Costing and Pricing for the Long Run

●​ Short-run pricing decisions have a time horizon of less than one year and include
decision such as:
○​ Pricing a one time only special order with no long run implications
○​ Adjusting a product mix and output volume in a competitive market.
●​ Long-Run pricing is a strategic decision designed to build long-run relationships with
customers based on stable and predictable prices.
○​ ALL costs matter: both manufacturing and non-manufacturing costs

Value Engineering
●​ Value engineering entail improvements in product designs, changes in materials
specifications and modifications in process methods
●​ To implement value engineering, managers must distinguish value-added activities and
costs from non-value-added activities and costs
○​ Value-added costs: if eliminated would reduce the actual or perceived value or
utility customers experience from using the product or service
○​ Non-value-added costs: if eliminated, would not reduce the actual or perceived
value or utility customers gain from using the product or service.

Alternative Cost- plus methods

●​ Because computing the specific amount of capital invested in a product is challenging,
managers use alternate cost bases to set prospective selling prices:
○​ Variable manufacturing cost
○​ Variable cost
○​ Manufacturing cost
○​ Full cost
■​ It allows for full recovery of all costs of the product
■​ It allows for price stability
■​ It is a simple approach

Life Cycle Product Budgeting and Costing

●​ Managers sometimes need to consider target prices and target costs over a multiple
year product life cycle.
●​ Product life cycle spans the time from initial R&D on product to when customer service
and support are no longer offered on that product

Environmental and Sustainability Costs

●​ Managing environmental costs is critical area where managers apply life-cycle costing
and value engineering
●​ Environmental costs that are incurred over several years of the product’s life cycle are
often locked in at product and process design stage
●​ A new organization, the Sustainability Accounting Standards Board (SASB) has begun
defining standards for environmental, social and governance (ESG) performance for
 different industries. When measured over multiple periods, companies that have higher
relevant ESG ratings have higher future profitability and financial performance, perhaps
because of customer loyalty and satisfaction, employee engagement or brand and
reputation.

HW:
(Q.2): After conducting a market research​study, Magnificent Manufacturing decided to produce a new
interior door to complement its exterior door line. It is estimated that the new interior door can be sold at a
target price of $300. The annual target sales volume for interior doors is 29,000. Magnificent has a target
operating income of 10​% of sales. What is the target cost for each interior​door?
300 * 29,000 = 8,700,000 * 0.10 = 870,000 ; 8,700,000 - 870,000 = 7,830,000 / 29,000 = 270

(Q.3): In response to competitive pressures at the end of 2019​, Diagnostic Instruments used​
value-engineering techniques to reduce manufacturing costs. Actual information for 2019 and 2020 is as​
follows:

2019 2020

$ $
Setup, production-order, and materials-handling costs per batch 8,700 8,200
 $ $
Total manufacturing-operations cost per machine-hour 62 47
$ $
Cost per engineering change 13,750 12,500
The management of Diagnostic Instruments wants to evaluate whether value engineering has succeeded
in reducing the target manufacturing cost per unit of one of its​products, HJ6, by 20​%. Actual results for
2019 and 2020 for HJ6 are as​follows

Actual Results Actual Results

for 2019 for 2020

Units of HJ6 produced 3,000 5,000

$ $
Direct material cost per unit of HJ6 3,400 1,600

Total number of batches required to produce HJ6 70 90

Total machine-hours required to produce HJ6 20,400 24,000

Number of engineering changes made 12 8

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Calculate the manufacturing cost per unit of HJ6 in 2019​, then in 2020.
2019: 3,400 , 203, ( 8,700 *70= 609,000 / 3,000) , 422 ( 62* 20,400 = 1,264,800 / 3000), 55 ( 13,750 *
12 = 165,000 / 3000) = 4,080
2020: 1,600 , 148 (8,200 * 90 = 738,000 /5,000), 226 ( 47 * 24,000 = 1,128,000 / 5,000) , 20 ( 12,500 * 8
= 100,000 / 5,000) = 1,994

Begin by computing the target manufacturing cost per unit for HJ6 in 2020. Determine the​formula, then
complete the computation. ​Mfg cost per unit in 2019 * Target Ratio of 2019’s cost for 2020 = Target
Manufacturing cost per unit = 4,080 * 0.8 (100-0.2) = 3,264. DID

Explain how Diagnostic Instruments reduced the manufacturing cost per unit of HJ6 in 2020. Select each
of the actions made by Diagnostic Instruments to reduce the manufacturing cost per unit of HJ6 in 2020.

Reduced the cost per unit in each four cost categories, reduced machine-hours per unit (cost
driver), Reduced the number of engineering changes made (cost driver)

What challenges might managers at Diagnostic Instruments encounter in achieving the target​cost? How
might they overcome these​challenges? Employees may feel the severe cost cutting may result in
quality problems that they will then be blamed for such as not making the necessary engineering
changes and Organizational conflicts may develop as the burden of cost cutting falls unequally on
different business function in the companies value chain
To overcome these​challenges, managers​should: Encourage employee participation and
engagement and clearly communicate goals and the strategy behind them

(Q.5): Dennis Inc. competes with Gonzalo Inc. in the distribution of mechanical pencils. Dennis also
identifies its three primary activities and cost pools as​ordering, receiving and​storage, and​shipping, and
it reports the following details for 2020​: For 2020​, Dennis buys 250,000 pencil packs at an average cost of
$4.75 per pack. Dennis plans to use​cost-plus pricing.
Activity​ Cost Driver​ Quantity of Cost Driver​ Cost per Unit of Cost Driver
1. Placing and paying for orders of pencil packs​ Number of orders​ 100​ $75 per order
2. Receiving and storage​ Loads moved​ 3,600​ $50 per load
3. Shipping of pencil packs to retailers​ Number of shipments​ 1,500​ $60 per shipment

Total: 1,187,500 ( 250,000 * 4.75) , 7,500 ( 100* 75), 180,000 (3,600 * 50) , 90,000 ( 1,500 * 60) =
1,465,000

Per Unit: 4.75 ( 1,187,500 /250,000) , 0.03 ( 7,500 / 250,000), 0.72 ( 180,000 /250,000), 0.36 (90,000 /
250,000) = 5.86

Now calculate the prospective selling price​(1) if Dennis marks up the purchase costs of the pencil packs
by 20​%. 4.75 * (1+0.20) = 5.70

Finally, calculate the prospective selling price​(2) ifDennis marks up the full cost of the pencil packs by
5​%. 5.86 * (1+0.05) = 6.15