5. Pricing Calculations

Question 1

What are the two methods for pricing products we will look at?

Answer 1

• mark-up pricing (cost-plus pricing)
• margin pricing

Question 2

What is mark-up pricing?

Answer 2

Mark-up pricing (or cost-plus pricing) is the pricing of products where the profit is a percentage of the cost

Question 3

What are the two variations of mark-up pricing we need to consider with regards to cost?

Answer 3

• full-cost mark-up pricing
• marginal-cost mark-up pricing

Question 4

Outline the pro-forma for full-cost mark-up costing per unit

Answer 4

Question 5

Outline the advantages (4) and disadvantages (3) of full-cost mark-up pricing

Answer 5

Question 6

Outline the pro-forma for marginal-cost mark-up per unit

Answer 6

Question 7

With regards to inflation risk for the buyer and seller, when does each bear the risk?

Answer 7

Seller:
* when a selling price is determined prior to delivery of the goods or services.
* when a credit period is offered to the buyer

Buyer:
* when the buyer agrees to prices based on actual cost incurred plus a profit mark-up

Question 8

What is margin pricing?

Answer 8

Margin pricing is the pricing of products where the profit is a percentage of the sales price

Question 9

Outline the pro-forma for margin costing per unit

Answer 9

Question 10

Outline the pro-forma for mark-up costing for sales as a whole

Answer 10

Question 11

Outline the pro-forma for margin costing for sales as a whole

Answer 11

Question 12

What is transfer pricing?

Answer 12

Transfer pricing is the value attached to the goods or services transferred between related parties (i.e. sales of goods/services between two divisions of the same company or two companies in the same group)

Question 13

Why are we concerned with transfer pricing in management accounts? Briefly describe a simple scenario outlining this

Answer 13

In Management Information we will typically see situations where one division will make a component that can either be sold externally, or transferred to another division to use in another product.

For example, imagine that LecCo (an electronics manufacturer) has two divisions, Alpha and Beta.
* Alpha makes a component (a processor chip called the X) which can be sold externally or transferred to another division (Beta).
* Beta then use this processor chip in a product (the LecFone) which is sold externally.
* The key question is: what transfer price should Alpha charge when it sells units of component X to Beta?

Question 14

What are the main aims of a transfer pricing system?

Answer 14

Companies and groups will want to achieve several different aims when setting a transfer price:
* To enable the realistic measurement of divisional profit.
* To provide the supplier with a realistic profit and the receiver with a realistic cost.
* To give autonomy to managers.
* To encourage goal congruence, whereby individual managers’ own goals are the same as the goals of the company / group as a whole.
* To ensure profit maximisation for the company / group as a whole.

As we will see, it may be difficult to reconcile all of these aims.

Question 15

What is meant by a goal-congruent decision?

Answer 15

A goal-congruent decision is one which maximises the contribution earned by the company / group of companies.

Question 16

What can we disregard when considering the goal congruence of any decisions regarding transfer price?

Answer 16

We will disregard any fixed costs, as these will be unaffected by any decisions made in the short-term (as they are fixed), and instead, focus on variable costs and revenues

Question 17

What decision is a company likely to make with regards to transfer-prices? How might this differ to division managers?

Answer 17

A company is likely to make a goal congruent decision that increases the contribution of the whole company

Division managers, however, migh take decisions that increase the contribution of their division at the detriment of the company

Question 18

What are the two optimimum values of transfer-prices that a division could set?

Answer 18

• the market-value for the goods (this is the maximum value)
• the variable production costs (this is the minimum value)

Question 19

Outline under what circumstances each of these transfer prices would be optimum

Answer 19

• If a perfectly competitive market exists for a product and the supplying division is operating at full capacity, then the external market price (as adjusted for any cost savings on internal transfers) is the optimum transfer price - this transfer price represents the opportunity cost for the transferring division
• If the supplying division has spare capacity, the optimum transfer price for decision making is the variable production cost incurred by the transferring division

Question 20

What is meant by the oppurtunity cost with regards to transfer pricing?

Answer 20

Oppurtunity cost is the ‘cost’ incurred by the transferring division for forgoing the external sale of the goods in order to transfer to the other division

It is the transfer price less any variable costs

Question 21

What might occur if the transfer price is set too high by the transferring division?

Answer 21

If they feel they are being charged too much, the receiving divisions might consider external alternatives to purchasing components

Question 22

Outline under what circumstances, from the whole-company’s point-of-view, it would be beneficial to buy-in from external suppliers

Answer 22

Question 23

What is two-part transfer pricing? Briefly describe it

Answer 23

Two-part transfer pricing involves two excahnges being made:
- the transfer of goods is charged at a predetermined standard variable cost throughout the period - the transfer price is the variable costs
- an additional periodic charge for fixed costs would then also be made by the supplying division to the receiving division - a contribution is made towards the fixed costs of the supplying division by the receiving division

Question 24

What is dual pricing? Briefly describe it

Answer 24

Dual transfer pricing involves the supplying division being credited with a different price from that which is charged to the receiving division.
* the receiving division will record the transfers at variable or marginal cost
* the supplying division is credited with the market value or with a cost-plus transfer price
* The over-arching head division will then make an adjsutment in its own accounts to reflect this difference between the divisions

Question 25

Why is dual pricing beneficial? What is a frawback

Answer 25

The dual pricing method can be effective in avoiding sub-optimal decisions - the supplying division has a profit incentive to make the transfer and the receiving division is receiving the goods at the minimum value.

However, it can be administratively cumbersome.

Question 26

REVIEW TRANSFER PRICING NOTES