Page 258 - DCOM302_MANAGEMENT_ACCOUNTING

Unit 13: Pricing Decisions

Like everything else, full cost pricing also has certain disadvantages which are as under: Notes
1. Tendency to set prices on inaccurate estimates;

2. Challenges of apportioning the fixed overheads properly into different products;
3. Unsuitable for short term decisions making particularly in situation like surplus production
capacity, tendering for contracts price and others;
4. Ignores competition and price elasticity of demand; and

5. Ignores opportunity costs and relevant costs.
13.3.2 Variable/Marginal Cost Pricing

Under marginal Cost pricing, selling price is determined by adding a mark up or margin on the
total variable costs (marginal cost). Its salient features are as under:
1. Based on the assumption that any price above variable cost would generate a certain level
of contribution towards meeting fi xed costs;
2. Consistent with the marginal costing technique;

3. When using this pricing method, need to be careful to ensure that it is sufficient to cover all

fixed cost and to generate sufficient margin for profit otherwise the long term survival of

the business might be at stake.
Example: Let’s look at Product A:
Production cost as follows:
Variable/direct material $1.50
Variable/direct labor $1.50
Variable Production overheads $1.00

Variable Administrative overheads $0.50
Variable Selling overheads $0.10
Total variable costs $4.60
Say required mark up of 65% $3.00
Variable Cost Plus Pricing $7.60
The selling price is determined at $7.60 where the company wants Product A to at least

cover its total variable cost and contribute towards recovery fixed costs and profi t.
Advantages of Variable/Marginal Cost Pricing are as under:
1. As it adopts the margin cost approach, it provides better information as it segregate the
variable and fi xed costs;
2. Highlights the importance of contribution;
3. Useful for contract bidding where competition could be quite intense;
4. Eliminates the difficulty of computing fixed costs into the products.

Disadvantages of Variable/Marginal Cost Pricing:
1. For short-term pricing decision, it’s alright otherwise needs to be very careful the pricing

in the long-term can recover fixed costs and generate suffi cient profit for the business;
2. Might be unsuitable for production costs consist a lot of fi xed costs.

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