Cost Accounting For Dummies
Book image
Explore Book Buy On Amazon

As you consider a price for your product when cost accounting, keep in mind how outside influences impact the price. Suppliers affect the cost of your product based on the rate they charge you for materials or component parts.

If you set your price too high, clients might consider buying from one of your competitors. A customer may not buy the product at all (from you or anyone else) if they consider the price to be a lot higher than the product’s value. Here are some influences on your product’s price.

Customers in cost accounting

The old saying goes “The customer is always right.” (Actually, the real saying is, “The customer may not always be right, but he or she is always the customer.”) Think of it another way: Treat the customer with respect. When it comes to pricing, deal with customers fairly. If you don’t, they’ll leave you and take their business elsewhere.

Technology allows smart customers to do their homework. If customers feel they aren’t being treated fairly, they’re be on the Internet in an instant, and they can find someone else who can offer the same product or service. Constantly improving technology is the great equalizer. Everyone has access to the same basic information about products and price.

Competitors in cost accounting

Customers are an influence in your pricing decisions. You have other influences that affect price, too.

Competitors are likely to offer products that compete directly with your products (which is why they’re called competitors). It can hurt when a competitor cuts prices or improves product design, and you need to decide how to respond. You might cut your prices. Maybe you can innovate an improved product and keep your price the same. It’s okay; you can analyze the costs you incur for each of your options and make a decision.

Customer can use technology to compare products as easily as they compare prices. If your competitor makes changes, and you don’t respond in some way, you can expect to lose business quickly.

Every business has (or should have) a website. It’s true for both retailers and commodity suppliers. Smart customers research their purchases. In fact, they even research where to get the best, cheapest, and fastest lunchtime burger. When you go out for lunch, if your local sandwich shop tells you it doesn’t need a website, it’s a safe bet that it’s losing business to a shop that has a site.

Suppliers in cost accounting

A reliable supplier can have an excellent impact on your prices. Consider the supplier that ships you a quality product and does it quickly. You have a dependable pipeline for supplies (retail goods or manufacturing material, for example). If you know what you’re getting and when you’re getting it, you can confidently build supply costs into your product’s price.

Special orders in cost accounting

Whether or not a customer order is a special order could have a big influence on the price you charge. That’s because generally speaking, your costs are different for a special order compared with orders you normally take from customers.

A special order assumes you have excess capacity — production capacity you’re not currently using. The concept also assumes that all fixed costs have already been paid through regular production. As a result, fixed costs are irrelevant and aren’t part of the decision to take on a special order.

You may be willing to accept a lower sale price for a special order because you have fewer costs to cover; however, there are some additional variables for special orders. There are cases where you actually may need to cover some of your fixed costs for a special order. In some cases, the special order may create more fixed costs.

Finally, your special-order sales price may be driven by a competitor’s market price. You might have to keep your sale price low to beat a competitor’s price.

Say you make baseball gloves. This table shows your sale price, cost, and profit for regular production.

Baseball Glove Company — Before Special Order
Units Produced: 300,000 Per Unit Total
Sales (revenue) $90 $27,000,000
Fixed cost -$3,000,000
Variable cost $70 -$21,000,000
Profit $3,000,000

A client contacts you with a special-order proposal. He’s willing to pay $74 per glove for 100,000 gloves, but the special-order glove requires some setup costs. You have to make changes to equipment to manufacture the new glove. You also need to load a different chemical in your machinery to spray waterproofing material on each glove.

The additional fixed costs for the special order total $300,000, and you consider these costs a one-time fixed cost for this special order. Your other fixed costs have already been paid, so they are irrelevant. The variable costs remain. You incur material and labor costs for any good you produce — that’s always true for normal production or a special order. This table shows your sale price, cost, and profit for the special order.

Baseball Glove Company — After Special Order
Units Produced: 100,000 Per Unit Total
Sales (revenue) $74 $7,400,000
Fixed cost -$300,000
Variable cost $70 -$7,000,000
Profit $100,000

The special order is profitable, so you should accept it. The profit is only $1 per glove ($100,000 profit ÷ 100,000 gloves). That’s not nearly as good as the profit from regular production ($10 per glove), but money is money, and it’s a darned sight better than letting your equipment sit idle.

But say the client isn’t 100 percent satisfied with a price of $74, the price they said they were willing to pay. Get ready: You’re about to be low-balled. The client tells you he has a bid from a competitor to make the gloves for $72.50 each.

Don’t touch this one. The order isn’t profitable at $72.50. Take a look at this calculation:

Profit = sales - fixed costs - variable costs
Profit = $7,250,000 - $300,000 - $7,000,000
Profit = -$50,000

Your “profit” is a $50,000 loss!

About This Article

This article is from the book:

About the book author:

Kenneth W. Boyd has 30 years of experience in accounting and financial services. He is a four-time Dummies book author, a blogger, and a video host on accounting and finance topics.

This article can be found in the category: