The Exact role costs play in pricing decisions depends on both the market conditions and the company’s approach to pricing. • To achieve a desired operating income, managers will examine relationships of costs to selling price and set formulas for pricing: • as a percentage of variable manufacturing costs • as a percentage of total variable costs • as a percentage of full costs • as a percentage of total manufacturing cost
Cost-Plus Pricing Relationship of Costs to same target selling price Alternative Markup percentages to achieve same sales price Sales $20 Variable costs Manufacturing $12 (20 – 12 ) / 12 = 66.67% Selling and Administrative 1.10 Unit variable costs 13.10 (20 – 13.10 ) / 13.10 = 52.67% Fixed Costs Manufacturing 3 Selling and Admin 2.90 Unit Fixed costs 5.90 Full Costs 19 ( 20 – 19 ) / 19 = 5.26 Desired Operating Income 1
Cost-Plus Pricing • The maximum price a company can charge is the one that does not drive customer away. • The minimum price might be considered to be zero (When companies give out free samples to gain entry into market) • In the short run: focus on pricing based on covering all the marginal costs (Variables of producing, selling etc) • In the Long Run: The price must be high enough to cover all costs including fixed costs.
Advantages of Contribution Approach in Cost-Plus Pricing • Prices based on variable costs represent a contribution approach to pricing. • The contribution margin approach offers more detailed information. • It displays variable and fixed-costs behavior patters separately. • It is very sensitive to cost-volume-profit relationship • It allows managers to prepare price schedules at different volume levels.
Advantages of Contribution Approach in Cost-Plus Pricing • It helps managers with pricing decisions by readily displaying the interrelationships among variable costs, fixed costs and potential changes in selling prices. • It offers insight into the short-run versus long-run effects of cutting prices on special orders • This method will not be beneficial if the managers indiscriminately substitute variable costs for full costs. • If managers will not use the data wisely.
Advantages of Absorption-Cost Approaches in Cost-Plus Pricing • In the long run, a firm must recover all costs to stay in business. Fixed costs will fluctuate as volume changes • It may indicate what competitors might charge, especially when they have same level of efficiency • It meets the cost-benefit test. It is too expensive to conduct individual cost-volume analysis for many products • It promotes price stability. This makes planning easier
Advantages of Absorption-Cost Approaches in Cost-Plus Pricing • It Provides the most defensible basis for justifying prices to all interested parties. (Govt, regulators) • It provides convenient reference points to Simplify hundreds or thousands of pricing decisions.
Target Costing Objective 8
Target Costing • When the market conditions are not favorable for the companies to influence the price, and still the management wants to achieve the desired profit, it must focus on the product’s cost.
- Fall '19
- Cordell Company
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