PRICING DECISIONS

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.
. In a competitive environment, the company must set a target cost and a target selling price.
!. The cost"plus pricing approach establishes a cost base and adds a markup to this base to
determine a target selling price.
#. The cost"plus pricing model gives consideration to the demand side$whether customers will pay
the target selling price.
%. &ales volume plays a large role in determining per unit costs in the cost"plus pricing approach.
'. 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.
(. The first step for time and material pricing is to calculate the material loading charge.
1). The material loading charge is e*pressed as a percentage of the total estimated costs of materials
for the year.
11. +ivisions within vertically integrated companies normally sell goods only to other divisions
within the same company.
12. ,sing 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.
1. If a cost"based transfer price is used, the transfer price must be based on variable cost.
1!. . problem with a cost"based transfer price is that it does not provide ade/uate incentive for the
selling division to control costs.
1#. In the formula for a minimum transfer price, opportunity cost is the contribution margin of goods
sold e*ternally.
1%. The market"based transfer price approach produces a higher total contribution margin to the
company than the cost"based approach.
1'. . negotiated transfer price should be used when an outside market for the goods does not e*ist.
1(. The number of transfers between divisions that are located in different countries has decreased as
companies rely more on outsourcing.
2). +ifferences in ta* rates between countries can complicate the determination of the appropriate
transfer price.
021. The absorption cost approach is consistent with generally accepted accounting principles because
it defines the cost base as the manufacturing cost.
022. The first step in the absorption cost approach is to compute the markup percentage used in setting
the target selling price.
023. 1ecause absorption cost data already e*ists in general ledger accounts, it is cost effective to use it
for pricing.
02. The markup percentage in the contribution approach is computed by dividing the desired
23I4unit plus fi*ed costs4unit by the variable costs4unit.
02!. ,nder the contribution approach, the cost base consists of all of the variable costs associated with
a product e*cept 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
5. T 10. T 15. T 20. T *25. F
MULTIPLE CHOICE QUESTIONS
2#. 5actors that can affect pricing decisions include all of the following e*cept
a. cost considerations.
b. environment.
c. pricing ob6ectives.
d. all of these are factors.
2%. In most cases, prices are set by the
a. customers.
b. competitive market.
c. largest competitor.
d. selling company.
2'. . 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.
2(. 7rices 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.
3). .ll of the following are correct statements about the target price e*cept 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 product8s 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 computed as
a. variable cost per unit 9 desired 23I per unit.
b. fi*ed cost per unit 9 desired 23I per unit.
c. total unit cost 9 desired 23I per unit.
d. variable cost per unit 9 fi*ed manufacturing cost per unit 9 desired 23I per unit.
32. In cost"plus pricing, the markup percentage is computed by dividing the desired 23I per unit by
the
a. fi*ed cost per unit.
b. total cost per unit.
c. total manufacturing cost per unit.
d. variable cost per unit.
33. The cost"plus pricing approach8s ma6or advantage is
a. it considers customer demand.
b. that sales volume has no effect on per unit costs.
c. it is simple to compute.
d. none of these.
3. The following per unit information is available for a new product of 2iley :ompany-
+esired 23I ; 2
5i*ed cost )
<ariable cost #)
Total cost 1))
&elling price 12
2iley :ompany8s markup percentage would be
a. 1(=.
b. 2=.
c. )=.
d. #)=.
3!. >enger :ompany has 6ust developed a new product. The following data is available for this
product-
+esired 23I per unit ;1'
5i*ed cost per unit 3)
<ariable cost per unit !
Total cost per unit %!
The target selling price for this product is
a. ;(3.
b. ;%!.
c. ;#3.
d. ;'.
3#. .ll of the following are correct statements about the cost"plus pricing approach e*cept 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 /uantity it budgeted.
3%. In the cost"plus pricing approach, the desired 23I per unit is computed by multiplying the 23I
percentage by
a. fi*ed costs.
b. total assets.
c. total costs.
d. variable costs.
,se the following information for /uestions 3'"3(.
+owning :ompany produces a high resolution computer monitor. The following information is available
for this product-
5i*ed cost per unit ; !)
<ariable cost per unit 1!)
Total cost per unit 2))
+esired 23I per unit #)
3'. +owning :ompany8s markup percentage would be
a. 12)=.
b. #)=.
c. )=.
d. 3)=.
3(. The target selling price for this monitor is
a. ;11).
b. ;2)).
c. ;21).
d. ;2#).
). In time and material pricing, a material loading charge covers all of the following e*cept
a. purchasing costs.
b. related overhead.
c. desired profit margin.
d. all of these are covered.
1. 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 6ob.
2. The labor charge per hour in time and material pricing includes all of the following e*cept
a. an allowance for a desired profit.
b. charges for labor loading.
c. selling and administrative costs.
d. overhead costs.
3. 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.
. In time and material pricing, the charge for a particular 6ob is the sum of the labor charge and the
a. materials charge.
b. material loading charge.
c. materials charge 9 desired profit.
d. materials charge 9 the material loading charge.
,se the following information for /uestions !"%.
The following data is available for :omputer 1ytes 2epair &hop for 2))3-
2epair technician8s wages ; (),)))
5ringe benefits 2),)))
3verhead 1!,)))
Total ;12!,)))
The desired profit margin is ;1) per labor hour. The material loading charge is )= of invoice cost. It is
estimated that !,))) labor hours will be worked in 2))3.
!. :omputer 1ytes? labor charge in 2))3 would be
a. ;2!.
b. ;2'.
c. ;32.
d. ;3!.
#. In @anuary 2))3, :omputer 1ytes repairs a computer that uses parts of ;'). Its material loading
charge on this repair would be
a. ;32.
b. ;'.
c. ;').
d. ;112.
%. In Aarch 2))3, :omputer 1ytes repairs a computer that takes two hours to repair and uses parts
of ;#). The bill for this computer repair would be
a. ;13).
b. ;1).
c. ;1'.
d. ;1!.
'. Begotiated transfer pricing is not always used because of each of the following reasons e*cept
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.
(. .ll of the following are approaches for determining a transfer price e*cept the
a. cost"based approach.
b. market"based approach.
c. negotiated approach.
d. time and material approach.
!). >hen a cost"based transfer price is used, the transfer price may be based on any of the following
e*cept
a. fi*ed cost.
b. full cost.
c. variable cost.
d. all of these may be used.
!1. .ll of the following are correct statements about the cost"based transfer price approach e*cept
that it
a. can understate the actual contribution to profit by the selling division.
b. can reduce a division manager8s control over the division8s performance.
c. bases the transfer price on standard cost instead of actual cost.
d. provides incentive for the selling division to control costs.
!2. The general formula for the minimum transfer price is- minimum transfer price e/uals
a. fi*ed cost 9 opportunity cost.
b. e*ternal purchase price.
c. total cost 9 opportunity cost.
d. variable cost 9 opportunity cost.
!3. <ariable costs of units sold internally will always be
a. lower than the variable costs of units sold e*ternally.
b. higher than the variable costs of units sold e*ternally.
c. the same as the variable costs of units sold e*ternally.
d. <ariable costs of units sold internally may be either higher or lower than for units sold
e*ternally.
!. In the formula for the minimum transfer price, opportunity cost is the CCCCCCCCCC of the goods
sold e*ternally.
a. variable cost
b. total cost
c. selling price
d. contribution margin
!!. 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.
!#. 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.
!%. .ll of the following are correct statements about the market"based approach e*cept that it
a. assumes that the transfer price should be based on the most ob6ective inputs possible.
b. provides a fairer allocation of the company8s 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.
!'. 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 e*ist.
c. no market price is available.
d. any of these situations e*ist.
!(. .ssuming the selling division has available capacity, a negotiated transfer price should be within
the range of
a. fi*ed cost per unit and the e*ternal purchase price.
b. total cost per unit and the e*ternal purchase price.
c. variable cost per unit and the e*ternal purchase price.
d. none of these is correct.
#). 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.
#1. The ma*imum transfer price from the buying division8s standpoint is the
a. total cost 9 opportunity cost.
b. variable cost 9 opportunity cost.
c. e*ternal purchase price.
d. e*ternal purchase price 9 opportunity cost.
,se the following information for /uestions #2"#3.
The 2ubber +ivision of Aorgan :ompany manufactures rubber moldings and sells them e*ternally for
;!). Its variable cost is ;2) per unit, and its fi*ed cost per unit is ;%. Aorgan8s president wants the 2ubber
+ivision to transfer !,))) units to another company division at a price of ;2%.
#2. .ssuming the 2ubber +ivision has available capacity of !,))) units, the minimum transfer price
it should accept is
a. ;%.
b. ;2).
c. ;2%.
d. ;!).
#3. .ssuming the 2ubber +ivision does not have any available capacity, the minimum transfer price
it should accept is
a. ;%.
b. ;2).
c. ;2%.
d. ;!).
#. .ll of the following are correct statements about transfers between divisions located in countries
with different ta* rates e*cept that
a. differences in ta* rates across countries complicate the determination of the appro"priate
transfer price.
b. many companies prefer to report more income in countries with low ta* rates.
c. companies must pay income ta* in the country where income is generated.
d. a decreasing number of transfers are between divisions located in different countries.
#!. Transfers between divisions located in countries with different ta* rates
a. simplify the determination of the appropriate transfer price.
b. are decreasing in number as more companies DlocalizeD operations.
c. encourage companies to report more income in countries with low ta* rates.
d. all of these are correct.
0##. >hich of the following is consistent with generally accepted accounting principlesE
a. .bsorption cost approach
b. :ontribution approach
c. <ariable"cost approach
d. 1oth absorption cost and contribution approach
0#%. ,nder the absorption cost approach, all of the following are included in the cost base e*cept
a. direct materials.
b. fi*ed manufacturing overhead.
c. selling and administrative costs.
d. variable manufacturing overhead.
0#'. The first step in the absorption cost approach is to compute the
a. desired 23I per unit.
b. markup percentage.
c. target selling price.
d. unit manufacturing cost.
0#(. The markup percentage in the absorption cost approach is computed by dividing the sum of the
desired 23I per unit and
a. fi*ed costs per unit by manufacturing cost per unit.
b. fi*ed costs per unit by variable costs per unit.
c. selling and administrative e*penses per unit by manufacturing cost per unit.
d. selling and administrative e*penses per unit by variable costs per unit.
0%). In the absorption cost approach, the markup percentage covers the
a. desired 23I only.
b. desired 23I and selling and administrative e*penses.
c. desired 23I and fi*ed costs.
d. selling and administrative e*penses only.
0%1. The absorption cost approach is used by most companies for all of the following reasons e*cept
that
a. absorption cost information is readily provided by a company8s cost accounting system.
b. absorption cost provides the most defensible bases for 6ustifying 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.
0%2. ,nder the contribution approach, the cost base includes all of the following e*cept
a. fi*ed manufacturing costs.
b. variable manufacturing costs.
c. total fi*ed costs.
d. variable selling and administrative costs.
0%3. In the contribution approach, the markup percentage covers the
a. desired 23I only.
b. desired 23I and fi*ed costs.
c. desired 23I and selling and administrative e*penses.
d. fi*ed costs only.
0%. The markup percentage denominator in the contribution approach is the
a. desired 23I per unit.
b. fi*ed costs per unit.
c. manufacturing cost per unit.
d. variable costs per unit.
0%!. The reasons for using the contribution approach include all of the following e*cept this approach
a. avoids arbitrary allocation of common fi*ed costs to individual product lines.
b. is more consistent with cost"volume"profit analysis.
c. provides the most defensible bases for 6ustifying prices to all interested parties.
d. provides the type of data managers need for pricing special orders.
Answers to Multile C!oi"e #uestions
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
27. b 35. a 43. d 51. d 59. c *67. c *75. c
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
E$ERCISES
E%. &'
&ole :ompany is considering introducing a new line of hand"held organizers targeting the preteen
population. &ole believes that if the organizers can be priced competitively at ;(), appro*imately !)),)))
units can be sold. The controller has determined that an investment in new e/uipment totaling ;',))),)))
will be re/uired. &ole re/uires a minimum rate of return of 1= on all investments.
Instructions
:ompute the target cost per unit of the handheld organizer.
Solution &' (6-10 min.)
&ales F!)),))) G ;()H ;!,))),)))
Iess desired 23I F;',))),))) G 1=H 1,12),)))
Target cost for !)),))) units ;3,''),)))
Target cost per unit J ;3,''),))) K !)),))) J ;'%.%#
E%. &&
:arter :orporation produces window air conditioners. The following information is available for :arter8s
anticipated annual volume of )),))) units.
7er ,nit Total
+irect materials ;21
+irect labor 2%
<ariable manufacturing overhead 3#
5i*ed manufacturing overhead ;#,))),)))
<ariable selling and administrative e*penses 2
5i*ed selling and administrative e*penses 3,#)),)))
The company has a desired 23I of 2!=. It has invested assets of ;%2,))),))).
E%. && (cont.)
Instru"tions
:ompute each of the following-
1. Total cost per unit.
2. +esired 23I per unit.
3. Aarkup percentage using total cost per unit.
. Target selling price.
Solution && (12 min.)
1. Total cost per unit-
7er ,nit
+irect materials ; 21
+irect labor 2%
<ariable manufacturing overhead 3#
5i*ed manufacturing overhead F;#,))),))) K )),))) 1!
<ariable selling and administrative e*penses 2
5i*ed selling and administrative e*penses F;3,#)),))) K )),)))H (
;1!)
2. +esired 23I per unit J F2!= G ;%2,))),)))H K )),))) J ;!
;! 9 ;)
3. Aarkup percentage using total cost per unit J $$$$ J 3)=
;1!)
. Target selling price J ;1!) 9 F;1!) G 3)=H J ;1(!
E%. &(
1arkley :orporation is in the process of setting a selling price for a new product it has 6ust designed. The
following data relate to this product for a budgeted volume of #),))) units.
7er ,nit Total
+irect materials ;1)
+irect labor 2)
<ariable manufacturing overhead !
5i*ed manufacturing overhead ;()),)))
<ariable selling and administrative e*penses 3
5i*ed selling and administrative e*penses !),)))
1arkley uses cost"plus pricing to set its target selling price. The markup on total unit cost is 2!=.
Instru"tions
:ompute each of the following for the new product-
1. Total variable cost per unit, total fi*ed cost per unit, and total cost per unit.
2. +esired 23I per unit.
3. Target selling price.
Solution &( (18 min.)
1. +irect materials ;1)
+irect labor 2)
<ariable manufacturing overhead !
<ariable selling and administrative e*penses 3
<ariable cost per unit ;3'
1udgeted :ost
Total :osts <olume 7er ,nit
5i*ed manufacturing overhead ;()),))) K #),))) J ;1!
5i*ed selling and administrative e*penses !),))) K #),))) J (
5i*ed cost per unit ;2
<ariable cost per unit ;3'
5i*ed cost per unit 2
Total cost per unit ;#2
2. Total cost per unit ;#2
Aarkup G 2!=
+esired 23I per unit ;1!.!)
3. Total cost per unit ;#2.))
+esired 23I per unit 1!.!)
Target selling price ;%%.!)
E%. &)
>hiz"by :ompany is in the process of setting a selling price for its newest model scooter, the Lip. The
controller of >hiz"by estimates variable cost per unit for the new model to be as follows-
+irect materials ;3)
+irect labor 2#
<ariable manufacturing overhead '
<ariable selling and administrative e*penses 1)
;%
In addition, >hiz"by anticipates incurring the following fi*ed cost per unit at a budgeted sales volume of
2),))) units-
Total :osts K 1udget <olume J :ost per
,nit
5i*ed manufacturing overhead ;'),))) 2),))) ;2
5i*ed selling and administrative e*penses !2),))) 2),))) 2#
5i*ed cost per unit ;!)
>hiz"by uses cost"plus pricing and would like to earn a 12 percent return on its investment F23IH of
;!)),))).
Instructions
:ompute the selling price that would provide >hiz"by a 12 percent 23I.
Solution 79 F# " 1) min.H
<ariable cost per unit ; %
5i*ed cost per unit !)
+esired 23I per unit 30
Target selling price ;12%
0;!),))) G .12 J ;#),)))M ;#),))) K 2),))) J ;3 per unit
E%. (*
&parks Nngine &ervice repairs and rebuilds diesel engines. The following budgeted cost data is available
for 2))3-
Time Aaterial
:harges :harges
Technicians8 wages and benefits ;3)),)))
7arts manager8s salary and benefits ; 3#,)))
3ffice manager8s salary and benefits !#,))) (,)))
3ther overhead 2,))) !!,)))
Total budgeted costs ;3'),))) ;1)),)))
&parks has budgeted for 1),))) hours of technician time during the coming year. It desires a ;32 profit
margin per hour of labor and a !)= profit margin on parts. &parks estimates the total invoice cost of parts
and materials in 2))3 will be ;!)),))).
Instructions
1. :ompute the rate charged per hour of labor.
2. :ompute the material loading charge.
3. &parks has received a re/uest from Aercer :orporation for an estimate to rebuild a diesel engine. The
company estimates that it would take 2) hours of labor and ;,))) of parts. :ompute the total
estimated bill.
Solution (* (18-20 min.)
1. 7er Oour
Total :ost Total Oours :harge
Oourly labor rate for repairs
Technicians8 wages and benefits ;3)),))) K 1),))) J ;3).))
3verhead costs
3ffice manager8s salary and benefits !#,))) K 1),))) J !.#)
3ther overhead 2,))) K 1),))) J 2.)
;3'),))) K 1),))) J 3'.))
7rofit margin 32.))
2ate charged per hour of labor ;%).))
Solution 80 Fcont.H
2.
Aaterial
Aaterial Total Invoice :ost, Ioading
:harges 7arts and Aaterials :harge
3verhead costs
7arts manager8s salary and benefits ;3#,)))
3ffice manager8s salary and benefits (,)))
;!,))) K ;!)),))) J (=
3ther overhead !!,))) K ;!)),))) J 11=
2)=
7rofit margin !)=
Aaterial loading charge %)=

3. @ob- Aercer :orporation
Iabor charges
2) hours P ;%) ;1,))
Aaterial charges
:ost of parts and materials ;,)))
Aaterial loading charge F%)= G ;,)))H 2,')) #,'))
Total price of labor and materials ;',2))
E%. (+
5rank8s Transmission &ervice has budgeted the following time and material for 2))2-
1,+QNTN+ :3&T& 532 2))2
Time Aaterial
:harges :harges
Aechanics8 wages and benefits ; %2,)))
&ervice manager8s salary and benefits ; 2,)))
3ffice employee8s salary and benefits 2,))) #,)))
:ost of parts used 1)),)))
3verhead Fsupplies, utilities, etc.H 2),))) 1%,)))
Total budgeted costs ;11#,))) ;1#!,)))
5rank budgets ,))) hours of repair time in 2))2 and will charge a profit of ;# per hour, in addition to a
2!= markup on the cost of parts.
3n 5ebruary 1!, 2))2, 5rank is asked to prepare a price estimate to rebuild the transmission in a 1((%
Iincoln Bavigator. 5rank estimates that this 6ob will take 12 labor hours and ;3)) in parts.
Instructions
1. :ompute the labor rate for 2))2.
2. :ompute the material loading charge rate for 2))2.
3. 7repare a time and materials price estimate for rebuilding the Bavigator transmission.
Solution (+ (18-20 min.)
1. :omputation of labor rate
Total :ost Total Oours 7er Oour :harge
Oourly labor rate for repairs
Aechanics8 wages and benefits ; %2,))) K ,))) J ;1'
3verhead costs
3ffice employee8s salary and benefits 2,))) K ,))) J #
3ther overhead 2),))) K ,))) J !
;11#,))) K ,))) J 2(
7rofit margin #
2ate charged per hour of labor ;3!
2. :omputation of material loading charge
Aaterial
Aaterial Total Invoice :ost, Ioading
:harges 7arts and Aaterials :harge
3verhead costs
&ervice manager8s salary and benefits ;2,)))
3ffice employee8s salary and benefits #,)))
',))) K ;1)),))) J '=
3ther overhead 1%,))) K 1)),))) J 1%=
;#!,))) K 1)),))) J #!=
7rofit margin 2!=
Aaterial loading charge ()=
3. 7rice estimate for time and materials
@ob- 2ebuild Bavigator transmission
Iabor charges- 12 hours P ;3! ;2)
Aaterial charges
:ost of parts and materials ;3))
Aaterial loading charge F()= G ;3))H 2%) !%)
Total price of labor and materials ;(()
E%. (,
Aathis :orporation manufactures automotive compact disc changers. It is a division of .merican Aotors,
which manufactures automobiles. Aathis sells the :+ changers to .merican, as well as to retail stores.
The following information is available for Aathis8s :+ changer- variable cost per unit ;1)!M fi*ed costs
per unit ;%!M and a selling price of ;2#) to outside customers. .merican currently purchases :+ changers
from an outside supplier for ;2) each. Top management of .merican would like Aathis to provide
!),))) changers per year at a transfer price of ;1)! each.
Instructions
:ompute the minimum transfer price that Aathis should accept under each of the following assumptions-
1. Aathis is operating at full capacity.
2. Aathis has sufficient e*cess capacity to provide the !),))) changers to .merican.
Solution (, (9 min.)
1. The minimum transfer price is ;2#) R;1)! 9 F;2#) S ;1)!HT, the outside market price, since Aathis
is operating at full capacity.
2. The minimum transfer price is ;1)!, the variable cost of the changers, since Aathis has e*cess
capacity. Oowever, since the market price is ;2) F.merican8s current costH, Aathis should be able to
negotiate a price much higher than ;1)!.
E%. (-
Aodine Aanufacturing, a division of +atson :orporation, produces car radiators. Aodine sells radiators
to auto parts stores, as well as to +atson. The following information is available for Aodine8s radiators-
5i*ed costs per unit ; ()
<ariable cost per unit #)
&elling price per unit 21!
+atson can purchase comparable radiators from an outside supplier for ;2)). In order to ensure a reliable
supply, +atson8s management ordered Aodine to provide 1)),))) radiators per year at a transfer price of
;2)) per unit. Aodine is currently operating at full capacity. It could avoid ; per unit of variable selling
costs by selling internally.
Instructions
1. :ompute the minimum transfer price that Aodine should be re/uired to accept.
2. :ompute the increase FdecreaseH in contribution margin for +atson for this transfer.
Solution (- (9 min.)
1. The minimum transfer price that Aodine should accept is-
F;#) S ; 9 F;21! S ;#)H J ;211
2. The decrease in contribution margin per unit to +atson is-
:ontribution margin lost by Aodine F;21! S ;#)H ;1!!
Increased contribution margin to vehicle division F;2)) S ;!#H 1
Bet decrease in contribution margin ; 11
Total contribution margin decrease is-
;11 G 1)),))) units J ;1,1)),)))
Ex. 84
.llcell Aanufacturing is a division of 1irch :ommunications, Inc. .llcell produces cell phones and sells
these phones to other communication companies, as well as to 1irch. 2ecently, the vice president of
marketing for 1irch approached .llcell with a re/uest to make 2),))) units of a special cell phone that
could be used anywhere in the world. The following information is available regarding the .llcell
division-
&elling price of regular cell phone ;')
<ariable cost of regular cell phone !
.dditional variable cost of special cell phone 3)
Instructions
:alculate 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 .llcell ;(! per phone. .llcell has available capacity.
2. The marketing vice president offers to pay .llcell ;(! per phone. .llcell has no available capacity
and would have to forgo sales of 2),))) phones to e*isting customers to meet this re/uest.
3. The marketing vice president offers to pay .llcell ;1! per phone. .llcell has no available capacity
and would have to forgo sales of 3),))) phones to e*isting customers to meet this re/uest.
Solution (. (13 min.)
1. .ssuming that .llcell Aanufacturing has available capacity, variable cost would be F;! 9 ;3)H or
;%! and the opportunity cost would be zero. Therefore, the minimum transfer price would be ;%! J
;%! 9 ;). &ince the ;(! transfer price being offered e*ceeds the ;%! minimum transfer price, the offer
should be accepted.
2. .ssuming no available capacity, and that the new units produced would be e/ual to the number of
standard units forgone, variable cost of the special cell phone would be F;! 9 ;3)H or ;%! and the
opportunity cost would be F;') " ;!H or ;3!. Therefore, the minimum transfer price would be ;11) J
;%! 9 ;3!. &ince this is higher than the ;(! transfer price, .llcell Aanufacturing should re6ect the
offer.
3. .ssuming no available capacity, and that in order to produce the 2),))) special cell phones, 3),)))
standard cell phones would be forgone, the minimum variable cost would be F;! 9 ;3)H or ;%! and
the opportunity cost would be-
Total contribution margin on standard cell phones F;') S ;!H G 3),)))
$$$$$$$$$$$$$$$$$$$$$$ J $$$$$$$$$$ J ;!2.!)
Bumber of special cell phones ;2),)))
Therefore, the minimum transfer price would be ;12%.!) J F;! 9 ;3)H 9 ;!2.!). &ince the ;1!
transfer price being offered e*ceeds the minimum transfer price of ;12%.!), .llcell Aanufacturing
should accept the offer.
E%. (/
7ubworld is a te*tbook publishing company that has contracts with several different authors. It also
operates a printing operation called 7rintpro. 1oth companies operate as separate profit centers. 7rintpro
prints te*tbooks written by 7ubworld authors, as well as books written by non"7ubworld authors. The
printing operation bills out at ;).)2 per page and a typical te*tbook re/uires #)) pages of print. .
developmental editor from 7ubworld approached the printing operation manager offering to pay ;).)12
per page for !,))) copies of a #))"page te*tbook. 3utside printers are currently charging ;).)1! per page.
7rintpro8s variable cost per page is ;).)1.
Instructions
1. :alculate the appropriate transfer price and indicate whether the printing should be done internally by
7rintpro under each of the following situations-
a. 7rintpro has available capacity.
b. 7rintpro has no available capacity and would have to cancel an outside customer8s 6ob to accept
the editor8s offer.
2. :alculate the change in contribution margin for each company, if top management forces 7rintpro to
accept the ;).)12 transfer price when it has no available capacity.
Solution (/ (13 min.)
1a. .ssuming that the printing operation has available capacity, the printing operation8s variable cost is
;).)1 and its opportunity cost is ;). The minimum transfer price would be ;).)1 J ;).)1 9 ;).
Therefore, in this case, the printing operation should accept the offer to print internally. The ;).)12
transfer price would provide a contribution margin of F;).)12 " ;).)1H or ;).))2 per page.
+epending on its bargaining strength, the printing operation might want to ask for a transfer price
higher than ;).)12, since the company is saving money at any price below the ;).)1! price charged
by outside printers.
1b. .ssuming no available capacity, the printing operation8s variable cost is ;).)1 per page and its
opportunity cost is F;).)2 S ;).)1H or ;).)1 per page. The minimum transfer price would be ;).)2 J
;).)1 9 ;).)1. Therefore, the printing would not accept the internal transfer price of ;).)12.
2. 7rintpro would lose-
F;).)2 " ;).)1H G #)) pages G !,))) copies J ;3),)))
7ubworld would save-
F;).)1! S ;).)12H G #)) pages G !,))) copies J ;(,)))
*Ex. 8
The following information is available for a product manufactured by >ilson :orporation-
7er ,nit Total
+irect materials ;12!
+irect labor (!
<ariable manufacturing overhead 3)
5i*ed manufacturing overhead ;!)),)))
<ariable selling and admin. e*penses 2)
5i*ed selling and admin. e*penses 11),)))
>ilson has a desired 23I of 1#=. It has invested assets of ;1#,!)),))) and e*pects to produce 2,)))
units per year.
Instructions
:ompute each of the following-
1. :ost per unit of fi*ed manufacturing overhead and fi*ed selling and administrative e*penses.
2. +esired 23I per unit.
3. Aarkup percentage using the absorption cost approach.
. Aarkup percentage using the contribution approach.
0Solution (' (12-14 min.)
;!)),))) per unit
1. 5i*ed manufacturing overhead J $$$$$$$$ J ;2!) per unit
2,)))
;11),)))
5i*ed selling and administrative e*penses per unit J $$$$ J ;!! per unit
2,)))
1#= G ;1#,!)),)))
2. +esired 23I per unit J $$$$$$$$$ J ;1,32) per unit
2,)))
;1,32) 9 F;2) 9 ;!!H
3. .bsorption cost markup percentage J $$$$$$$$$$$ J 2%(=
;12! 9 ;(! 9 ;3) 9 ;2!)
;1,32) 9 F;2!) 9 ;!!H
. :ontribution markup percentage J $$$$$$$$$$$ J #)2=
;12! 9 ;(! 9 ;3) 9 ;2)
0E%. (&
7eachtree +oors, Inc. is in the process of setting a target price on its newly designed patio door. :ost data
relating to the door at a budgeted volume of !,))) units is as follows-
7er ,nit Total
+irect materials ;2!)
+irect labor 1%)
<ariable manufacturing overhead ')
5i*ed manufacturing overhead ;!)),)))
<ariable selling and administrative e*penses 2!
5i*ed selling and administrative e*penses 3%!,)))
0E%. (& (cont.)
7eachtree uses cost"plus pricing that provides it with a 2!= 23I on its patio door line. . total of
;,))),))) in assets is committed to production of the new door.
Instructions
1. :ompute each of the following under the absorption approach-
a. Aarkup percentage needed to provide desired 23I.
b. Target price of the patio door.
2. :ompute each of the following under the contribution approach-
a. Aarkup percentage needed to provide desired 23I.
b. Target price of the patio door.
0Solution (& (12-14 min.)
1. .bsorption approach
a. :omputation of unit manufacturing cost-
7er ,nit
+irect materials ;2!)
+irect labor 1%)
<ariable manufacturing overhead ')
5i*ed manufacturing overhead F;!)),))) K !,)))H 1))
Total manufacturing cost ;#))
:omputation of markup percentage to provide a 2!= 23I-
Aarkup R2!= G F;,))),))) K !,)))HT 9 R;2! 9 F;3%!,))) K !,)))HT ;3))
7ercentage J $$$$$$$$$$$$$$$$$$$$$$$$$$ J $$ J !)=
;#)) ;#))
b. :omputation of target price-
Target price- ;#)) 9 F!)= G ;#))H J ;())
2. :ontribution approach
a. :omputation of unit variable cost-
7er ,nit
+irect materials ;2!)
+irect labor 1%)
<ariable manufacturing overhead ')
<ariable selling and administrative e*penses 2!
Total variable cost ;!2!

:omputation of markup percentage to provide a 2!= 23I-
Aarkup R2!= G F;,))),))) K !,)))HT 9 RF;!)),))) K !,)))H 9 F;3%!,))) K !,)))HT
7ercentage J
$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$
;!2!
;3%!
J $$ J %1.2(=
;!2!
b. :omputation of target price-
Target price- ;!2! 9 F%1.2(= G ;!2!H J ;())
COMPLETION STATEMENTS
''. The difference between the target price and the desired profit is the CCCCCCCCCCCCCCCCC cost of
the product.
'(. In the cost"plus pricing formula, the target selling price e/uals cost 9 FCCCCCCCCCCCCCCCC G
costH.
(). The CCCCCCCCCCCCCCC pricing approach has a ma6or advantage- it is simple to compute.
(1. ,nder the time and material pricing approach, the material charge is based on the cost of direct
materials used and a material CCCCCCCCCCCCCCCCCC for related overhead costs.
(2. The transfer of goods between divisions of the same company is termed CCCCCCCCCCCCC sales.
(3. The three approaches for determining a transfer price are negotiated, CCCCCCCCCCCCCCCC based,
and CCCCCCCCCCCCCCCCC based transfer prices.
(. To ensure that the selling division attempts to control its costs, the transfer price should be based
on CCCCCCCCCCCCCCCCC cost instead of actual cost.
(!. The formula for the minimum transfer price is- Ainimum transfer price J <ariable cost 9
CCCCCCCCCCCCCCCCCCC.
(#. CCCCCCCCCCCCCCCCCC involves contracting with an e*ternal party to provide a good or service,
rather than performing the work internally.
(%. The CCCCCCCCCCCCCCCCCC approach is consistent with generally accepted accounting principles
because it defines the cost base as the manufacturing cost.
Answers to Comletion Statements
''. target
'(. markup percentage
(). cost"plus
(1. loading charge
(2. internal
(3. cost, market
(. standard
(!. 3pportunity cost
(#. 3utsourcing
(%. absorption cost
MATC1ING
('. Aatch the items in the two columns below by entering the appropriate code letter in the space
provided.
.. :ost"plus pricing N. 3utsourcing
1. Aarket"based transfer price 5. Target selling price
:. Aarkup Q. Time and material pricing
+. Begotiated transfer price O. <irtual companies
CCCC 1. :ontracting with an e*ternal party to provide a good or service.
CCCC 2. .n approach to cost"plus pricing that uses two pricing rates.
CCCC 3. 7roduct8s selling price is determined by adding a markup to a cost base.
CCCC . Transfer price is determined by agreement of division managers.
CCCC !. :ompanies that have no manufacturing facilities.
CCCC #. 7ercentage applied to a product8s cost.
CCCC %. 7rice that will provide the desired profit on a product.
CCCC '. Transfer price is based on e*isting prices of competing products.
Answers to Mat"!in2
1. N !. O
2. Q #. :
3. . %. 5
. + '. 1
SHO!T"#NS$E! ESS#% QUESTIONS
S-A E ))
. variation on cost"plus pricing is time and material pricing. ,nder this approach, two pricing rates are
set.
!&'uir&()
N*plain where this approach is used and identify the steps involved in time and material pricing. .lso
e*plain what the material loading charge covers and how it is e*pressed.
Solution ))
The time and material pricing approach is used often in service industries, especially professional firms
and consulting firms. This approach involves three steps- F1H calculate the labor charge per hour, F2H
calculate the charge for obtaining and holding materials, and F3H calculate the charges for a particular 6ob.
The material loading charge covers the costs of purchasing, handling, and storing materials, plus any
desired profit margin on the materials. It is e*pressed as a percentage of the total estimated costs of parts
and materials.
S-A E +**
There are three possible approaches for determining a transfer price- negotiated, cost"based, and market"
based transfer prices.
!&'uir&()
N*plain how the transfer price is determined under each of the approaches.
Solution +**
,nder the negotiated transfer price approach, the transfer price will range between the e*ternal 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. ,nder the market"
based approach, the minimum transfer price is the unit variable cost plus the unit opportunity cost.