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Lesson 4 a Pricing.pptx

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Lesson 4 a Pricing.pptx

Uploaded by

Ebsa Mohammed
Copyright
© © All Rights Reserved
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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MANAGERIAL ACCOUNTING

PRICING
Learning Outcomes

1. Understand the role of cost information in pricing decisions.


2. Understand the four scenarios and how to use pricing in each
case.
3. Understand the concept of target costing.
4. Discuss cost-plus pricing.
Role of cost information in pricing decisions

•Price takers are those firms that have little control over the prices
of their products or services.
• For price takers cost information is of vital importance in
deciding on the output and mix of products and services.
• Price setters are those firms that have some discretion over the
setting of selling prices for their products or services.
• Cost information is of vital importance to price setters in making
pricing decisions.
Role of cost information in pricing decisions (Cont’d)

•Firms may be price setters for some of their products /services


and price takes for others.

Four situations will be considered:


1. A price setting firm facing a short-run pricing decision
2. A price setting firm facing a long-run pricing decision
3. A price taker firm facing a short-run product-mix decision
4. A price taker firm facing a long-run product-mix decision
A price setting firm facing a short-run pricing
decision
• Applies where companies are faced with the opportunity of
bidding for one time special orders in competition with other
suppliers.

• In this situation only the incremental cost of undertaking


the order should be taken into account.

• Given the short-term one-off nature of the opportunity many


costs will be non-incremental.
A price setting firm facing a short-run pricing
decision (cont’d)
Bids should be made at prices that exceed the incremental cost
and must meet the following conditions:

1. Sufficient capacity must be available to meet the order.


2 The bid price should not effect future selling prices and the
customer should not expect repeat business at short-term
incremental cost.
3. The order will utilize unused capacity for only a short period
and capacity will be released for use on more profitable
opportunities.
A price setting firm facing a long-run pricing
decision
• Three scenarios are considered:

1. Pricing customized products using cost-plus pricing.


2. Pricing non-customized products using cost-plus pricing or demand estimates.
3. Pricing non-customized products using target costing.

• In the long-term a firm can adjust the supply of resources that are committed to it
- therefore a product or service should be priced to cover all of the resources that
are committed to it.

• Price setters have stronger grounds for adopting ABC.


Pricing customized products using cost-
plus pricing
1. An accurate costing system is required since undercosting will result in
acceptance of unprofitable business and overcosting in the loss of profitable
business.

2.To determine the selling price a full cost/long-run cost should be calculated and a
mark-up added (i.e. a cost-plus selling price is determined - see slides 9 and 10 for
a more detailed explanation).

3. Cost assignment for pricing should be based on direct cost tracing or cause-and-
effect assignments — Arbitrary allocations (e.g. some business/facility-sustaining
costs) should be allocated using behavioural drivers or covered within the mark-
up.

4. ABC provides a better understanding of cost behaviour for negotiating with


customers the price and size of the orders.
A price setting firm facing long-run
pricing decisions (cont.)
• Pricing non-customized products (Cost-plus pricing):

1. Pricing decision involves large volumes to many customers of a single


product/service.
2. Cost-plus pricing requires an estimate of sales volume to determine unit cost in
order to derive the cost-plus price.
3. Recommended that cost-plus prices are estimated for a range of potential sales
volumes.

• Pricing non-customized products (Using demand estimates):

If approximations of demand can be derived they may be preferable to using the


cost-plus pricing approach. (‘Crude estimates of demand may serve instead of
careful estimates of demand but cost gives remarkably little insight into
demand.’
A price setting firm facing long-run pricing decisions (cont.)

• Pricing non-customized products (Target costing):

1. Target costing is the reverse of cost-plus pricing —The target selling price is the starting
point.

2. Four stages are involved:


Stage 1: Determine the target price which customers will be prepared to pay for the product.
Stage 2: Deduct a target profit margin from the target price to determine the target cost.
Stage 3: Estimate the actual cost of the product.
Stage 4: If estimated actual cost exceeds the target cost investigate ways of driving down the
actual cost to the target cost.

3. Marketing factors and customer research provide the basis for determining selling price (Not
cost).

4. Emphasizes a team approach to achieving the target cost.

5. Most suited to high sales volume products.


A price taker firm facing short-run
product-mix decisions

• Applies where opportunities exist for taking on short-


term business at a market determined selling price.

• Cost information required and the same conditions apply


as those specified for a price setter facing short-term
pricing decisions.

• If short-term capacity constraints apply the product mix


should be based on maximizing contribution per limiting
factor
A price taker firm facing long-run product-mix decisions

• In the long-term a firm can adjust the supply of resources that are committed to it –
Therefore the sales revenue from a product or service should be sufficient to cover all of the
resources that are committed to it.

• Periodic profitability analysis is required to ensure that only profitable products/services


are marketed.

• Profitability analysis should be used as an attention-directing mechanism.

• Ideally ABC hierarchical profitability analysis should be used.


Cost-plus pricing

• Target mark-ups seek to provide a contribution to non-assigned costs and profit.

• Target mark-ups are also adjusted to reflect demand, types of products, industry
norms, competitive position, etc.

• Criticisms of cost-plus pricing:


1. Ignores demand
2. Does not necessarily ensure that total sales revenue will exceed total cost.
3. Can lead to wrong decisions if budgeted activity is used to unitize costs.
4. Circular reasoning — Volume estimates are required to estimate unit fixed
costs and ultimately price.

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