Cost Based Pricing

Introduction to Cost Based Pricing

In these techniques, 'cost' is the base and the following methods fall within this category.

Ø   Actual Cost of Production: -

This is actually the very simple method of fixation of transfer price. In this method, the actual cost of production is consider as transfer price for inter divisional transfers. The actual cost of production might contain only variable costs or total costs that are including fixed cost.

Ø   Full Cost Plus: -

In this technique, the total cost of sales along with some percentage of profit is charged through the transferring division to the transferee division. The % of profit might be on the capital used or on the cost of sales. The advantage of this method is that the profit measurement becomes feasible.

Ø   Standard Cost: -

Standard cost is also known as 'predetermined cost' based on technical analysis for material, labor and overhead. Within this method, transfer price is fixed based on standard cost. The transferring unit absorbs the variance that is difference among standard cost and actual cost. This method is relatively simple for operation once the standards are set. Though it becomes necessary to revise the standards at regular intervals if not the standard cost might become outdated.

Ø   Marginal Cost Pricing: -

Within this method, only the marginal cost is charged like 'transfer prices'. The logic employed in this method is that fixed costs are in any case unavoidable and therefore should not be charged to the buying division. So only marginal cost should be taken like transfer price.

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