The Absorption Costing Approach to Cost-Plus Pricing

Allocating a just and proper monetary value to a merchandise or service may be a slippery reconciliation act for a company. Many houses have an on-going battle with puting their pricing schemes. It is a good known fact that the success of any merchandise or service relies straight on the ability to sell them which anon straight depends on the right pricing scheme ( Bosse, 2009 ).

The pricing can non be merely indiscriminately guessed by the company. There are several steps that ought to be considered while organizing the pricing scheme. By implementing originative judgements and escalating the consciousness of consumer motive, a company can prehend the market. Pricing is non simply a selling, fiscal or operational determination ; alternatively it influences all facets of the house ( Petersn, 2008 ).

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Preliminary Situation for PricingErner ( 2010 ) references two possible state of affairss to see for pricing: The first one declares that the merchandise in inquiry has several rivals who offer merchandises with less distinction. Hence a market monetary value already exists. In this instance clients will non buy merchandises with high market monetary values. Therefore the company does non hold to carry on extended research about the pricing scheme as they already have a guideline nowadays.

The 2nd state of affairs indicates that the market monetary value does non be. Herein the merchandise does non hold any direct rivals and no pricing criterions are available. The company has to make up one’s mind how to monetary value its merchandises or services. In such a place the company must stress more on market research, client perceptual experience, costing, monetary value proving etc.

( Hilton, 2009 ).The Absorption Cost Approach to Cost-Plus PricingFor pricing determinations accounting information can be used particularly if the house is a leader in the market or a price-maker. As there is hardly clip for analysing demand and fringy cost for each merchandise or service exhaustively, directors have to depend on a Swift and unworldly method for finding monetary values. Therefore companies apply the Cost-plus Pricing ( CPP ) method in which the sum cost of the merchandise or service adds a border to determine the merchandising monetary value ( Hilton, 2009 ).

However many companies are price-takers as they set their monetary values harmonizing to the market leaders and have to follow the market, seting their monetary values due to competition. Even in such instances understanding costs supports doing managerial determinations e.g. which and how many merchandises or services should be produced ( Pietersz, n.

g. ).To give a considerable return on the shareholder ‘s investing the determined monetary value in pricing standard merchandises must cover all costs such as production, administrative, fixed and variable gross revenues cost ( Erner, 2010 ) . As this should non be the instance the concern will bear losingss and may non even be extant.

Groking the company ‘s selling scheme is required for using cost information in pricing determinations ( Collier, 2009 ).Determine the Cost CoverageBefore adding a coveted net income border the full costs[ 1 ]for each merchandise or service has to be calculated ( Ingram, Albright, ; A ; Hill, 2003 ) . Flowingly the company has to underscore the cost coverage that can be done by the Absorption Cost Approach ( ACA ) or the Contribution Approach ( CA ) ( Erner, 2010 ).In the pricing determination the unit cost of a completed merchandise is a cardinal step.

The so called Unit Product Cost ( UPC ) stipulates the value of goods stock list completed and the cost of sold goods ( Tatum, n.g. ) . On the one side variable costing categories costs harmonizing to their behaviour into variable or fixed.

For finding the UPC variable bing merely includes costs straight varied to production i.e. direct stuff and direct labour cost as besides the variable fabrication operating expense.The fixed fabrication operating expense costs are dealt like period disbursals i.

e. write off them – like selling and disposal cost – in the period in which they incur. Fixed costs are non regarded in variable UPC. On the other side soaking up costing classes the costs harmonizing to their map either into fabrication or non-manufacturing costs.

For ciphering the UPC by using the ACA all fabrication costs, variable or fixed, are included ( Ingram, Albright, ; Hill, 2003 ).Contribution ApproachIn the CA the cost base consists of the variable disbursals associated with a merchandise. The mark-up used must include the fixed costs sing the coveted net income per unit. The cost base must be kept free of any component of fixed costs easing the pricing in particular state of affairss ( Guilding, Drury, ; A ; Tayles, 2005 ).

In the ACA the cost base is defined as the cost to fabricate a individual unit. The merchandising and disposal costs which are non included in the cost base are considered in the mark-up phase that is added on to the mark merchandising monetary value ( Guilding, Drury, ; A ; Tayles, 2005 ).The ACA illustrates the pricing determination as dishonestly easy. It seems that a company merely has to cipher its UPC, determine the net income degree they want and set the monetary value.

“ It appears that a company can disregard demand and arrive at a monetary value that will safely give whatever net income it wants ” ( Garrison, Noreen, ; A ; Brewer, 2010, p. 760 ).The ACA depends on unit gross revenues anticipations and nor the UPC nor the mark-up can be determined without them. In this attack it is anticipated that clients need the predicted unit gross revenues and are willing to pay any monetary value the house stipulates.

But clients have a pick as they can either purchase from a rival or make up one’s mind non to purchase the merchandise at all if the monetary value is set excessively high ( Garrison, Noreen, & Brewer, 2010 ).Determine Mark-up for Absorption Cost Approach“ A mark-up is the per centum added to be for net income, whereas the border is the per centum of the merchandising monetary value that is represented by net income ” ( Collier, 2009, p. 173 ).The ACA and CA both bury some cost elements in the mark-up.

The grade up per centum has non merely to cover the inhumed costs but besides has to bring forth a hearty return on assets employed ( Erner, 2010 ) . The mark-up over cost ought to be set harmonizing to the market conditions, but many houses rest their mark-up upon desired net income and cost ( Garrison, Noreen, & A ; Brewer, 2010 ).

The concluding phase considers seting the monetary values pursuant to the market conditions. The CPP normally tends to disregard the relationship between the monetary value and the volume to be produced which in bend can ensue in lower net incomes, deficient demand etc.

Thus the gross revenues prognosiss need to be met in order for the pricing to be dependable. The concluding merchandising monetary value may be much higher than the figure received due to the mark-up phase as companies ( can ) disregard the competitory placement, promotional scheme, merchandise distinction, boxing etc. ( Erner, 2010 ). 

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The Absorption Costing Approach to Cost-Plus Pricing. (2016, Nov 25). Retrieved from