Pricing calculations

Question 1

What is Cost-plus pricing ?

Answer 1

When the sales price is determined by calculating cost of a product, then adding a percentage mark-up for profit.

Cost + profit = sales price

Question 2

What costs do we use in cost-plus pricing ?

Answer 2

Full costs.
Marginal (variable) costs.

Question 3

What are the options for calculating a full-cost plus price ?

Answer 3

Unit sales price = total production cost + % markup
Unit sales price = total production cost + total other costs + % markup

Question 4

What are the advantages of full cost-plus pricing ?

PICP

Answer 4

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.

Question 5

What are the disadvantages of full cost-plus pricing ?
PNAV

Answer 5

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.

Question 6

What are the options for calculating a marginal cost-plus price ?

Answer 6

Unit sales price = Total variable production cost + % markup
Unit sales price = Total variable cost + % markup

Question 7

What are the advantages of marginal cost-plus pricing ?

Answer 7

Simple
Avoids arbitrary apportionment and absorption of fixed costs.
Useful for short-term decisions.

Question 8

What are the disadvantages of marginal cost-plus pricing ?

Answer 8

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.

Question 9

What is transfer pricing ?

Answer 9

A TP is the amount charged by one part of an organization for goods / services to another part of the same organization.

Question 10

What happens if … Division A ‘gives’ product to Division B ?

Answer 10

Division A must be a cost center and NOT a profit or investment center.

Question 11

To make Division A a profit center … ?

Answer 11

Then, Division A needs a ‘revenue’ from a TP.

Question 12

To make Division B release that Division A does not make the goods for free …

Answer 12

Division B needs a ‘cost’ from a TP.

Question 13

So, what does TP encourage within a business ?

Answer 13

TP encourages divisional managers to act in a way to maximize shareholder wealth (goal congruence).

Question 14

What are the aims of TP ?
MMEAP

Answer 14

Measure divisional profits.
Measure costs and revenues.
Autonomy to mangers.
Encourage goal congruence.
Profit maximization.

Question 15

How much should the TP be?

4 methods

Answer 15

Can be determined by:
Market price
Cost-plus price
2 part transfer price
Dual pricing

Question 16

What is the optimum TP in a perfectly competitive market ?

Answer 16

If the supplying division is operating at FULL capacity then the Market price is the best to use.

Question 17

How is 2 part TP accounted for ?

Answer 17

Part 1 - standard variable cost.
Part 2 - periodic fixed charge.

Receiving division is aware of cost behavior patterns of supplying division.

Question 18

How is Dual pricing decided ?

Answer 18

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.

Question 19

What does Dual-pricing encourage ?

Answer 19

Optimal decision making.

Question 20

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 ?

Answer 20

Contribution = Sales price - all marginal costs

Question 21

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 ?

Answer 21

The marginal cost of Division A (the supplying division) = Mca

Question 22

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 ?

Answer 22

Division B’s Contribution = Sales price - marginal cost of Div B (Mcb)

Question 23

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 ?

Answer 23

A’s minimum TP to B’s maximum TP.

Question 24

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?

Answer 24

Net sales price = A’s sales price - selling costs

Question 25

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 ?

Answer 25

Division B’s contribution = Sales price (B) - MCb

Question 26

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 ?

Answer 26

TP = Div A’s net sales price.

Every unit A supplies to B > loss in external net revenue.

Question 27

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 ?

Answer 27

TP = Mca

A is already selling all it can externally, so with spare capacity, it can make extra goods for Div B.

Question 28

How do you calculate a minimum TP a company will set if the division is to manufacture to capacity ?

Answer 28

Minimum TP = market price - variable costs to sell