Accounting Topic 5 (Pricing Decisions)

Question 1

control

Answer 1

budgeting
variance analysis

Question 2

decision making

Answer 2

• Decision making using financial statements
  
  • Costing
  • Pricing decisions
    Operating decisions

Question 3

pricing decisions

Answer 3

• Setting appropriate prices is one of the most difficult decisions
  ○ Direct impact on revenue - profits
  ○ Establishing a product/service depends upon customers price reaction
  § Managers ability to analyse the marketplace (see market potential)
  § Setting prices too low or too high -> right price depends on market research
  ○ Managers need to know when to use cost-based or market based approaches
  ○ Managers rely on management accounting
  ○ Pricing has to be consistent with organisation goals and strategic plans
  § Pricing wats e.g. supermarket industry
  § Pricing strategies and organisational goals
  § How competitive the industry is, need to know the strength of competitive advantage as that will dictate revenue markets
  § Margins reflect performance effectively

Question 4

pricing policy objectives

Answer 4

○ Maximising profits
§ Attract the investors
○ Maintaining a minimum rate of return on investment
○ Maintaining or gaining market share
§ Attract customers, all about strategy
○ Being customer focused
§ Maintain customers, increase customer base
○ Identifying both short-run and long-run pricing strategies
○ Setting socially responsible prices
§ Of your product
§ Do you care about your customers
§ Socially responsible prices - CSR is becoming more attractive attribute not only for investors but also buyers: lower prices of as a result of lower oil prices or lower gas and electricity costs, do not someone else will and end up loosing good number of customers
CSR affects your prices -

Question 5

external factors affecting pricing

Answer 5

1. demand
2. customer needs
3. competition - quantity and quality of competing products or services

Question 6

internal factors affecting pricing

Answer 6

1. constraints caused by costs
2. desired return on investment
3. quality and quantity of materials and labour
4. allocation of scarce resources

Question 7

approaches to pricing

Answer 7

1. economists view
2. accountants view
3. marketers view

Question 8

why is revenue not a straight line?

Answer 8

1. Competitor increase = decrease price = total revenue do down in much slower pace as number of products selling is increasing -> line is going to go up but the curve will be slightly different as you have competitors coming in = cant set the same prices
2. Price elasticity of demand - increase prices too much, may end up losing a much bigger proportion of customers

Question 9

limitations of economists view

Answer 9

• Economic analysis can be insightful when applied to historical data
  ○ Limited practical use for setting future prices
  ○ Forecasting future based on histroical info - not going to work
  
  • Virtually impossible to forecast accurately the revenue and cost curves
    Consequences of predicting the future

Question 10

accountants point of view

Answer 10

cost plus
* Make profit, revenue has to be above costs (cost + a mark up = profit)
* How big is your markup depends on how much profit
* Selling price is determined by adding a mark up on a cost base
○ Selling price = cost + (markup percentage x cost)
* Size of mark up depends on desired return
○ Typically return on capital employed
* Which cost base to use?
Fixed or variable = absorption cost basis or full cost basis

Question 11

limitations of accountants point of view

Answer 11

• Cost plus pricing requires an estimate of sales volume to determine unit cost in order to derive the cost plus price
  
  • Demand is ignored
    ○ In an environment with little or no competition, a company may have to set its own price
    ○ Assumes all product demand is completely inelastic
    ○ Cant charge whatever you want = charge too much = lose your customers
    ○ Porter’s 5 forces = how easy is to for a customer to switch companies
  • Circular reasoning - volume estimates are required to estimate unit fixed costs and ultimately price
    ○ More products you are making = more costs are going down = as they are fixed
  • Difficult to determine the capital invested to support a product
    ○ Assets are normally used for many different products and it is necessary to allocate investments in assets to different products
    Capital employed - part of the capital is shared as a company increases sharing it between the products

Question 12

marketers view

Answer 12

• Firms in reality cant charge whatever they like
  ○ Business operate in a competitive environment
  
  • Marketers view takes into account competitors prices
    ○ Prices can be set lower, higher or equal to those of competitors to “position” the products
    ○ Differentiation and perceived value
  • Marketers point of view should override those of economists and accountants
    Set a price that customers are willing to buy that product but at the same time need to maximise your profits = set prices at the beginning = waste low in order to gain market share

Question 13

marketers view with new products

Answer 13

1. Penetration
   a. Low initial prices - to get the market share
   b. Subsequently higher prices when sufficient market share has been acquired
   c. Discourage competition
   
   2. Skimming
      a. High initial prices - little later prices go down e.g. iPhones
      b. Recoup past investment in product - spent so much on R&D to deliver and develop your product
      Subsequently lower prices when segment is saturated due to attracted competition

Question 14

marketers view with existing products

Answer 14

1. Target pricing procedure
   a. Identify the price at which a product/service will be competitive
   i. Market research - how mcuh or how many customers are going to have and how much to sell it for
   b. Define the desired profit
   i. Profit is based more on revenue
   ii. Setting the price based on market research, too high = lose customers
   iii. How much profits you want to make effectively will dictate the cost that you need to have
   c. Compute target cost
   i. Maximum cost to be incurred for resources needed
   ii. Selling price less profit margin
   Target price - desired profit = target cost

Question 15

advantages of target costing

Answer 15

• Gives managers ability to control or dictate the costs of a new product at the planning stage of the product’s life cycle
  
  • In competitive environment, enables managers to analyse a product’s potential before committing resources to its production
  • Pricing decision takes place immediately after the market research has been completed
    ○ Market research reveals:
    § Potential demand for the product
    § Maximum price customers are willing to pay
    Does the market research account for comp adv or how different your product is

Question 16

differences between cost-based pricing and target costing

Answer 16

• Target costing
  ○ Focuses on holding costs down it
  ○ Plans and designs the product before the costs are actually committed and incurred
  
  • Cost based pricing
    ○ Focuses on reducing costs only after the product has been produced
    ○ This often leads to random efforts to cut costs - reduce product quality
    Hold the costs down to sell the products - this is how much your costs need to be if you want to make this much profit

Question 17

marketers point of view vs accountants

Answer 17

Marketers view point - start with revenue, this is how much you can sell at this price, this is what your cost should be if you want desired profit

Accounting view point - these are your costs, this is your desired profit ad this is how much you can sell your product for

Question 18

committed costs

Answer 18

costs of design, development, engineering, testing and production that are engineered into a product/service at design stage of development

Question 19

incurred costs

Answer 19

actual costs incurred in making the product