Page 292 - DMGT403_ACCOUNTING_FOR_MANAGERS

Unit 14: Pricing Decision

selling overheads – fixed as well as variable plus normal profit. In the long-term planning, Notes
selling price must cover all costs plus a desired profit. There are, however, a variety of business
situations where fixation of selling price may vary from inclusion of desired profit to selling
even below total cost. Marginal costing technique helps in determining the most profitable
relationship between costs, prices and volume of business.
When there is considerable unfilled capacity it may be necessary to accept a lower contribution
in order to provide work in the factory. Alternatively, if there is sufficient order, normal price
may be quoted and the contribution obtainable may be high. The aim of the fixer of prices is to
sell the present and future capacity for the greatest obtainable contribution. When the capacity
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
Overheade 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.

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