Question 1

The Machining Division has a capacity of 2,000 units. Its sales and cost data are: $$\begin{array} { l r } 
\text { Selling price per unit } & \$ 100 \
\text { Variable manufacturing costs per unit } & \$ 25 \
\text { Variable administrative costs per unit } & \$ 5 \
\text { Total fixed manufacturing overhead } & \$ 20,000 \
\text { Total fixed administrative costs } & \$ 5,000
\end{array}$$ The Machining Division is currently selling 1,900 units to outside customers, and the Assembly Division wants to purchase 300 units from Machining. If the transaction takes place, the variable administrative costs per unit on the units transferred to Assembly will be $2/unit, not $5/unit. What should be the transfer price?

Accepted Answer

The transfer price should be equal to the variable manufacturing cost per unit plus the variable administrative cost per unit. In this case, the variable manufacturing cost per unit is $25 and the variable administrative cost per unit is $2. Therefore, the transfer price should be $25 + $2 = $27.

Question 2

Market-based pricing:

Accepted Answer

Market-based pricing considers both demand and competitors' prices to determine the optimal price point. This approach allows businesses to stay competitive while also ensuring that they maximize profit based on consumer demand.

Question 3

Not-for-profit pricing decisions:
I. Are made using the same practices as for-profit pricing decisions
II. Sometimes result in different prices for different customers
III. Sometimes subsidize particular groups of people

Accepted Answer

Not-for-profit pricing decisions sometimes result in different prices for different customers and sometimes subsidize particular groups of people. However, not-for-profit organizations often have different goals and values than for-profit companies, which may result in different pricing strategies. Therefore, not-for-profit pricing decisions are not always made using the same practices as for-profit pricing decisions.

Question 4

Division X sells organic high-gluten flour to Division Y. Division X incurs costs of $0.375 per kilogram of flour. Division Y makes loaves of bread that sell for $2.50 each. Division Y incurs costs of $1.25 per loaf, excluding the cost of flour. Each loaf of bread uses one-half kilogram of flour.
What is the operating income per loaf for Division Y if the transfer price is set at $0.625 per kilogram for flour?

Accepted Answer

Division Y incurs a cost of $0.625 per half kilogram of flour ($0.375 x 2) purchased from Division X. Thus, the total cost per loaf for Division Y is $1.25 + $0.625 = $1.875. 
Revenue per loaf is $2.50.
Operating income per loaf = Revenue per loaf - Total cost per loaf = $2.50 - $1.875 = $0.6250.
Therefore, the operating income per loaf for Division Y is $0.9375.

Question 5

In Canada, dumping is:
I. Selling a product at a price that is below the market price
II. Not a legal problem for Canadian companies that have no foreign subsidiaries
III. Prosecuted by setting tariffs

Accepted Answer

The answer of In Canada, dumping is:
I. Selling a product...

Question 6

What is the basis of the government legislation to restrict a company's ability to shift income via transfer pricing?

Accepted Answer

The basis of government legislation to restrict a company's ability to shift income via transfer pricing is that transfer prices should be the same as those in an arm's length transaction. This ensures that transactions between related parties are conducted as if the parties were unrelated, preventing companies from manipulating prices to shift profits to lower-tax jurisdictions.

Question 7

What is the best transfer price policy?

Accepted Answer

The opportunity cost approach is considered the best transfer price policy as it reflects the true economic cost of transferring goods or services within a company, ensuring optimal decision-making and resource allocation.

Question 8

In Canada, predatory pricing occurs when:

Accepted Answer

Predatory pricing refers to the practice of setting prices very low in order to drive out competition and increase market share. This can harm consumers in the long run by reducing competition and leading to higher prices once the competition has been eliminated.

Question 9

The Kelso Division produces and sells a product to external and internal customers. Per-unit information about its operations include: $\begin{array}{l}
\begin{array}{lr}
\text { Selling price per unit to external customers } & \$ 250 \
\text { Variable manufacturing costs per unit } & 115 \
\text { Fixed manufacturing overhead costs per unit } &70
\end{array}\

\end{array}$
  If Kelso is operating at capacity and has unlimited external customer demand, what should be the transfer price for Kelso's product?

Accepted Answer

Since Kelso is operating at capacity and has unlimited external customer demand, the transfer price should be based on the variable cost of the product, which is $160. However, since the internal customer is a part of the same company, the transfer price should also consider the opportunity cost of selling to the external customer instead. The contribution margin per unit when selling to external customers is $250 - $160 = $90. Therefore, the transfer price should be at least equal to the contribution margin, which is $90. Choice B is the closest option to this price.

Question 10

Division S sold a part to both Division P and outside customers last year. The revenues from these sales were $30,000 (1,000 units) and $35,000 (1,000 units), respectively. Next year, S plans to increase the unit sales price to $42 and wants a proportionate increase in the sales price to Division P. The unit costs are $9 variable and $15 fixed. If Division P does not agree to the price increase, 50% of Division S's fixed costs will be eliminated.
What is the highest price Division P would be willing to pay for external purchases?

Accepted Answer

Division P would be willing to pay up to the external market price of $36.00, which is the current price Division S charges to outside customers.

Question 11

The Kelso Division produces and sells a product to external and internal customers. Per-unit information about its operations include: $\begin{array}{l}
\begin{array}{lr}
\text { Selling price per unit to external customers } & \$ 250 \
\text { Variable manufacturing costs per unit } & 115 \
\text { Fixed manufacturing overhead costs per unit } &70
\end{array}\

\end{array}$
  If Kelso has sufficient excess capacity to meet internal demand, what should be the transfer price for Kelso's product?

Accepted Answer

The transfer price should at least cover the variable costs when there is excess capacity, which is $115 per unit in this case. Fixed costs are not relevant for the transfer price decision in this scenario because they are incurred regardless of whether the product is sold internally or externally.

Question 12

Division X sells organic high-gluten flour to Division Y. Division X incurs costs of $0.375 per kilogram of flour. Division Y makes loaves of bread that sell for $2.50 each. Division Y incurs costs of $1.25 per loaf, excluding the cost of flour. Each loaf of bread uses one-half kilogram of flour.
What is the operating income per kilogram of flour for Division X if the transfer price is set at $0.625/kg?

Accepted Answer

The operating income per kilogram of flour for Division X is calculated as the transfer price minus the cost per kilogram. With a transfer price of $0.625/kg and costs of $0.375/kg, the operating income is $0.625 - $0.375 = $0.25 per kilogram.

Question 13

The Internet and global competition:

Accepted Answer

The Internet has increased the use of market-based pricing as consumers can easily compare prices and availability of products globally, leading to more competitive pricing strategies among businesses.

Question 14

Prices that are calculated using elasticities:

Accepted Answer

Elasticity-based pricing often involves setting prices by applying a mark-up over variable costs, taking into account the elasticity of demand to optimize pricing strategy.

Question 15

Price elasticity of demand:

Accepted Answer

Price elasticity of demand indicates how much the quantity demanded of a product will change in response to a change in its price. It is a measure of the sensitivity of sales to changes in price.

Question 16

Division X sells organic high-gluten flour to Division Y. Division X incurs costs of $0.375 per kilogram of flour. Division Y makes loaves of bread that sell for $2.50 each. Division Y incurs costs of $1.25 per loaf, excluding the cost of flour. Each loaf of bread uses one-half kilogram of flour.
What is the operating income for the entire organization if 100,000 loaves of bread are sold?

Accepted Answer

The operating income for the entire organization can be calculated by first determining the total revenue from selling 100,000 loaves of bread, then subtracting the total costs incurred by both divisions. Total revenue is $2.50 per loaf * 100,000 loaves = $250,000. The cost of flour per loaf is $0.375 * 0.5 = $0.1875, so for 100,000 loaves, the cost of flour is $0.1875 * 100,000 = $18,750. Division Y's other costs are $1.25 per loaf * 100,000 loaves = $125,000. The total costs are $18,750 (flour) + $125,000 (other costs) = $143,750. Therefore, the operating income is $250,000 (revenue) - $143,750 (total costs) = $106,250.

Question 17

The Machining Division is currently operating at capacity (2,000 units). Its sales and cost data are: $$\begin{array} { l r } 
\text { Selling price per unit } & \$ 100 \
\text { Variable manufacturing costs per unit } & \$ 25 \
\text { Variable administrative costs per unit } & \$ 5 \
\text { Total fixed manufacturing overhead } & \$ 20,000 \
\text { Total fixed administrative costs } & \$ 5,000
\end{array}$$ If the Assembly Division is currently buying from an outside supplier at $98 per unit, what will be the effect on overall company profits if internal sales of 2000 units from Machining to Assembly take place at the optimum transfer price?

Accepted Answer

The answer of The Machining Division is currently operating at...

Question 18

Dual-rate transfer pricing systems are appropriate when the:

Accepted Answer

Dual-rate transfer pricing systems are appropriate when the selling department has excess capacity because the variable cost of producing one additional product is very low or close to zero. In this case, the company can benefit from transferring goods between departments at a lower rate, thus increasing overall profitability.

Question 19

The death spiral is:
I. Setting prices very low
II. Two organizations conspiring to set prices
III. A problem of prices based on average cost and declining sales

Accepted Answer

The death spiral refers to a problem of prices based on average cost and declining sales, which leads to a vicious cycle of decreasing profits, lower investment, and decreased capacity. Setting prices very low (option I) may be a short-term strategy to attract buyers, but it does not necessarily lead to a death spiral. Conspiring to set prices (option II) is illegal and unethical, and should not be considered as a viable option.

Question 20

Which of the following transfer pricing systems potentially takes the most time to establish?

Accepted Answer

The negotiated transfer pricing system potentially takes the most time to establish because it involves discussions and concessions between the two divisions or companies involved in the transfer pricing arrangement. It can involve a lengthy negotiation process and may require external mediators to reach an agreement. In contrast, market-based transfer pricing relies on existing market prices, dual-rate transfer pricing uses two different rates based on predetermined criteria, and full-cost transfer pricing utilizes actual costs plus a markup, all of which are more straightforward and easier to establish.

Quiz 14: Strategic Management of Costs