MBA Accounting

Salient Points on Full Cost Plus Pricing:

• Traditional method of pricing a product;
• Most commonly used method;
• Prices are set by adding a percentage of profit ( either a mark up or a margin) to the total cost of the product;
• Consistent with the absorption costing technique;
• Commonly used by wholesalers, retailers, construction contractors, services, government contractors;

• Useful in situation where:

•  Products are made based on specification by the customers;

•  Main objective is to make profit after considering fixed costs of  the  business;

• The costs are difficult to estimate in advance;

•  Expected demand at different price levels is difficult to estimate.

Simple Illustration:

Let’s look at Product A:

Production cost as follows:

Variable cost -material $1.50

Variable cost- labor     $1.50

Total variable cost      $3.00

Fixed cost                  $3.00

(excludes administrative and selling overheads)

Required 50% mark up on total production cost.

For Full-Cost Plus Pricing:

Total cost = $3.00+$3.00 =$6.00

50% on total/full cost = 50% x $6.00 =$3.00

Hence, Selling price = $6.00+$3.00 =$9.00 per unit.

By pricing at $9.00, the company wants Product A to at least cover its total production cost.

Advantages Of Full Cost Plus Pricing:

• Easy and simple to understand;
• Pricing decisions become standardized;
• Adopts a conservative approach that in the long run to at least ensure the recovery of fixed cost of a business;
• Difficult of estimating demands can be avoided.

Disadvantages Of Full Cost Plus Pricing:

·     Tendency to set prices on inaccurate estimates;

·      Challenges of apportioning the fixed overheads properly into different products

·       Unsuitable for short term decisions making particularly in situation like surplus production capacity, tendering for contracts price and others;

·      Ignores competition and price elasticity of demand and

·      Ignores opportunity costs and relevant costs.