1

Click to edit Master title style

• Click to edit Master text styles– Second level

• Third level– Fourth level

» Fifth level

1

9

Differential Analysis and Product Pricing

Student Version

1-29-22

1

1

Prepare differential analysis reports for a variety of managerial decisions.

9-2

1-39-33

Sunk Costs

Costs that have been incurred in the past are not relevant to the decision. These costs are called sunk costs.

1

1-49-44

Differential revenue is the amount of increase or decrease in revenue that is expected from a course of action as compared with an alternative action.

Differential Revenue

1

1-59-55

Differential cost is the amount of increase or decrease in cost that is expected from a course of action as compared with an alternative action.

Differential Cost

1

1-69-66

Differential income (or loss) is the difference between the differential revenue and the differential costs. Differential income indicates that a particular decision is expected to be profitable, while a differential loss indicates the opposite.

Differential Income or Loss

1

1-79-77

Marcus Company is considering leasing or disposing of the following equipment:

Lease or Sell

Cost of equipment $200,000Less accumulated depreciation 120,000Book value $ 80,000Lease Option:

Total revenue for five-year lease 160,000Total estimated repair, insurance,

and property tax expenses during life of lease 35,000

Sell Option:Sales price $100,000Commission on sale 6%

1

1-89-88

Differential Analysis Report—Lease or SellExhibit 2

1

1-99-99

Management may consider discontinuing the product or segment of a business that is generating losses. Based on the information contained in the condensed income statement (Slide 10), management of Battle Creek Cereal Co. is considering discontinuing Bran Flakes.

Discontinue a Segment or Product

1

1-109-1010

Income (Loss) by ProductExhibit 4

1

1-119-1111

Differential Analysis Report—Discontinue an Unprofitable Segment

Don’t discontinue Bran Flakes!

Exhibit 5

1

1-129-1212

Make or Buy

An automobile manufacturer has been purchasing instrument panels for $240 a unit. The factory currently operates at 80% of capacity. The cost per unit is estimated as follows:

Direct materials $ 80Direct labor 80Variable factory overhead 52Fixed factory overhead 68Total estimated cost per unit $280

1

1-139-1313

Differential Analysis Report—Make or BuyExhibit 7

1

1-149-1414

The amount of income that is foregone from an alternative use of an asset, such as cash, is called an opportunity cost.

Opportunity Cost

1

1-159-1515

A business produces kerosene as follows:

Process or Sell

Batch size 4,000 gallonsCost of producing kerosene $2,400 per batchSelling price $0.80 per gallon

(continued)

1

1-169-1616

The kerosene can be processed further to yield gasoline as follows:

Process or Sell

Input batch size 4,000 gallonsLess evaporation (20%) 800 (4,000 × 20%)Output batch size 3,200

Additional processing costs $650 per batch

Selling price $1.25 per gallon

1

(continued)

1-179-1717

Differential Analysis Report—Process or SellExhibit 9

1

1-189-1818

Accept Business at a Special Price

B-Ball Inc. manufactures basketballs as follows:

Monthly productive capacity 12,500 basketballsCurrent monthly sales 10,000 basketballsNormal (domestic) selling price $30.00 per basketballManufacturing costs:

Variable costs $12.50 per basketballFixed costs 7.50 Total $20.00 per basketball

1

1-199-1919

The manufacturer receives an offer from an exporter for 5,000 basketballs at $18 each. Production can be spread over three months, so these basketballs can be manufactured using normal capacity. Domestic sales would not be affected.

Accept Business at a Special Price

1

1-209-2020

Differential Analysis Report—Sell at Special Price

Exhibit 10

1

1-219-2121

1

2

Determine the selling price of a product using the total cost, product cost, and variable cost concepts.

9-21

1-229-2222

Markup

Using the cost-plus methods, managers add to the cost an amount called a markup. This allows for all costs plus a profit to be included in the selling price.

2

1-239-2323

Manufacturing Cost

Selling Expenses

Administrative Expenses

The markup is determined by applying the following formula:

Markup percentag

e

=Desired profit Total costs

Desired

selling price

Desired Profit

2

1-249-2424

Manufacturing costs:Direct materials ($3.00 × 100,000) $ 300,000Direct labor ($10.00 × 100,000) 1,000,000Factory overhead:

Variable costs ($1.50 × 100,000) $150,000 Fixed costs 50,000 200,000Total manufacturing costs $1,500,000Selling and administrative expenses:

Variable expenses ($1.50 × 100,000) $150,000Fixed costs 20,000

Total selling and administrative expenses 170,000Total cost $1,670,000

2

1-259-2525

Only the desired profit is covered in the markup.

Desired profit Total costs

= 9.6%=

Total cost per calculator $16.70Markup ($16.70 × 9.6%) 1.60Selling price $18.30

$160,000 $1,670,000

Markup Percentage

2

1-269-2626

Using the product cost concept, only the costs of manufacturing the product are included in the cost amount to which the markup is added. The markup percentage is computed as follows:

Product Cost Concept

Markup Percentage =

Desired Profit + Total Selling and Administrative Expenses

Total Product Cost

2

1-279-2727

Manufacturing costs:Direct materials ($3.00 × 100,000) $ 300,000Direct labor ($10.00 × 100,000) 1,000,000Factory overhead:

Variable costs ($1.50 × 100,000) $150,000 Fixed costs 50,000 200,000Total manufacturing costs $1,500,000Selling and administrative expenses:

Variable expenses ($1.50 × 100,000) $150,000Fixed costs 20,000

Total selling and administrative expenses 170,000Total cost $1,670,000

2

1-289-2828

Manufacturing Cost

Product Cost

MarkupAdministrative

Expense

+

Selling Expense

+

Desired Profit

Desired

Desired Selling

Selling PricePrice

Desired Selling Price

2

1-299-2929

Markup Percentage

Desired Profit +

=

Total Selling and Administrative Expenses

Total Manufacturing Costs

Calculating the Markup Percentage

Markup Percentage

$160,000 + $170,000

=$1,500,000

Markup Percentage = 22%

2

1-309-3030

Digital Solutions Inc. would price each calculator at $18.30 per unit, as shown below:

2

Manufacturing cost per calculator $15.00Markup ($15.00 × 22%) 3.30Selling price $18.30

1-319-3131

Variable Cost Concept

The variable cost concept emphasizes the distinction between variable and fixed costs in product pricing. Only variable costs are include in the cost amount to which the markup is added.

2

1-329-3232

Product Cost

Markup

Variable Manufacturing

Cost+

Variable Administrative

and Selling Expenses

Total Fixed Costs + Desired Profit

Desired

Selling Price

2

1-339-3333

Markup Percentage

Desired Profit + =

Total Fixed Costs

Total Variable Costs

Markup Percentage

Markup Percentage

$160,000 + $50,000 + $20,000 =

$1,600,000

Direct materials ($3 × 100,000) $ 300,000Direct labor ($10 × 100,000) 1,000,000Variable factory overhead

($1.50 × 100,000) 150,000Variable selling and

administrative expenses ($1.50 × 100,000) 150,000

Total variable costs $1,600,000

2

1-349-3434

Markup Percentage

Desired Profit + =

Total Fixed Costs

Total Variable Costs

Markup Percentage

Markup Percentage

$160,000 + $50,000 + $20,000 =

$1,600,000

Markup Percentage=

$230,000

$1,600,000= 14.4%

2

1-359-3535

Variable cost per calculator $16.00Markup ($16.00 × 14.4%) 2.30Selling price $18.30

Digital Solutions Inc. would price each calculator at $18.30 per unit, as shown below:

2

1-369-3636

Target Costing

Target costing is a method of setting prices that combines market-based pricing with a cost reductive emphasis. A future price is anticipated, using the demand-based methods or the competition-based methods.

Target Cost = Expected Selling Price – Desired Profit

2

1-379-3737

1

3

Compute the relative profitability of products in bottleneck production processes.

9-37

1-389-3838

Production Bottlenecks and Profits

A production bottleneck (or constraint) occurs at the point in the process where the demand for the company’s product exceeds the ability to produce the product.

3

1-399-3939

Sales price per unit $130 $140

$160

Variable cost per unit 40 40

40

Contribution margin per unit $ 90 $100

$120

Heat treatment hours per unit 1 hr. 4 hrs.

8 hrs.

Small Medium LargeWrench Wrench Wrench

The product unit contribution margin and the number of hours of heat treatment used by each wrench are as follows:

(continued)

3

1-409-4040

Unit Contribution Margin per Bottleneck Hour

=Unit Contribution Margin

Heat Treatment Hours per Unit

Small Wrenches

Unit Contribution Margin per Bottleneck Hour

=$90

1 hr.= $90 per hour

Medium Wrenches

Unit Contribution Margin per Bottleneck Hour

= $100

4 hrs.= $25 per hour

Large Wrenches

Unit Contribution Margin per Bottleneck Hour

=$120

8 hrs.= $15 per hour

3

1-419-4141

Unit Contribution Margin per Bottleneck Hour

=Unit Contribution Margin

Heat Treatment Hours per Unit

Small Wrenches

Unit Contribution Margin per Bottleneck Hour

=$90

1 hr.= $90 per hour

Medium Wrenches

Unit Contribution Margin per Bottleneck Hour

= $100

4 hrs.= $25 per hour

Large Wrenches

Unit Contribution Margin per Bottleneck Hour

=$120

8 hrs.= $15 per hour

The small wrench is the most profitable

product per bottleneck hour.

3

1-429-4242

Contribution Margin (per unit) per Bottleneck Hour for Small

Wrench

=

Revised Price of Large Wrench

Variable Cost per Unit for Large

Wrench–

Bottleneck Hours per Unit for Large Wrench

$90 =

Revised Price of Large Wrench – $40

8 $720 = Revised Price of Large Wrench – $40

$760 = Revised Price of Large Wrench

3

1-439-4343