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Chapter 10

Chapter 10. Price. Direct and Indirect Costs. Direct costs Can be specifically and accurately assigned to a given unit of production of a product or service Most direct costs are “variable” Indirect costs

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Chapter 10

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  1. Chapter 10 Price

  2. Direct and Indirect Costs Direct costs Can be specifically and accurately assigned to a given unit of production of a product or service Most direct costs are “variable” Indirect costs Incurred in the operation of a production plant or service process, but normally cannot be related directly to any given unit of production of a product or service Often referred to as “overhead”

  3. Variable and Fixed Costs Variable costs Vary directly and proportionally with the units of products or services produced Fixed costs Generally remain the same regardless of the number of units of products or services produced Semivariable costs Vary with the number of units of products or services produced but are partly variable and partly fixed

  4. Typical Product Cost Buildup Direct Materials $ 5,500 + Direct labor 2,000 + Factory overhead 2,500 = Manufacturing cost $ 10,000 + General, admin. and selling cost 1,500 = Total cost $ 11,500 + Profit 920 = Selling price $ 12,420

  5. How Prices are Set Cost approach Price is set greater than direct costs, allowing for sufficient contribution to cover indirect costs and overhead, and leaving a margin for profit Market approach Prices are set in the marketplace and may not be directly related to cost

  6. Seven Types of Purchases Raw materials Sensitive commodities, such as copper, wheat, and crude oil Steel and cement Special items Custom-ordered items and materials that are special to the organization’s product line Standard production items Fasteners, many forms of commercial steel, valves, and tubing, whose prices are fairly stable and are quoted on a basis of “list price with some discount

  7. Seven Types of Purchases Items of small value Items of small comparative value Includes maintenance, repair, and operating (MRO) supplies Capital goods Long-term assets that are not bought or sold in the regular course of business, have an ongoing effect on the organization’s operations, have an expected use of more than one year, involve large sums of money, and generally are depreciated May be tangible (e.g., land, buildings, and equipment) or intangible (e.g., goodwill)

  8. Seven Types of Purchases Services Includes many types of services, such as advertising, auditing, consulting, architectural design, legal, insurance, personnel travel, copying, security, and waste removal Resale Items that formerly were manufactured in-house but have been outsourced to a manufacturing supplier Items sold in the retail sector, such as clothing sold in general-line department stores; food sold through supermarkets; tools sold in hardware stores; and tires, batteries, and accessories sold in gasoline/filling stations

  9. Competitive Bidding Bidders must be qualified to make the item in question in accordance with the buyer’s specifications and to deliver it by the date required Bidders must be sufficiently reliable in other respects to warrant serious consideration as suppliers Bidders must be numerous enough to ensure a truly competitive price Bidders must not be more numerous than necessary

  10. Conditions for Competitive Bidding There must be at least two, and preferably more, qualified bidders The suppliers must want the business a “buyer’s market” Specifications must be clear No collusion between bidders

  11. Four Contract Pricing Options Firm-fixed-price (FFP) Price set is not subject to change, under any circumstances Cost-plus-fixed-fee (CPFF) Occurs if the item is experimental and the specifications are not firm, or if costs in the future cannot be predicted Buyer agrees to reimburse the supplier for all reasonable costs incurred (under a set of definite policies under which “reasonable” is determined) in doing the job or producing the required item or service, plus a specified dollar amount of profit A maximum amount may be specified for the cost

  12. Four Contract Pricing Options Cost-no-fee (CNF) If the buyer can argue persuasively that there will be enough subsidiary benefits to the supplier from doing a particular job, then the supplier may be willing to do it provided only the costs are reimbursed Cost-plus-incentive-fee (CPIF) Both buyer and seller agree on a target cost figure, a fixed fee, and a formula under which any cost over- or underruns are shared

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