What is full cost pricing and how does it work?

Answer 1

The cost pricing is the theory that the price of an object is determined by the sum of the cost of the resources that went into making it. The cost can compose any of the factors of production(including labour, capital, or land) and taxation. FULL COST PRICINGFull cost pricing is a practice where the price of a product is calculated by a firm on the basis of its direct costs per unit of output plus a markup to cover overhead costs and profits. The overhead costs are generally calculated assuming less than full capacity operation of a plant in order to allow for fluctuating levels of production and costs. GUIDING PRINCIPLE The guiding principle underlying the FCP Policy is that a government business should not enjoy any net competitive advantage (or disadvantage) in respect of its private sector counterparts simply because of its public sector ownership. That is, the policy aims to achieve competitive neutrality between public and private sector businesses. Application of this principle requires the removal of the special advantages and disadvantages resulting from government ownership so that any edge in competition should result solely from superior management and operational factors. Where cost comparisons with private sector organizations are required, it is essential that those comparisons be on a similar basis and be credible. Otherwise, competition may be undermined leading to distortions in market efficiency. Under the FCP Policy, the principle of competitive neutrality is met by ensuring that prices charged by Significant Business Activities (SBA) reflect a similar cost structure to that faced by a private sector competitor so that it is subject to the same pressures from competition as its private sector equivalents. While this aim is best achieved by ensuring that prices, in all situations where an SBA is competing, are based on the full cost of supplying a product, the policy does allow sufficient flexibility for SBA's to price in a competitive manner according to market conditions. For example, the policy permits the setting of "loss-leader" prices provided that a prescribed rate of return is achieved in the medium term. Where a SBA enjoys special privileges or advantages (arising from its public ownership) over the private sector, a compensating upward revision of SBA costs would be appropriate to ensure a 'level playing field' is maintained. IMPLEMENTING FULL COST PRICING This section focuses on the practical considerations of implementing full cost pricing. •The concepts of costing and pricing; •Components of a full cost price and how they are valued; •Treatment of community service obligations; •Structural reforms required; and •Reporting and compliance measures. DISTINCTION BETWEEN COSTING AND PRICING It is important to distinguish between the terms 'costing' and 'pricing' as they are quite different notions. Costing involves determining the value of resources consumed in the production of goods or the provision of a service. Costing's role in pricing is to act as a benchmark against which pricing and production decisions can be made. Pricing refers to the process of determining a figure at which products or services will be exchanged in the marketplace. The focus on pricing is on the income received from the exchange of the good or service. While cost is an important consideration in pricing, optimal pricing policies will also fully reflect additional market and competitive considerations as well as the need to achieve a rate of return on equity invested. Thus, in a competitive market, pricing is not independent of other suppliers and the value that consumers place on products. This should ensure that there are price disciplines on significant business activities s which will not allow pricing to be determined solely on a "cost plus" basis. The FCP Policy uses full cost to establish the cost benchmark for pricing decisions. However, the policy recognizes that significant business activities s operates in a commercial environment and, therefore, does not prevent the use of marginal cost or avoidable cost for specific pricing decisions if appropriate but this must be with the established benchmark and must be consistent with achieving the required rate of return. The use of techniques such as 'Activity Based Costing' is permitted by the Policy where such a system ensures that all costs (both direct and indirect) are fully allocated to cost pools and then to specific goods or services. By: Shafaq Chohan