Accounting Exam 3 Chapter 12 Setting Normal Product Selling Prices The normal selling price is the target selling price to be achieved in the long term The normal selling price must be high enough to cover all costs and expenses fixed and variable and provide a reasonable profit Managers can use one of two market methods to determine selling price 1 Demand based concept Sets the price according to the demand for the product High demand price is set high Low demand price is set low 2 Competition based concept Sets the price according to the price offered by competitors Managers use a cost plus method called total cost concept to determine the selling price They do this by estimating a cost amount per unit and adding a markup Normal Selling Price Cost Amount per unit Markup Managers determine the markup based on desired profit for the product This markup should be large enough to earn a profit and cover any costs and expenses that aren t included in the cost amount Markup an amount that is added to a cost amount to determine product price Total Cost Concept manufacturing cost plus the selling and admin expenses are included in the total cost per unit The markup per unit is then computed and added to total cost per unit to determine the normal selling price 1 How to apply the total cost concept Step 1 Estimate the total manufacturing costs DM DL FOH Step 2 Estimate the total selling and administrative expenses Step 3 Estimate the total cost Total manufacturing cost selling and admin expenses Step 4 Determine the total cost per unit using this formula Total Cost Total Cost per Unit Estimate units produced and sold Step 5 Compute the markup percentage using this formula Markup Percentage Desired Profit Total Cost The desired profit is normally computed based on a rate of return on assets using this formula Desired Profit Desired rate of return X Total assets Step 6 Determine the markup per unit using this formula Markup per Unit Markup percentage X Total cost per unit Step 7 Determine the normal selling price by adding the markup per unit to the total cost per unit Total cost per unit Markup per unit Normal selling price per unit 2 Target Costing Target Costing a concept used to design and manufacture a product at a cost that will deliver a target profit for a given market determined price Method of setting prices that combines market based pricing w a cost reduction emphasis Under target costing a future selling price is anticipated Target Cost Expected selling price Desired profit Target costing tries to reduce costs The target cost is normally less than current cost so managers have to try to cut costs from the design and manufacturing of the product The planned cost reduction is also referred to as the cost drift Target costing is especially useful in highly competitive markets such as automobiles and smartphones tablets 3