Cost and Pricing Decisions

Cost and Pricing Decisions

Executive Summary

Cost allocation and pricing decisions help to determine the profitability of a product. Various methods can be used to evaluate the effectiveness of the various methods for a specific company’s individual needs. Cost allocation is necessary to maintain efficient use of resources, awareness of full cost direct and indirect, as well as maintaining proper accounting. Although not all factors in cost allocation are always at the forefront of consideration they are all reviewed, some are more important in various phases than others.

The major cost allocations discussed are joint costs, sunk costs, and opportunity costs. Pricing decision includes cost plus pricing, Target costing, and activity based pricing and the disadvantages and benefits of each.

Cost Allocation

According to Jiambalvo, companies practice cost allocation for four main reasons (Jiambalvo, 2009):

• To provide Information for educated decisions

• To reduce frivolous use of common resources

• The encourage managers to evaluate the efficiency of internally provided services

• To calculate the full costs of products for both accounting and determining cost-based pricing.

It is commonly upheld that the opportunity costs should equal the allocated cost. The opportunity cost, evaluates the cost of the item in terms of what could have been done with the resource, For instance, the cost of building a house on property that could have been sold and the profit used toward other opportunities. The possible sales profit would be the opportunity cost of building the house. Although this is hard to determine on a consistent basis due to heavy daily fluctuation is allows manager to set a standard or bottom line for the item. This information provided to manager enables them to make better decisions on where to begin for the allocated cost. Opportunity costs examine the economic potential cost of every purchasing decision made within the...