COST ACCOUNTING- A MANAGERIAL
EMPHASIS, 15TH EDITION,
SRIKANT/ GEORGE/ MADHAV/
CHRISTOPHER
Chapter 13
Pricing Decisions
and
Cost Management
PRICING AND BUSINESS
How companies price a product or service
ultimately depends on the demand and supply for it
Three influences on demand and supply:
1. Customers – influence price through their effect on the
demand for a product or service, based on factors such
as quality and product features
2. Competitors – influence price through their pricing
schemes, product features, and production volume
3. Costs – influence prices because they affect supply (the
lower the cost, the greater the quantity a firm is willing
to supply)
TIME HORIZONS AND PRICING
Short-run pricing decisions have a time horizon of
less than one year and include decisions such as:
Pricing a one-time-only special order with no long-run
implications
Adjusting product mix and output volume in a
competitive market
Long-run pricing decisions have a time horizon of
one year or longer and include decisions such as:
Pricing a product in a major market where there is
some leeway in setting price
DIFFERENCES AFFECTING PRICING:
LONG RUN VS. SHORT RUN
1. Costs that are often irrelevant for short-run policy
decisions, such as fixed costs that cannot be
changed, are generally relevant in the long run
because costs can be altered in the long run
2. Profit margins in long-run pricing decisions are
often set to earn a reasonable return on investment
– prices are decreased when demand is weak and
increased when demand is strong
ALTERNATIVE LONG-RUN PRICING
APPROACHES
Market-Based: price charged is based on what
customers want and how competitors react
Cost-Based: price charged is based on what it cost to
produce, coupled with the ability to recoup the costs
and still achieve a required rate of return
MARKETS AND PRICING
Competitive Markets – use the market-
based approach
Less-Competitive Markets – can use either
the market-based or cost-based approach
Noncompetitive Markets – use cost-based
approaches
MARKET-BASED APPROACH
Starts with a target price
Target Price – estimated price for a product or
service that potential customers will pay
Estimated on customers’ perceived value for a
product or service and how competitors will
price competing products or services
UNDERSTANDING THE MARKET
ENVIRONMENT
Understanding customers and competitors is
important because:
1. Competition from lower cost producers has meant that
prices cannot be increased
2. Products are on the market for shorter periods of time,
leaving less time and opportunity to recover from pricing
mistakes
3. Customers have become more knowledgeable and demand
quality products at reasonable prices
Five Steps in Developing
Target Prices and Target Costs
1. Develop a product that satisfies the needs of potential
customers
2. Choose a target price
3. Derive a target cost per unit:
Target Price per unit minus Target Operating Income per
unit
4. Perform cost analysis
5. Perform value engineering to achieve target cost
VALUE ENGINEERING
Value Engineering is a systematic evaluation of all
aspects of the value chain, with the objective of reducing
costs while improving quality and satisfying customer
needs
Managers must distinguish value-added activities and
costs from non-value-added activities and costs
VALUE ENGINEERING TERMINOLOGY
Value-Added Costs – a cost that, if eliminated,
would reduce the actual or perceived value or
utility (usefulness) customers obtain from using
the product or service
Non-Value-Added Costs – a cost that, if
eliminated, would not reduce the actual or
perceived value or utility customers obtain from
using the product or service. It is a cost the
customer is unwilling to pay for
COST-BASED (COST-PLUS) PRICING
The general formula adds a markup component to
the cost base to determine a prospective selling
price
Usually only a starting point in the price-setting
process
Markup is somewhat flexible, based partially on
customers and competitors
FORMS OF COST-PLUS PRICING
Setting a Target Rate of Return on Investment: the
Target Annual Operating Return that an organization
aims to achieve, divided by Invested Capital
Selecting different cost bases for the “cost-plus”
calculation:
Variable Manufacturing Cost
Variable Cost
Manufacturing Cost
Full Cost
COMMON BUSINESS PRACTICE
Most firms use full cost for their cost-based pricing
decisions, because:
Allows for full recovery of all costs of the product
Allows for price stability
It is a simple approach