Models and Concepts Affecting the Pricing Decisions of Manac Plc - Essay Example

?Finance and Accounting Report to the Board of Directors i. The models and concepts affecting the pricing decisions taken by organizations, critically reflecting upon their usefulness (maximum mark 33%). The Maniac Plc deals with the sale and production of normal electrical goods. A full evaluation of costing requirements has conducted by the organization to recognize those regions which have not met financial plan expectations. The models and concepts which affect the pricing decisions of a firm are management accounting decisions. The pricing policy of a firm is affected by a number of factors which contains the variable and fixed costs of the firm and the ecological factors which contains competitor analysis and legal analysis. Pricing models can be utilized to explain, forecast or explain pricing circumstances, or to prescribe pricing decisions. Irrespective of their planned use, however, models are basically abstractions of actuality. Even though they are less difficult than the real world, models should have relevant possessions of the realism they are calculated to represent. A number of more particular criteria served as the foundation for evaluating the pricing models are reviewed. Two criteria are valid to the assumptions on which the form is based. Such assumptions must be stated openly so that the user is cognizant of their existence and so able to assess their relevance and importance. Secondly, the assumptions must be realistic. “The pricing decision is a critical one for most marketers, yet the amount of attention given to this key area is often much less than is given to other marketing decisions. One reason for the lack of attention is that many believe price setting is a mechanical process requiring the marketer to utilize financial tools, such as spreadsheets, to build their case for setting price levels” (Pricing Decisions 1998). When dealers talk regarding what they do as component of their responsibilities for selling products, the tasks connected with setting cost are frequently not at the highest of the list. Marketers in a large amount are more interested in talking about their actions connected to promotion, market research, product development and other tasks that are viewed as the more attractive and exciting elements of the job. However, pricing decisions have vital consequences for the marketing organization and the concentration given by the dealer to pricing is just as significant as the concentration given to extra identifiable marketing actions. Some significant causes affect pricing include: Most Flexible Marketing Mix Variable: For dealers, price is the large amount variable of all marketing choices. Unlike distribution and product decisions, which can take years or months to change or several forms of promotion which may be time consuming to change, price can be changed very quickly. The elasticity of pricing choices is chiefly significant in times when the dealer seeks to rapidly stimulate demand or respond to contestant value actions. For instance, a marketer can get on a field salesperson’s request to lesser cost for a possible vision throughout a phone discussion. Similarly, a dealer in charge of online processes can raise costs on hot selling products with the click of a few website buttons. Setting the Right Price: Pricing decisions made quickly without adequate research, analysis and planned evaluation can lead a losing income to the marketing organization. Prices set also may signify that the company is missing out on extra profits that could be earned if the target market is eager to spend extra to obtain the product. Furthermore, efforts to raise an originally low priced product to a higher cost can be met by consumer resistance as they can feel that the dealer is effecting to take benefit of their consumers. Setting of high prices can also impact on income as it prevents interested consumers from purchasing the manufactured goods. For setting the right price, substantial market knowledge is important and mostly, with new products testing of different pricing choices is also suggested. Trigger of First Impressions - Often consumers’ awareness for a product is formed as soon as they learn the price, such as when a product is first seen when walking down the aisle of a store. While the final decision to make a purchase may be based on the value offered by the entire marketing offering (i.e., entire product), it is possible that the customer will not evaluate a marketer’s product at all based on price alone. It is important for marketers to know if customers are more likely to dismiss a product when all they know is its price. If so, pricing may become the most important of all marketing decisions. Important Part of Sales Promotion: Many times cost changes are divisions of sales promotions that lesser cost for a temporary basis to stimulate interest in the product. On the other hand, as we noted in the conversation of promotional pricing in the Sales Promotion tutorial, marketers have to guard against the enticement to adjust costs too often, since repeatedly decreasing and increasing price can lead consumers to be conditioned to anticipate cost decreases and, consequently, withhold purchase in anticipation of the cost reduction happens again. “There are a number of influencing factors which are not controlled by the company but will impact pricing decisions. Understanding these factors requires the marketer conduct research to monitor what is happening in each market the company serves since the effect of these factors can vary by market” (Factors Affecting Pricing Decision 1998). Pricing is normally quite diverse and the decision making is extra complex. The diverse pricing concepts that the nonprofit organization faces contain pricing in donor and user markets. Two kinds of monetary pricing survive that are variable and fixed. There can be a permanent fee for consumer, or the price can vary depending on the user’s capability to pay. When a contribution looking for business will accept a contribution of any size, it is utilizing variable pricing. The price concept is not all times as clear cut as for simple homogeneous goods sold in everyday dealings. There are a number of abstractly difficult industries and product that can create troubles which may contains clothing, agriculture, steel ships, banking services and automobiles, etc to name a few. Resource consumption accounting is a type of principle based management accounting which helps the managers in decision-maintain system for the organization. One more concept which effects the pricing decision is move pricing. Transfer pricing is fairly applicable in case of the manufacturing industries. “The transfer price is the value (or price) placed on the goods, services and intangibles that are transferred within the firms, as they move from one organizational entity (e.g., a division, an unit, a subunit, a division) to another within a corporate group” (Li & Ferreira n.d., pp. 24-25). Transfer pricing assists in lowering the operating costs and also assists in lowering the efficient tax price of international operations. ii. The role of standard costing and variance analysis in management accounting and a critically discussion of the value and limitations of variance analysis as a means of identifying key areas which have contributed to the overall profit figure (maximum mark 33%).  Being the financial director at Manac Plc, where both standard as well as absorption costing is used, it is necessary that the firm meets its budgeted target profits which are due to a difference in the variances in the budget. In this section of the report, the role of standard costing and variance analysis in management accounting is being discussed. “The concept of standard costing evolved because of the limitations of historical costing” (Patra & Panda 2006, p. 124). Standard costing and variance analysis play a major role in management cost accounting. An understanding of the variance analysis can be helpful in identifying the variances in the actual budget from the standard budget. Standard costing is the planned unit cost for a product or a service produced or done in a particular financial period. Standard costs are calculated through pre determined costs which are also known as base costs. The standard costs are mainly useful in measuring the performance in an organization in a definite time period. Standard costing is also very beneficial in stock valuation and in fixing the price of the products. Variance analysis is the evaluation of performance by identifying the variances where timely reporting maximizes a prospect for managerial action. Standard costing is done on the basis of coding. “Coding is essential for all budgets and cost elements, so that every item of cost can be related to its budget and to its place in the structure of the project” (Harrison & Lock 2004, p. 212). The standard costing system enables variances in budget to be analyzed in detail and thus allows for better and effective cost control in the organization. The standard costing system is a very effective system and has the benefits, because it compares the actual performance in a firm with the standard performance that has been pre determined by the firm. Standard costing is mainly suitable for manufacturing firms or such type of firms which has to repeat its actions from day to day. Firms mainly use the variance analysis for direct materials, labor costs and very less for overheads. This is because overheads cannot be pre determined and thus it is very difficult to prescribe standard costing and then do variance analysis for overheads. Standard costing and variance analysis also have several limitations in analyzing why a firm’s actual budget is not the same as the firm’s standard budget. One of the main drawbacks of the standard costing is that the principles of standard costing are very difficult to apply in the case of real life scenarios as these principles act very odd to apply in the modern business trends which require compromising on business issues. “Managerial cost accounting processes are the means of providing cost information in an efficient and reliable manner on a continuing basis” (Managerial Cost Accounting Concepts and Standards for the Federal Government: Statement of Federal Financial Accounting Standards: Number 4 1995, p. 25). The full adherence to standard costing principles will in turn reduce the quality of the service provided by the firm which may in turn lead to externalization of costs and there might occur a downfall in the customer service that is being provided. Another associated drawback with standard costing and variance analysis is that these processes are very time consuming and expensive. Also another drawback is that the standards set needs to be updated and should not be outdated. Similarly, the variances especially of the overhead variances are very difficult to understand even for managers and thus this type of analyzing using the standard costing and variance analysis might not be always ready to be applicable in all the situations. Also another disadvantage or limitation associated with standard costing is that standard costing is dependent upon the standards set, therefore if the set up standards are outdated or not applicable to the situation of the firm then this might results in inappropriate standard costing which in turn cause high variances. An Example of Standard Costing and Variance: Suppose in the production of pen $ 5 is the cost of raw material while $ 2 is the labor cost. The half yearly production of pens is 10000 units. Therefore the standard half yearly costing is 10000 * 5 * 2 = $ 100,000. But analyzing the budget of the half year the managers found that the half yearly costing is $ 125,000. This shows a variance of $ 50,000. The manager identifying the variance found that while the prescribed standard costing for labor is $ 2 a strike among the laborers caused in revising the standards and the actual cost was $ 2.50 per unit. This implies that 10000 * 5 * 2.5 = 1, 25,000. Therefore, there arose a variance of $ 25000 when the labor cost was raised by 0.5. Thus difference in variance can arise any time and it might not be always possible for a firm to conduct its activities especially the costing activities according to the prescribed standards. High difference between standard costing and variance analysis causes labor inefficiency and inefficiency in costing too. While stating the limitations there are several advantages associated with standard costing and they are that standard costing allows budgets to be set which makes the decision making process in the organization very easier and more realistic; while variance analysis is the actual difference between the actual and the standards set. Setting up unrealistic standards causes high variance and affects the profits of the firm negatively. This results in the profit figures being either too high or low from the standard profits. Usually chances are greater for profits going down. Thus standard costing and variance analysis has advantages as well as disadvantages. This is mainly due to the quality and the realistic attitude of the standards set. Manac plc needs to set appropriate standards for standard costing as well as variance analysis to become a fruitful venture. iii. The advantages and disadvantages of introducing an Activity Based costing system to replace the current Absorption Costing system. Introducing Activity Based Costing (ABC) System in the organizations has turn out to be an increasingly significant tool over the past two decades. Absorption costing system in the organization is the one of the most generally used method of cost allocation both historically and currently. It is a method used for allocating costs to the services and products. It is generally used as apparatus for control and planning. ABC method was normally developed as a method to speak to the various problems associated with the traditional method of cost management scheme, that tend to have the incapability to precisely assess actual service and production costs or offer useful data for the operating decisions. ABC is one of the special costing methods that recognizes activities in a company and allocates the cost of every activity with resources to every services or products according to the real consumption by each. Absorption method is the one of the widely used cost allocation method; hence, this method is also called as full cost method or traditional method. It allocates all the production cost to the product cost. This is the reason behind the name of full cost method to the Absorption Costing system in the organization. Primary use of “Absorption Costing System” (Absorption Costing 2011) in the organization is to reporting various data to the exterior stakeholders mainly shareholders. During the period of Industrial Revolution, absorption method proved as one of the most precious tools for the managers. On the other hand cost structure of the company started to change dramatically for the period of 1970s and 80s. Indirect cost of manufacturing and overhead cost were rising at higher rate than any of the direct cost of labor because of the rising technology and cost of capital in the manufacturing environment. Until then, decision creator and manger of the organizations’ considered that a direct correlation exits among the production overhead costs and direct labor hours. On the other hand, the nature of costs was varying and production overhead costs and direct labor cost were becoming increasingly negatively correlated over time. So, there is need for fundamental change in the traditional costing method with the intention to allocate overhead cost of manufacturing to the product cost. Introducing an Activity Based costing system to replace the current Absorption Costing system helps to overcome these entire problems and helps to formulate one of the most significant costing systems in the organizations. ABC offered management with one of the most valuable instrument to assist in assessing and allocating the cost of product more realistically. “ABC is a useful decision making-framework for economic analysis in service sectors, particularly in the areas of planning, control and decision-making.” (Krishnan 2006, p. 78). It offered the means by which to isolate and explanation for cost with regard to the various activities connected with those costs. Under this method costs of product are not strictly isolated to the cost of manufacturing and are expanded to consist of non-manufacturing costs such as, distribution, selling, administrative and marketing that can be straightly traced to the product during the activities. This method charges products for the cost of capability they really use and not for idle capability like the Absorption costing. ABC facilitates managers of the organization to attribute costs to products and activities more precisely than any of the traditional costing method. The activities accountable for the costs can be recognized and passed on to users merely when the service or product uses the activity. Some of the benefits ABC provides are better means of recognizing high costs of overhead per unit and finding methods to reduce the costs. The method it works is one of the first main activities recognized in the process scheme. Next pools of cost are formed for groups of activities that can be assigned together. Subsequently, this cost drivers are recognized. “The number of cost drivers used varies depending on the balance between accuracy and complexity. After determining the cost drivers, rates are calculated. The rates are then applied to the respective cost drivers for each product or service that is being considered. The overhead cost per unit is then derived by dividing the total cost for the product by the total product units” (Activity-Based Costing 1999). To compete productively, organizations must alter the method they report and manage costs. This method is replacing the old foundation of inventory valuation and cost accounting. ABC is a managerial accounting scheme which finds out the activities of the cost without distortion and offers management with pertinent and appropriate information. It does not symbolize merely a new set of overhead allotment rules or methods to value inventory. A managerial accounting cost system of expensing every cost is connected with manufacturing a specific product. Absorption costing utilizes the overhead costs and total direct costs connected with manufacturing a product as the cost base. In general accepted accounting principles (GAAP) need absorption costing for outside reporting. ABC represents a method to observe operating costs and offers ways to dissect the fundamental activities, which root costs to exist. Activity Based Management (ABM) is a natural expansion of ABC. It facilitates managers of the organization to observe non-value-added activities and create rational judgments to eradicate them. ABM relies on the ABC scheme to indicate where non-value-added activities subsist and to value the financial advantages connected with their removal. Advantage of ABC: More correct costing of products/services, consumers, SKUs, allocation channels. Superior understanding overhead. Easier to recognize for everybody. Rather than just total cost this will helps to make use of unit cost. Incorporates well with Six Sigma and other constant development programs in the organization. Creates observable waste and non-value added items in the organizations. Supports scorecards and performance of the company. Facilitates costing procedures, value streams and supply chains. ABC mirrors way job is done. Help for benchmarking. Disadvantages of ABC: Difficult to recognize the overall proceeding and activities that affects the costs. Hard to select the most appropriate cost drive. Difficult to assess cost on the basis of behavior and activities. Not appropriate for small business establishment. Process of collection of data is very time consuming. The capital outlay on the ABC and its following running costs can be a road block for organizations. Reference List Absorption Costing. 2011. Accounting Tools. [Online] Available at [Accessed on 04 January, 2012]. Activity-Based Costing. 1999. Rockford Consulting Group, Ltd. RCG University. [Online] Available at [Accessed on 04 January, 2012]. Factors Affecting Pricing Decision. 1998. KnowThis.com. [Online] Available at [Accessed on 04 January, 2012]. Harrison, F & Lock, D 2004. Advanced Project Management: A Structured Approach. 4th Edn. Gower Publishing Limited. Available at [Accessed on 04 January, 2012]. Krishnan, A 2006. An Application of Activity Based Costing in Higher Learning Institution: A Local Case Study. Contemporary Management Research. pp. 75-90. Vol. 2. Available at < http://www.academic-journals.org/CMR/cmr%20papers/%28Vol.%2002,%20No.%2002%291.%20Pages%2075-90.pdf> [Accessed on 04 January, 2012]. Li, D & Ferreira, MP n.d. Internal or External Factors on Firms’ Transfer Pricing Decisions: Insights from Organization Studies. Nota & Economicas. Available at < http://notas-economicas.fe.uc.pt/texts/ne027n0190.pdf> [Accessed on 04 January, 2012]. Managerial Cost Accounting Concepts and Standards for the Federal Government: Statement of Federal Financial Accounting Standards: Number 4. 1995. Available at < http://books.google.co.in/books?id=ugpVWUuQNTUC&pg=PA104&dq=standard+costing+and+variance+analysis&hl=en#v=onepage&q=standard%20costing%20and%20variance%20analysis&f=false> [Accessed on 04 January, 2012]. Patra, K & Panda, JK 2006. Accounting and Finance for Managers. Sarup & Sons. Available at < http://books.google.co.in/books?id=-Veoral4SOoC&pg=PA124&dq=standard+costing+and+variance+analysis&hl=en#v=onepage&q=standard%20costing%20and%20variance%20analysis&f=false> [Accessed on 04 January, 2012]. Pricing Decisions. 1998. KnowThis.com. [Online] Available at [Accessed on 04 January, 2012]. Read More