 Hello and welcome to this session. This is Professor Farhad in which we would look at legal issues relating to cost and cost of sales. Simply put, those legal issues will be legal terms that relate to cost accounting. These topics will also be covered on the CPA PEC exam section. As always, I'm gonna remind you to connect with me on LinkedIn and subscribe to my YouTube where I have over 1,800 plus accounting, auditing, tax, finance, as well as Excel tutorials. If you like my lectures, please like them and share them. If they benefit you, it means they might benefit other people, connect with me on Instagram and Facebook. On my website, farhadclutchers.com, you will find additional resources to complement and supplement this course, as well as your CPA preparation, other accounting courses. And here are the five terms we're gonna be going over that deals with cost and sales price if you are taken a cost accounting course. And sometimes if you are, these topics are covered in a macro or a microeconomics. And those are predatory pricing, dumping price discrimination, peak load pricing and price fixing. And obviously I'm gonna go over each one of them separately starting with predatory pricing. Predatory pricing is basically setting a selling price below cost with the intent to harm competition by driving competitors out of the market or by creating a barrier for them to enter into the market. Well, hold on a second, what does that mean? Simply put, you are selling at a loss. So you are selling below your cost, you are selling at a loss. What is the purpose of this? Why would you do something like this? Well, two reasons. First, you wanna take the market from your competition. So that's what you would do. If you sell below cost, everybody will buy from you, they will not buy from them. Or two, you don't want another competitor to enter the market. So you make it cost prohibitive for them. You make it unprofitable for them to enter the market. It is this practice is considered anti-competitive and illegal and under antitrust laws. In the US we have antitrust laws, it's illegal under antitrust laws. Now, how do you prove? Like for example, how do you show that one company is committing predatory pricing? We'll use the marginal cost or the average variable cost. We use it as a floor for this predatory pricing. What does that mean? Let's look at an example. Let's assume we have two companies, P and C. We have a predator company and a competitor company. They produce a similar product while employing similar technologies. The variable cost should be about $5.10. Now, the company C adopt an industry practice. So the industry practice is to add 10% to your variable cost. So simply put, you end up selling the product at $5.61, that's the industry practice. In order to dominate the market, the company P, what they did is they're selling it at $5.00. What does that mean? It means company P, they are losing 10 cent per unit. Well, what is that going to do? Well, that's good for the customers. If you are the customer, you're like, that's great. This company is selling it for $5.00. So attract customers, old and new. And what's gonna happen, you will drive C out of the market because C cannot sell if they cannot sell, they cannot produce revenue. Why are they in business if they cannot sell? Because you're in the business to sell and make a profit. Eventually, company P then raises the price to $6.63 once they put you out of business. Now they put you out of business, they have a monopoly, they will start selling at $6.30, a markup of 30%, recouping all the losses. And that's why in the US, that's illegal because it's not in the best interest of consumer in the long run. You don't want to have competition. You don't want to have monopolies. You want to have competition. You want to have a healthy market. Another term we need to be familiar with is dumping. And what is dumping? Dumping occurs when a company export its product to a consumer in another country. You're dumping it into another country at an export price below its domestic price. Here kind of sounds like price, predatory pricing, but it's not, it's you export and you sell it below what you're selling it in your home country. Okay, for example, an electronic company in a foreign country sells its product in the US. Let's assume a Taiwanese company sells its product in the US. For example, they sell it in Taiwan for $15 apiece. They would sell it in the US for $10. Means they're dumping their product in the domestic market, okay? Dumping benefit consumer as well in the short term at the expense of the producers in the importing country. So for example, as a US consumer, you're going to be happy that they're selling it to you at a cheaper rate. Then what happened? The US companies that are producing those units, those electronics units, they will usually seek protection in a form of tariffs. They will lobby the government. Could you please place taxes on the Taiwanese import? This way their prices are at par with our prices so we can compete. So this way they will level the playing field. So everyone is selling using the same rules. Okay, policymakers disagree on the merit of prohibiting dumping. I mean, because think about it, it's good for the consumer, not good for the industry. So who should you protect as a government? Should you protect the consumer or should you protect the industry? So protection of the domestic industries for national security reasons versus practice of free trade and free market. So you have to choose. Do I want to, am I a protectionist? Do I want to protect my industries? Or do I want to believe in free trade and let my citizen enjoy free trade, which is lower prices for a product? That's a decision policymakers will have to make. It depends on many factors. Again, this is beyond the scope of this course. This is not public policy course, but the point you need to know is what is dumping. Price discrimination is another term you need to be familiar with, is the practice of selling identical goods or services to different customers at different prices. So you're selling the same thing, but for different people with different prices. Now, why would you do that? When is that legal and when is that illegal? Well, price discrimination required market segmentation. So if you can segment your market, what does that mean? Let's assume a movie theater. They might sell the tickets for students for $7 and non-students for 14. This makes sense because they want to attract students. Students don't have a lot of money. So they want to encourage them. They want them to get used to going to the theater. Maybe after they become students, once they are used to this culture, they will keep on going to the theater. So that's why you would lure them by selling them the ticket for $7 and non-students for 14. That's fine. You segmented the market. You did not discriminate. In a sense, discriminate based on gender, color, race, religion or anything like that. So price discrimination benefit companies because it can enable them to sell product to customers who may not otherwise purchase them. So if you have the movie theater at $14, maybe a lot of students can't afford to do that but at $7, they will. And eventually they will buy them at $14 later on. For example, if an airline company has empty seats, it would rather sell those seats at a discount than not at all. So for example, if you bought your ticket two months ago, maybe you paid $600. Or now, somebody next to you might be able to buy the ticket for $400 because the plane is empty and the company discounted the tickets. Well, they're sitting next to you but they paid $400. Well, it is price discrimination but it's basically because supply and demand. It's not because of any other reason. So however, again, price discrimination basis on race, religion, disability, gender, or any other similar factors is illegal. But for market segmentation, if you segment your market, that's fine. Peak loading pricing is the practice of setting prices highest when the quantity demanded for the product approach, its physical capacity to produce it. Simply put, when you have high demand, you might raise your prices. When you have low demand for your product, you may lower your prices. Who's known for this? Utility companies and travel providers. Try to travel now obviously because of the coronavirus, but usually when you want to travel on August, if you're going on vacation June, July, August, prices are higher. It's as simple as that. Even within, if you travel on the weekend, the prices are different than you travel during the work week for airlines. Why? Because it's a peak load pricing. So they engage in peak load pricing when facing high demand levels. For example, a warm weather geographical location. Peak loads for electricity occur in the late afternoon hours when the temperature is the highest. This is where they charge you the most. Travel services, again, airlines during certain season. Christmas, Thanksgiving is notorious for that. All the prices are high. So this is peak load pricing. So they increase their prices. Price fixing is the agreement among business competitor to set a price for a particular level. This is where you're talking to your competitor. Let's talk, let's see if we can set one price. Generally, the idea to fix a price at a level higher than the equilibrium. If we all agree to sell it higher than the equilibrium, then we all benefit, but we are benefiting on the expense of the consumer here, price fixing. So price fixing is a particularly legal and ethical problem because it's not universally illegal. In the US, it's illegal. In other countries, it may not be illegal. So price discrimination benefit to the company because it enabled them to sell the product to customers who may not otherwise purchase them at that cost. So it will benefit them because you're charging a premium. Managers must be careful to price fixing because the activities of law enforcement officials regarded as illegal include even informal or unspoken agreement to fix prices. Sometime you may fix prices without even having in quote agreement. Implicitly, you have to be very careful. This appeared to be the case for a company called Dynamic Random Access Memory DRAM. Companies from Germany, South Korea and Japan were charged with price fixing their product in the US kind of implicitly. If you're interested, you can Google the case, but basically it doesn't have to be in writing to be in agreement because we said it's an agreement. It doesn't have to be explicitly spelled out to be in writing. If it's implicit, it appears to be price fixing. It might be price fixing. At the end of the day, a judge or the US Treasury or the US Department of Commerce will determine that. Anyhow, in the next session, we'll start to look at more differential analysis and specifically, I will be working most likely on make or buy decision, make or buy decision. As always, I'm gonna ask you to like this recording, share it, put it in playlist, and don't forget to visit my website for additional resources for hatlectures.com. Good luck, study hard and stay safe.