Appendix A

Appendix A Pricing Products and Services

True/False Questions

1. The price elasticity of demand is used to determine the markup over cost when computing the profit-maximizing price.

Ans: True AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Easy

2. Assume that the price elasticity of demand is less than -1. If the absolute value of the price elasticity of demand increases, the profit-maximizing price increases.

Ans: False AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Hard

3. If the unit sales for one product are more sensitive to price increases than another product, then its markup over variable cost should be more than for the other product if the company wants to maximize profit.

Ans: False AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Medium

4. Demand for a product is said to be elastic if a change in price has little effect on the number of units sold.

Ans: False AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Medium

5. The demand for products that are sold in discount stores is generally less elastic than the demand for products sold in upscale boutiques.


6. The price elasticity of demand can be estimated using the formula ln(1 + percentage change in quantity sold)/ln(1 + percentage change in selling price).

Ans: True AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Easy

Garrison/Noreen/Brewer, Managerial Accounting, Twelfth Edition A-3


7. Under the absorption approach to cost-plus pricing described in the text, all fixed costs are included in the cost base in setting a selling price.


8. The absorption costing approach to cost-plus pricing will result in attaining the company's required rate of return only if forecasted unit sales are realized.

Ans: True AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 2 Level: Medium

9. The markup over cost under the absorption costing approach would decrease if the required rate of return increases, holding everything else constant.


10. The markup over cost under the absorption costing approach would decrease if the unit product cost increases, holding everything else constant.

Ans: True AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 2 Level: Hard

11. Holding all other things constant, an increase in variable production costs will affect:A) the markup under the absorption costing approach to cost-plus pricing.B) the markup used to compute the profit-maximizing price.C) both the markup under the absorption costing approach to cost-plus pricing and

the markup used to compute profit-maximizing price.D) neither the markup under the absorption costing approach to cost-plus pricing

nor the markup used to compute profit-maximizing price.

Ans: A AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1; 2 Level: Hard

A-4 Garrison/Noreen/Brewer, Managerial Accounting, Twelfth Edition


Multiple Choice Questions

12. Holding all other things constant, an increase in fixed production costs will affect:A) the markup under the absorption costing approach to cost-plus pricing.B) the markup used to compute the profit-maximizing price.C) both the markup under the absorption costing approach to cost-plus pricing and

the markup used to compute profit-maximizing price.D) neither the markup under the absorption costing approach to cost-plus pricing

nor the markup used to compute profit-maximizing price.

Ans: A AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1; 2 Level: Hard

13. Holding all other things constant, if fixed costs increase, the profit-maximizing price will:A) increase.B) decrease.C) remain the same.D) The effect cannot be determined.

Ans: C AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Hard

14. When using the absorption approach to cost-plus pricing described in the text:A) all costs are included in the cost base.B) the “plus” or markup figure contains fixed costs and desired profit.C) the cost base is made up of the unit product cost.D) only selling and administrative expenses are included in the cost base.

Ans: C AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 2 Level: Medium

15. Which of the following items are included in the cost base under the absorption approach to cost-plus pricing?

Variable Cost Fixed Cost

Production SellingProductio

n SellingA) Yes Yes Yes NoB) No Yes No YesC) Yes Yes No NoD) Yes No Yes No

Ans: D AACSB: Analytic AICPA BB: Critical Thinking



AICPA FN: Reporting LO: 2 Level: Medium



16. Fipps Company's management believes that every 7% increase in the selling price of one of the company's products results in a 12% decrease in the product's total unit sales. The variable production cost of this product is $38.00 per unit and the variable selling and administrative cost is $5.00 per unit.The product's profit-maximizing price according to the formula in the text is closest to:A) $47.82B) $51.17C) $99.78D) $91.35

Ans: D AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Medium

Solution:

Price elasticity of demand= ln(1 + % change in quantity sold)/ln(1 + % change in price)= ln(1 + −12%)/ln(1 + 7%) = −1.8894

Profit maximizing markup on variable cost = -1/(1+ed) = −1/(1+(-1.8894)) = 1.1244Profit-maximizing price = (1+ Profit-maximizing markup on variable cost)*Variable cost per unit = (1 + 1.1244)*($38 + $5) = (2.1244)*$43 = $91.35 (rounded)

17. Goren Company's management has found that every 3% decrease in the selling price of one of the company's products leads to a 8% increase in the product's total unit sales. The product's absorption costing unit product cost is $12.70. The variable production cost of the product is $1.20 per unit and the variable selling and administrative cost is $4.30 per unit.

According to the formula in the text, the product's profit-maximizing price is closest to:A) $9.10B) $21.02C) $9.62D) $15.43

Ans: A AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Medium



Solution:

Price elasticity of demand= ln(1 + % change in quantity sold)/ln(1 + % change in price)= ln(1 + 8%)/ln(1 + −3%) = ln(1.08)/ln(0.97) = −2.5267

Profit maximizing markup on variable cost = −1/(1+ed) = −1/(1 + (−2.5267)) = 0.6550Profit-maximizing price = (1+ Profit-maximizing markup on variable cost)*Variable cost per unit = (1 + 0.6550)*($1.20 + $4.30) = (1.6550)*$5.50 = $9.10

18. Inoye Company recently changed the selling price of one of its products. Data concerning sales for comparable periods before and after the price change are presented below.

Selling Price Unit Sales

$36.00 2,500$37.00 2,350

The product's variable cost is $21.00 per unit.According to the formula in the text, the product's profit-maximizing price is closest to:A) $39.91B) $22.84C) $38.81D) $37.71


Solution:

Percent change in price = ($37.00 − $36.00)/$36.00 = 2.78%Percent change in total unit sales = (2,350 − 2,500)/2,500 = -6%Price elasticity of demand= ln(1 + % change in quantity sold)/ln(1 + % change in price)= ln(1 + −6%)/ln(1 + 2.78%) = −2.2565

Profit maximizing markup on variable cost = −1/(1 + ed) = -1/(1 + (−2.2565)) = 0.7959Profit-maximizing price = (1 + Profit-maximizing markup on variable cost)*Variable cost per unit = (1 + 0.7959)*$21.00 = (1.7959)*$21.00 = $37.71



19. Ericksen Company's management believes that every 7% decrease in the selling price of one of the company's products leads to a 19% increase in the product's total unit sales. The product's price elasticity of demand as defined in the text is closest to:A) -1.39B) -2.88C) -2.40D) -1.83

Ans: C AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Easy

Solution:

Price elasticity of demand= ln(1 + % change in quantity sold)/ln(1 + % change in price)= ln(1 + 19%)/ln(1 + −7%) = -2.40

20. Haptas Company recently changed the selling price of one of its products. Data concerning sales for comparable periods before and after the price change are presented below.


$24.00 6,900$25.00 6,600

The product's price elasticity of demand as defined in the text is closest to:A) −1.04B) −1.13C) −1.09D) −1.10


Solution:

Percent change in price = ($24 − $25)/$25 = −4%Percent change in total unit sales = (6,900 − 6,600)/6,600 = −4.545%Price elasticity of demand= ln(1 + % change in quantity sold)/ln(1 + % change in price)= ln(1 + 4.545%)/ln(1 + -4%) = −1.09



21. Willow Company manufactures and sells 20,000 units of Product Z each year. In order to produce and sell this many units, it has been necessary for the company to make an investment of $500,000 in Product Z. The company requires a 20% rate of return on all investments in products. Selling and administrative expenses associated with Product Z total $200,000 per year. The unit product cost of Product Z is $20. The company uses the absorption costing approach to cost-plus pricing described in the text. The selling price for Product Z is:A) $25.00B) $30.00C) $35.00D) $40.00


Solution:

Markup percentage on absorption cost= [(Required ROI × Investment) + Selling and administrative expenses]÷ [Unit product cost × Units sales]

Markup on absorption cost = [(20% × $500,000) + $200,000] ÷ ($20.00 × 20,000)= [$100,000 + $200,000] ÷ $400,000 = 75.00%

Target selling price = $20.00 + (75.00% × $20.00) = $35.00



22. Kirk, Inc., manufactures a product with the following costs:

Per unit Per yearDirect materials...................................................... $17.40Direct labor............................................................ $15.10Variable manufacturing overhead.......................... $4.10Fixed manufacturing overhead.............................. $696,600Variable selling and administrative expenses........ $2.90Fixed selling and administrative expenses............. $761,400

The company uses the absorption costing approach to cost-plus pricing described in the text. The pricing calculations are based on budgeted production and sales of 54,000 units per year.

The company has invested $420,000 in this product and expects a return on investment of 12%.

The selling price based on the absorption costing approach would be closest to:A) $67.43B) $49.86C) $90.59D) $66.50


Solution:

Direct materials.......................................... $17.40Direct labor................................................ 15.10Variable manufacturing overhead.............. 4.10Fixed manufacturing overhead.................. 12.90 Unit product cost........................................ $49.50


Markup on absorption cost = [(12% × $420,000) +($2.90 × 54,000 + $761,400)] ÷ ($49.50 × 54,000)= [$50,400 + $918,000] ÷ $2,673,000 = 36.23%




23. Mahaffey, Inc., uses the absorption costing approach to cost-plus pricing described in the text to set prices for its products. Based on budgeted sales of 56,000 units next year, the unit product cost of a particular product is $63.40. The company's selling and administrative expenses for this product are budgeted to be $1,237,600 in total for the year. The company has invested $540,000 in this product and expects a return on investment of 8%.

The selling price for this product based on the absorption costing approach would be closest to:A) $86.27B) $85.50C) $68.47D) $116.34


Solution:

Markup percentage on absorption cost= [(Required ROI × Investment) + Selling and administrative expenses]÷ [Unit product cost × Unit sales]

Markup on absorption cost = [(8% × $540,000) + $1,237,600] ÷ ($63.40 × 56,000)= [$43,200 + $1,237,600] ÷ $3,550,400 = 36.07%


24. Perkins Company estimates that an investment of $500,000 would be needed to produce and sell 25,000 units of Product A each year. At this level of activity, the unit product cost would be $40. Selling and administrative expenses would total $300,000 each year. The company uses the absorption costing approach to cost-plus pricing described in the text. If a 20% rate of return on investment is desired, then the required markup for Product A would be:A) 10%B) 20%C) 30%D) 40%




Solution:


Markup on absorption cost = [(20% × $500,000) + $300,000] ÷ ($40 × 25,000)= [$100,000 + $300,000] ÷ $1,000,000 = 40%

25. The following information is available on Morton Company's Product B:

Number of units sold each year........ 40,000Unit product cost............................... $25Investment in the product line........... $850,000Required return on investment.......... 20%

The company uses the absorption costing approach to cost-plus pricing described in the text and a 60% markup. Based on these data, the company's total selling and administrative expenses associated with Product B each year are:A) $625,000B) $600,000C) $510,000D) $430,000

Ans: D AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 2 Level: Hard

Solution:

Markup percentage on absorption cost= [(Required ROI × Investment) + Selling and administrative expenses]÷ [Unit product cost × Units sales]= [(20% × $850,000) + Selling and administrative expenses] ÷ [$25 × 40,000] = 60%= [$170,000 + Selling and administrative expenses] ÷ $1,000,000 = 60%$170,000 + Selling and administrative expenses = $600,000Selling and administrative expenses = $430,000



26. Jaap Corporation makes a product with the following costs:

Per unit Per yearDirect materials...................................................... $12.50Direct labor............................................................ $13.10Variable manufacturing overhead.......................... $3.80Fixed manufacturing overhead.............................. $1,314,500Variable selling and administrative expenses........ $2.50Fixed selling and administrative expenses............. $869,000



The markup on absorption cost would be closest to:A) 144.5%B) 8.0%C) 34.3%D) 34.9%


Solution:

The unit product cost is:Direct materials........................................................................ $12.50Direct labor.............................................................................. 13.10Variable manufacturing overhead............................................ 3.80Fixed manufacturing overhead ($1,314,500 ÷ 55,000 units)... 23.90 Unit product cost...................................................................... $53.30

Markup percentage on absorption cost= [(Required ROI × Investment) + Selling and administrative expenses]÷ [Unit product cost × Units sales]= [(8% × $200,000) + ($2.50 × 55,000 + $869,000)] ÷ [$53.30 × 55,000] = 34.9%



27. Laflam Corporation uses the absorption costing approach to cost-plus pricing described in the text to set prices for its products. Based on budgeted sales of 55,000 units next year, the unit product cost of a particular product is $53.60. The company's selling and administrative expenses for this product are budgeted to be $709,500 in total for the year. The company has invested $100,000 in this product and expects a return on investment of 15%.The markup on absorption cost for this product would be closest to:A) 24.1%B) 15.0%C) 24.6%D) 39.1%


Solution:

Markup percentage on absorption cost= [(Required ROI × Investment) + Selling and administrative expenses]÷ [Unit product cost × Units sales]= [(15% × $100,000) + $709,500] ÷ [$53.60 × 55,000] = 24.6%

28. Hieko Company, a manufacturer of moderate-priced time pieces, would like to introduce a new electronic watch. To compete effectively, the watch could not be priced at more than $30. The company requires a return on investment of 15% on all new products. The plan is to produce and sell 25,000 watches each year. This would require a $500,000 investment. The target cost per watch would be:A) $27.00B) $20.00C) $21.50D) $23.00


Solution:

Projected sales (25,000 units × $30 per unit)............... $750,000Less desired profit (15% × $500,000).......................... 75,000 Target cost for 25,000 units......................................... $675,000Target cost per unit ($675,000 ÷ 25,000 units)............ $27.00



29. Home Products, Inc., is planning the introduction of a new food dryer. To compete effectively, the dryer would have to be priced at no more than $40 per unit. An investment of $600,000 would have to be made in order to produce and sell the new dryer. The company requires a return on investment of at least 25% on new products. Assuming that the company expects to produce and sell 30,000 dryers per year, the target cost per dryer would be closest to:A) $18.00B) $35.00C) $20.00D) $24.67

Ans: B AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 3 Level: Easy

Solution:

Projected sales (30,000 units × $40 per unit)............... $1,200,000Less desired profit (25% × $600,000).......................... 150,000 Target cost for 30,000 units......................................... $1,050,000Target cost per unit ($1,050,000 ÷ 30,000 units)......... $35.00

30. Aldose Candy Company is implementing a target costing approach for its latest new product, the “Big Glob” candy bar. The following information relates to the Big Glob project:

Target cost per candy bar....................................... $0.30Expected annual sales (in units) of candy bars...... 400,000Required investment in additional assets............... $800,000Desired return on investment................................. 20%

Based on this information, what is Aldose's target selling price per bar for the Big Glob?A) $0.46B) $0.50C) $0.55D) $0.70




Solution:

(Expected annual sales in units × Target selling price) − (Desired return on investment × Required investment)= (400,000 × Target selling price) − (20% × $800,000) = ($0.30 × 400,000)= (400,000 × Target selling price) = $120,000 + $160,000= (400,000 × Target selling price) = $280,000Target selling price = $0.70

31. The management of Giammarino Corporation is considering introducing a new product--a compact barbecue. At a selling price of $78 per unit, management projects sales of 10,000 units. Launching the barbecue as a new product would require an investment of $100,000. The desired return on investment is 11%. The target cost per barbecue is closest to:A) $86.58B) $78.00C) $76.90D) $85.36


Solution:


32. Hanisch Corporation would like to use target costing for a new product it is considering introducing. At a selling price of $22 per unit, management projects sales of 50,000 units. The new product would require an investment of $400,000. The desired return on investment is 14%. The target cost per unit is closest to:A) $22.00B) $23.80C) $20.88D) $25.08




Solution:


33. A new product, an automated crepe maker, is being introduced at Knutt Corporation. At a selling price of $59 per unit, management projects sales of 70,000 units. Launching the crepe maker as a new product would require an investment of $500,000. The desired return on investment is 12%. The target cost per crepe maker is closest to:A) $59.00B) $66.08C) $58.14D) $65.12


Solution:




Use the following to answer questions 34-36:

Diercks Company makes a product with the following costs:

Per unit Per yearDirect materials...................................................... $22.30Direct labor............................................................ $11.00Variable manufacturing overhead.......................... $1.70Fixed manufacturing overhead.............................. $1,360,800Variable selling and administrative expenses........ $1.70Fixed selling and administrative expenses............. $733,600



Direct labor is a variable cost in this company.

34. The markup on absorption cost is closest to:A) 25.0%B) 114.2%C) 26.4%D) 12.0%


Solution:


Markup percentage on absorption cost= [(Required ROI × Investment) + Selling and administrative expenses]÷ [Unit product cost × Units sales]= [(12% × $400,000) + ($1.70 × 56,000 + $733,600)] ÷ [$59.30 × 56,000] = [$48,000 + $828,800] ÷ $3,320,800 = 26.4%



35. The selling price based on the absorption costing approach is closest to:A) $74.10B) $74.96C) $44.24D) $93.66

Ans: B AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 2 Level: Medium

Solution:


Markup percentage on absorption cost= [(Required ROI × Investment) + Selling and administrative expenses]÷ [Unit product cost × Units sales]= [(12% × $400,000) + ($1.70 × 56,000 + $733,600)] ÷ [$59.30 × 56,000] = [$48,000 + $828,800] ÷ $3,320,800 = 26.4%

The target selling price is determined as follows:Unit product cost................ $59.30Markup--26.4%.................. 15.66 Target selling price............ $74.96

36. If every 10% increase in price leads to an 11% decrease in quantity sold, the profit-maximizing price is closest to:A) $74.10B) $203.00C) $201.51D) $192.18




Solution:Price elasticity of demand= ln(1 + %change in quantity sold)/ln(1 + %change in price)= ln(1 + −11%)/ln(1 + 10%) = −1.22268

Variable cost per unit = $22.30 + $11.00 + $1.70 +$1.70 = $36.70

Profit maximizing markup on variable cost = −1/(1 + ed) = −1/(1+(-1.22268)) = 4.4907Profit-maximizing price = (1 + Profit-maximizing markup on variable cost)*Variable cost per unit = (1+4.4907)*$36.70 = (5.4907)*$36.70 = $201.51


Alsberg Corporation's vice president in charge of marketing believes that every 2% decrease in the selling price of one of the company's products would lead to a 3% increase in the product's total unit sales. The product's absorption costing unit product cost is $12.90. The variable production cost is $1.80 per unit and the variable selling and administrative cost is $2.20 per unit.

37. The product's price elasticity of demand as defined in the text is closest to:A) −1.46B) −1.77C) −1.76D) −1.32


Solution:

Price elasticity of demand= ln(1 + %change in quantity sold)/ln(1 + %change in price)= ln(1 + 3%)/ln(1 + −2%) = −1.46



38. The product's profit-maximizing price according to the formula in the text is closest to:A) $5.69B) $40.76C) $6.95D) $12.64


Solution:


Profit maximizing markup on variable cost = −1/(1 + ed) = −1/(1+(−1.4631)) = 2.16Profit-maximizing price = (1+ Profit-maximizing markup on variable cost)*Variable cost per unit = (1 + 2.16)*$4.00 = (3.16)*$4.00 = $12.64


Boe Company's management believes that every 3% decrease in the selling price of one of the company's products would lead to a 9% increase in the product's total unit sales. The product's variable cost is $11.30 per unit.



Solution:





Ans: A AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Easy

Solution:


Profit maximizing markup on variable cost = −1/(1 + ed) = −1/(1+(−2.83)) = 0.546Profit-maximizing price = (1 + Profit-maximizing markup on variable cost)*Variable cost per unit = (1 + 0.546)*$11.30 = (1.546)*$11.30 = $17.46


Coco Company recently changed the selling price of one of its products. Data concerning sales for comparable periods before and after the price change are presented below.


$50.00 1,700$47.00 1,900

The product's variable cost is $18.50 per unit.




Ans: D AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Easy

Solution:

Percent change in price = ($47.00 − $50.00) ÷ $50.00 = −6%Percent change in quantity sold = (1,700 − 1,900) ÷ 1,700 = 11.76%Price elasticity of demand = ln(1 + %change in quantity sold)/ln(1 + %change in price)= ln(1 + 11.76%)/ln(1 + −6%) = −1.80



Solution:

Percent change in price = ($47.00 − $50.00) ÷ $50.00 = −6%Percent change in quantity sold = (1,700 − 1,900) ÷ 1,700 = 11.76%Price elasticity of demand= ln(1 + %change in quantity sold)/ln(1 + %change in price)= ln(1 + 11.76%)/ln(1 + −6%) = −1.7969

Profit maximizing markup on variable cost = -1/(1 + ed) = −1/(1+(−1.7969)) = 1.254Profit-maximizing price = (1 + Profit-maximizing markup on variable cost)*Variable cost per unit = (1 + 1.254)*$18.50 = (2.254)*$18.50 = $41.70




Nance Company is about to introduce a new product. It is expected that the following costs would be incurred at an activity level of 40,000 units produced and sold each year:

Per Unit TotalVariable production costs...................................... $10Fixed production costs........................................... $5 $200,000Variable selling and administrative costs.............. $2Fixed selling and administrative costs................... $3 $120,000

Nance Company uses the absorption costing approach to cost-plus pricing as described in the text.

43. Assume that the company uses a markup of 75% in order to determine selling prices. The selling price for one unit of product would be:A) $21.00B) $26.25C) $31.50D) $35.00

Ans: B AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 2 Level: Medium

Solution:

The unit product cost is:Variable production cost...................................................... $10Fixed manufacturing overhead ($200,000 ÷ 40,000 units). 5 Unit product cost................................................................. $15

The target selling price is determined as follows:Unit product cost................ $15.00Markup--75%..................... 11.25 Target selling price............ $26.25



44. Assume that the company has not yet determined a markup to use on the new product. The new product would require an investment of $1,200,000. The company requires a 25% rate of return on investment in all new products. The markup under the absorption costing approach would be closest to:A) 70.0%B) 50.0%C) 83.3%D) 63.3%


Solution:

The unit product cost is:Variable production cost...................................................... $10Fixed manufacturing overhead ($200,000 ÷ 40,000 units). 5 Unit product cost................................................................. $15

Markup percentage on absorption cost= [(Required ROI × Investment) + Selling and administrative expenses]÷ [Unit product cost × Units sales]= [(25% × $1,200,000) + ($2.00 × 40,000 + $120,000)] ÷ [$15 × 40,000]= [$300,000 + $200,000] ÷ $600,000 = 83.3%



45. After introducing the product, the company finds that it has excess capacity. A foreign dealer has offered to purchase 5,000 units of the product at a special price of $21 per unit. This sale would not disturb regular business. If the special price is accepted on the 5,000 units, the effect on total profits for the year should be:A) $45,000 increaseB) $30,000 increaseC) $5,000 increaseD) $26,250 decrease

Ans: A AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 2 Level: Hard

Solution:

Incremental revenue (5,000 units @ $21 per unit)........................... $105,000Less incremental costs:

Variable production costs (5,000 units @ $10 per unit)................ 50,000Selling and administrative costs (5,000 units @ $2 per unit)........ 10,000

Total incremental cost....................................................................... 60,000 Incremental net operating income..................................................... $ 45,000


Diewold Company has just developed a new product. At an expected sales level of 50,000 units per year, the company anticipates that the following costs will be incurred:

Per Unit TotalVariable production costs................................ $16Fixed production costs..................................... $8 $400,000Variable selling and administrative costs........ $4Fixed selling and administrative costs............. $5 $250,000

Diewold Company uses the absorption costing approach to cost-plus pricing as described in the text.



46. The new product would require an investment of $1,500,000 on which the company would like to earn a return of 18%. The markup using the absorption costing approach would be:A) 72%B) 43.3%C) 60%D) 22.5%


Solution:

The unit product cost is:Variable production costs.................................................... $16Fixed manufacturing overhead ($400,000 ÷ 50,000 units). 8 Unit product cost................................................................. $24

Markup percentage on absorption cost= [(Required ROI × Investment) + Selling and administrative expenses]÷ [Unit product cost × Units sales]= [(18% × $1,500,000) + ($4.00 × 50,000 + $250,000)] ÷ [$24 × 50,000]= [$270,000 + $450,000] ÷ $1,200,000 = 60%

47. After introducing the new product, the company finds that it has excess capacity. A foreign dealer has offered to purchase 3,000 units at a special price of $26 per unit. This sale would not disturb regular business. If the special price is accepted on the 3,000 units, the company's overall net income for the year should:A) increase by $6,000B) decrease by $48,000C) decrease by $21,000D) increase by $18,000

Ans: D AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 2 Level: Hard



Solution:

Incremental revenue (3,000 units @ $26 per unit)........................... $78,000Less incremental costs:

Variable production costs (3,000 units @ $16 per unit)................ 48,000Selling and administrative (3,000 units @ $4 per unit)................. 12,000

Total incremental cost....................................................................... 60,000 Incremental net operating income..................................................... $18,000


Eckley Company uses the absorption costing approach to cost-plus pricing as described in the text to set prices for its products. Based on budgeted sales of 49,000 units next year, the unit product cost of a particular product is $51.00. The company's selling and administrative expenses for this product are budgeted to be $1,009,400 in total for the year. The company has invested $240,000 in this product and expects a return on investment of 13%.

48. The markup on absorption cost for this product would be closest to:A) 53.4%B) 13.0%C) 41.6%D) 40.4%


Solution:

Markup percentage on absorption cost= [(Required ROI × Investment) + Selling and administrative expenses]÷ [Unit product cost × Units sales]= [(13% × $240,000) + $1,009,400] ÷ [$51 × 49,000]= [$31,200 + $1,009,400] ÷ $2,499,000 = 41.6%



49. The selling price based on the absorption costing approach for this product would be closest to:A) $71.60B) $57.63C) $101.41D) $72.24


Solution:

Markup percentage on absorption cost= [(Required ROI × Investment) + Selling and administrative expenses]÷ [Unit product cost × Units sales]= [(13% × $240,000) + $1,009,400] ÷ [$51 × 49,000]= [$31,200 + $1,009,400] ÷ $2,499,000 = 41.64%

The target selling price is determined as follows:Unit product cost................ $51.00Markup--41.64%................ 21.24 Target selling price............ $72.24


The management of Musselman Corporation would like to set the selling price on a new product using the absorption costing approach to cost-plus pricing. The company's accounting department has supplied the following estimates for the new product:

Per Unit TotalDirect materials............................................................... $27Direct labor..................................................................... $16Variable manufacturing overhead................................... $8Fixed annual manufacturing overhead............................ $216,000Variable selling and administrative expenses................. $3Fixed annual selling and administrative expenses.......... $72,000

Management plans to produce and sell 9,000 units of the new product annually. The new product would require an investment of $1,305,000 and has a required return on investment of 10%.



50. The absorption costing unit product cost is:A) $51B) $54C) $75D) $86


Solution:

The unit product cost is:Direct materials................................................................... $27Direct labor.......................................................................... 16Variable manufacturing overhead....................................... 8Fixed manufacturing overhead ($216,000 ÷ 9,000 units). . . 24 Unit product cost................................................................. $75

51. To the nearest whole percent, the markup percentage on absorption cost is:A) 25%B) 34%C) 15%D) 10%


Solution:


Markup percentage on absorption cost= [(Required ROI × Investment) + Selling and administrative expenses]÷ [Unit product cost × Units sales]= [(10% × $1,305,000) + ($3.00 × 9,000 + $72,000)] ÷ [$75 × 9,000]= [$130,500 + $99,000] ÷ $675,000 = 34%



52. The unit target selling price using the absorption costing approach is closet to:A) $115B) $86C) $101D) $83


Solution:


Markup percentage on absorption cost= [(Required ROI × Investment) + Selling and administrative expenses]÷ [Unit product cost × Units sales]= [(10% × $1,305,000) + ($3.00 × 9,000 + $72,000)] ÷ [$75 × 9,000]= [$130,500 + $99,000] ÷ $675,000 = 34%

The target selling price is determined as follows:Unit product cost................ $ 75Markup--34%..................... 26 Target selling price............ $101


Wenner Corporation would like to use target costing for a new product it is considering introducing. At a selling price of $44 per unit, management projects sales of 10,000 units. The new product would require an investment of $900,000. The desired return on investment is 10%.



53. The desired profit according to the target costing calculations is:A) $90,000B) $350,000C) $44,000D) $440,000

Ans: A AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 3 Level: Easy

Solution:

Desired profit = 10% × $900,000 = $90,000

54. The target cost per unit is closest to:A) $44.00B) $38.50C) $48.40D) $35.00


Solution:



The management of Rademacher Corporation is considering introducing a new product--a compact lawn blower. At a selling price of $24 per unit, management projects sales of 30,000 units. The lawn blower would require an investment of $200,000. The desired return on investment is 12%.



55. The desired profit according to the target costing calculations is:A) $696,000B) $24,000C) $86,400D) $720,000


Solution:Desired profit = 12% × $200,000 = $24,000

56. The target cost per lawn blower is closest to:A) $24.00B) $23.20C) $26.88D) $25.98


Solution:

Desired profit = 12% × $200,000 = $24,000Projected sales (30,000 units × $24 per unit)............... $720,000Less desired profit (12% × $200,000).......................... 24,000 Target cost for 30,000 units......................................... $696,000Target cost per unit ($696,000 ÷ 30,000 units)............ $23.20



Essay Questions

57. Quickel Company makes a product that has the following costs:


The company uses the absorption costing approach to cost-plus pricing as described in the text. The pricing calculations are based on budgeted production and sales of 33,000 units per year.The company has invested $100,000 in this product and expects a return on investment of 12%.

Required:

a. Compute the markup on absorption cost.b. Compute the selling price of the product using the absorption costing approach.c. Assume that every 10% increase in price leads to a 16% decrease in quantity sold.

Assuming no change in cost structure and that direct labor is a variable cost, compute the profit-maximizing price.



Ans:

a.Direct materials.......................................... $10.30Direct labor................................................ 10.40Variable manufacturing overhead.............. 1.60Fixed manufacturing overhead.................. 13.00 Unit product cost........................................ $35.30

Markup on absorption cost = [(12% × $100,000) + ($1.80 × 33,000 + $495,000)] ÷ ($35.30 × 33,000)= [($12,000) + ($554,400)] ÷ $1,164,900 = 48.62%

b. Target selling price = $35.30 + 48.62% × $35.30 = $52.46

c. Price elasticity of demand= ln(1 + % change in quantity sold)/ln(1 + % change in price)= ln(1 + −16%)/ln(1 + 10%) = −1.83

Profit maximizing markup on variable cost = −1/(1 + ed) = −1/(1 + (−1.83)) = 1.2058Profit-maximizing price = (1 + Profit-maximizing markup on variable cost)*Variable cost per unit = (1 + 1.2058)*$24.10 = (2.2058)*$24.10 = $53.16

AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1; 2 Level: Hard



58. Nicely Corporation's marketing manager believes that every 2% decrease in the selling price of one of the company's products would lead to a 3% increase in the product's total unit sales. The product's absorption costing unit product cost is $23.20. The variable production cost is $1.80 per unit and the variable selling and administrative cost is $1.30.

Required:

b. Compute the product's price elasticity of demand as defined in the text.c. Compute the product's profit-maximizing price according to the formula in the

text.

Ans:

a. Price elasticity of demand= ln(1 + %change in quantity sold)/ln(1 + %change in price)= ln(1 + 3%)/ln(1 + −2%)= −1.46

b. Profit maximizing markup on variable cost = -1/(1+ed) = -1/(1+(-1.46)) = 2.16Profit-maximizing price = (1+ Profit-maximizing markup on variable cost)*Variable cost per unit = (1 + 2.16)*($1.30 +$1.80) = (3.16)*$3.10 = $9.79

AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 1 Level: Medium

59. Pasley Corporation recently changed the selling price of one of its products. Data concerning sales for comparable periods before and after the price change are presented below.


$78.00 6,500$82.00 6,060

The product's variable cost is $22.10 per unit.

Required:

b. a Compute the product's price elasticity of demand as defined in the text.d. Compute the product's profit-maximizing price according to the formula in the

text.



Ans:

a. % change in quantity = -6.77%% change in price = 5.13%

Price elasticity of demand= ln(1 + %change in quantity sold)/ln(1 + %change in price)= ln(1 + −6.77%)/ln(1 + 5.13%) = −1.40

b. Profit maximizing markup on variable cost = −1/(1 + ed) = -1/(1+(−1.40)) = 2.49Profit-maximizing price = (1 + Profit-maximizing markup on variable cost)*Variable cost per unit = (1 + 2.49)*$22.10 = (3.49)*$22.10 = $77.13


60. Robak Corporation manufactures a product that has the following costs:


The company uses the absorption costing approach to cost-plus pricing as described in the text. The pricing calculations are based on budgeted production and sales of 44,000 units per year.The company has invested $160,000 in this product and expects a return on investment of 13%.

Required:

a. Compute the markup on absorption cost.b. Compute the selling price of the product using the absorption costing approach.



Ans:

a.Direct materials.......................................... $15.40Direct labor................................................ 17.90Variable manufacturing overhead.............. 1.20Fixed manufacturing overhead.................. 13.20 Unit product cost........................................ $47.70

Markup on absorption cost = [(13% × $160,000) +($2.00 × 44,000 + $919,600)] ÷ ($47.70 × 44,000)= [($20,800) + ($1,007,600)] ÷ $2,098,800 = 49.00%

b. Target selling price = $47.70 + 49.00% × $47.70 = $71.07


61. The management of Landstrom Corporation would like to set the selling price on a new product using the absorption costing approach to cost-plus pricing. The company's accounting department has supplied the following estimates for the new product:

Per Unit TotalDirect materials............................................................... $28Direct labor..................................................................... $12Variable manufacturing overhead................................... $9Fixed annual manufacturing overhead............................ $132,000Variable selling and administrative expenses................. $4Fixed annual selling and administrative expenses.......... $30,000

Management plans to produce and sell 6,000 units of the new product annually. The new product would require an investment of $1,036,200 and has a required return on investment of 10%.

Required:

a. Determine the unit product cost for the new product.b. Determine the markup percentage on absorption cost for the new product.c. Determine the target selling price for the new product using the absorption costing

approach.



Ans:

a. The unit product cost is:Direct materials................................................................... $28Direct labor.......................................................................... 12Variable manufacturing overhead....................................... 9Fixed manufacturing overhead ($132,000 ÷ 6,000 units). . . 22 Unit product cost................................................................. $71

b. Markup percentage on absorption cost= [(Required ROI × Investment) + Selling and administrative expenses]÷ [Unit product cost × Units sales]= [(10% × $1,036,200) + ($4.00 × 6,000 + $30,000)] ÷ [$71 × 6,000] = 37%

c. The target selling price is determined as follows:Unit product cost................ $71.00Markup--37%..................... 26.27 Target selling price............ $97.27

AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting LO: 2 Level: Easy



62. Bohmker Corporation is introducing a new product whose direct materials cost is $25 per unit, direct labor cost is $13 per unit, variable manufacturing overhead is $9 per unit, and variable selling and administrative expense is $4 per unit. The annual fixed manufacturing overhead associated with the product is $18,000 and its annual fixed selling and administrative expense is $9,000. Management plans to produce and sell 1,000 units of the new product annually. The new product would require an investment of $110,500 and has a required return on investment of 10%. Management would like to set the selling price on a new product using the absorption costing approach to cost-plus pricing.

Required:

a. Determine the unit product cost for the new product.b. Determine the markup percentage on absorption cost for the new product.c. Determine the target selling price for the new product using the absorption costing

approach.

Ans:

a. The unit product cost is:Direct materials........................................................................ $25Direct labor.............................................................................. 13Variable manufacturing overhead............................................ 9Fixed manufacturing overhead ($18,000 ÷ 1,000 units).......... 18 Unit product cost...................................................................... $65

b. Markup percentage on absorption cost= [(Required ROI × Investment) + Selling and administrative expenses]÷ [Unit product cost × Units sales]= [(10% × $110,500) + ($4.00 × 1,000 + $9,000)] ÷ [$65 × 1,000] = 37%

c. The target selling price is determined as follows:Unit product cost................ $65.00Markup--37%..................... 24.05 Target selling price............ $89.05




63. Lodholz Corporation would like to use target costing for a new product that is under consideration. At a selling price of $93 per unit, management projects sales of 10,000 units. The new product would require an investment of $900,000. The desired return on investment is 17%.

Required:

Determine the target cost per unit for the new product.

Ans:



64. The management of Thebeau, Inc., is considering a new product that would have a selling price of $72 per unit and projected sales of 40,000 units. The new product would require an investment of $600,000. The desired return on investment is 19%.

Required:

Determine the target cost per unit for the new product.

Ans:





65. Management of Niemczyk Corporation is considering a new product–an outside speaker–that would have a selling price of $31 per unit and projected sales of 10,000 units. Launching the new product would require an investment of $700,000. The desired return on investment is 16%.

Required:

Determine the target cost per unit for the outdoor speaker.

Ans:

Projected sales (10,000 units × $31 per unit)......... $310,000Less desired profit (16% × $700,000).................... 112,000 Target cost for 10,000 units................................... $198,000Target cost per unit ($198,000 ÷ 10,000 units)...... $19.80



Appendix A

Documents

critical thinking aicpa

analytic aicpa bb

analytic aicpa fn

reflective thinking

critical thinking ans

critical thinking level

absorption approach

costplus pricing