ABSORPTION AND MARGINAL COSTING METHODS
A bike company based in England, Raleigh Bike Inc., is planning to sell its existing inventory of Mini Bike in a new market (Scotland). Total production is expected to be 10,000 units. Allocated production costs are provided as follows:
Allocated Production Costs in E
Raw Materials 200,000
Direct Labour 300,000
Variable Overheads 50,000
Allocated Fixed Overheads 150,000
Total or Full Cost 700,000
As an accounting manager of the company, you will need to answer the following questions for chairing the Company Board Meeting.
1) Calculate the selling price (per unit) required to give a profit margin of ten percent (10%) on full cost pricing (Absorption Costing Method) as initially planned by the company. (7.5 marks)
2) Due to heavy competition in the Scottish markets, the company is planning to employ a price penetration strategy in order to enter the markets successfully. The market condition in Scotland is proved to be much worst than is originally forecasted. In addition, the company is being left with substantial unsold bike stock. What will be the penetration selling price, if the company is employing Contribution Margin Pricing (Marginal or Variable Costing Method) with a mark-up of 5% to base the price on the average variable cost. (7.5 marks)
3) As an accounting manager, evaluate which pricing strategy (1 or 2) is the best policy. Justify your answer critically to the Company Board Meeting. Hint: this is a conceptual question, calculation is not required. Higher marks will be given for rigorous answers with complete Harvard referencing. (15 marks) Total 30 marks
Sample Solution
In order to calculate the selling price per unit for full cost pricing with a 10% margin, we can use the following formula: Selling Price = Full Cost * 1.1 (Chen et al., 2020). Using this formula and the allocated production costs provided, we can calculate that the selling price per unit for full cost pricing would be $770 ($700,000 * 1.1).
The concept of absorption costing is based on assigning all costs related to producing and selling a product or service to the specific item being sold (Chen et al., 2020). In other words, when using this method all fixed overhead expenses as well as variable overhead expenses are included in the total production cost. This ensures that each individual product reflects its true cost of production which helps a company determine whether or not it’s making money off of its products.
It is important to note that while direct labor and raw materials may change from one product to another due their uniqueness, fixed overhead expenses remain relatively constant from time period to time period regardless of changes in volume or number of products produced (Datar & Gupta 2018). Thus factoring these costs into our calculations allows us accurately reflect total allocated production costs thereby ensuring accuracy when setting prices.
In conclusion, using absorption costing by incorporating both variable and fixed overheads in calculating total allocated production costs provides companies with an insight into how much money they need receive from each sale order make profit . Through applying simple formula outlined above ,we able quickly determine required selling price give desired 10 % margin initially planned by Raleigh Bike Incorporated .. This information invaluable chairing board meetings — enabling members explore potential strategies effectively meet customer needs while still maintaining profitability operationally.
