Managerial Accounting: Chapter 8 Pricing Overview
Chapter 8 Pricing Summary
Learning Objectives
LO 1: Compute a target cost when the market determines a product price.
LO 2: Compute a target selling price using cost-plus pricing.
LO 3: Use time-and-material pricing to determine the cost of services provided.
LO 4: Determine a transfer price using negotiated, cost-based, and market-based approaches.
Target Costing (LO 1)
Definition: Target cost = Market Price - Desired Profit.
**Key Considerations: **
Market demand and price sensitivity influence pricing.
Companies must control costs to achieve targeted profits under competitive conditions.
Steps to establish target cost:
Identify market segment.
Conduct market research for product features and pricing.
Set desired profit to calculate target cost.
Cost-Plus Pricing (LO 2)
Definition: Method where price = Cost + Markup.
Process: Requires establishing a cost base and adding a desired profit margin.
Limitations: Does not always consider demand or market conditions adequately.
Time-and-Material Pricing (LO 3)
Definition: A pricing approach utilizing separate rates for labor and materials.
Commonly used in service sectors (e.g., repair, consulting).
Calculation Steps:
Calculate labor rate based on direct labor costs and overhead.
Determine material loading charges.
Combine labor and material charges for overall pricing.
Transfer Pricing (LO 4)
Definition: Price at which goods are sold between divisions of the same company.
Methods of pricing:
Negotiated: Divisions agree on transfer price.
Cost-based: Based on production costs.
Market-based: Based on market prices.
Pricing strategies must align with capacity considerations and the opportunity cost of internal selling.
Challenges: Tax implications and transfer price adjustments for divisions in different countries.
Absorption-Cost and Variable-Cost Pricing (LO *5)
Absorption-Cost Pricing: Includes all manufacturing costs (fixed and variable).
Variable-Cost Pricing: Considers only variable costs, useful for short-run decisions.
Both methods are designed to recover associated costs and achieve desired returns.
1.) A company must price its product to cover its costs and earn a reasonable profit.
2.) Prices are set by the competitive market when market demand and price sensitivity influence pricing decisions.
3.) Companies that sell products whose prices are set by market forces are called price takers.
4.) The calculation to determine target cost is: Target Cost = Market Price - Desired Profit.
5.) In cost-plus pricing, the costs used are comprised of direct costs plus overhead costs.
6.) For Sunland company producing a new lightweight radio:
Desired profit per unit = $2.20
Expected unit selling price = $24
Calculation: Total Target Cost = (Selling Price × Units) - (Desired Profit × Units)
Total Target Cost = ($24 × 11000) - ($2.20 × 11000) = $264,000 - $24,200 = $239,800.
7.) In cost-plus pricing, the target selling price is computed as Selling Price = Cost + Markup.
8.) The labor charge per hour in time-and-material pricing includes direct labor costs and overhead, but does not include profit margin.
9.) In time-and-material pricing, a material loading charge typically covers variability in material costs, but it does not cover direct labor charges.
10.) In time-and-material pricing, the charge for a particular job is the sum of the labor charge and the material charge.
11.) Labor data for Bramble Repair Shop for 2022 is required to calculate costs but is not provided here.
12.) The price used to record a sale between divisions within the same vertically integrated company is called the transfer price.
13.) The overall objective in the determination of a transfer price is to maximize profits both at the divisional level and for the company as a whole.
14.) The cost-plus pricing approach major advantage is that it provides a straightforward method to ensure costs are covered and profits are made.
15.) In the minimum transfer price formula, variable cost is defined as the variable cost of production per unit.