Cost Accounting (14th Edition)

COST-PLUS PRICING 445
Exhibit 12-5 Target Manufacturing Costs of Provalue II for 2012
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PROVALUE II
PROVALUE
Budgeted
Budgeted Actual Manufacturing
Manufacturing Costs
for 200,000 Units
(1)
Manufacturing
Cost per Unit
(2) = (1) ÷ 200,000
Cost per Unit
(Exhibit 12-1)
(3)
Direct manufacturing costs
Direct material costs
(200,000 kits × $385 per kit)
Direct manufacturing labor costs
(530,000 DML-hours
× $20 per hour)
Direct machining costs
(300,000 machine-hours × $38 per machine-hour)
$ 77,000,000
10,600,000
11,400,000
$385.00
53.00
57.00
$460.00
64.00
76.00
Direct manufacturing costs 99,000,000
495.00 600.00
Manufacturing overhead costs
Ordering and receiving costs
(21,250 orders × $80 per order)
Testing and inspection costs
(3,000,000 testing-hours × $2 per hour)
Rework costs
( 32,500 rework-hours × $40 per hour)
1,700,000
6,000,000
1,300,000
8.50
30.00
6.50
12.00
60.00
8.00
Manufacturing overhead costs 9,000,000
45.00 80.00
Total manufaturing costs $108,000,000
$ 540.00 $ 680.00
To avoid these pitfalls, target-costing efforts should always (a) encourage employee participation
and celebrate small improvements toward achieving the target, (b) focus on the
customer, (c) pay attention to schedules, and (d) set cost-cutting targets for all value-chain
functions to encourage a culture of teamwork and cooperation.
Cost-Plus Pricing
Instead of using the market-based approach for long-run pricing decisions, managers
sometimes use a cost-based approach. The general formula for setting a cost-based price
adds a markup component to the cost base to determine a prospective selling price.
Because a markup is added, cost-based pricing is often called cost-plus pricing, with the
plus referring to the markup component. Managers use the cost-plus pricing formula as
a starting point. The markup component is rarely a rigid number. Instead, it is flexible,
depending on the behavior of customers and competitors. The markup component is
ultimately determined by the market. 4
Cost-Plus Target Rate of Return on Investment
We illustrate a cost-plus pricing formula for Provalue II assuming Astel uses a 12%
markup on the full unit cost of the product when computing the selling price.
Decision
Point
Why is it important
to distinguish cost
incurrence from
locked-in costs?
Learning
Objective 6
Price products using
the cost-plus approach
. . . cost-plus pricing is
based on some
measure of cost plus
a markup
Cost base (full unit cost of Provalue II) $720.00
Markup component of 12% (0.12 * $720) ƒƒ86.40
Prospective selling price $806.40
4 Exceptions are pricing of electricity and natural gas in many countries, where prices are set by the government on the basis of
costs plus a return on invested capital. Chapter 15 discusses the use of costs to set prices in the defense-contracting industry. In
these situations, products are not subject to competitive forces and cost accounting techniques substitute for markets as the
basis for setting prices.