some students may include materials handling, materials