Cost accounting is an important aspect of financial analysis. Reflectively, the process involves calculation of cost variable against expected profit margin. Several methods have been proposed by experts in calculating cost of production as a determinant of pricing rates. Specifically, this paper adopts Cost-plus pricing method in deriving the selling price of computer products for Legit Technologies Ltd. The rate used in these calculations is 25% in order to set a selling price that attract a profit margin of 25% of the final selling price. Other costing methods are mentioned against their strengths and weaknesses in ethical application within an accounting environment.
Legit Technologies Ltd deals with manufacturing of computers. The company produces sophisticated computers which are sold in the local market. The company has been in operation for over 10 years and has established a strong market despite facing stiff competition. As part of competitive sustainability policy, the company has set a competitive price in the computer market. This involves scientific market price decision analysis on best pricing method for determining selling price of its products. Reflectively, the cost of production plays an immense role in determining selling price of its products. Generally, the set price caters for production cost and targeted profit levels. Thus, this analytical treatise attempts to explicitly review costing methods. These methods are used to determine the cost of production and eventual market price of Legit Technologies Ltd computer products.
Raw materials and associated cost of production
Raw materials used by this company include silica sand, bauxite, gold, iron ore, petroleum, copper ore, tin ore, lead ore, and gallium ore among others. The table below summarizes the costs incurred during production in the year 2011.
|Other direct expenses||20,000||573500|
|Salary to factory manager||145,000|
|Depreciation on – Plant and machinery||7,000|
|– Factory buildings||28,000|
|Other expenses – Factory power||31,000|
|Lighting and heating||6,250|
|Total cost of production||3,500||147500|
|Add: opening Work In Progress||147500|
|Less: closing Work In Progress||7,000|
|Factory cost of production (cost of finished goods)||28,000|
|Salary to factory manager||31,000|
|Depreciation on – Plant and machinery||6,250|
|Other expenses – Factory power||10,000||240950|
The above are major costs that the company incurred in manufacturing computers in the year 2011 in the production of 2000 units. The company has to set selling price for these units in order to cater for costs incurred and also attain the target profit.
Determination of the selling price
The selling price for these products is determined using Cost-Plus mark up strategy. According to Vithala (28), Cost-plus pricing refers to the pricing of a product at a predetermined margin over the product’s estimated production costs. This method is flexible but has issues on its viability as a profitability pricing strategy. In its application, the company ignores customer’s valuation of the product. However, this may harm profitability if it overstates the price in a weak market. Since this company deals in a single market product, Cost-plus pricing is ideal since it is easier to calculate and has provisions for adjustment of prices when the cost of production goes up. Notability, there is no standard rate since it is predetermined by the management based on profit level that the company wants to realize as a percentage of cost. For this case, the hypothetical rate is set at 25% on cost. The cost of production for the 2000 units is $ 961,950.
The cost per unit = $961, 950/2000 = $480.975
The mark up = 25% of $480.975 = $120.244
The selling price will be calculated as follows:
Selling price = cost price + Mark up.
= $480.975+ $120.244 = $601.219
Why this is a good sale price
The selling price of $601.219 is thus charged per unit sold. This price is considered a fair selling price because it covers all the costs of production within a profit margin of 25 % on every item sold. The price is 125% of the cost of production. This means that the cost of production is100% and the profit is 25% on every unit of output sold.
Units to produce to meet the sale price
The total sale price is 125% of $961, 950= $1202437.5. Thus, to derive the units that must be sold to meet the selling price, the total sale price is divided by price per unit. Therefore, units to be sold to realize the sale price is equal to $1202437.5/$601.219 = 1999units.
Appropriate costing method for this company
Activity Based Costing
This is the most preferred method of costing in this company. This method allocates overhead costs to the products more logically than the traditional method. Traditional method allocates overhead costs simply on the basis of machine hours. The activity based Cost-plus pricing is most appropriate because it first allocates the overheads to activities that facilitated their incurrence. The costs are then allocated to the products that require these activities in the manufacturing process. Legit Technologies Ltd has many overheads and need to use a costing method that takes care of them. Activity based costing improves the control of overheads by matching overheads costs with their causes. Reflectively, this system is “flexible and able to relate costs to customers, processors, management responsibility, and not just products” (Marx 01). The method focuses on activities and their basic cause. Thus, Legit Technologies Ltd Company is able to analyse and justify manufacturing cycle for its products
Methods not considered fit for this company
- Process costing method: the method is considered inappropriate due to a number of disadvantages. Firstly, the method is inaccurate when costing products. It may include some indirect costs that are not part of the production costs (Osmond 1). The method is also time-consuming as it has to take into account the equivalent units. Calculation of equivalent units may consume a lot of time.
- Direct costing: for this method, the process of coming up with standard cost is difficult. Some technical skills are required to calculate the standard costing matrix. Plenty of the management time and money will be required in order to scrutinize standard costs.
- Absorption costing: The method only absorbs the costs that were actually incurred by the company during production. The method is time consuming.
- Contribution costing: in this method, the selling price is computed by summing up all direct costs and adding on them the contribution summation. When products are many, it is time consuming to allocate overheads to products.
Ethical considerations of costing method
The methods should not be used in manipulation of financial statements. The method selected should suit all financial activities. Failure to identify the right method, that is, through either overstated or understated costs may portray erroneous results of the company’s financial strength (Maher, Stickney & Weil, 44). Therefore, cost accountants should check an appropriate method to use in analysis. If this is not well checked, the company may use the wrong information in decision making since costs and profits may be overstated or understated.
Maher, Michael, Stickney Clyde, and Weil Roman. Managerial Accounting: An Introduction to Concepts, Methods and Uses, London: Edward Elgar Publishing, 2011. Print.
Marx, Carl. Activity Based Costing (ABC) And Traditional Costing Systems, New York: Cengage Learning, 2010. Print.
Osmond, Vitez. Advantages & Disadvantages of Process Costing Under Accounting, Liverpool: Liverpool University, 2011. Print.
Vithala, Rao. Handbook of Pricing Research in Marketing, London: Edward Elgar Publishing, 2009. Print.