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Transfer pricing-DONE!
Transfer pricing-DONE!
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 markup to this base
to determine a 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.
13. There are two approaches for determining a transfer price: cost-based and market-
based.
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 compute the markup 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 markup percentage in the contribution approach is computed by dividing the desired
ROI/unit plus fixed costs/unit by the variable costs/unit.
*25. Under the contribution approach, the cost base consists of all of the variable costs
associated with a product except variable selling and administrative costs.
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
5. T 10. T 15. T 20. T *25. F
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.
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.
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.
32. In cost-plus pricing, the markup percentage is computed by dividing the desired ROI per
unit by the
a. fixed cost per unit.
b. total cost per unit.
c. total manufacturing cost per unit.
d. variable cost per unit.
35. Wenger Company has just developed a new product. The following data is available for
this product:
Desired ROI per unit $18
Fixed cost per unit 30
Variable cost per unit 45
Total cost per unit 75
The target selling price for this product is
a. $93.
b. $75.
c. $63.
d. $48.
36. All of the following are correct statements about the cost-plus pricing approach except that
it
a. is simple to compute.
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 computed by multiplying
the ROI percentage by
a. fixed costs.
b. total assets.
c. total costs.
d. variable costs.
Downing Company produces a high resolution computer monitor. The following information is
available for this product:
Fixed cost per unit $ 50
Variable cost per unit 150
Total cost per unit 200
Desired ROI per unit 60
38. Downing Company's markup percentage would be
a. 120%.
b. 60%.
c. 40%.
d. 30%.
39. The target selling price for this monitor is
a. $110.
b. $200.
c. $210.
d. $260.
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. labor charge per hour.
d. charges for a particular job.
42. The labor charge per hour in time and material pricing includes all of the following except
a. an allowance for a desired profit.
b. charges for labor 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.
c. divide material charges by the total estimated costs 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 labor charge
and the
a. materials charge.
b. material loading charge.
c. materials charge + desired profit.
d. materials charge + the material loading charge.
47. In March 2003, Computer Bytes repairs a computer that takes two hours to repair and
uses parts of $60. The bill for this computer repair would be
a. $130.
b. $140.
c. $148.
d. $154.
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. Variable costs of units sold internally will always be
a. lower than the variable costs of units sold externally.
b. higher than the variable costs of units sold externally.
c. the same as the variable costs of units sold externally.
d. Variable costs of units sold internally may be either higher or lower than for units sold
externally.
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.
b. market-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.
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. none of these is correct.
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.
62. Assuming the Rubber Division has available capacity of 5,000 units, the minimum
transfer price it should accept is
a. $7.
b. $20.
c. $27.
d. $50.
63. Assuming the Rubber Division does not have any available capacity, the minimum
transfer price it should accept is
a. $7.
b. $20.
c. $27.
d. $50.
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 appro-
priate 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. Contribution approach
c. Variable-cost approach
d. Both absorption cost and contribution 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 compute the
a. desired ROI per unit.
b. markup percentage.
c. target selling price.
d. unit manufacturing cost.
*69. The markup percentage in the absorption cost approach is computed 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 markup 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 contribution 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.
Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans.
26. d 34. b 42. b 50. a 58. d *66. a *74. d
2 b 35. a 43. D 51. d 59. c *67. c *75. c
7
.
28. c 36. c 44. D 52. d 60. a *68. d
29. d 37. b 45. D 53. d 61. c *69. c
30. d 38. d 46. A 54. d 62. b *70. b
31. c 39. d 47. D 55. c 63. d *71. d
32. b 40. d 48. D 56. b 64. d *72. c
33. c 41. c 49. d 57. c 65. c *73. b
EXERCISES
Ex. 76
Sole Company is considering introducing a new line of hand-held organizers targeting the
preteen population. Sole believes that if the organizers can be priced competitively at $90,
approximately 500,000 units can be sold. The controller has determined that an investment in
new equipment totaling $8,000,000 will be required. Sole requires a minimum rate of return of
14% on all investments.
Instructions
Compute the target cost per unit of the handheld organizer.
Ex. 77
Carter Corporation produces window air conditioners. The following information is available for
Carter's anticipated annual volume of 400,000 units.
Per Unit Total
Direct materials $21
Direct labor 27
Variable manufacturing overhead 36
Fixed manufacturing overhead $6,000,000
Variable selling and administrative expenses 42
Fixed selling and administrative expenses 3,600,000
The company has a desired ROI of 25%. It has invested assets of $72,000,000.
Ex. 77 (cont.)
Instructions
Compute each of the following:
1. Total cost per unit.
2. Desired ROI per unit.
3. Markup percentage using total cost per unit.
4. Target selling price.
$45 + $0
3. Markup percentage using total cost per unit = ———— = 30%
$150
Ex. 78
Barkley 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 60,000 units.
Per Unit Total
Direct materials $10
Direct labor 20
Variable manufacturing overhead 5
Fixed manufacturing overhead $900,000
Variable selling and administrative expenses 3
Fixed selling and administrative expenses 540,000
Barkley uses cost-plus pricing to set its target selling price. The markup on total unit cost is
25%.
Instructions
Compute each of the following for the new product:
1. Total variable cost per unit, total fixed cost per unit, and total cost per unit.
2. Desired ROI per unit.
3. Target selling price.
Budgeted Cost
Total Costs Volume Per Unit
Fixed manufacturing overhead $900,000 ÷ 60,000 = $15
Fixed selling and administrative expenses 540,000 ÷ 60,000 = 9
Fixed cost per unit $24
Ex. 79
Whiz-by Company is in the process of setting a selling price for its newest model scooter, the
Zip. The controller of Whiz-by estimates variable cost per unit for the new model to be as
follows:
Direct materials $30
Direct labor 26
Variable manufacturing overhead 8
Variable selling and administrative expenses 10
$74
In addition, Whiz-by 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 $480,000 20,000 $24
Fixed selling and administrative expenses 520,000 20,000 26
Fixed cost per unit $50
Whiz-by uses cost-plus pricing and would like to earn a 12 percent return on its investment
(ROI) of $500,000.
Instructions
Compute the selling price that would provide Whiz-by a 12 percent ROI.
Solution 79 (6 - 10 min.)
Variable cost per unit $ 74
Fixed cost per unit 50
Desired ROI per unit 3*
Target selling price $127
*$50,000 × .12 = $60,000; $60,000 ÷ 20,000 = $3 per unit
Ex. 80 LATER!!
Sparks Engine Service repairs and rebuilds diesel engines. The following budgeted cost data is
available for 2003:
Time Material
Charges Charges
Technicians' wages and benefits $300,000
Parts manager's salary and benefits $ 36,000
Office manager's salary and benefits 56,000 9,000
Other overhead 24,000 55,000
Total budgeted costs $380,000 $100,000
Sparks has budgeted for 10,000 hours of technician time during the coming year. It desires a
$32 profit margin per hour of labor and a 50% profit margin on parts. Sparks estimates the total
invoice cost of parts and materials in 2003 will be $500,000.
Instructions
1. Compute the rate charged per hour of labor.
2. Compute the material loading charge.
3. Sparks has received a request from Mercer Corporation for an estimate to rebuild a diesel
engine. The company estimates that it would take 20 hours of labor and $4,000 of parts.
Compute the total estimated bill.
20%
Profit margin 50%
Material loading charge 70%
Labor charges
20 hours @ $70 $1,400
Material charges
Cost of parts and materials $4,000
Material loading charge (70% × $4,000) 2,800 6,800
Total price of labor and materials $8,200
Ex. 81 LATER!!
Frank's Transmission Service has budgeted the following time and material for 2002:
Time Material
Charges Charges
Mechanics' wages and benefits $ 72,000
Service manager's salary and benefits $ 42,000
Office employee's salary and benefits 24,000 6,000
Cost of parts used 100,000
Overhead (supplies, utilities, etc.) 20,000 17,000
Total budgeted costs $116,000 $165,000
Frank budgets 4,000 hours of repair time in 2002 and will charge a profit of $6 per hour, in
addition to a 25% markup on the cost of parts.
On February 15, 2002, Frank is asked to prepare a price estimate to rebuild the transmission in
a 1997 Lincoln Navigator. Frank estimates that this job will take 12 labor hours and $300 in
parts.
Instructions
1. Compute the labor rate for 2002.
2. Compute the material loading charge rate for 2002.
3. Prepare a time and materials price estimate for rebuilding the Navigator transmission.
Ex. 82
Mathis Corporation manufactures automotive compact disc changers. It is a division of
American Motors, which manufactures automobiles. Mathis sells the CD changers to American,
as well as to retail stores. The following information is available for Mathis's CD changer:
variable cost per unit $105; fixed costs per unit $75; and a selling price of $260 to outside
customers. American currently purchases CD changers from an outside supplier for $240 each.
Top management of American would like Mathis to provide 50,000 changers per year at a
transfer price of $105 each.
Instructions
Compute the minimum transfer price that Mathis should accept under each of the following
assumptions:
1. Mathis is operating at full capacity.
2. Mathis has sufficient excess capacity to provide the 50,000 changers to American.
Solution 82 (9 min.)
1. The minimum transfer price is $260 [$105 + ($260 – $105)], the outside market price, since
Mathis is operating at full capacity.
2. The minimum transfer price is $105, the variable cost of the changers, since Mathis has
excess capacity. However, since the market price is $240 (American's current cost), Mathis
should be able to negotiate a price much higher than $105.
Ex. 83
Modine Manufacturing, a division of Datson Corporation, produces car radiators. Modine sells
radiators to auto parts stores, as well as to Datson. The following information is available for
Modine's radiators:
Fixed costs per unit $ 90
Variable cost per unit 60
Selling price per unit 215
Datson can purchase comparable radiators from an outside supplier for $200. In order to ensure
a reliable supply, Datson's management ordered Modine to provide 100,000 radiators per year
at a transfer price of $200 per unit. Modine is currently operating at full capacity. It could avoid
$4 per unit of variable selling costs by selling internally.
Instructions:
1. Compute the minimum transfer price that Modine should be required to accept.
2. Compute the increase (decrease) in contribution margin for Datson for this transfer.
Solution 83 (9 min.)
1. The minimum transfer price that Modine should accept is:
Instructions
Calculate the minimum transfer price and indicate whether the internal transfer should occur for
each of the following:
1. The marketing vice president offers to pay Allcell $95 per phone. Allcell has available
capacity.
2. The marketing vice president offers to pay Allcell $95 per phone. Allcell has no available
capacity and would have to forgo sales of 20,000 phones to existing customers to meet this
request. Iàequal to the number of orders hehe
3. The marketing vice president offers to pay Allcell $145 per phone. Allcell has no available
capacity and would have to forgo sales of 30,000 phones to existing customers to meet this
request.
2. Assuming no available capacity, and that the new units produced would be equal to the
number of standard units forgone, variable cost of the special cell phone would be ($45 +
$30) or $75 and the opportunity cost would be ($80 - $45) or $35. Therefore, the minimum
transfer price would be $110 = $75 + $35. Since this is higher than the $95 transfer price,
Allcell Manufacturing should reject the offer.
3. Assuming no available capacity, and that in order to produce the 20,000 special cell phones,
30,000 standard cell phones would be forgone, the minimum variable cost would be ($45 +
$30) or $75 and the opportunity cost would be:
Therefore, the minimum transfer price would be $127.50 = ($45 + $30) + $52.50. Since the
$145 transfer price being offered exceeds the minimum transfer price of $127.50, Allcell
Manufacturing should accept the offer.
Ex. 85
Pubworld is a textbook publishing company that has contracts with several different authors. It
also operates a printing operation called Printpro. Both companies operate as separate profit
centers. Printpro prints textbooks written by Pubworld authors, as well as books written by non-
Pubworld authors. The printing operation bills out at $0.02 per page and a typical textbook
requires 600 pages of print. A developmental editor from Pubworld approached the printing
operation manager offering to pay $0.012 per page for 5,000 copies of a 600-page textbook.
Outside printers are currently charging $0.015 per page. Printpro's variable cost per page is
$0.01.
Instructions
1. Calculate the appropriate transfer price and indicate whether the printing should be done
internally by Printpro under each of the following situations:
a. Printpro has available capacity.
b. Printpro has no available capacity and would have to cancel an outside customer's job to
accept the editor's offer.
2. Calculate the change in contribution margin for each company, if top management forces
Printpro to accept the $0.012 transfer price when it has no available capacity.
1b. Assuming no available capacity, the printing operation's variable cost is $0.01 per page and
its opportunity cost is ($0.02 – $0.01) or $0.01 per page. The minimum transfer price would
be $0.02 = $0.01 + $0.01. Therefore, the printing would not accept the internal transfer
price of $0.012.
Wilson has a desired ROI of 16%. It has invested assets of $16,500,000 and expects to produce
2,000 units per year.
Instructions
Compute each of the following:
1. Cost per unit of fixed manufacturing overhead and fixed selling and administrative
expenses.
2. Desired ROI per unit.
3. Markup percentage using the absorption cost approach.
4. Markup percentage using the contribution approach.
16% × $16,500,000
2. Desired ROI per unit = ————————— = $1,320 per unit
2,000
*Ex. 87
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:
Instructions
1. Compute each of the following under the absorption approach:
a. Markup percentage needed to provide desired ROI.
b. Target price of the patio door.
2. Contribution approach
a. Computation of unit variable cost:
Per Unit
Direct materials $250
Direct labor 170
Variable manufacturing overhead 80
Variable selling and administrative expenses 25
Total variable cost $525
89. In the cost-plus pricing formula, the target selling price equals cost +
(________________ × cost).
91. 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.
92. The transfer of goods between divisions of the same company is termed
_____________ sales.
93. The three approaches for determining a transfer price are negotiated,
________________ based, and _________________ based transfer prices.
94. To ensure that the selling division attempts to control its costs, the transfer price should
be based on _________________ cost instead of actual cost.
95. The formula for the minimum transfer price is: Minimum transfer price = Variable cost +
___________________.
MATCHING
98. Match the items in the two columns below by entering the appropriate code letter in the
space provided.
Answers to Matching
1. E 5. H
2. G 6. C
3. A 7. F
4. D 8. B
SHORT-ANSWER ESSAY QUESTIONS
S-A E 99
A variation on cost-plus pricing is time and material pricing. Under this approach, two pricing
rates are set.
Required:
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 99
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
labor 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.
S-A E 100
There are three possible approaches for determining a transfer price: negotiated, cost-based,
and market-based transfer prices.
Required:
Explain how the transfer price is determined under each of the approaches.
Solution 100
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 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.