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Cost-Based Pricing

Introduction

Cost-based pricing is a pricing method wherein a mark-up is added over costs incurred to come-up with the suggested price of the product. The goal of doing business is to maximize wealth and profits. Cost-based pricing ensures that costs are fully recovered and desired profits are met.

In a Nutshell

Cost-based pricing, or cost-plus pricing, sets price by adding a mark-up on cost incurred in production.

The mark-up could be based on all costs, production costs only, variable costs only, or other relevant costs.

Cost-Plus Pricing Formula

The price derived from applying mark-up over the cost of the product is known as cost-plus price.

Cost-Plus Price = Cost + Mark-up

The mark-up can be computed as a percentage of total costs, product costs, variable manufacturing costs, or total variable costs.

Example

ABC Company identified the following costs incurred in producing 500 units of its new product. Compute for the cost-plus price assuming a mark-up of:
1. 20% based on total costs;
2. 75% based on product costs;
3. 125% based on variable manufacturing costs; and
4. 50% based on total variable costs.

  Total Per unit
Direct materials $3,000 $6.00
Direct labor $2,600 $5.20
Variable factory overhead $2,000 $4.00
Fixed factory overhead $1,500 $3.00

The company expects to incur $2,800 variable selling and administrative costs and $1,850 fixed selling and administrative costs. (Per unit: $5.60 for VS&A and $3.70 for FS&A)

1.) 20% based on total costs

Total cost per unit = $6.00 + 5.20 + 4.00 + 3.00 + 5.60 + 3.70 = $27.5

Price = Cost + Mark-up

Price = $27.60 + (20% x $27.60)

Price = $33.00

2.) 75% based on product costs

Total product cost per unit = $6.00 + 5.20 + 4.00 + 3.00 = $18.20

Price = $18.20 + (75% x $18.20)

Price = $31.85

3.) 125% based on variable manufacturing costs

Total product cost per unit = $6.00 + 5.20 + 4.00 = $15.20

Price = $15.20 + (125% x $15.20)

Price = $34.20

4.) 50% based on total variable costs

Total product cost per unit = $6.00 + 5.20 + 4.00 + 5.60 = $20.80

Price = $20.80 + (50% x $20.80)

Price = $31.20

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