Pricing calculations Flashcards
What is Cost-plus pricing ?
When the sales price is determined by calculating cost of a product, then adding a percentage mark-up for profit.
Cost + profit = sales price
What costs do we use in cost-plus pricing ?
Full costs.
Marginal (variable) costs.
What are the options for calculating a full-cost plus price ?
Unit sales price = total production cost + % markup
Unit sales price = total production cost + total other costs + % markup
What are the advantages of full cost-plus pricing ?
PICP
Price is easy and quick to calculate.
If working at normal capacity, it should ensure a profit is made.
Can justify price increases if costs rise.
Pricing decisions can be delegated.
What are the disadvantages of full cost-plus pricing ?
PNAV
Profit maximization may not be achieved as relationship between price and demand is ignored.
No incentive to control costs.
Arbitrary absorption of OH into product costs.
Vicious circle.
What are the options for calculating a marginal cost-plus price ?
Unit sales price = Total variable production cost + % markup
Unit sales price = Total variable cost + % markup
What are the advantages of marginal cost-plus pricing ?
Simple
Avoids arbitrary apportionment and absorption of fixed costs.
Useful for short-term decisions.
What are the disadvantages of marginal cost-plus pricing ?
Potential losses in long term if sales prices doesn’t cover fixed costs.
May not be relevant to business’s with heavy fixed cost base.
Profit maximization may not be achieved as relationship between price and demand is ignored.
What is transfer pricing ?
A TP is the amount charged by one part of an organization for goods / services to another part of the same organization.
What happens if … Division A ‘gives’ product to Division B ?
Division A must be a cost center and NOT a profit or investment center.
To make Division A a profit center … ?
Then, Division A needs a ‘revenue’ from a TP.
To make Division B release that Division A does not make the goods for free …
Division B needs a ‘cost’ from a TP.
So, what does TP encourage within a business ?
TP encourages divisional managers to act in a way to maximize shareholder wealth (goal congruence).
What are the aims of TP ?
MMEAP
Measure divisional profits.
Measure costs and revenues.
Autonomy to mangers.
Encourage goal congruence.
Profit maximization.
How much should the TP be?
4 methods
Can be determined by:
Market price
Cost-plus price
2 part transfer price
Dual pricing
What is the optimum TP in a perfectly competitive market ?
If the supplying division is operating at FULL capacity then the Market price is the best to use.
How is 2 part TP accounted for ?
Part 1 - standard variable cost.
Part 2 - periodic fixed charge.
Receiving division is aware of cost behavior patterns of supplying division.
How is Dual pricing decided ?
Divisions records TP at different amounts:
Supplying division - records revenue at MP or total cost-plus.
Receiving division - records purchases at supplying divisions standard variable cost only.
What does Dual-pricing encourage ?
Optimal decision making.
Basic TP situation:
Div A makes good at a marginal cost (Mca)
Div B takes goods to turn into finished good at a marginal cost (Mcb)
Finished product has a sales price (SP)
How do you calculate the company’s contribution ?
Contribution = Sales price - all marginal costs
Basic TP situation:
Div A makes good at a marginal cost (Mca)
Div B takes goods to turn into finished good at a marginal cost (Mcb)
Finished product has a sales price (SP)
How do you calculate the minimum TP that Div A (the supplying division) will accept ?
The marginal cost of Division A (the supplying division) = Mca
Basic TP situation:
Div A makes good at a marginal cost (Mca)
Div B takes goods to turn into finished good at a marginal cost (Mcb)
Finished product has a sales price (SP)
How do you calculate the maximum TP that Div B (the receiving division) will pay ?
Division B’s Contribution = Sales price - marginal cost of Div B (Mcb)
Situation 1: Basic
Div A makes good at a marginal cost (Mca)
Div B takes goods to turn into finished good at a marginal cost (Mcb)
Finished product has a sales price (SP)
How do you determine the acceptable range of TPs ?
A’s minimum TP to B’s maximum TP.
Situation 2: Div A can sell internally and / or externally
Same as Situation 1, Div A has selling costs and a sales price.
How do you calculate the net sales price per unit that A will get if it sells externally?
Net sales price = A’s sales price - selling costs
Situation 2: Div A can sell internally and / or externally
Same as Situation 1, Div A has selling costs and a sales price.
What is maximum TP that Div B will pay ?
Division B’s contribution = Sales price (B) - MCb
Situation 2: Div A can sell internally and / or externally
Same as Situation 1, Div A has selling costs and a sales price.
What is the lowest TP Div A will accept if it is at full capacity ?
TP = Div A’s net sales price.
Every unit A supplies to B > loss in external net revenue.
Situation 2: Div A can sell internally and / or externally
Same as Situation 1, Div A has selling costs and a sales price.
What is the lowest TP Div A will accept if it has spare capacity ?
TP = Mca
A is already selling all it can externally, so with spare capacity, it can make extra goods for Div B.
How do you calculate a minimum TP a company will set if the division is to manufacture to capacity ?
Minimum TP = market price - variable costs to sell
