PADMASHREE DR. D.Y.PATIL UNIVERSITY

DEPARTMENT OF BUSINESS MANAGEMENT

COST ACCOUNTING

ASSIGNMENT

ON

COST ANALYSIS ON PRICING DECISIONS

GROUP MEMBERS

RAJEEV MEHRA – 33

SACHIN SALUNKE – 37

A.B. NITIN – 47

AKSHAYA IYER – 48

IRAM USMANI – 49

SUMY THOMAS – 50

RONAK GALA – 51

ABRAHAM JEYRAJ – 52

SHRADHA KAMAT – 53

MANISHA DASAN – 57

VISHAL LALZARE – 35

SUBMITTED TO: Prof. Shweta Kumari.

INDEX

1. INTRODUCTION.2. WHEN CAN WE USE COST ANALYSIS.

3. WHY IS COST ANALYSIS IMPORTANT.

4. PRICING DECISIONS.

5. MAJOR INFLUENCES ON PRICING DECISIONS.

6. ECONOMIC PROFIT MAXIMISING MODEL.

7. ROLE OF ACCOUNTING PRODUCT COSTS IN PRICING.

8. DETERMINING THE MARKUP.

9. OTHER ISSUES.

10.ABC ELIMINATES DISTORTION.

11.LEGAL LIMITATIONS.

12.PRIMARY DATA OF THE COMPANY.

13.DESCRIPTION ABOUT THE PRODUCT.

14.QUESTIONAIRE.

15.BIBLIOGRAPHY.

Cost Analysis and Pricing Decisions

Introduction Cost analysis is an economic evaluation technique that involves the systematic collection, categorization, and analysis of

program or intervention costs, and Cost of illness.

When Can We Use Cost Analysis? Cost analysis can be used as a stand-alone evaluation method when

only one program is being assessed, information about program effectiveness is not available, or

The interventions being assessed and compared are equally effective.

Cost analysis allows researchers to achieve cost minimization for the programs under consideration (with the goal to identify the least costly method to obtain a certain level of output). Cost analysis can also be used together with effectiveness assessment techniques within the framework of three types of economic evaluation:

cost-effectiveness analysis, cost-benefit analysis, or

Cost-utility analysis.

What are Costs? Costs are the values of all the resources (e.g., labor, buildings, equipment, and supplies), tangible or intangible, used to produce a good or a service. In everyday life we generally think of the financial or monetary cost of goods and services we consume. The "price tag" is what we refer to at the store. Costs in Perfect Markets

Perfect market conditions exist when 1. numerous buyers and sellers can enter and withdraw from the market

at no cost, 2. all buyers are identical,

3. all buyers possess the same relevant information, and

4. The goods and services traded are the same.

Costs in Imperfect Markets The prices of tradable goods produced under perfect market conditions reflect their opportunity costs. We have to adjust the prices of goods purchased under imperfect market conditions to get correct estimates of their costs. The methods described below are different ways to derive true economic costs of resources in imperfect markets.

Using Cost-To-Charge Ratios (CCRs) Market distortions (e.g., taxes and subsidies) are another reason for the discrepancies between the prices and economic costs.

Micro-Costing Micro-costing is a more precise method than is using cost-to-charge ratios but it is also more complex and time-consuming. Micro-costing involves identifying and determining a value for the resources actually consumed to produce the good or service.

Surveys A survey can be used to estimate a person's willingness to pay (WTP) or how much they would need to be paid to give up something.

Note Regardless of the nature of the resource or the method that is used to assess its value, be conscious of and consider all aspects of the true cost of a resource. For example:

Labor costs should include wages or salaries as well as benefits (e.g., paid vacations, health insurance, bonuses, and retirement fund contributions), and perquisites (e.g., the use of a car).

Supplies and equipment costs should include shipping charges, installation, and maintenance costs.

Transportation costs should include maintenance, gasoline, and insurance.

Whether or not sales taxes are included in the cost of a resource varies, depending on the study perspective. If the cost analysis is conducted from a societal perspective, taxes are considered a resource transfer and should not be included in the cost. If the cost analysis is conducted from any other perspective, sales taxes should be included, because they are part of the price paid to secure the use of that resource.

Why is Cost Analysis Important? Cost analysis is an important component of all economic evaluation techniques. It is a useful tool for planning and self-assessment. Cost analysis is particularly useful for the following purposes: Planning and Cost Projections Cost analysis can be used as a tool for

developing and justifying budgets, and determining the level of funding changes necessary to achieve a

desired change in disease prevalence/incidence.

Assessing Efficiency A program is considered efficient when the maximum amount of output (i.e., cases treated or persons screened) is produced from the given level of inputs (i.e., resources). Cost analysis makes it possible to assess the efficiency of programs by

comparing cost profiles from equally effective programs, and identifying cost categories for further efficiency studies.

Accountability

Cost analysis involves tracking expenses, which allows us to know how the funds are spent and whether they are spent as intended.

Assessing Equity Cost analysis can indicate whether a program spends more resources per capita in urban areas than in rural areas and whether the difference is the result of allocation mechanisms or of differences in need.

Framing a Cost Analysis When you are conducting a cost analysis, the first step is to determine a detailed research strategy or framework that will later guide the data collection and analysis efforts. We follow seven steps to frame a cost analysis.

1. Defining the Problem Conducting a study involves considerable expenditure of resources; therefore, research dollars must be allocated efficiently. In the first step of framing a cost analysis, we need to identify the problem and the reasons that justify expending the limited resources on the study. We have to consider the following questions:

What is the problem to be analyzed? Why is it important?

What aspects of the problem need to be explained?

What questions need to be answered?

2. Defining the Options To obtain estimates that are as accurate as possible, all relevant organizational and technological aspects of available options/interventions must be considered, which includes defining the items below.

3. Defining the Audience The structure of the analysis depends on who will be using the results of the cost analysis. We have to consider the following questions:

Who will be using the results of the analysis? What are the information needs of the audience?

How will the results be used?

4. Defining the Perspective

The study perspective determines which costs are relevant and should be included in the cost analysis. The perspective takes into account who bears the costs and who gains from available interventions

5. Defining the Time Frame The time frame must be long enough to capture the full extent of the program costs (the costs of the intervention itself) and of the side effects. The time frame must be long enough to account for

program start-up and maintenance costs, seasonal variations, and

cost of intervention, including side effects.

6. Defining the Analytic Horizon We have to choose an analytic horizon that is:

long enough to capture the full costs and effects of programs with an impact that occurs at different times, and

short enough that future costs and benefits are not uncertain.

The time frame and analytic horizon diagram below illustrates a time frame with a much longer analytic horizon. Time frame and analytic horizon

7. Choosing a Format Depending on the availability of data and resources, we can choose to use one of three formats:

1. Retrospective analyses: Can be conducted when the intervention of interest is already in place or has been carried out previously. When the analysis starts, the costs have already been incurred.

2. Prospective analyses: Costs have not yet been incurred when the study starts. We will therefore track the costs as they occur.

3. Models: Costs are based on estimated values from other studies.

Pricing Decisions.

 The pricing decision is a critical one for most marketers, yet the amount of attention given to this key area is often much less than is given to other marketing decisions. One reason for the lack of attention is that many believe price setting is a mechanical process requiring the marketer to utilize financial tools, such as spreadsheets, to build their case for setting price levels. While financial tools are widely used to assist in setting price, marketers must consider many other factors when arriving at the price for which their product will sell.

I. Major Influences on Pricing Decisions

Internal Factors - When setting price, marketers must take into consideration several factors which are the result of company decisions and actions. To a large extent these factors are controllable by the company and, if necessary, can be altered. However, while the organization may have control over these factors making a quick change is not always realistic. For instance, product pricing may depend heavily on the productivity of a manufacturing facility (e.g., how much can be produced within a certain period of time). The marketer knows that increasing productivity can reduce the cost of producing each product and thus allow the marketer to potentially lower the product’s price. But increasing productivity may require major changes at the manufacturing facility that will take time (not to mention be costly) and will not translate into lower price products for a considerable period of time.

External Factors - There are a number of influencing factors which are not controlled by the company but will impact pricing decisions. Understanding these factors requires the marketer conduct research to monitor what is happening in each market the company serves since the effect of these factors can vary by market.

A. Consumer demand influences: Consumer demand is a major influence on all aspects of the operations. Consideration is given to the price that customers are willing to pay, the quality desired, and any accompanying trade-offs. Companies routinely use market research and test marketing to gain such information.

B. Consider competitors’ strategies: A company cannot set prices without considering the products and pricing strategies of competitors.

C. Costs’ importance is industry specific: Costs are a factor in the pricing process, more in some industries than in others. In agriculture, for example, grain and meat prices are market-driven. In many other cases (gasoline and automobiles), prices are set by adding a markup to cost. Generally speaking, prices are set by considering both cost and market influences.

D. Firms conscious of other factors: Firms are also conscious of political, legal, and image-related issues when setting prices. Price discrimination, regulatory agencies, and concerns about reputation are often a factor.

Other factors influencing Price Decision:-

Firm’s profit and other objectives.

Nature of product and its life expectancy.

Pricing decision as long-run decision or short term decision or one-time

spare capacity decision.

Nature of suppliers in the market.

Economic and political climate and trend and likely changes in them in

future.

Government guidelines, if any.

I.Economic Profit-Maximizing Model

A. One more unit incurs marginal costs: Marginal cost is the addition to total cost from the production of one additional unit. Marginal

revenue, in contrast, is the addition to total revenue from the sale of the next additional unit of product. Profits are maximized if a company sells a quantity that coincides with the intersection of the marginal revenue and marginal cost curves. That quantity, when plotted against the demand curve, derives the optimal price (e.g., see Exhibit 15-3).

B. Elastic demand is price sensitive: The impact of price changes on sales volume is known as price elasticity. Demand is elastic if a price increase has a large negative impact on sales volume and vice versa. The measurement of price elasticity is an important objective of market research, as a good understanding of this concept helps managers determine the best price for a product.

C. Several limitations: There are several limitations to using the economist’s model in practice:

1. Market research seldom sufficient: Market research is seldom sufficient to predict the exact effect of a price change on demand, because many other factors (e.g., product design, advertising, company image, and quality) are also influential.

2. Limited use: The model is not valid for all forms of markets (an oligopolistic market, for example, which has only a few sellers).

3. Marginal costs too expensive: Practically speaking, costs accounting systems cannot provide the marginal cost information needed in the model for a company’s various product lines.

II.Role of Accounting Product Costs in Pricing

In management accounting, cost accounting establishes budget and actual cost of operations, processes, departments or product and the analysis of variances, profitability or social use of funds. Managers use cost accounting to support decision-making to cut a company's costs and improve profitability. As a form of management accounting, cost accounting need not follow standards such as GAAP, because its primary use is for internal managers, rather than outside users, and what to compute is instead decided pragmatically.

Costs are measured in units of nominal currency by convention. Cost accounting can be viewed as translating the supply chain (the series of events in the production process that, in concert, result in a product) into financial values.

There are various managerial accounting approaches:

standardized or standard cost accounting lean accounting

activity-based costing

resource consumption accounting

throughput accounting

marginal costing/cost-volume-profit analysis

Classical cost elements are:

1. raw materials2. labor

3. indirect expenses/overhead

Cost accounting has long been used to help managers understand the costs of running a business. Modern cost accounting originated during the industrial revolution, when the complexities of running a large scale business led to the development of systems for recording and tracking costs to help business owners and managers make decisions.

In the early industrial age, most of the costs incurred by a business were what modern accountants call "variable costs" because they varied directly with the amount of production. Money was spent on labor, raw materials, power to run a factory, etc. in direct proportion to production. Managers could simply total the variable costs for a product and use this as a rough guide for decision-making processes.

Some costs tend to remain the same even during busy periods, unlike variable costs, which rise and fall with volume of work. Over time, the importance of these "fixed costs" has become more important to managers. Examples of fixed costs include the depreciation of plant and equipment, and the cost of departments such as maintenance, tooling, production control, purchasing, quality control, storage and handling, plant supervision and engineering. In the early twentieth century, these costs were of little importance to most businesses. However, in the twenty-

first century, these costs are often more important than the variable cost of a product, and allocating them to a broad range of products can lead to bad decision making. Managers must understand fixed costs in order to make decisions about products and pricing.

For example: A company produced railway coaches and had only one product. To make each coach, the company needed to purchase $60 of raw materials and components, and pay 6 laborers $40 each. Therefore, total variable cost for each coach was $300. Knowing that making a coach required spending $300, managers knew they couldn't sell below that price without losing money on each coach. Any price above $300 became a contribution to the fixed costs of the company. If the fixed costs were, say, $1000 per month for rent, insurance and owner's salary, the company could therefore sell 5 coaches per month for a total of $3000 (priced at $600 each), or 10 coaches for a total of $4500 (priced at $450 each), and make a profit of $500 in both cases.

Elements of cost

1. Material(Material is a very important part of business)

A. Direct material

2. Labor

A. Direct labor

3. Overhead

A. Indirect material

B. Indirect labor

(In some companies, machine cost is segregated from overhead and reported as a separate element)

They are grouped further based on their functions as,

1. Production or works overheads 2. Administration overheads

3. Selling overheads

4. Distribution overheads

Classification of costs

Classification of cost means, the grouping of costs according to their common characteristics. The important ways of classification of costs are:

By nature or element: materials, labor, expenses By functions: production, selling, distribution, administration, R&D,

development,

By traceability: direct and indirect

By variability: fixed, variable, semi-variable

By controllability: controllable, uncontrollable

By normality: normal, abnormal

Standard cost accounting

In modern cost accounting, the concept of recording historical costs was taken further, by allocating the company's fixed costs over a given period of time to the items produced during that period, and recording the result as the total cost of production. This allowed the full cost of products that were not sold in the period they were produced to be recorded in inventory using a variety of complex accounting methods, which was consistent with the principles of GAAP (Generally Accepted Accounting Principles). It also essentially enabled managers to ignore the fixed costs, and look at the results of each period in relation to the "standard cost" for any given product.

For example: if the railway coach company normally produced 40 coaches per month, and the fixed costs were still $1000/month, then each coach could be said to incur an overhead of $25 ($1000 / 40). Adding this to the variable costs of $300 per coach produced a full cost of $325 per coach.

This method tended to slightly distort the resulting unit cost, but in mass-production industries that made one product line, and where the fixed costs were relatively low, the distortion was very minor.

For example: if the railway coach company made 100 coaches one month, then the unit cost would become $310 per coach ($300 + ($1000 / 100)). If the next month the company made 50 coaches, then the unit cost = $320 per coach ($300 + ($1000 / 50)), a relatively minor difference.

An important part of standard cost accounting is a variance analysis, which breaks down the variation between actual cost and standard costs into various components (volume variation, material cost variation, labor cost variation, etc.) so managers can understand why costs were different from what was planned and take appropriate action to correct the situation.

The development of throughput accounting

Main article: Throughput accounting

As business became more complex and began producing a greater variety of products, the use of cost accounting to make decisions to maximize profitability came under question. Management circles became increasingly aware of the Theory of Constraints in the 1980s, and began to understand that "every production process has a limiting factor" somewhere in the chain of production. As business management learned to identify the constraints, they increasingly adopted throughput accounting to manage them and "maximize the throughput dollars" (or other currency) from each unit of constrained resource.

For example: The railway coach company was offered a contract to make 15 open-topped streetcars each month, using a design that included ornate brass foundry work, but very little of the metalwork needed to produce a covered rail coach. The buyer offered to pay $280 per streetcar. The company had a firm order for 40 rail coaches each month for $350 per unit.

The company accountant determined that the cost of operating the foundry vs. the metalwork

shop each month was as follows:

Overhead Cost by Department

Total CostHours Available

per monthCost per

hour

Foundry $ 7,300.00 160 $45.63

Metal shop $ 3,300.00 160 $20.63

Total $10,600.00 320 $33.13

The company was at full capacity making 40 rail coaches each month. And since the foundry was expensive to operate, and purchasing brass as a raw material for the streetcars was expensive, the accountant determined that the company would lose money on any streetcars it built. He showed an analysis of the estimated product costs based on standard cost accounting and

recommended that the company decline to build any streetcars.

Standard Cost Accounting Analysis Streetcars Rail coach

Monthly Demand 15 40

Price $280 $350

Foundry Time (hrs) 3.0 2.0

Metalwork Time (hrs) 1.5 4.0

Total Time 4.5 6.0

Foundry Cost $136.88 $ 91.25

Metalwork Cost $ 30.94 $ 82.50

Raw Material Cost $120.00 $ 60.00

Total Cost $287.81 $233.75

Profit per Unit $ (7.81) $116.25

However, the company's operations manager knew that recent investment in automated foundry equipment had created idle time for workers in that department. The constraint on production of the railcoaches was the metalwork shop. She made an analysis of profit and loss if the company took the contract using throughput accounting to determine the profitability of products by

calculating "throughput" (revenue less variable cost) in the metal shop.

Throughput Cost Accounting Analysis

Decline Contract

Take Contract

Coaches Produced 40 34

Streetcars Produced 0 15

Foundry Hours 80 113

Metal shop Hours 160 159

Coach Revenue $14,000 $11,900

Streetcar Revenue $ 0 $ 4,200

Coach Raw Material Cost $(2,400) $(2,040)

Streetcar Raw Material Cost $ 0 $(1,800)

Throughput Value $11,600 $12,260

Overhead Expense $(10,600) $(10,600)

Profit $1,000 $1,660

After the presentations from the company accountant and the operations manager, the president understood that the metal shop capacity was limiting the company's profitability. The company could make only 40 rail coaches per month. But by taking the contract for the streetcars, the company could make nearly all the railway coaches ordered, and also meet all the demand for streetcars. The result would increase throughput in the metal shop from $6.25 to $10.38 per hour of available time, and increase profitability by 66 percent.

Activity-based costing

Main article: Activity-based costing

Activity-based costing (ABC) is a system for assigning costs to products based on the activities they require. In this case, activities are those regular actions performed inside a company. "Talking with customer regarding invoice questions" is an example of an activity inside most companies.

Accountants assign 100% of each employee's time to the different activities performed inside a company (many will use surveys to have the workers themselves assign their time to the different activities). The accountant then can determine the total cost spent on each activity by summing up the

percentage of each worker's salary spent on that activity.

A company can use the resulting activity cost data to determine where to focus their operational improvements. For example, a job-based manufacturer may find that a high percentage of its workers are spending their time trying to figure out a hastily written customer order. Via ABC, the accountants now have a currency amount pegged to the activity of "Researching Customer Work Order Specifications". Senior management can now decide how much focus or money to budget for resolving this process deficiency. Activity-based management includes (but is not restricted to) the use of activity-based costing to manage a business.

While ABC may be able to pinpoint the cost of each activity and resources into the ultimate product, the process could be tedious, costly and subject to errors.

As it is a tool for a more accurate way of allocating fixed costs into product, these fixed costs do not vary according to each month's production volume. For example, an elimination of one product would not eliminate the overhead or even direct labor cost assigned to it. ABC better identifies product costing in the long run, but may not be too helpful in day-to-day decision-making.

Lean accounting

Main article: Lean accounting

Lean accounting has developed in recent years to provide the accounting, control, and measurement methods supporting lean manufacturing and other applications of lean thinking such as healthcare,

construction, insurance, banking, education, government, and other industries.

There are two main thrusts for Lean Accounting. The first is the application of lean methods to the company's accounting, control, and measurement processes. This is not different from applying lean methods to any other processes. The objective is to eliminate waste, free up capacity, speed up the process, eliminate errors & defects, and make the process clear and understandable. The second (and more important) thrust of Lean Accounting is to fundamentally change the accounting, control, and measurement processes so they motivate lean change & improvement, provide information that is suitable for control and decision-making, provide an understanding of customer value, correctly assess the financial impact of lean improvement, and are themselves simple, visual, and low-waste. Lean Accounting does not require the traditional management accounting methods like standard costing, activity-based costing, variance reporting, cost-plus pricing, complex transactional control systems, and untimely & confusing financial reports. These are replaced by:

lean-focused performance measurements simple summary direct costing of the value

streams

decision-making and reporting using a box score

financial reports that are timely and presented in "plain English" that everyone can understand

radical simplification and elimination of transactional control systems by eliminating the need for them

driving lean changes from a deep understanding of the value created for the customers

eliminating traditional budgeting through monthly sales, operations, and financial planning processes (SOFP)

value-based pricing

correct understanding of the financial impact of lean change

As an organization becomes more mature with lean thinking and methods, they recognize that the combined methods of lean accounting in fact creates a lean management system (LMS) designed to provide the planning, the operational and financial reporting, and the motivation for change required to prosper the company's on-going lean transformation.

Marginal costing

See also: Cost-Volume-Profit Analysis and Marginal cost

This method is used particularly for short-term decision-making. Its principal tenets are:

Revenue (per product) − variable costs (per product) = contribution (per product)

Total contribution − total fixed costs = (total profit or total loss)

Thus, it does not attempt to allocate fixed costs in an arbitrary manner to different products. The short-term objective is to maximize contribution per unit. If constraints exist on resources, then Managerial Accounting dictates that marginal cost analysis be employed to maximize contribution per unit of the

constrained resource (see Development of throughput accounting, above).

A. Product costs provide start: Product costs give managers a starting point when setting pricing policies. Although the lowest price could be zero (as in a free sample promotion), all costs must be covered for an organization to break even in the long run. No organization can price it products below total cost indefinitely and continue to stay in business. Therefore, the price floor is the total cost, and the price ceiling is the amount that consumers are willing to pay. Most prices fall somewhere in-between these two points.

B. General cost-plus formula: There are several ways to define the cost factor in formula, and for each, the markup is adjusted to yield the same target price.

Price = Cost + (Markup percentage X Cost)

 

C. Long-term costs = absorption cost: For long-term pricing, cost may be defined as absorption cost (direct materials, direct labor, variable manufacturing overhead, and fixed manufacturing overhead). Because all manufacturing costs are considered here, this definition of cost reminds managers that all elements of production must be covered by a firm’s selling price. Also these data are readily available because the absorption cost is used for valuing inventory on the balance sheet. A disadvantage to using absorption cost is the inconsistency with cost-volume-profit analysis, which allows managers to study the effects of changes in sales and prices on profitability.

D. Total cost a factor: Managers may also use total cost as the cost factor in the formula. Total cost would include absorption manufacturing cost plus selling and administrative costs.

E. No fixed costs not considered: Variable-pricing formulas define cost as all variable costs. Some managers prefer this method because of its consistency with cost-volume-profit analysis and special-order decision making. On the negative side, prices may be set too low

because in the long run, all costs must be covered by the selling price. Variable costs may be defined as variable manufacturing cost or total variable cost, with the markup adjusted accordingly.

III.Determining the Markup

Markup refers to the percentage of an item's cost that a retailer adds when reselling it to customers. The higher the markup, the more the retailer will profit. In order to calculate the amount of a markup, you need to know the retail price and actual cost of the item. The markup is usually reported as a percentage.

Difficulty: HOW TO CALCULATE A MARK UP

o 1Determine the cost to produce or acquire the product that you are selling. For example, if you are determining the markup for a table, you may check your purchase invoice to see that it cost you $300 to buy wholesale.

o 2Divide the selling price of the item by the cost of the item. For example, if you sold the table for $330 and you bought it for $300, you would divide $330 by $300 to get "1.1."

o 3Subtract "1" from the result in the step above to calculate the markup expressed as a decimal. Continuing the example, you would subtract "1" from "1.1" to get "0.1."

o 4Multiply the markup expressed as a decimal by 100 to change the markup to a percent. Finishing this example, you would multiply "0.1" by 100 to get 10 percent, which is the amount of your markup.

Companies can calculate markup by determining cost of the product and profit desired.

To calculate the markup on a product, your company needs to know the cost of the item. This can be the expense to produce it or the cost to buy it wholesale. The markup is the price above the cost that your company charges to sell the product. The markup will be the profit on the sale of each item.

Difficulty:Instructions

o 1Determine the cost of the product and the percent of profit that your company wants to make on each sale. For example, you produce widgets for $3 a piece. You want to make 150 percent profit on each sale. If you convert the percentage to decimal form, then 150 percent equals 1.50.

o 2Add 100 percent to the percent of the profit that the company wants to make on each sale, as determined in the step above. This represents the cost to produce the product. In decimal form, one hundred percent equals one. In the example, one plus 1.50 equals 2.50. Alternatively, you could write this in its percentage form as 100 percent plus 150 percent equals 250 percent.

o 3Multiply the cost of the product by the number calculated in Step Two. In the example, $3 times 2.50 equals a selling price of $7.50. Alternatively, this can be expressed as $3 times 250 percent equals a selling price of $7.50.

o 4Subtract the selling price from the cost of the product to determine the markup. In the example, $7.50 minus $3 equals a $4.50 markup.

A. Markup % covers costs and provides return: Regardless of the definition of cost, a markup percentage determines a price that will cover all costs and provide a return to the company (i.e., return-on-investment pricing). The following formula is used to calculate the target profit needed in the markup calculation, namely:

Target Profit= Average Invested Capital X Target ROI

 

B. Then use target profit: The target profit is then employed to derive the markup percentage for the company’s pricing policy:

Markup % = (Target Profit + Any Total Annual Costs Not in Base)

Annual Volume X Cost per unit*

* Cost as defined in the chosen cost-pricing formula

C. Not applicable to all markets: Like the economist’s model, the accountant’s cost-plus model is not applicable to all markets, for

example, in agriculture where the individual producer cannot affect prices. Also the model cannot be applied without due consideration of other variables in the marketplace such as product life-cycle, competition, and promotion. Therefore, the cost-plus formula is often used only as a starting point in price determination.

I. Other Issues

A. Labor & materials marked up: Time and materials pricing is used by home builders, print shops, repair shops, consultants, and other similar "job-oriented" businesses. The cost of labor and materials used on a job is marked up by a factor to cover the overhead and desired profit margin. The overhead charges and profit margin are often "buried" in the labor rate.

B. Competitive bidding sealed: Competitive bidding requires the submission of sealed bids in an effort to secure a contract for a project or product. The higher the bid price, the greater the profit for the contractor if the contractor gets the job. Of course, a high-priced bid lowers the probability of being the ultimate selection.

1. Cover variable cost when excess exists: With excess capacity, a firm should cover a variable costs in its bid price and be willing to settle for a contribution to fixed costs.

2. No excess capacity consider total costs: If there is no excess capacity, a firm should attempt to obtain a price in excess of total job cost.

A. New product pricing more uncertain: Strategic pricing of new products is more difficult than pricing an existing product because of the uncertainty associated with production and demand. Two pricing strategies are frequently used: price skimming (setting the initial price high to reap profits before competition enters the market) and penetration pricing (settling the initial price low to quickly gain a large market share).

B. Target costing uses market research: A number of firms use target costing in product pricing. Under this approach, a company uses market research to determine the price at which a product will sell. It then subtracts an estimated profit margin to yield the target cost. Finally, engineers and cost analysts

work together to design a product that can be manufactured for the allowable cost.

C. ABC eliminates distortion: Activity-based costing helps eliminate cost distortion. Because pricing decisions are often based on cost, incorrect costs could lead to significant error in under- and over-pricing a product, perhaps resulting in (1) a sale below cost, or (2) a price that is set too high and eventual lost customers.

Activity-Based Costing (ABC) is a method of allocating costs to products and services. It is generally used as a tool for planning and control. It was developed as an approach to address problems associated with traditional cost management systems, that tend to have the inability to accurately determine actual production and service costs, or provide useful information for operating decisions. With these defiencies managers can be exposed to making decisions based on inaccurate data. The higher exposure is for companies with multiple products or services.

ABC allows managers to attribute costs to activities and products more accurately than traditional cost accounting methods. The activities responsible for the costs can be identified and passed on to users only when the product or service uses the activity. Some of the advantages ABC offers is an improved means of identifying high overhead costs per unit and finding ways to reduce the costs.

The way it works is first major activities are identified in the process system. Next cost pools are created for groups of activities that can be allocated together. Following this cost drivers are identified. The number of cost drivers used vary depending on the balance between accuracy and complexity. After determining the cost drivers, rates are calculated. The rates are then applied to the respective cost drivers for each product or service that is being considered. The overhead cost per unit is then derived by dividing the total cost for the product by the total product units.

ABC eliminates distortion :

Activity-based costing helps eliminate cost distortion. Because pricing decisions are often based on cost, incorrect costs could lead to significant error in under- and over-pricing a product, perhaps resulting in (1) a sale below cost, or (2) a price that is set too high and eventual lost customers.

Legal limitations:

Businesses must stay within the legal framework of pricing as regulated by the Robinson—Patman Act, the Clayton Act, and the Sherman Act. Careful records must be kept to document that a company does not engage in price discrimination (charging different prices to different customers for the same goods and services) and predatory pricing (temporarily cutting a price to boost demand, with the intention of later restricting supply and raising the price).

B. Businesses must stay within the legal framework of pricing as regulated by the Robinson—Patman Act, the Clayton Act, and the Sherman Act. Careful records must be kept to document that a company does not engage in price discrimination (charging different prices to different customers for the same goods and services) and predatory pricing (temporarily cutting a price to boost demand, with the intention of later restricting supply and raising the price

C. EG- The Cooper Pen Company example illustrates how production volume differences create product cost distortions . In their example, the traditional cost system allocates overhead costs using a plant wide rate of 300% of direct labor costs. This causes the high volume products (blue and black pens) to be charged with too much overhead and the low volume products (red and purple pens) to be charged with too little overhead. The reason for these distortions is revealed by the faulty assumption underlying the traditional cost allocation system, i.e., that all overhead costs are driven by production volume, or that the link between cause (driver) and effect (cost) cannot be established. Traditional cost systems treat all overhead costs as unit level costs. However, as ABKY explain, production volume is only one of many cost drivers. A factory producing a large variety of products will have a much greater need for support (e.g., purchasing, scheduling, setup, order tracking and quality control) than a factory that produces a few products. 

PRIMARY DATA

To get the industry experience of cost analysis in pricing decisions, the company that our group has choosen is JAIPAN INDUSTRIES LTD. We have focused on one particular product and its pricing strategies ie. Japan mixer grinder.

Below is a brief introduction about the company and the product which has been continued with the interview taken of the manager.

Business Type : Exporter / Manufacturer

Year Established 1984

No. Of Employees 35

Bankers BANK OF BARODA

Standard Certification ISO 9000

Products Manufacturing and Exporting

Household appliances, kitchen appliances, food processors, mixer grinder,

hand blender, juicer, iron, sandwich toasters, grill oven toaster, roti make...

JAIPAN has a history that percolates into success but not without the ups and downs which every corporate that has reached the zenith goes through, teething problems really, but once the ball was set rolling, we never looked back. Our corporate mission has been to set up the largest and the best Domestic Appliances Production in the world, providing the Indian consumer with the best to reduce her household burden so that she can utilise the time thus saved in the benefit of the family and thus, the society at large.

JAIPAN Group of Industries was established in 1981 by Shri J.N. Agarwal, a technocrat with years of experience in the design and manufacture of consumer durables. It all began with the production of 25 Mixer Grinders and 100 Non-stick Cookware per day and subsequently with a range like Food Processors, Sandwich Toasters, Blenders, OTGs, Roti makers, Juicer-Mixer-Grinders, Pressure Cookers, Popcorn Machines, Ceiling Fans, Steam Irons, Imported Capsuled Sandwich Bottom S.S. Utensils with Glass Lid and Heat Proof Sandwich Toasters.

In fact, JAIPAN is the only brand with seven different models of mixer grinders apart from over 100 models and sizes of Greblon coated non-stick cookware. Over the years, some models and products have been discontinued and newer ones added to keep the product portfolio fresh and resourceful.

Currently, the Company has state-of-the-art manufacturing facilities in Mumbai, Palghar and Silvassa. All these incorporate latest automated machines manned by some of the best in the business. This invariably leads to technologically upgraded products.

A strong marketing network is the key to any successful business. At the core, JAIPAN has a team of professionals in Sales and Marketing who work towards set

goals strategised by the men at the helm. Over the years, JAIPAN has developed an extensive and tangible network of dealers, distributors and sales agents. This network spread over India makes the products available from Leh to Kanyakumari and from Punjab to Kolkata.

Today, the Company has a chain of over 5000 dealers who are well connected to the Head Office in Mumbai. The popularity of JAIPAN products is not restricted to India alone. The products find ample demand in foreign countries like Bangladesh, Germany, Mauritius, Muscat, Nepal, Sri Lanka, Switzerland, U.A.E., etc. As a part of its marketing strategy, JAIPAN has developed a force of After Sales Service professionals as well. Qualified engineers are at the beck and call of consumers, who face even the slightest worry with JAIPAN products.

JAIPAN has become synonymous with Quality and has won certificates like ISI and UL. The products are comparable with the best international brands and conform to ISI, CE, BSGS and TUV standards. Each of the products is subjected to a series of rigid quality control tests before it reaches the consumer.

DESCRIPTION ABOUT MIXER GRINDER

These Mixer Grinder are tested on certain parameters to ensure high performance without any flaw. Apart from this, we are able in providing customized solutions to our clients as per their specifications in given time frame. Distinctive Features of Mixer Grinder: * Elegant design * Compact in size * Durable structure * Efficient quality * High performance * Weight of about 10 kg * Components with various blades for different types of cutting and chopping * Comes with additional and optional attachments such as; Atta Kneader, Coconut Scraper, Citrus Juicer and Vegetable Cutter Technical Parameters of Mixer Grinder : Capacity - 600grms of any soaked grains Motor - 150 W Single Phase 960 RPM Voltage - 220 V, AC, 50 Hz. Power Cord - 5 Amps 3 Pin Plug Minimum volume - From 200 grams onwards

NAME: N.A. USMANI

DESIGNATION: IMPORT – EXPORT MANAGER

1.What are the raw materials needed for your product??

Motor which is manufactured at office itself Wire. Circuit (outsourcing) Plastic body which is manufactured at the company itself

2.At what price do you purchase it??

Copper is bought at the market price.

3. What are the discount applied??

When they buy in bulk they get a discount of 5%-10%.

4. How do you price your product? On what basis??

Pricing vary from product to product. Volume based pricing are given special discount.

5. How do you reduce the costs incurred??

No bargaining on reduction of costs because they believe in quality products.

6. At what percent you get profits??

Approximately 25-30% of margin is kept while bringin the product in market.

7. Do you apply your profits anywhere??

Yes.. Profits are applied on making their firm more stronger and thus expanding their business.

8. Which pricing method is followed to decide the price of your product?

Volume based pricing

9. Do you conduct a market survey before deciding the price of the product?

Yes..it depends on the demand in the market and competitor analysis.

Bibliography:-

1. www.alicoskun.net

2. www.answers.com

3. www.uic.edu

4. www.designadvisor.org

5. www.sjsu.edu

6. www.bvwglobal.com

7. www.pricesystems.com