Contribution-Margin Approach to Pricing

Contribution-Margin Approach to pricing is also a cost-plus type of pricing. The difference between the variable cost and revenue related to any given quantity of products is called Contribution Margin. The term measures the contribution these products make towards meeting period costs and desired profit. In contribution approach pricing models also, only variable costs are used as the basis of pricing. The pricing model is concerned only with the costs that vary with the product or service being priced. Allocation or apportionment of fixed cost to product or service is ignored in this approach to pricing.

To illustrate how pricing issue is solved through contribution approach model, let us assume that the following variable cost data that relates to an imaginary company FDP Ltd., a single product company which manufactures TV boosters.

Selling price equals variable costs plus 75 percent. So, the selling price of the product is Rs.(180 + 75% x 180) = Rs.(180 + 135) = Rs.315.

The above illustration totally ignores the fixed cost in pricing the product. Although fixed costs are not assigned to cost objectives under the contribution approach, they must be taken into consideration in determining the mark-up to be added to the variable cost to arrive at the target selling price. The mark-up is added in such a way that it provides enough revenue to cover all of the fixed costs and still provide a satisfactory profit.

The contributions approach is appealing for a variety of reasons. Managers can easily visualize the relationship between prices and costs that vary directly with sales. Variable cost data is available readily as they are used in segmental contribution reports and variable costing income statements. The complications of fixed cost allocation are not necessary with the contribution approach.

In addition to serving as a potential cost base for establishing the price of new and standard products, the contribution margin approach is an excellent analytical tool in a number of other pricing decisions. This approach uses the incremental view that the only costs relevant to pricing decisions are those costs that would be avoided if the sales order were not accepted. Contribution margin approach leads directly into the study of cost, volume, profit and revenue interactions. Since competition and customer demand also enter the pricing decision, selling prices hardly have a constant relationship to product cost. The net income depends upon a combination of price, volume, sales mix and cost structures. Thus, the contribution margin pricing approach allows management a rapid way of assessing the sensitivity of volume and price interactions.

A word of warning about the role of the contribution approach in pricing seems appropriate at this point. There is always the danger that the use of the contribution margin could lead to short-term underpricing as a result, of which the long-run financial health of the company would be affected. However, if the information available in the contribution margin approach is used in cost-volume-profit analysis, there is no reason for the short run attitude to dominate.

Email based Accounting assignment help - homework help at Expertsmind

Are you searching Accounting expert for help with Contribution-Margin Approach to Pricing questions?  Contribution-Margin Approach to Pricing topic is not easier to learn without external help?  We at www.expertsmind.com offer finest service of Accounting assignment help and Accounting homework help. Live tutors are available for 24x7 hours helping students in their Contribution-Margin Approach to Pricing related problems. We provide step by step Contribution-Margin Approach to Pricing question's answers with 100% plagiarism free content. We prepare quality content and notes for Contribution-Margin Approach to Pricing topic under  Accounting theory and study material. These are avail for subscribed users and they can get advantages anytime.

Why Expertsmind for assignment help

1. Higher degree holder and experienced experts network
2. Punctuality and responsibility of work
3. Quality solution with 100% plagiarism free answers
4. Time on Delivery
5. Privacy of information and details
6. Excellence in solving Accounting questions in excels and word format.
7. Best tutoring assistance 24x7 hours