The influence of contextual factors on cost system design and pricing decisions : a study of UK companies in the food processing and other industries

In an attempt to provide a better understanding of product costing system design, this study utilises the
contingency theory approach to investigate the contingent relationships between several contextual
factors and the design of product costing system simultaneously. This study also investigates the
contingent relationships between several contextual factors with the importance of cost-plus pricing, and
the mediating effect of the importance attached to cost-plus pricing on the relationship between
contingent factors and product costing system design. In addition, this study investigates the implications
of fit, internal consistency or coalignment between the contextual factors and product costing system
design on organisational effectiveness. This study also seeks to develop a wider and more comprehensive
view of product costing system design than the approach that has generally been used by previous studies
(i. e. classifying costing systems by two discrete alternatives, either traditional or ABC systems).

In addition, in today's competitive environment comprehensive product cost systems should provide
increased accuracy for managerial decisions concerning products, pricing and discontinuing and/ or
reengineering existing products. In markets where there is a generally accepted market price, firms have
limited power to make pricing adjustments. Undoubtedly firms have to decide which products to sell and
to determine the target product mix. Therefore, undertaking periodic profitability analysis is of vital
importance. In the more common situation, where the market price is not given a priori, cost-plus pricing
may be used whereby an appropriate percentage mark-up is added to the estimated cost to determine the
proposed selling price. Therefore where cost information is used for cost-plus pricing decisions accurate
cost information is likely to be crucial. While there is a substantial literature on costing systems, far less is
known about the use of cost data in pricing decisions and profitability analysis. A distinguishing feature
of the research is that it provides a contribution to the research literature on the understanding of the role
that cost information plays in determining the selling prices and profitability analysis.

A cross-sectional survey employing a questionnaire method of data collection was adopted. A total of 152
usable responses were received representing a response rate of 17%. For purposes of analysis, the
research utilises descriptive statistics and structural equation modeling (SEM) multivariate statistical
techniques enabled by EQS 5.7 version software (Bentler, 1995). Thus, this study is one of the first
studies in product costing systems and cost-plus contingency literature to utilise SEM for validating the
research constructs, controlling measurement error and for testing the structural relationships between the
constructs simultaneously. Also, this is the first study to investigate and compare product costing
practices in a single industry (i. e. the food industry) with the other UK industries, and therefore,
examining and controlling to some extent for industry effects for the observed practices.

The results of the descriptive analysis show that direct costing measures are extensively used for costplus
pricing and profitability analysis purposes. Other absorption costing measures are also used but to a
significantly lesser extent. Despite the popularity of the cost-plus pricing approach, only 50% of the
companies report using it in their price setting with emphasis being more given to market factors such as
competition and demand. The findings also emphasise that analysing the profitability of products and
services at periodic intervals is considered to be a vitally important task. The results of structural equation
modelling suggest a strong support for the influence in determining selling prices, importance of cost
information, aspects relating to the intensity of competition, and the extent of the use of total quality
management have a significant influence on the level of cost system sophistication. This research also
provided insightful findings relating to the effectiveness of sophisticated costing systems. The results also
indicate that market share, customisation, the influence in determining selling prices, aspects of
differentiation strategy, intensity of competition, and the importance of cost information influence the
importance of cost-plus pricing. Finally, this study contributes to the literature by utilising the structural
equation modelling method, which has several advantages over other multivariate data analysis.