Pricing calculations (5)

Question 1

Define full cost

Answer 1

Full cost is production cost + non production cost

Question 2

Define marginal (variable) cost

Answer 2

Marginal cost is variable production cost + variable non production cost

Question 3

Define full cost plus pricing

Answer 3

There are two options:
(1) Unit sales price = total production cost plus mark up

(2) Unit sales price = total production cost plus total costs plus mark up

Question 4

State the advantages and disadvantages of full cost plus pricing

Answer 4

Advantages:

• Price is quick and easy to calculate
• Can justify price increases if costs rise
• Pricing decisions can be delegated
• If at normal capacity, ensures profit is made

Disadvantages:

• 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

Question 5

Define marginal cost plus pricing

Answer 5

There are two options:
(1) Unit sales price = total variable production cost plus mark up

(2) Unit sales price = total variable cost plus mark up

Question 6

State the advantages and disadvantages of marginal cost plus pricing

Answer 6

Advantages:

• Simple
• Avoids arbitrary apportionment and absorption of fixed costs
• Very useful for short term decisions, concerning use of excess capacity or one off contracts

Disadvantages:

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

Question 7

Distinguish between mark up and margin

Answer 7

• A mark up is the profit expressed as a % of cost

- A margin is the profit expressed as a % of the sales price

Question 8

Define transfer pricing

Answer 8

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

Question 9

What are the aims of transfer pricing?

Answer 9

• measure divisional profits
• measure costs and revenues
• autonomy to managers
• encourage goal congruence
• Profit maximisation

Question 10

There are four practical methods to determine a transfer price, define (1) market price

Answer 10

In a perfectly competitive market, the optimum transfer price is the market price providing the supplying division is operating at full capacity. This should be reduced for cost savings from internal transfers.

Question 11

There are four practical methods to determine a transfer price, define (2) cost-plus price

Answer 11

Cost plus transfer pricing works in the same way as cost plus pricing

Question 12

There are four practical methods to determine a transfer price, define (3) two-part transfer price

Answer 12

The transfer is accounted for in two parts:

(1) transfer price = standard variable cost
(2) = periodic fixed charge

This ensures the recovering division is aware of the cost behaviour patterns of the supplying division

Question 13

There are four practical methods to determine a transfer price, define (4) Dual pricing

Answer 13

Each division records the transfer price 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