1. (5-A3) Formulas for Pricing Randy Azarski, a building contractor, builds houses in tracts, often building as many as 20 homes simultaneously. Azarski has budgeted costs for an expected number of houses in 20XO as follows: Direct materials Direct labor Job construction overhead Cost of jobs Selling and administrative costs Total costs $3,500,000 1,000,000 1,500,000 $6,000,000 1,500,000 $7.500.000 The job construction overhead includes approximately $800,000 of fixed costs, such as the salaries of supervisors and depreciation on equipment. The selling and administrative costs include $500,000 of variable costs, such as sales commissions and bonuses that depend fundamentally on overall profitability. Azarski wants an operating income of $1.5 million for 20X0. Compute the average target markup percentage for setting prices as a percentage for the following: (1) Direct materials plus direct labor (2) The full "cost of jobs" (3) The variable "cost of jobs" (4) The full "cost of jobs" plus selling and administrative costs (5) The variable "cost of jobs" plus variable selling and administrative costs 2. (5-37) Unit Costs and Total Costs You are a CPA who belongs to a downtown business club. Annual dues are $150. You use the club solely for the lunches, which cost $9 each. You have not use the club much in recent years, and you are wondering whether to continue your membership. (1) You are confronted with a variable-cost plus a fixed-cost behavior pattern. Plot each on a graph, where the vertical axis is total cost and the horizontal axis is annual volume in number of lunches. Also plot a third graph that combines the previous two graphs. (2) What is the cost per lunch if you pay for your own lunch once a year? Twelve times a year? Two hundred times a year? (3) Suppose the average price of lunches elsewhere is $10. (a) How many lunches must you have at the luncheon club so that the total costs of the lunches would be the same, regardless of where you ate for that number of lunches? (b) Suppose you ate 200 lunches a year at the club. How much would you save in relation to the total costs of eating elsewhere? 3. (5-42) Pricing to Maximize Contribution Reynolds Company produces and sells picture frames. One particular frame for 8x10 photos was an instant success in the market, but recently competitors have come out with comparable frames. Reynolds has been charging $12.50 wholesale for the frames, and sales have fallen from 10,000 units last year to 7,000 units this year. The product manager in charge of this frame is considering lowering the price to $10 per frame. He believes sales will rebound to 10,000 units at the lower price, but they will fall to 6,000 units at the $12.50 price. The unit variable cost of producing and selling the frames is $6, and $60,000 of fixed cost is assigned to the frames. (1) Assuming that the only prices under consideration are $10 and $12.50 per frame, which price will lead to the largest profit for Reynolds? Explain why. (2) What subjective considerations might affect your pricing decision? 4. (5-43) Target Selling Prices Consider the following data from Blackmar Company's budgeted income statement (in thousands of dollars): $90,000 30,000 6,000 36,000 Target sales Variable costs Manufacturing Selling and administrative Total variable costs Fixed costs Manufacturing Selling and administrative Total fixed costs Total of all costs Operating income 8,000 6,000 14,000 50,000 $40,000 Compute the following markup percentages that would be used for obtaining the same target sales as a percentage of (1) total variable costs, (2) full costs, and (3) variable manufacturing costs. 5. (5-45) Target Costing Quality Corporation believes that there is a market for a portable electronic toothbrush that can be easily carried by business travelers. Quality's market research department has surveyed the features and prices of electronic brushes currently on the market. Based on this research, Quality believes that $70 would be about the right price. At this price, marketing believes that about 80,000 new portable brushes can be sold over the product's life cycle. It will cost about $1,000,000 to design and develop the portable brush. Quality has a target profit of 20% of sales. Determine the total and unit target cost to manufacture, sell, distribute, and service the portable brushes. 6. (5-48) Analysis with Contribution Income Statement The following data have been condensed from LaGrande Corporation's report of 2009 operation (in millions of euros): Variable 300 140 Fixed 280 Manufacturing cost of goods sold Selling and administrative expenses Sales Total 580 200 900 (1) Prepare the 2009 income statement in contribution form, ignoring income taxes. (2) La Grand's operations have been fairly stable from year to year. In planning for the future, top management is considering several options for changing the annual pattern of operations. You are asked to perform an analysis of their estimated effects. Use your contribution income statement as a framework to compute the estimated operating income (in millions) under each of the following separate and unrelated assumptions: a) Assume that a 10% reduction in selling prices would cause a 30% increase in the physical volume of goods manufactured and sold. b) Assume that an annual expenditure of 30 million for a special sales promotion campaign would enable the company to increase its physical volume by 10% with no change in selling prices. Assume that a basic redesign of manufacturing operations would increase annual fixed manufacturing costs by 80 million and decrease variable manufacturing costs by 15% per product unit, but with no effect on physical volume or selling prices. Assume that a basic redesign of selling and administrative operations would double the annual fixed expenses for selling and administration and increase the variable expenses for selling and administration by 25% per product unit; it would also increase physical volume by 20%. Selling prices would be increased by 5%. e) Would you prefer to use the absorption form of income statement for the preceding analyses? Explain. (3) Discuss the desirability of alternatives a-d in number (2). If only one alternative could be selected, which would you choose? Explain. d) 7. (5-54) Effects of Volume on Operating Income The Wittred Division of Melbourne Sports Company manufactures boomerangs, which are sold to wholesalers and retailers. The division manager has set a target of 250,000 boomerangs for next month's production and sales has developed an accurate budget for that level of sales. The manager has also prepared an analysis of the effects on operating income of deviations from the target: Volume in units Sales at $3.00 Full costs at $2.00 Operating income 200,000 $600,000 400,000 $200,000 250,000 $750,000 500,000 $250,000 300,000 $900,000 600,000 $300,000 The costs have the following characteristics. Variable manufacturing costs are $ .80 per boomerang; variable selling costs are $.60 per boomerang; fixed manufacturing costs per month are $125,000; and fixed selling and administrative costs per month are $25,000. (1) Prepare a correct analysis of the changes in volume on operating income. Prepare a tabulated set of income statements at levels of 200,000, 250,000, and 300,000 boomerangs. Also show percentages of operating income in relation to sales. (2) Compare your tabulation with the manager's tabulation. Why is the manager's tabulation incorrect? 8. (5-63) Special Order As discussed in Item 1 of Nike's 10-K, one of the companies their own is Cole Haan. Cole Haan makes a variety of fashion footwear, such as dress shoes. One of these products is a man's loafer. This shoe is in strong demand. Suppose sales on this loafer during the present year, 20x0, are expected to hit the 1,000,000 mark. Full plant capacity is 1,150,000 units, but the 1,000,000 unit mark is considered normal capacity. The following unit price and cost breakdown is applicable in 20X0: Per unit Sales price $145.00 Less: Manufacturing costs Materials $49.00 Direct labor 22.00 Overhead: Variable 14.00 Fixed 16.00 Total manufacturing costs $101.00 Gross margin $44.00 Less selling and administrative expense Selling: Variable $5.50 Fixed 9.00 Administrative fixed 12.00 Packaging variable* 3.50 Total selling and administrative expenses $30.00 Net profit before taxed $14.00 *Two types of packaging are available: deluxe, $3.50 per unit; and standard, $2.00 per unit. Variable During March, the company received two-special-order requests from Nordstrom and Macy's. These orders are not part of the budgeted 1,000,000 unit sales for 20x0, but there is sufficient capacity for possibly one order to be accepted. Orders received and their terms are as follows: Order from Nordstrom: 75,000 loafers at $136.00 per unit, deluxe packaging Order from Macy's: 90,000 loafers at $130.00 per unit, standard packaging Since these orders were made directly to Cole Haan, no variable selling costs will be incurred. (1) Analyze the profitability of each of these two special orders. Which special order should be accepted? (2) What other aspects need to be considered in addition to profitability. 1. (5-A3) Formulas for Pricing Randy Azarski, a building contractor, builds houses in tracts, often building as many as 20 homes simultaneously. Azarski has budgeted costs for an expected number of houses in 20XO as follows: Direct materials Direct labor Job construction overhead Cost of jobs Selling and administrative costs Total costs $3,500,000 1,000,000 1,500,000 $6,000,000 1,500,000 $7.500.000 The job construction overhead includes approximately $800,000 of fixed costs, such as the salaries of supervisors and depreciation on equipment. The selling and administrative costs include $500,000 of variable costs, such as sales commissions and bonuses that depend fundamentally on overall profitability. Azarski wants an operating income of $1.5 million for 20X0. Compute the average target markup percentage for setting prices as a percentage for the following: (1) Direct materials plus direct labor (2) The full "cost of jobs" (3) The variable "cost of jobs" (4) The full "cost of jobs" plus selling and administrative costs (5) The variable "cost of jobs" plus variable selling and administrative costs 2. (5-37) Unit Costs and Total Costs You are a CPA who belongs to a downtown business club. Annual dues are $150. You use the club solely for the lunches, which cost $9 each. You have not use the club much in recent years, and you are wondering whether to continue your membership. (1) You are confronted with a variable-cost plus a fixed-cost behavior pattern. Plot each on a graph, where the vertical axis is total cost and the horizontal axis is annual volume in number of lunches. Also plot a third graph that combines the previous two graphs. (2) What is the cost per lunch if you pay for your own lunch once a year? Twelve times a year? Two hundred times a year? (3) Suppose the average price of lunches elsewhere is $10. (a) How many lunches must you have at the luncheon club so that the total costs of the lunches would be the same, regardless of where you ate for that number of lunches? (b) Suppose you ate 200 lunches a year at the club. How much would you save in relation to the total costs of eating elsewhere? 3. (5-42) Pricing to Maximize Contribution Reynolds Company produces and sells picture frames. One particular frame for 8x10 photos was an instant success in the market, but recently competitors have come out with comparable frames. Reynolds has been charging $12.50 wholesale for the frames, and sales have fallen from 10,000 units last year to 7,000 units this year. The product manager in charge of this frame is considering lowering the price to $10 per frame. He believes sales will rebound to 10,000 units at the lower price, but they will fall to 6,000 units at the $12.50 price. The unit variable cost of producing and selling the frames is $6, and $60,000 of fixed cost is assigned to the frames. (1) Assuming that the only prices under consideration are $10 and $12.50 per frame, which price will lead to the largest profit for Reynolds? Explain why. (2) What subjective considerations might affect your pricing decision? 4. (5-43) Target Selling Prices Consider the following data from Blackmar Company's budgeted income statement (in thousands of dollars): $90,000 30,000 6,000 36,000 Target sales Variable costs Manufacturing Selling and administrative Total variable costs Fixed costs Manufacturing Selling and administrative Total fixed costs Total of all costs Operating income 8,000 6,000 14,000 50,000 $40,000 Compute the following markup percentages that would be used for obtaining the same target sales as a percentage of (1) total variable costs, (2) full costs, and (3) variable manufacturing costs. 5. (5-45) Target Costing Quality Corporation believes that there is a market for a portable electronic toothbrush that can be easily carried by business travelers. Quality's market research department has surveyed the features and prices of electronic brushes currently on the market. Based on this research, Quality believes that $70 would be about the right price. At this price, marketing believes that about 80,000 new portable brushes can be sold over the product's life cycle. It will cost about $1,000,000 to design and develop the portable brush. Quality has a target profit of 20% of sales. Determine the total and unit target cost to manufacture, sell, distribute, and service the portable brushes. 6. (5-48) Analysis with Contribution Income Statement The following data have been condensed from LaGrande Corporation's report of 2009 operation (in millions of euros): Variable 300 140 Fixed 280 Manufacturing cost of goods sold Selling and administrative expenses Sales Total 580 200 900 (1) Prepare the 2009 income statement in contribution form, ignoring income taxes. (2) La Grand's operations have been fairly stable from year to year. In planning for the future, top management is considering several options for changing the annual pattern of operations. You are asked to perform an analysis of their estimated effects. Use your contribution income statement as a framework to compute the estimated operating income (in millions) under each of the following separate and unrelated assumptions: a) Assume that a 10% reduction in selling prices would cause a 30% increase in the physical volume of goods manufactured and sold. b) Assume that an annual expenditure of 30 million for a special sales promotion campaign would enable the company to increase its physical volume by 10% with no change in selling prices. Assume that a basic redesign of manufacturing operations would increase annual fixed manufacturing costs by 80 million and decrease variable manufacturing costs by 15% per product unit, but with no effect on physical volume or selling prices. Assume that a basic redesign of selling and administrative operations would double the annual fixed expenses for selling and administration and increase the variable expenses for selling and administration by 25% per product unit; it would also increase physical volume by 20%. Selling prices would be increased by 5%. e) Would you prefer to use the absorption form of income statement for the preceding analyses? Explain. (3) Discuss the desirability of alternatives a-d in number (2). If only one alternative could be selected, which would you choose? Explain. d) 7. (5-54) Effects of Volume on Operating Income The Wittred Division of Melbourne Sports Company manufactures boomerangs, which are sold to wholesalers and retailers. The division manager has set a target of 250,000 boomerangs for next month's production and sales has developed an accurate budget for that level of sales. The manager has also prepared an analysis of the effects on operating income of deviations from the target: Volume in units Sales at $3.00 Full costs at $2.00 Operating income 200,000 $600,000 400,000 $200,000 250,000 $750,000 500,000 $250,000 300,000 $900,000 600,000 $300,000 The costs have the following characteristics. Variable manufacturing costs are $ .80 per boomerang; variable selling costs are $.60 per boomerang; fixed manufacturing costs per month are $125,000; and fixed selling and administrative costs per month are $25,000. (1) Prepare a correct analysis of the changes in volume on operating income. Prepare a tabulated set of income statements at levels of 200,000, 250,000, and 300,000 boomerangs. Also show percentages of operating income in relation to sales. (2) Compare your tabulation with the manager's tabulation. Why is the manager's tabulation incorrect? 8. (5-63) Special Order As discussed in Item 1 of Nike's 10-K, one of the companies their own is Cole Haan. Cole Haan makes a variety of fashion footwear, such as dress shoes. One of these products is a man's loafer. This shoe is in strong demand. Suppose sales on this loafer during the present year, 20x0, are expected to hit the 1,000,000 mark. Full plant capacity is 1,150,000 units, but the 1,000,000 unit mark is considered normal capacity. The following unit price and cost breakdown is applicable in 20X0: Per unit Sales price $145.00 Less: Manufacturing costs Materials $49.00 Direct labor 22.00 Overhead: Variable 14.00 Fixed 16.00 Total manufacturing costs $101.00 Gross margin $44.00 Less selling and administrative expense Selling: Variable $5.50 Fixed 9.00 Administrative fixed 12.00 Packaging variable* 3.50 Total selling and administrative expenses $30.00 Net profit before taxed $14.00 *Two types of packaging are available: deluxe, $3.50 per unit; and standard, $2.00 per unit. Variable During March, the company received two-special-order requests from Nordstrom and Macy's. These orders are not part of the budgeted 1,000,000 unit sales for 20x0, but there is sufficient capacity for possibly one order to be accepted. Orders received and their terms are as follows: Order from Nordstrom: 75,000 loafers at $136.00 per unit, deluxe packaging Order from Macy's: 90,000 loafers at $130.00 per unit, standard packaging Since these orders were made directly to Cole Haan, no variable selling costs will be incurred. (1) Analyze the profitability of each of these two special orders. Which special order should be accepted? (2) What other aspects need to be considered in addition to profitability