Page 128 - Microsoft Word - 00 Prelims.docx

Chapter 5

Which cost to use?

Actual or standard cost

 The advantage is that prices can be set in advance and
fixed for the period concerned. This makes marketing
simpler and may attract customers who value knowing
exactly how much they will pay.

 The main disadvantage is that if significant variances
occur, then the price may have been set too low and a loss
ensues.

 The main advantage of using actual costs is that a profit is
guaranteed. However, there is less incentive for the
supplier to control costs as inefficiencies can be passed on
to customers.

Marginal or full cost Relevant costs

 Simpler – no need for the  Relevant costs can be used to
absorption of fixed overheads. arrive at a minimum tender price
for a one-off tender or contract.
 More consistent with the use of

contribution in decision making.  The minimum price should be
equal to the total of all of the
 Difficulty lies in setting an relevant cash flows.

appropriate margin or mark-up as

this will need to ensure that fixed  The use of relevant costs is only
costs are covered. suitable for a one-off decision
since:
 In practice, the danger is that
prices are set too low.  fixed costs may become relevant in

the long run
 Marginal costing is particularly

useful in short-term decisions  there are problems estimating
concerning the use of excess incremental cash flows

capacity or one off contracts.
 there is a conflict between
accounting measures such as profit
and this approach

122