Cost-plus pricing with overhead rates
Overheads are added to direct costs with percentage rates, from materials up to the list price.
Formulas
- Material cost = direct materials + material overhead
- Conversion cost = direct labour + production overhead
- Production cost = material + conversion
- Total cost = production cost + administration and selling overheads
- Discounts are deducted from the higher price: divide by (1 − rate)
Your turn
Three problems on this topic. Amounts with or without thousands separators, a point for pence.
Task
The market allows a list price of £4,440.00. Customers get a 15% trade discount and a 3% cash discount. Total cost is £3,405.79. How much profit is left (backward calculation)?
Cash price in £
Profit in £
Profit mark-up in % of total cost (2 decimal places)
Amounts like 12,500 or 12500.50; percentages as a number (12.5). Round to the penny or 2 decimal places.
Worked example
An order uses £7,500.00 direct materials and £2,000.00 direct labour. Overhead rates: material 26%, production 210%, administration 11%, selling 15%. Work out the production cost and the total cost.
Worked solution
- 1.Material cost = £7,500.00 + 26% = £7,500.00 + £1,950.00 = £9,450.00
- 2.Conversion cost = £2,000.00 + 210% = £2,000.00 + £4,200.00 = £6,200.00
- 3.Production cost = £9,450.00 + £6,200.00 = £15,650.00
- 4.Total cost = £15,650.00 + 11% + 15% of production cost = £15,650.00 + £1,721.50 + £2,347.50 = £19,719.00
Typical mistake: Applying administration and selling overheads to direct costs instead of production cost.
The total cost of an order is £6,068.00. The quote adds a 6% profit mark-up, allows a 2% cash discount and a 5% trade discount. Work out the prices (each rounded to the penny).
Worked solution
- 1.Cash price = £6,068.00 × 1.06 = £6,432.08
- 2.The cash discount is taken off the invoice price, so divide: £6,432.08 / 0.98 = £6,563.35
- 3.The trade discount is taken off the list price: £6,563.35 / 0.95 = £6,908.79
Typical mistake: Adding the discounts on top (× 1.02) instead of dividing (÷ 0.98); the customer deducts them from the higher price.
Frequently asked questions
Why divide for discounts?
The customer deducts the discount from the higher price, so you divide by (1 − rate) to end up with the price you need.