Accounting For Dummies®, 4th Edition

11.2. Are Costs Really That Important?

Without good cost information, a business operates in the dark. Cost data is needed for the following purposes:

• Setting sales prices: The common method for setting sales prices (known as cost-plus or markup on cost) starts with cost and then adds a certain percentage. If you don't know exactly how much a product costs, you can't be as shrewd and competitive in your pricing as you need to be. Even if sales prices are dictated by other forces and not set by managers, managers need to compare sales prices against product costs and other costs that should be matched against each sales revenue source.

• Formulating a legal defense against charges of predatory pricing practices: Many states have laws prohibiting businesses from selling below cost except in certain circumstances. And a business can be sued under federal law for charging artificially low prices intended to drive its competitors out of business. Be prepared to prove that your lower pricing is based on lower costs and not on some illegitimate purpose.

• Measuring gross margin: Investors and managers judge business performance by the bottom-line profit figure. This profit figure depends on the gross margin figure you get when you subtract your cost of goods sold expense from your sales revenue. Gross margin (also called gross profit) is the first profit line in the income statement (see Figures 4-1 and 9-1, as well as Figure 11-1 later in this chapter, for examples). If gross margin is wrong, ...