For many years, Leno Corporation has used a straightforward cost-plus pricing system, marking its goods up approximately 25 percent of total cost. The company has been profitable; however, it has recently lost considerable business to foreign competitors that have become very aggressive in the marketplace. These firms appear to be using target costing.
An example of Leno's problem is typified by item no. 8976, which has the following unit-cost characteristics:
Direct material .............................................................................. $30
Direct labor ..................................................................................... 75
Manufacturing overhead ................................................................. 50
Selling and administrative expenses ............................................... 25
The going market price for an identical product of comparable quality is $195, which is significantly below what Leno is charging.
Required:
1. Contrast cost-plus pricing and target costing. Which of the two approaches could be aptly labeled price-led costing? Why?
2. What is Leno's current selling price of item no. 8976?
3. If Leno used target costing for item no. 8976, what must happen to costs if the company desires to meet the market price and maintain its current rate of profit on sales? By how much?
4. Would the identification of value-added and non-value-added costs assist Leno in this situation?
Briefly explain.
5. Suppose that by previous cost-cutting drives, costs had already been "pared to the bone" on item no. 8976. What might Leno be forced to do with its markup on cost to remain competitive? By how much?
6. Early in this chapter, the text noted that in many industries, prices are the result of an interaction between market forces and costs. Explain what is meant by this statement.
7. Build a spreadsheet: Construct an Excel spreadsheet to solve requirements (2) and (3) above. Show how the solution will change if the following information changes: the direct material and direct labor per unit are $25 and $85, respectively?