Freddy D’s is setting a selling price on a new product using the absorption cost

Question

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?

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

Explanation / Answer

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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