Accounting Business Reporting for Decision Making

CHAPTER 11 Costing and pricing in an entity 483

the costing system design is not appropriate for the entity. The current design assumes that products

consume resources in the same manner in each department. Also, as a volume cost driver has been

selected, the higher volume products will always be burdened with more of the indirect costs. This

could suggest a need for the entity to look more closely at the selection of cost pools and cost drivers.

How will Coconut Plantations use this unit cost information?

•   If the pricing policy is cost plus mark-up, the unit cost can be increased by the desired mark-up to

set the selling price. However, what would be the impact if an incorrect cost driver had been used to

allocate costs?

•   The unit cost enables inventory valuation for financial reporting — manufacturing costs incurred for

the accounting period can be divided between ending work-in-process inventory and finished goods.

When goods are sold, the unit cost enables the calculation of the cost of sales.

•   Coconut Plantations can determine the contribution of each product to the company’s profits.

This information will assist with decisions regarding product mix, production promotion and cost

management strategies to improve profitability.

Illustrative example 11.4 demonstrates the determination of an inventoriable product cost using

volume-based cost drivers. If products do not consume resources in relation to volume, then

cross-subsidisation between products will result. To obtain a more accurate inventoriable product cost,

an entity could classify the indirect manufacturing costs into activity costs pools and assign costs using

activity-based cost drivers. The activity view of costs recognises that factors other than labour hours or

machine hours influence resource consumption.

As mentioned, the inventoriable cost is primarily used to satisfy financial reporting requirements. The

question could be asked whether this cost is appropriate for internal decision making. For more informed

decision making, the determination of a full product cost would be more suitable. This would require

both manufacturing and non-manufacturing costs to be assigned to the product. The process for deter-

mining the full cost of a cost object was explained earlier in this chapter; this requires the indirect cost

pools to include non-manufacturing costs.

VALUE TO BUSINESS

•   Manufacturing entities need to determine the inventoriable product cost for financial reporting

purposes.

•   An inventoriable product cost includes only manufacturing costs.

•   Non-manufacturing costs are expensed in the current accounting period.

•   Depending on the operating characteristics of the manufacturing entity, either a job costing or a

process costing system will be used.

•   Process costing is used by entities producing only one product, or multiple products that go through

the same processes and consume resources in the same way.

•   Job costing is used by entities manufacturing products that consume resources differently and

whose costing system needs to separate costs by individual jobs.

11.6 Pricing of products and services

LEARNING OBJECTIVE 11.6 Discuss pricing issues for products and services.

As we have learned from earlier chapters, an entity’s profit is determined by income less expenses (costs

that have been consumed). So far in the chapter we have examined issues in relation to cost deter-

mination. Let’s now focus on how an entity sets its pricing policy for the determination of the indi-

vidual product/service price in order to calculate sales revenue. To maximise profits, an entity should

charge customers the highest price possible, but not such a high price that the customers will buy from