CHAPTER Pricing Decisions, Analyzing Customer Profitability, and Activity-Based Pricing Summary of Questions by Objectives and Bloom’s Taxonomy Item SO BT Item True-False Statements 1 K C K 10 K 11 K 12 C 13 K 14 Multiple Choice Questions 32 K 52 33 K 53 34 K 54 35 K 55 36 K 56 37 AP 57 38 K 58 39 K 59 40 AP 60 41 AP 61 42 AP 62 43 AP 63 44 AP 64 45 AP 65 46 C 66 47 AP 67 48 AP 68 49 C 69 50 AP 70 51 AP 71 Matching 129 1, 3-6 K Exercises 130 AP 134 131 AP 135 132 AP 136 133 AP 137 Challenge Exercises 147 AN 148 Short-Answer Essays 150 C 151 SO BT Item SO BT Item SO BT 2 2 2 K K K K C C K 15 16 17 18 19 20 21 3 4 4 K K K K K K K 22 23 24 25 26 27 28 4 5 5 K K K K K C K 1 1 1 2 2 2 2 2 2 AP AP AP AP AP AP AP AP AP C C C C C C AP AP AP AP AP 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 2 2 2 3 3 3 3 3 3 AP AP AP AP AP AP K K AP C AP AP AP AP AP AP AP AN AP AP 92 93 94 95 96 97 98 99 100 101 102 103 104 105 106 107 108 109 110 111 3 3 3 4 4 4 4 4 4 4 2 3 AP AP AP AP 138 139 140 141 3 AP AN AN AP 142 143 144 145 5,6 AN 149 AP 3,4 C 152 C 153 Item SO BT 29 30 31 6 K K K AP AP AP AP AP AP K K C C AP AP AP AP AP AP AP AP AP AP 112 113 114 115 116 117 118 119 120 121 122 123 124 125 126 127 128 5 5 6 5 6 6 6 K K AP AP AP K C K AP AP AP AP AP AP AP AP AP 5,6 AP AP AP AP 146 5,6 AP C 8- Test Bank to accompany Jiambalvo Managerial Accounting 5th Edition TRUE-FALSE The most difficult part of determining the profit-maximizing price is determining the demand function Even though the same percentage markup may be applied to all customers, some customers may be more profitable than others Generally, the higher the price, the lower the quantity demanded The selling price that maximizes revenues is the price that will also maximize profit A demand function is the relation between price and quantity demanded Charging a higher price per unit causes an increase in profits for the company because the selling price is larger than the variable cost A company should never price a product below full cost Fixed costs will affect a special order decision when the selling company is at capacity A company cannot increase profits if it accepts a special order at a price below its incremental variable cost 10 In order for a special order to be accepted, the full cost of the product must be covered 11 When evaluating a special order, only costs that are incremental in nature should be a part of the analysis 12 A company should accept all orders for which a company has the capacity to produce 13 As long as fixed costs increase by less than the excess of incremental revenue over incremental cost, the acceptance of a special order will increase a company’s net income 14 The most difficult part of using cost-plus pricing is determining the demand function 15 Cost-plus pricing is circular for the manufacturing industry in that demand must be estimated to determine the fixed manufacturing costs per unit before the cost is marked up to obtain a selling price, which has a major impact on the quantity demanded 16 A company using cost-plus pricing starts with an estimate of the cost and adds a markup to arrive at a price that allows for a reasonable level of profit 17 Cost-plus pricing is the pricing method that begins with a careful analysis of competing products and customer needs and wants 18 Product cost can be easily adjusted after the design phase is complete as long as production has not begun 19 The target costing process begins with the design of the product Chapter Pricing Decisions 8-3 20 The first step in the target costing process is to estimate how much a product will cost to develop 21 Prices developed using target costing are based on competing products and customer needs and wants 22 Target costing establishes selling prices based on the full cost of the product 23 Target cost is computed by determining the appropriate selling price and then subtracting desired profit from it 24 In effect, a CPM system uses ABC to allocate costs to customers instead of to products and services 25 A customer’s profitability is calculated by dividing the sales revenue generated from each customer by the cost of goods sold for each customer 26 In a CPM system, costs are allocated to customers, who are the cost objectives 27 When order processing costs not vary based on the size of the order, a customer who makes large, infrequent orders is generally more profitable than a customer who makes small, more frequent orders, for the same quantity and price 28 Activity-based pricing is utilized when a customer buying products is charged for the full cost of a product or service plus a markup added to the cost 29 In activity-based pricing, customers are offered separate prices for separate items or services they choose in addition to the price of goods they purchase 30 Suppliers adopting activity-based pricing may encourage customers to limit the variety of goods they purchase to mitigate the price to be charged 31 Activity-based pricing uses ABC concepts to determine one optimum uniform price to charge all customers Answers: T T T F T F F 10 11 12 13 T T F F F T 14 15 16 17 18 19 F T T F F F 20 21 22 23 24 25 F T F T T F 26 27 28 29 30 31 T T F T T F 8- Test Bank to accompany Jiambalvo Managerial Accounting 5th Edition MULTIPLE CHOICE 32 Which one of the following does economic theory suggest? A Set a price that allows profit maximization B Set a price that allows the minimum number of units to be sold at the highest unit price C Set a price that will maximize revenues D Set a price that will maximize market share 33 Which of the following factors is considered in a product pricing decision made using cost-plus pricing? A Price customers are willing to pay B Selling and administrative costs C Competitors’ actions D Fixed cost per unit 34 What occurs to the quantity demanded as the price decreases? A It will increase B It will decrease C It will remain constant D It will increase and then decrease 35 Which of the following stays constant when the price per unit changes? A Demand B Contribution margin per unit C Total fixed costs D Profit 36 Which of the following statements about price, demand, and profit is generally true? A As price increases, demand decreases B As demand increases, profit decreases C As price increases, demand increases D As price decreases, demand decreases 37 Rosetone Retail sells one product with a variable cost of $3.50 per unit The demand at different prices to be charged is shown below: Units Demanded Unit Price 10,000 $9 15,000 $8 20,000 $7 25,000 $6 If fixed costs are $42,000, what price should Rosetone charge in order to maximize profits? A $9 B $8 C $7 D $6 Chapter Pricing Decisions 8-5 38 Which of the following statements about prices and profit is true? A Higher prices always lead to lower profits because fewer units will be sold B Higher prices always lead to lower demand and higher profits C Higher prices combine with lower demand to change the level of profits D Higher prices will be offset by lower demand so profits will stay constant 39 What should be maximized when setting the price for a product? A Total revenue B Contribution margin per unit C Net income D The number of units of product sold 40 Winslow Carpet produces and sells berber carpet by the yard with a variable cost of $16 per yard Total fixed costs are $280,000 The following chart represents the estimated demand at various price levels Yards Demanded 57,000 67,500 72,500 86,000 Unit Price $25 $24 $23 $21 Which price will generate the largest profit for Winslow Carpets? A $25 B $24 C $23 D $21 41 Wilkes Manufacturing sells one product with a variable unit cost of $18 The company knows that the price charged will affect demand Fixed costs are $275,000 If sales exceed 50,000 units, the company will need to lease additional manufacturing space and equipment at an additional cost of $100,000 per year The following chart represents the estimated demand at various price levels: Units Demanded 25,000 50,000 75,000 100,000 Unit Price $30 $28 $25 $23 Based on this information which of the following statements is true? A Selling the units at $23 will generate the largest profit B Selling the units at either $23 or $28 will generate a profit of $225,000 C Selling the units at either $25 or $28 will generate a profit of $225,000 D Selling the units at $28 will generate the largest profit 8- Test Bank to accompany Jiambalvo Managerial Accounting 5th Edition 42 Testor Paints sells varnish with a variable cost of $6.50 per gallon The company is unsure which price to charge in order to maximize profits The price charged will also affect the demand Gallons Demanded 20,000 30,000 40,000 50,000 Unit Price Per Gallon $11 $10 $9 $8 If fixed costs are $80,000 and the chart above represents the demand at various prices, what price should be charged in order to maximize profits? A $11 B $10 C $9 D $8 43 Dollar Deals sells a single product that has a unit variable cost of $9 per unit The company’s total fixed costs are $220,000 The company estimates demand at various activity levels as follows: Units Demanded 54,000 65,000 72,000 82,000 Unit Price $15 $14 $13 $12 What price should Dollar Deals charge to maximize profits? A $15 B $14 C $13 D $12 44 Calico Joe Fabrics sells a single product The company estimates total fixed costs at $360,000 with demand, price, and total variable costs as follows: Units Demanded 73,000 83,000 93,000 103,000 113,000 Unit Price $31 30 29 28 27 Total Variable Costs $1,606,000 1,826,000 2,046,000 2,266,000 2,486,000 What price should Calico Joe Fabrics charge to maximize profits? A $31 B $30 C $29 D $28 E $27 Chapter 45 Pricing Decisions 8-7 Calico Joe Fabrics sells a single product The company estimates total fixed costs at $360,000 with demand and unit variable costs at various activity levels as follows: Units Demanded 73,000 83,000 93,000 103,000 113,000 Unit Price $31 30 29 28 27 Total Variable Costs $1,606,000 1,826,000 2,046,000 2,266,000 2,486,000 How much profit will Calico Joe Fabrics have if a price of $26 is charged and demand is 120,000? A $120,000 B $3,120,000 C $480,000 D $2,760,000 46 Calico Joe Fabrics sells a single product The company estimates total fixed costs at $360,000 with demand and unit variable costs at various activity levels as follows: Units Demanded 73,000 83,000 93,000 103,000 113,000 Unit Price $31 30 29 28 27 Total Variable Costs $1,606,000 1,826,000 2,046,000 2,266,000 2,486,000 How would you best describe Calico’s variable cost per unit over the range shown? A It is constant B It is increasing as volume increases C It is decreasing as volume increases D There is not enough information provided to determine the answer 47 Palm Decor sells a single product that has variable costs of $12 per unit The company estimates the following demand at various unit prices: Units Demanded 31,000 37,000 44,000 56,000 60,000 Unit Price $19 18 17 16 15 What price should Palm Decor charge to maximize profits? A $19 B $18 C $17 D $16 8- Test Bank to accompany Jiambalvo Managerial Accounting 5th Edition 48 Right Air Supply sells a specialized air filter that has a variable cost of $10 each Fixed costs are estimated to be $700,000 across all levels of sales shown below: Units Demanded 80,000 90,000 100,000 110,000 120,000 Unit Price $35 $33 $31 $30 $28 What price should Right Air Supply charge to maximize profits? A $35 B $33 C $31 D $30 E $28 49 Right Air Supply sells a specialized air filter that has a variable cost of $10 each Fixed costs are estimated to be $700,000 across all levels of sales shown below: Units Demanded 80,000 90,000 100,000 110,000 120,000 Unit Price $35 $33 $31 $30 $28 What information given, if any, is not relevant to the price maximization decision? A The selling prices B The variable costs per unit C The quantities demanded D The total fixed costs 50 Right Air Supply sells a specialized air filter that has a variable cost of $10 each Fixed costs are estimated to be $700,000 across all levels of sales shown below: Units Demanded 80,000 90,000 100,000 110,000 120,000 Unit Price $35 $33 $31 $30 $28 What price should Right Air Supply charge to maximize revenues? A $35 B $33 C $31 D $28 Chapter 51 Pricing Decisions 8-9 Maker Sun Chairs is trying to determine the optimal price to charge for its galvanized deck chairs The company has total fixed costs of $120,000 and the deck chairs have a unit variable cost of $27.00 per unit Maker Sun Chairs has determined that the following relationships exist between price and demand: Unit Price $45 $44 $43 $42 Unit Demand 7,200 7,800 8,400 8,800 How much is the contribution margin at a price of $45? A $324,000 B $129,600 C $12,600 D $9,600 52 Maker Sun Chairs is trying to determine the optimal price to charge for its galvanized deck chairs The company has total fixed costs of $120,000 and the deck chairs have a unit variable cost of $27.00 per unit Maker Sun Chairs has determined that the following relationships exist between price and demand: Unit Price $45 $44 $43 $42 Unit Demand 7,200 7,800 8,400 8,800 What is the anticipated revenue at a price of $44? A $343,200 B $132,600 C $12,600 D $387,200 53 Maker Sun Chairs is trying to determine the optimal price to charge for its galvanized deck chairs The company has total fixed costs of $120,000 and the deck chairs have a unit variable cost of $27.00 per unit Maker Sun Chairs has determined that the following relationships exist between price and demand: Unit Price $45 $44 $43 $42 Unit Demand 7,200 7,800 8,400 8,800 What is the anticipated profit at a price of $43? A $134,400 B $14,400 C $194,400 D $361,200 8- 10 Test Bank to accompany Jiambalvo Managerial Accounting 5th Edition 54 Maker Sun Chairs is trying to determine the optimal price to charge for its galvanized deck chairs The company has total fixed costs of $120,000 and the deck chairs have a unit variable cost of $27.00 per unit Maker Sun Chairs has determined that the following relationships exist between price and demand: Unit Price $45 $44 $43 $42 Unit Demand 7,200 7,800 8,400 8,800 What is the anticipated profit at a price of $42? A $12,000 B $132,000 C $249,600 D $369,600 55 Maker Sun Chairs is trying to determine the optimal price to charge for its galvanized deck chairs The company has total fixed costs of $120,000 and the deck chairs have a unit variable cost of $27.00 per unit Maker Sun Chairs has determined that the following relationships exist between price and demand: Unit Price $45 $44 $43 $42 Unit Demand 7,200 7,800 8,400 8,800 What price should Maker Sun Chairs charge in order to maximize its profit? A $45 B $44 C $43 D $42 56 Tong Chin is the manager of an Asian restaurant She is considering four price levels for an allyou-can-eat buffet Her estimate of price and quantity demanded are: Buffet Meal Price $17.00 $16.00 $15.00 $14.00 Meals Demanded 3,200 3,700 4,000 4,400 Monthly operating costs include $16,400 of fixed costs and average variable costs of $9.40 per meal Which price will yield the largest monthly profit? A $17 B $16 C $15 D $14 8- 28 Test Bank to accompany Jiambalvo Managerial Accounting 5th Edition Answers 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 A D A C A C C C B D B B B A A D D D D B 52 53 54 55 56 57 58 59 60 61 62 63 64 65 66 67 68 69 70 71 A B A C B A A D C B B D C B D C B C A D 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 D D C B B C C C A B C A B A B C B A B C 92 93 94 95 96 97 98 99 100 101 102 103 104 105 106 107 108 109 110 111 C C A A B A A A A A A A C D C A B D B A 112 113 114 115 116 117 118 119 120 121 122 123 124 125 126 127 128 D A A A A B B A B C A C B A D B A Chapter Pricing Decisions 8-29 MATCHING 129 Match each of the following terms with the phrase that most closely describes it Activity-based pricing Customer profitability analysis Target costing Economic pricing Cost-plus pricing A A system that starts with what consumers are willing to pay for a product and tries to design a product at a cost that allows a reasonable profit B A way of using activity-based methods to assess which customers are covering the costs they are generating C A system that charges customers for the services they consume D A system that prices based on the laws of supply and demand E A system that sets prices based on costs Answer C B A D E 8- 30 Test Bank to accompany Jiambalvo Managerial Accounting 5th Edition EXERCISES 130 Suez Bakery produces and sells chocolate silk pies, each having a variable cost of $3.80 Total fixed costs are $34,000 Management estimates demand at various activity levels as follows: Units Demanded 6,000 7,200 8,000 8,900 10,100 a b Unit Price $10.20 9.40 8.50 8.00 7.50 Calculate the total contribution margin at each price level Which price maximizes profit? Answer a Quantity 6,000 7,200 8,000 8,900 10,100 b 131 Unit Price $10.20 9.40 8.50 8.00 7.50 Unit Variable Cost $3.80 3.80 3.80 3.80 3.80 Contribution Margin $38,400 40,320 37,600 37,380 37,370 $9.40 The editor of Times Daily is considering three alternative prices for his new monthly periodical His estimate of price and quantity demanded are: Price $7.99 $6.50 $4.75 Quantity Demanded 27,000 36,000 57,000 Monthly costs of producing and delivering the magazines include $100,000 of fixed costs and variable costs of $2.50 per issue Which price will yield the largest monthly profit? Answer Quantity 27,000 36,000 57,000 Unit Price $7.99 6.50 4.75 Unit Variable Cost $2.50 2.50 2.50 $7.99 will yield the largest monthly profit Contribution Margin $148,230 144,000 128,250 Fixed Costs $100,000 100,000 100,000 Profit $48,230 44,000 28,250 Chapter 132 Pricing Decisions 8-31 Kitchen Zone has come out with a new line of electric can openers that it plans to test market through a series of demonstrations at the local mall throughout the month of August If the demonstrations result in enough sales, the program will be expanded to other malls in the region The cost of the demonstrations is a flat fee of $2,400 to the mall owner/operator and a commission of 15% of revenue to the person giving the demonstrations Kitchen Zone’s fixed costs of producing the can opener are $3,200 per production run The company plans to wait for all orders to come in, and then it will produce exactly the number of units ordered (there will be no beginning or ending inventory) Variable production costs are $7 per can opener In addition, it will cost approximately $3.50 per set to ship each can opener to customers Based on experience with similar items, focus group responses, and survey information, estimates for unit amounts at estimated activity levels follow: a b Price Quantity $38 400 $52 360 $66 280 Calculate the expected profit for each price Which price maximizes company profit? Answer a Quantity 400 360 280 b 133 Unit Price $38.00 52.00 66.00 Unit Variable Cost $16.20 18.30 20.40 Contribution Margin $ 8,720 12,132 12,768 Fixed Costs $5,600 5,600 5,600 Profit $3,120 6,532 7,168 $66 maximizes company profit WDT, Inc is a large company that publishes ‘how-to’ books for small construction projects WDT is considering the purchase of a new binding machine to bind the books The variable cost of each book is estimated to be $7.40 Management has estimated demand at various prices as follows: Unit Price $16 15 13 11 Quantity 720 850 830 900 930 Calculate the profit-maximizing price for the “how-to” books Answer Quantity Unit Price 720 $16 850 15 830 13 900 11 930 Profit maximizing price = $15 Unit Variable Cost $7.40 7.40 7.40 7.40 7.40 Contribution Margin $6,192 6,460 4,648 3,240 1,488 8- 32 Test Bank to accompany Jiambalvo Managerial Accounting 5th Edition 134 Budget Enterprises is considering a special order from an overseas customer for 10,000 units at a price of $40.00 per unit The company’s product normally sells for $52.00 per unit and has variable manufacturing costs of $21.00 per unit and variable selling costs of $4.00 per unit Fixed manufacturing costs are $500,000 and fixed selling and administrative costs are $200,000 Budget Enterprises has the capacity to produce 100,000 units and is currently producing 80,000 If Budget accepts the order, it will incur legal and accounting fees of $7,000 in connection with the order, though variable selling costs will not be incurred on the special order and it will not affect any of its other operations a How much are the incremental revenues associated with the special order? b How much are the incremental costs associated with the special order? c How much additional profit or loss will be incurred if the order is accepted? Answer a $40.00 × 10,000 = $400,000 b $21.00 × 10,000 = $210,000 7,000 $217,000 c $400,000 – $217,000 = $183,000 profit 135 Canon Equipment produces a machete that it sells for $45 each The cost of producing 20,000 machetes in the prior year was: Direct material Direct labor Variable overhead Fixed overhead Total cost $220,000 100,000 140,000 120,000 $580,000 At the start of the current year, the company received an order for 2,000 machetes from a company in South America Management of Canon has mixed feelings about the order On the one hand, they welcome the order because they currently have excess capacity This is also the company’s first international order On the other hand, the company in South America is only willing to pay $37 for each machete What will be the effect on profit of accepting the order? Answer Accepting the order will result in $28,000 of incremental profit Incremental revenue ($37 × 2,000) Incremental costs: Direct material ($11 × 2,000) Direct labor ($5 × 2,000) Variable overhead ($7 × 2,000) Incremental profit $74,000 $22,000 10,000 14,000 46,000 $28,000 Chapter 136 1.4 × ($40 + ($500,000 ữ 50,000)) = $70.00 b 1.3 ì ($40 + ($500,000 ÷ 100,000) = $58.50 Mayfair Furniture is considering the production of an automatic reclining office chair that the company would price at a markup of 30% above full cost Management estimates that the variable cost of each chair will be $80 and total fixed costs per year will be $34,000 a Assuming sales of 800 chairs, what is the full cost of a chair? b Assume that the quantity demanded at the price calculated in part a is only 680 chairs What is the full cost of each chair and what is the anticipated selling price? Answer a Variable cost per unit Fixed costs per unit ($34,000 ÷ 800) Full cost per unit b 138 8-33 Janus Decor produces and sells stainless steel patio chairs Janus uses cost-plus pricing The chairs have a variable cost per unit of $40.00 Janus has annual fixed costs of $500,000 a If Janus can sell 50,000 chairs and has a markup of 40% of total cost, what price will Janus charge? b If Janus can sell 100,000 chairs and has a markup of 30% of total cost, what price will Janus charge? Answer: a 137 Pricing Decisions $ 80.00 42.50 $122.50 Variable cost per unit Fixed costs per unit ($34,000 ÷ 680) Full cost per unit $ 80.00 50.00 $130.00 Full cost per unit Markup of 30% Price $130.00 39.00 $169.00 A company believes it can sell 40,000 of its proposed new combo cell phone/garage door openers at a price of $250 each There will be annual fixed costs associated with developing, marketing, and manufacturing the gadget of $5,000,000 If the company desires to make a profit of 20% of selling price on the phone/opener, what is the target variable cost per unit? Answer Revenues ($250 × 40,000) Profit (0.20 × $10,000,000) Fixed costs Total variable cost Variable cost per phone/opener $10,000,000 (2,000,000) (5,000,000) $3,000,000 $75 8- 34 Test Bank to accompany Jiambalvo Managerial Accounting 5th Edition 139 The product design team of Steed Motors is in the process of designing a new 20” dirt bike The company estimates that variable costs will be $80 per unit and fixed costs will be $120,000 per year a Suppose the company wants to set its price equal to full cost plus 25% and it estimates that it can sell 4,000 units What price will the company set? b Suppose the company sets a price as in Part a, but the number of units demanded at that price turns out to be 3,000 Revise the price in light of the change in demand c Compare the two prices you calculated Why are the prices different? What is likely to happen to the quantity demanded if the company is forced to raise its price to the price calculated in part b? Answer a 140 Variable cost per unit Fixed cost per unit ($120,000 ÷ 4,000) Total Markup of 25% Price $ 80.00 30.00 110.00 27.50 $137.50 b Variable cost per unit Fixed cost per unit ($120,000 ÷ 3,000) Total Markup of 25% Price $ 80.00 40.00 120.00 30.00 $150.00 c The price in the second scenario is higher because the fixed costs are being spread over fewer units causing the fixed cost per unit to be higher As the full cost goes up, so does the markup and price However, if price goes up, demand is likely to fall, so the company will not sell as many units as previously estimated Sanders Oven Company is developing a “professional” model oven aimed at the home market The company estimates that variable costs will be $980 per oven and total fixed costs will be $840,000 per year a Suppose the company wants to set its price equal to full cost plus 40 percent The company estimates that it can sell 4,000 units What price will the company set? b What is the risk involved with setting the price based on an estimate of how many units will be sold? Answer a b Variable cost per unit Fixed cost per unit ($840,000 ÷ 4,000) Total Markup of 40% Price $ 980 210 1,190 476 $1,666 Price influences the quantity demanded, but the estimated quantity demanded is being used to determine the price Chapter 141 Pricing Decisions 8-35 A cross-functional team at Enrich, Inc is developing a new product using the target costing method Product features in comparison to competing products suggest a price of $1,500 per unit The company requires a profit of 30% of selling price How much is the target cost per unit? Answer $1,500 – (30% × $1,500) = $1,050 142 Savor Enterprises has determined the following costs for customers: Order processing (per order) Additional handling costs if order marked rush (per order) Customer service calls (per call) Relationship management costs (per customer per year) $ 8.00 10.00 14.00 3,500 In addition to these costs, product costs amount to 85 percent of sales In the prior year, the company had the following experience with Hanson Electronics, one of its customers: Sales Number of orders Percent of orders marked rush Calls to customer service $54,000 250 70% 160 Calculate the profitability of the Hanson Electronics account Answer Sales Expenses: Cost of goods sold (0.85 × $54,000) $45,900 Order processing (250 × $8.00) 2,000 Rush handling (0.7 × 250 × $10.00) 1,750 Customer service (160 × $14.00) 2,240 Relationship management costs 3,500 Profitability/(loss) on customer Hanson Electronics 143 $54,000 55,390 ($1,390) Randall Equipment uses activity-based pricing The pricing structure is to charge customers the direct cost of the products they order with a markup of 40% on direct costs plus the cost of the services that are provided The service costs are $8.00 per order, $2.00 for each product that is ordered, and $1.50 per pound for shipping Wilson, Inc made 10 orders for goods with a total direct cost of $4,000 Wilson ordered 50 different products that weighed a total of 560 lbs What is the total price paid by Wilson? Answer Direct cost Markup on direct cost Ordering cost (10 × $8) Picking costs (50 × $2) Shipping (560 × $1.50) Total price paid $4,000 1,600 80 100 840 $6,620 8- 36 Test Bank to accompany Jiambalvo Managerial Accounting 5th Edition 144 Moscovitz Produce developed the following information on indirect costs for assessing customer profitability Cost Pool Processing electronic orders Processing nonelectronic orders Annual Cost Cost Driver $1,000,000 Number of orders $2,000,000 Number of orders Picking orders $3,000,000 Packaging orders $1,500,000 Returns $3,000,000 Number of different products ordered Number of items ordered Number of returns Annual Driver Quantity Customer Acme Deli Boson Cafe 500,000 500 400,000 1000 1,000,000 800 1800 50,000,000 1,000,000 1,000,000 50,000 200 Acme Deli and Boson Cafe each generated revenues in the last year of $600,000 and had direct costs associated with their orders of $450,000 How much is the cost per unit of the cost driver in each of the cost pools? Answer Cost Pool Processing electronic orders Processing non-electronic orders Picking orders Packaging orders Returns Annual Cost $1,000,000 $2,000,000 $3,000,000 $1,500,000 $3,000,000 Annual Driver Quantity 500,000 400,000 1,000,000 50,000,000 50,000 Cost per Driver unit $2.00 per order $5.00 per order $3.00 per item $0.03 per item $60 per return Chapter 145 Pricing Decisions 8-37 Project Depot has determined the following costs for its customers using an activity-based costing system: Order processing (per order) Additional handling costs if order marked rush (per order) Customer service calls (per call) Relationship management costs (per customer per year) $ 14 3,500 In addition to these costs, product costs amount to 85 percent of sales In the prior year, the company had the following experience with one of its customers, Shannon Tools: Sales Number of orders Percent of orders marked rush Calls to customer service $54,000 250 70% 160 For the coming year, Project Depot has told Shannon Tools that it will be switched to an activitybased pricing system In addition to regular prices, Shannon Tools will be required to pay: Order processing (per order) Additional handling costs if order marked rush (per order) Customer service calls (per call) $8 10 18 Calculate the expected profitability of the Shannon Tools account for the coming year if activity is the same as in the prior year Answer Revenue Sales $54,000 Order processing fee (250 × $8) 2,000 Rush order fee (0.70 × 250 × $10) 1,750 Customer service fee (160 × $18) 2,880 Total revenue Expenses: Cost of goods sold (0.85 × $54,000) 45,900 Order processing (250 × $6.00) 1,500 Rush handling (0.70 × 250 × $9.00) 1,575 Customer service (160 × $14.00) 2,240 Relationship management costs 3,500 Profitability of Shannon Tools account $60,630 54,715 $ 5,915 8- 38 Test Bank to accompany Jiambalvo Managerial Accounting 5th Edition 146 APL Internet Services has analyzed its customer and order handling data for the past year and has determined the following costs: Order processing cost per order Customer tech support calls (per call) Additional costs if tech support is after hours Relationship management costs (per customer per year) $ 12 $950 In addition to these costs, product costs amount to 80% of sales In the prior year, APL had the following experience with Tapper Recreation, one of its customers: Sales Number of orders Calls to tech support Percent of tech support calls after hours $9,400 42 62 40% For the coming year, APL has told Tapper Recreation that it will be switched to an activity-based pricing system In addition to regular prices, Tapper will be required to pay: Order processing (per order) $ Customer tech support calls (per call) 15 Additional costs if a tech support call is after hours 28 Calculate the total revenue to be billed to Tapper Recreation if activity is the same as in the prior year Answer Sales Order processing fees ($7 × 42) Tech support calls ($15 × 62) After hours tech support calls ($28 × 40% × 62) Total revenue $ 9,400 294 930 694 $11,318 Chapter Pricing Decisions 8-39 CHALLENGE EXERCISES 147 Smythe Moving Company has estimated monthly sales of $255,000 It estimates $166,000 of total manufacturing costs with 25% of these costs fixed Its selling and distribution costs are estimated at a total of $42,000 with 30% of these costs fixed a b c How much is Smythe’s markup percentage on full cost to arrive at the target selling price? How much is Smythe’s markup percentage on variable costs to arrive at the target selling price? Which approach might a manager prefer and why? Answer a Sales Manufacturing costs $166,000 Selling and distribution 42,000 Full cost Profit Markup = $47,000 ÷ $208,000 = 22.60% $255,000 208,000 $ 47,000 b Sales Manufacturing variable costs ($166,000 × 75%) Selling and distribution ($42,000 × 70%) Variable cost Contribution margin Markup = $101,100 ÷ $153,900 = 65.69% c $255,000 $124,500 29,400 ` 153,900 $101,100 Managers will prefer the approach that allows them to generate the highest amount of profit In this case, both methods use the same selling price Only the basis on which the markup is calculated differs While the profit based on variable costs displays ‘profit’ at $101,100, fixed costs have not been deducted, so the profit only appears to be greater 8- 40 Test Bank to accompany Jiambalvo Managerial Accounting 5th Edition 148 Lawn Butler is a local operation that provides mowing services for 300 customers each month The company has analyzed the indirect costs associated with servicing its various customers in order to assess customer profitability Budgeted amounts for 2014 appear below: Cost Pool Cost Repairs made due to mowing damage Processing billings Travel costs to customer's home Return visits for inadequate services Cost Driver $18,200 4,180 57,750 24,000 Quantity Number of repairs Number of invoices sent Number of miles driven Hours incurred for return visits 350 880 105,000 800 The direct cost of each mowing is $24 Two customers are of concern to management, each of whom seem to be ‘high maintenance’ Data on these customers follows: S Wallace Number of mowings Number of repairs Number of invoices sent Number of miles driven Hours incurred for return visits Customer revenue Quantity 52 26 416 $2,220 H Willis Number of mowings Number of repairs Number of invoices sent Number of miles driven Hours incurred for return visits Customer revenue Quantity 24 12 620 15 $1,080 Discuss the profitability of each customer and recommend to management what action should be taken Answer Cost Pool Cost Driver Quantity $18,200 4,180 ÷ ÷ Travel costs to customer's home 57,750 ÷ Return visits for inadequate services 24,000 ÷ Repairs made due to mowing damage Processing billings S Wallace Revenue Cost of mowing ($24*52); ($24*24) Gross margin Other costs: Repairs made due to mowing damage Processing billings Travel costs to customer's home Return visits for inadequate services Total other costs ABC Customer profitability 350 880 105,00 800 Cost per Driver Unit $52.00 4.75 0.55 30.00 H Willis $2,220 1,248 972 $1,080 576 504 364 124 229 180 897 $ 75 104 57 341 450 952 ($ 448) While customer Wallace has generated only a small amount of profit, he is still contributing $75 of profit for the year Although he requests a number of repairs and requires numerous billings, the company is still earning a profit on his account Customer Willis’s location is apparently quite a distance away as seen by the number of miles driven in spite of fewer mowing He also has required several return visits for issues that may be considered ‘picky’ by some One option is to charge for return visits, but sales may be lost to competitors since customers often think they are entitled to ‘good’ service done right the first time The company may consider applying late fee charges for past due accounts, to cover the cost of additional billings In addition, a mileage fee may be charged for customers who live outside a designated area to offset the additional costs of Chapter 149 Pricing Decisions 8-41 traveling Lawn Butler should also consider training its employees to avoid situations that require repairs to be made, such as mowing sprinkler heads and damaging property with the mowers Southeast Pools uses cost-plus pricing with a 30% mark-up on total cost The company is currently building 320 pools per year with total variable cost of $5,760,000 In addition, the company incurs $720,000 in fixed costs annually and has a capacity to build 450 pools a How much will the company price each pool on average? b If demand falls to 250 pools and the company wants to continue to earn the same markup percentage on total cost as earned in part a., what price should the company charge per pool? c Identify two problems with cost-plus pricing Answer a Variable cost per pool Fixed cost per pool ($720,000 ÷ 320) Total Markup of 30% Price $18,000 2,250 20,250 6,075 $26,325 b Variable cost per pool Fixed cost per pool ($720,000 ÷ 250) Total Markup of 30% Price $18,000 2,880 20,880 6,264 $27,144 c One problem is choosing what markup percentage to use A second problem relates to a circular issue Demand must be estimated to determine the fixed manufacturing costs per unit in order to determine the price However, the price affects the quantity demanded, causing the number of units demanded to change SHORT-ANSWER ESSAYS 150 Explain why cost-plus pricing is “circular”? Answer Cost-plus pricing lets both the price and the quantity be selected without regard to market conditions When the price is set, the quantity demanded in the market will most likely not be the quantity used to set the price in the first place This means that a new price will have to be computed based on the actual quantity demanded at the old price But again, the new price will not likely result in the quantity used to set it being achieved 151 Explain the steps involved in target costing and contrast it to cost-plus pricing Answer Target costing starts with the price that consumers are willing to pay for a given quantity of a product with a set of features Then the company’s desired profit is subtracted to determine how much the cost can be It is then the task of the design team to assess if a product can be developed at that cost Cost-plus pricing takes the costs as a given, adds a markup and just assumes that the quantity used in setting the price can be sold at the price determined 8- 42 Test Bank to accompany Jiambalvo Managerial Accounting 5th Edition 152 What is activity-based pricing and why is it used? Answer Activity-based pricing charges customers not only for the goods they purchase, but also for the costs of servicing them It will encourage customers to minimize the use of expensive services, thus allowing the company to use fewer resources 153 What is CPM? For what purpose might managers use it? Answer CPM is customer profitability measurement It is a system that allocates the indirect costs of servicing customers to cost pools, and then assigns the costs to customers’ accounts using cost drivers Subtracting indirect and product costs from customer revenue, results in a measure of profitability Managers use this analysis to assess how profitable each customer is, and often decide to eliminate or change pricing for customers who consume excessive amounts of resources ... decrease by $2,950 B No, profit will decrease by $2,250 C Yes, profit will increase by $3,800 D Yes, profit will increase by $500 8- 14 Test Bank to accompany Jiambalvo Managerial Accounting 5th Edition... Selling the units at $28 will generate the largest profit 8- Test Bank to accompany Jiambalvo Managerial Accounting 5th Edition 42 Testor Paints sells varnish with a variable cost of $6.50 per... the total amount of additional cost paid by the customer? A $1,246 B $77.04 C $1,540 D $476 8- 26 Test Bank to accompany Jiambalvo Managerial Accounting 5th Edition 123 A company using activity-based