Variable Cost and Contribution Margin

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CHAPTER 12
PRICING DECISIONS AND COST MANAGEMENT

12-1The three major influences on pricing decisions are
1.Customers
2.Competitors
3.Costs

12-2Not necessarily. For a one-time-only special order, the relevant costs are only those costs that will change as a result of accepting the order. In this case, full product costs will rarely be relevant. It is more likely that full product costs will be relevant costs for long-run pricing decisions.

12-3Two examples of pricing decisions with a short-run focus: 1.Pricing for a one-time-only special order with no long-term implications. 2.Adjusting product mix and volume in a competitive market.

12-4Activity-based costing helps managers in pricing decisions in two ways. 1.It gives managers more accurate product-cost information for making pricing decisions. 2.It helps managers to manage costs during value engineering by identifying the cost impact of eliminating, reducing, or changing various activities.

12-5Two alternative starting points for long-run pricing decisions are 1.Market-based pricing, an important form of which is target pricing. The market-based approach asks, “Given what our customers want and how our competitors will react to what we do, what price should we charge?” 2.Cost-based pricing which asks, “What does it cost us to make this product and, hence, what price should we charge that will recoup our costs and achieve a target return on investment?”

12-6A target cost per unit is the estimated long-run cost per unit of a product (or service) that, when sold at the target price, enables the company to achieve the targeted operating income per unit.

12-7Value engineering is a systematic evaluation of all aspects of the value-chain business functions, with the objective of reducing costs while satisfying customer needs. Value engineering via improvement in product and process designs is a principal technique that companies use to achieve target cost per unit.

12-8A value-added cost is a cost that customers perceive as adding value, or utility, to a product or service. Examples are costs of materials, direct labor, tools, and machinery. A nonvalue-added cost is a cost that customers do not perceive as adding value, or utility, to a product or service. Examples of nonvalue-added costs are costs of rework, scrap, expediting, and breakdown maintenance.

12-9No. It is important to distinguish between when costs are locked in and when costs are incurred, because it is difficult to alter or reduce costs that have already been locked in.

12-10Cost-plus pricing is a pricing approach in which managers add a markup to cost in order to determine price.

12-11Cost-plus pricing methods vary depending on the bases used to calculate prices. Examples are (a) variable manufacturing costs; (b) manufacturing function costs; (c) variable product costs; and (d) full product costs.

12-12Two examples where the difference in the costs of two products or services is much smaller than the differences in their prices follow: 1.The difference in prices charged for a telephone call, hotel room, or car rental during busy versus slack periods is often much greater than the difference in costs to provide these services. 2.The difference in costs for an airplane seat sold to a passenger traveling on business or a passenger traveling for pleasure is roughly the same. However, airline companies price discriminate. They routinely charge business travelers––those who are likely to start and complete their travel during the same week excluding the weekend––a much higher price than pleasure travelers who generally stay at their destinations over at least one weekend.

12-13Life-cycle budgeting is an estimate of the revenues and costs attributable to each product from its initial R&D to its final customer servicing and support.

12-14Three benefits of using a product life-cycle reporting format are: 1.The full set of revenues and costs...
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