ACTG 2010 Chapter Notes - Chapter 3: Demand Curve, Inferior Good, Normal Good
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Cost-Based Pricing
Companies use various strategies to set price. Since cost is animportant determinant of supply and is known to the producer, manycompanies base price on cost. Still other companies use atarget-costing strategy, or strategies based on the initialconditions in the market.
A cost-based pricing approach starts with product cost and thendesired profit is added. Usually, there is some cost base and amarkup. The markup is a percentage applied to base cost; itincludes desired profit and any costs not included in the basecost. Companies that bid for jobs routinely base bid price oncost.
Example: Linder Company makes and sells vitaminsupplements. The following information from last year's accountingrecords showed:
| Cost of Goods Sold | $254,000 |
| Selling and administrativeexpense | 86,360 |
| Operating income | 111,760 |
The markup percentage must include all costs that are not a partof cost of goods sold plus the desired profit. For Linder Company,the markup on COGS is found as follows:
| Markup on COGS | = (Selling and administrativeexpenses + Operating income)/COGS |
| = ($86,360 + $111,760)/$254,000 =0.78 or 78% |
Now, if Linder Company produces a new product with manufacturingcost of $2 per unit, the unit price at this markup is:
| Price = $2 + (0.78 Ã $2) = $2.00 +$1.56 = $3.56 |
A Company does not have to use Cost of Goods Sold as the basisof the markup. For example, a job-order firm might decide to usethe markup on prime costs (direct materials and direct labor) tocost jobs. Suppose that Carl's Custom Cabinetry wants to price jobsbased on prime costs plus a markup on prime cost. Last year'sincome statement revealed the following information:
| Prime costs | $134,000 |
| Overhead | 73,700 |
| Selling and administrativeexpense | 38,860 |
| Operating income | 50,920 |
| Markup on Prime Cost | = (Overhead + Selling andadministrative expenses + Operating income)/Prime cost |
| = ($73,700 + $38,860 +$50,920)/$134,000 = 1.22 or 122% |
Carl is pricing a new job with estimated direct materials of$4,300 and direct labor of $1,800. The estimated price is:
| Price = ($4,300 + $1,800) + (1.22 Ã$6,100) = $6,100 + $7,442 = $13,542 |
Neither Linder Company nor Carl's Custom Cabinets must use theprice figured according to the markup. This is just a firstapproximation. Carl, for example, may want to set a lower price inhopes of getting more business from this particular customer.Linder Company may want to charge a higher price based on marketconsiderations.
Target Costing
Another approach to pricing a product or service is targetcosting. The target cost is based on the price (target price) thatcustomers are willing to pay. The Marketing Department determineswhat characteristics and price for a product are most acceptable toconsumers. Then, it is the job of the company's engineers to designand develop the product such that cost and profit can be covered bythat price. Japanese firms have been doing this for years; Americancompanies are beginning to use target costing. So first the targetprice is set. Then the desired profit is deducted, and theremaining amount is the target cost.
| Target cost = Target price -Desired profit |
Determining the target cost is relatively easy. Actuallydesigning and manufacturing a product that will achieve the targetcost and sell for the target price is more difficult. As a result,target costing is an iterative process as the firm works to refinethe proposed product to meet the cost and price targets.
Price Discrimination
Price discrimination refers to the charging of different pricesto different customers for essentially the same product. TheRobinson-Patman Act was passed in 1936 as a means of outlawingprice discrimination by manufacturers or suppliers; services andintangibles are not included under the act.
The Robinson-Patman Act does allow price discrimination undercertain specified conditions: (1) if the competitive situationdemands it and (2) if costs (including costs of manufacture, sale,or delivery) can justify the lower price. According to the secondcondition, a lower price offered to one customer must be justifiedby identifiable cost savings and the amount of the discount must beat least equaled by the amount of cost saved.
To compute a cost differential, the company creates classes ofcustomers based on the average costs of selling to those customers.Then all customers in each group are charged a cost-justifiableprice.
Example: Raul Company manufactures specializedelastic bandages used to reinforce athletes' wrists or ankles. Raulsells to a number of individual physical therapists and athletictrainers as well as to Medallion Gym, a national chain of physicalfitness facilities. The average manufacturing cost is $169 per case(a case contains 100 plastic-wrapped elastic bandages). RaulCompany sold 350,000 cases last year to the following two classesof customer.
| Price | Quantity | |
|---|---|---|
| Medallion Gym | $235 | 175,000 |
| Individual trainers and physicaltherapists | $241 | 175,000 |
Medallion Gym requires that the bandages be individuallypackaged in boxes with the Medallion name on the label. This boxand special labelling costs $0.34 per unit. Raul also pays allshipping costs, which amounted to $1,400,000 last year.
The individual trainers and physical therapists order in smalllots that require special picking and packing in the factory; thespecial handling adds $20 to the cost of each case sold. Salescommissions to the independent jobbers who sell Raul products tothe trainers and physical therapists average 10 percent of sales.Bad debts expense amounts to 1 percent of sales.
The cost per case for each customer category can be computed asfollows:
| Medallion Gym: | |
|---|---|
| Manufacturing cost per case | $169.00 |
| Box and special labelling ($0.34 Ã100) | 34.00 |
| Shipping ($1,400,000/175,000cases) | 8.00 |
| Total cost per case | $211.00 |
| Individual Trainers and PhysicalTherapists: | |
|---|---|
| Manufacturing cost per case | $169.00 |
| Special handling | 20.00 |
| Sales commission ($241 x 0.10) | 24.10 |
| Bad debts expense ($241 x0.01) | 2.41 |
| Total cost per case | $215.51 |
Profit and profit percentages are as follows:
| Medallion Gym | Trainers and Physical Therapists | |
|---|---|---|
| Price per case | $235.00 | $241.00 |
| Less: cost per case | 211.00 | 215.51 |
| Profit per case | $24.00 | $25.49 |
| Profit percentage | 10.21% | 10.58% |
The company will need to see if the profit percentages range areclose to one another; if so, there would be a cost justificationfor the price differential. If not, the company may need toconsider potential price discrimination and change its price forthe customer group that it considers to be "out of line."
For each of the following situations, determine whether or notthere is price discrimination according to the Robinson-PatmanAct.
| 1. | Dr. Jeffrey Lowman, M.D., chargesless to patients who he feels cannot afford his usual fee.- Selectyour answer -YesNoItem 1 |
| 2. | Damian Company manufacturesspecialty jams and jellies. Damian is located in Amarillo, Texas,and sells only to stores in the Amarillo area. Sometimes Damianoffers a price break to store owners whose children attend the sameschools as Damian's children. - Select your answer -YesNoItem2 |
| 3. | A national manufacturer of hairproducts charges a significantly lower price to large chain storesthan to smaller stores. The price differential is not supported bycost differences. - Select your answer -YesNo |
I KNOW THIS IS A LONG QUESTION BUT CAN SOMEONE PLEASE!! ANSWERTHE FULL QUESTION it is not due immediately
Genuine Spice Inc. began operations on January 1, 2016. Thecompany produces eight-ounce bottles of hand and body lotion calledEternal Beauty. The lotion is sold wholesale in 12-bottle cases for$100 per case. There is a selling commission of $20 per case. TheJanuary direct materials, direct labor, and factory overhead costsare as follows:
| DIRECT MATERIALS | ||||
| CostBehavior | Units perCase | Cost perUnit | Cost perCase | |
| Cream base | Variable | 100 ozs. | $0.02 | $2.00 |
| Natural oils | Variable | 30 ozs. | 0.30 | 9.00 |
| Bottle (8-oz.) | Variable | 12 bottles | 0.50 | 6.00 |
| $17.00 | ||||
| DIRECT LABOR | ||||
| Department | CostBehavior | Time perCase | Labor Rateper Hour | Cost perCase |
| Mixing | Variable | 20 min | $18.00 | $6.00 |
| Filling | Variable | 5 | 14.40 | 1.20 |
| 25 min. | $7.20 | |||
| FACTORYOVERHEAD | ||
| CostBehavior | Total Cost | |
| Utilities | Mixed | $600 |
| Facility lease | Fixed | 14,000 |
| Equipment depreciation | Fixed | 4,300 |
| Supplies | Fixed | 660 |
| $19,560 | ||
Part AâBreak-Even Analysis
The management of Genuine Spice Inc. wishes to determine thenumber of cases required to break even per month. The utilitiescost, which is part of factory overhead, is a mixed cost. Thefollowing information was gathered from the first six months ofoperation regarding this cost:
| 2016 | CaseProduction | Utility Total Cost |
|---|---|---|
| January | 500 | $600 |
| February | 800 | 660 |
| March | 1,200 | 740 |
| April | 1,100 | 720 |
| May | 950 | 690 |
| June | 1,025 | 705 |
| Required-Part A: | |
| 1. | Determine the fixed andvariable portion of the utility cost using the high-lowmethod. |
| 2. | Determine the contributionmargin per case. |
| 3. | Determine the fixed costs permonth, including the utility fixed cost from part (1). |
| 4. | Determine the break-even numberof cases per month. |
Part BâAugust Budgets
During July of the current year, the management of Genuine SpiceInc. asked the controller to prepare August manufacturing andincome statement budgets. Demand was expected to be 1,500 cases at$100 per case for August. Inventory planning information isprovided as follows:
Finished Goods Inventory:
| Cases | Cost | |
|---|---|---|
| Estimated finished goods inventory,August 1, 2016 | 300 | $12,000 |
| Desired finished goods inventory,August 31, 2016 | 175 | 7,000 |
Materials Inventory:
| CreamBase | Oils | Bottles | |
|---|---|---|---|
| (ozs.) | (ozs.) | (bottles) | |
| Estimated materials inventory,August 1, 2016 | 250 | 290 | 600 |
| Desired materials inventory, August31, 2016 | 1,000 | 360 | 240 |
There was negligible work in process inventory assumed foreither the beginning or end of the month; thus, none was assumed.In addition, there was no change in the cost per unit or estimatedunits per case operating data from January.
| Required-Part B: | |||
| 5. | Prepare the August productionbudget.* | ||
| 6. | Prepare the August directmaterials purchases budget.* | ||
| 7. | Prepare the August direct laborbudget. Round the hours required for production to the nearesthour.* | ||
| 8. | Prepare the August factoryoverhead budget. If an amount box does not require an entry, leaveit blank. (Entries of zero (0) will be cleared automatically byCNOW.)* | ||
| 9. | Prepare the August budgetedincome statement, including selling expenses. NOTE: Because you arenot required to prepare a cost of goods sold budget, the cost ofgoods sold calculations will be part of the budgeted incomestatement. *
|
Part CâAugust Variance Analysis
During September of the current year, the controller was askedto perform variance analyses for August. The January operating dataprovided the standard prices, rates, times, and quantities percase. There were 1,500 actual cases produced during August, whichwas 250 more cases than planned at the beginning of the month.Actual data for August were as follows:
Actual Direct Materials | ||
|---|---|---|
| Priceper Unit | Quantity per Case | |
| Cream base | $0.016per oz. | 102ozs. |
| Natural oils | $0.32per oz. | 31ozs. |
| Bottle (8-oz.) | $0.42per bottle | 12.5bottles |
| Actual Direct | Actual Direct Labor | |
|---|---|---|
| LaborRate | Timeper Case | |
| Mixing | $18.20 | 19.50min. |
| Filling | 14.00 | 5.60min. |
| Actual variable overhead | $305.00 |
| Normal volume | 1,600cases |
The prices of the materials were different than standard due tofluctuations in market prices. The standard quantity of materialsused per case was an ideal standard. The Mixing Department used ahigher grade labor classification during the month, thus causingthe actual labor rate to exceed standard. The Filling Departmentused a lower grade labor classification during the month, thuscausing the actual labor rate to be less than standard.
| Required-Part C: | |
| 10. | Determine and interpret thedirect materials price and quantity variances for the threematerials. |
| 11. | Determine and interpret thedirect labor rate and time variances for the two departments. Roundhours to the nearest hour. |
| 12. | Determine and interpret thefactory overhead controllable variance. |
| 13. | Determine and interpret thefactory overhead volume variance. |
Questions (Part A)
1. Determine the fixed and variable portion of the utility costusing the high-low method.
| AtHigh Point | AtLow Point | |
|---|---|---|
| Variable cost per unit | ||
| Total fixed cost | ||
| Total cost |
2. Determine the contribution margin per case.
3. Determine the fixed costs per month, including the utilityfixed cost from part (1).
1 | Total fixed costs: | |
2 | ||
3 | ||
4 | ||
5 | ||
6 |
4. Determine the break-even number of cases per month.cases
Production Budget
5. Prepare the August production budget. Enter all amounts aspositive numbers.
| Genuine Spice Inc. | |
| Production Budget | |
| For the Month Ended August 31, 2016 | |
| Cases | |
| Plus | |
| Total | |
| Less | |
Direct Materials Purchases Budget
6. Prepare the August direct materials purchases budget. Enterall amounts as positive numbers.
| Genuine Spice Inc. | ||||
| Direct Materials Purchases Budget | ||||
| For the Month Ended August 31, 2016 | ||||
| Cream Base (ozs.) | Natural Oils (ozs.) | Bottles (bottles) | Total | |
| Plus | ||||
| Less | ||||
| Total | ||||
| X | ||||
Direct Labor Budget
7. Prepare the August direct labor budget. Round the hoursrequired for production to the nearest hour. Enter all amounts aspositive numbers.
| Genuine Spice Inc. | |||
| Direct Labor Budget | |||
| For the Month Ended August 31, 2016 | |||
| Mixing | Filling | Total | |
| X | |||
Factory Overhead Budget
8. Prepare the August factory overhead budget. Enter all amountsas positive numbers. If an amount box does not require an entry,leave it blank. (Entries of zero (0) will be cleared automaticallyby CNOW.)
| Genuine Spice Inc. | |||
| Factory Overhead Budget | |||
| For the Month Ended August 31, 2016 | |||
| Fixed | Variable | Total | |
| Factory overhead: | |||
| Utilities | |||
| Facility lease | |||
| Equipment depreciation | |||
| Supplies | |||
| Total | |||
Budgeted Income Statement
9. Prepare the August budgeted income statement, includingselling expenses. Enter all amounts as positive numbers. NOTE:Because you are not required to prepare a cost of goods soldbudget, the cost of goods sold calculations will be part of thebudgeted income statement.
| Genuine Spice Inc. | |||
| Budgeted Income Statement | |||
| For the Month Ended August 31, 2016 | |||
| Sales | |||
| Finished goods inventory,August 1 | |||
| Direct materials inventory,August 1 | |||
| Direct materialspurchases | |||
| Less direct materialsinventory, August 31 | |||
| Cost of direct materials forproduction | |||
| Direct labor | |||
| Factory overhead | |||
| Less finished goods inventory,August 31 | |||
| Cost of goods sold | |||
| Gross profit | |||
| Selling expenses | |||
| Income before income tax | |||
Variance Analysis (Part C)
10. Determine and interpret the direct materials price andquantity variances for the three materials.
| Direct Materials Price Variance | ||||||
| CreamBase | NaturalOils | Bottles | ||||
| Difference | ||||||
| X | ||||||
| Direct materials pricevariance | ||||||
| Direct Materials Quantity Variance | ||||||
| CreamBase | NaturalOils | Bottles | ||||
| Difference | ||||||
| X | ||||||
| Direct materials quantityvariance | ||||||
The fluctuation in caused the direct material price variances.All the quantity variances were indicating .
11. Determine and interpret the direct labor rate and timevariances for the two departments. Round hours to the nearest tenthof an hour.
| Direct Labor Rate Variance | ||||
| MixingDepartment | FillingDepartment | |||
| Difference | ||||
| X | ||||
| Direct labor ratevariance | ||||
| Direct Labor Time Variance | ||||
| MixingDepartment | FillingDepartment | |||
| Difference | ||||
| X | ||||
| Direct labor timevariance | ||||
The change in the caused the labor rate variances. This changehave been responsible for the direct labor time variance.
12. Determine and interpret the factory overhead controllablevariance.
| Factory Overhead Controllable Variance | ||
| Factory overhead controllablevariance | ||
The factory overhead controllable variance was caused by thevariance in .
13. Determine and interpret the factory overhead volumevariance. Round rate to four decimal places.
| Factory Overhead Volume Variance | ||
| Normal volume (cases) | ||
| Actual volume (cases) | ||
| Difference | ||
| X | ||
| Factory overhead volumevariance | ||
The volume variance indicates the cost of .
