Management Accounting - Setting Prices

The product cost per unit under absorption costing is $15.00 and under variable costing are 10.60.

Cost-plus pricing lead to a complicated pricing structures, since distributors and customers negotiated separate product prices from manufacturers, introduced incentives, let prices vary from customer to customer, covered some products by contract and some don’t etc.

According to Investopedia, “Full costing is an accounting method used to determine the complete end-to-end cost of producing products or services.” Full costing is also called "full costs" or "absorption costing."

Firms use cost-plus pricing in order to cover their operating costs. Cost-plus means they can increase the price to their customers with whom they have contracts when the operating costs rise. Operating costs can rise for many reasons and cost-plus pricing allows firms the flexibility to manage operating costs. This flexibility is often needed when the price of a service or good is not known or hard to predict in advance (Magloff, 2011).

Indeed, costs should be utilized as a gauge to set the lower bounds of the prices for the products and accommodations you are selling. An efficacious pricing strategy includes elements of several methods. However, regardless of the policy utilized, price must be justified by value to the customer. Recollect, ultimately, customers determine

This is an excellent short case to introduce the managerial accounting issues related to the "joint cost" problem. Classic microeconomics argues unequivocally that attempts to assign cost to individual products in a "joint" set constitute a complete waste of time--"just maximize the total revenue over the batch." Like the comparable adage to "price so that marginal cost equals marginal revenue," the economists' advice about joint costing is certainly accurate, given the assumptions, but not particularly useful in practice. Most managerial accountants, including this author, believe that there are important managerial issues involved in accounting for joint cost in real companies. This case covers those issues for a real company.

The shortcoming of absorption costing is that it does not always provide the best signal on the strategy to price a product. Moreover, absorption costing assigns both fixed and variable manufacturing costs to products and mix them that makes management to face challenges to distinguish between the two costs.

In absorption costing, all manufacturing costs, both fixed and variable, are assigned to units of product. Units are said to fully absorb manufacturing costs. Most countries require some form of absorption costing for both external financial reports and for tax reports. Also, most companies across the world use absorption costing in their management reports. It is the most common approach to product costing throughout the world. It is also known as Job-Order Costing.

Lewis Company has been using absorption costing to assess the cost of the modules they manufacture. The use of a variable income statement may allow the firm to make better decision regarding pricing as it will allow for increased transparency and easier calculation of the number of units which will need to be solid to break even. The first stage is to convert the income statement into a contribution statement.

The company uses another very good cost based measure which is the calculation of fixed and variable costs separately. Generally, the companies follow a simple approach of calculating unit cost for each activity, and then multiplying it by the total number of units to be produced to calculate the total cost of production. But, there are minor loopholes in this approach, which if left unnoticed, may emerge out as non-existent costs, which spoil the whole estimation. For e.g. if a company does outsourcing for one of the stages of production, then it does not have to incur fixed costs for that stage. But, it may go unnoticed by the companies which uses combined fixed and variable cost system.

The strategy for setting a product’s price often has to be changed when the product is part of a product mix. In this case, the firm looks for a set of prices that maximizes its profits on the total product mix. Pricing is difficult because the various products have related demand and costs and face different degrees of competition.

Manufacturing costing methods are accounting techniques that are used to help understand the value of inputs and outputs in the production process. By tracking and categorizing the information according to a rigorous accounting system, corporate management can determine with a high degree of accuracy, the cost per unit production and other key performance indicators. Management needs this information in order to make informed decisions about the production levels, pricing, competitive strategy ,future investments and a host of other concerns .

The absorption costing method identifies the importance of fixed costs involved in production, which is accepted by Inland Revenue as stock is not undervalued. It also shows less fluctuation in net profits in case of constant production but fluctuating sales.

In the case of Pedro and his peanut business, Pedro started a business of selling peanut bags and considered marginal costing approach for allocating cost, whereby he is making money but his accountant Mark Webb depicts a real picture of how he should allocate costs to his peanuts business that involves taking into account the fixed overheads by absorbing them, this process is known as absorption costing technique. Using absorption costing mark is able to tell Pedro that actually he is incurring a cost of $6,252 by doing the business of peanuts. He has also explained to him the advantages of using this techniques and how he can recover the cost and make profit out of peanut business.

Price another element of the four P’s within the marketing mix, out of all the four P’s price is the one that creates sales revenue, the rest are cost (expenses). The pricing decision of the product or service will decided or affects the number of sales and how much it earns. An organization could have the best product however; if the product price too high or low it could result in low or lost profits. So the question is what is the value of the product or service (Mind Tools, 2014)? One of the ways of finding out the value of the product or service is determining customer’s feels the value of product is. This could be done by researching consumer’s opinions about the pricing; this will help establish the price point of product or service