CHAPTER 15

Target Costing and Cost Analysis for Pricing

Decisions

ANSWERS TO REVIEW QUESTIONS

15.1 Four major influences on pricing decisions are as follows:

(1) Customer demand: Management must consider customers demand for their
product, which reflects the price that customers are willing to pay for the
product.

(2) Actions of competitors: When pricing its product, management must consider
the likely pricing decisions and product design decisions of competing firms.

(3) Costs: No organization or industry can price its product below total production
costs indefinitely.

(4) Political, legal, and image-related issues: Management must consider the way
the public perceives the firm and must adhere to certain laws when setting
prices.

15.2 The statement that prices are determined by production costs is too simplistic.
Although firms must price their products and services above their total costs in the
long run, management cannot ignore demand issues and the economic
environment. Setting prices generally is a balance between cost-related issues
and economic market forces.

15.3 In the long run, every organization must price its product or service above the
total cost of production. While the market for the product also is critically
important, costs cannot be ignored.

15.4 It is crucial to define the firms product when considering the reaction of
competitors, so that the competitors can be identified. For example, is a firm that
produces glass bottles competing only with other firms that produce glass bottles,
or is the firm competing with all companies that produce containers? Defining the
product as glass bottles or containers is an important step in identifying who the
firms competitors are.

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Managerial Accounting, 5e 15- 1
15.5 In most industries, both market forces and cost considerations heavily influence
prices. No organization can price its products below their production costs in the
long run. On the other hand, no company can set prices at cost plus a markup
without keeping an eye on the market. The product or service must be sold at a
price customers are willing to pay.

15.6 The profit-maximizing price is the price for which the associated quantity is
determined by the intersection of the marginal cost and marginal revenue curves.
This intersection is shown in Exhibit 15-3 in the text.

15.7 (a) Total revenue: Price multiplied by quantity sold.

(b) Marginal revenue: The amount by which total revenue increases when one
additional unit is sold.

(c) Demand curve: A graphical or mathematical expression of the relationship

between the price and the quantity sold.

(d) Price elasticity: The impact of price changes on sales volume.

(e) Cross-elasticity: The extent to which a change in a products price affects the
demand for substitute products.

15-8 (a) Total cost: Unit cost multiplied by quantity produced.

(b) Marginal cost: Additional cost when one more unit is produced.

15.9 Three limitations of the economic, profit-maximizing model of pricing are as

follows:

(1) The firms demand and marginal revenue curves are difficult to determine with
precision.

(2) The marginal-cost, marginal-revenue paradigm, as described in the text, is not

valid for all forms of market organization.

(3) Cost-accounting systems are not designed to measure the marginal changes
in cost incurred as production and sales increase unit by unit. To measure
marginal cost would entail a very costly information system.

15.10 Determining the best approach to pricing requires a cost-benefit trade-off. While
the marginal-cost, marginal-revenue paradigm results in a profit-maximizing price,
only a sophisticated and costly information system can collect marginal-cost data.
Thus, the firm will incur greater cost in order to obtain better decisions.

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15-2 Solutions Manual
15.11 The general formula for cost-plus pricing is as follows:

Price = cost + (markup percentage cost)

The price is equal to cost plus a markup. Depending on how cost is defined, the
markup percentage may differ. Several different definitions of cost, each
combined with a different markup percentage, can result in the same price for a
product or service.

15-12 The four cost bases commonly used in cost-plus pricing are the following:
absorption manufacturing cost, total cost, variable manufacturing cost, and total
variable cost. Each of these cost bases can result in the same price under cost-
based pricing if the markup percentage used in the cost-plus pricing formula is
changed. For example, a lower markup percentage would be applied to total cost
than would be applied to total variable cost.

15.13 Four reasons often cited for the widespread use of absorption cost as the cost
base in cost-plus formulas are as follows:

(1) In the long run, the price must cover all costs and a normal profit margin.

(2) Absorption-cost and total-cost pricing formulas provide a justifiable price that
tends to be perceived as equitable by all parties.

(3) When a companys competitors have similar operations and cost structures,
cost-plus pricing based on full costs gives management an idea of how
competitors may set prices.

(4) Absorption-cost information is provided by a firms cost-accounting system,

because it is required for external financial reporting under generally accepted
accounting principles. Since absorption-cost information already exists, it is
cost-effective to use for pricing.

15.14 The primary disadvantage of absorption-cost or total-cost pricing formulas is that

they obscure the cost behavior 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.

15.15 Three advantages of pricing based on variable cost are as follows:

(1) Variable-cost data do not obscure the cost behavior pattern by unitizing fixed
costs and making them appear variable.

(2) Variable-cost data do not require allocation of common fixed costs to individual
product lines.
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Managerial Accounting, 5e 15- 3
 (3) Variable-cost data are exactly the type of information managers need when
facing certain decisions, such as whether to accept a special order.

15.16 The behavioral problem that can result from the use of a variable-cost pricing
formula is that managers may perceive the variable cost of a product or service as
the floor for the price. They may tend to set the price too low for the firm to cover
its fixed costs.

15.17 Return-on-investment pricing is an approach under which the price is set so that it
will cover costs and also earn a profit that will provide a target return on the
invested capital.

15.18 Price-led costing refers to the process under target costing of first determining the
acceptable market price for a product or service and then determining the cost at
which the product or service must be produced.

15.19 To be successful at target costing, management must listen to the companys

customers. By doing so, management will learn the products, features, and
quality that customers are willing to buy as well as the price they are willing to
pay.

15.20 Value-engineering is a cost-reduction and process-improvement technique used to

help bring the cost of manufacturing a product or providing a service into line with
its target cost.

15.21 Tear-down methods can be used in a service-industry firm just as they are used in
the manufacturing industry. The various steps in providing a service can be
analyzed for cost improvements just as a products materials and manufacturing
operations can be analyzed for the same purpose.

15.22 Under time-and-material pricing, the price includes a cost-based charge for labor,
a cost-based charge for material, and generally a markup on one or both of these
production-cost factors.

15.23 When a firm has excess capacity, there is no opportunity cost in accepting an
additional production job. Therefore, it is not necessary to reflect such an
opportunity cost in setting a bid price. On the other hand, if the firm is already at
full capacity, there is an opportunity cost to accepting another production job. In
this case, it is appropriate to include in the price an estimate of the opportunity
cost associated with the job for which the bid is being prepared.

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15-4 Solutions Manual
15.24 The decision to accept or reject a special order and the selection of a price for a
special order are similar decisions. If a price has been offered for a special order,
management can base its acceptance or rejection decision on whether or not that
price covers the incremental cost of producing the order. Another way of viewing
the problem is to set the minimum price for the special order at a level sufficient
to cover the incremental cost of producing the order.

15.25 (a) Skimming pricing: Setting a high initial price for a new product in order to reap
short-run profits. Over time, the price is reduced gradually.

(b) Penetration pricing: Setting a low initial price for a new product in order to
penetrate a market deeply and gain a large and broad market share.

(c) Target costing: Conducting market research to determine the price at which a
new product will sell and then, given the likely sales price, computing the cost
for which the product must be manufactured in order to provide the firm with
an acceptable profit margin. Then engineers and cost analysts work together
to design a product that can be manufactured for the allowable cost. This
process is used widely in the development stages of new products.

15-26 (a) Unlawful price discrimination: Quoting different prices to different customers
for the same product or service, even though the different prices cannot be
justified by differences in the cost incurred to produce, sell, and deliver the
product or service.

(b) Predatory pricing: Temporarily cutting a price to broaden demand for a product
with the intention of later restricting the supply and raising the price again.

15-27 Traditional, volume-based product-costing systems often overcost high-volume

and relatively simple products while undercosting low-volume and complex
products. This practice can result in overpricing high-volume and relatively simple
products and underpricing low-volume and complex products. Such strategic
pricing errors can have a disastrous impact on a firms competitive position.

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Managerial Accounting, 5e 15- 5
SOLUTIONS TO EXERCISES
EXERCISE 15-28 (30 MINUTES)

1. Tabulated price, quantity, and revenue data:

(1) (2) (3) (4)

Total
Quantity Unit Revenue Changes
Sold per Sales per in Total
Month Price Month* Revenue

20 ................................
$1,000 ........................................................................
$20,000
40 950
................................ 38,000 } ................. $18,000
........................................................................
60 900
................................ 54,000 } ................. 16,000
........................................................................
80 850
................................ 68,000 } ................. 14,000
........................................................................
100 800
................................ 80,000 } ................. 12,000
........................................................................

*Column (1) times column (2).

Differences between amounts in column (3).

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15-6 Solutions Manual
EXERCISE 15-28 (CONTINUED)

2. Total revenue curve:

Dollars

$80,000 Total revenue

$70,000

$60,000

$50,000

Curve is increasing
throughout its range,
$40,000 but at a declining rate

$30,000

$20,000

$10,000

Quantity sold
20 40 60 80 100 per month

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Managerial Accounting, 5e 15- 7
EXERCISE 15-29 (30 MINUTES)

1. Tabulated cost and quantity data:

(1) (2) (3) (4)

Quantity
Produced Average Total Changes
and Sold Cost per Cost per in Total
per Month Unit Month* Cost
20 ................................
$900 ........................................................................
$18,000
40 850
................................ 34,000 } .................. $16,000
........................................................................
60 820
................................ 49,200 } .................. 15,200
........................................................................
80 860
................................ 68,800 } .................. 19,600
........................................................................
100 ................................ } .................. 20,200
........................................................................
890 89,000

*Column (1) times column (2).

Differences between amounts in column (3).

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15-8 Solutions Manual
EXERCISE 15-29 (CONTINUED)
2. Total cost curve:
Dollars

$90,000
Total cost

$80,000

$70,000

$60,000

Total cost increases

$50,000 at an increasing rate

$40,000

$30,000

$20,000
Total cost increases
at an declining rate

$10,000

Quantity sold
20 40 60 80 100 per month

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Managerial Accounting, 5e 15- 9
McGraw-Hill/Irwin 2002 The McGraw-Hill Companies,
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15-10 Solutions Manual
EXERCISE 15-30 (40 MINUTES)

1. Tabulated revenue, cost, and profit data:

(1) (2) (3) (4) (5)

Quantity Total Total
Produced Sales Revenue Cost Profit
and Sold Price per per per
per Month per Unit Month* Month
Month**
20 ................................
$1,000 ........................................................................
$20,000 $18,000 ...................................................
$2,000
40 950 ........................................................................
................................ 38,000 34,000 ...................................................
4,000
60 900 ........................................................................
................................ 54,000 49,200 ...................................................
4,800
80 850 ........................................................................
................................ 68,000 68,800 ...................................................
(800)
100 ................................
800 80,000 89,000
........................................................................
...................................................
(9,000)

*Column (1) times column (2).

Column (1) times average cost per unit given in the preceding exercise.
**Column (3) minus column (4).

2. Total revenue and cost curves: see next page.

3. Of the five candidate prices listed, $900 is the optimal price. This price produces
a monthly profit of $4,800, which is greater than the profit at the other four
candidate prices.

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Managerial Accounting, 5e 15- 11
EXERCISE 15-30 (CONTINUED)
2. Total revenue and cost curves:
Dollars
$90,000

Total cost
$80,000

Total revenue
$70,000

$60,000

Total profit at the profit-
maximizing quantity and
$50,000
price.

$40,000


$30,000

$20,000

$10,000

Quantity sold
20 40 60 80 100 per month

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15-12 Solutions Manual
EXERCISE 15-31 (25 MINUTES)

Dollars

Total cost

Total revenue

Total profit at profit-maximizing quantity and price

Quantity sold per

q* month
Dollars per unit

Marginal cost
p*

Demand (average
revenue)
Marginal revenue
Quantity sold
q* per month

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Managerial Accounting, 5e 15- 13
EXERCISE 15-32 (15 MINUTES)

1. Profit on sales of 60,000 units:

Sales revenue (60,000 6 p ) ........................................ 360,000 p

Less: Variable costs:
Manufacturing and administrative (60,000 3 p ) . . 180,000 p
Sales commissions (60,000 6 p 10%) ............ 36,000 p 216,000 p
Contribution margin ...................................................... 144,000 p
Less: Fixed costs (60,000 p + 5,000 p ) ............................ 65,000 p
Profit ........................................................................... 79,000 p

p denotes Argentinas peso

2. Required price on special order:

Unit contribution margin target additional profit

required on special order = unit sales volume in special order

20,000p
= 2 p per unit
10,000
Sales price required = unit variable cost + required unit
contribution margin
= 3 p + 2 p = 5 p per unit
As an alternative approach, let X denote the price required in order to earn
additional profit of 20,000 p on the special order:

10,000 X 10,000(3 p ) = 20,000 p

10,000 X = 50,000 p
X = 5 p per unit

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15-14 Solutions Manual
EXERCISE 15-33 (30 MINUTES)

Answers will vary widely, depending on the company and the product chosen. The
answer should include a general discussion of the use of target costing in setting a
price for a new product. The target-costing approach includes the following key
features: price-led costing; focus on the customer; focus on product design; focus
on process design; use of cross-functional teams; analysis of life-cycle costs; and
a value-chain orientation. Target costing makes extensive use of value engineering
to reduce production costs and bring them into line with the target cost.
EXERCISE 15-34 (30 MINUTES)

Markup percentage profit required to total annual costs not

+
applied to cost base in achieve target ROI included in cost base
cost-plus = cost base per unit
pricing formula annual
used in cost-plus
volume
pricing formula

total variable selling and total annual

$60,000
1. Markup percentage = administrative costs fixed costs
480 $400

$60,000 (480 $50) [480 ($250 $100)]

=
480 $400

$60,000 $24,000 $168,000

= $192,000

= 131.25%

Thus the Wave Darters price would be set equal to $925, where
$925 = $400 + ($400 131.25%).

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Managerial Accounting, 5e 15- 15
EXERCISE 15-34 (CONTINUED)

In the preceding formula:

$60,000 = target profit (given)
480 = annual volume of Wave Darter production and sales (from Exhibit 15-5)
$400 = variable manufacturing cost per unit (from Exhibit 15-5)
$50 = variable selling and administrative cost per unit (from Exhibit 15-5)
$250 = applied fixed manufacturing cost per unit (from Exhibit 15-5)
$100 = allocated fixed selling and administrative cost per unit (from Exhibit 15-5)

total selling and

$60,000
2. administrative costs
Markup percentage = 480 $650*

$60,000 [480 ($50 $100)]

=
480 $650

$60,000 $72,000
= $312,000

= 42.31% (rounded)

Thus the Wave Darters price would be set equal to $925, where
$925 = $650 + ($650 42.31%) with rounding.

*$650 = absorption manufacturing cost (from Exhibit 15-5).

The other amounts used in this formula were defined in requirement (1).

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15-16 Solutions Manual
EXERCISE 15-35 (30 MINUTES)

1. Price = total unit cost + (markup percentage total unit cost)

$450 = total unit cost + (12.5% total unit cost)

$450 = total unit cost 1.125

$450
Total unit cost = = $400
1.125

variable
Allocated fixed total all selling and
=
selling and unit manufacturing administrative
administrative cost cost costs cost

= $400 ($250 + $50) $60

= $40

Cost-Plus Pricing Formula

2. a. $250 $450 = $250 + (80% $250)*
Variable manufacturing cost ..........................................
50
Applied fixed manufacturing cost ..................................

b. $300 $450 = $300 + (50% $300)

Absorption manufacturing cost ......................................

Variable manufacturing cost ..........................................

$250
Variable selling and administrative
cost ...........................................................................
60

c. $310 $450 = $310 + (45.16%

Total variable cost ........................................................
$310)**

*($450 $250) $250 = 80%

($450 $300) $300 = 50%
**($450 $310) $310 = 45.16% (rounded)

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Managerial Accounting, 5e 15- 17
EXERCISE 15-36 (25 MINUTES)

Cost-Plus Pricing Formula

(1) $200 $400 = $200 + (100% $200) a
Variable manufacturing cost ..........................................
70
Applied fixed manufacturing cost ..................................

(2) $270 $400 = $270 + (48.15%

Absorption manufacturing cost ......................................
$270) b
30
Variable selling and administrative cost .........................
Allocated fixed selling and
administrative cost .....................................................
50

(3) Total cost $350 $400 = $350 + (14.29%

$350) c

Variable manufacturing cost ..........................................

$200
30
Variable selling and administrative cost .........................

(4) $230 $400 = $230 + (73.91%

Total variable cost ........................................................
$230) d

Explanatory Notes:
a
($400 $200) $200 = 100%
b
($400 $270) $270 = 48.15% (rounded)
c
($400 $350) $350 = 14.29% (rounded)
d
($400 $230) $230 = 73.91% (rounded)

EXERCISE 15-37 (15 MINUTES)

1. Material component of time and material pricing formula:

material material material handling

cost cost and storage costs
1.05
incurred incurred annual cost of materials

on job on job used in Repair Department

2. Material component of price, using formula developed in requirement (1):

[$8,000 + ($8,000 .04)] 1.05

= $8,320 1.05
= $8,736
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15-18 Solutions Manual
EXERCISE 15-37 (CONTINUED)

New price to be quoted on yacht refurbishment:

Total price of job = time charges + material charges
= $9,000* + $8,736 **
= $17,736

*From Exhibit 15-7.

**
From requirement (1).

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Managerial Accounting, 5e 15- 19
SOLUTIONS TO PROBLEMS
PROBLEM 15-38 (25 MINUTES)

1. The manufacturing overhead rate is $18.00 per standard direct-labor hour, and the
standard product cost includes $9.00 of manufacturing overhead per pressure
valve. Accordingly, the standard direct-labor hours per finished valve is 1/2 hour
($9 $18). Therefore, 30,000 units per month would require 15,000 direct-labor
hours.

2. The analysis of accepting the Glasgow Industries order of 120,000 units is as

follows:

Totals for
120,000
Per Unit Units
Incremental revenue ..................................................... $19 .00 $2,280,000
Incremental costs:
Variable costs:
Direct material ...................................................... $ 5 .00 $ 600,000
Direct labor ........................................................... 6.00 720,000
Variable overhead ................................................. 3 .00 360,000
Total variable costs ........................................... $14 .00 $1,680,000
Fixed overhead:
Supervisory and clerical costs
(4 months @ $12,000) ............................................ 48,000
Total incremental costs ................................................. $1,728,000
Total incremental profit ................................................. $ 552,000

The following costs are irrelevant to the analysis:

Shipping

Sales commission

Fixed manufacturing overhead (both traceable and allocated)

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15-20 Solutions Manual
PROBLEM 15-38 (CONTINUED)

3. The minimum unit price that Badger Valve and Fitting Company could accept
without reducing net income must cover the variable unit cost plus the additional
fixed costs.

Variable unit cost:

Direct material .......................................................... $ 5 .00
Direct labor .............................................................. 6.00
Variable overhead ..................................................... 3 .00 $14.00
Additional fixed cost ($48,000 120,000) ..................... .40
Minimum unit price ....................................................... $14.40

4. Badgers management should consider the following factors before accepting the
Glasgow Industries order:

The effect of the special order on Badgers sales at regular prices.

The possibility of future sales to Glasgow Industries and the effects of

participating in the international marketplace.

The companys relevant range of activity and whether or not the special order
will cause volume to exceed this range.

The effect on machinery or the scheduled maintenance of equipment.

Other possible production orders that could come in and require the capacity
allocated to the Glasgow job.

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Managerial Accounting, 5e 15- 21
PROBLEM 15-39 (25 MINUTES)
1,000,000 doses to be packaged
1. Direct-labor hours (DLH) required for job = 2,000 doses/DLH
= 500 DLH

Traceable out-of-pocket costs:

Direct labor ($8.00 500) ......................................................... $4,000

Variable overhead ($6.00 500) ................................................ 3,000
Administrative cost .................................................................... 1,000
Total traceable out-of-pocket costs.......................................... $8,000

total traceable out -of -pocket costs

Minimum price per dose = 1,000,000doses

$8,000
= 1,000,000

= $.008

2. As in requirement (1), 500 direct-labor hours are required for the job.

Direct labor ($8.00 500) ............................................................. $4,000

Variable overhead ($6.00 500) ................................................... 3,000
Fixed overhead ($10.00 500) ...................................................... 5,000
Administrative cost ........................................................................ 1,000
Total cost .................................................................................. $13,000
Maximum allowable return (15%) ................................................... 1,950
Total bid price ........................................................................... $14,950

total bid price

Bid price per dose = 1,000,000doses

$14,950
= 1,000,000

= $.01495 per dose

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15-22 Solutions Manual
PROBLEM 15-39 (CONTINUED)

3. Under the supposition that the price computed by North American

Pharmaceuticals, Inc. using Wyants criterion is greater than $.015, the factors
that North Americans management should consider before deciding whether or
not to submit a bid at the maximum allowable price include whether North
American has excess capacity, whether there are available jobs on which earnings
might be greater, and whether the maximum bid of $.015 contributes toward
covering fixed costs.

PROBLEM 15-40 (25 MINUTES)

1. Target costing is more appropriate. MPE is limited in terms of what price it can
charge due to market conditions. A cost-plus-markup approach will use the
desired markup for the company; however, the resulting price may too high and
not competitive. In such an environment it makes more sense to use target
costing, which begins with the price to be charged and works backward to
determine the allowable cost.

2. Target profit = asset investment x rate of return

= $18,000,000 x 12%
= $2,160,000

3. Revenue = target profit + variable cost + fixed cost

= $2,160,000 + (25,000 hours x $22) + $1,900,000
= $4,610,000

Since total revenue must equal $4,610,000, the revenue per hour must be
$184.40 ($4,610,000 25,000 hours).

4. Target profit = asset investment x rate of return

= $18,000,000 x 14%
= $2,520,000

Revenue = target profit + variable cost + fixed cost

= $2,520,000 + (25,000 hours x $22) + $1,900,000
= $4,970,000

No. A 14% return requires that MPE generate revenue per service hour of
$198.80 ($4,970,000 25,000 hours), which is clearly in excess of the $175
market price.

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Managerial Accounting, 5e 15- 23
PROBLEM 15-40 (CONTINUED)

5. To achieve a 14% return and a $175 revenue-per-hour figure, the company must
trim its costs. MPE could use value engineering, a technique that utilizes
information collected about a services design and associated production process.
The goal is to examine the design and process and then identify improvements
that would produce cost savings.

PROBLEM 15-41 (30 MINUTES)

1. Cost-plus pricing begins by computing an items cost and then adds an

appropriate markup. The result is the items selling price. In contrast, target
costing begins by determining an appropriate selling price. A target profit is next
subtracted from that price to yield the cost (i.e., the target cost) that must be
achieved.

Target costing could be labeled price-led costing because it begins by

determining a target selling price. In contrast, cost-plus pricing methods begin
with the cost and culminate in determination of the selling price.

2. The current selling price is $225:

Direct $
material... 30
Direct 7
labor 5
Manufacturing 5
overhead 0
Selling and administrative 2
expenses. 5
Total $18
cost. 0
Markup ($180 x 25%) 4
... 5
Selling $22
price... 5

3. Lenos markup is $45, which is 20% of the current $225 selling price ($45
$225). To achieve a 20% markup on a $195 selling price, the company must
reduce its costs by $24.

Selling $19
price.. 5
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15-24 Solutions Manual
 Less: 20% markup ($195 x 20%) 3
. 9
Target $15
cost 6

Current $18
cost.. 0
Less: Target 15
cost. 6
Required cost $
reduction 24

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Managerial Accounting, 5e 15- 25
PROBLEM 15-41 (CONTINUED)

4. Yes. The company should focus its efforts on trimming non-value-added costs.
These costs are associated with non-value-added activities (i.e., activities that are
either (a) unnecessary and dispensable or (b) necessary, but inefficient and
improvable).

5. If costs cannot be reduced below $180, Leno will have to reduce its markup to
remain competitive. Assuming a desire to achieve the going market price of $195,
the markup must equal $15 ($195 - $180), or 8.33 % of cost ($15 $180). Given
that the current markup on cost is 25%, a reduction of 16.67% is needed (25.00%
- 8.33%).

6. The statement means that selling prices are a function of market conditions;
however, the selling prices must cover a companys costs in the long run. Also, in
a number of industries, prices are based on costs. Yet, the prices are subject to
the reaction of customers and competitors.

PROBLEM 15-42 (35 MINUTES)

1. Target costing is market driven, beginning with a determination of the selling price
that customers are willing to pay. That price is dependent on the product they
purchase and the products features. It is only natural that a marketing team
becomes heavily involved in this process, since customer feedback is crucial to
the design process.

2. Add cabinet doors: [(10 x 1) + (20 x 2) + (30 x 3) + (60 x 4) + (80 x 5)] = 780; 780
200 = 3.900

Expand storage area: [(10 x 1) + (40 x 2) + (70 x 3) + (50 x 4) + (30 x 5)] = 650;
650 200 = 3.250

Add security lock: [(30 x 1) + (60 x 2) + (50 x 3) + (40 x 4) + (20 x 5)] = 560; 560
200 = 2.800

New appearance for table top: [(10 x 1) + (20 x 2) + (50 x 3) + (60 x 4) + (60 x 5)]
= 740; 740 200 = 3.700

Extend warranty: [(40 x 1) + (70 x 2) + (30 x 3) + (35 x 4) + (25 x 5)] = 535; 535
200 = 2.675

McGraw-Hill/Irwin 2002 The McGraw-Hill Companies,

Inc.
15-26 Solutions Manual
PROBLEM 15-42 (CONTINUED)

Ranking (from strongest to weakest):

1Add cabinet doors (3.900)
2New appearance for table top (3.700)
3Expand storage area (3.250)
4Add security lock (2.800)
5Extend warranty (2.675)

3. (a) DF currently earns a $16 profit on each table sold ($80 - $64), which
translates
into a 20% markup on sales ($16 $80). The current competitive market
price is $95, which means that if DF maintains the 20% markup, it will earn
$19 ($95 x 20%) per unit. The maximum allowable cost is therefore $76
($95 - $19).

(b) Customers feel most strongly about adding cabinet doors and giving the
table top a new appearance. Both of these features can be added, and DF
will be able to earn its 20% markup. The third and fifth most desirable
features (the expanded storage area and extended warranty) are too
costly. If it desires, DF could also add a lock to the storage area.
(Calculations follow.)

Maximum allowable $76.0

cost... 0
Less: Current 64.0
cost... 0
Cost of additional $12.0
features 0

1Add cabinet $
doors. 6.00
2New appearance for table 4.2
top 5
Subtotal $10.2
5
4Add security 1.6
lock.. 5
Total $11.9
.. 0

4. An expanded storage area would be the most logical additional feature in view of
its no. 3 ranking. DF might use value engineering to study the design and
McGraw-Hill/Irwin 2002 The McGraw-Hill Companies,
Inc.
Managerial Accounting, 5e 15- 27
 production process of both the table as currently manufactured as well as the
proposed new features. The goal is to identify improvements and associated
reductions in cost that may allow the company to add previously rejected options.

McGraw-Hill/Irwin 2002 The McGraw-Hill Companies,

Inc.
15-28 Solutions Manual
PROBLEM 15-43 (45 MINUTES)

1. The order will boost Graydons net income by $27,900, as the following
calculations show.
Sales revenue............................................. $165,000
Less: Sales commissions (10%)................... 16,500 $148,500
Less manufacturing costs:
Direct material........................................ $ 29,200
Direct labor............................................ 56,000
Variable manufacturing overhead *.................... 16,800
Total manufacturing costs 102,000
Income before taxes.................................... $ 46,500
Income taxes (40%).................................... 18,600
Net income .............................................. $ 27,900

*Based on an analysis of the year just ended, variable overhead is 30 percent of

direct labor ($2,250 $7,500). For Premiers Foods order:

Direct-labor cost x .30 = $56,000 x .30 = $16,800.

2. Yes. Although this amount is below the $165,000 full-cost price, the order is still
profitable. Graydon can afford to pick up some additional business, because the
company is operating at 75 percent of practical capacity.
Sales revenue.................................................. $127,000
Less: Sales commissions (10%)........................ 12,700 $114,300
Less manufacturing costs:
Direct material $ 29,200

Direct labor 56,000

Variable manufacturing overhead 16,800

Total manufacturing costs 102,000

Income before taxes......................................... $ 12,300
Income taxes (40%).......................................... 4,920
Net income ................................................... $ 7,380

Note that the fixed manufacturing overhead and fixed corporate administration
costs are not relevant in this decision, because these amounts will remain the
same regardless of what Graydons management decides about the order.

McGraw-Hill/Irwin 2002 The McGraw-Hill Companies,

Inc.
Managerial Accounting, 5e 15- 29
PROBLEM 15-43 (CONTINUED)

3. The break-even price is $113,333, computed as follows:

Let P = break-even bid price

P 0.1 P - $102,000 = 0
0.9 P = $102,000

P = $113,333
Income taxes can be ignored, because there is no tax at the break-even point.

4. Profits will probably decline. Graydon originally used a full-cost pricing formula to
derive a $165,000 bid price. A drop in the selling price to $127,000 signifies that
the firm is now pricing its orders at less than full cost, which would decrease
profitability.
Reduced prices could lead to an increase in income if the company is able to
generate additional volume. This situation will not occur here, because the
problem states that Graydon has operated and will continue to operate at 75
percent of practical capacity.

PROBLEM 15-44 (40 MINUTES)

1. Target costing is the design of a product, and the processes used to produce it, so
that ultimately the product can be manufactured at a cost that will enable a firm to
make a profit when the product is sold at an estimated market-driven price. This
estimated price is called the target price, the desired profit margin is called the
target profit, and the cost at which the product must be manufactured is called the
target cost.
2. Value engineering (or value analysis) refers to a cost-reduction and process
improvement technique that utilizes information collected about a product's design
and production processes and then examines various attributes of the design and
processes to identify candidates for improvement efforts.

Value engineering focuses on improving those qualities that the customer

desires, while reducing or eliminating unnecessary moves, queues, setups, and
other such activities that the customer will not pay for. The process is reengineered
to eliminate non-value-added work and thereby enhance the value of the process to
the customer.

McGraw-Hill/Irwin 2002 The McGraw-Hill Companies,

Inc.
15-30 Solutions Manual
PROBLEM 15-44 (CONTINUED)

3. Pharsalia Electronics' current profit on sales is 10 percent [($350 -$315)/$350].

Therefore, the target cost for the new product must be $300 less 10 percent, or
$270 [$300 ($300 10%)].

4. The proposed changes to the just-in-time cell manufacturing process at Pharsalia

Electronics will bring costs down to $266 per unit, which is below the $270 target
cost limit. Adjusted costs under the JIT cell manufacturing process are calculated as
follows:

Increase/
Current (Decrease) Revised

Material:
Purchased components............................. $110 $110
All other................................................... 40 40

Labor:
Manufacturing, direct................................ 65 $ 15 80
Setups..................................................... 9 (9) 0
Material handling...................................... 18 (18) 0
Inspection................................................ 23 (23) 0

Machining:
All............................................................ 35 (5) 30

Other:
Finished-goods warehousing..................... 5 (5) 0
Warranty*................................................. 10 (4) 6

Total JIT Cost................................................ $315 $(49) $266

*40% reduction

McGraw-Hill/Irwin 2002 The McGraw-Hill Companies,

Inc.
Managerial Accounting, 5e 15- 31
PROBLEM 15-45 (30 MINUTES)

1. (a) Time charges:

annual overhead (excluding
hourly charge to
Hourly labor cost + material handling and storage) + cover profit magin
annual labor hours

$108,000
= $16 + 12,000
+ $4

= $29 per labor hour

(b) Material charges:

Material cost material cost material handling and storage costs

incurred on job incurred on job annual cost of materials used
Material cost material cost $25,000
= incurred on job incurred on job $250,000

2. PRICE QUOTATION

Time charges: Labor time ....................................................................................

400 hours
Rate ..........................................................................................
$29 per hour
Total .............................................................................................
$11,600

Material changes:Cost of materials for job ................................................................

$60,000
6,000*
+ Charge for material handling and storage ....................................
Total .............................................................................................
$66,000

Total price of job: Time .............................................................................................

$11,600
66,000
Material ........................................................................................
Total .............................................................................................
$77,600

*Charge for material handling and storage):

10% = $25,000 $250,000; 10% $60,000 = $6,000

McGraw-Hill/Irwin 2002 The McGraw-Hill Companies,

Inc.
15-32 Solutions Manual
PROBLEM 15-45 (CONTINUED)

3. Price of job without markup on material costs (from requirement 2) . $77,600

Markup on total material costs ($66,000 10%) ............................. 6,600
Total price of job ........................................................................... $84,200

PROBLEM 15-46 (50 MINUTES)

1. Gargantuan Industries should price the standard compound at $22 per case and
the commercial compound at $30 per case. The contribution margin is the highest
at these prices as shown in the following calculations:

Standard Compound
$ 18 $ 20 $ 21
Selling price per case .................................................................... $ 22 $ 23
16 16 16
Variable cost per case ................................................................... 16 16
$ 2 $ 4 $ 5
Contribution margin per case ......................................................... $ 6 $ 7
120 100 90
Volume in cases (in thousands) ..................................................... 80 50
Total contribution margin (in thousands) .........................................
$240 $400 $450 $480 $350

Commercial Compound
$ 25 $ 27 $ 30
Selling price per case .................................................................... $ 32 $ 35
21 21 21
Variable cost per case ................................................................... 21 21
$ 4 $ 6 $ 9
Contribution margin per case ......................................................... $ 11 $ 14
175 140 100
Volume in cases (in thousands) ..................................................... 55 35
Total contribution margin (in thousands) .........................................
$700 $840 $900 $605 $490

McGraw-Hill/Irwin 2002 The McGraw-Hill Companies,

Inc.
Managerial Accounting, 5e 15- 33
PROBLEM 15-46 (CONTINUED)
2. a. Gargantuan Industries should continue to operate during the final six months
of the current year because any shutdown would be temporary. The company
intends to remain in the business and expects a profitable operation during the
next year. This is a short-run decision problem. Therefore, the fixed costs are
irrelevant to the decision, because they cannot be avoided in the short run.
The products do have a positive contribution margin so operations should
continue.

GARGANTUAN INDUSTRIES
BOISE PLANT
PROJECTED CONTRIBUTION MARGIN
FOR THE SIX-MONTH PERIOD ENDING DECEMBER 31
(IN THOUSANDS)
Standard Commercial Total
Sales ............................................................................................
$1,150 $1,225 $2,375
Variable costs:
Selling and administrative ..........................................................
$ 200 $ 245 $ 445
Manufacturing ...........................................................................
600 490 1,090
Total variable costs ................................................................
$ 800 $ 735 $1,535
$ 350
Contribution margin .......................................................................$ 490 $ 840

b. Gargantuan Industries should consider the following qualitative factors when

making the decision about the Boise Plant.

The effect on employee morale.

The effect on market share.

The disruption of production and sales due to a shutdown.

The effect on the local community.

McGraw-Hill/Irwin 2002 The McGraw-Hill Companies,

Inc.
15-34 Solutions Manual
PROBLEM 15-47 (30 MINUTES)

1. The minimum price per blanket that Omaha Synthetic Fibers, Inc. could bid
without reducing the companys net income is $24 calculated as follows:

Raw material (6 lbs. @ $1.50 per lb.) ............................................. $ 9 .00

Direct labor (.25 hrs. @ $7.00 per hr.) ............................................ 1.75
Machine time ($10.00 per blanket) ................................................. 10.00
Variable overhead (.25 hrs. @ $3.00 per hr.) .................................. .75
Administrative costs ($2,500 1,000) ............................................ 2 .50
Minimum bid price ..................................................................... $24 .00

2. Using the full cost criteria and the maximum allowable return specified, Omaha
Synthetic Fibers, Inc.s bid price per blanket would be $29.90 calculated as
follows:

Relevant costs from requirement (1) .............................................. $24.00

Fixed overhead (.25 hrs. @ $8.00 per hr.) ...................................... 2 .00
Subtotal .................................................................................... $26.00
Allowable return (.15 $26) .......................................................... 3 .90
Bid price ................................................................................... $29 .90

3. Factors that management should consider before deciding whether to submit a bid
at the maximum acceptable price of $25 per blanket include the following:

The company should be sure there is sufficient excess capacity to fill the order
and that no additional investment is necessary in facilities or equipment that
would increase fixed costs.

If the order is accepted at $25 per blanket, there will be a $1 contribution per
blanket to fixed costs. However, the company should consider whether there
are other jobs that would make a greater contribution.

Acceptance of the order at a low price could cause problems with current
customers who might demand a similar pricing arrangement.

McGraw-Hill/Irwin 2002 The McGraw-Hill Companies,

Inc.
Managerial Accounting, 5e 15- 35
PROBLEM 15-48 (50 MINUTES)

1. Budgeted overhead costs:

Department I Department II
Variable overhead
Department I: 37,500 $8 ........................................................
$300,000
Department II: 37,500 $4 ........................................................ $150,000
150,000
Fixed overhead ............................................................................. 150,000
Total overhead ..............................................................................
$450,000 $300,000
Total budgeted overhead for both
departments ($450,000 + $300,000) ............................................ $750,000
Total expected direct-labor hours for
both departments (37,500 + 37,500) ............................................ 75,000

budgeted overhead
Predetermined overhead rate = budgeted direct-labor hours

$750,000
= 75,000

= $10 per direct-labor hour

2. Basic Advanced
Total cost ......................................................................................
$400 $500
Markup (15% of cost)
Basic: $400 .15 .....................................................................
60
Advanced: $500 .15 ............................................................... 75
Price ............................................................................................
$460 $575

3. Department I Department II
Budgeted overhead (from requirement 1)........................................
$450,000 $300,000
37,500
Budgeted direct-labor hours .......................................................... 37,500
Calculation of predetermined overhead rate ................................... 300,000
$ 450 ,000 $
37,500 37,500
$12
Predetermined overhead rate ........................................................ $8

McGraw-Hill/Irwin 2002 The McGraw-Hill Companies,

Inc.
15-36 Solutions Manual
PROBLEM 15-48 (CONTINUED)

4. Basic Advanced
Direct material ..............................................................................
$160 $260
140
Direct labor ................................................................................... 140
Manufacturing overhead:
Department I:
Basic: 2 $12 .......................................................................
24
Advanced: 8 $12 ................................................................ 96
Department II:
Basic: 8 $8 .........................................................................
64
Advanced: 2 $8 .................................................................. 16
Total cost ......................................................................................
$388 $512

5. Basic Advanced
Total cost (from requirement 4).......................................................
$388.00 $512.00
Markup (15% of cost)
Basic: $388 .15 ......................................................................
58.20
Advanced: $512 .15 ............................................................... 76 .80
Price ............................................................................................
$446 .20 $588 .80

6. The management of Sounds Fine, Inc. should use departmental overhead rates.
The overhead cost structures in the two production departments are quite different,
and departmental rates more accurately assign overhead costs to products. When
the company used a plantwide overhead rate, the Basic speakers were overcosted
and the Advanced speakers were undercosted. This in turn resulted in the Basic
model being overpriced and the Advanced model being underpriced. The cost and
price distortion resulted from the following facts: (1) the Basic speakers spend most
of their production time in Department II, which is the least costly of the two
departments; and (2) the Advanced speakers spend most of their production time in
Department I, which is more costly than Department II.

McGraw-Hill/Irwin 2002 The McGraw-Hill Companies,

Inc.
Managerial Accounting, 5e 15- 37
PROBLEM 15-49 (40 MINUTES)

1. Bid based on standard pricing policy:

Direct material ............................................................................. $256,000

Direct labor (11,000 DLH @ $15) .................................................. 165,000
Manufacturing overhead (11,000 DLH @ $9) ................................. 99,000
Full manufacturing costs .......................................................... $520,000
Markup (50% of full cost) ............................................................. 260,000
Standard pricing policy bid ........................................................... $780,000

2. Minimum bid acceptable to Zylar:

Direct material ............................................................................. $256,000

Direct labor (11,000 DLH @ $15) .................................................. 165,000
Variable manufacturing overhead (11,000 @ $5.40 a) ..................... 59,400
Opportunity cost of lost sales b ...................................................... 35,200
Minimum bid ................................................................................ $515,600
a
budgeted variable overhead
Proportion of variable overhead = budgeted total overhead

$972,000
= $1,620,000

= 60%

total overhead variable

Variable overhead rate = rate

overhead proportion

= ($9.00) (.6)

= $5.40

McGraw-Hill/Irwin 2002 The McGraw-Hill Companies,

Inc.
15-38 Solutions Manual
Problem 15-49 (Continued)

b
Selling price per unit of standard product....................................... $12,000
Variable costs per unit
Direct material .......................................................................
$2,500
Direct labor (250 DLH @ $15) ................................................ 3,750
Variable overhead (250 DLH @ $5.40) ................................... 1,350 7,600
Net contribution per unit ................................................................ $ 4,400
Standard product requirements (12,000 DLH 3) .......................... 36,000 DLH
Special order requirements ...........................................................
11,000 DLH
Total hours required ......................................................................
47,000 DLH
Plant capacity per quarter (15,000 DLH 3) ..................................
45,000 DLH
2,000 DLH
Shortage in hours .........................................................................
Lost unit sales (2,000 DLH 250 DLH) .......................................... 8
Lost contribution ........................................................................... $35,200

Lyan Companys assistant purchasing manager is not acting ethically. The

details of the bid submitted by Zylar Industries are confidential between Zylar
Industries and Lyan Company. It is unfair and unethical to give this information to
Zylars competitor. If Lyan Company had wanted competing bids on the
specialized equipment, the bids should have been solicited at the same time from
the relevant set of manufacturers. Each competing firm should receive the same
specifications on the customized equipment and be given the same time frame in
which to complete the bid. Moreover, the competing firms should be made aware
that more than one bid is being solicited.

McGraw-Hill/Irwin 2002 The McGraw-Hill Companies,

Inc.
Managerial Accounting, 5e 15- 39
PROBLEM 15-50 (50 MINUTES)

1. The lowest price Biloxi Corporation would bid for a one-time special order of
25,000 pounds (25 lots) would be $34,750, which is equal to the variable costs of
the order calculated as follows:

(a) Direct material:

On a one-time only special order, chemicals used in manufacturing the firms

main product have a relevant cost of their expected future cost, represented
by the current market price per pound. Chemicals not used in current
production have a relevant cost of their value to the firm.
RH-3: (400 pounds per lot) (25 lots) = 10,000 pounds.
Substitute CN-5 on a one-for-one basis to its total of 5,500
pounds. The relevant cost is the salvage value. ........................ $ 500
The remaining 4,500 pounds would be RH-3 at a relevant cost
of $.90 per pound, its expected future cost. .............................. 4,050
JX-6: (300 pounds per lot) (25 lots) = 7,500 pounds at
$.60 per pound. ....................................................................... 4,500
MZ-8: (200 pounds per lot) (25 lots) = 5,000 pounds at
$1.60 per pound. ..................................................................... 8,000
BE-7: (100 pounds per lot) (25 lots) = 2,500 pounds.
The relevant cost per pound is $.65 $.10 (handling charge) =
$.55.
The amount the company could realize by selling BE-7. is 2,500
pounds at $.55 per pound ................................................. 1,375
$18,425

McGraw-Hill/Irwin 2002 The McGraw-Hill Companies,

Inc.
15-40 Solutions Manual
PROBLEM 15-50 (CONTINUED)

(b) Direct labor:

(60 DLH per lot) (25 lots) = 1,500 direct-labor hours (DLH)

Because only 800 hours can be scheduled during regular time this month,
overtime would have to be used for the remaining 700 hours; therefore,
overtime is a relevant cost of this order.
(1,500 DLH) ($7.00 per DLH) ................................................................... $10,500
(700 DLH) ($3.50 per DLH) ......................................................................2,450
Total direct-labor cost .................................................................................
$12,950

(c) Overhead:

This special order will not increase fixed overhead costs. Therefore, fixed
overhead is not relevant, and the relevant overhead charge is the variable
overhead rate:

(1,500 DLH) ($2.25 per DLH) = ................................................................

3,375

Total cost of special order ...........................................................................

$34,750*

*$34,750 = $18,425 + $12,950 + $3,375

2. Calculation of the price for recurring orders of 25,000 pounds (25 lots) is as
follows.

(a) Direct material:

Because of the possibility of future orders, raw materials must all be charged
at their expected future cost represented by the current market price per
pound.

RH-3: (10,000 pounds)

($.90 per pound) ................................................................. . $ 9,000
JX-6: (7,500 pounds)
($.60 per pound) ................................................................
.............................................................................................. ) 4,500
MZ-8: (5,000 pounds)
($1.60 per pound) .............................................................. 8,000

McGraw-Hill/Irwin 2002 The McGraw-Hill Companies,

Inc.
Managerial Accounting, 5e 15- 41
 BE-7: (2,500 pounds)
($.65 per pound) ................................................................ 1,625
$23,125
PROBLEM 15-50 (CONTINUED)

(b) Direct labor:

60% of the production of a batch (900 DLH) can be done on regular time; the
remaining 600 DLH cause overtime to be incurred and are a relevant cost of
this new product.

Regular time
(1,500 DLH) ($7.00 per DLH) ................................................................. $10,500
Overtime premium
(600 DLH) ($3.50 per DLH) .................................................................... 2,100
Total direct-labor cost .................................................................................
$12,600

(c) Overhead:

All new products should contribute to fixed overhead as well as cover all
variable costs and provide a markup. Therefore, the overhead charge would
be:

(1,500 DLH) ($6.00 per DLH) ...................................................................

$9,000

(d) Markup and price calculation:

Full manufacturing cost ...............................................................................

$44,725 *
11,181
Markup (25%) .............................................................................................
Full manufacturing cost plus 25% markup .................................................... $55,906

*$44,725 = $23,125 + $12,600 + $9,000

Rounded.

3. The owner of Taylor Nursery is not acting ethically in this situation. It is

inappropriate to allow Biloxi Corporation to revise its bid on the basis of
confidential information included in the details of the Dalton Industries bid. All
firms competing for the Taylor Nursery contract should be given the same product
specifications, information, and time frame with which to prepare a bid.

McGraw-Hill/Irwin 2002 The McGraw-Hill Companies,

Inc.
15-42 Solutions Manual
SOLUTIONS TO CASES
CASE 15-51 (45 MINUTES)

1. The total sales price can be determined by the following formula:

Let S = IC + T + NIAT
Where S = total price
IC = incremental cost
T = taxes
T = (S IC)t
t = tax rate
NIAT = net income after taxes
NIAT = S desired return on total price
Substituting for the known items, the formula is revised to read:
S = IC + (S IC) .4 + .10 S
The incremental costs for the three-year order are calculated as shown in the
following schedule.

McGraw-Hill/Irwin 2002 The McGraw-Hill Companies,

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Managerial Accounting, 5e 15- 43
CASE 15-51 (CONTINUED)

Current Amount
Amounts Contract Inflation Details of (in
Cost Item (in thousands) Increase Rate Years Calculations thousands)
Direct material $200 10% 5% 3 (200 .10 1.05 3) $ 63.0
Direct labor 400 10% 10% 3 (400 .10 1.10 3) 132.0
Indirect labor 100
Supplies 40 10% 10% 3 (40 .10 1.10 3) 13.2
Additional supplies $4 10% 3 (4 1.10 3) 13.2
Power 120 10% 20% 3 (120 .10 1.20 3) 43.2
Additional power $10 20% 3 (10 1.20 3) 36.0
Factory administration 60 $15* 10% 3 (15 1.10 3) 49.5
Depreciation 70
Sales commission $10 10.0
Total incremental costs $360.1

*The current amount of factory administration, $60,000, will be unchanged, but an additional part-time factory
supervisor will be hired at an annual cost of $15,000.

The company has idle capacity that will be fully utilized by this order. The capacity costs (i.e., depreciation)
would be expensed whether management accepted the order or not. Therefore, the depreciation is a sunk cost and
is not considered an incremental cost of the order.

McGraw-Hill/Irwin 2002 The McGraw-Hill Companies, Inc.

15-44 Solutions Manual
CASE 15-51 (CONTINUED)

The total price needed by Polaski for the three-year order is $432,120 as shown in
the calculations below:

S = IC + ( S IC ) .4 + .10 S
S = $360,100 + ( S $360,100).4 + .10 S
S = $360,100 + .4 S $144,040 + .10 S
.5 S = $216,060
S = $432,120
2. If the three-year order is to contribute nothing to net income after taxes, Polaski
would set the total price at $360,100, an amount equal to the incremental costs to
produce the order.

CASE 15-52 (60 MINUTES)

Memorandum
Date: Today
To: President, CPI
From: I.M. Student
Subject: Convention fee
CPI can maximize its contribution from its annual convention by charging a single, flat
fee of $300. Using this fee structure, CPIs contribution will be $400,925 as shown by the
detailed calculations for the separate pricing option and the three single, flat fee options
that follow.

Pricing Option Contribution

Separate pricing $374,200
Flat fee options:
$325 400,100
300 400,925
275 387,550

McGraw-Hill/Irwin 2002 The McGraw-Hill Companies,

Inc.
Managerial Accounting, 5e 15- 45
 CASE 15-52 (CONTINUED)
(a) Contribution analysis for separate pricing
(estimated hotel registrations = 60% 2,000 = 1,200):

Estimated Contri-
Function Attendance Revenue Expense bution
Registration .................... 100% 2,000 = 2,000 $100,000 $ -0- $100,000
Reception ....................... 100% 2,000 = 2,000 -0- 50,000 (50,000)
Annual meeting* .............. 100% 2,000 = 2,000 -0- -0-* -0-
Keynote luncheon ............ 90% 2,000 = 1,800 72,000 45,000 27,000
Six concurrent sessions* . 70% 2,000 = 1,400 84,000 -0-* 84,000
Plenary session* ............. 70% 2,000 = 1,400 70,000 -0-* 70,000
Six workshops ................. 50% 2,000 = 1,000 100,000 -0-* 100,000
Banquet .......................... 90% 2,000 = 1,800 90,000 54,000 36,000
Hotel credit for free rooms
1,200
$125 .8 3
50

(7,200)
7,200
Total ............................... $516,000 $141,800 $374,200

*Meeting rooms and halls are free when 1,000 members are expected to register at the
hotel.

Reflects 20% discount.

McGraw-Hill/Irwin 2002 The McGraw-Hill Companies,

Inc.
15-46 Solutions Manual
CASE 15-52 (CONTINUED)

(b) Contribution analysis for flat fee pricing.

$325 $300 $275

Fee Fee Fee
Number of attendees (given) 1,600 1,750 1,900
Estimated hotel registrations (60%) 960 1,050 1,140
Number of free rooms
(registration divided by 50, with
no fractional credit) 19 21 22
Revenue (fee attendees) $520,000 $525,000 $522,500
Expenses
Reception ($25 100% attendees) $ 40,000 $ 43,750 $ 47,500
Annual meeting* 2,000 -0- -0-
Keynote luncheon ($25 90% 36,000 39,375 42,750
attendees)
Six concurrent sessions* 1,200 -0- -0-
Plenary session* 2,000 -0- -0-
Six workshops 1,200 -0- -0-
Banquet ($30 90% attendees) 43,200 47,250 51,300
Total expenses $125,600 $130,375 $141,550
Revenue less expenses $394,400 $394,625 $380,950
Room credit ($300 free rooms) 5,700 6,300 6,600
Contribution $400,100 $400,925 $387,550

*Meeting rooms and halls are free when 1,000 members are expected to
register at the hotel.

Reflects 20% discount.

McGraw-Hill/Irwin 2002 The McGraw-Hill Companies,

Inc.
Managerial Accounting, 5e 15- 47
CURRENT ISSUES IN MANAGERIAL ACCOUNTING
ISSUE 15-53

HIGH FUEL PRICES MAY HURT STORES, NOT CONSUMERS," THE WALL STREET
JOURNAL , SEPTEMBER 28, 2000, DANIEL MACHALABA AND REBECCA QUICK.
1. Retailers will absorb increased shipping costs instead of passing them along to
customers for the holiday season discussed in this article. The highly competitive
nature of the season determines that the cost of retail goods will be determined by
market-based pricing.

2. Cost-based pricing is when sellers determine their costs and add a profit margin.
Market-based pricing is when a competitive price is determined at which the
product will sell. As mentioned above, market-based pricing is likely to prevail in
this scenario.

ISSUE 15-54

CAR MAKERS MAY TRY TO ALTER PRICING PRACTICES," THE WALL STREET
JOURNAL , JANUARY 24, 2000, JOSEPH B. WHITE AND FARA WARNER.
U. S. auto dealers are changing their pricing policies as a result of the surge in online
auto trading by adjusting their online prices on a daily basis. A growing number of
dealers already are abandoning the practice of negotiating down from an MSRP, as
more consumers come to showrooms armed with invoice price information downloaded
from the internet.

McGraw-Hill/Irwin 2002 The McGraw-Hill Companies,

Inc.
15-48 Solutions Manual
ISSUE 15-55

AUTO MAKERS BOOST CHARGES FOR SHIPPING NEW CARS BECAUSE OF

HIGHER FUEL COSTS," THE WALL STREET JOURNAL, OCTOBER 25, 2000,
SHOINN FREEMAN.
1. The issue involved in the decision to pass on to consumers the higher prices of fuel
costs are increased pressure on profit margins as real prices for new cars actually
decline.

2. As all auto makers feel the decline in profits, cost-based pricing takes priority
across the industry. Without profits the auto industry cannot stay in business, and
therefore all makers have to raise prices. The auto makers do not have to compete
against each other on an unbalanced price-competitive field.

ISSUE 15-56

VOLKSWAGEN AG PLANS ONLINE SUPPLY MARKET IN MOVE TO CUT COSTS," THE

WALL STREET JOURNAL , APRIL 13, 2000.
In a competitive bidding situation, two or more companies submit sealed bids for a
product, service, or project to a buyer. The buyer selects one of the companies for
the job on the basis of the bid price and the design specifications for the job.
Volkswagen hopes to take the lead in establishing a European Internet-supply
network. Although the supply network could result in competitive bidding, its focus
will be on the efficiency of the supply chain.

ISSUE 15-57

CHANGING CODE: FOR POLICY MAKERS, MICROSOFT SUGGESTS NEED TO

RECAST MODELS - AGENCIES SCRAMBLE AS WEB POSES GOOD MONOPOLIES,
SKEWS CLASSIC ECONOMICS - AVALANCHE VS. THERMOSTAT, " THE WALL
STREET JOURNAL , JUNE 9, 2000, ALAN MURRAY.
1. Several car manufacturers recently joined together to form a single linked
exchange that big auto companies will use for purchasing parts. The combined
purchasing platform is being done so the auto industry can have standards. The
end result will be more competition.

McGraw-Hill/Irwin 2002 The McGraw-Hill Companies,

Inc.
Managerial Accounting, 5e 15- 49
 2. In information businesses, the desire for everyone to be part of the same network
is intense. This is the network effect.

ISSUE 15-58

TARGET COSTING CAN BOOST YOUR BOTTOM LINE, " STRATEGIC FINANCE , JULY
1999, GERMAIN BOER AND JOHN ETTLIE.

Using the bottom-up approach engineers can add the estimated prices of purchased
components and estimated production costs for each part that goes into a new
product. Databases containing current component purchase prices, product routings,
and bills of material for existing parts enable design engineers to estimate the cost of
new parts. Another approach is to deduct the desired margin for a product from the
predicted selling price. This approach is consistent with the Japanese concept of
price-down, cost-down, which says production costs must decline as the price of a
product declines. In other words, the market determines the acceptable cost for a
product.

ISSUE 15-59

MACHINE CIGARETTE VENDORS SUE PHILIP MORRIS ON PRICES," THE WALL

STREET JOURNAL , FEBRUARY 4, 1999.
Price discrimination is when a vendor sells their products at different prices to various
buyers, usually using such techniques as merchant rebates, buybacks and other
promotional fees. Whether the case in question constitutes price discrimination will
be determined by the courts.

ISSUE 15-60

HOW SHOULD WE PRICE OUR PRODUCTS? " CONVERTING , AUGUST 2000, SKIP
HEINTZELMAN.

The article discusses several methods of pricing products, including full-cost

coverage, marking up material cost, marking up full factory cost, and marking up
conversion cost.

According to the article, marking up material costs to price products will tend to
encourage jobs using low-priced materials and penalize products requiring higher-
priced materials.

McGraw-Hill/Irwin 2002 The McGraw-Hill Companies,

Inc.
15-50 Solutions Manual