CHAPTER 9

PRICING

SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE, BLOOM’S TAXONOMY, LEVEL OF DIFFICULTY, AACSB CODES, AND CPA CODES

Bloom’s: AN = Analysis AP = Application C = Comprehension

E = Evaluation K = Knowledge

LOD: E = Easy M = Medium H = Hard

AACSB: AN = Analytic

CPA: F = Financial Reporting MA = Management Accounting

SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE, BLOOM’S TAXONOMY, LEVEL OF DIFFICULTY, AACSB CODES, AND CPA CODES (CONT’D)

Bloom’s: AN = Analysis AP = Application C = Comprehension

E = Evaluation K = Knowledge

LOD: E = Easy M = Medium H = Hard

AACSB: AN = Analytic

CPA: F = Financial Reporting MA = Management Accounting

SUMMARY OF LEARNING OBJECTIVES BY QUESTION TYPE

Note: TF = True-False C = Completion BE = Brief Exercise

MC = Multiple Choice Ex = Exercise SAE = Short-Answer Essay

Ma = Matching MP = Multi-Part

CHAPTER LEARNING 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 the 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 total 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 x 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 x manufacturing cost per unit).

4. Calculate a target selling price using variable cost-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 x 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. 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 total 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.

TRUE-FALSE STATEMENTS

1. In a competitive market, a company is forced to act as a price taker and must emphasize minimizing and controlling costs.

2. Sales volume plays a large role in determining per unit costs in the cost-plus pricing approach.

3. The first step in the absorption-cost approach is to calculate the markup percentage used in setting the target selling price.

4. Under the variable cost-plus pricing approach, the cost base consists of all of the variable costs associated with a product except variable selling and administrative costs.

5. The first step for time-and-material pricing is to calculate the material loading charge.

6. Divisions within vertically integrated companies normally sell goods only to other divisions within the same company.

7. Differences in tax rates between countries can complicate the determination of the appropriate transfer price.

ANSWERS TO TRUE-FALSE STATEMENTS

MULTIPLE CHOICE QUESTIONS

8. 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.

9. In most cases, prices are set by the

a) customers.

b) competitive market.

c) largest competitor.

d) selling company.

10. 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.

11. 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.

12. Which of the following statements about the target price is incorrect?

a) It is the price the company believes would place it in the optimal position for its target audience.

b) It is used to determine a product's target cost.

c) It is determined after the company has identified its market and does market research.

d) It is determined after the company sets its desired profit amount.

13. 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.

14. 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.

15. 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

16. 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.

17. 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.

18. In cost-plus pricing, the markup percentage is calculated 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.

19. 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.

20. The following per unit information is available for a new product of Blue Ribbon Company that uses total cost-plus pricing:

Desired ROI $ 15

Fixed cost 50

Variable cost 100

Total cost 150

Selling price 165

Blue Ribbon Company's markup percentage would be

a) 9%.

b) 10%.

c) 30%.

d) 65%.

21. 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.

22. Which statement below regarding the cost-plus pricing approach is incorrect?

a) It is simple to calculate.

b) It considers customer demand.

c) It includes only variable costs in the cost base.

d) It will only work when the company sells the quantity it budgeted.

23. 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 24–25.

Red Grass Company produces high definition television sets and uses total cost-plus pricing. 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

24. Red Grass Company's markup percentage would be

a) 140%.

b) 75%.

c) 40%.

d) 35%.

25. The target selling price for this television is

a) $240.

b) $400.

c) $440.

d) $540.

26. 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 markup percentage?

a) 10%

b) 20%

c) 100%

d) 200%

27. 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

28. 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 markup on cost?

a) 141.67%

b) 100%

c) 50%

d) 41.67%

29. 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.

30. The absorption-cost plus pricing approach

a) includes manufacturing costs in the cost base.

b) includes variable selling and administrative costs in the cost base only.

c) includes fixed selling and administrative costs in the cost base only.

d) includes both variable and fixed selling and administrative costs in the cost base.

31. 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.

32. The first step in the absorption-cost approach is to calculate the

a) desired ROI per unit.

b) markup percentage.

c) target selling price.

d) unit manufacturing cost.

33. The markup 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.

34. 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.

35. Which of the following is a reason that most companies would not use the absorption-cost approach?

a) Because the absorption-cost information is readily provided by a company's cost accounting system.

b) Because the absorption cost provides the most defensible basis for justifying prices to interested parties.

c) Because basing prices on only variable costs could encourage managers to set too low a price in order to boost sales.

d) Because this approach is more consistent with cost-volume-profit analysis.

36. Maggie Co. has variable manufacturing costs per unit of $20, and fixed manufacturing cost per unit of $15. Variable selling and administrative costs per unit are $4, while fixed selling and administrative costs per unit are $6. Maggie desires an ROI of $7.50 per unit. If Maggie Co. uses the absorption-cost approach, what is its markup percentage?

a) 8.33%

b) 50%

c) 16.67%

d) 25%

37. Under the variable cost-plus approach, the cost base includes all of the following except

a) incremental manufacturing costs.

b) variable manufacturing costs.

c) total fixed costs.

d) variable selling and administrative costs.

38. In the variable cost-plus approach, the markup 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.

39. The markup percentage denominator in the variable cost-plus approach is the

a) desired ROI per unit.

b) fixed costs per unit.

c) manufacturing cost per unit.

d) variable costs per unit.

40. Which of the following is a reason for not using the variable cost-plus approach?

a) It avoids arbitrary allocation of common fixed costs to individual product lines.

b) It is more consistent with cost-volume-profit analysis.

c) It provides the most defensible bases for justifying prices to all interested parties.

d) It provides the type of data managers need for pricing special orders.

41. Maggie Co. has variable manufacturing costs per unit of $20, and fixed manufacturing cost per unit of $10. Variable selling and administrative costs per unit are $5, while fixed selling and administrative costs per unit are $2. Maggie desires an ROI of $8 per unit. If Maggie Co. uses the variable cost-plus approach, what is its markup percentage?

a) 50%

b) 80%

c) 30%

d) 100%

42. 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.

43. 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.

44. 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.

45. 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.

46. 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.

47. 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 48–50.

The following data are available for Wheels ‘N Spokes Repair Shop for 2022:

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 2022.

48. Wheels ‘N Spokes’ labour charge in 2022 would be

a) $50.

b) $65.

c) $70.

d) $85.

49. In January 2022, Wheels ‘N Spokes repairs a bicycle that uses parts worth $200. Its material loading charge on this repair would be

a) $35.

b) $70.

c) $235.

d) $270.

50. In March 2022, 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.

51. Time-and-material pricing would be best suited to a

a) shampoo manufacturer.

b) construction company.

c) plastic container manufacturer.

d) restaurant.

52. Which of the following is true?

a) In most cases, a company sets the price instead of it being set by the competitive market.

b) The difference between the target price and the desired profit is the target cost of the product.

c) In a competitive environment, the company must set a target cost and a target selling price.

d) The target cost is the price the company believes would place it in the most competitive position.

53. Which of the following is true?

a) There are two approaches for determining a transfer price: cost-based and market-based.

b) If a cost-based transfer price is used, the transfer price must be based on variable cost.

c) A problem with a cost-based transfer price is that it does not provide adequate incentive for the selling division to control costs.

d) The market-based transfer price approach produces a higher total contribution margin to the company than the cost-based approach.

54. Which of the following is true about the negotiated transfer pricing approach?

a) A minimum transfer price is established by the buying division.

b) A negotiated transfer price should be used when an outside market for the goods does not exist.

c) A maximum transfer price is established by the selling division.

d) It is used more often than the cost-based and market-based approaches.

55. Why is negotiated transfer pricing not always used?

a) The market price information is sometimes not easily obtainable.

b) There is 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) The opportunity cost is sometimes not determinable.

56. 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.

57. 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.

58. Which statement below regarding the cost-based transfer price approach is incorrect?

a) It can understate the actual contribution to profit by the selling division.

b) It can reduce a division manager's control over the division's performance.

c) It bases the transfer price on standard cost instead of actual cost.

d) It provides incentive for the selling division to control costs.

59. 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.

60. 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.

61. 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

62. 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.

63. 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.

64. Which statement below regarding the market-based approach is incorrect?

a) It assumes that the transfer price should be based on the most objective inputs possible.

b) It provides a fairer allocation of the company's contribution margin to each division.

c) It produces a higher company contribution margin than the cost-based approach.

d) It ensures that each division manager is properly motivated and rewarded.

65. 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.

66. 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.

67. The transfer price approach that results 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.

68. 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 69–70.

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.

69. 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.

70. 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.

71. Which statement below regarding transfers between divisions located in countries with different tax rates is incorrect?

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.

72. 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.

73. 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

74. 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 of available capacity. What is the minimum transfer price the Food Division should accept?

a) $25

b) $55

c) $80

d) $150

75. Opportunity cost

a) is the value of a second option that must be given up 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.

Use the following information to answer questions 76–80.

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

76. 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) $37

b) $11

c) $38

d) $40

77. 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

78. 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

79. 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.

80. 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) $16.00

d) $40.00

81. 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.

82. 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.

83. 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.

84. 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?

a) It wants to make use of excess capacity in the seller’s division.

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.

85. 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.

86. 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.

87. 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.

88. 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.

d) currency fluctuations.

ANSWERS TO MULTIPLE CHOICE QUESTIONS

BRIEF Exercises

Brief Exercise 89

Advent Company wants to introduce a new printer called the Blitzer. The company believes demand will be 10,000 units per year at a price of $50 per printer. Advent would invest $300,000 and requires a 50% return on their investment.

Instructions

Calculate the target cost per unit for the new Blitzer printer.

Solution 89

Sales (10,000 x $50) $500,000

Less desired ROI ($300,000 x 50%) 150,000

Target cost for 10,000 units $350,000

Target cost per unit ($350,000 / 10,000) $35.00

Brief Exercise 90

Growing Inc. manufactures growth charts. Growing Inc. has recently invested in a new machine that can individualize the picture displayed on the growth chart. It believes demand for this new type of growth chart will be 50,000 charts per year at $15 per chart. The machine will cost $500,000. They would like to earn 45% on this investment.

Instructions

Calculate the total target cost for 50,000 units for the new style of growth chart.

Solution Exercise 90

Sales (50,000 x $15) $750,000

Less desired ROI ($500,000 x 45%) 225,000

Target cost for 50,000 units $525,000

Brief Exercise 91

Newcomers Inc. wants to introduce RoboGrass, a robotic lawnmower, with technological updates that will appeal to a niche market. The company believes demand will be 8,000 units per year at a price of $1,800 per machine. Newcomers would invest $3,000,000 and requires a 60% return on their investment.

Instructions

Calculate the target cost for the 8,000 units and the target cost per unit for the new RoboGrass lawnmower.

Solution 91

Sales (8,000 x $1,800) $14,400,000

Less desired ROI ($3,000,000 x 60%) 1,800,000

Target cost for 8,000 units $12,600,000

Target cost per unit ($12,600,000 / 8,000) $1,575.00

Brief Exercise 92

Live Edge, a wood manufacturer, would like to introduce a new live edge kitchen island table. The maximum price for the table is $800. The company requires a return on investment of 50% on all new products. The plan is to produce and sell 4,000 tables which would require a $400,000 investment.

Instructions

Calculate the target cost per live edge table.

Solution 92

Sales (4,000 x $800) $3,200,000

Less desired ROI ($400,000 x 50%) 200,000

Target cost for 4,000 units $3,000,000

Target cost per table ($3,000,000 / 4,000) $750.00

Brief Exercise 93

Talia 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% markup on total per unit cost.

Solution 93

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 + (Markup percentage x Total unit cost) = Target selling price

$121 + (40% X $121) = $169.40

Brief Exercise 94

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 94

Brief Exercise 95

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 markup percentage using a total cost approach.

Solution 95

The markup percentage would be:

Brief Exercise 96

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) Markup percentage using a total cost approach.

Solution 96

a) ROI is equal to net income divided by invested assets.

For Ivy Company, budgeted ROI is $750,000 ÷ $4,000,000 = 18.75%

b) For Ivy Company, the budgeted markup percentage is Net Income / Total Cost:

Brief Exercise 97

Explain the three-steps to the absorption cost-plus pricing approach.

Solution 97

The three steps to the absorption cost-plus pricing approach are:

1. The first step in the absorption-cost approach is to calculate the manufacturing cost per

unit.

1. The second step in the absorption-cost approach is to calculate the markup percentage
2. The third and final step is to set the target selling price.

Brief Exercise 98

Crafty Designs has variable manufacturing costs of $15 per unit and fixed manufacturing costs of $5 per unit. Variable selling and administrative costs are $2 per unit and fixed selling and administrative costs are $1 per unit. Crafty desires an ROI of $4 per unit. Crafty Designs uses the absorption-cost approach to pricing.

Instructions

Calculate the markup percentage for Crafty Designs.

Solution 98

Variable Manufacturing Costs $15

Fixed Manufacturing Costs 5

Total Manufacturing Costs $20

Selling and Admin Costs $3

Markup $4

Total $7

Markup percentage = $7 / $20 = 35%

Brief Exercise 99

Omnic Enterprises has variable manufacturing costs of $20 per unit and fixed manufacturing costs of $8 per unit and a markup percentage of 25%. The company uses the absorption-cost approach to pricing.

Instructions

Calculate the target selling price for Omnic Enterprises.

Solution 99

Target selling price = ($20 + $8) + (.25 x $28) = $35.00

Brief Exercise 100

Hanson Manufacturing has variable manufacturing costs of $30 per unit and fixed manufacturing costs of $10 per unit. The company has variable selling and administrative costs of $6 per unit and fixed selling and administrative costs of $4 per unit.

The company uses the absorption-cost approach and has a markup percentage of 30%.

Instructions

Calculate Hanson’s desired ROI per unit.

Solution 100

Desired ROI = (.30 x $40) - $10 = $2.00

Brief Exercise 101

Murray and Sons has variable manufacturing costs of $35 per unit and fixed manufacturing costs of $15 per unit. Variable selling and administrative costs are $5 per unit and fixed selling and administrative costs are $2 per unit. Murray and Sons desires an ROI $15 per unit. Murray and Sons uses the absorption-cost approach to pricing.

Instructions

Calculate the markup percentage for Murray and Sons.

Solution 101

Variable Manufacturing Costs $35

Fixed Manufacturing Costs 15

Total Manufacturing Costs $50

Selling and Admin Costs $ 7

Markup $15

Total $22

Markup percentage = $22 / $50 = 44%

Brief Exercise 102

Explain the three-steps to the variable cost-plus pricing approach.

Solution 102

The three steps to the variable cost-plus pricing approach are:

1. The first step in the variable-cost approach to cost-plus pricing is to calculate the variable

cost per unit.

1. The second step in the variable-cost approach is to calculate the markup percentage.
2. The third step is to set the target selling price.

Brief Exercise 103

Crafty Designs has variable manufacturing costs of $15 per unit and fixed manufacturing costs of $5 per unit. Variable selling and administrative costs are $2 per unit and fixed selling and administrative costs are $1 per unit. Crafty desires an ROI $4 per unit. Crafty Designs uses the variable cost plus pricing approach.

Instructions

Calculate the markup percentage for Crafty Designs.

Solution 103

Variable Manufacturing Costs $15

Variable Selling and Admin 2

Total Manufacturing Costs $17

Fixed Manufacturing Costs $ 5

Fixed Selling and Admin $ 1

Markup $ 4

Total $10

Markup percentage = $10 / $17 = 59%

Brief Exercise 104

Everett Electronics has variable manufacturing costs of $40 per unit and fixed manufacturing costs of $20 per unit. Variable selling and administrative costs are $10 per unit and fixed selling and administrative costs are $5 per unit. Everett uses the variable cost plus pricing approach and desires an ROI per unit of $25.

Instructions

Calculate the markup percentage for Everett Electronics.

Solution 104

Variable Manufacturing Costs $40

Variable Selling and Admin 10

Total Manufacturing Costs $50

Fixed Manufacturing Costs $20

Fixed Selling and Admin $ 5

Markup $25

Total $50

Markup percentage = $50 / $50 = 100%

Brief Exercise 105

Carlisle Manufacturing has variable manufacturing costs of $15 per unit and fixed manufacturing costs of $5 per unit. The company has variable selling and administrative costs of $6 per unit and fixed selling and administrative costs of $2 per unit. The company uses the variable-cost approach and has a markup percentage of 100%.

Instructions

Calculate Carlisle’s desired ROI per unit.

Solution 105

Desired ROI per unit = [1.00 x ($15 + $6)] – ($5 + $2) = $14.00

Brief Exercise 106

Carlisle Manufacturing has variable manufacturing costs of $15 per unit and fixed manufacturing costs of $5 per unit. The company’s has variable selling and administrative costs of $6 per unit and fixed selling and administrative costs of $2 per unit. The company uses the variable-cost approach and has a markup percentage of 100%.

Instructions

Calculate the target selling price for Carlisle Manufacturing Enterprises.

Solution 106

Target selling price = ($15 + $6) + (1.00 x $21) = $42.00

Brief Exercise 107

Murray and Sons has variable manufacturing costs of $35 per unit and fixed manufacturing costs of $15 per unit. Variable selling and administrative costs are $5 per unit and fixed selling and administrative costs are $2 per unit. Murray and Sons desires an ROI $15 per unit. Murray and Sons uses the variable cost plus pricing approach.

Instructions

Calculate the markup percentage for Murray and Sons.

Solution 107

Variable Manufacturing Costs $35

Variable Selling and Admin 5

Total Manufacturing Costs $40

Fixed Manufacturing Costs $15

Fixed Selling and Admin $ 2

Markup $15

Total $32

Markup percentage = $32 / $40 = 80%

Brief Exercise 108

Tree-Top Spaces prepares a price quotation to estimate the cost to build a one of kind tree-top abode for a customer. Tree-Top estimates the job will require 250 hours of labour at an hourly rate of $125/hr and $25,500 in parts and materials. The material loading charge is 45%.

Instructions

Calculate the total price quotation.

Solution 108

Labour charge: 250 hours @ $125 per hour $31,250

Material charges

Cost of parts and materials $25,500

Material loading charge (45% × $25,500) 11,475 36,975

Total price of labour and material $68,225

Brief Exercise 109

Aliment Company has a time rate of $30 per hour, material loading charge of 25% for ordering, handling, and storing parts and 8% for the desired profit on materials.

Instructions

Calculate the total charge for a job that requires 6 hours of labour time and $100 in parts.

Solution 109

Labour charges

6 hours @ $30 $180.00

Material charges

Cost of parts and materials $100.00

Material loading charge (.25 +.08) × $100 33.00 133.00

Total price of labour and materials $313.00

Brief Exercise 110

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 110

The total bill would equal (16 hours x $75) + $750 + ($750 x 55%) = $2,362.50

Brief Exercise 111

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 111

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 $7.50 + ($15 – $7.50) = $15.

Brief Exercise 112

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 112

If the tire division has excess capacity, then its opportunity cost is zero. In this case, the minimum transfer price is $7.50 + $0 = $7.50.

Brief Exercise 113

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 113

The minimum transfer price is equal to Sandbar’s variable cost plus its opportunity cost. In this case the minimum transfer price is $52 + ($82 – $38) = $96.

Brief Exercise 114

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 manufacturing cost $60 per unit

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 114

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 customers.

Brief Exercise 115

Thingumabobs Inc. makes both widgets and gadgets. Both use whatsits in the manufacture of its products. The Widget Division makes its own whatsits, but the Gadget Division purchases its whatsits from an outside supplier for $10 each. The manager of the Gadget Division has inquired about purchasing his whatsits directly from the Widget Division. The manager of the Widget Division has calculated the cost of making a whatsit as $8. If the two managers come to an agreement, what will be the price agreed to?

Solution 115

The external purchasing price of the whatsit is currently $10. The Gadget Division would therefore, not pay more than that. However, the whatsit costs the Widget Division $8 to make, so that manager would not sell for less than that. Therefore, the negotiated price would be somewhere between $8 and $10.

Exercises

Exercise 116

Light Fixtures Plus, a manufacturer of light fixtures would like to introduce a new semi-flush ceiling light. The fixture could not be priced at more than $250. The company requires a return on investment of 40% on all new products. The plan is to produce and sell 2,500 fixtures, which would require a $400,000 investment.

Instructions

Calculate the target cost per light fixture.

Solution 116

Sales (2,500 x $250) $625,000

Less desired ROI ($400,000 x 40%) 160,000

Target cost for 2,500 units $186,000

Target cost per light fixture ($186,000 / 2,500) $74.40

Exercise 117

Trout 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 117 (6–10 min.)

Sales (750,000 x $30) $22,500,000

Less desired ROI ($3,750,000 x 10%) 375,000

Target cost for 750,000 units $22,125,000

Target cost per unit = $22,125,000 ÷ 750,000 = $29.50

Exercise 118

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) Markup percentage using total cost per unit.

d) Target selling price.

Solution 118 (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% x $325,000,000) ÷ 600,000 = $108.33

$108.33 + $0

c) Markup percentage using total cost per unit = ———––––— = 41 %

$262

d) Target selling price = $262 + ($262 x 41%) = $369.42

Exercise 119

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 markup 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 119 (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

Markup x 15%

Desired ROI per unit $ 23.25

c)

Total cost per unit $155.00

Desired ROI per unit 23.25

Target selling price $178.25

Exercise 120

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:

Budgeted Cost

Total Costs Volume 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 120 (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 x.12 = $30,000; $30,000 ÷ 20,000 = $1.50 per unit

Exercise 121

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 markup 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 markup 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 121 (5–8 min.)

a) Markup percentage is $48,000 / $600,000 = 8%.

b) Bid = $55,000 x 1.08 = $59,400.

Quick should remind the customer that the 8% markup 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 and below industry average.)

Exercise 122

Crafty Designs has variable manufacturing costs of $15 per unit and fixed manufacturing costs of $5 per unit. Variable selling and administrative costs are $2 per unit and fixed selling and administrative costs are $1 per unit. Crafty desires an ROI $4 per unit. Crafty Designs uses the absorption-cost approach to pricing.

Instructions

Calculate the target selling price for Crafty Designs.

Solution 122

Variable Manufacturing Costs $15

Fixed Manufacturing Costs 5

Total Manufacturing Costs $20

Selling and Admin Costs $3

Markup $4

Total $7

Markup percentage = $7 / $20 = 35%

Target selling price = $20 + (.35 x $20) = $27

Exercise 123

Murray and Sons has variable manufacturing costs of $35 per unit and fixed manufacturing costs of $15 per unit. Variable selling and administrative costs are $5 per unit and fixed selling and administrative costs are $2 per unit. Murray and Sons desires an ROI $15 per unit. Murray and Sons uses the absorption-cost approach to pricing.

Instructions

Calculate the target selling price for Murray and Sons.

Solution 123

Variable Manufacturing Costs $35

Fixed Manufacturing Costs 15

Total Manufacturing Costs $50

Selling and Admin Costs $ 7

Markup $15

Total $22

Markup percentage = $22 / $50 = 44%

Target selling price = $50 + (.44 x $50) = $72.00

Exercise 124

Everett Electronics has a target selling price of $100 per unit, variable manufacturing costs of $40 per unit and fixed manufacturing costs of $20 per unit. Variable selling and administrative costs are $10 per unit and fixed selling and administrative costs are $5 per unit. Everett uses the absorption-cost approach to pricing and expects to sell 10,000 units.

Instructions

Prepare a budgeted income statement and determine Everett’s budgeted ROI given an investment of $1,000,000.

Solution 124

EVERETT ELECTRONICS

Budgeted Absorption-Cost Income Statement

Revenue (10,000 units × $100) $1,000,000

Less: Cost of goods sold (10,000 units × $60) _600,000

Gross profit 400,000

Less: Selling and administrative expenses [10,000 units × ($10 + $5)] _150,000

Net income $ 250,000

Budgeted ROI

Net income = $250,000 = 20%

Invested Assets $1,000,000

Exercise 125

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 125 (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 126

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.

Instructions

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) Markup percentage using the absorption-cost approach.

d) Markup percentage using the variable cost-plus approach.

Solution 126 (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 markup percentage = —————————————— = 279%

$62.50 + $47.50 + $15 + $125

$660 + ($125 + $27.50)

d) Variable cost-plus markup percentage = —————————————— = 602%

$62.50 + $47.50 + $15 + $10

Exercise 127

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. Markup 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. Markup percentage needed to provide desired ROI.

ii. Target price of the patio door.

Solution 127 (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 markup percentage to provide a 25% ROI:

Markup [25% x ($4,000,000 ÷ 5,000)] + [$25 + ($375,000 ÷ 5,000)] $300

Percentage = —————————————————————————— = ——– = 50%

$600 $600

ii. Computation of target price:

Target price: $600 + (50% x $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 markup percentage to provide a 25% ROI:

Markup [25% x ($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% x $525) = $900

Exercise 128

Everett Electronics has a target selling price of $100 per unit, variable manufacturing costs of $40 per unit and fixed manufacturing costs of $20 per unit. Variable selling and administrative costs are $10 per unit and fixed selling and administrative costs are $5 per unit. Everett uses the variable-cost approach to pricing and expects to sell 10,000 units.

Instructions

Prepare a budgeted income statement and determine Everett’s budgeted ROI given an investment of $1,000,000.

Solution 128

EVERETT ELECTRONICS

Budgeted Variable-Cost Income Statement

Revenue (10,000 units × $100) $1,000,000

Less: Variable Costs ($50 x 10,000) _500,000

Contribution margin 500,000

Less: Fixed Costs

Manufacturing (10,000 units × $20) $200,000

Selling and administrative expenses (10,000 units × $5) 50,000 250,000

Net income $ 250,000

Budgeted ROI

Net income = $250,000 = 20%

Invested assets $1,000,000

Exercise 129

Everett Electronics has a target selling price of $100 per unit, variable manufacturing costs of $40 per unit and fixed manufacturing costs of $20 per unit. Variable selling and administrative costs are $10 per unit and fixed selling and administrative costs are $5 per unit. Everett uses the variable-cost approach to pricing and expects to sell 10,000 units.

Instructions

Prepare a budgeted income statement and determine Everett’s markup percentage given an investment of $1,000,000.

Solution 129

EVERETT ELECTRONICS
Budgeted Variable-Cost Income Statement

Revenue (10,000 units × $100) $1,000,000

Less: Variable Costs ($50 x 10,000) _500,000

Contribution margin 500,000

Less: Fixed Costs

Manufacturing (10,000 units × $20) $200,000

Selling and administrative expenses (10,000 units × $5) 50,000 250,000

Net income $ 250,000

Markup Percentage

Net income + Fixed Costs = ($250,000 + $250,000) = 100%

Cost of Goods Sold $500,000

Exercise 130

Montsela Company uses time-and-material pricing. The following budgeted cost data is available for 2022:

Time Material

Charges Charges

Technicians' wages and benefits $ 75,000

Parts manager’s salary and benefits $50,000

Office manager’s salary and benefits 55,000 25,000

Other overhead 15,000 20,000

Total budgeted costs $145,000 $95,000

Montsela has budgeted for 5,000 hours of technician time during the coming year. It desires a $25 profit margin per hour of labour and a 30% profit margin on parts. Montsela estimates the total invoice cost of parts and materials in 2022 will be $200,000.

Instructions

a) Calculate the rate charged per hour of labour.

b) Calculate the material loading charge.

c) Montsela has received a request for a job. The company estimates that it would take 100 hours of labour time and $600 in materials. Calculate the total charge for the job.

Solution 130

a)

Per Hour

Total Cost Total Hours Charge

Hourly labour rate for repairs

Technicians' wages and benefits $75,000 ÷ 5,000 = $15.00

Overhead costs

Office manager's salary and benefits 55,000 ÷ 5,000 = 11.00

Other overhead 15,000 ÷ 5,000 = 3.00

$145,000 ÷ 5,000 = 29.00

Profit margin 25.00

Rate charged per hour of labour $54.00

b)

Total Invoice Material

Material Cost, Parts Loading

Charges and Materials Charge

Overhead costs

Parts manager's salary and benefits $50,000

Office manager's salary and benefits 25,000

$75,000 ÷ $200,000 = 37.5%

Other overhead 20,000 ÷ $200,000 = 10%

47.5%

Profit margin 30%

Material loading charge 77.5%

c)

Labour charges

100 hours @ $54 $5,400.00

Material charges

Cost of parts and materials $600.00

Material loading charge (.775 × $600) 465.00 1065.00

Total price of labour and materials $6,465.00

Exercise 131

Greasy Spoon Service repairs commercial food preparation equipment. The following budgeted cost data is available for 2022:

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 2022 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 131 (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)

Total Invoice Material

Material Cost, Parts Loading

Charges 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 132

Forrest Painting Service has budgeted the following time-and-material for 2022:

Budgeted Costs For 2022

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 2022 and will charge a profit of $12 per hour, in addition to a 25% markup on the cost of paint.

On February 15, 2022, 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 2022.

b) Calculate the material loading charge rate for 2022.

c) Prepare a time-and-materials price estimate for painting the building.

Solution 132 (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:

Total Invoice Material

Material Cost of Loading

Charges 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% x $600) 540 1,140

Total price of labour and materials $1,458

Exercise 133

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 133 (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 134

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 134 (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 $15 x 65,000 units = $975,000

Exercise 135

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 135 (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 is $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

Net Income $ 384,000

Wheels To Go’s Net Income is $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 136

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 and selling expenses will not be avoided in the transaction?

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 (provide a range from low to high)?

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 136 (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 137

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 137 (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 138

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 138 (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.

All other costs are irrelevant to the decision.

COMPLETION STATEMENTS

139. The difference between the target price and the desired profit is the ___ cost of the product.

140. In the cost-plus pricing formula, the target selling price equals cost + (___ x cost).

141. The ___ pricing approach has a major advantage: it is simple to calculate.

142. The ___ pricing approach is consistent with generally accepted accounting principles because it defines the cost base as the manufacturing cost.

143. Under variable cost plus pricing, the markup percentage is calculated by dividing markup plus ___ costs by the total variable costs.

144. 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.

145. The transfer of goods between divisions of the same company is termed ___ sales.

146. The three approaches for determining a transfer price are: negotiated, ___-based, and ___-based transfer prices.

147. To ensure that the selling division attempts to control its costs, the transfer price should be based on ___ cost instead of actual cost.

148. The formula for the minimum transfer price is: Minimum transfer price = Variable cost + ___.

149. ___ involves contracting with an external party to provide a good or service, rather than performing the work internally.

ANSWERS TO COMPLETION STATEMENTS

139 target

140. markup percentage

141. cost-plus

142. absorption-cost

143. fixed

144. loading charge

145. internal

146. cost, market

147. standard

148. opportunity cost

149. outsourcing

MATCHING

150. 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. Markup G. Time-and-material pricing

D. Negotiated transfer price H. Virtual companies

____ 1. Contracting with an external party to provide a good or service

____ 2. An approach to cost-plus pricing that uses two pricing rates and is common in service industries

____ 3. Product's selling price is determined by adding a markup to a cost base

____ 4. Transfer price is determined by agreement of division managers

____ 5. Companies that have no manufacturing facilities

____ 6. Percentage applied to a product's cost

____ 7. Price that will provide the desired profit on a product

____ 8. Transfer price is based on existing prices of competing products

ANSWERS TO MATCHING

1. E

2. G

3. A

4. D

5. H

6. C

7. F

8. B

SHORT-ANSWER ESSAY QUESTIONS

SAE 151

Why do most companies that use cost-plus pricing use either the absorption cost or the total cost as the basis?

Solution 151

Most companies that use cost-plus pricing use either the absorption cost or the total cost

as the basis. The reasons are as follows:

1. A company’s cost accounting system provides absorption cost information most easily.

Because absorption cost data already exist in general ledger accounts, it is cost-effective

to use them for pricing.

2. Basing the cost-plus formula on only variable costs could encourage managers to set too

low a price in order to boost sales. There is the fear that if only variable costs are used,

managers will substitute them for total costs and this can lead to suicidal price-cutting.

3. The absorption cost or total cost is the easiest basis to defend when prices need to be

justified to all interested parties—managers, customers, and governments.

SAE 152

Explain the major disadvantage of variable-cost pricing.

Solution 152

The major disadvantage of variable-cost pricing is that managers may set the price too

low and consequently fail to cover their fixed costs. In the long run, failure to cover fixed costs

will lead to losses. As a result, companies that use variable-cost pricing must use higher markups to make sure that the price they set will give a fair return.

SAE 153

Because the absorption-cost approach includes allocated fixed costs, it does not clarify how the company’s costs will change as the sales volume changes. Identify three specific reasons why some managers prefer the variable-cost approach.

Solution 153

The specific reasons for using the variable-cost approach, even though the basic accounting data are less accessible, are as follows:

1. Variable-cost pricing, being based on variable costs, is more consistent with the cost-volume-profit analysis that managers use to measure the profit implications of changes in price and volume.
2. Variable-cost pricing provides the type of data that managers need for pricing special orders. It shows the incremental cost of accepting one more order.
3. Variable-cost pricing avoids an arbitrary allocation of common fixed costs (such as executive salary) to individual product lines.

SAE 154

A 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 154

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.

SAE 155

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 155

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.

MULTI-PART QUESTION

156. Elektroniks Company has two divisions, A and B. Division A makes a silicon part R27 which cannot be acquired from any other manufacturer. It sells this product for $10.00 and the variable cost of production is $7.25.

Due to a downturn in demand, Division B is operating at only half of its capacity and has made a bid on a job that it desperately needs to win. The job would contain part R27 and the cost break down of the bid is as follows:

Part R27 $8.00

Other parts required $10.00

Variable costs of production $30.00

Fixed factory overhead $8.00

Variable selling & admin $15.00

Profit component $ 5.00

Bid price $76.00

Instructions

a) Should Division A transfer part R27 to Division B? Why or why not?

b) Discuss whether a transfer is in the best interest of Elektroniks Company as a whole.

Solution 156

a) If Division A is operating at full capacity, then the minimum transfer price will be $10. If Division A has sufficient capacity to supply the part to B, then the minimum transfer price will be A’s variable costs of $7.25.

Otherwise, the maximum price that B would accept is $8 + $5 = $13.

b) If the job is only a one-time situation and does not result in A having to lose its regular customers, the transfer is in Elektronik’s long-term interest.

If the bid results in a long-term relationship, then the transfer will also be in Elektronik’s interest since any lost contribution margin from A’s customers will be picked up on a recurring basis from B’s relationship.

But if it is only a one-time contract and A has to turn away customers, the company has to be assured that it can recover those customers down the road.

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