Test bank managerial accounting by kieso weygandt 5e ch008

Compute a target selling price using cost-plus pricing to determine the cost of services provided.. The material charge is based on the cost of direct parts and materials used and a mate

CHAPTER 8

Pricing

ASSIGNMENT CLASSIFICATION TABLE

Brief Exercises Exercises

A Problems

B Problems

* 1 Compute a target cost when

the market determines a

product price.

* 2 Compute a target selling

price using cost-plus

pricing to determine the

cost of services provided.

* 4 Determine a transfer price

using the negotiated,

cost-based, and market-based

approaches.

11, 12, 13,

14, 15, 16, 17

ASSIGNMENT CHARACTERISTICS TABLE

Problem

Number Description

Difficulty Level

Time Allotted (min.)

1A Use cost-plus pricing to determine various amounts Simple 20–30 2A Use cost-plus pricing to determine various amounts Simple 20–30 3A Use time-and-material pricing to determine bill Simple 20–30 4A Determine minimum transfer price with no excess capacity

and with excess capacity.

and with excess capacity.

BLOOM’S TAXONOMY TABLE

Correlation Chart between Bloom’s Taxonomy, Study Objectives and End-of-Chapter Exercises and Problems Study Objective

BE8-7 BE8-8 BE8-9 E8-11 E8-12 E8-13 E8-14 E8-15 P8-4A P8-5A P8-6A P8-4B P8-5B P8-6B

Explain issues involved in transferring goods between divisions in different countries.

Manag Analysis Communication Ethics Case

Decision Making Across the Organization Real-World Fo

Decision Making Across the Organization Real-World Focus Communication Ethics Case

5 EXPLAIN ISSUES INVOLVED IN TRANSFERRING GOODS BETWEEN DIVISIONS IN DIFFERENT COUNTRIES.

*6 DETERMINE PRICES USING ABSORPTION-COST ING AND VARIABLE-COST PRICING.

PRIC-CHAPTER REVIEW

External Sales

1 (S.O 1) Some of the many factors that can affect pricing decisions include:

a Pricing Objectives

• Gain market share

• Achieve a target rate of return

b Environment

• Political reaction to prices

• Patent or copyright protection

3 Companies can set prices (1) where the product is specially made for a customer, (2) when there are few or no other producers capable of manufacturing a similar item, or (3) when a company can effectively differentiate its product or service from others.

Pricing in a Competitive Market

4 Once a company has identified its segment of the market, it does market research to determine the target price. The target price is the price that the company believes would place it in the optimal position for its target audience Once the company has determined the target price, it can determine its target cost by setting a desired profit The difference between the target price and the desired profit is the target cost of the product The target cost includes all product and period costs necessary to make and market the product.

Target selling price = Cost + (Markup Percentage X Cost)

6 The cost-plus approach has a major advantage: it is simple to compute However, the cost model does not give consideration to the demand side—that is, will the customers pay the price In addition, sales volume plays a large role in determining per unit costs The lower the sales

7 Instead of using both fixed and variable costs to set prices, some companies simply add a markup

to their variable costs Using variable costing as the basis avoids the problem of using poor cost information related to fixed cost per unit computations.

Time and Material Pricing

8 (S.O 3) Under time and material pricing, the company sets two pricing rates—one for the labor used on a job and another for the material The labor rate includes direct labor time and other employee costs The material charge is based on the cost of direct parts and materials used and

a material loading charge for related overhead costs.

9 Using time and material pricing involves three steps: (1) calculate the per-hour labor charge, (2) calculate the charge for obtaining and holding materials, and (3) calculate the charges for a particular job.

The per-hour labor charge typically includes the direct labor cost of an employee, selling, administrative, and similar overhead costs, and an allowance for a desired profit of employee time The charge for materials typically includes the invoice price of any materials used on the job plus a material loading charge The charges for any particular job are then a result of (1) the labor charge, (2) the direct charge for materials, and (3) the material loading charge.

10 To illustrate a time and material pricing situation, assume the following data for Rancho Park Golf Club Repair Service:

Rancho Park Golf Club Repair Service Budgeted Costs for the Year 2009

Other overhead (supplies, depreciation,

Step 1: During 2009 Rancho Park budgets 1,300 of hours for repair time, and it desires a profit margin of $6 per hour of labor Computation of the hourly charges are as follows:

Per Hour Per Hour Total Cost ÷ Total Hours = Charge

Hourly labor rate for repairs

Step 2: Rancho Park estimates that the total invoice cost of parts and materials used in 2009 will

be $30,000 and it desires a 10 percent profit margin markup on the invoice cost of parts and materials The computation of the material loading charge used by Rancho Park during 2009 is as follows:

Step 3: Rancho Park prepares a price quotation to estimate the cost to fix a set of woods for a patron Rancho Park estimates the job will require a half hour of labor and $150 in parts and materials Rancho Park’s price quotation is as follows:

Rancho Park Golf Club Repair Service Time and Materials Price Quotation

Job: Arnold Palmer, repair of set of woods

Material charges

Material loading charge (40% X 150) 60.00 210.00

Internal Sales

11 (S.O 4) Divisions within vertically integrated companies normally transfer goods or services to other divisions within the same company, as well as to customers outside the company When goods are transferred internally, the price used to record the transfer between the two divisions

is called the transfer price Three possible approaches for determining a transfer price are (1) negotiated transfer prices, (2) cost-based transfer prices, and (3) market-based transfer prices.

Negotiated Transfer Prices

12 The negotiated transfer price is determined through agreement of division managers Using the negotiated transfer pricing approach, a minimum transfer price is established by the selling division, and a maximum transfer price is established by the purchasing division.

Calculating the minimum transfer price depends on whether the selling division has excess capacity or not If the selling division has no excess capacity, then the minimum transfer price is the variable cost plus its lost contribution margin (also known as opportunity cost) If the selling division has excess capacity, then the minimum transfer price is the variable cost.

Cost-Based Transfer Prices

13 Another method of determining transfer prices is to base the transfer price on the costs incurred

by the division providing the goods If a transfer price is used, the transfer price may be based on variable costs alone, or on variable costs plus fixed costs A markup may be added to these cost numbers This method, however, may lead to a loss of profitability for the company and unfair evaluations of division performance.

Market-Based Transfer Prices

14 The market-based transfer price is based on existing market prices of competing goods or services A market-based system is often considered the best approach because it is objective and generally provides the proper economic incentives Unfortunately, however, there is often not

a well-defined market for the good or service being transferred and thus companies resort to a cost-based system.

Transfers Between Divisions in Different Countries

15 (S.O 5) As more companies “globalize” their operations, an increasing number of transfers are between divisions that are located in different countries Companies must pay income tax in the country where income is generated In order to maximize income, and minimize income tax, many companies prefer to report more income in countries with low tax rates, and less income in countries with high tax rates This is accomplished by adjusting the transfer prices they use on internal transfers between divisions located in different countries The division in the low-tax-rate country is allocated more contribution margin, and the division in the high-tax-rate country is allocated less.

*Absorption Cost Pricing

*16 (S.O 6) Absorption cost pricing is consistent with generally accepted accounting principles (GAAP) because it defines the cost base as the manufacturing cost Both variable and fixed selling and administrative costs are excluded from this cost base Thus, selling and administrative costs plus the target ROI must be provided through the markup.

The steps in using the absorption cost approach are as follows:

a Compute the unit manufacturing cost.

b Compute the markup percentage using the formula:

Desired ROI per unit +

Selling and Adminstrative Expenses Perr Unit

= MarkupPercentage X ManufacturingCost Per Unit

c Set the target selling price using the formula:

Manufacturing

Cost Per Unit + ( Markup

Percentage X

Manufacturing Cost Per Unit ) = Selling PriceTarget

The steps in using the contribution approach are as follows:

a Compute the unit variable cost.

b Compute the markup percentage using the formula:

Desired ROI Per Unit

+ Fix xed Costs Per Unit

= Markup Percentage X Variable Costs

2 In the long run a company must price its product to cover its costs andearn a reasonable profit In most cases, a company does not set theprice—it is set by the competitive market (laws of supply and demand).

In this situation, companies are called price takers because the price ofthe product is set by market forces

3 In some situations the company does set the price This occurs wherethe product is specially made for a customer or when there are few or noother producers capable of manufacturing a similar item It also occurswhen a company can effectively differentiate its product from others

B Target Costing.

1 In a competitive market, the price of a product is greatly affected bysupply and demand No company in the market can affect the price to asignificant degree

2 A company chooses the segment of the market it wants to compete in(its market niche) in a competitive market

TEACHING TIP

3 Once the company has identified its market segment, it conducts marketresearch to determine the target price The target price is the pricethe company believes would place it in the best position for its targetaudience.

4 Once the company determines the target selling price it determines itstarget cost by setting a desired profit

5 The difference between the target price and the desired profit is thetarget cost of the product The target cost includes all product and periodcosts necessary to make and market the product

C Cost-Plus Pricing.

1 In a noncompetitive environment, the company is faced with the task ofsetting its own price, which is commonly a function of the cost of theproduct

2 The typical approach is to use cost-plus pricing which involves lishing a cost base and adding to this cost base a markup to determine atarget selling price

estab-3 The size of the markup depends on the desired return on investment(ROI) for the product line or product

4 The cost-plus pricing formula is expressed as follows: Target SellingPrice = Cost + (Markup Percentage X Cost) Markup Percentage iscomputed by dividing Desired ROI Per Unit by Total Unit Cost

Use ILLUSTRATION 8-2 to explain the computation of the markup percentageand target selling price using the cost-plus pricing approach

Also available as teaching transparency.

TEACHING TIP

5 The cost-plus pricing approach’s major advantage is that it is simple tocompute However, it does not give consideration to the demand side Inaddition, sales volume plays a large role in determining per unit costswhich in turn affect selling price.

6 The lower the sales volume, the higher the selling price the companymust charge to meet its desired ROI This occurs because fixed costsare spread over fewer units and the fixed cost per unit increase

3 Using time-and-material pricing involves three steps:

a Calculate the per hour labor charge

b Calculate the charge for obtaining and holding materials

c Calculate the charges for a particular job

ILLUSTRATION 8-3 lists the steps involved in time-and-material pricing.Emphasize that both the labor charge and the material loading charge contain adesired profit margin

Also available as teaching transparency.

TEACHING TIP

4 The charge for labor time is expressed as a rate per labor hour whichincludes:

a The direct labor cost of the employee (hourly rate or salary andfringe benefits)

b Selling, administrative, and similar overhead costs

c An allowance for a desired profit or ROI per hour of employee time

5 The charge for materials typically includes a material loading chargewhich covers the costs of purchasing, receiving, handling, and storingmaterials, plus any desired profit margin on the materials themselves

6 The material loading charge is expressed as a percentage of the totalestimated costs of parts and materials for the year The companydetermines this percentage by doing the following:

a Estimating the total annual costs for purchasing, receiving, handling,and storing materials

b Dividing the amount in a by the total estimated cost of parts andmaterials

c Adding a desired profit margin on the materials themselves

7 The charges for any particular job are the sum of the

a Labor charge,

b Charge for materials, and

c Material loading charge

E Internal Sales.

2 When companies transfer goods internally, the price used to record thetransfer between the divisions is the transfer price.

3 Setting a transfer price is often complicated because of competinginterests among divisions within the company A transfer price that is toohigh will benefit the selling division, but hurt the purchasing division

4 There are three possible approaches for determining a transfer price:

a Negotiated transfer prices

b Cost-based transfer prices

c Market-based transfer prices

F Negotiated Transfer Prices.

1 The negotiated transfer price is determined through agreement ofdivision managers It will range between the external purchase price perunit and the sum of the unit variable cost plus unit opportunity cost

2 Opportunity cost is the contribution margin per unit of goods soldexternally

3 The minimum transfer price equals variable cost plus opportunity costwhether the seller is at full capacity or has excess capacity However,opportunity cost will vary depending on whether a division is at fullcapacity or has excess capacity

4 Given excess capacity (zero opportunity cost) to the selling division, itwould be in the company’s best interest for the buying division to purchasegoods internally as long as the selling division’s variable cost is less thanthe outside price

6 In the minimum transfer price formula, variable cost is defined as thevariable cost of units sold internally which will differ from the variablecost of units sold externally in some instances (i.e reduced sellingexpenses for internal sales).

7 Under negotiated transfer pricing, the selling division, establishes, aminimum transfer price and the purchasing division establishes amaximum transfer price

8 Companies often do not use negotiated transfer pricing because:

a Market price information is sometimes not easily obtainable

b A lack of trust between the two negotiating divisions may lead to abreakdown in negotiations

c Negotiations often lead to different pricing strategies from division

to division which is sometimes costly to implement

G Cost-Based Transfer Prices.

1 One method of determining transfer prices is to base the transfer price

on the costs incurred by the division producing the goods

2 A cost-based transfer price may be based on full cost, variable cost, orsome modification including a markup

3 The cost-based approach often leads to poor performance evaluationsand purchasing decisions Under this approach, divisions sometimesuse improper transfer prices which leads to a loss of profitability andunfair evaluations of division performance

4 The cost-based approach does not provide the selling division withproper incentive In addition, this approach does not reflect the sellingdivision’s true profitability, and doesn’t even provide adequate incentive