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a. Variable cost per unit $ 980

a. Variable cost per unit $ 980

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Chapter 8



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



0



400,000



0



1000



1,000,000



800



1800



50,000,000



1,000,000



1,000,000



50,000



2



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 8



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)



$



6

9

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)



$



4

7

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)

$ 7

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 8



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 ì 70%)

Variable cost

Contribution margin

Markup = $101,100 ữ $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

7

26

416

6

$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

2

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

0

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 8



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.



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