Pricing and cost management Huron Lago and Flashdance SOLUTIONS

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University of Illinois, Chicago *

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326

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Accounting

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Apr 3, 2024

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ACTG 326: Cost Accounting – Spring Semester 2024 Pricing considerations: Applications Contents PART 1: Short-term pricing .......................................................................................................................... 2 Huron Company ....................................................................................................................................... 2 PART 2: Long-run pricing decisions using market-based pricing .................................................................. 3 Lago Company ......................................................................................................................................... 3 PART 3: Long-run pricing using cost-plus pricing ......................................................................................... 4 Flashdance Company ............................................................................................................................... 4 b05da3820f73ccc84533385078378cd618c3fcc2.docx - 1

ACTG 326: Cost Accounting – Spring Semester 2024 PART 1: Short-term pricing Huron Company Huron Company has a current production capacity level of 200,000 units per month. At this level of production, variable costs are $0.60 per unit and fixed costs are $0.50 per unit. Current monthly sales are 173,000 units. Lord Company has contacted Huron Company about purchasing 20,000 units at $1.00 each. Current sales would not be affected by the special order, though the order requires additional setup of $1,500. Required: 1. What is the net cost or benefit if Huron accepts the special order? Incremental revenue $ 20,000 20,000 units * $1/unit Incremental variable cost -12,000 20,000 units * $0.60/unit Incremental contribution margin $ 8,000 Incremental fixed cost -1,500 Incremental operating income $ 6,500 2. What qualitative considerations should Huron Company take into account before accepting the order?  Will other customers find out about the special pricing?  How will Huron respond if Lord returns for another order, and wants similar pricing?  How likely is it that Huron would receive an alternative, better-priced opportunity? b05da3820f73ccc84533385078378cd618c3fcc2.docx - 2

ACTG 326: Cost Accounting – Spring Semester 2024 PART 2: Long-run pricing decisions using market-based pricing Lago Company Lago Company is considering introducing a new product to its existing product lineup. If Lago produces the product, they expect to produce 1,000 units at a market price of $150 per unit. Lago Company has identified the following incremental costs for the production of its new product: Direct materials $35,000 Direct labor 25,000 Variable indirect production costs 30,000 Fixed indirect production costs 15,000 Variable selling and administrative costs 7,500 Fixed selling and administrative costs 12,500 Total costs $125,000 Required: 1. Suppose Lago Company wishes to generate $50,000 in operating income from the new product. a. What is the target cost per unit of the product? Target revenue $150,000 1,000 units*$150/unit -Target costs 100,000 Fill in the difference Target OI $ 50,000 From above in (1) Per unit target cost = $100,000 (from Target costs above)/1,000 units = $100/unit b. Assuming that product costs cannot be adjusted, will Lago launch the new product? Why or why not? No, because the total target costs ($100,000) are less than the projected cost of $125,000. This is the same as saying no, because the target cost per unit is $100 is less than the projected cost per unit of $125 ($125=$125,000 total expected costs/1,000 units). 2. Suppose instead that Lago Company has a requirement that each product yield an operating income of at least 15% of the revenues from the product. a. What is the target cost per unit of the product? Target revenue $150,000 1,000 units*$150/unit -Target costs 127,500 Fill in the difference Target OI $ 22,500 15%*150,000 Per unit target cost = $127,500 (from Target costs above)/1,000 units = $127.50/unit b. Assuming that product costs cannot be adjusted, will Lago launch the new product? Why or why not? b05da3820f73ccc84533385078378cd618c3fcc2.docx - 3

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ACTG 326: Cost Accounting – Spring Semester 2024 Yes, because the total target costs ($127,500) are more than the projected cost of $125,000. PART 3: Long-run pricing using cost-plus pricing Flashdance Company Alex Owens, CEO of Flashdance, Inc., has determined that the company will expand its current line of dance-inspired street wear to include high-end leg warmers. She has asked CFO Nick Hurley to choose a cost-plus system upon which to set prices. Target revenues and projected manufacturing costs for the new product line are presented below. Projected revenues and expenses for legwarmer line Target sales $96,750 Manufacturing costs Variable manufacturing costs 32,250 Fixed manufacturing costs 8,600 Total manufacturing costs 40,850 Gross profit 55,900 SG&A Variable SG&A 6,450 Fixed SG&A 6,450 Total SG&A 12,900 Net operating income $43,000 Required: 1. Calculate the markup percentages needed to achieve target sales using a. Variable manufacturing costs. Markup = Target sales/Variable manufacturing costs -1 = $96,750/32,250 -1 = 200% b. Total variable costs. Markup = Target sales/Total variable costs -1 = $96,750/(32,250+6,450) -1 = 150% c. Total manufacturing costs. Markup = Target sales/Total manufacturing costs -1 = $96,750/(40,850) -1 = 137% d. Full costs. Markup = Target sales/Full costs -1 = $96,750/(40,850+12,900) -1 = 80% 2. Why might Alex choose one cost base over another? Which do you recommend for this situation and why?  Full costs because managers are less likely to make an adjustment to the markup that results in pricing below full cost  Full cost to generate price stability (similar to prior point)  Variable costs – easier to see short-run pricing effects  I recommend full costs because this is a long-run decision. b05da3820f73ccc84533385078378cd618c3fcc2.docx - 4

ACTG 326: Cost Accounting – Spring Semester 2024 b05da3820f73ccc84533385078378cd618c3fcc2.docx - 5

ACTG 326: Cost Accounting – Spring Semester 2024 3. Suppose Alex is considering a request for a one-time special order of headbands that match legwarmers? Would the costs Alex considers for that decision be the same as or different from those she is considering in this situation? Why or why not? The costs she would consider for a short-term pricing decision, like the special order, are different from those she would consider for a long-run pricing decision like that above. For the short-run pricing decision, only the costs associated with the order are relevant; fixed costs of production, for example would likely be unaffected and therefore irrelevant. Over the long-run, Alex needs to take all costs into account when setting prices so she can cover all costs in the long-run. b05da3820f73ccc84533385078378cd618c3fcc2.docx - 6

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