Accounting: The Language of Business - Vol. 1 (Part 152)

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Money is not worth dying for. I know, because years ago, while nearly a million dollars in debt, suicide was an option. Rather than run, rich dad suggested I write down all the mistakes I made and then seek help. If I made accounting mistakes, I talked to an accountant. If there was a legal mistake, I talked to an attorney. That was my way out. That is how I got smarter.

Robert Kiyosaki

 Differential Analysis and Product Pricing (Part F)

by

Charles Lamson

Product Cost Concept

Using the product cost concept, only the costs of manufacturing the product, termed the product cost, are included in the cost amount to which the markup is added. Estimated selling expenses, administrative expenses, and profit are included in the markup. The markup percentage is determined by applying the following formula:

Markup percentage = Desired profit + Total selling and administrative expenses / Total manufacturing costs

The numerator of the markup percentage formula is the desired profit plus the total selling and administrative expenses. These expenses must be included in the markup, since they are not included in the cost amount to which the markup is added. The denominator of the formula includes the costs of direct materials, direct labor, and factory overhead.

To illustrate, assume the same data used in the preceding illustration from part 151. The manufacturing cost for Digital Inc.'s calculator is $1,500,000, or $15 per unit, computed as follows:

The desired profit is $160,000 (20% * $800,000), and the total selling and administrative expenses are $170,000 [(100,000 units * $1.50 per unit) + $20,000]. The markup percentage for a calculator is 22%, computed as follows:

Markup percentage = Desired profit + Total selling and administrative expenses / Total manufacturing cost

Markup percentage = $160,000 + $170,000 / $1,500,000

Markup percentage equals $330,000 / $1,500,000 = 22%

Based on the manufacturing cost per calculator and the markup percentage, Digital Solutions Inc. would price each calculator at $18.30 per unit, as shown below:

Variable Cost Concept 

The variable cost concept emphasizes the distinction between variable and fixed costs in product pricing. Using the variable cost concept, only variable costs are included in the cost account to which the markup is added. All variable manufacturing costs, as well as variable selling and administrative expenses, are included in the cost amount. Fixed manufacturing costs, fixed selling and administrative expenses, and profit are included in the markup.

The markup percentage is determined by applying the following formula:

Markup percentage = Desired profit + Total fixed costs / Total variable costs

The numerator of the markup percentage formula is the desired profit plus the total fixed manufacturing costs and the total fixed selling and administrative expenses. These costs and expenses must be included in the markup, since they are not included in the cost amount to which the markup is added. The denominator of the formula includes the total variable costs.

To illustrate, assume the same data used in the two preceding illustrations. The calculator variable cost is $1,600,000, or $16 per unit, computed as follows:

The desired profit is $160,000 (20% * $800,000), the total fixed manufacturing costs are $50,000, and the total fixed selling and administrative expenses are $20,000. The markup percentage for a calculator is 14.4%, computed as follows:

Markup percentage = Desired profit + Total fixed costs / Total variable costs

Markup percentage = $160,000 + $50,000 + $20,000 / $1,600,000

Markup percentage = $230,000 / $1,600,000 = 14.4%

Based on the variable cost per calculator and the markup percentage, Digital Solutions Inc. would price each calculator at $18.30 per unit, as shown below.

*WARREN, REEVE, & FESS, 2005, ACCOUNTING, 21ST ED., PP. 1,004-1,005*

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