AN INTRODUCTION TO
COSTING & PRICING
PRIMER ON COSTING
AGENDA
CLASSIFICATION OF COSTS
BREAK EVEN ANALYSIS
MARGINAL COSTING
CONTRIBUTION
LEVERAGE
PRICING CONCEPTS
PRICING APPROACHES
PRICING STRATEGIES
PRIMER ON COSTING
CLASSIFICATION OF COSTS
BASED ON BEHAVIOR
BASED ON FUNCTIONALITY
BASED ON RELEVANCE TO PROJECT
PRIMER ON COSTING
BASED ON BEHAVIOR
FIXED COSTDo not vary with units producedInsurance of factory, MD fee
VARIABLE COSTVary directly with number of units producedRaw Materials
SEMI-VARIABLE COSTPartly Fixed and Partly VariableTelephone Bills
PRIMER ON COSTING
FIXED COST IS VARIABLE
VARIABLE COST IS FIXED
COMMENT!!!!!
PRIMER ON COSTING
BREAK-EVEN ANALYSIS
FC
TC
VC
BEPMS
CO
STS
/ R
EV
EN
UE
S
NO. OF UNITS PRODUCED / SOLD
X
Y
REV
PRIMER ON COSTING
BREAK-EVEN ANALYSIS
BREAK EVEN POINT
NO PROFIT NO LOSS
ALL FIXED COSTS ABSORBED
FURTHER PRODUCTION INCURS ONLY VARIABLE COST COMPONENT
MARGINAL COSTING
PRIMER ON COSTING
BREAK-EVEN ANALYSIS
BREAK EVEN = FIXED COSTSSELLING PRICE - VARIABLE COST
PRIMER ON COSTING
MARGINAL : UNIT INCREASE ; ONE MORE UNIT PRODUCED
WHAT IS THE COST INCURRED
IN THE PRODUCTION OF ONE MORE UNIT OF THE SAME ITEM ?
KEEP BREAK EVEN CAPACITY AS LOW AS POSSIBLE
OFFERS PRICING FLEXIBILITY
MARGINAL COSTING
PRIMER ON COSTING
FAIRLY NEW CONCEPT
GIVES GREATER CONTROL TO DECISION MAKING
SELLING PRICE - VARIABLE COST PER UNIT
FIXED COMPONENT HAS BEEN ABSORBED
CONTRIBUTION
PRIMER ON COSTING
CONTRIBUTION
SELLING PRICE
- VARIABLE COST/ UNIT
CONTRIBUTION
- FIXED COST/ UNIT
PROFIT/ UNIT
PRIMER ON COSTING
The following information is available about ABC International
Selling price per Unit = Rs.20/-Variable cost per Unit= Rs.12/-Total Fixed Costs = Rs. 560,000/-
a) What is the Break Even output ? b) What is the Profit earned when the output is 100,000 units ?
c) What is the break even sales in rupees ?
BREAK EVEN ANALYSIS
EXAMPLE
PRIMER ON COSTING
BREAK EVEN ANALYSIS
SOLUTION
BREAK EVEN OUTPUT = FC / (SP - VC) = 560,000 / (20-12) = 70,000 UNITS
PROFIT AT 100,000 = Q (P - V) - F = (100,000 (20-12)) - 560,000 = Rs.240,000/-
BREAK EVN SALES = BEQ * P = 70,000 * 20 = Rs.1,400,000
PRIMER ON COSTING
BREAK EVEN ANALYSIS
MARGIN OF SAFETY
SAFETY MEASURE
LEVEL OF SALES ABOVE BREAK EVEN SALES VALUE
PREFERABLE TO BE MAINTAINED HIGH
PRIMER ON COSTING
BREAK EVEN ANALYSIS
P / V RATIO
PROFIT / VOLUME RATIO
SENSITIVITY OF SYSTEM TO CHANGES IN VARIABLES
P / V RATIO = (CONTRIBUTION MARGIN / VALUE OF SALES)
HIGHER THE BETTER
PRIMER ON COSTING
BREAK EVEN ANALYSIS
MARGIN OF SAFETY AND P / V RATIO
HOW MUCH PROFIT DOES EACH UNIT ABOVE BEP CONTRIBUTE ?
EFFECTIVELY, MARGINAL COSTING !!!
PROFIT = P / V RATIO * MARGIN OF SAFETY
PRIMER ON COSTING
CONCEPT OF LEVERAGE
EFFECT OF THE PRESENCE OF A FIXED COMPONENT
LEVERAGE : GREATER OUTPUT FOR LOWER INPUT !
FINANCIAL LEVERAGE AND OPERATING LEVERAGE
FINANCIAL LEVERAGE - DEBT / EQUITY
HIGHER THE FIXED COMPONENT ; HIGHLY LEVERAGED
PRIMER ON COSTING
OPERATING LEVERAGE
DUE TO PRESENCE OF FIXED COSTS
HIGHER THE FIXED COST, HIGHER THE OPERATING LEVERAGE
HIGHLY LEVERAGED ; BREAK EVEN INCREASES
BEYOND THAT PROFITS ARE HIGH; BELOW THAT LOSSES ARE HIGH
ELSE BREAK EVEN DECREASES
AND PROFITS AND LOSSES ARE NOT SO PRONOUNCED
PRIMER ON COSTING
OPERATING LEVERAGE
FC
TC
VC
CO
STS
/ R
EV
EN
UE
S
NO. OF UNITS
REV
0 100 200 300 400 500
100
200
300
400
500
PRIMER ON COSTING
OPERATING LEVERAGE
FC = 80 (APPROX) ; VC = 4 (APPROX) BREAK EVEN AT 200 UNITS
SALES COST REVENUES PROFIT
100 230 120 (110)
200 250 250 0
300 280 350 130
400 320 470 150
PRIMER ON COSTING
OPERATING LEVERAGE
FC
TC
VC
CO
STS
/ R
EV
EN
UE
S
NO. OF UNITS
REV
0 100 200 300 400 500
100
200
300
400
500
PRIMER ON COSTING
OPERATING LEVERAGE
FC = 100 (APPROX) ; VC = 8 (APPROX) BREAK EVEN AT 120 UNITS
SALES COST REVENUES PROFIT
100 145 135 (10)
120 160 160 0
200 200 250 50
300 250 320 70
PRIMER ON COSTING
DEGREE OF OPERATING LEVERAGE
DEGREE OF SENSITIVITY
CHANGE IN OPERATING INCOME WRT CHANGE IN UNITS SOLD
(% Change in EBIT) / (% Change in Units Sold )
* EBIT - EARNINGS BEFORE INTEREST AND TAX
PRIMER ON COSTING
TYPES OF BREAK EVEN
1. ACCOUNTING BREAK EVEN
2. CASH BREAK EVENBased on Operating Cash FlowsIs there a cash flow problem every year ?
2. FINANCIAL BREAK EVENBased on Net Present Value CriterionTo undertake the project or not
PRIMER ON COSTING
INTER-RELATIONSHIPS
VARIABLE INC / DEC IMPACT
P/V RATIO MoS BEP
SELLINGPRICE
INC
DEC
INC
DEC
INC
DEC
DEC
INC
VARIABLECOST
INC
DEC
DEC
INC
DEC
INC
INC
DEC
FIXEDCOSTS
INC
DEC
NO CHANGE
NO CHANGE
DEC
INC
INC
DEC
PRIMER ON COSTING
BASED ON FUNCTIONALITY
PRIME COST Related to prime activity of producing goods
Direct Labour, Direct material, Direct Expenditure
PRODUCTION OVERHEADSOverall production relatedElectricity in plant, consumables
ADMINISTRATIVE OVERHEADSManager salaries, Interests
SELLING AND DISTRIBUTION OVERHEADSSalesman Commissions, Ad expenditure
PRIMER ON COSTING
BASED ON FUNCTIONALITY
DIRECT LABOUR DIRECT MATERIALS DIRECT EXPENSES
PRIME COST
PRODUCTION OVERHEADS
WORKS COST
SELLING AND DISTRIBUTION OVERHEADS
ADMINISTRATIVE OVERHEADS
COST OF PRODUCTION
COST OF GOODS SOLD
PROFIT
SELLING PRICE
PRIMER ON COSTING
BASED ON RELEVANCE TO PROJECT
OPPORTUNITY COST Cost forgone in adopting a project in favour of another
Cost forgone by not adopting a projectReturns forgone if the same had been invested elsewhere
SUNK COSTAlready committedCannot be recovered
DIFFERENTIAL COSTSAdditional expense due to some change / additionCaused by specific decisions taken
REPLACEMENT COSTCost of replacing an existing asset
PRIMER ON COSTING
PRICING CONCEPTS
PRICE
AMOUNT OF MONEY CHARGED FOR A PRODUCT / SERVICE
VALUE THAT A CUSTOMER EXCHANGES FOR PERCEIVED BENEFITS
ONLY P TO PROVIDE REVENUES
PRIMER ON COSTING
PRICING CONCEPTS
ART ZONE
COST OF PRODUCTION
CU
ST
OM
ER
S’
LIM
IT
EC
ON
OM
IC C
ON
DIT
ION
SCOMPETITORS’ PRICES
LOSS LEADER
PREMIUM
NE
W S
EG
ME
NT
FO
OL
HA
RD
Y
PRIMER ON COSTING
PRICING CONCEPTS
PE
RC
EIV
ED
VA
LU
E
COST
PREMIUMVALUE FOR MONEY
ECONOMY OVER PRICED
PRIMER ON COSTING
PRICING CONCEPTS
1. COST PLUS PRICING
COST PLUS STANDARD MARK UP
UNIT COST = VC +(FC / UNIT COST)
PRICE = UNIT COST / (1 - DESIRED RETURN)
PRIMER ON COSTING
PRICING CONCEPTS
2. BREAK EVEN / TARGET PROFIT PRICING
PRICE AT WHICH BREAK EVEN IS ACHIEVED
PRICE AT WHICH TARGET PROFIT IS MADE
BEP = FC / CONTRIBUTION
PRIMER ON COSTING
PRICING CONCEPTS
2. BREAK EVEN / TARGET PROFIT PRICINGPRICE
($)DEMAND
TOBREAKEVEN
EXPECTEDDEMANDAT GIVEN
PRICE
REVENUE TOTALCOST
PROFIT
14 75000 71000 994000 1010000 (16000)
16 50000 67000 1072000 970000 102000
18 37500 60000 1080000 900000 180000
20 30000 42000 840000 720000 120000
22 25000 23000 506000 530000 (24000)
PRIMER ON COSTING
PRICING CONCEPTS
3. VALUE BASED PRICING
BASED ON BUYERS’ PERCEPTION OF VALUE
WHAT THEY WOULD PAY NOT WHAT I WOULD OFFER
4. COMPETITOR BASED PRICING
GOING RATE
PRIMER ON COSTING
PRICING STRATEGIES
1. MARKET SKIMMING2. MARKET PENETRATION3. PRODUCT LINE4. OPTIONAL PRODUCT5. CAPTIVE PRODUCT6. BY PRODUCT7. PRODUCT BUNDLING8. DISCOUNT AND ALLOWANCE
cash, quantity, functional, seasonal discountstrade in, promotional allowances
9. SEGMENTEDcustomer, product form, location, time
10. PSYCHOLOGICAL11. PROMOTIONAL12. GEOGRAPHIC
fob, uniform, zone, basing point, freight absorption13. INTERNATIONAL14. BUS STATION
PRIMER ON COSTING
PRIMER ON COSTING