Managerial Accounting
by James Jiambalvo
Chapter 8:
Pricing Decisions,
Analyzing Customer
Profitability, And
Activity-Based Pricing
Slides Prepared by:
Scott Peterson
Northern State
University
Objectives
1. Compute the profit maximizing price for a
product or service.
2. Perform incremental analysis related to
pricing a special order.
3. Explain the cost-plus approach to pricing and
why it is inherently circular for manufacturing
firms.
4. Explain the target costing process for a new
product.
Objectives
(continued)
5. Analyze customer profitability.
6. Explain the activity-based pricing
approach.
The Profit Maximizing Price
1. Economic theory focuses on the
“demand function.”
2. Own-price elasticity: the higher the
price, the lower the quantity
demanded.
Pricing Special Orders
1. Generally, products are not sold for
less than full cost.
2. In some cases it may be beneficial to
charge a price less than full cost.
3. Special order.
a. Order will not affect demand for a
firm’s other products (or current
sales).
b. Company may be better off charging
a price below full cost.
Pricing Special Orders:
Example, Model A Standard
Unit Costs
Direct Material:
Direct Labor:
Variable Overhead:
Fixed Overhead:
Total:
$30
$15
$10
$20
$75
Should Quality Lens Company accept
(or reject) a bid for 20,000 lenses for $73
each? It depends on whether there is
“excess capacity.”
Cost-Plus Pricing
1. Cost-Plus Pricing is simple, but limited.
2. Ignores demand for product.
3. Leads to circular pricing schemes for
manufacturers.
4. Ignores own-price elasticity.
Target Costing
1. Target Costing Process:
a. Specify features and price.
b. Determine desired profit.
c. Target cost = price – desired profit.
d. Design to meet the target cost.
2. Change price and/or features if product
cannot be designed to meet target cost.
Analyzing Customer
Profitability: Revisiting the
Wholesale Office Supply Case
1. Customer Profitability System (CPM).
a. Indirect costs of servicing customers
assigned to cost pools.
 Returns
 Shipments
b. Using cost drivers, costs are
assigned to customers
2. Customer revenues – product costs indirect costs (above) = customer
profitability.
Activity-Based Pricing
1. Activity-Based Pricing uses the same
information as customer profitability.
2. Also called menu-based pricing.
3. Examples include:
a.
b.
c.
d.
e.
f.
Charge for Internet order: $1.25
Charge for phone, fax or mail order: $4.75
Charge per order line item: $1.00
Delivery charge per mile: $0.40
Per pound packing charge: $0.50
Per item restocking fee: $1.00
Quick Review Question #1
1. To determine the profit-maximizing
price a manager must:
a. Estimate the quantity demanded
for various prices.
b. Estimate variable costs.
c. Both (a) and (b).
d. None of the above.
Quick Review Answer #1
1. To determine the profit-maximizing
price a manager must:
a. Estimate the quantity demanded
for various prices.
b. Estimate variable costs.
c. Both (a) and (b).
d. None of the above.
Quick Review Question #2
2. Cost-plus pricing:
a. Leads to profit maximization.
b. Is inherently circular for
manufacturing firms.
c. Is difficult to perform.
d. None of the above are correct.
Quick Review Answer #2
2. Cost-plus pricing:
a. Leads to profit maximization.
b. Is inherently circular for
manufacturing firms.
c. Is difficult to perform.
d. None of the above are correct.
Quick Review Question #3
3. Target costing:
a. Requires specification of desired
level of profit.
b. Targets specific costs for reduction.
c. Is used primarily with products that
are already in production.
d. Leads to profit maximization.
Quick Review Answer #3
3. Target costing:
a. Requires specification of desired
level of profit.
b. Targets specific costs for reduction.
c. Is used primarily with products that
are already in production.
d. Leads to profit maximization.
Quick Review Question #4
4. Customer profitability is measured as:
a. Revenue – cost of goods sold.
b. Revenue – indirect manufacturing
costs.
c. Revenue – cost of goods soldindirect service costs.
d. Revenue – cost of goods sold –
indirect manufacturing costs.
Quick Review Answer #4
4. Customer profitability is measured as:
a. Revenue – cost of goods sold.
b. Revenue – indirect manufacturing
costs.
c. Revenue – cost of goods soldindirect service costs.
d. Revenue – cost of goods sold –
indirect manufacturing costs.
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