Managerial Accounting by James Jiambalvo Chapter 8: Pricing Decisions, Analyzing Customer Profitability, And Activity-Based Pricing Slides Prepared by: Scott Peterson Northern State University

Objectives Compute the profit maximizing price for a product or service. Perform incremental analysis related to pricing a special order. Explain the cost-plus approach to pricing and why it is inherently circular for manufacturing firms. Explain the target costing process for a new product.

Objectives (continued) Analyze customer profitability. Explain the activity-based pricing approach.

The Profit Maximizing Price Economic theory focuses on the “demand function.” Own-price elasticity: the higher the price, the lower the quantity demanded.

Pricing Special Orders Generally, products are not sold for less than full cost. In some cases it may be beneficial to charge a price less than full cost. Special order. Order will not affect demand for a firm’s other products (or current sales). Company may be better off charging a price below full cost.

Pricing Special Orders: Example, Model A Standard Unit Costs Direct Material: $30 Direct Labor: $15 Variable Overhead: $10 Fixed Overhead: $20 Total: $75 Should Quality Lens Company accept (or reject) a bid for 20,000 lenses for $73 each? It depends on whether there is “excess capacity.”

Cost-Plus Pricing Cost-Plus Pricing is simple, but limited. Ignores demand for product. Leads to circular pricing schemes for manufacturers. Ignores own-price elasticity.

Target Costing Target Costing Process: Specify features and price. Determine desired profit. Target cost = price – desired profit. Design to meet the target cost. Change price and/or features if product cannot be designed to meet target cost.

Analyzing Customer Profitability: Revisiting the Wholesale Office Supply Case Customer Profitability System (CPM). Indirect costs of servicing customers assigned to cost pools. Returns Shipments Using cost drivers, costs are assigned to customers Customer revenues – product costs - indirect costs (above) = customer profitability.

Activity-Based Pricing Activity-Based Pricing uses the same information as customer profitability. Also called menu-based pricing. Examples include: Charge for Internet order: $1.25 Charge for phone, fax or mail order: $4.75 Charge per order line item: $1.00 Delivery charge per mile: $0.40 Per pound packing charge: $0.50 Per item restocking fee: $1.00

Quick Review Question #1 To determine the profit-maximizing price a manager must: Estimate the quantity demanded for various prices. Estimate variable costs. Both (a) and (b). None of the above.

Quick Review Answer #1 To determine the profit-maximizing price a manager must: Estimate the quantity demanded for various prices. Estimate variable costs. Both (a) and (b). None of the above.

Quick Review Question #2 Cost-plus pricing: Leads to profit maximization. Is inherently circular for manufacturing firms. Is difficult to perform. None of the above are correct.

Quick Review Answer #2 Cost-plus pricing: Leads to profit maximization. Is inherently circular for manufacturing firms. Is difficult to perform. None of the above are correct.

Quick Review Question #3 Target costing: Requires specification of desired level of profit. Targets specific costs for reduction. Is used primarily with products that are already in production. Leads to profit maximization.

Quick Review Answer #3 Target costing: Requires specification of desired level of profit. Targets specific costs for reduction. Is used primarily with products that are already in production. Leads to profit maximization.

Quick Review Question #4 Customer profitability is measured as: Revenue – cost of goods sold. Revenue – indirect manufacturing costs. Revenue – cost of goods sold-indirect service costs. Revenue – cost of goods sold – indirect manufacturing costs.

Quick Review Answer #4 Customer profitability is measured as: Revenue – cost of goods sold. Revenue – indirect manufacturing costs. Revenue – cost of goods sold-indirect service costs. Revenue – cost of goods sold – indirect manufacturing costs.

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