Chapter 8 Study Notes: Transfer Pricing and Costing Methodologies

Announcements and Upcoming Responsibilities

  • The study announcements were set to help students prepare for the exam over the following week.

  • Today's agenda includes:

    • Finishing Chapter 8

    • Review problems related to the material

    • Discussion on transfer pricing

Review Problems and Quiz Instructions

  • Review date materials distributed:

    • Review problems provided in advance for individual practice

    • Class discussion on solving problems scheduled for Thursday

  • Excel case study due tonight:

    • Submissions to be made via Dropbox folder

    • Only one group member needs to submit the Excel workbook

    • All group members must complete the Brightspace Excel case study quiz

    • Quiz consists of fill-in-the-blank and multiple-choice questions corresponding to the case study

    • Due tonight before midnight

Study Schedule Leading Up to Exam

  • After today, students should review Chapter 8 notes and practice problems:

    • Focus on homework and lab quiz tomorrow (Wednesday)

    • Chapter 8 lab at 04:00 PM, hybrid format (in-person and Zoom)

  • Wiley quiz for Chapters 7 and 8 due Thursday night:

    • 60 minutes to complete, starting from when the link is clicked

    • Practice based on prior quizzes

  • Exam review scheduled for Monday, and the exam itself is Tuesday

Quick Overview of Previous Chapters

  • Chapter 5: Cost Behavior and Analysis

    • Key Topics:

    • Cost behavior types: fixed, variable, and mixed costs

    • Contribution Margin (CM): total, per unit, and as a percentage (CM Ratio)

    • Calculating break-even and target net income

    • Margins of safety in dollars and as a percentage of sales

  • Chapter 6: Multiple Product Scenarios

    • Key Concepts:

    • Weighted average contribution margin for breakeven analysis

    • Decision-making for maximizing production of multiple products utilizing limited resources

    • Degree of operating leverage for predicting profit changes with sales variations

  • Chapter 7: Incremental Analysis Decisions

    • Focused on five major decisions without specific formulas:

    1. Special Orders: Accept if incremental revenue exceeds incremental costs

    2. Make or Buy (Outsourcing): Choose the option with the lowest overall cost impacting net income

    3. Sell or Process Further: Assess net income from normal selling versus processing for further production

    4. Retain or Replace Equipment: Compare total costs over useful life of each option

    5. Eliminate or Keep a Division: Compare fixed cost savings with lost contribution margin

Summary of Chapter 8 Concepts

  • Discussed transfer pricing, target costing, and cost-plus pricing:

    • Target Costing:

    • For price takers (high competition): calculate target cost to maintain profitability and remain competitive

    • Calculation: Desired profit = ROI percentage a0(\text{Desired Cost} = \text{Market Price} - \text{Desired Profit} )

    • Cost-Plus Pricing:

    • For price makers (less competition): set price based on total cost plus desired markup or profit

    • Calculation: Selling Price = Internal Costs + Markup Percentage (\text{Selling Price} = \text{Cost} + \text{(Cost} \times \text{Markup Percentage)})

  • Transfer Pricing:

    • Minimum transfer pricing determined by internal variable costs and opportunity cost based on capacity:

    • At full capacity:

      • Formula: Minimum Transfer Price = Variable Cost + Lost Contribution Margin

      • Example: Sole division sells soles at external customer price and pays $11 variable cost, contributing $7 from outside sales, yielding $18 as transfer price (market price)

    • With excess capacity:

      • Minimum transfer price equals variable cost only, as there is no contribution margin loss from external sales

      • Example: Total variable cost minus savings derived internally recognized, setting a lower transfer price

Practice Problems Overview and Key Points

  • Real-world application of principles in practice scenarios showing impact of decisions on profitability

  • Variants between full capacity scenarios (where opportunity cost is considered) vs. excess capacity (where no opportunity cost applies)

  • Students advised to practice problems allocating time to strengthen mastery of discussed concepts before the exam

Key Formulas

  • Target Cost:
    [ \text{Target Cost} = \text{Market Price} - \text{Desired Profit} ]

  • Cost-Plus Selling Price:
    [ \text{Selling Price} = \text{Cost} + \text{(Cost} \times \text{Markup Percentage)}]

  • Minimum Transfer Price:

    • At Full Capacity:
      [ \text{Minimum Transfer Price} = \text{Variable Cost} + \text{Opportunity Cost} ]

    • With Excess Capacity:
      [ \text{Minimum Transfer Price} = \text{Internal Variable Cost} ]

    • Variable Cost Savings: Included if transferring internally

  • Both the selling price decrease and transfer costing impact when inter-company transfers dictated by management require thorough understanding of implications on profitability.

Final Notes

  • Encouragement for students to leverage practice materials and review handouts available for effective exam preparation.