Page 297 - DMGT403_ACCOUNTING_FOR_MANAGERS

Accounting for Managers

Notes
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 profit.
The 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 fixed 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 sufficient profit for the business;
2. Might be unsuitable for production costs consist a lot of fixed costs.

14.4.3 Rate of Return Pricing

For this type of pricing, the company needs to specify the rate of return on its capital invested.
Similar to Cost pricing, the difference is that the marked up will be based on the target rate of
return. The salient features include:
1. The target rate of return varies with market norm or what management considers a fair
return.
2. Useful method to use when a business has invested too much on the project or products.
3. However, difficult to use where a company has too many product lines or competes in
many markets.

Example: Capital invested/employed $2,000,000
Target return 10%
Estimated costs $500,000
Mark up
= 10% × $2,000,000
$500,000
= 40%

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