Pricing calculations

Question 1

what is cost plus pricing and what costs should we use?

Answer 1

• adding a markup to total goods/services
  Two types:
• full cost
• marginal variable cost

Question 2

what are the advantages of full cost-plus pricing

Answer 2

• price is quick and easy to calculate
• can justify price increases if costs rise
• pricing decisions can be delegated
• if working at normal capacity, it ensures a profit is made

Question 3

what are the disadvantages of full cost-plus pricing?

Answer 3

• profit maximisation may not be achieved as the relationship between price and demand is ignored
• no incentive to control costs
• arbitrary absorption of overhead into product costs
• vicious circle

Question 4

calculating marginal cost-plus pricing

Answer 4

unit sales price= total variable production cost + mark-up %
or total variable cost + mark up %

Question 5

advantages of marginal cost-plus pricing

Answer 5

• simple
• it avoids arbitrary apportionment and absorption of fixed costs
• very useful for short term decisions, concerning use of excess capacity or one off contracts

Question 6

disadvantages of marginal cost-plus pricing

Answer 6

• may make losses in the long term if sales prices does not cover fixed costs
• may not be relevant to businesses with heavy fixed costs base
• profit maximisation may not be achieved as the relationship between price and demand is ignored

Question 7

what is transfer pricing

Answer 7

the amount charged by one part of an organisation for the provision of goods or services to another part of the same organisation

Question 8

aims of a transfer pricing system

Answer 8

• to enable realistic measurement of divisional profit
• to provide supplier with realistic profit
• give autonomy to managers
• encourage goal congruence
• profit maximisation

Question 9

4 practical methods to determine a transfer price:

Answer 9

• market price
• cost-plus price
• two-part transfer price
• dual pricing

Question 10

market price

Answer 10

if a perfectly competitive market exists for a product, then the external market price is the optimum transfer price if the supplying division is operating at full capacity

Question 11

cost-plus approach to transfer pricing

Answer 11

• usually used where there is no external market for product or service
• pre-determined cost should be used than actual cost

Question 12

two part transfer pricing

Answer 12

• standard variable cost and fixed charge
• ensures goal congruence

Question 13

dual pricing

Answer 13

each division records the TP at a different amount to encourage optimal decision making
- Supplying division - records revenue at market price or total cost plus
- Receiving division - records purchases at the supplying divisions standard variable cost only

Question 14

optimum transfer price=

Answer 14

external market price - cost savings with internal transfer