Chapter
12
Differential Analysis and Product Pricing
Managers can also use one of three cost-plus methods to determine the
price:
Electronic stores such
Best Buy use the
competition-based
concept. lf a buyer
demonstrates that a
lower price is available
from Target or another
competitor, Best Buy will
often match the price.
as
1. Total cost concept
2. Product cost concept
3. Yariable cost concept
cost-plus methods determine the normal selling price by estimating a
amount per unit and adding a markup, as shown below.
Normal Selling price
:
Cost Amount per
Unit
*
Markup
The cost amount per unit depends on the cost concept used. M
determines the markup trased on the desired profit for the product. The
should be sufficient to earn the desired profit plus cover any costs and
that are not included in the cost amount.
Total Cost Concept
Under the total cost concept, manufacturing cost plus the selling and admio
tive expenses are included in the total cost per unit. The markup per unit is
computed and added to total cost per unit to determine the normal selling
The total cost concept is applied using the following steps:
Step 1. Estimate the total manufacturing cost as shown below.
Manufacturing costs:
Direct materials
SXXX
labor
Factory overhead
Direct
Total manufacturing
XXX
XXX
cost
S-XI
Step 2. Estimate the total selling and administrative expenses.
Step 3. Estimate the total cost as shown below.
costs
expenses
Total manufacturing
Selling and administrative
Total
cost
SXXX
XXX
S*XI
step 4. Divide the total cost by the number of units expected to be
and sold to determine the total cost per unit, as shown below.
Total Cost per Unit
:
Total Cost
Estimated Units Produced and Sold
Step 5. Compute the markup percentage as follows:
Markup Percentage
:
Desired Profit
Total Cost
The desired profit is normally computed based on a rate of retum on
as follows:
Desired Profit
:
Desired Rate of Return X Total Assets
step 6. Determine the markup per unit by multiplying the markup
times the total cost per unit as follows:
Markup per Unit
:
Markup percentage X Total Cost per Unit
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dl
Chapter
12
Differential Analysis and product pricing
Step 7. Normal selling price: $18.30
unit
unit
Total cost per
Markup per
Normal selling price per
516.70
1.60
j]tiq
unit
The ability of the selling price of $1g.30 ro generate the desired pro&
$160,000 is illustrated by the income statement shown below.
Nebula Inc.
Income Statement
Sales (100,000 units
x
S18.30)
s
1,830,000
Expenses:
Variable (100,000 units x S16.00)
Fixed (550,000 + 520,000)
s
r,600,000
70,000
lncome from operations
1,670,000
i__.r_qapqq
The total cost concept is often used by contractors who sell producs
government agencies. This is because in many cases goyernment contractGs
required by law to be reimbursed for their products on a total-cost-pius-g
basis.
PRorum cosr coNcEn
Lri'ii
l*:iil
Markup:
Administrative Expense
Selling Expense
rE*
Desired Profit
:iiXrll
!i{.+i
3:+
iii:lltr
iiEt:
:i,F_:
":.e,n!
;!;,tF
[ra]I
Product Cost:
Manufacturing Cost
' Ddsir€d::,"
SEllllgF-r.i
Product Cost Concept
Under the product cost concept, only the costs of
turing the product, termed the product costs, are in
in the cost amount per unit to which the markup is
Estimated selling expenses, administrative expenses"
desired profit are included in the markup. The markup
unit is then computed and added to the product com
unit to determine the normal selling price.
The product cost concept is applied using the fo
steps:
EEN
xtiii
Step 1. Estimate the total product costs as follows:
Product costs:
Direct materials
Direct labor
Factory overhead
Total product cost
SXXX
XXX
XXX
SXXX
Step 2. Estimate the total selling and administrative expenses.
Federal law prevents companies competing in similar
markets from sharing cost and price information, or what is
commonly termed "price fixing.,, For example, the Federal
Trade Commission brought a suit against the major record
labels and music retailers for conspiring to set CD prices *
a minimum level, or MAP (minimum advertised price- r
settling the suit, the major labels ceased their MAp poli*
and provided S143 million in cash and CDs for consLrrnari
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488
Chapter t 2 Differential Analysis and Product Pricing
Step 7. Normal selling price: $18.30
unit
unit
Total cost Per
MarkuP Per
Normal selling price per
516'70
'l
unit
'60
i-l-q!g
Theabilityofthesellingpriceof$ls.30togenefatethedesiredproii.
below'
$160,000 is illustrated by the income statement shown
Nebula lnc.
lncome Statement
Sales
(1
00,000 units
x
S1
51 8.30)
,83o,ooo
Expenses:
Variable (100,000 units x 516.00)
Fixed (55o,ooo + 52o,ooo)
51
,600,000
70,000
1,670,000
Ll-q0,q9q
lncome from oPerations
The total cost concept is often usecl by contractors who sell procluct.
govefnment agencies. This is because in many cases govefnment contractori
Iequired by law to be reimbursecl for their products on a total-cost-plus-p
basis.
PRonucf cosT coNcEPf
Desired
Selling Price
MarkuP:
Adm inistrative ExPense
Selling ExPense
Desired Profit
Product Cost:
Manufacturing Cosl
Prq ralffict
Ll*sE
C*rtc*Bt
Under the product cost concept, only the costs of ntarl-turing the product, termed the product costs, are incl'--'
'-in the cost amount per unit to which the markup is :rc'
Estimated selling expenses' administrative expenses' -'desired profit are included in the markup' The marktt:
unit is then computed and added to the product co\: ''
unit to determine the normal selling price'
The procluct cost concept is applied using the fo11'-'r
'
{
steps:
Step L. Estimate the total product costs as follou's:
Product costs:
Direct materials
Direct labor
Factory overhead
Total product cosl
SXXX
XXX
XXX
ilu
Step 2. Estimate the total selling and administrative expenses'
tl=i2'{i
Federal law prevents companies competing in
Fnql{E
similar
markets from sharing cost and price information, or what is
commonly termed "price fixing." For example, the Federal
Trade Commission brought a suit against the major record
labels and music retailers for conspiring to set CD p' :=' '
a minimum level, or MAP (minimum advertised pr :=
settling the suit, the major labels ceased their MAP p: - and provided S143 million in cash and CDs for consu^-:
Chaper
12
Differential Analysis and Product pricing
Step 5. Markup per unit: $3.30
Markup per Unit
:
:
Markup percentage X product Cost per Unit
22o/o X $15.00 : $3.30 per unit
Step 6. Normal selling price: $18.30
Total product cost per
Markup per
unit
unit
Normal selling price per
unit
$15.00
3.30
51 B.3O
Variable Cost Concept
Under the variable cost concept, only variable costs are included in the cost a
per unit to which the markup is added. All variable manufacturing costs, as
as variatrle selling and administrative expenses, are included in the cost amr
Fixed manufacturing costs, fixed selling and administrative expenses, and desi
profit are included in the markup. The markup per unit is then added to
variable cost per unit to determine the normal selling price.
The variable cost concept is applied using the following steps:
Step 1. Estimate the total variable product cost as follows:
Variable product costs:
Direct materials
SXXX
Direct labor
XXX
Variable factory overhead
xxx
Total variable product cost
sryx
step 2. Estimate the total vaiable selling and administrative expenses.
Step 3. Determine the total vanable cost as follows:
Total variable product cost
Total variable selling and administrative expenses
Total variable cost
SXXX
XXX
SXXX
Step 4. Compute the variable cost per unit as follows:
Variable Cost per
Unit:
Total Yariable Cost
Estimated Units Produced and Sold
Step 5. Compute the markup percentage as follows:
Markup percentage
-
Desired Profit
*
Total Fixed Costs and Expenses
Total Variable Cost
The numerator of the markup percentage is the desired profit plus the
fixed costs (fixed factory overhead) and expenses (selling and admin
These fixed costs and expenses must be included in the markup pe
since they are not included in the cost amount to which the markup is
As illustrated for the total and product cost concepts, the desired proft
normally computed based ot a rate of return on assets as follows:
Desired Profit : Desired Rate of Return X Total Assets
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