PRICINING DECISION AND CONTRIBUTION THEORY

PRICINING DECISION AND CONTRIBUTION THEORY Product pricing enable organizations make appropriate pricing decision. It must be done with good product cost knowledge, otherwise it will not be done intelligently. FACTOR AFFECTING PRODUCT PRICING 1. DEMAND FOR THE PRODUCT: The quantity for which the product is demended if known would go a long way to given an idea at which price they would be sold. 2. LEVEL OF ACTIVITY: The level of activity of the firm is also a determinant factor. 3. AVAILABILITY OF SUBSTITUTES: Here, when there exists a close substitute, the price of which product is fixed having in mind the existence of such substitute price. 4. CHANGES IN DEMAND AND SUPPLY: This means whether the demand for the product is elastic or inelastic. METHOD OF COSTS USED BY COMPANY FOR PRICING 1. TOTAL COST METHOD: Under this method, selling price is based on the total costs. It is suitable for long term pricing as full cost are recovered and profit is maximized in the long run. It also tends to stabilize the price in the market 2. COVERSION COST METHOD: Is based on the basis that because materials do not earn any profit, profits should be related to the services performed. That is the value added in the form of conversion cost. 3. MARGINAL COST METHOD: The method here is flexible in its approach. It is mostly useful in the short-term period. Rising of prices lowers demands and the corresponding revenue. 4. DIFFERENT COST METHOD: This is the change in the costs which result from the adoption of an alternative course of action. Alternative action may arise due to change in volume price, product mix, or sales promotion, or refuse decision. 5. LEARNING CURVE METHOD: This method is another technique developed for the pricing of products in firms which undertake large and costly non-report orders which vary in size. OBJECTIVES OF INTRA COMPANY TRANSFER PRICING 1. Current performance evaluation 2. To produce or buy 3. Improvement of profit position 4. Accurate estimate of earnings 5. Divisional autonomy TOTAL COST PLUS A PERCENTAGE OF PROFIT METHOD The method consists in adding a suitable specific percentage in profit to the cost of transfer. Let us assume, for example, that 4000 units of a product manufactured annually by a plant costing N800 are retransferred to another unit and that the rate of return on the capital is expected to be 20% per annum. If the cost of the units transferred be N5.00 each, the transfer price will be. FORMULA Transfer price=unit cost + capital employed x rate of return Total unit produced. Tp=N 5 + 8000 x 20 400units 100 = 5+2x0.2 = 5+0.4 = N 5.4 MARKET PRICE METHOD This is a rational method which is based on the principle of opportunity cost market price, wherever, available may be adopted for pricing intra-company transfers. It consignor gets a fair reward and an incentive for efficient production. In this method no time is lost in bargaining and there no dispute about transfer prices. DIFFICUTIES AND LIMITATION OF MARKET PRICE METHOD 1. It is difficult in obtaining market price 2. It market price consist of elements of selling and distribution expenses such as commission, bad debt and ware house cost. 3. It adjustment in choosing stock is required to be made for the profit included. BALANCE PRICE METHOD Here the transfer price is negotiated between the consignor and consignee departments, as if the two were independent undertaking trying to make the best of the bargain. In theis method the managers feel recognized in the scheme of affairs and hence are method towards putting in their best. LIMITATIONS ON THE BARGAINED PRICE METHOD. 1. Non-availability of suitable price quotations from outside source. 2. Quotations may not be reliable. 3. The transfer price is dependent not only on the productive ability but also on the negotiating ability of the departmental manager. ACCOUNTING FOR INTER-PROCESS PROFIT When inter-process profit is included in the account, it is advisable to have three columns in the ledger to indicate the cost, profit and the total. This facilitates the calculation of the profit to be provided for inclusion in closing stock in each process and in the final finished stock. Therefore inclusion of inter-process profit creates unnecessary complications in the accounts. As the internal profit remains merged in process stock, work in progress, and finished good, suitable adjustment is made in the balance sheet in order to include such unrealized profit. INCLUSION This chapter has examined product pricing decision which may for external products or internal, or intra company uses. It also involves a lot of decision areas since it is a major determinant of the success or otherwise the companies. These is need to paint staking go through it.