3 Relevant Costing

Question 1

What are relevant costs?

Answer 1

• These are only costs and benefits that will be affected by a decision
• Therefore there will be a change in the future cash flows
  o If the cash flow or component of the cash flow does not change it is not relevant

Question 2

What are differential costs?

Answer 2

Costs which differ between alternatives and therefore are relevant

Question 3

What are sunk costs?

Answer 3

Costs that are incurred no matter what
* If you have brought a buss pass your daily allowance will be used each day no matter if you use it or not

Question 4

What are opportunity costs?

Answer 4

Benefits forgone for selecting an alternative
* If you decide to go on a night out you are not just spending on drinks and food but giving up a shift at work

Question 5

What is cannibalisation?

Answer 5

If you drop one department you might see a drop in sales in another. This is because you no longer offer all the services for someone under one roof so someone might go else where.
* On questions where this is the case be careful that you don’t only take from TO but also from COGS

Question 6

When do you sell or process further?

Answer 6

• Need to find value after split off
• Take costs after split off to get relevant revenue
• If this is greater than before pre split of turnover then process further

Question 7

What are special orders?

Answer 7

Special order pricing is a technique used to calculate the lowest price of a product or service at which a special order may be accepted and below which a special order should be rejected. Usually a business receives special orders from customers at a price lower than normal. In such cases, the business will not accept the special order if it can sell all its output at normal price. However when sales are low or when there is idle production capacity, special orders should be accepted if the incremental revenue from special order is greater than incremental costs

Question 8

What do you do if you have a capacity constraint?

Answer 8

• Find contribution per machine hour and priorities those that give the greatest contribution to fixed costs
• Can use contribution margin ratio for easier com

Question 9

What is the contribution margin ratio?

Answer 9

Contribution margin / Sales
Shows the proportion of each £1 in sales is available to cover fixed costs

Question 10

What are normal goods?

Answer 10

• For a normal good the higher the price the less the demand
• As incomes rise so will the demand
• Food, clothing

Question 11

What factors have an influence on price?

Answer 11

• Cost
• Demand
• Quality
• Competitors
• Substitutes
• Inflation
• Age of product
• Disposable incomes

Question 12

What is price elasticity of demand?

Answer 12

A measure of the responsiveness of demand to a change in price
% Change in demand / % Change in price

Question 13

What does a PED > 1 show?

Answer 13

The product is described as having elastic demand. This means that a small change in price will cause a proportionately greater change in quantity demanded.

Question 14

What does a PED < 1 show?

Answer 14

The product has inelastic demand and prices can be changed greatly without creating large changes in demand

Question 15

What is cost plus pricing?

Answer 15

The price of the product is calculated by adding an appropriate profit mark up to the product’s cost. This cost could be:
* Absorption/full cost (including ABC)
* Marginal cost
* Relevant cost
* Standard cost

Question 16

What are the advantages of Cost Plus Pricing?

Answer 16

• Readily understood/easy to apply
• Readily determined
• Doesn’t require a linear and stable price/quantity relationship

Question 17

What are the disadvantages of Cost Plus Pricing

Answer 17

• Ignores the impact that the price will have on quantity demanded.
• If the basis of absorbing overheads changes, the price of the product will change
• Price may need to be adjusted to reflect market conditions.

Question 18

What is market penetration?

Answer 18

A policy of low prices when the product is first launched to obtain sales volume and market share.
Useful if:
* The firm wants to discourage new entrants into the market
* The firm wishes to shorten the initial period of the product’s life cycle
* There are significant economies of scale to be achieved

Question 19

What is market skimming?

Answer 19

Involves charging high prices when a product is first launched and spending heavily on advertising and sales promotion to obtain sales. As the product moves into the later stages of its life cycle (growth, maturity and decline)lower prices will be charged. The aim of market skimming is to gain high unit profits early in the product’s life.

Question 20

What is premium pricing?

Answer 20

• Making a product appear ‘different’ so as to justify a premium price. The product may be different in terms of quality, reliability, durability, after-sales service or extended warranties.
• Heavy advertising can establish brand loyalty which can help to sustain a premium

Question 21

What is price discrimination?

Answer 21

When a company can sell into two or more separate markets, it might be able to charge a different price in each market. To be successful the company must prevent the transfer of goods from the cheap market to the more expensive one

Question 22

What is product bundling?

Answer 22

Selling a number of products or services as a package at a price lower than the aggregate of their individual prices.

Question 23

What is psychological pricing?

Answer 23

Psychological pricing strategies include pricing a product at £19.99 instead of £20. Another example would be withdrawing an unsuccessful product from the market and then re-launching it at a higher price, the customer having equated the lower price with lower quality (which was not the seller’s intention).

Question 24

What is product line pricing?

Answer 24

Most organisations sell not just one product but a range of products. Focus is placed on the profit from the whole range rather than the profit on each single product.

Question 25

What is complimentary product pricing?

Answer 25

These products are sold separately but are used together. One product would tend to be priced competitively which attracts demand for the complementary product. E.g. Games consoles and games.

Question 26

What are loss leaders?

Answer 26

Particularly useful in retailing, a very low price is charged for one product, which is intended to make consumers buy additional products in the range that carry higher profit margins.

Question 27

What is controlled pricing?

Answer 27

Monopolies have the potential power to charge very high prices for their goods/services as demand is inelastic. Frequently monopolies are regulated to ensure customers receive value for money.

Question 28

What are volume discounters?

Answer 28

These are given in order to increase sales volume without reducing prices permanently. They also allow differentiation between customers i.e. wholesale v retail.