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Eighth Edition
Chapter 8
Pricing
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Chapter Outline
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 the negotiated,
cost-based, and market-based approaches.
LEARNING OBJECTIVE 1
Compute a target cost when the market determines a
product price.
LO 1
Copyright ©2018 John Wiley & Sons, Inc. 3
Target Costing (1 of 4)
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.
LO 1 Copyright ©2018 John Wiley & Sons, Inc. 4
Target Costing (2 of 4)
Establishing a Target Cost
• 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.
LEARNING OBJECTIVE 2
Cost-Plus Pricing
• In an environment with little or no competition, a company
may have to set its own price.
• When a company sets price, the price is normally a function
of product cost: cost-plus pricing.
• Approach requires establishing a cost base and adding a
markup to determine a target selling price.
LO 2
Copyright ©2018 John Wiley & Sons, Inc. 11
Cost-Plus Pricing (1 of 8)
Selling Price − Cost = Markup (Profit)
• In determining the proper markup, a company must
consider competitive and market conditions.
• Size of the markup (the “plus”) depends on the desired
return on investment for the product:
ROI = net income ÷ invested assets
Cost + Markup = Target Selling Price
Per Unit
Direct materials $23
Direct labor 17
Variable manufacturing overhead 12
Variable selling and administrative expenses 8
$ 60 double ruled
Variable cost per unit $60
Think more's desired 20% ROI now results in a $80 ROI per
unit [(20% × $2,000,000) ÷ 5,000].
At 5,000 units, how much would Think more mark up its total unit costs
to earn a desired ROI of $80 per unit.
$80 (desired ROI per unit)
42.11%
$190 (total unit cost)
LO 2 Copyright ©2018 John Wiley & Sons, Inc. 19
Variable-Cost Pricing (1 of 8)
Alternative pricing approach:
Simply add a markup to variable costs.
• Avoids the problem of uncertain cost information related to
fixed-cost-per-unit computations.
• Helpful in pricing special orders or when excess capacity
exists.
Major disadvantage is that managers may set the price too
low and fail to cover fixed costs.
LEARNING OBJECTIVE 3
Use time-and-material pricing to determine the cost of
services provided.
Time-and-material pricing an approach in which the company uses two
pricing rates:
• One for labor used on a job - includes direct labor time and other
employee costs.
• One for material - includes cost of direct parts and materials and a
material loading charge for overhead.
LO 3
Copyright ©2018 John Wiley & Sons, Inc. 25
Time-and-Material Pricing
Illustration: Assume the following data for Lake Holiday
Marina, a boat and motor repair shop.
Job: Repair TV
Labor charges: 4 hours @ $32.50 $130
Material charges
Cost of parts and materials $50
Material loading charge (40% × $50) 20 70
Total price of labor and material $200
$ 200 double ruled
LEARNING OBJECTIVE 4
Determine a transfer price using the negotiated, cost-
based, and market-based approaches.
Vertically integrated companies
• Grow in either direction of its suppliers or its customers.
• Frequently transfer goods to other divisions as well as
outside customers.
LO 4
Copyright ©2018 John Wiley & Sons, Inc. 35
Transfer Prices (2 of 3)
How do you price goods “sold” within the company?
a. $10 c. $40
b. $30 d. $70
LO 4 Copyright ©2018 John Wiley & Sons, Inc. 51
Market-Based Transfer Prices (3 of 3)
Question
The Plastics Division of Weston Company manufactures plastic
molds and then sells them for $70 per unit. Its variable cost is $30
per unit, and its fixed cost per unit is $10. Management would like
the Plastics Division to transfer 10,000 of these molds to another
division within the company at a price of $40. The Plastics Division
is operating at full capacity. What is the minimum transfer price that
the Plastics Division should accept?
a. $10 c. $40
Solving, we find:
MP = ($40 + $38) ÷ $87 = 89.66%
Per Unit
Direct materials $23
Direct labor 17
Variable manufacturing overhead 12
Variable selling and administrative expense 8
$ 60 double ruled
Total unit variable cost $60
Solving, we find:
$40 ($35 $30)
MP 175%
$60
Using the $165 target price produces the desired 20% ROI
at a volume level of 10,000 units.