Freddy D’s is setting a selling price on a new product using the absorption costing approach to cost-plus pricing.
Unit Year
Direct material |
$29 |
|
Direct labor |
$20 |
|
Variable manufacturing overhead |
$8 |
|
Fixed annual manufacturing overhead |
$120,000 |
|
Variable selling and administrative expense |
$3 |
|
Fixed annual selling and admin expense |
$16,000 |
Freddy D’s Manager Nick plans to produce and sell 4,000 units
annually. Freddy D’s new product will require an investment of
$643,000 and have a required return on investment of 20%.
Determine the unit product cost for the new product.
Determine the markup percentage on absorption cost for the new product.
Determine the target selling price for the new product using the absorption costing approach.
What is a problem with using the absorption costing approach?
Rreq 1. | ||||||
Unit cost as per Absorption costing: | ||||||
Material | 29.00 | |||||
Labour | 20.00 | |||||
Variable OH | 8.00 | |||||
Fixed Oh | 30.00 | |||||
Unit Product Cost | 87.00 | |||||
Req 2: | ||||||
Markup Required:; | ||||||
Total Selling and admin Oh | 28000.00 | |||||
(4000*3+16000) | ||||||
Add: Desired return on Invstment | 128600 | |||||
(643000*20%) | ||||||
Total Markup required | 156600.00 | |||||
Total Cost under Absorption | 348000 | |||||
(4000 unts @ 87) | ||||||
Markup % (156600/348000*100) | 45% | |||||
Req 3: | ||||||
Unit product cost | 87 | |||||
Add: Markup @ 45% | 39.15 | |||||
Selling price per unit | 126.15 | |||||
Req 4: | ||||||
Under absorption costing, the problem lies in fixing the selling price based on Unit product cost is that this unit product cost varies with the variation in production level as the average fixed cost goes on changing with the production. | ||||||
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