Industrial Drums Ltd produces standard size containers used in industry. The price of containers was set by adding a margin to costs as follows:

Direct materials $25

Direct labour 40

Factory services 10

Factory cost 75

Margin 20

Prices $95

Direct materials and direct labour are considered variable costs. The factory services are considered to be all fixed costs and the allocation rate is established by dividing the budgeted expense costs of $250 000 by the plant capacity of 100 000 direct labour hours. For the past few years production has averaged 40 000 units of product, but it is expected that full utilisation will be achieved in the coming year. The price of $95 is well established in the

industry.

In quoting for a government tender which called for 10 000 special containers, the cost accountant estimated the direct materials cost to be $5.00 lower than the standard product, but that labour would be about the same. he therefore quoted a price of $90.00 per unit.

The technical sales manager thought that the chances of winning the contract would be prejudiced by the method of applying the mark-up on the special order. In the manufacture of the standard product the mark-up represented 2 hours at $10 per hour, or 26.67 per cent of factory cost. in the special order the cost accountant had used the same base, but the margin now represented about 28.6% of factory cost. The sales manager maintained that the mark-up should be reduced to something below $20.

Required:

(a) Comment on the general method employed in setting prices.  (5 marks)

(b) Indicate whether you agree or disagree with the inclusion of factory services and the $20 mark-up in computing the unit price on the special contract. Justify your answer with relevant calculations.  (10 marks)

(c) Would it have made any difference in the pricing decision if the excess capacity could not be used in producing the standard product, and if so, how should the price have then been determined? Discuss.  (5 marks)

Answer rating: 100% (QA)

a The method employed in setting prices is not ideal The price of the standard product is set by add... View the full answer