Management Accounting – Setting Prices

cco Management Accounting Tutorial 5 15-3. List and briefly describe 4 major baffles on determine decisions Customer Demand the demands of customers are of paramount importance in completely phases of business operations, from the excogitation of a relieve oneself to the eagernessting of its harm. Product-design issues and get dressed considerations are interrelated, so they must(prenominal)(prenominal) be examined simultaneously. For example, for a higher(prenominal)(prenominal) quality crossway you select higher quality materials which will affect a higher equal and needs more time and this will mavin to a higher set on a harvest-feast.Also, a manager must not value its crossing out of the grocery price range. Actions of Competitors companies must keep an eye on its competitors. If its competitor reduces its determine on a product, they might confound to follow suit to avoid losing its market share. However, hotshot must not follow the actions of its co mpetitors blindly as a guild has to predict competitive reactions to its product-design and set strategy. The company must withal be careful to properly define its product, such(prenominal) that if they increase the price of the product will the consumers continue purchasing the product? equals some prices are determined almost entirely by market forces. Industries such as agriculture where most products are market-driven. To make a profit, farmers must produce at a equal below the market price. This is very furious as it is not always possible to produce at a price lower than the market price and this will inevitably lead to losses for the farmers. In other industries, prices are set by adding a markup to proceeds follows so managers do have some analogue in find out the markup. Therefore, both market forces and cost considerations heavily influence prices.No organization or industry foundation price its products below their production costs indefinitely. And no companys worry can set prices blindly at a cost plus a markup without retentivity an eye on the market. policy-making, Legal and image-related issues managers must adhere to certain police forces. The law generally prohibits companies from discriminating among their customers in scenery prices. It is also forbidden in collusion in price setting surrounded by major sign of the zodiacs. Political considerations also can be relevant.For example, if the debaucheds in an industry are comprehend by the public as reaping unfairly large profits, there whitethorn be political pressure on legislators to tax those profits differentially or to intervene in some way to regulate prices Companies also consider their public image in the price-setting process. A firm with a reputation for very high quality products may set the price of a new product high to be consistent with its image. 15-11. frame the general formula for indeterminate determine, and briefly explain its use. Price = Cost + (Marku p % * Cost) 15-12. List the 4 common cost bases used in cost-plus pricing.How can they all final result in the same price? versatile manufacturing cost + (Markup % * Variable manufacturing cost) Absorption manufacturing cost + (Markup % * Absorption manufacturing cost) Total cost + (Markup % * Total cost) Total variable star cost + (Markup % * Total variable cost) some(prenominal) different definitions of cost, each combined with a different markup percentage can result in the same price for a product or service. 15-13. List 4 reasons often cited for the widespread use of absorption cost as the cost base in cost-plus pricing formulas. In the long run, the price must over all costs and a normal profit rim.Basing the cost-plus formula on only variable costs could encourage managers to set in any case low a price in order to boost sales. This will not happen if managers scan that a variable cost-plus pricing formula requires a higher markup to cover icy costs and profit. Ne vertheless, many managers argue that pile extend to view the costs base in a cost-plus pricing formula as the floor for setting prices. If prices are set too close to variable manufacturing cost, the firm will fail to cover its fixed costs. Ultimately, such a practice could result in the failure of the business. Absorption-cost or total-cost pricing formulas translate a justifiable price that tends to be sensed as equitable by all parties. Consumers generally deduct that a company must make a profit on its product or service in order to remain in business. Justifying a price as the total cost of production, sales, and administrative activities, plus a reasonable profit margin, seems reasonable to buyers. When a companys competitors have similar operations and cost structure, cost-plus pricing base on full costs gives management an idea of how competitors may set prices Absorption-cost training is provided by a firms cost accountancy system, because it is needed for externa l financial reporting under generally accepted accounting formulas. Since absorption-cost study already exists, it is cost-effective to use it for pricing. The alternative would involve preparing particular(a) product-cost info specifically for the pricing decision. In a firm with hundreds of products, such data could be expensive to product. 15-14. What is the primary disadvantage of basing the cost-plus pricing formula on absorption cost? The primary disadvantage of absorption-cost or total-cost pricing formulas is hat they obscure the cost sort pattern of the firm. Since absorption-cost and total-cost data include allocated fixed costs, it is not clear from these data how the firms total costs will change as volume changes. other way of stating this criticism is that absorption-cost data are not consistent with cost-volume-profit analysis. CVP analysis emphasizes the distinction between fixed and variable costs. This approach enables managers to predict the set up of cha nges in prices and sales volume on profit. Absorption-cost and total-cost information obscures the distinction between variable and fixed costs. 5-15. List 3 advantages of pricing based on variable cost Variable-cost data do obscure the cost behavior pattern by unitizing fixed costs and making them appear variable. Thus, variable-cost information is more consistent with cost-volume profit analysis often used by managers to see the profit implications of changes in price and volume Variable-cost data do not require allocation of common fixed costs to mortal product lines. Variable-cost data are exactly the type of information managers need when facing certain decisions, such as whether to accept a excess order.This decision often requires an analysis that separates fixed and variable costs 15-16. apologise the behavioral problem that can result when cost-plus prices are based on variable cost. If the managers perceive the variable cost of a product or service as the floor for t he price, they may tend to set the price too low for the firm to cover its fixed costs. Therefore, if variable-cost data are used as the basis for cost-plus pricing, managers must understand the need for higher markups to ensure that all costs are covered. 15-17. soon explain the concept of return-on-investment pricingA common approach to determine the profit margin in cost-plus pricing is to base profit on the firms goat return on investment 15-18. Explain the invent price-led costing. objective lens costing sets the target cost by first determining the price at which a product can be change in the marketplace. Subtracting the target profit margin from this target price yields the target cost, that is, the cost at which the product must be manufactured. This simple, only when strategically important, relationship can expressed in the following equationTarget cost = Target price Target profit 15-19. Why is a focus on the customer such a key principle of target costing? To be successful at target costing, management must listen to the companys customers. Management needs to sharp seek customer feedback and then the products must be designed to retaliate customer demand and be sold at a price they are willing to pay. In short, the target costing approach is market driven. 15-25. Describe the following approaches to pricing new products skimming pricing, penetration pricing and target costing.Skimming pricing which the initial product price is set high, and short-term profits are reaped on the new product. The initial market will be small, due in part to the high initial price. This pricing approach often is used for unique products, where there are people who must have it whatever the price. As the product gains acceptance and its call down broadens, the price is lowered gradually. Eventually, the product is priced in range that appeals to several kinds of buyers. cleverness pricing which the initial price is set relatively low. By setting a low pric e for a new product, the management hopes to sink in a ew market deeply, quickly gaining a large market share. This pricing approach often is used for products that are of good quality, but do not stand out as vastly expose than competing products. Target cost where the company first uses market research to determine the price at which a new product can be sold. Given the likely sales price, management computes the cost for which the product must be manufactured in order to provide the firm with the cost for which the product must be manufactured in order to provide the firm with an acceptable profit margin.Finally, the engineers and cost analysts work together to design a product that can be manufactured for the allowable costs. This method is used widely by companies in the development stages of new products. It is intercommunicate long-run cost that will enable a firm to interject and remain in the market for the product and compete successfully with the firms competitors. 1 5-27. Briefly explain the potential negative consequences in pricing decisions from using a traditional, volume-based product-costing system. Use of a traditional, volume-based product-costing system may result in significant cost distortion among product lines.In many cases, high-volume and relatively simple products are overcosted while low-volume and complex products are undercosted. This results from the fact that high0volume and relatively simple products require proportionately less activity per unit for heterogeneous manufacturing support activities than do low-volume and complex products, yet a traditional product-costing system, in which all overhead is assigned on the basis of a adept unit-level activity like DL hours, it fails to capture the cost implications of product diversity.