Exam 11: Pricing Decisions, Incl Target Costing and Transfer Pricing

One approach to the development of a transfer price is to use the market value if the item has an existing market at the time of transfer.

The target market for a product or service should be given strong consideration before the final price is chosen.

Management accountants are directly involved in designing products that meet target costs.

Beyond the sales level that achieves maximum profits, total costs rise at a slower rate than total revenue.

Using a market transfer price would cause the selling division manager to sell directly to an outside customer rather than transferring goods to a buying division manager.

Target costing is a useful pricing tool because it allows the company to critically analyze the potential for success of a product before committing resources to its production.

For several years, Patel Division has produced an electronic component that it sells to Morrison Division at the prevailing market price of $27. Patel manufactures the component only for Morrison Division and has previously made no sales of this product to outside customers. The product is available from independent suppliers who would charge the Morrison Division $27 per unit. Patel Division currently produces and sells 30,000 of these components each year and also manufactures several other products. The following annual cost information was compiled after the close of 2010 operations, during which time Patel Division operated at full capacity: Patel Division (2010) Costper Commonent Direct materials \ 9.00 Direct labor (hourly basis) 11.20 Variable overhead \ 5.00 General fixed overhead of plant 12.40 Traceable fixed overhead (\ 90,000\div30,000) 3.00 Variable shipping expenses 1.00 Total unit cost \ 41.60 General fixed overhead represents allocated joint fixed costs such as building depreciation, property taxes, and salaries of production executives. If production of the components were discontinued, $72,000 of the annual traceable fixed overhead could be eliminated. The costs to be saved currently require cash outlays; the balance of traceable fixed overhead is equipment depreciation on machinery that could be used elsewhere in the plant. a. Compute the incremental cost per unit of this product manufactured by Patel Division. b. The division manager contends that producing the components to accommodate other divisions is a sound policy as long as variable costs are recovered by sales. Should Patel Division continue to produce the components for Morrison Division?

An example of a pricing objective is to

Organizations will not invest in making a product or providing a service unless it will provide a minimum return.

A negotiated transfer price

Setting appropriate prices is one of the simplest decisions that managers make on a day-to-day basis.

The pricing objective of maximizing profits

Legal constraints and ethical considerations should be considered when developing a company's pricing policy.

The use of transfer pricing encourages accountability for seller-customer relationships.

Overall company profits will not be enhanced if a buying division acquires products from outside suppliers at an annual cost that is less than the incremental cost to the supplying division within the company.

A transfer price should not contain any profit since the profit for a product should be determined when the product is completed.

Seven years ago, Jared Singh formed the Singh Corporation and began producing computer equipment for home use. Because of the highly technical and competitive nature of the industry, Singh established a research and development division that is responsible for continuous evaluation and updating of critical electronic parts used in all of the corporation's products. The staff of the R&D Division has been very successful, contributing to the corporation's number one ranking in the industry in the United States. Two years ago, the R&D Division took on the added responsibility of producing all microchip circuit boards for Singh computer equipment. One of its specialties is a graphics dissemination board (GDB). The GDB is a major factor in the quality of the Singh computers. Demand for the GDB has increased significantly in the last year, and the R&D Division has had to increase its production and assembly labor force. Three outside customers want to purchase the GDB for their computer products. To date, the R&D Division has been producing the GDBs only for internal use. The controller of the R&D Division wants to create a transfer price for GDBs that will be used for all intracompany transfers. The following information has been projected for the next six months: Costs: Direct materials \7 71,800 Direct labor 796,200 Overhead costs 410,300 Costs allocated from corporate office 988,700 A profit factor of at least 20 percent must be added to the cost (including costs allocated from the corporate office) of the GDB for internal transfer purposes. The outside customers are willing to pay $45 for the GDB. Demand over the next six months is estimated at 78,000 GDBs for internal use and 22,000 for external customers. a. Compute the cost of producing and distributing one GDB. Round answers to nearest two decimal places. b. What should be the transfer price used by the R&D Division? What factors influenced your decision?

An internal issue to be considered when setting a price is

The state of Illinois has passed a law requiring that every automobile be inspected at least once a year for pollution control. Anfang Enterprises is considering entering into this type of business. After extensive studies, Joseph Anfang has developed the following set of projected annual data on which to make his decision: Direct service labor \ 363,000.00 Variable service overhead costs 270,000.00 Fixed service overhead costs 280,000.00 Marketing expenses 120,000.00 General and administrative expenses 170,000.00 Minimum profit 90,000.00 Cost of assets employed 500,000.00 Anfang believes that his company will inspect 100,000 automobiles per year. The company earns an average of 18.75 percent return on its assets. - The price to be charged for inspecting each automobile using the time and materials pricing method would be calculated as follows:

Both internal and external factors can influence the pricing decision.