What is the total cost concept in managerial accounting?

2. Example of the total cost concept in accounting

Let’s assume that Miracle Company (a fictitious entity) manufactures and sells computer equipment. The company uses the total cost concept to determine the selling price of its products. The following information is available for Miracle Company:

Miracle Company
Total Cost Pricing Approach

Step

Manufacturing costs:

 

Direct materials

100,000 units x $6

$ 600,000

 

Direct labor

100,000 units x $8

$ 800,000

 

Variable factory overhead

100,000 units x $4

$ 400,000

 

Fixed factory overhead

 

$ 200,000

1

Total manufacturing cost

 

$ 2,000,000

 
 

Selling and administrative (S&A) expenses:

 

Variable expenses

100,000 units x $3

$ 300,000

 

Fixed expenses

 

$ 100,000

2

Total S&A expenses

 

$ 400,000

 

3

Total cost

$2,000,000 + $400,000

$ 2,400,000

 
 

Expected number of units to be sold

 

100,000 units

4

Total cost per unit

$2,400,000 ÷ 100,000 units

$ 24.00 per unit

 
 

Total assets

 

$ 6,400,000

 

Desired rate of return

 

15%

5a

Desired profit

$6,400,000 x 15%

$ 960,000

5b

Markup percentage

960,000 ÷ 2,400,000

40%

5c

Markup per unit

$24 per unit x 40%

$ 9.60 per unit

 

6

Selling price

$24.00 + $9.60

$33.60

As we can see from this example, the calculation of the selling price of a product under the total cost approach is fairly simple and straightforward. To determine the selling price, we simply needed to estimate the unit product cost and decide how much profit we want. One of the weaknesses of this method, as well as other cost-plus methods, is that we have ignored the demand for the product and relied on our forecast of the future sales. Essentially, we have assumed that customers want to buy the number of units we have estimated to be produced and sold and are willing to pay the price the company decided to charge (i.e., $33.60).

The only way Miracle Company will receive the desired rate of return (i.e., 15% in our example) is if the customers buy the projected number of units (i.e., 100,000). If the company sells less than 100,000 units, the rate of return will be less than 15%. If the company sells more than 100,000 units, the rate of return will be greater than 15%.

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