Pricing Decisions in Accounting: Full Cost-Plus, Marginal Cost-Plus, Mark-Up vs Margin, and Transfer Pricing Explained
Why this matters: Price is the single lever that links costs, demand, and profit. For ICAB students and accounting practitioners, being able to calculate, justify and critique pricing methods is essential — not just for exams, but for real business decisions. This guide explains four core topics with clear steps, worked examples and exam-focused tips.
1. Full Cost-Plus Pricing
1.1 What is full cost-plus pricing?
Full cost-plus pricing sets the selling price by first estimating the full cost of a product (or service) and then adding a profit mark-up. The general formula is:
Selling Price = Full Cost + Mark-up
Two common ways to define “full cost”:
- Production cost only — direct materials, direct labour and production overheads. (Non-production overheads like selling and admin are excluded.)
- Total cost — production cost plus selling, distribution and administrative overheads.
If you use production cost only you must apply a higher mark-up to recover non-production costs. If you include all overheads in the base, the mark-up is smaller.
1.2 Worked example — XY Ltd
Data
- Variable production cost per unit = CU40
- Fixed production overhead = CU60,000 (period)
- Selling, distribution & admin = CU50,000 (period)
- Planned output = 5,000 units
- Target mark-up = 25% on full cost
Step 1 — production cost per unit
Total variable production = 40 × 5,000 = CU200,000 Total production cost = 200,000 + 60,000 = CU260,000 Production cost per unit = 260,000 ÷ 5,000 = CU52
Step 2 — include selling & admin
Selling & admin per unit = 50,000 ÷ 5,000 = CU10 Full cost per unit = 52 + 10 = CU62
Step 3 — add 25% mark-up
Mark-up = 62 × 25% = CU15.50 Selling price = 62 + 15.50 = CU77.50
Result: Selling Price = CU77.50
1.3 Advantages & limitations
Advantages
- Simple to calculate and explain.
- Delegation-friendly — junior staff can quote using a standard mark-up.
- If capacity is normal, price above full cost helps cover all expenses.
- Easier to justify price increases when costs rise.
Disadvantages
- Ignores the price–demand relationship — price may reduce demand.
- Encourages less cost control because costs are simply passed through.
- Requires arbitrary overhead apportionment which can distort unit costs.
- Can trigger a vicious cycle: if budgeted output is missed, full cost per unit rises → higher price → even lower demand.
1.4 ICAB exam tip
When answering full cost-plus questions: show unit breakdowns, state bases for apportionment, and apply the mark-up last. Write brief reasons if asked whether to include non-production overheads in the “full cost”.
2. Marginal Cost-Plus Pricing
2.1 What is marginal cost-plus pricing?
Marginal cost-plus pricing uses only the variable (marginal) cost as the pricing base and then adds a mark-up to generate contribution toward fixed costs and profit.
Selling Price = Marginal Cost + Mark-up
2.2 Worked example — Product Y
Data
- Variable production cost = CU7.00
- Variable selling & distribution cost = CU3.80
- Fixed production = CU17,900 (period)
- Fixed selling/admin = CU24,800 (period)
- Planned sales = 26,800 units
- Mark-up = 30% of marginal cost
Step 1 — marginal cost per unit
Marginal cost = 7.00 + 3.80 = CU10.80
Step 2 — selling price with 30% mark-up
Selling price = 10.80 + (10.80 × 30%) = 14.04 CU
Step 3 — contribution & profit
Contribution per unit = 14.04 − 10.80 = CU3.24 Total contribution = 3.24 × 26,800 = CU86,832 Less fixed costs = 17,900 + 24,800 = CU42,700 Net profit = 86,832 − 42,700 = CU44,132
2.3 When is marginal pricing useful?
- Short-term offers, special orders, clearance pricing.
- When spare capacity exists and fixed costs are sunk for the period.
- In retail where purchase cost defines variable cost and mark-up determines price.
2.4 Advantages & disadvantages
Advantages
- Simpler and avoids arbitrary fixed-cost allocation.
- Highlights contribution — useful for short-term decisions.
- Flexible in competitive situations.
Disadvantages
- May fail to recover fixed costs over the long term if used exclusively.
- Can encourage under-pricing if managers ignore capital recovery.
- Doesn’t ensure profit maximisation unless demand response is considered.
2.5 ICAB exam tip
In marginal pricing problems show contribution clearly. Markers expect total contribution then fixed cost deduction to arrive at profit or loss.
3. Mark-Up vs Margin
3.1 Definitions
- Mark-up = Profit as a percentage of cost.
- Margin = Profit as a percentage of selling price.
3.2 Example
If cost = CU80 and selling price = CU100:
- Profit = CU20
- Mark-up = 20 ÷ 80 = 25%
- Margin = 20 ÷ 100 = 20%
3.3 Quick reference table
| Cost (CU) | Selling Price (CU) | Profit (CU) | Mark-Up % | Margin % |
|---|---|---|---|---|
| 80 | 100 | 20 | 25% | 20% |
| 50 | 75 | 25 | 50% | 33.3% |
3.4 ICAB exam tip
When a question states a margin (for example “20% margin”), do not treat it as mark-up. Convert using the selling price base or use the formula:
Cost = Selling Price × (1 − Margin%)
4. Transfer Pricing
4.1 What is transfer pricing?
Transfer pricing is the system used when one part (division) of a company supplies goods or services to another part. The internal price chosen affects divisional profits, manager incentives, and overall company performance.
4.2 Aims of a transfer pricing system
- Enable fair measurement of divisional performance.
- Provide supplier with a realistic return and receiver with a realistic cost.
- Grant managerial autonomy while promoting goal congruence (divisions act in the company's interest).
- Encourage decisions that maximise company profit.
4.3 Common transfer pricing methods
- Market price: Use external market price when a competitive market exists. Adjust for costs saved on internal transfers (packaging, distribution).
- Cost-plus price: Supplier uses cost plus a markup. Use standard costs rather than actual to avoid transferring inefficiencies.
- Two-part pricing: Charge variable cost for each unit plus a periodic lump sum to recover fixed costs.
- Dual pricing: Receiver is charged marginal/standard variable cost; supplier is credited with market price or cost-plus to preserve profit incentive.
4.4 Example — sub-optimal decision caused by cost-plus
Illustrative data:
- Division S (supplier): variable cost per unit = CU20; fixed cost allocated = CU10; full cost = CU30. It applies a 10% mark-up → transfer price = CU33.
- Division R (receiver): further processing cost = CU15; sale price of finished good = CU40.
Company view: Relevant variable cost = 20 + 15 = CU35. Selling price 40 → contribution CU5 per unit → profitable.
Division R view: Treats transfer price CU33 as variable cost → total perceived variable cost = 33 + 15 = CU48 → selling price 40 → loss CU8 per unit → R will refuse to produce.
Conclusion: Cost-plus internal pricing can lead to goal incongruence and sub-optimal company decisions. Two-part or dual pricing can help align managerial incentives.
4.5 ICAB exam tip
Always answer transfer pricing questions from both the company’s total perspective and from the divisional manager’s perspective. Explain behavior and incentive effects, not just arithmetic.
5. Summary comparison
| Method | Basis | When Best | Key Limitation |
|---|---|---|---|
| Full cost-plus | Total cost + mark-up | Stable demand; long-term costing | Ignores demand sensitivity; arbitrary overhead apportionment |
| Marginal cost-plus | Variable cost + mark-up | Short-term decisions; spare capacity | May not recover fixed costs long term |
| Mark-up | Profit % of cost | Manufacturer pricing | Can be confused with margin |
| Margin | Profit % of sales | Retail pricing and reporting | Numerically lower percent than mark-up (can mislead) |
| Transfer pricing | Internal charging | Divisionalised firms | May harm goal congruence if misapplied |
6. Exam tips & FAQs (ICAB focused)
Exam tips
- Always show clear stepwise calculations — marks for method as well as result.
- State assumptions (e.g., basis of overhead apportionment, whether fixed costs are included).
- For marginal pricing problems, compute contribution first then deduct fixed costs.
- When discussing transfer pricing, include both divisional and company perspectives and mention goal congruence.
- Label mark-up vs margin explicitly when the question specifies a percentage.
FAQs
Q1. Is cost-plus pricing still used in practice?
A: Yes — especially in regulated industries (utilities, government contracts) and jobbing work where predictable margins are needed.
Q2. When should marginal pricing be preferred?
A: For one-off jobs, special orders or when the firm has spare capacity and wants to maximise contribution.
Q3. What is the main danger of poor transfer pricing?
A: It can create departmental incentives that conflict with the company's overall profitability, leading to sub-optimal decisions.
Q4. Who uses mark-up and who uses margin?
A: Manufacturers tend to think in mark-ups (cost-based), retailers report margins (sales-based). Both are valid but mustn’t be mixed up in calculations.
7. Conclusion
Pricing is both an art and a science. Full cost-plus pricing is simple and ensures cost recovery; marginal cost-plus pricing is flexible and contribution-focused for short-term choices. Mark-up and margin are distinct perspectives on profit and must be used correctly. Transfer pricing requires care to balance divisional autonomy with company-wide goals. For ICAB preparation: practice numerical problems, explain assumptions clearly, and always discuss managerial implications as well as calculations.
Cost & Management Accounting — MCQ Practice
MCQs Practice
- 1. A product costs CU80 and sells for CU100. The mark-up is:
a) 20% b) 25% c) 16.7% d) 33.3%
Answer: b) 25% - 2. Marginal cost-plus pricing is most appropriate when:
a) Recovering long-term fixed costs
b) Deciding a one-off special order
c) Setting regulated utility tariffs
d) Allocating overheads across departments
Answer: b) Deciding a one-off special order - 3. Transfer pricing that charges the receiver marginal cost and credits the supplier market price is called:
a) Two-part pricing
b) Full cost pricing
c) Dual pricing
d) Standard costing
Answer: c) Dual pricing - 4. Using full cost-plus pricing ignoring demand risk can lead to:
a) Better market share
b) Sub-optimal pricing and falling demand
c) Higher contribution per unit
d) Reduced fixed costs
Answer: b) Sub-optimal pricing and falling demand - 5. If marginal cost = CU10 and desired margin is 20% of selling price, the selling price is:
a) CU12.00 b) CU12.50 c) CU13.00 d) CU14.00
Answer: b) CU12.50 (because Selling Price × (1 − 0.20) = 10 → SP = 12.50)
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