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Strategic Cost Management · Pricing Decisions and Strategies

Cost-Based Pricing Methods with Numerical Examples

Updated 11 October 2026 · Fact-checked

Cost-based pricing sets the selling price by starting from cost and adding a margin. Under full cost pricing you add a markup to total cost. Under marginal cost pricing you add a markup to variable cost. Under ROCE pricing the markup is set to earn a target return on capital employed.

Understand Cost-Based Pricing Methods

Cost-based pricing starts with what the product costs and adds a profit margin. The idea is simple: a price must recover cost and leave a profit. The methods differ in which cost you start from and how you decide the margin.

Full cost (absorption) pricing starts from the total cost per unit: variable cost plus a share of fixed cost. You then add a markup, usually a percentage of cost. It is easy to use and ensures all costs are recovered in the long run. Its weakness is that the fixed cost per unit depends on the assumed volume, so the price can change when volume changes.

Variable or marginal cost pricing starts from the variable cost per unit and adds a markup large enough to cover fixed cost and profit. It suits short-run decisions such as special orders, or when there is spare capacity. It can mislead if used for every sale, because fixed cost may then not be recovered.

Return on capital employed (ROCE) pricing works backwards from the profit you want. You decide a target return on the capital employed in the product or division. Required profit = target ROCE × capital employed. You turn this into a markup on cost and then into a price. It links price to the capital the business invests.

Cost-plus pricing is the general name for adding a markup to cost. The markup can be on cost or on selling price. Read the question carefully, because a 25% markup on cost is not the same as a 25% margin on sales.

Key rules to remember

Full cost per unit
Full cost = Variable cost per unit + Fixed cost ÷ Budgeted units
Use the volume the question states. Include selling and distribution cost if the question asks for full cost of sales.
Cost-plus price (markup on cost)
Selling price = Cost × (1 + Markup %)
Cost may be full cost or variable cost, depending on the method.
Price from margin on sales
Selling price = Cost ÷ (1 − Margin % on sales)
Use when profit is given as a percentage of selling price.
Required profit under ROCE
Required profit = Target ROCE % × Capital employed
Capital employed may include fixed assets and working capital, as the question states.
Markup % for ROCE pricing
Markup % on cost = Required profit ÷ Total cost × 100
Total cost here means the cost base the markup is applied to, for the same volume.
Markup on variable cost
Markup on variable cost = Fixed cost + Required profit
Divide by variable cost to get a markup percentage.

How to solve Cost-Based Pricing Methods questions

Use this order for any cost-based pricing question. It keeps the cost base, volume and markup consistent.

  1. 1Identify the method asked for: full cost, variable or marginal cost, cost-plus or ROCE.
  2. 2Fix the volume. Use budgeted or normal output as the question states, and split costs into variable and fixed.
  3. 3Compute the cost base per unit: full cost or variable cost, as the method needs.
  4. 4Work out the profit or markup. For ROCE, compute required profit = target ROCE × capital employed.
  5. 5Convert profit into a markup on the chosen cost base. Check whether the markup is on cost or on selling price.
  6. 6Compute the selling price per unit and, if asked, total sales and total profit.
  7. 7Verify by recomputing total profit: total sales − total cost, and for ROCE divide by capital employed.
  8. 8State the recommendation or comment briefly, such as a limitation of the method.

Quickest way: Total-first method for ROCE and markup questions

When to use it: Use when the question gives fixed cost, volume and capital employed and asks for a price that earns a target return.

  1. Compute total cost for the year at the given volume.
  2. Add required profit (ROCE × capital employed) to get total sales needed.
  3. Divide total sales by units to get the price per unit.
  4. For marginal pricing, add fixed cost to required profit, then add variable cost to get total sales.
  5. Check the price by recomputing profit in one line.

Common mistakes in Cost-Based Pricing Methods

  • Applying the markup to the wrong cost base, for example full cost markup percentage on variable cost.

    Students copy a percentage from one method into another without checking what it was based on.

    Fix: Write the cost base next to the markup. A markup computed on full cost applies only to full cost.

  • Confusing markup on cost with margin on sales.

    Both are called profit percentages and appear similar in wording.

    Fix: Use Cost × (1 + markup) for markup on cost, and Cost ÷ (1 − margin) for margin on sales.

  • Using the wrong volume to spread fixed cost.

    The question may give both actual and budgeted units, and students pick the wrong one.

    Fix: Use the volume the question links to pricing, usually budgeted or normal output, and say so in your answer.

  • Forgetting to compute profit from ROCE and using the ROCE percentage directly as the markup.

    The percentage looks like a markup, but it applies to capital, not cost.

    Fix: Always compute required profit = ROCE × capital employed first, then divide by the cost base.

  • Leaving out selling and distribution or administration overheads in the cost base.

    Students stop at the cost of production.

    Fix: Read whether the question asks for cost of production or total cost of sales. Include all overheads if full cost is asked.

  • Recommending marginal cost pricing as a long-term policy without comment.

    The method gives a low price that looks attractive.

    Fix: State that it suits short-run or spare-capacity situations, and fixed cost must be recovered across sales overall.

Worked examples

Example 1

A company makes 10,000 units a year. Variable cost is ₹60 per unit and fixed cost is ₹2,00,000. Capital employed is ₹10,00,000 and the target ROCE is 15%. Find the selling price per unit under ROCE pricing, and the markup percentage on full cost.

Show the solution
  1. Total variable cost = 10,000 × ₹60 = ₹6,00,000.
  2. Total cost = ₹6,00,000 + ₹2,00,000 = ₹8,00,000.
  3. Full cost per unit = ₹8,00,000 ÷ 10,000 = ₹80.
  4. Required profit = 15% × ₹10,00,000 = ₹1,50,000.
  5. Total sales needed = ₹8,00,000 + ₹1,50,000 = ₹9,50,000.
  6. Selling price per unit = ₹9,50,000 ÷ 10,000 = ₹95.
  7. Markup on full cost = ₹1,50,000 ÷ ₹8,00,000 × 100 = 18.75%.
  8. Check: ₹80 × 1.1875 = ₹95.

Answer: The selling price is ₹95 per unit, which is a markup of 18.75% on full cost.

Example 2

Using the same data, a customer offers to buy extra units at a price based on marginal cost pricing. The firm wants a markup of 50% on variable cost for this order. Compute the price. Also state the profit per unit and whether the order recovers the fixed cost per unit of ₹20.

Show the solution
  1. Variable cost per unit = ₹60.
  2. Markup = 50% × ₹60 = ₹30.
  3. Price = ₹60 + ₹30 = ₹90.
  4. Contribution per unit = ₹90 − ₹60 = ₹30.
  5. Full cost per unit is ₹80, so profit on a full cost basis = ₹90 − ₹80 = ₹10.
  6. Contribution of ₹30 exceeds the fixed cost per unit of ₹20, and since fixed cost is already covered by regular sales, the extra order adds ₹30 per unit to profit.

Answer: The price is ₹90 per unit. It gives a contribution of ₹30 per unit, which is acceptable for an extra order if spare capacity exists and regular sales are not affected.

Exam tips

  • Write the cost base and volume at the top of your working. Examiners give marks for a clear structure even if one figure slips.
  • Show required profit separately in ROCE questions. It is usually a marked step.
  • Read whether the markup is on cost or on sales before you start.
  • Close with a one-line comment on the limitation of the method, such as ignoring demand and competition.

Practice questions from Pricing Decisions and Strategies

Cost-Based Pricing Methods in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Cost-Based Pricing Methods: frequently asked questions

What is the difference between full cost pricing and marginal cost pricing?

Full cost pricing adds a markup to total cost, including a share of fixed cost. Marginal cost pricing adds a markup to variable cost only, and the markup must cover fixed cost and profit. Full cost suits long-run pricing. Marginal cost suits short-run decisions such as special orders.

How do you calculate selling price using target ROCE?

Multiply the target ROCE by capital employed to get required profit. Add this to total cost to get total sales needed. Divide by units to get the price per unit.

Is markup on cost the same as margin on sales?

No. Markup is a percentage of cost, while margin is a percentage of selling price. A 25% markup on cost equals a 20% margin on sales, so always check which one the question uses.

What are the limitations of cost-plus pricing?

It ignores demand, competitors and price elasticity. Fixed cost per unit depends on assumed volume, so the price can be circular. It also gives little reason to control cost.