Chapter 10-Relation of Cost to Price, Meaning of Cost

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Questions and Answers

What does cost of revenue primarily include?

Expenses that remain constant regardless of sales volume

General administrative expenses

All expenses that occur when services are sold (correct)

Fixed costs related to manufacturing products

Which factor does not justify a seller’s insistence on a specific price based on costs?

Quality of goods sold

Market demand for the product

Inefficiency in supplying goods (correct)

Assuming risk in business

Which of the following is NOT typically included in the cost of services?

Sales commissions related to service sales

Transportation costs for delivering services

Legal fees for business operations (correct)

Contract labor for specific projects

What question arises regarding the costs of different manufacturers?

Should price be fixed regardless of supplier efficiency? Signup and view all the answers

Which statement accurately reflects the relationship between cost and market price?

Goods will sell for what the market is willing to pay, not merely based on costs. Signup and view all the answers

What does 'fair price' signify for a supplier?

The lowest price that assures continuous supply of proper quality. Signup and view all the answers

What must the supplier's total costs include for sustainability?

Total costs including a reasonable profit. Signup and view all the answers

Which of the following describes a 'continuous supply'?

A reliable supply from a supplier making a reasonable profit. Signup and view all the answers

Why might the prices set by monopolists be considered fair?

They cover costs and ensure supply continuity. Signup and view all the answers

What influences the determination of a 'fair price'?

Knowledge of production processes and logistical costs. Signup and view all the answers

Which statement is true regarding fair prices between different sellers?

Fair prices can vary even for satisfactory substitutes. Signup and view all the answers

What role does historical experience play in pricing decisions?

It helps in estimating fair and just prices based on past data. Signup and view all the answers

What challenge do supply managers face regarding fair prices?

Continuously exercising judgment under varying circumstances. Signup and view all the answers

What is described as a price that may still be considered fair despite being set by a monopolist?

A price arising from collusion among sellers Signup and view all the answers

What can result when suppliers do not cover total costs and receive a profit?

Suppliers being forced out of business Signup and view all the answers

Which cost is typically classified as a direct cost?

Materials used in production Signup and view all the answers

What is the relationship between direct costs and variable costs typically considered?

Most direct costs are variable costs Signup and view all the answers

Which of the following is an example of an indirect cost?

Rental costs for manufacturing space Signup and view all the answers

What is a potential disadvantage of using average rates for overhead costs?

It may lead to inaccurate pricing strategies Signup and view all the answers

What type of costs remain constant regardless of production volume?

Fixed costs Signup and view all the answers

What can semivariable costs be described as?

Costs that vary with productivity but have fixed portions Signup and view all the answers

How is factory overhead often historically determined?

A percentage of direct labor cost Signup and view all the answers

Which of the following best describes direct labor costs?

Wages paid to professionals delivering services Signup and view all the answers

What component is not typically included in the total manufacturing cost buildup?

Profit margin Signup and view all the answers

What might cause a prevailing market price to be considered unfair?

Prices resulting from monopolistic or coercive actions Signup and view all the answers

In what scenario might a supplier choose to accept reduced costs?

In the event of high competition Signup and view all the answers

What type of costs could be included when calculating selling, general, and administrative expenses?

Expenses for advertising and marketing Signup and view all the answers

What is a common challenge faced when determining the actual price of a service?

Prices fluctuate over time Signup and view all the answers

When calculating costs, which element is based on an estimation of production volume?

Overhead distribution Signup and view all the answers

If a company's costs increase in direct proportion to the increase in sales of services, which type of expense is primarily involved?

Variable Costs Signup and view all the answers

What is the critical question that arises after accepting the definition of cost provided in the text?

Whose cost is being referenced? Signup and view all the answers

Given that market price is not determined by cost, what should a seller primarily focus on when setting prices?

Market demand and willingness to pay Signup and view all the answers

If a seller is not entitled to a price that yields profit merely because they're in business, what other justifications for a price are deemed acceptable?

A seller's quality and service. Signup and view all the answers

What is the primary implication if all businesses were automatically entitled to a profit, regardless of their costs?

A disregard for service and quality. Signup and view all the answers

What is required for a seller to be entitled to get a price that even covers their costs?

To efficiently supply needed goods. Signup and view all the answers

If a price is based on average cost of raw materials, what aspect of those raw material costs is considered?

Average cost over a time period Signup and view all the answers

What is a key distinction between the cost of services and the cost of general goods?

Cost of services fluctuate based on sales, goods, do not. Signup and view all the answers

Why should a seller not assume they are entitled to a price that yields a profit, regardless of costs, quality, or service?

Because it can lead to inefficient operations and market failure. Signup and view all the answers

What is the primary goal a supply manager should aim for when determining a 'fair price'?

To ensure a constant supply of necessary quality, at the lowest possible cost Signup and view all the answers

What is the key difference between 'direct costs' and a 'fair price' of an item?

A fair price should necessarily always cover direct costs, but may also include costs beyond these. Signup and view all the answers

What is the significant difference between a 'fair price' and the prevailing market price?

The prevailing price may not always represent what is needed by the supplier for long-term sustainability. Signup and view all the answers

Why is it important that a supply manager understands a supplier's cost structure when determining a 'fair price'?

It allows the manager to evaluate if the price supports continuous supply and reasonable profit. Signup and view all the answers

How might a 'fair price' differ between two suppliers providing similar products?

One supplier may have higher costs, thus a higher 'fair price', which could still be considered 'fair'. Signup and view all the answers

What is the long term risk of only paying direct costs of goods regularly?

This may not allow the supplier to cover total costs and profit necessary for long-term supply. Signup and view all the answers

What is the potential issue with a 'prevailing price' that is unusually high?

It might be a result of artificially inflated conditions such as collusion. Signup and view all the answers

What factor is the most critical when defining a fair price for a specific item?

Ensuring a continuous, quality supply at the lowest possible price. Signup and view all the answers

Why might some businesses choose to use 'average rates' for overhead instead of precise allocated costs?

Because it is a simpler method of allocation, even though it might not be as accurate. Signup and view all the answers

How does prior experience help in setting a 'fair price' in supply management?

It helps in understanding production and logistics costs for a given good or service. Signup and view all the answers

If a company uses the last price paid in the immediately prior fiscal period to calculate direct material costs, what potential issue might arise when compared to using a weighted average?

It could reflect an outdated price that does not account for current market fluctuations, potentially leading to inaccurate cost calculations. Signup and view all the answers

When categorizing costs, if a company operating at full capacity increases its production by 10%, which cost is least likely to show a directly proportional increase?

Semivariable Costs Signup and view all the answers

A company is assessing its current overhead allocation and realizes they have been allocating overhead based on a historical direct labor rate, despite the fact that labor is no longer the largest cost element. What's the most significant accounting and financial implication of continuing to use this method?

It could lead to inaccurate product costing, potentially misguiding pricing decisions and profitability estimates. Signup and view all the answers

Which of the following scenarios most accurately reflects a situation where a 'black' or 'grey' market price arises, potentially making it an 'unfair' price?

A seller artificially stimulates demand for a common product to sell it for a much higher price. Signup and view all the answers

In the scenario where a company is operating at a lower capacity, what is most likely to happen to their price of direct costs AND factory overhead?

The price of direct costs WILL likely remain relatively constant (per unit), but fixed factory overhead costs per unit would increase because they would need to be spread across fewer units. Signup and view all the answers

A supplier is calculating the 'fair price' for a new machine for a manufacturing company. Which aspect, though very relevant, is not a direct component of arriving at the fair price, according to the context?

The fact that the item may appear to be a 'must-have' by the company. Signup and view all the answers

If a company decides to fully allocate its fixed costs based on an anticipated production forecast, what is a possible consequence of this decision, if the actual production is substantially lower than forecasted?

The per-unit cost of products will increase as the fixed costs will be spread across fewer units. Signup and view all the answers

A supply manager is negotiating with a long term supplier. The supplier insists on a specific price based on their total costs, while the market price is lower. According to the content, which justification cannot be invoked by the supplier?

The fact that the negotiated price is similar to the competitor's price Signup and view all the answers

A company is trying to determine the price at which to sell a batch of products. They need to account for a combination of semi-variable costs like electricity, direct costs like materials, and the fixed cost of their property taxes. Which cost does NOT have to be directly allocated to the products in order to derive a total cost per product?

The fixed costs of property taxes. Signup and view all the answers

Which scenario could lead to a supply manager having the most difficulty in determining a 'fair and just price' for a needed item?

Multiple suppliers present highly varied prices for what seems to be the same product. Signup and view all the answers

Study Notes

Fair Price Definition & Relationship to Cost

A fair price ensures a continuous supply of the right quality at the needed time, and only a supplier making a reasonable profit can sustain such a supply (in the long run).
A fair price covers the supplier's total costs including a reasonable profit.
While individual items may not always capture their full cost share, prices should at least cover direct costs.
Fair prices to different suppliers for the same item may vary, and a buyer can pay both prices simultaneously.
The presence of a monopoly or seller collusion, in itself, does not make a price unfair. Current market prices, even those established through coercion, may not be fair.

Factors Affecting Fair Price

Current market prices are not inherently fair; black/grey markets or prices manipulated through coercion aren't considered fair.
Supply managers must consider past experience, production knowledge, and logistics costs (storage, transportation, service delivery, and other relevant costs) to determine a fair price.

Cost Components and Classification

To remain in business long-term, a supplier needs to cover total costs, including overhead and profit.
Cost can be narrowly defined (e.g., direct labor & direct material) or more broadly (including overhead).
Cost calculation accuracy is crucial for setting fair prices.
Costs are classified as direct (directly assigned) and indirect (overhead) costs.
- Direct costs are easily assigned to specific products/services, like raw materials or manufacturing time.
- Indirect costs relate to general business operations, not directly tied to specific units, like rent, utilities, and staff salaries.
Direct costs are often variable; they change proportionally with production volume.
Indirect costs can be fixed, variable, or semi-variable. Fixed costs remain constant; variable costs change with production; semi-variable costs vary with output but not proportionately (e.g., utilities).
- Overhead allocation is often a percentage of direct costs (e.g., a percentage of direct labor costs).
- Standard costs, or average prices from the prior period, are common for determining direct material costs, as actual prices fluctuate.

Cost Accounting in Manufacturing and Services

Manufacturing cost = direct materials + direct labor + factory overhead
Total cost = Manufacturing cost + general, administrative, and selling costs.
Service cost includes expenses associated with service provision, such as commissions, professional fees, transportation, and rental costs.
Different suppliers may have diverse cost structures, and a fair price should reflect this diversity, not just the lowest cost structure. Fair prices should cover the costs of all suppliers, not just the most efficient, promoting continuous supply.

Cost vs. Market Price

Cost alone does not determine market price, market forces and customer demand are significant factors.
A seller's insistence on a price solely based on cost, irrespective of quality, service, or efficiency, is not justified.
A supplier unable to efficiently deliver needed goods/services does not deserve a price that even covers costs.
A supplier needs to cover total costs, including overhead and profit, to remain in business; otherwise, fewer suppliers leads to scarcity, higher prices, lower quality, and worse service.

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Explore the definition of fair price and its connection to costs in supply management. This quiz covers factors that affect fair pricing, including market conditions and supplier profitability. Test your understanding of cost components and their classifications in the context of fair pricing strategies.

Chapter 10-Relation of Cost to Price, Meaning of Cost

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Questions and Answers

What does cost of revenue primarily include?

Which factor does not justify a seller’s insistence on a specific price based on costs?

Which of the following is NOT typically included in the cost of services?

What question arises regarding the costs of different manufacturers?

Which statement accurately reflects the relationship between cost and market price?

What does 'fair price' signify for a supplier?

What must the supplier's total costs include for sustainability?

Which of the following describes a 'continuous supply'?

Why might the prices set by monopolists be considered fair?

What influences the determination of a 'fair price'?

Which statement is true regarding fair prices between different sellers?

What role does historical experience play in pricing decisions?

What challenge do supply managers face regarding fair prices?

What is described as a price that may still be considered fair despite being set by a monopolist?

What can result when suppliers do not cover total costs and receive a profit?

Which cost is typically classified as a direct cost?

What is the relationship between direct costs and variable costs typically considered?

Which of the following is an example of an indirect cost?

What is a potential disadvantage of using average rates for overhead costs?

What type of costs remain constant regardless of production volume?

What can semivariable costs be described as?

How is factory overhead often historically determined?

Which of the following best describes direct labor costs?

What component is not typically included in the total manufacturing cost buildup?

What might cause a prevailing market price to be considered unfair?

In what scenario might a supplier choose to accept reduced costs?

What type of costs could be included when calculating selling, general, and administrative expenses?

What is a common challenge faced when determining the actual price of a service?

When calculating costs, which element is based on an estimation of production volume?

If a company's costs increase in direct proportion to the increase in sales of services, which type of expense is primarily involved?

What is the critical question that arises after accepting the definition of cost provided in the text?

Given that market price is not determined by cost, what should a seller primarily focus on when setting prices?

If a seller is not entitled to a price that yields profit merely because they're in business, what other justifications for a price are deemed acceptable?

What is the primary implication if all businesses were automatically entitled to a profit, regardless of their costs?

What is required for a seller to be entitled to get a price that even covers their costs?

If a price is based on average cost of raw materials, what aspect of those raw material costs is considered?

What is a key distinction between the cost of services and the cost of general goods?

Why should a seller not assume they are entitled to a price that yields a profit, regardless of costs, quality, or service?

What is the primary goal a supply manager should aim for when determining a 'fair price'?

What is the key difference between 'direct costs' and a 'fair price' of an item?

What is the significant difference between a 'fair price' and the prevailing market price?

Why is it important that a supply manager understands a supplier's cost structure when determining a 'fair price'?

How might a 'fair price' differ between two suppliers providing similar products?

What is the long term risk of only paying direct costs of goods regularly?

What is the potential issue with a 'prevailing price' that is unusually high?

What factor is the most critical when defining a fair price for a specific item?

Why might some businesses choose to use 'average rates' for overhead instead of precise allocated costs?

How does prior experience help in setting a 'fair price' in supply management?

If a company uses the last price paid in the immediately prior fiscal period to calculate direct material costs, what potential issue might arise when compared to using a weighted average?

When categorizing costs, if a company operating at full capacity increases its production by 10%, which cost is least likely to show a directly proportional increase?

Which of the following scenarios most accurately reflects a situation where a 'black' or 'grey' market price arises, potentially making it an 'unfair' price?

In the scenario where a company is operating at a lower capacity, what is most likely to happen to their price of direct costs AND factory overhead?

A supplier is calculating the 'fair price' for a new machine for a manufacturing company. Which aspect, though very relevant, is not a direct component of arriving at the fair price, according to the context?

If a company decides to fully allocate its fixed costs based on an anticipated production forecast, what is a possible consequence of this decision, if the actual production is substantially lower than forecasted?

A supply manager is negotiating with a long term supplier. The supplier insists on a specific price based on their total costs, while the market price is lower. According to the content, which justification cannot be invoked by the supplier?

Which scenario could lead to a supply manager having the most difficulty in determining a 'fair and just price' for a needed item?

Study Notes

Fair Price Definition & Relationship to Cost

Factors Affecting Fair Price

Cost Components and Classification

Cost Accounting in Manufacturing and Services

Cost vs. Market Price

Studying That Suits You

Description

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