1. @ 2012, Cengage Learning Differential Analysis, Product Pricing, and Activity-Based Costing LO 2a – Determining the Selling Price of a Product Using the Product Cost Concept

2. Setting Normal Product Selling Prices  The basic approaches to setting prices are:  Market methods  Demand-based concept  Competition-based concept  Cost-plus methods  Total cost concept  Product cost concept  Variable cost concept LO 2

3.  The demand-based concept sets the price according to the demand for the product.  The competition-based concept sets the price according to the price offered by competitors. Setting Normal Product Selling Prices LO 2

4. Product Cost Concept  Under the product cost concept, only the costs of manufacturing the product, termed the product costs, are included in the cost amount per unit to which the markup is added. LO 2

5.  Step 1:Estimate the total product costs as follows: Product Cost Concept LO 2 Product costs: Direct materials$XXX Direct laborXXX Factory overhead XXX Total product cost$XXX

6.  Step 2: Estimate the total selling and administrative expenses. Product Cost Concept LO 2

7.  Step 3: Divide the total product cost by the number of units expected to be produced and sold to determine the total product cost per unit, as shown below. Product Cost Concept LO 2 Product Cost per unit = Total Product Cost Estimated Units Produced and Sold

8.  Step 4.Compute the markup percentage as follows: Product Cost Concept LO 2 Markup Percentage = Desired Profit + Total Selling and Administrative Expenses Total Product Cost

9.  Step 5.Determine the markup per unit by multiplying the markup percentage times the product cost per unit as follows: Product Cost Concept LO 2 Markup per Unit = Markup Percentage x Product Cost per Unit

10.  Step 6.Determine the normal selling price by adding the markup per unit to the product cost per unit as follows: Product Cost Concept LO 2 Total product cost per unit$XXX Markup per unit XXX Normal selling price per unit$XXX

11. Product Cost Concept LO 2 Manufacturing costs: Direct materials ($3.00 * 100,000)$ 300,000 Direct labor ($10.00 * 100,000)1,000,000 Factory overhead 200,000 Total Manufacturing costs$1,500,000 Selling and administrative expenses 170,000 Total cost$1,670,000 Total assets$800,000 Desired rate of return20% Assume the following data for 100,000 calculators that Digital Solutions Inc. expects to produce and sell during the current year:

12. Product Cost Concept LO 2  Step 1:Estimate the total product cost as follows: Product costs: Direct materials$ XXXXX Direct laborXXXXX Factory overhead XXX Total product cost$1,500,000

13.  Step 2: Estimate the total selling and administrative expenses. Product Cost Concept LO 2 Management expects total selling and administrative expenses to be $170,000.

14.  Step 3: Divide the total product cost by the number of units expected to be produced and sold to determine the total product cost per unit, as shown below. Product Cost Concept LO 2 Product Cost per Unit = Total Product Cost Estimated Units Produced and Sold Product Cost per Unit = $1,500,000 100,000 units = $15.00 per unit

15.  Step 4.Compute the markup percentage as follows: Product Cost Concept LO 2 Markup Percentage = Desired Profit + Total Selling and Administrative Expenses Total Product Cost Markup Percentage = $160,000 + $170,000 $1,500,000 Markup Percentage = $330,000 $1,500,000 = 22% Desired Rate of Return x Total Assets 0.20 x $800,000

16. Product Cost Concept LO 2  Step 5.Determine the markup per unit by multiplying the markup percentage times the product cost per unit as follows: Markup per Unit = Markup Percentage x Product Cost per Unit Markup per Unit = 22% x $15.00 = $3.30 per unit

17.  Step 6.Determine the normal selling price by adding the markup per unit to the product cost per unit as follows: LO 2 Total product cost per unit$15.00 Markup per unit 3.30 Normal selling price per unit$18.30 Product Cost Concept

18. LO 2 Manufacturing Cost Product Cost Markup Administrative Expense + Selling Expense + Desired Profit Desired Selling Price