Page 296 - DMGT403_ACCOUNTING_FOR_MANAGERS

Unit 14: Pricing Decision

Notes
Example: Let’s look at Product A:
Production cost as follows:

Variable cost-material $1.50
Variable cost-labor $1.50
Total variable cost $3.00
Fixed cost $3.00
(excludes administrative and selling overheads)
Required 50% mark up on total production cost.
For Full-Cost Plus Pricing:
Total cost = $ 3.00 + $ 3.00 =$ 6.00

50% on total/full cost = 50% × $ 6.00 = $ 3.00
Hence, Selling price = $ 6.00 + $ 3.00 = $ 9.00 per unit.
By pricing at $ 9.00, the company wants Product A to at least cover its total production cost.
Full Cost Pricing has many advantages. A few of them are as under:
1. Easy and simple to understand;
2. Pricing decisions become standardized;
3. Adopts a conservative approach that in the long run to at least ensure the recovery of fixed
cost of a business;
4. Difficult of estimating demands can be avoided.
Like everything else, full cost pricing also has certain disadvantages which are as under:
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.

14.4.2 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 fixed 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.

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