Page 254 - DCOM302_MANAGEMENT_ACCOUNTING

Unit 13: Pricing Decisions

sell the present and future capacity for the greatest obtainable contribution. When the capacity Notes

remains unused, the potential contribution is being sacrificed and the acceptance of an order with

a lower contribution will at least partially meet from fixed costs being incurred. This amount of

contribution would otherwise be lost if the order is refused. In fixing the lower price than normal,

the price fixed must take into consideration the following:
1. The amount of contributions at the proposed price;
2. The possibility of other more remuneration job;
3. Comparison with normal selling price in order to determine the concession being offered;
and

4. The possible adverse effect upon the future sales and customer’s confidence in the
company’s pricing or trading policy.

Example: X Ltd. is found to be working below the normal capacity due to recession. The
directors have been approached by another company with an enquiry for a special purpose job.
The costing department estimated the following in respect of that job:
Direct materials ` 1,00,000
Direct labour 5000 hours @ ` 3 = 15,000

Overhead costs: Normal recovery rates:
Variable = Re 1 per hour.
Fixed = ` 1.50 per hour.
You are required to advise the company on the minimum prices to be charged.
Solution:
Marginal costs will have to be determined as follows:
(`)

1. Direct materials 1,00,000
2. Add: Direct Labour 15,000
3. Add: Variable overhead @ Re 1 per hour for 5000 hours 5,000
4. Total marginal costs 1,20,000

The floor price, the absolute minimum price should be ` 1,20,000. That is, a total of marginal

costs. At this level, it will not make any contribution. Hence, a certain portion of fixed costs must

be added to the marginal costs to accept the job with profit. In this case, the fixed overhead is
found to be ` 7,500 (5,000 hours × ` 1.5 per hour).
Thus, this technique assists in pricing a product.

Notes Objectives of Pricing Decisions
The following are the key objectives of pricing decisions:
1. The important pricing objective is to exploit the firm’s competitive position in the

market place.
2. The products are priced in such a way that suffi cient resources are made available
for the firm’s expansion, developmental investment, etc.

Contd...

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