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ACC 801 Study Guide - Midterm Guide: Monopolistic Competition, Target Costing, Financial Statement


Department
Accounting
Course Code
ACC 801
Professor
George Gekas
Study Guide
Midterm

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Chapter 12: PRICING AND PROFITABILITY ANALYSIS
Price Elasticity of Demand
- It is measured as the percentage change in quantity divided by the percentage change in price
- A relative elastic demand exists if a small percent change in price will lead to a greater percent
change in quantity demanded
- The opposite is true for inelastic demand
Monopoly –There is only one firm in the market perhaps because there are barriers to entry and/or very
unique product.
Oligopoly – There are only few sellers fairly high barriers of entry and rather unique product
Perfect competition – There are many buyers and sellers, of which no one is large enough to influence the
market. Very low barriers to entry and the product is rather common
Monopolistic competition – It has both the characteristics of both monopoly and perfect competition some
barriers some uniqueness but differentiation
Approaches to pricing
1. Cost-based pricing= prices are established using ‘cost’ plus markup
2. Target pricing= prices are influenced by market conditions and set in advance
Target Costing
- Sets the cost of a product or service based on the price that customers are willing to pay
- If the cost-plus pricing turns out to be higher than what customers will accept, additional redesigning
re-work will result or the opportunity to produce within target cost is lost.
- Target Costing is more than cost based pricing as it also includes market considerations.
Cost plus Pricing (markup applied)
-Markup is a percentage applied to base cost; the mark up includes desired profit and any costs not
included in the base cost.
-
Markup formula on COGS=(Sellingadministrative expenses+Operating Income)
COGS
-
Markup formulaon DM =(Direct Labour +Overhead +Sellingadministrative expenses +Operating Income)
Direct Materials
Other Pricing Policies. The basic principle behind pricing is that competition is good and should be
encouraged.
-Penetration pricing: the pricing of a new product at a low initial price to build market share quickly
-Price skimming: a higher price is charged when a product or service is first introduced
-Predatory pricing: Prices are set below cost aiming to destroy/eliminate the competition
-Dumping: is predatory pricing on the international market.
-Price gouging: occurs when firms with great market power price products ‘too high’
The Legal System and Pricing
-Price discrimination: refers to the charging of different prices to different customers for essentially
the same product.
-The competition Act outlaws price discrimination. It allows discrimination under certain
circumstances:
If the competitive situation demands it
If costs can justify the lower price
Measuring Profit
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-Profit: a measure of the difference between what resources a firm puts into making and selling a
product or service and what it receives in exchange
- Profits are measured to:
1. Determine the viability of the firm
2. Measure profitability of the firm
3. Measure managerial performance
- Profits are used to inform interested third parties of the firm’s performance. Reporting profits may also
signal the market about the opportunities for others to enter the business and earn a profit
-Absorption Costing Approach
Also called full costing
It assigns all manufacturing costs, direct materials, direct labor, variable overhead and a share
of fixed overhead to each unit of product – thus, each unit of product absorbs some of the
fixed manufacturing overhead in addition to its variable manufacturing costs
Abs costing is required for external financial reporting
Absorption
Costing Income Statement
-Variable Costing Approach
Also called direct costing
Assigns only unit level variable manufacturing costs to the product- these costs include
direct materials, direct labor, variable overhead
Fixed overhead is treated as a period cost and is not inventoried with the other product costs
– it is expensed in the period incurred
Variable Costing Income Statement
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