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Learning Objective 3 Price products using the target-costing approach. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 12 - 1 Target Price and Target Cost Target price is the estimated price for a product (or service) that potential customers will be willing to pay. Target Price – Target operating income per unit = Target cost per unit ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 12 - 2 Target Price and Target Cost Steps in developing target prices and target costs: 1. Develop a product that satisfies the needs of potential customers. 2. Choose a target price. 3. Derive a target cost per unit. 4. Perform value engineering to achieve target costs. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 12 - 3 Implementing Target Pricing and Target Costing Latisha’s management wants a 15% target operating income on sales revenues of CC. Target sales revenue is $750 per unit. What is the target cost per unit? $750 × .15 = $112.50, $750 – $112.50 = $637.50 Current full cost per unit of CC is $662.80 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 12 - 4 Implementing Target Pricing and Target Costing Value engineering is a systematic evaluation of all aspects of the value-chain business function with the objective of reducing costs. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 12 - 5 Value-Added Costs A value-added cost is a cost that customers perceive as adding value, or utility, to a product or service: Adequate memory Pre-loaded software Reliability Easy-to-use keyboards ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 12 - 6 Learning Objective 4 Price products using the cost-plus approach. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 12 - 7 Cost-Plus Pricing The general formula for setting a cost-based price is to add a markup component to the cost base. Cost base $ X Markup component Y Prospective selling price $X + Y ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 12 - 8 Cost-Plus Pricing Assume that Latisha’s engineers have redesigned CC into CCI at a new cost of $637.50. The company desires a 20% markup on the full unit cost. What is the prospective selling price? ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 12 - 9 Cost-Plus Pricing Cost base: Markup component: (637.50 × .20) Prospective selling price: ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster $637.50 127.50 $765.00 12 - 10 Cost-Plus Pricing Assume that the capital investment needed for CCI is $75 million, and the company (pretax) target rate of return on investment is 17%. What is the target annual operating income that Latisha needs to earn from CCI? $75,000,000 × .17 = $12,750,000 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 12 - 11 Cost-Plus Pricing What is the target operating income per unit? $12,750,000 ÷ 100,000 units = $127.50/unit ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 12 - 12 Cost-Plus Pricing The 17% target rate of return on investment expresses the company’s expected annual operating income as a percentage of investment. The 20% markup expresses operating income per unit as a percentage of the full product cost per unit. ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 12 - 13 Advantages of Using Full Costs Full recovery of all costs of the product Price stability Simplicity ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 12 - 14 Alternative Cost-Plus Methods Variable manufacturing costs Variable costs of the product Manufacturing function costs ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 12 - 15 End of Chapter 12 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 12 - 16