Association of Chartered Certified Accountants (ACCA) Certification Practice Test

What key factor does a firm consider to establish its selling price using cost-plus pricing?

1. The average variable cost of production

2. The profit margin added to average cost

3. The market demand for the product

4. The cost of raw materials

The correct answer is: The profit margin added to average cost

In cost-plus pricing, a firm determines the selling price by adding a specific profit margin to the average cost of producing the product. This method provides a clear and structured way to ensure that the firm covers all of its costs (both fixed and variable) while also achieving a desired level of profitability. The process typically involves calculating the total costs associated with the production of the product (which includes variable costs, fixed costs, and overheads) and then deciding on an appropriate profit margin based on the firm's financial goals, market positioning, and competitive analysis. This profit margin is then added to the average cost to arrive at the selling price. For a business using this pricing strategy, understanding the average cost is pivotal because it ensures that all costs are accounted for in the final price, thereby reducing the risk of incurring losses. Establishing a profit margin that reflects the firm's objectives and market conditions is also crucial, as this affects the overall pricing strategy and financial health of the firm.