ACCT2002 Chap.11 Pricing Decisions and Cost Management
Pricing Decisions and Cost Management
Pricing decisions combine customer demand, competitor responses and cost information. In the short run, idle capacity can make incremental cost the relevant floor for a specific order; in the long run, price must support the resources required to design, produce, market, distribute and support the offering.
Target costing begins with a market-based price and required profit to derive an allowable cost, then uses cross-functional design to close the cost gap before costs become locked in. Cost-plus pricing starts from a defined cost base and applies a mark-up, so the analyst must state exactly what the base includes.
This chapter also develops life-cycle budgeting, cost incurrence versus locked-in cost and the non-cost factors that keep a formula from becoming a pricing rule.
What this chapter covers
- 01
The three major factors affecting price
- 02
Short-run and long-run pricing
- 03
Target price, target profit and target cost
- 04
Value engineering and closing the cost gap
- 05
Cost-plus pricing and mark-up bases
- 06
Cost incurrence and locked-in costs
- 07
Life-cycle budgeting and costing
- 08
Non-cost factors in pricing practice
Derive a target cost and cost-reduction gap
- 2Required profit per unit is 18% × $460 = $82.80.
- 3Target cost per unit is target price minus required profit: $460 − $82.80 = $377.20.
- 2The cost-reduction gap is current estimated cost minus target cost: $392 − $377.20 = $14.80 per unit.
- 2Across 24,000 units, the life-cycle gap is $355,200 if volume and unit estimates hold.
- 1Management should use value engineering to redesign functions and processes without assuming that an arbitrary quality cut creates customer value.
Key terms
- Target price
- The estimated price customers are willing to pay, considering value and competing offerings.
- Target cost
- Target price less required operating profit.
- Value engineering
- Systematic evaluation of product functions to achieve target cost while protecting customer value.
- Cost-plus pricing
- A pricing method that adds a mark-up to a defined cost base.
- Locked-in cost
- A future cost that has not yet been incurred but is largely determined by an earlier design or process decision.
- Life-cycle costing
- Accumulation of costs from research and design through production, distribution, service and disposal.
- Cost incurrence
- The point at which a resource is consumed and recognised as a cost.
Pricing Decisions and Cost Management FAQ
What are the three major pricing factors?
The course recap identifies customers, competitors and costs as the major influences. Their relative importance changes with market structure, differentiation, capacity and time horizon.
Is target cost the same as standard cost?
No. Target cost is an allowable long-run cost derived from market price and required profit, often before production. Standard cost is a benchmark for performing a defined process.
Why must the cost-plus base be stated?
A mark-up on variable manufacturing cost is not comparable with the same percentage on full life-cycle cost. The base determines which resources the mark-up must cover.
When are most costs locked in?
Many life-cycle costs are committed by research, design, specifications and supplier choices before production spending occurs. That is why early cross-functional action matters.
Exam move
Put target costing and cost-plus pricing on opposite sides of a page and draw their direction arrows. For each pricing case, state the horizon, capacity condition and strategic objective before calculating. Build a life-cycle map that distinguishes when cost is locked in from when cash is spent. After finding a target-cost gap, propose functional redesigns rather than blanket percentage cuts.
In oral practice, explain why no single cost figure mechanically determines price.
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