CHAPTER 15

Target Costing and Cost Analysis for

Pricing Decisions

EXERCISE 15-34 (25 MINUTES)

   Cost-Plus Pricing Formula

(1) $600 $1,200 = $600 + (100%  $600) a
Variable manufacturing cost ..........................................
Applied fixed manufacturing cost ..................................
210

(2) $810 $1,200 = $810 + (48.15%  $810) b

Absorption manufacturing cost ......................................
  90
Variable selling and administrative cost .........................
Allocated fixed selling and
 administrative cost .....................................................
  150

(3) Total cost $1,05 $1,200 = $1,050 + (14.29% 

0 $1,050) c

Variable manufacturing cost ..........................................

$600
  90
Variable selling and administrative cost .........................

(4) $690 $1,200 = $690 + (73.91%  $690) d

Total variable cost ........................................................

Explanatory Notes:
a
($1,200 – $600) ÷ $600 = 100%
b
($1,200 – $810) ÷ $810 = 48.15% (rounded)
c
($1,200 – $1,050) ÷ $1,050 = 14.29% (rounded)
d
($1,200 – $690) ÷ $690 = 73.91% (rounded)
EXERCISE 15-35 (30 MINUTES)

Markup percentage profit required to total annual costs not

+
applied to cost base in achieve target ROI included in cost base
cost-plus = cost base per unit
annual
pricing formula  used in cost-plus
volume
pricing formula
total variable selling and total annual
$60,000 
1. Markup percentage = administrative costs fixed costs
480  $400
$60,000 (480 $50) [480 ($250 $100)]
=
480 $400
$60,000 $24,000 $168,000
= $192,000

= 131.25%
Thus, the Wave Darter’s price would be set equal to $925, where
$925 = $400 + ($400  131.25%).

EXERCISE 15-36 (15 MINUTES)

1. Material component of time and material pricing formula:

 material  material material handling 
  
 cost  cost
  
and storagecosts 
 1.05
incurred incurred annual cost of materials  
  
 on job  on job used in Repair Department 

2. Material component of price, using formula developed in requirement

(1):
[$8,000 + ($8,000  .04)]  1.05
  = $8,320  1.05
  = $8,736
New price to be quoted on yacht refurbishment:
Total price of job = time charges + material charges
= $9,000* + $8,736 **
= $17,736

*From Exhibit 15-7.

**
From requirement (1).
 PROBLEM 15-39 (30 MINUTES)

1. (a) Time charges:

annual overhead (excluding
Hourly labor cost + material handling and storage) +
annual labor hours
hourly charge to
cover profit magin
$220,000
= $25.00 + 20,000
+ $5.00

= $41.00 per labor hour

(b) Material charges:

Material cost  material cost material handling and storage costs 

   
incurred on job incurred on job annual cost of materials used 
Material cost  material cost $25,250 
=    
incurred on job  incurred on job $252,500 

2. PRICE QUOTATION

Time charges: Labor time ....................................................................................

800 hours
 Rate ..........................................................................................
 $ per hour
41.00
Total .............................................................................................
$32,800

Material charges: Cost of materials for job ................................................................

$150,000
  15,000*
+ Charge for material handling and storage ....................................
Total .............................................................................................
$165,000

Total price of job: Time .............................................................................................

$ 32,800
 165,000
Material ........................................................................................
Total .............................................................................................
$197,800

*Charge for material handling and storage):

10% = $25,250 ÷ $252,500; 10%  $150,000 = $15,000
Price of job without markup on material costs (from requirement 2) . $ 197,800
3.
Markup on total material costs ($165,000  10%) ...........................    16,500
Total price of job ........................................................................... $214,300
PROBLEM 15-42 (30 MINUTES)

1. Cost-plus pricing begins by computing an item’s cost and then adds an

appropriate markup. The result is the item’s selling price. In contrast,
target costing begins by determining an appropriate selling price. A
target profit is next subtracted from that price to yield the cost (i.e., the
“target cost”) that must be achieved.

Target costing could be labeled price-led costing because it begins by

determining a target selling price. In contrast, cost-plus pricing methods
begin with the cost and culminate in determination of the selling price.

2. The current selling price is $6,750:

Direct $ 900
material…………………………….......
Direct 2,250
labor…………………………………….
Manufacturing 1,500
overhead……………………
Selling and administrative expenses……. 750
Total $5,400
cost………………………………….
Markup ($5,400 x 25%) 1,350
……………………...
Selling $6,750
price………………………………......

3. Lehigh’s markup is $1,350, which is 20% of the current $6,750 selling

price ($1,350 ÷ $6,750). To achieve a 20% markup on a $5,500 selling
price, the company must reduce its costs by $1,000.

Selling $5,500
price………………………………….
Less: 20% markup ($5,500 x 20%) 1,100
……….
Target $4,400
cost……………………………………

Current $5,400
cost………………………………….
Less: Target 4,400
cost…………………………..
Required cost $1,000
reduction………………….

4. Yes. The company should focus its efforts on trimming non-value-added

costs. These costs are associated with non-value-added activities (i.e.,
 activities that are either (a) unnecessary and dispensable or (b) necessary,
but inefficient and improvable).
5. If costs cannot be reduced below $5,400, Lehigh will have to reduce its
markup to remain competitive. Assuming a desire to achieve the going
market price of $5,500, the markup must equal $100 ($5,500 - $5,400), or
1.85% of cost ($100 ÷ $5,400). Given that the current markup on cost is
25%, a reduction of 23.15% is needed (25.00% - 1.85%).

6. The statement means that selling prices are a function of market

conditions; however, the selling prices must cover a company’s costs in the
long run. Also, in a number of industries, prices are based on costs. Yet,
the prices are subject to the reaction of customers and competitors.

7. In the electronic version of the solutions manual, press the CTRL key
and click on the following link: 10E - BUILD A SPREADSHEET 15-
42.XLS