PRICING
SUMMARY OF QUESTIONS BY OBJECTIVES AND BLOOM’S TAXONOMY
Item SO BT Item SO BT Item SO BT Item SO BT Item SO BT
True-False Statements 1. 1 C 6. 2 C 11. 6 K 16. 7 K 21. 3 C 2. 1 K 7. 2 C 12. 7 K 17. 7 C 22. 3 K 3. 1 K 8. 5 K 13. 7 K 18. 7 K 23. 3 K 4. 2 C 9. 5 K 14. 7 C 19. 8 K 24. 4 K 5. 2 C 10. 5 K 15. 6 C 20. 8 C 25. 4 C
Multiple Choice Questions
26. 1 K 42. 5 C 58. 7 C 74. 4 K 90. 6 C 27. 1 K 43. 5 C 59. 7 K 75. 4 C 91. 6 C 28. 1 K 44. 5 K 60. 7 C 76. 1 AP 92. 6 C 29. 1 C 45. 5 AP 61. 6 K 77. 2 AP 93. 6 C 30. 1 C 46. 5 AP 62. 7 AP 78. 2 AP 94. 7 C 31. 2 K 47. 5 AP 63. 7 AP 79. 2 AP 95. 7 C 32. 2 K 48. 7 C 64. 8 C 80. 7 AP 96. 7 C 33. 2 C 49. 7 K 65. 8 K 81. 7 AP 97. 4 C 34. 2 AP 50. 7 K 66. 3 K 82. 3 AP 98. 7 C 35. 2 AP 51. 7 C 67. 3 K 83. 4 AP 99. 5 C 36. 2 C 52. 6 K 68. 3 K 84. 7 C 100. 6 K 37. 2 K 53. 6 C 69. 3 K 85. 7 AP 101. 7 K 38. 2 AP 54. 6 K 70. 3 K 86. 7 AP 102. 7 C 39. 2 AP 55. 7 C 71. 3 C 87. 7 AP 103. 8 K 40. 5 K 56. 7 K 72. 4 K 88. 7 AP 41. 5 K 57. 7 C 73. 4 K 89. 7 AP Brief Exercises 104. 2 AP 106. 2 AP 108. 5 AP 110. 7 AP 112. 7 AP 105. 2 AP 107. 2 AP 109. 7 AP 111. 7 AP 113. 7 AN Exercises 114. 1 AP 118. 5 AP 122. 8 AP 126. 5 AN 115. 2 AP 119. 5 AP 123. 7 AN 127. 2 AP 116. 2 AP 120. 7 AN 124. 3,4 AP 128. 7 AP 117. 2 AP 121. 7 AN 125. 3,4 AP 129. 7 AP Completion Statements 130. 1 K 132. 2 K 134. 6 K 136. 6 K 138. 8 K 131. 2 K 133. 5 K 135. 7 K 137. 6 K 139. 3 K Matching 140. 1-8 K
Short Answer Essay
141. 5 C 142. 7 C
Multi Part Question
SUMMARY OF STUDY OBJECTIVES BY QUESTION TYPE
Item Type Item Type Item Type Item Type Item Type Item Type Item Type Study Objective 1 1. TF 3. TF 27. MC 29. MC 76. MC 130. C 2. TF 26. MC 28. MC 30. MC 114. Ex 140. Ma Study Objective 2 4. TF 31. MC 35. MC 39. MC 104. BE 115. Ex 131. C 5. TF 32. MC 36. MC 77. MC 105. BE 116. Ex 132. C 6. TF 33. MC 37. MC 78. MC 106. BE 117. Ex 140. Ma 7. TF 34. MC 38. MC 79. MC 107. BE 127. Ex Study Objective 3 21. TF 23. TF 67. MC 69. MC 71. MC 124. Ex 139. C 22. TF 66. MC 68. MC 70. MC 82. MC 125. Ex 140. Ma Study Objective 4 24. TF 72. MC 74. MC 83. MC 124. Ex 140. Ma 25. TF 73. MC 75. MC 97. Ex 125. Ex Study Objective 5 8. TF 40. MC 43. MC 46. MC 108. BE 126. Ex 141. Es 9. TF 41. MC 44. MC 47. MC 118. Ex 133. C 10. TF 42. MC 45. MC 99. MC 119. Ex 140. Ma Study Objective 6 11. TF 53. MC 90. MC 93. MC 136. C 143. MP 15. TF 54. MC 91. MC 100. MC 137. C 52. MC 61. MC 92. MC 134. C 140. Ma Study Objective 7 12. TF 49. MC 59. MC 85. MC 96. MC 112. BE 135. C 13. TF 50. MC 60. MC 86. MC 98. MC 113. BE 140. Ma 14. TF 51. MC 62. MC 87. MC 101. MC 120. Ex 142. Es 16. TF 55. MC 63. MC 88. MC 102. MC 121. Ex 143. MP 17. TF 56. MC 80. MC 89. MC 109. BE 123. Ex 18. TF 57. MC 81. MC 94. MC 110. BE 128. Ex 48. MC 58. MC 84. MC 95. MC 111. BE 129. Ex Study Objective 8 19. TF 64. MC 103. MC 138. C 20. TF 65. MC 122. Ex 140. Ma
Note: TF = True-False C = Completion BE = Brief Exercise MC = Multiple Choice Ex = Exercise Es = Short Answer Essay Ma = Matching MP = Multi Part
CHAPTER STUDY OBJECTIVES
1. Calculate a target cost when the market determines a product’s price. To calculate a
target cost, the company determines its target selling price. Once the target selling price is set, it determines its target cost by setting a desired profit. The difference between the target price and the desired profit is the target cost of the product.
2. Calculate a target selling price using full cost-plus pricing. In cost-plus pricing, the
company determines a cost base and adds a markup to it to determine a target selling price. The cost-plus pricing formula is as follows: cost (markup percentage cost) target selling price.
3. Calculate a target selling price using absorption cost-plus pricing. The absorption
cost-plus approach uses the manufacturing cost as the cost base and covers the selling and administrative costs plus the target ROI through the markup. The target selling price is calculated as follows: manufacturing cost per unit (markup percentage manufacturing cost per unit).
4. Calculate a target selling price using variable plus pricing. The variable
cost-plus approach uses all of the variable costs, including selling and administrative costs, as the cost base and covers the fixed costs and target ROI through the markup. The target selling price is calculated as follows: variable cost per unit (markup percentage variable cost per unit).
5. Use time-and-material pricing to determine the cost of services provided. Under
time-and-material pricing, the company sets two pricing rates: one for the labour used on a job and another for the material. The labour rate includes direct labour time and other employee costs. The material charge is based on the cost of the direct parts and materials that are used and a material loading charge for related overhead costs.
6. Define transfer price and its role in an organization. The transfer price is the amount
charged for goods that are transferred between two divisions of the same company. Transfer-pricing policy should achieve goal congruence, maintain division autonomy, and provide accurate performance evaluation among division managers.
7. Determine a transfer price using the negotiated, cost-based, and market-based approaches. The negotiated price is determined by an agreement between division
managers. A cost-based transfer price may be based on full cost, variable cost, or some modification including a markup. The cost-based approach often leads to poor
performance evaluations and purchasing decisions. The advantage of the cost-based system is its simplicity. A market-based transfer price is based on actual market prices for products and services. A market-based system is often considered the best approach because it is objective and generally creates good economic incentives.
8. Explain issues involved in transferring goods between divisions in different
countries with different tax rates. Companies must pay income tax in the country where
the income is generated. In order to increase income and pay less income tax, many companies prefer to report more income in countries with low tax rates, and less income in countries with high tax rates. This is done by adjusting the transfer prices they use on internal transfers between divisions that are located in different countries.
TRUE-FALSE STATEMENTS
1. In most cases, a company sets the price instead of it being set by the competitive market. 2. In a competitive market, a company is forced to act as a price taker and must emphasize
minimizing and controlling costs.
3. The difference between the target price and the desired profit is the target cost of the product.
4. In a competitive environment, the company must set a target cost and a target selling price.
5. The cost-plus pricing approach establishes a cost base and adds a mark-up to this base to determine a target selling price.
6. The cost-plus pricing model gives consideration to the demand side—whether customers will pay the target selling price.
7. Sales volume plays a large role in determining per unit costs in the cost-plus pricing approach.
8. In time and material pricing, the material charge is based on the cost of direct materials used and a material loading charge for related overhead costs.
9. The first step for time and material pricing is to calculate the material loading charge. 10. The material loading charge is expressed as a percentage of the total estimated costs of
materials for the year.
11. Divisions within vertically integrated companies normally sell goods only to other divisions within the same company.
12. Using the negotiated transfer pricing approach, a minimum transfer price is established by the selling division.
14. If a cost-based transfer price is used, the transfer price must be based on variable cost. 15. A problem with a cost-based transfer price is that it does not provide adequate incentive
for the selling division to control costs.
16. In the formula for a minimum transfer price, opportunity cost is the contribution margin of goods sold externally.
17. The market-based transfer price approach produces a higher total contribution margin to the company than the cost-based approach.
18. A negotiated transfer price should be used when an outside market for the goods does
not exist.
19. The number of transfers between divisions that are located in different countries has decreased as companies rely more on outsourcing.
20. Differences in tax rates between countries can complicate the determination of the appropriate transfer price.
21. The absorption cost approach is consistent with generally accepted accounting principles because it defines the cost base as the manufacturing cost.
22. The first step in the absorption cost approach is to calculate the mark-up percentage used in setting the target selling price.
23. Because absorption cost data already exists in general ledger accounts, it is cost effective to use it for pricing.
24. The mark-up percentage in the variable cost-plus approach is calculated by dividing the desired ROI/unit plus fixed costs/unit by the variable costs/unit.
25. Under the variable cost-plus approach, the cost base consists of all of the variable costs associated with a product except variable selling and administrative costs.
ANSWERS TO TRUE-FALSE STATEMENTS
Item Ans. Item Ans. Item Ans. Item Ans. Item Ans.
1. F 6. F 11. F 16. T 21. T
2. T 7. T 12. T 17. F 22. F
3. T 8. T 13. F 18. T 23. T
4. F 9. F 14. F 19. F 24. T
MULTIPLE CHOICE QUESTIONS
26. Factors that can affect pricing decisions include all of the following except a. cost considerations.
b. environment. c. pricing objectives. d. all of these are factors. 27. In most cases, prices are set by the
a. customers.
b. competitive market. c. largest competitor. d. selling company.
28. A company must price its product to cover its costs and earn a reasonable profit in a. all cases.
b. its early years. c. the long run. d. the short run.
29. Prices are set by the competitive market when
a. the product is specially made for a customer.
b. there are no other producers capable of manufacturing a similar item. c. a company can effectively differentiate its product from others.
d. a product is not easily distinguished from competing products. 30. All of the following are correct statements about the target price except it
a. is the price the company believes would place it in the optimal position for its target audience.
b. is used to determine a product's target cost.
c. is determined after the company has identified its market and does market research.
d. is determined after the company sets its desired profit amount. 31. In cost-plus pricing, the target selling price is calculated as
a. variable cost per unit + desired ROI per unit. b. fixed cost per unit + desired ROI per unit. c. total unit cost + desired ROI per unit.
d. variable cost per unit + fixed manufacturing cost per unit + desired ROI per unit. 32. In cost-plus pricing, the mark-up percentage is calculated by dividing the desired ROI per
unit by the
a. fixed cost per unit. b. total cost per unit.
d. variable cost per unit.
33. The cost-plus pricing approach's major advantage is a. it considers customer demand.
b. that sales volume has no effect on per unit costs. c. it is simple to calculate.
d. it can be used to determine a product’s target cost.
34. The following per unit information is available for a new product of Blue Ribbon Company: Desired ROI $ 15
Fixed cost 50
Variable cost 100
Total cost 150
Selling price 165
Blue Ribbon Company's mark-up percentage would be a. 9%.
b. 10%. c. 30%. d. 65%.
35. Bryson Company has just developed a new product. The following data are available for this product:
Desired ROI per unit $40 Fixed cost per unit 60 Variable cost per unit 90 Total cost per unit 150 The target selling price for this product is
a. $190. b. $150. c. $130. d. $100.
36. All of the following are correct statements about the cost-plus pricing approach except that it a. is simple to calculate.
b. considers customer demand.
c. includes only variable costs in the cost base.
d. will only work when the company sells the quantity it budgeted.
37. In the cost-plus pricing approach, the desired ROI per unit is calculated by multiplying the ROI percentage by
a. fixed costs. b. total assets. c. total costs.
d. variable costs.
Use the following information for questions 38-39
Red Grass Company produces high definition television sets. The following information is available for this product:
Fixed cost per unit $ 100 Variable cost per unit 300 Total cost per unit 400 Desired ROI per unit 140 38. Red Grass Company's mark-up percentage would be
a. 140%. b. 75%. c. 40%. d. 35%.
39. The target selling price for this television is a. $240.
b. $400. c. $440. d. $540.
40. In time and material pricing, a material loading charge covers all of the following except a. purchasing costs.
b. related overhead. c. desired profit margin. d. all of these are covered.
41. The first step for time and material pricing is to calculate the a. charge for obtaining materials.
b. charge for holding materials. c. labour charge per hour. d. charges for a particular job.
42. The labour charge per hour in time and material pricing includes all of the following except a. an allowance for a desired profit.
b. charges for labour loading. c. selling and administrative costs. d. overhead costs.
43. The last step in determining the material loading charge percentage is to a. estimate annual costs for purchasing, receiving, and storing materials. b. estimate the total cost of parts and materials.
d. add a desired profit margin on the materials themselves.
44. In time and material pricing, the charge for a particular job is the sum of the labour charge and the
a. materials charge. b. material loading charge.
c. materials charge + desired profit.
d. materials charge + the material loading charge. Use the following information for questions 45-47
The following data are available for Wheels ‘N Spokes Repair Shop for 2012: Repair technician's wages $ 150,000
Fringe benefits 50,000 Overhead 80,000
Total $280,000
The desired profit margin is $15 per labour hour. The material loading charge is 35% of invoice cost. It is estimated that 4,000 labour hours will be worked in 2012.
45. Wheels ‘N Spokes’ labour charge in 2012 would be a. $50.
b. $65. c. $70. d. $85.
46. In January 2012, Wheels ‘N Spokes repairs a bicycle that uses parts of $200. Its material loading charge on this repair would be
a. $35. b. $70. c. $235. d. $270.
47. In March 2012, Wheels ‘N Spokes repairs a bicycle that takes three hours to repair and uses parts of $70. The bill for this repair would be
a. $244.50. b. $289.50. c. $304.50. d. $349.50.
48. Negotiated transfer pricing is not always used because of each of the following reasons
except that
a. market price information is sometimes not easily obtainable.
b. a lack of trust between the negotiating divisions may lead to a breakdown in the negotiations.
c. negotiations often lead to different pricing strategies from division to division. d. opportunity cost is sometimes not determinable.
49. All of the following are approaches for determining a transfer price except the a. cost-based approach.
b. market-based approach. c. negotiated approach. d. time and material approach.
50. When a cost-based transfer price is used, the transfer price may be based on any of the following except
a. fixed cost. b. full cost. c. variable cost.
d. all of these may be used.
51. All of the following are correct statements about the cost-based transfer price approach
except that it
a. can understate the actual contribution to profit by the selling division. b. can reduce a division manager's control over the division's performance. c. bases the transfer price on standard cost instead of actual cost.
d. provides incentive for the selling division to control costs.
52. The general formula for the minimum transfer price is: minimum transfer price equals a. fixed cost + opportunity cost.
b. external purchase price. c. total cost + opportunity cost. d. variable cost + opportunity cost.
53. A firm’s transfer pricing policy should accomplish all of the following except a. promote goal congruence.
b. maintain divisional autonomy.
c. provide accurate performance evaluation. d. maximize the taxes paid in a foreign country.
54. In the formula for the minimum transfer price, opportunity cost is the __________ of the goods sold externally.
a. variable cost b. total cost c. selling price
d. contribution margin
55. The transfer price approach that conceptually should work the best is the a. cost-based approach.
c. negotiated price approach.
d. time and material pricing approach.
56. The transfer price approach that is often considered the best approach because it generally provides the proper economic incentives is the
a. cost-based approach. b. market-based approach. c. negotiated price approach.
d. time and material pricing approach.
57. All of the following are correct statements about the market-based approach except that it a. assumes that the transfer price should be based on the most objective inputs
possible.
b. provides a fairer allocation of the company's contribution margin to each division. c. produces a higher company contribution margin than the cost-based approach. d. ensures that each division manager is properly motivated and rewarded. 58. The negotiated transfer price approach should be used when
a. the selling division has available capacity and is willing to accept less than the market price.
b. an outside market for the goods does not exist. c. no market price is available.
d. any of these situations exist.
59. Assuming the selling division has available capacity, a negotiated transfer price should be within the range of
a. fixed cost per unit and the external purchase price. b. total cost per unit and the external purchase price. c. variable cost per unit and the external purchase price. d. variable cost per unit and the opportunity cost.
60. The transfer price approach that will result in the largest contribution margin to the buying division is the
a. cost-based approach. b. market-based approach. c. negotiated price approach.
d. time and material pricing approach.
61. The maximum transfer price from the buying division's standpoint is the a. total cost + opportunity cost.
b. variable cost + opportunity cost. c. external purchase price.
d. external purchase price + opportunity cost. Use the following information for questions 62-63
The Wood Division of Fir Products, Inc. manufactures wood mouldings and sells them externally for $110. Its variable cost is $40 per unit, and its fixed cost per unit is $14. Fir's president wants the Wood Division to transfer 5,000 units to another company division at a price of $54.
62. Assuming the Wood Division has available capacity of 5,000 units, the minimum transfer price it should accept is
a. $14. b. $40. c. $54. d. $110.
63. Assuming the Wood Division does not have any available capacity, the minimum transfer price it should accept is
a. $14. b. $40. c. $54. d. $110.
64. All of the following are correct statements about transfers between divisions located in countries with different tax rates except that
a. differences in tax rates across countries complicate the determination of the appropriate transfer price.
b. many companies prefer to report more income in countries with low tax rates. c. companies must pay income tax in the country where income is generated. d. a decreasing number of transfers are between divisions located in different
countries.
65. Transfers between divisions located in countries with different tax rates a. simplify the determination of the appropriate transfer price.
b. are decreasing in number as more companies "localize" operations.
c. encourage companies to report more income in countries with low tax rates. d. all of these are correct.
66. Which of the following is consistent with generally accepted accounting principles? a. Absorption cost approach
b. Variable cost-plus approach c. Variable-cost approach
d. Both absorption cost and variable cost-plus approach
67. Under the absorption cost approach, all of the following are included in the cost base
except
a. direct materials.
b. fixed manufacturing overhead. c. selling and administrative costs. d. variable manufacturing overhead.
68. The first step in the absorption cost approach is to calculate the a. desired ROI per unit.
b. mark-up percentage. c. target selling price. d. unit manufacturing cost.
69. The mark-up percentage in the absorption cost approach is calculated by dividing the sum of the desired ROI per unit and
a. fixed costs per unit by manufacturing cost per unit. b. fixed costs per unit by variable costs per unit.
c. selling and administrative expenses per unit by manufacturing cost per unit. d. selling and administrative expenses per unit by variable costs per unit. 70. In the absorption cost approach, the mark-up percentage covers the
a. desired ROI only.
b. desired ROI and selling and administrative expenses. c. desired ROI and fixed costs.
d. selling and administrative expenses only.
71. The absorption cost approach is used by most companies for all of the following reasons
except that
a. absorption cost information is readily provided by a company's cost accounting system.
b. absorption cost provides the most defensible bases for justifying prices to interested parties.
c. basing prices on only variable costs could encourage managers to set too low a price to boost sales.
d. this approach is more consistent with cost-volume-profit analysis.
72. Under the variable cost-plus approach, the cost base includes all of the following except a. fixed manufacturing costs.
b. variable manufacturing costs. c. total fixed costs.
d. variable selling and administrative costs.
73. In the variable cost-plus approach, the mark-up percentage covers the a. desired ROI only.
b. desired ROI and fixed costs.
c. desired ROI and selling and administrative expenses. d. fixed costs only.
74. The mark-up percentage denominator in the variable cost-plus approach is the a. desired ROI per unit.
b. fixed costs per unit.
d. variable costs per unit.
75. The reasons for using the variable cost-plus approach include all of the following except this approach
a. avoids arbitrary allocation of common fixed costs to individual product lines. b. is more consistent with cost-volume-profit analysis.
c. provides the most defensible bases for justifying prices to all interested parties. d. provides the type of data managers need for pricing special orders.
76. Cuff budgets sales of its truck tires at $160 per tire and estimates that 10,000 tires can be sold during the coming year. Variable costs per tire are $60 and Cuff desires a profit of $30 per tire. The target cost per tire is
a. $160. b. $130. c. $80. d. $100.
77. Hen Company has developed a new product, egg crates that prevent breakage. The cost per crate is $50 and the company expects to sell 1,000 crates per year. Hen Company has invested $1,000,000 in equipment to produce the crates and desires a 10% return on investment. What is Hen Company’s desired mark-up percentage?
a. 10% b. 20% c. 100% d. 200%
78. Hen Company has developed a new product, egg crates that prevent breakage. The cost per crate is $50 and the company expects to sell 1,000 crates per year. Hen Company has invested $1,000,000 in equipment to produce the crates and desires a 10% return on investment. What is Hen Company’s selling price for one egg crate?
a. $110 b. $150 c. $100 d. $250
79. Partridge Co. has produced a product with a total unit cost of $60 and a desired ROI per unit of $25. If Partridge Co.’s target selling price is $85, what is its percentage mark-up on cost?
a. 141.67% b. 100% c. 50% d. 41.67%
80. Management of the Catering Company would like the Food Division to transfer 10,000 cans of its final product to the Restaurant Division for $80. The Food Division sells the product to customers for $150 per unit. The Food Division’s variable cost per unit is $55
and its fixed cost per unit is $25. The Food Division is currently operating at full capacity. What is the minimum transfer price the Food Division should accept?
a. $25 b. $55 c. $80 d. $150
81. Management of the Catering Company would like the Food Division to transfer 10,000 cans of its final product to the Restaurant Division for $80. The Food Division sells the product to customers for $150 per unit. The Food Division’s variable cost per unit is $55 and its fixed cost per unit is $25. The Food Division has 10,000 units available capacity. What is the minimum transfer price the Food Division should accept?
a. $25 b. $55 c. $80 d. $150
82. Maggie Co. has variable manufacturing costs per unit of $20, and fixed manufacturing cost per unit is $15. Variable selling and administrative costs per unit are $4, while fixed selling and administrative costs per unit $6. Maggie desires an ROI of $7.50 per unit. If Maggie Co. uses the absorption cost approach, what is its mark-up percentage?
a. 8.33% b. 50% c. 16.67% d. 25%
83. Maggie Co. has variable manufacturing costs per unit of $20, and fixed manufacturing cost per unit is $10. Variable selling and administrative costs per unit are $5, while fixed selling and administrative costs per unit $2. Maggie desires an ROI of $8 per unit. If Maggie Co. uses the variable cost-plus approach, what is its mark-up percentage?
a. 50% b. 80% c. 30% d. 100%
84. Opportunity cost
a. Is the value of another option that must be given up in order to achieve the first option.
b. Must be subtracted from the variable production cost to determine the minimum transfer price on an internal transfer.
c. Must be considered in determining the transfer price only when the company has sufficient excess capacity to meet demand.
d. Refers to the fixed cost applied to products that are transferred between divisions.
Division A produces a product that it sells to the outside market. It has compiled the following:
Variable manufacturing cost per unit $10 Variable selling costs per unit $3 Total fixed manufacturing costs $150,000 Total fixed selling costs $30,000 Per unit selling price to outside buyers $40 Capacity in units per year 30,000
85. Division B of the same company is currently buying an identical product from an outside provider for $38 per unit. It wishes to purchase 5,000 units per year from Division A. Division A is currently selling 30,000 units of the product per year. If the internal transfer is made, Division A will not incur any selling costs. What would be the minimum transfer price per unit that Division A would be willing to accept?
a. $10 b. $11 c. $38 d. $40
86. Division B of the same company is currently buying an identical product from an outside provider for $38 per unit. It wishes to purchase 5,000 units per year from Division A. Division A is currently selling 25,000 units of the product per year. If the internal transfer is made, Division A will not incur any selling costs. What would be the minimum transfer price per unit that Division A would be willing to accept?
a. $10 b. $11 c. $38 d. $40
87. Division B of the same company is currently buying an identical product from an outside provider for $38 per unit. It wishes to purchase 5,000 units per year from Division A. Division A is currently selling 25,000 units of the product per year. If the internal transfer is made, Division A will not incur any selling costs. What would be the maximum transfer price per unit that Division B would be willing to accept?
a. $10 b. $11 c. $38 d. $40
88. Division B of the same company is currently buying an identical product from an outside provider for $38 per unit. It wishes to purchase 5,000 units per year from Division A. Division A is currently selling 25,000 units of the product per year. If the internal transfer is made, Division A will not incur any selling costs. At what price would the internal transfer occur?
a. At the lowest price that is acceptable to Division A b. At the maximum price that is acceptable to Division B
c. It depends on the negotiation skills of the division managers d. No transfer will occur
89. Division B of the same company is currently buying an identical product from an outside provider for $38 per unit. It wishes to purchase 5,000 units per year from Division A. Division A is currently selling 26,000 units of the product per year. If the internal transfer is made, Division A will not incur any selling costs. What would be the minimum transfer price per unit that Division A would be willing to accept?
a. $10.00 b. $14.60 c. $15.40 d. $40.00
90. What would be a legitimate reason for upper management to insist on an internal transfer even though the product could be sourced outside the company at a price that is lower than the company’s variable cost?
a. Management is concerned that its manufacturing equipment will soon be obsolete, and it wants to get full use out of it before it happens.
b. Management wants to ensure a secure supply of the product. c. The company has excess capacity.
d. There is never a legitimate reason that justifies an internal transfer if a product can be sourced outside the company at a price that is lower than the company’s variable cost.
91. Why is transfer pricing important?
a. It plays a key role in determining the ultimate profitability of the company as a whole.
b. It plays a key role in determining the profitability of the division that sells the product.
c. It plays a key role in determining the profitability of the division that buys the product.
d. It plays a key role in determining the profitability of both the selling and buying divisions of the company.
92. What should be the objective(s) of a firm’s transfer pricing policy? a. Ensure a secure source of inputs at the best price possible.
b. Promote goal congruence, while maintaining divisional autonomy so that accurate performance evaluation can be made.
c. Develop a cooperative relationship between divisions, while maintaining enough competitiveness to ensure the survival of the firm.
d. Develop a pricing system that facilitates good record keeping that is acceptable under GAAP.
93. What legitimate reason might management have for insisting that one of its divisions buy a part from another division within the same company even though the buying division could source the part at a lower price externally?
b. It is concerned about the external supplier’s ability to deliver the part on a timely basis.
c. It wants to make use of excess capacity in the buyer’s division.
d. There is never a legitimate reason that justifies ordering a division to buy internally when it could source the product cheaper externally.
94. What is a critical reason for a company to use cost-plus pricing?
a. The company has significant differences between its variable and fixed costs. b. The company’s suppliers have recently increased prices.
c. The company operates in a highly competitive market. d. The company operates in a less competitive market. 95. Market-based prices are least likely to be influenced by:
a. The degree of product differentiation in the industry. b. The level of competition in the industry.
c. The cost to manufacture the product or service. d. If the product is a commodity.
96. Which of the following has the most impact on setting a market-based price? a. Changes in quality of the product or service
b. Prices charged by the company’s suppliers c. The efficiency of the company’s supply chain d. Demand for the service or product
97. Variable cost-plus pricing is most effective when a company: a. experiences high demand for its products.
b. produces a product over many years. c. has excess capacity.
d. is operating at full capacity and receives a special order. 98. Market-based pricing is influenced by all of the following except:
a. Government regulation. b. Internal transfer prices. c. Product differentiation. d. Demand for the product.
99. Time and material pricing would be best suited to a: a. Hairdressing salon.
b. Construction company.
c. Plastic container manufacturer. d. Insurance company.
100. Generally, a transfer of products between two divisions should take place if it:
a. allows one division to benefit from technology developed in another division. b. results in increased incremental income to the company as a whole.
c. increases awareness within the company of activity in the various divisions. d. assists the management to evaluate performance of the divisions.
101. In setting internal transfer prices, the minimum price that the selling division would accept is:
a. A price that will result in a profit to the selling division. b. A price that will result in a profit to the purchasing division.
c. Its variable cost of the product plus opportunity costs lost by the transfer. d. Its variable cost plus an internal profit margin.
102. In setting internal transfer prices, the maximum price that the purchasing division would accept is:
a. A price that will result in a profit to the selling division. b. A price that will result in a profit to the purchasing division.
c. Its variable cost of the product plus opportunity costs gained by the transfer. d. Its external cost to purchase the product.
103. Transfer pricing between divisions of multi-national companies is complicated by: a. Fluctuations in tax rates between countries.
b. Labour and other cost considerations. c. Supplier reliability.
ANSWERS TO MULTIPLE CHOICE QUESTIONS
Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans.
26. d 38. d 50. a 62. b 74. d 86. a 98. b 27. b 39. d 51. d 63. d 75. c 87. c 99. b 28. c 40. d 52. d 64. d 76. b 88. c 100. b 29. d 41. c 53. d 65. c 77. d 89. c 101. c 30. d 42. b 54. d 66. a 78. b 90. b 102. d 31. c 43. d 55. c 67. c 79. d 91. d 103. a 32. b 44. d 56. b 68. d 80. d 92. b 33. c 45. d 57. c 69. c 81. b 93. b 34. b 46. b 58. d 70. b 82. b 94. d 35. a 47. d 59. c 71. d 83. b 95. c 36. c 48. d 60. a 72. c 84. a 96. d 37. c 49. d 61. c 73. b 85. d 97. c
BRIEF EXERCISES
Brief Exercise 104Talia Corp. produces digital cameras. For each camera produced, direct materials are $27, direct labour is $15, variable manufacturing overhead is $18, fixed manufacturing overhead is $32, variable selling and administrative expenses are $7, and fixed selling and administrative expenses are $22.
Instructions
Calculate the target selling price assuming that a 40% mark-up on total per unit cost.
Solution Brief Exercise 104
Direct materials...$27 Direct labour... 15 Variable manufacturing overhead...18 Fixed manufacturing overhead...32 Variable selling and administrative expenses...7 Fixed selling and administrative expenses...22 Total unit cost...$121 Total unit cost + (Mark-up percentage X Total unit cost) = Target selling price
$121 + (40% X $121) = $169.40
Brief Exercise 105
Tina Co. expects to produce 75,000 products in the coming year and has invested $15,000,000 in the equipment needed to produce the products. Tina requires a return on investment of 10%.
Instructions
What is Tina Co’s ROI per unit?
Solution Brief Exercise 105
ROI per unit = (Total investment X Desired ROI percentage) Number of units
= ($15,000,000 X 10%) = $20 75,000
Brief Exercise 106
MagTag produces washing machines and dryers. The following per unit information is available for washing machines: direct materials, $35; direct labour, $30; variable manufacturing overhead, $18; fixed manufacturing overhead, $103; variable selling and administrative expenses, $17; fixed selling and administrative expenses, $97. MagTag desires an ROI per unit of $75.
Instructions
Calculate MagTag’s mark-up percentage using a total cost approach.
The mark-up percentage would be:
$75
= 25% $35 + $30 + $18 + $103 + $17 + $97
Brief Exercise 107
Ivy Company has invested $4,000,000 in assets to produce 25,000 units of its finished product. Ivy’s budget for the year is as follows: net income, $750,000; variable costs, $2,625,000; fixed costs, $500,000.
Instructions
Calculate each of the following: a. Budgeted ROI.
b. Mark-up percentage using a total cost approach.
Solution Brief Exercise 107
a. ROI is equal to net income divided by invested assets. For Ivy Company budgeted ROI is: Budgeted ROI = $750,000 ÷ $4,000,000 = 18.75%
b. The mark-up percentage is equal to:
Net income Total cost
For Ivy Company the budgeted mark-up percentage is: $750,000
= 24% $2,625,000 + $500,000
Brief Exercise 108
On a recent job repairing a small boat engine, Marine Repairs Company worked 16 hours and used parts with a cost of $750. Marine Repairs Company charges $75 per hour of labour and has a material loading charge of 55%.
Instructions
Calculate the total bill for repairing the small boat engine.
Solution Brief Exercise 108
The total bill would equal:
(16 hours X $75) + $750 + ($750 X 55%) = $2,362.50
Brief Exercise 109
Two Wheel Green Machines manufactures and sells bicycles. The tire manufacturing division sells its product to customers for $15 each. The variable cost per tire is $7.50, and fixed costs per tire are $3.00. The bicycle assembly division has been buying tires from an outside source for $14 each. Upper management wants the tire division to transfer 50,000 tires to the assembly division within the company at a price of $12 per tire. The tire division is operating at full capacity.
Instructions
Calculate the minimum transfer price that the tire division should accept.
Solution Brief Exercise 109
The minimum transfer price is equal to the tire division’s variable cost plus its opportunity cost. The opportunity cost is equal to its contribution margin on goods sold to external parties. Thus, the minimum transfer price in this case is:
Minimum transfer price = $7.50 + ($15 – $7.50) = $15.
Brief Exercise 110
Two Wheel Green Machines manufactures and sells bicycles. The tire manufacturing division sells its product to customers for $15 each. The variable cost per tire is $7.50, and fixed costs per tire are $3.00. The bicycle assembly division has been buying tires from an outside source for $14 each. Upper management wants the tire division to transfer 50,000 tires to the assembly division within the company at a price of $12 per tire. The tire division has sufficient excess capacity to provide the 50,000 tires to the assembly division.
Instructions
Calculate the minimum transfer price that the tire division should accept.
Solution Brief Exercise 110
If the tire division has excess capacity, then its opportunity cost is zero. In this case, the minimum transfer price is:
Minimum transfer price = $7.50 + $0 = $7.50.
Brief Exercise 111
Sandbar Company, a division of Dudge Cars, produces automotive batteries. Sandbar sells the batteries to its customers for $82 per unit. The variable cost per unit is $38, and fixed costs per unit are $16. Top management of Dudge Cars would like Sandbar to transfer 30,000 special, high-performance batteries to another division within the company. Sandbar’s variable cost on these special batteries is $52 per unit. Sandbar is operating at full capacity.
Instructions
Calculate the minimum transfer price that Sandbar should accept.
Solution Brief Exercise 111
The minimum transfer price is equal to Sandbar’s variable cost plus its opportunity cost. In this case the minimum transfer price is:
Minimum transfer price = $52 + ($82 – $38) = $96.
Brief Exercise 112
Fragmented Company has two divisions, A and B. Division A makes a part that Division B currently purchases from an outside supplier for $80. Division B approaches Division A to purchase the product internally.
Cost information on this part for Division A is as follows:
Variable selling costs $20 per part Fixed costs $15 per unit
Division A is operating at full capacity and sells all of its output to external customers for $102 per part.
Instructions
Calculate the minimum amount that Division A would accept to transfer the part to Division B.
Solution Brief Exercise 112
Outside selling price includes variable selling costs of $20.
Therefore transfer at $102 – 20 = $82 and Division A is in the same position as if it sold to its outside customer
Brief Exercise 113
Using the information above to calculate what the maximum price that Division B would accept from Division A for the part.
Solution Brief Exercise 113
Outside purchasing price of the part is currently $80. Division B would therefore not accept a price higher than that.
EXERCISES
Exercise 114Trout Company is considering introducing a new line of pagers targeting the preteen population. Trout believes that if the pagers can be priced competitively at $30, approximately 750,000 units can be sold. The controller has determined that an investment in new equipment totalling
$3,750,000 will be required. Trout requires a minimum rate of return of 10% on all investments.
Instructions
Calculate the target cost per unit of the pager.
Solution Exercise 114 (6-10 min.)
Sales (750,000 × $30) $22,500,000 Less desired ROI ($3,750,000 × 10%) 375,000 Target cost for 750,000 units $22,125,000 Target cost per unit = $22,125,000 ÷ 750,000 = $29.50
Exercise 115
Rita Corporation produces commercial fertilizer spreaders. The following information is available for Rita's anticipated annual volume of 600,000 units.
Per Unit Total
Direct materials $37
Direct labour 43
Variable manufacturing overhead 65
Fixed manufacturing overhead $15,000,000 Variable selling and administrative expenses 73
Fixed selling and administrative expenses 11,400,000 The company has a desired ROI of 20%. It has invested assets of $325,000,000.
Instructions
Calculate each of the following: a. Total cost per unit.
b. Desired ROI per unit.
c. Mark-up percentage using total cost per unit. d. Target selling price.
Solution Exercise 115 (12 min.)
a. Total cost per unit:
Per Unit
Direct materials $ 37
Direct labour 43
Variable manufacturing overhead 65 Fixed manufacturing overhead ($15,000,000 ÷ 600,000) 25 Variable selling and administrative expenses 73 Fixed selling and administrative expenses ($11,400,000 ÷ 600,000) 19 $262
b Desired ROI per unit = (20% × $325,000,000) ÷ 600,000 = $108.33 $108.33 + $0
c. Mark-up percentage using total cost per unit =———— = 41 % $262
d. Target selling price = $262 + ($262 × 41%) = $369.42
Exercise 116
Goliath Corporation is in the process of setting a selling price for a new product it has just designed. The following data relate to this product for a budgeted volume of 40,000 units.
Per Unit Total
Direct materials $15
Direct labour 35
Variable manufacturing overhead 12
Fixed manufacturing overhead $2,100,000 Variable selling and administrative expenses 8
Fixed selling and administrative expenses 1,300,000
Goliath uses cost-plus pricing to set its target selling price. The mark-up on total unit cost is 15%.
Instructions
Calculate each of the following for the new product:
a. Total variable cost per unit, total fixed cost per unit, and total cost per unit. b. Desired ROI per unit.
c. Target selling price.
Solution Exercise 116 (18 min.)
a. Direct materials $15
Direct labour 35
Variable manufacturing overhead 12 Variable selling and administrative expenses 8 Variable cost per unit $70
Budgeted Cost
Total Costs Volume Per Unit Fixed manufacturing overhead $2,100,000 ÷ 40,000 = $52.50 Fixed selling and administrative expenses 1,300,000 ÷ 40,000 = 32.50
Fixed cost per unit $85
Variable cost per unit $70 Fixed cost per unit 85 Total cost per unit $155 b. Total cost per unit $155
Mark-up × 15% Desired ROI per unit $ 23.25 c. Total cost per unit $155.00
Target selling price $178.25
Exercise 117
Tree Top Company is in the process of setting a selling price for its newest model stunt kite, the Looper. The controller of Tree Top estimates variable cost per unit for the new model to be as follows:
Direct materials $15
Direct labour 13
Variable manufacturing overhead 4 Variable selling and administrative expenses 5 $37
In addition, Tree Top anticipates incurring the following fixed cost per unit at a budgeted sales volume of 20,000 units:
Total Costs ÷ Budget Volume = Cost per Unit Fixed manufacturing overhead $240,000 20,000 $12 Fixed selling and administrative expenses 260,000 20,000 13
Fixed cost per unit $25
Tree Top uses cost-plus pricing and would like to earn a 12 percent return on its investment (ROI) of $250,000.
Instructions
Calculate the selling price that would provide Tree Top a 12 percent ROI.
Solution Exercise 117 (6 - 10 min.)
Variable cost per unit $ 37.00 Fixed cost per unit 25.00 Desired ROI per unit 1.50 Target selling price $ 63.50 *$250,000 × .12 = $30,000; $30,000 ÷ 20,000 = $1.50 per unit
Exercise 118
Greasy Spoon Service repairs commercial food preparation equipment. The following budgeted cost data is available for 2012:
Time Material Charges Charges
Technicians' wages and benefits $600,000
Parts manager's salary and benefits $ 72,000 Office manager's salary and benefits 112,000 18,000 Other overhead 48,000 110,000 Total budgeted costs $760,000 $200,000
Greasy Spoon has budgeted for 10,000 hours of technician time during the coming year. It desires a $64 profit margin per hour of labour and a 50% profit margin on parts. Greasy Spoon estimates the total invoice cost of parts and materials in 2012 will be $500,000.
Instructions
a. Calculate the rate charged per hour of labour. b. Calculate the material loading charge.
c. Greasy Spoon has received a request from Lime Corporation for an estimate to repair a commercial fryer. The company estimates that it would take 20 hours of labour and $8,000 of parts. Calculate the total estimated bill.
Solution Exercise 118 (18-20 min.)
a. Per Hour
Total Cost Total Hours Charge Hourly labour rate for repairs
Technicians' wages and benefits $600,000 ÷ 10,000 = $60.00 Overhead costs
Office manager's salary and benefits 112,000 ÷ 10,000 = 11.20 Other overhead 48,000 ÷ 10,000 = 4.80 $760,000 ÷ 10,000 = 76.00
Profit margin 64.00
Rate charged per hour of labour $140.00
b. Material
Material Total Invoice Cost,Loading Charges Parts and Materials Charge
Overhead costs
Parts manager's salary and benefits $72,000 Office manager's salary and benefits 18,000
$90,000 ÷ $500,000 = 18% Other overhead 110,000 ÷ $500,000 = 22% 40%
Profit margin 50%
Material loading charge 90%
c. Job: Lime Corporation Labour charges
20 hours @ $140 $2,800
Material charges
Cost of parts and materials $8,000
Material loading charge (90% × $8,000) 7,200 15,200 Total price of labour and materials $18,000
Exercise 119
Forrest Painting Service has budgeted the following time and material for 2012: BUDGETED COSTS FOR 2012
Time Material Charges Charges Painters’ wages and benefits $36,000
Service manager's salary and benefits $21,000 Office employee's salary and benefits 12,000 3,000
Cost of paint 50,000
Overhead (supplies, utilities, etc.) 10,000 8,500 Total budgeted costs $58,000 $82,500
Forrest budgets 4,000 hours of paint time in 2012 and will charge a profit of $12 per hour, in addition to a 25% mark-up on the cost of paint.
On February 15, 2012, Forrest is asked to prepare a price estimate to paint a building. Forrest estimates that this job will take 12 labour hours and $600 in paint.
Instructions
a. Calculate the labour rate for 2012.
b. Calculate the material loading charge rate for 2012.
c. Prepare a time and materials price estimate for painting the building.
Solution Exercise 119 (18-20 min.)
a. Computation of labour rate
Total Cost Total Hours Per Hour Charge Hourly labour rate for repairs
Painters' wages and benefits $36,000 ÷ 4,000 = $9.00 Overhead costs
Office employee's salary and benefits 12,000 ÷ 4,000 = 3.00 Other overhead 10,000 ÷ 4,000 = 2.50 $58,000 ÷ 4,000 = 14.50
Profit margin 12.00
Rate charged per hour of labour $26.50 b. Computation of material loading charge
Material Material Total Invoice Cost Loading Charges of Paint Charge Overhead costs
Service manager's salary and benefits $21,000 Office employee's salary and benefits 3,000
24,000 ÷ $50,000 = 48%
Other overhead 8,500 ÷ 50,000 = 17% $32,500 ÷ 50,000 = 65%
Profit margin 25%
Material loading charge 90%
c. Price estimate for time and materials Job: Paint building
Labour charges: 12 hours @ $26.50 $ 318 Material charges
Cost of paint $600
Material loading charge (90% × $600) 540 1,140 Total price of labour and materials $1,458
Exercise 120
Rose Corporation manufactures state-of-the-art DVD players. It is a division of Sany TV, which manufactures televisions. Rose sells the DVD players to Sany, as well as to retail stores. The following information is available for Rose's DVD player: variable cost per unit $150; fixed costs
per unit $75; and a selling price of $400 to outside customers. Sany currently purchases DVD players from an outside supplier for $390 each. Top management of Sany would like Rose to provide 20,000 DVD players per year at a transfer price of $150 each.
Instructions
Calculate the minimum transfer price that Rose should accept under each of the following assumptions:
a. Rose is operating at full capacity.
b. Rose has sufficient excess capacity to provide the 20,000 players to Sany.
Solution Exercise 120 (9 min.)
a. The minimum transfer price is $400 [$150 + ($400 – $150)], the outside market price, since Rose is operating at full capacity.
b. The minimum transfer price is $150, the variable cost of the DVD players, since Rose has excess capacity. However, since the market price is $390 (Sany's current cost); Rose should be able to negotiate a price much higher than $150.
Exercise 121
Green Grass Co., a division of Lawn Supplies, Inc., produces lawn mowers. Green Grass sells its lawn mowers to home improvement stores, as well as to Lawn Supplies, Inc. The following information is available for Green Grass’ mowers:
Fixed costs per unit $ 230 Variable cost per unit 150 Selling price per unit 500
Lawn Supplies, Inc. can purchase comparable lawn mowers from an outside supplier for $475. In order to ensure a reliable supply, the management of Lawn Supplies, Inc. ordered Green Grass to provide 65,000 lawn mowers per year at a transfer price of $475 per unit. Green Grass is
currently operating at full capacity. It could avoid $10 per unit of variable selling costs by selling internally.
Instructions
a. Calculate the minimum transfer price that Green Grass should be required to accept. b. Calculate the increase (decrease) in contribution margin for Lawn Supplies, Inc. for this
transfer.
Solution Exercise 121 (9 min.)
a. The minimum transfer price that Green Grass should accept is: [($150 – $10 + ($500 – $150)]= $490
b. The decrease in contribution margin per unit to Lawn Supplies, Inc. is: Contribution margin lost by Green Grass ($500 – $150) $350 Increased contribution margin to Lawn Supplies ($475 – $140) 335 Net decrease in contribution margin $ 15 Total contribution margin decrease is:
Exercise 122
Canada’s Tires is a division of the Wheels To Go Company. Canada’s Tires produces bicycle tires in its automated plant in Canada. Fixed costs per tire are $5, and variable costs are $2 per tire. The tires are shipped to Wheels To Go’s plant in Africa where bicycles are assembled and sold locally at a sales price of $50 each. Fixed costs to make the bicycles are $10 per unit and variable costs per unit are $15 plus the cost of the tires. Wheels To Go has a tax rate of 30% in Canada, and 20% in Africa.
Instructions
a. Calculate the after tax income for Canada’s Tires, the African assembly division, and the company as a whole if 100,000 tires are transferred at Canada’s Tires’ full cost. Assume the 100,000 tires are all used to produce 50,000 bicycles.
b. Calculate the after tax income for Canada’s Tires, the African assembly division, and the company as a whole if 100,000 tires are transferred at 110% of Canada’s Tires’ full cost. Assume the 100,000 tires are all used to produce 50,000 bicycles.
c. What would be your recommendation to Wheels To Go?
Solution Exercise 122 (13 min.)
a. Canada’s Tires
Sales (100,000 tires X $7/tire) $700,000 Less expenses (100,000 X $7/tire) 700,000
Net Income $ 0
Assembly Division
Sales (50,000 bicycles X $50/bicycle) $2,500,000 Less expenses
Tires (100,000 tires X $7/tire) $700,000 Other Variable (50,000 bicycles X $15/bicycle) 750,000
Fixed Costs (50,000 bicycles X $10/bicycle) 500,000 1,950,000
Income before tax 550,000
Income tax at 20% 110,000
Net Income $440,000
Wheels To Go’s Net Income $0 + $440,000 = $440,000. b. Canada’s Tires
Sales (100,000 tires X $7/tire X 1.10) $770,000 Less expenses (100,000 X $7/tire) 700,000
Income before tax 70,000
Income tax at 30% 21,000
Net Income $49,000
Assembly Division
Sales (50,000 bicycles X $50/bicycle) $2,500,000 Less expenses
Tires (100,000 tires X $7.70/tire) $770,000 Other Variable (50,000 bicycles X $15/bicycle) 750,000
Fixed Costs (50,000 bicycles X $10/bicycle) 500,000 2,020,000
Income before tax 480,000
Income tax at 20% 96,000
Wheels To Go’s Net Income $49,000 + $384,000 = $433,000.
c. Wheels To Go should transfer the tires at full cost resulting in zero net income in Canada and therefore no tax owing in Canada. By “locating the profit” in the location with the lower tax rate, Wheels To Go will pay a lower total tax amount, resulting in a larger after tax income.
Exercise 123
International Chemicals is a division of World Wide Chemicals. It produces HDL which is a ingredient used in many products. Variable costs to produce HDL include $7 per litre manufacturing costs, and $2/litre selling expense. International Chemicals’ fixed costs are $100,000. It currently sells 75,000 litres of HDL to customers for $12/litre.
EKP is another division of World Wide Chemicals. It uses HDL, and has been sourcing its needs from an outside supplier for $10/litre.
Instructions
a. What is the minimum price International Chemicals would be willing to sell HDL to EKP if it has sufficient capacity to satisfy demand from both EKP and other customers?
b. What is the highest price EKP would be willing to pay International Chemicals for HDL? c. If the transfer does occur, what would be the transfer price?
d. If International Chemicals has capacity to produce 75,000 litres of HDL, and EKP needs 10,000 litres, what is the minimum price International Chemicals would be willing to accept?
Solution Exercise 123 (13 min.)
a. International Chemicals should be willing to sell HDL to EKP at its variable cost of $9/litre. b. EKP will not be willing to pay International Chemicals more than $10/litre, which is the price it
can purchase HDL from other sources.
c. The transfer would occur, with a price somewhere in the $9 to $10 per litre range.
d. In order to satisfy EKP’s demand for 10,000 litres, International Chemicals would lose sales of 10,000 litres. Therefore, the minimum transfer price would be variable cost + opportunity cost, or $9/litre + ($12 - $9)/litre = $12 per litre.
Exercise 124
The following information is available for a product manufactured by Gardenia Corporation: Per Unit Total
Direct materials $62.50 Direct labour 47.50 Variable manufacturing overhead 15.00
Fixed manufacturing overhead $250,000 Variable selling and admin. expenses 10.00
Fixed selling and admin. expenses 55,000
Gardenia has a desired ROI of 16%. It has invested assets of $8,250,000 and expects to produce 2,000 units per year.
Calculate each of the following:
a. Cost per unit of fixed manufacturing overhead and fixed selling and administrative expenses. b. Desired ROI per unit.
c. Mark-up percentage using the absorption cost approach. d. Mark-up percentage using the variable cost-plus approach.
Solution Exercise 124 (12-14 min.)
$250,000
a. Fixed manufacturing overhead = ———————— = $125 per unit 2,000
$55,000
Fixed selling and administrative expenses per unit = ———— = $27.50 per unit
2,000
16% × $8,250,000
b. Desired ROI per unit = ————————— = $660 per unit 2,000
$660 + ($10 + $27.50)
c. Absorption cost mark-up percentage = —————————————— = 279% $62.50 + $47.50 + $15 + $125
$660 + ($125 + $27.50)
d. Variable cost-plus mark-up percentage =—————————————— = 602% $62.50 + $47.50 + $15 + $10
Exercise 125
Peachtree Doors, Inc. is in the process of setting a target price on its newly designed patio door. Cost data relating to the door at a budgeted volume of 5,000 units is as follows:
Per Unit Total
Direct materials $250
Direct labour 170
Variable manufacturing overhead 80
Fixed manufacturing overhead $500,000 Variable selling and administrative expenses 25
Fixed selling and administrative expenses 375,000
Peachtree uses cost-plus pricing that provides it with a 25% ROI on its patio door line. A total of $4,000,000 in assets is committed to production of the new door.
Instructions
a. Calculate each of the following under the absorption approach: i. Mark-up percentage needed to provide desired ROI. ii. Target price of the patio door.
b. Calculate each of the following under the variable cost-plus approach: i. Mark-up percentage needed to provide desired ROI.
ii. Target price of the patio door.
Solution Exercise 125 (12-14 min.)
a. Absorption approach
i. Computation of unit manufacturing cost:
Per Unit
Direct materials $250
Direct labour 170
Variable manufacturing overhead 80 Fixed manufacturing overhead ($500,000 ÷ 5,000) 100 Total manufacturing cost $600 Computation of mark-up percentage to provide a 25% ROI:
Mark-up [25% × ($4,000,000 ÷ 5,000)] + [$25 + ($375,000 ÷ 5,000)] $300
Percentage = —————————————————————————— = —— = 50%
$600 $600
ii. Computation of target price:
Target price: $600 + (50% × $600) = $900 b. Variable cost-plus approach
i. Computation of unit variable cost:
Per Unit
Direct materials $250
Direct labour 170
Variable manufacturing overhead 80 Variable selling and administrative expenses 25 Total variable cost $525
Computation of mark-up percentage to provide a 25% ROI:
Mark-up [25% × ($4,000,000 ÷ 5,000)] + [($500,000 ÷ 5,000) + ($375,000 ÷ 5,000)] Percentage = ————————————————————————————————— $525 $375 = —— = 71.43% $525
ii. Computation of target price:
Target price: $525 + (71.43% × $525) = $900
Exercise 126
Sani Sanukesh operates a catering company. Sani provides food and servers for parties; she also rents tables, chairs, linens, chocolate fountains, table ware, and recommends florists on
occasion. Eduardo and Griselda Quintanilla contacted Sani about catering for their daughter’s wedding. They have requested an open bar, appetizers for 300 guests, an exquisite 3-layer wedding cake, and 40 tables with colourful linens, fine china and crystal stemware. Sani created the following bid for the Quintanillas:
Food: (300 guests x $7.50) $2,250 Wedding cake: $150 Beverages: (300 x $5) $1,500 Servers (12 x 4 hours x $10) $480 Bartender (1 x 3 hours x $12)$36 Linen Rentals: $80 Table Rentals: $200 Dinnerware Rentals: $80 Glassware Rentals: $80 Total $4,856
Imagine that the Quintanillas nearly faint when they are presented with the bid. Eduardo suggests that their target costs for their daughter’s wedding was $3,750, and no more. How could Sani work with the parents to reduce costs?
Solution Exercise 126 (5-8 min.)
Sani will need to meet with the Quintanillas to identify which features of the reception are non-negotiable for the family, and then model other costs around those central features. For example, if lavish dinnerware is essential, then that will be kept, but perhaps the wedding cake could be scaled back, or turned into festive cupcakes. In addition, the length of the party could be reduced by an hour, which would reduce costs for servers and the bartender. It’s possible that the
Quintanillas could bring in their own glassware and linens. Finally, the guest list could be pared down to 250 for a substantial savings. Others may consider cutting the guest list as a starting point.
Exercise 127
Quick Konstruct builds custom, high-end homes. Each home requires a bid, and Quick’s bidding practise is to estimate the costs of materials, direct labour and subcontracting fees. These are totalled and mark-up is applied to cover overhead and profit. In the next year, Quick believes it will be the successful bidder on 10 jobs with the following total revenues and costs:
Revenues $648,000 Materials $200,000
Direct labour $250,000
Subcontractors $150,000 $600,000 Excess $48,000 The excess is created to cover overhead and profits.
Instructions
a. What is the mark-up percentage on total direct costs?
b. If Quick is asked to bid on a job with estimated direct costs of $55,000, what is the amount of the total bid? If the customer complains that the profit is too high, how might Quick counter that comment?
Solution Exercise 127 (5-8 min.)
b. Bid = $55,000 x 1.08 = $59,400.
Quick should remind the customer that the 8% mark-up on costs is not purely profit, since it first has to cover Quick’s overhead. (In the construction industry, a mere 8% to cover overhead and profit is rather low.)
Exercise 128
The Doormat Company has two divisions, Doors and Mats. The Door Division has the capacity to make 100,000 Doors and regularly sells 90,000 doors each year to the outside market. Information about the doors is as follows:
Selling price $100 per door Variable manufacturing costs $75 per door
The Mat Division currently buys 20,000 doors from an outside supplier for $90 each and would like to buy them from the Door Division. They have suggested a price of $80 per door.
Instructions
Calculate the change in net income for the Doormat Company if the transfer between divisions takes place at that price.
Solution Exercise 128 (5-8 min.)
Savings by not purchasing outside 20,000 x $90 = $1,800,000 Variable cost of the doors 20,000 x $75 = (1,500,000) Contribution lost on regular sales 10,000 x ($100 - $75) = (250,000) Income effect $ 50,000
Exercise 129
The Sunrise Mattress Company uses transfer pricing for all work in process transfers between its divisions. Senior management believes that the transfer price is an important tool to motivate appropriate behaviour and believes that each division should negotiate its prices when a transfer takes place. To make the mattresses that the company sells, the Spring Division buys processed cloth padding from an outside supplier.
Cost information on the foam produced in the Foam Division is as follows: Raw material costs $10 per tonne
Variable manufacturing costs $17 per tonne Fixed manufacturing costs $15 per tonne Variable selling costs $4 per tonne Outside selling price $40 per tonne Annual production capacity 100,000 tonnes The Foam Division currently produces and sells at its capacity.
Instructions
If the Spring Division were to change from cloth padding to foam padding for its mattresses, calculate the transfer price that the Foam Division would accept.
Solution Exercise 129 (5-8 min.)
As the Foam Division is operating at full capacity, it would accept its current selling price less any avoidable costs, which are the selling costs. $40 - $4 = $36.
COMPLETION STATEMENTS
130. The difference between the target price and the desired profit is the _________________ cost of the product.
131. In the cost-plus pricing formula, the target selling price equals cost + (________________ × cost).
132. The _______________ pricing approach has a major advantage: it is simple to calculate. 133. Under the time and material pricing approach, the material charge is based on the cost of
direct materials used and a material __________________ for related overhead costs. 134. The transfer of goods between divisions of the same company is termed _____________
sales.
135. The three approaches for determining a transfer price are: negotiated, ________________ based, and _________________ based transfer prices.
136. To ensure that the selling division attempts to control its costs, the transfer price should be based on _________________ cost instead of actual cost.
137. The formula for the minimum transfer price is: Minimum transfer price = Variable cost + ___________________.
138. __________________ involves contracting with an external party to provide a good or service, rather than performing the work internally.
139. The __________________ approach is consistent with generally accepted accounting principles because it defines the cost base as the manufacturing cost.
ANSWERS TO COMPLETION STATEMENTS
130. target 131. mark-up percentage 132. cost-plus 133. loading charge 134. internal 135. cost, market 136. standard 137. opportunity cost 138. outsourcing 139. absorption costMATCHING
140. Match the items in the two columns below by entering the appropriate code letter in the space provided.
A. Cost-plus pricing E. Outsourcing B. Market-based transfer price F. Target selling price C. Mark-up G. Time and material pricing D. Negotiated transfer price H. Virtual companies
____ a. Contracting with an external party to provide a good or service. ____ b. An approach to cost-plus pricing that uses two pricing rates.
____ c. Product's selling price is determined by adding a mark-up to a cost base. ____ d. Transfer price is determined by agreement of division managers.
____ e. Companies that have no manufacturing facilities. ____ f. Percentage applied to a product's cost.
____ g. Price that will provide the desired profit on a product.
ANSWERS TO MATCHING
a. E e. H
b. G f. C
c. A g. F
SHORT-ANSWER ESSAY QUESTIONS
Short Answer Essay 141A variation on cost-plus pricing is time and material pricing. Under this approach, two pricing rates are set. Explain where this approach is used and identify the steps involved in time and material pricing. Also explain what the material loading charge covers and how it is expressed.
Solution Short Answer Essay 141
The time and material pricing approach is used often in service industries, especially professional firms and consulting firms. This approach involves three steps: (1) calculate the labour charge per hour, (2) calculate the charge for obtaining and holding materials, and (3) calculate the charges for a particular job. The material loading charge covers the costs of purchasing, handling, and storing materials, plus any desired profit margin on the materials. It is expressed as a percentage of the total estimated costs of parts and materials.
Short Answer Essay 142
There are three possible approaches for determining a transfer price: negotiated, cost-based, and market-based transfer prices. Explain how the transfer price is determined under each of the approaches.
Solution Short Answer Essay 142
Under the negotiated transfer price approach, the transfer price will range between the external purchase price per unit and the sum of unit variable cost and unit opportunity cost. In the cost-based approach, the transfer price is cost-based on either the full cost or the variable cost of the selling division. Under the market-based approach, the minimum transfer price is the unit variable cost plus the unit opportunity cost.
