Transcript Cost-Based Pricing

PowerPoint
Presentations for
Cornerstones of
Cost Accounting
First Canadian Edition
Adapted by
George Gekas
Ryerson University
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Pricing and Profitably
Analysis
12
12-2
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Basic Pricing Concepts
1
“A business that does not make a profit
for the buyer of a commodity, as well as
for the seller, is not a good business.
Buyer and seller must both be wealthier
in some way as a result of a
transaction, else the balance is broken.”
Henry Ford, 1926
12-3
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Basic Pricing Concepts
1
• Price Elasticity of Demand
• It is measured as the percentage change in
quantity divided by the percentage change in price
• If demand is relatively elastic, a small percent
change in price will lead to a greater percent
change in quantity demanded
• The opposite is true for inelastic demand
12-4
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Basic Pricing Concepts
1
• Market Structure and Price
• Perfect Competition
•
•
Monopolistic Competition
•
•
Characteristics of both monopoly and perfect
competition
Oligopoly
•
•
Many buyers and sellers, of which no one is large
enough to influence the market
Few sellers
Monopoly
•
Only one firm in the market; there may be barriers to
entry
12-5
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Basic Pricing Concepts
1
Market Structure Types
12-6
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Cost and Pricing Policies
2
Approaches to Pricing
1. Cost-Based Pricing:
•
Prices are established using “cost” plus
markup
2. Target Pricing:
•
Prices are influenced by market conditions
12-7
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Cost and Pricing Policies
2
Cost-Based Pricing
Markup is a percentage applied to base cost; includes
desired profit and any costs not included in the
base cost.
Markup on COGS = (Selling and administrative expenses
+ Operating income)/COGS
Markup on DM = (Direct labour + Overhead
+ Selling and administrative expense
+ Operating income)/ Direct materials
See Cornerstone 12-1
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12-8
Cost and Pricing Policies
2
Target Costing and Pricing
• Sets the cost of a product or service based on the
price that customers are willing to pay
• It is more than cost-based pricing as it also includes
market conditions.
• If the cost-plus pricing turns out to be higher than
what customers will accept, additional redesigning
re-work will result or the opportunity is lost.
12-9
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Cost and Pricing Policies
2
Other Pricing Policies
•
The basic principle behind pricing is that competition is good
and should be encouraged.
• Penetration Pricing
•
Pricing a new product at a low initial price to build market
share quickly
• Price Skimming
•
Charging a higher price when a product or service is first
introduced
• Price Gouging
•
Occurs when firms with market power price products
“too high”
12-10
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The Legal System and
Pricing
3
Government Plays Important Role in Pricing
• Predatory Pricing
•
Setting price below cost aiming to destroy/eliminate the
competition
• Dumping
•
Predatory pricing on the international market
• Price Discrimination
•
Charging different prices to different customers for
essentially the same product
See Cornerstone 12-2
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12-11
The Legal System and
Pricing
3
• The Competition Act
• Outlaws price discrimination
• Allows discrimination under certain circumstances:
• If the competitive situation demands it
• If costs can justify the lower price
12-12
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The Product Life Cycle
4
• Product Life Cycle
•
Describes the product’s profit behaviour throughout its
four stages of development.
•
•
•
•
•
Introduction
Growth
Maturity
Decline
Helps firm understand the different competitive
pressures on a product in each stage.
12-13
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The Product Life Cycle
4
12-14
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The Product Life Cycle
4
12-15
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The Product Life Cycle
4
12-16
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Measuring Profit
5
Profit: A measure of the difference between
what resources a firm puts into making and
selling a product or service and what it receives
in exchange
Profits are measured to:
1. Determine the viability of the firm
2. Measure managerial performance
3. Determine whether or not a firm adheres to
government regulations
4. Signal the market about the opportunities for others
to earn a profit
12-17
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Measuring Profit
5
• Absorption-Costing Approach
•
•
•
Also called full costing
Required for external financial reporting
Assigns all manufacturing costs, direct materials,
direct labour, variable overhead, and a share of
fixed overhead to each unit of product—thus,
each unit of product absorbs some of the fixed
manufacturing overhead in addition to its variable
manufacturing costs
See Cornerstone 12-3
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12-18
Measuring Profit
5
• Variable-Costing Approach
•
•
•
Also called direct costing
Assigns only unit-level variable manufacturing
costs to the product; these costs include direct
materials, direct labour, variable overhead
Fixed overhead is treated as a period cost and is
not inventoried with the other product costs—it is
expensed in the period incurred
See Cornerstone 12-4
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12-19
Measuring Profit
5
12-20
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Measuring Profit
5
12-21
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Measuring Profit
5
12-22
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Analysis of Profit-Related
Variances
6
Sales price variance = (Actual price – Expected
price) × Quantity sold
Price volume variance = (Actual volume
– Expected volume) × Expected price
Contribution margin variance = Annual
contribution margin = Budgeted contribution margin
Contribution margin volume variance = (Actual
quantity sold – Budgeted quantity sold)
× Budgeted average unit contribution margin
See Cornerstones 12-5, 12-6, and 12-7
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12-23
Analysis of Profit-Related
Variances
6
Sales Mix Variance =
= [(Product 1 actual units – Product 1 budgeted units)
× (Product 1 budgeted unit contribution margin
– Budgeted average unit contribution margin)]
+ [(Product 2 actual units – Product 2 budgeted units)
× (Product 2 budgeted unit contribution margin
– Budgeted average unit contribution margin)]
See Cornerstone 12-8
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12-24
Analysis of Profit-Related
Variances
6
Market Share Variance = [(Actual market share
percentage – Budgeted market share percentage)
× (Actual industry sales in units)] × (Budgeted
average unit contribution margin)
Market Size Variance = [(Actual industry sales
in units – Budgeted industry sales in units)
× (Budgeted market share percentage)]
(Budgeted average unit contribution margin)
See Cornerstone 12-9
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12-25
Limitations of Profit
Measurement
7
Limitations of profit include:
• Focus on past performance
• Uncertain economic conditions
• Difficulty of capturing all important factors in
financial measures
Successful firms measure far more than
accounting profit.
12-26
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End of
Chapter 12
12-27
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