Excerpt from Research Proposal :

Dibsa should turn towards the market-based pricing strategy, which sees the implementation of competitive prices for the 3-in-1 Lawnmower. The selection of this combination of strategies would generate several impacts upon the company, but most of them would be obvious at product lifecycle level. In this order of ideas:

The sales revenues would be significantly high throughout the first six months and they would allow the company to cover for the large costs incurred in the manufacturing of the product as well as register profits; they would however decrease with the implementation of the market pricing strategy and the 3-in-1 Lawnmower would metamorphose from a star product into a cash cow

The costs incurred in the manufacturing of the new lawnmower have already begun to decrease and will continue to do so; the actual impact of the pricing strategy is limited, with the specification however that these costs will not be allowed to increase over an imposed limit, pegged to the retail price and the expected sales

Profits would be increased throughout the first six months, but will then decrease; the lower profits will however be more sustainable in the future as they will be based on a solid product that attracts customers through quality and functionality, rather than the element of novelty

6. Absorption and Marginal Costing

The stands of specialized economists on the issue of absorption and marginal costing vary. For instance, some argue that absorption allows the organizations to set prices which reveal the maximum utility of the product, whereas others argue that the utility revealed through absorption is the expected, not the maximum one (Hilton, Swieringa and Turner, 1988, p.196). Aside the utility revealed, absorption costing is generally characterized by the fact that it includes all manufacturing costs and sometimes all, or part of the overheads, in the final cost of the product and it does this with the aid of overhead absorption rates. Marginal costing on the other hand assigns only the variable costs to products (BPP Professional Education). Given the situation at Nippers and the previous recommendation towards a skimming pricing strategy continued by a market oriented retail policy, it is at this stage advisable for Mrs. Dibsa to select the marginal costing system for the reason that it allows her accountant to selectively integrate the costs in the retail price and also as the movements in sales will be able to reveal linkages to costs and profits. This system of organizing sales, costs and revenues will allow Mrs. Dibsa to make better informed decisions which support her in reaching her organizational goals.

7. The New Costing Schedule

Costs per special order

Rand

Direct wages

313,000

Supervisor costs

90,000

General overheads

40,000

Machine depreciation

28,000

Machine overheads

220,000

Materials

333,750

Testing and correction costs

20,000

Marketing Expenses

50,000

Bank loan

236,000

Total expenses

1,330,750

The initial costing schedule is widely comprehensive and sufficient and offers a true depiction of the financial implications of manufacturing Nippers' 3-in-1 Lawnmower. Yet, it is necessary to make some changes in the amounts of money initially estimated. In this order of ideas, the following changes have been made:

Direct wages increased from R285,000 to R313,000 as specialists with the new technique will be brought in Supervisory costs were decreased from R115,000 to R90,000 as the employee handling the task will lose his incentive pay in the value of R25,000

Machine depreciation has been adjusted to more realistic expectations and was increased from R23,000 to R28,000

Due to the reduced hours available on the machines, the costs with machine overheads were increased from R180,000 to R220,000

The costs with materials were decreased from R340,000 to R333,750

Aside these modifications, it was also necessary to introduce new categories of costs which were first overlooked:

The testing and correction costs refer to the expenses incurred with the process of verifying the functionality and capabilities of the 3-in-1 Lawnmower and correcting and features which need adjustments

The marketing costs refer to the expenses incurred...

Appropriateness of Relevant Costs

In the case of Mrs. Dibsa's costing structure and schedules, as well as in the cases of other companies and similar situations, it has to be mentioned that the inclusion of relevant costs within the basis of forming the retail price may prove as an efficient course of action within the short run, but its applicability in the long-term may however be reduced. There are two main reasons behind this statement and they are succinctly summarized below:

First, including relevant costs in the retail price may lead to the formation of a price which is unrealistic within the market as it does not consider customer demand and competitors' offer

Secondly, the relevant costs may easily suffer alterations, meaning that the price will have to be adjusted with every modification in the costing schedule

9. Importance of Break-Even Analysis

The break-even analysis is yet another financial tool which allows Nippers to identify the number of items they need to sell in order to break even and begin to generate a return on their investment. The break-even analysis is a crucial step in the development of any business plan, but also in the appraisal of a project or the establishment of the retail price. The break-even analysis bases its computations on four categories of elements -- the variable cost per unit, the fixed costs, the expected sales (in units) and the retail price per unit. Based on these, it will retrieve the total variable cost, the total of all costs, the sales revenues and the profits. The break-even point is achieved when the total costs meet the sales revenues.

A clear and cut calculation of the Nippers' break-even point cannot be offered due to lack of information. Yet, assuming that the company intends to sell 3,000 units at a retail price of R1,000, when the variable costs per unit are of R263.25 and the fixed costs total up to R541,000, they will break even and begin to register profits at the volume of 734 units sold:

Source: Financial Calculators from KJE Computer Solutions, 2009

Finally then, the importance of the break-even analysis is given by the fact that Nippers can use it before actually launching their product or before setting a retail price in order to identify the volume of sales required for them to begin to generate a return on investment.

10. Limitations of the Break-Even Analysis

Regardless of the utility of the break-even analysis, fact remains that its implementation could at times pose some challenges for Mrs. Dibsa's organization, generally pegged to the tool's limitations:

It demands clear separation of fixed and variable costs, and this may at times be difficult to achieve -- the best example in this sense is given by wages and overheads, which can be included in either of the two cost categories, depending on the situation

It considers that variable costs per unit do not suffer modifications throughout the manufacturing process -- which may in fact occur at various levels

Finally, it does not consider any market elements, such as demand, and is entirely a cost-based tool, revealing as such the limitations pegged to the internal setting of the price (Kurtz, 2008, p.621)

References:

Berman, K., Knight, J., Case, J., 2006, Financial Intelligence: A Manager's Guide to Knowing what the Numbers Really Mean, Harvard Business Press

Bolander, S.F., Gooding, C.W., Mister, W.G., 1999, Transfer Pricing Strategies and Lot Sizing Decisions, Journal of Managerial Issues, Vol. 11

Drudy, C., 2004, Management and Cost Accounting, 6th Edition, Cengage Learning EMEA

Goetz, Jr., J.F., 1985, the Pricing Decision: A Service Industry's Experience, Journal of Small Business Management, Vol. 23

Hilton, R.W., Swieringa, R.J., Turner, M.J., 1988, Product Pricing, Accounting Costs and Use of Product-Costing Systems, the Accounting Review, Vol. 63, No. 2

Kurtz, D.L., 2008, Contemporary Marketing, 13th Edition, Cengage Learning…