Pricing Decisions - Overheads, Cost Accounting B Com Notes | EduRev

Cost Accounting

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B Com : Pricing Decisions - Overheads, Cost Accounting B Com Notes | EduRev

The document Pricing Decisions - Overheads, Cost Accounting B Com Notes | EduRev is a part of the B Com Course Cost Accounting.
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Pricing Decisions (Discriminating Price and Differential Selling)
Under normal circumstances, selling price is based on total cost i.e. production, administration and selling overheads - fixed as well as variable plus normal profit. In the long term planning selling price must cover all costs plus a desired profit. There are however, variety of business situations where fixation of selling price may vary from inclusion of desired profit to selling even below total cost. Marginal costing technique helps in determining the most profitable relationship between costs, prices and volume of business.

When there is considerable unfilled capacity it may be necessary to accept a lower contribution in order to provide work in the factory. Alternatively, if there is sufficient order normal price may be quoted and the contribution obtainable may be high. The aim of the prices fixer is to sell the present and future capacity for the greatest obtainable contribution. When the capacity is remaining unused, the potential contribution is being sacrificed and the acceptance of an order with a lower contribution will at least partially meet from fixed costs being incurred. This amount of contribution would otherwise be lost if the order is refused. In fixing the lower price than normal, the price fixed must take into consideration the following:

  1. the amount of contributions at the proposed price;
  2. the possibility of other more remuneration job;
  3. comparison with normal selling price in order to determine the concession being offered; and
  4. the possible adverse effect upon the future sales and customer’s confidence in the company’s pricing or trading policy.

If the selling price is below the marginal cost, loss will be more than the fixed costs because variable expenses will not be covered fully. Hence efforts should be made to sell the products at a price which is equal to the marginal cost or more than the marginal cost. Product should be discontinued if the price obtained is below the marginal cost so that loss may not be more than the fixed costs. But in the following special circumstances production may be continued even if the selling price is below the marginal cost.

  1. When a new product is introduced in the market: The new product may be sold at a very low price to make it popular. This is done with the expectation that sale will increase with the passage of time and cost of production will come down as a result of increase in sales.
  2. When foreign market is to be explored to earn foreign exchange: Government sometimes allow import quota against foreign exchange earned and profit from import quota may be much more than the loss on exporting the product at a price below the marginal cost.
  3. When the firm has already purchased large quantities of materials: It is appropriate to convert the material into finished goods and sell these at a price below the marginal cost if the sale of materials will give rise to loss which is more than the loss incurred if the production is done.
  4. Closure of business means breaking of business connections with customers and the connections may be re-established at a heavy expenditure on advertisement and sales promotion and the same may likely to be retarded because other firms will take advantage of the particular firm’s closure and win over the customers. In such instances, it is better to continue the production and to sell the product at a price below the marginal cost.
  5. When the sales of one product at a price below the marginal cost will push up the sales of other profitable product.
  6. When the employees can not be retrenched.
  7. When competitors are to be eliminated from the market.
  8. When goods are of perishable nature. It is better to sell the perishable goods at a price which they can realise, otherwise these goods will perish and nothing will be realised.

In the case of export orders, besides the usual variable cost, the quotation should take into account, the following:

(1) Increase in the cost arising out of:

  • Additional packing cost required for sea-worthiness;
  • Additional checks for quality (this being vital as goods should not be returned if rejected for quality);
  • Freight and insurance charges, if not borne by the purchaser;
  • Cost of capital blocked, if payment is not made in advance or is delayed. 

(2) Cost benefits arising out of:

  • Exemptions (non-payments) of customs duty;
  • Exemption of central excise duty on excisable goods or draw-back as per the Central Excise and Sales Tax Act;
  • Subsidies from Government;
  • Saving in Sales promotion expenses and other overheads.

(3) Earning of Foreign Exchange.
Though the principles applicable for pricing exports are much the same as for home markets, special points to be noted are:

  1. High export price may facilitate reduction of selling price in the home market.
  2. Low export price, as low as marginal cost, may be advocated on grounds of benefits that arise out of large volume, (recovery of fixed charges) thus increasing profitability.
  3. Export prices even below marginal cost may be advocated with an idea of obtaining from the Government, import licences for essential raw materials on grounds of having contributed to export trade and foreign exchange.
  4. Even lower price when goods are dumped in the export market. Dumping is a sales technique often tried in export markets. Large quantities of merchandise are sold at low prices and before competitors recover of the shock, these dumped merchandise get a foot hold in the export market paving its way for future sales, when upward revision of prices may be possible. One has to be careful that dumped merchandise are not re-exported to compete in the internal market.
  5. Tax credit on export profits and sales may justify lower export prices.

However, in normal times, pricing should be based on full costs as far as practicable since selling only on the basis of marginal cost may mean a loss (contribution may be less than the total fixed expenses). Marginal costing as a basis for fixation of selling price, is suitable only for utilising excess or idle capacity. If any concessional price is to be offered to a new set of customers, it must not affect the existing market.

Concept Of Pricing Decision And Objectives Of Pricing Policy
Pricing Decision
Organizations producing goods and services need to set the price for their product. Setting the price for an organization's product is one of the most important decisions a manager faces. It is one of the most crucial and difficult decisions a firm's manager has to make. Pricing is a profit planning exercise. Cost is one of the major considerations in price determination of the product. It is one of the three major factors which influence ricing decision. The two other factors are customers and competitors.

Customer: In a situation where the product has many substitutes, customers decide the price. That is, the demand of customers are the paramount importance in setting the price of the product. In such a situation, the firm should try to deliver the value, in the form of product and/or service, at the target cost so that a reasonable profit can be earned. Similarly, under competitive condition, price is determined by market forces and an individual firm or an individual customer can not influence the price.
Competitors: When there are only few players in the market, competitors usually, react to the price changes and, therefore, pricing decisions are influenced by the possible reaction of competitors. As such management must keep watchful eye on the firm's competitors. That is, knowledge of competitors' strategy is essential for pricing decision in an oligopoly situation.
Cost: Cost is the third major factor. Its role in price setting varies widely among industries. Some industries determine price by market forces and in some industries, managers set prices a on the basis of production costs. Firms want to charge a price that covers its costs like production costs, distribution costs and costs relate with selling the product and also including a fair return for its effort.

Objectives Of Pricing Policy
Formulation of pricing policy begins with the classification of the basic objectives of the firm. Pricing objectives have to be in conformity with overall organizational objectives. In most of the situation, profit maximization is the main objective of price policy, but it is only one objective. Following may be other objectives of pricing policy in an organization:
1. Pricing the goods based on reasonable costs.
2. Increase the market share or growth rate at the expense of immediate profits.
3. Avoid adverse public reaction consequent on charging high price.
4. Ethical consideration not to reap high profit.
5. Immediate survival of the firm.
6. Charge reasonable price so as to have good relations with government and public at large.
7. Maximization of prestige of the firm rather than profit, and
8. To safeguard against the emergence of new producers in same line.
Although its importance varies from firm to firm, pricing is one of the tools that a firm has at its disposal in its attempt to reach the stated objectives.

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