Intermediate: Discussion of marginal and absorption cost approaches to pricing. ML is an engineering company that specializes in providing engineering facilities to businesses that cannot justify operating their own facilities in-house. ML employs a number of engineers who are skilled in different engineering techniques that enable ML to provide a full range of engineering facilities to its customers. Most of the work undertaken by ML is unique to each of its customers, often requiring the manufacture of spare parts for its customers’ equipment, or the building of new equipment from customer drawings. As a result most of ML’s work is short term, with some jobs being completed within hours while others may take a few days.

To date ML has adopted a cost-plus approach to setting its prices. This is based on an absorption costing system that uses machine hours as the basis of absorbing overhead costs into individual job costs. The managing director is concerned that over recent months ML has been unsuccessful when quoting for work with the consequence that there has been an increase in the level of unused capacity. It has been suggested that ML should adopt an alternative approach to its pricing based on marginal costing since any price that exceeds variable costs is better than no work.

Required:

With reference to the above scenario:

4) briefly explain absorption and marginal cost approaches to pricing;

(i) discuss the validity of the comment any price that exceeds variable costs is better than no work.

(10 marks)

CIMA P2 Management Accounting: Decision Management