Currington Company wants to use absorption cost-plus pricing to set the selling price on a newly remodeled product. The company plans to invest $158,000 in operating assets to produce and sell 12,000 units.

Currington Company wants to use absorption cost-plus pricing to set the selling price on a newly remodeled product. The company plans to invest $158,000 in operating assets to produce and sell 12,000 units. Its required return on investment (ROI) in its operating assets is 16%. The accounting department has provided cost estimates for the new product as follows:

	Per Unit			Total
Direct materials	$	4.40
Direct labor	$	3.40
Variable manufacturing overhead	$	1.40
Fixed manufacturing overhead				$	70,800
Variable selling and administrative expenses	$	1.40
Fixed selling and administrative expenses				$	12,280

Required:

1. What is the unit product cost for the remodeled product? (Round intermediate calculations and final answer to 2 decimal places.)

2. What is the markup percentage on absorption cost for the remodeled product? (Round intermediate calculations to 2 decimal places.)

3. What selling price would the company establish for its remolded product using a markup percentage on absorption cost? (Round intermediate calculations and final answer to 2 decimal places.)

4. Suppose the company actually produced and sold only 10,000 units (instead of its planned sales volume of 12,000 units) at the selling price that you derived in requirement 3. What ROI did the company actually earn at this lower sales volume? (Round intermediate calculations to 2 decimal places. Round your percentage answer to 1 decimal place.)

5. Assume that the company wants to raise the price of its newly remodeled product with the intention of achieving the product’s desired ROI at the lower sales volume of 10,000 units. Using absorption cost-plus pricing, what would be the revised selling price at this lower sales volume? (Round your intermediate percentages to 1 decimal place. Round all other intermediate calculations to 2 decimal places.)

 

Explanation

1.

The unit product cost is computed as follows:

Direct materials	$	4.40
Direct labor		3.40
Variable manufacturing overhead		1.40
Fixed manufacturing overhead ($70,800 ÷ 12,000 units)		5.90
Unit product cost	$	15.10

2.

The markup percentage is computed as follows:

Markup percentage on absorption cost	=	(Required ROI × Investment) + Selling and administrative expenses
		Unit sales × Unit product cost
	=	(16% × $158,000) + [($1.40 × 12,000 units) + $12,280]
		12,000 units × $15.10 per unit
	=	$54,360
		$181,200
	=	30%

3.

The selling price is computed as follows:

Unit product cost	$	15.10
Markup (30% × $15.10)		4.53
Selling price per unit	$	19.63

4.

The revised unit product cost is computed as follows:

Direct materials	$	4.40
Direct labor		3.40
Variable manufacturing overhead		1.40
Fixed manufacturing overhead ($70,800 ÷ 10,000 units)		7.08
Unit product cost	$	16.28

The net operating income at a sales volume of 10,000 units is computed as follows:

Sales (10,000 units × $19.63 per pad)	$	196,300
Cost of goods sold
(10,000 units × $16.28 per unit)		162,800
Gross margin		33,500
Selling and administrative expenses ($1.4
per unit × 10,000 units + $12,280)		26,280
Net operating income	$	7,220

The return on investment (ROI) at a sales volume of 10,000 units is computed as follows:

ROI = Net operating income ÷ Average operating assets

ROI = $7,220 ÷ $158,000

ROI = 4.6%

5.

The revised markup percentage would be computed as follows:

Markup percentage on absorption cost	=	(Required ROI × Investment) + Selling and administrative expenses
		Unit sales × Unit product cost
	=	(16% × $158,000) + [($1.40 × 10,000 units) + $12,280]
		10,000 units × $16.28 per unit
	=	$51,560
		$162,800
	=	31.7%

The revised selling price would be computed as follows:

Unit product cost	$	16.28
Markup (31.7% × $16.28)		5.16
Selling price per unit	$	21.44

It is quite possible that customers will be displeased with the price increase of $1.81 per unit ( = $21.44 per unit – $19.63 per unit). This may cause sales volume to drop below 10,000 units, thereby further depressing profits. Currington’s customers are not required to pay whatever price is necessary for the company to meet its financial goals. The customers can choose to reject Currington’s price increase and spend their money elsewhere.

Thanks