Problem 1: Nancy Company Has Budgeted Sales Of The Following
Problem 1 Nancy Company Has Budgeted Sales Of The Follo
Nancy Company has budgeted sales of $300,000 with the following budgeted costs: direct materials $60,000; direct manufacturing labor $40,000; factory overhead (variable) $30,000; factory overhead (fixed) $50,000; selling and administrative expenses (variable) $20,000; selling and administrative expenses (fixed) $30,000.
Question 1:
Compute the average markup percentage for setting prices as a percentage of the full cost of the product.
Question 2:
Compute the average markup percentage for setting prices as a percentage of the variable cost of the product.
Question 3:
Compute the average markup percentage for setting prices as a percentage of the variable manufacturing costs.
Problem 2
Better Food Company recently acquired an olive oil processing company with an annual capacity of 2,000,000 liters, which processed and sold 1,400,000 liters last year at a market price of $4 per liter.
The purpose of the acquisition was to supply oil to the cooking division, which needs 800,000 liters annually. The olive oil division's production costs at capacity are: direct materials $1.00 per liter, direct processing labor $0.50 per liter, variable processing overhead $0.24 per liter, fixed processing overhead $0.40 per liter, totaling $2.14 per liter.
The management is considering transfer prices for sales from the division to the cooking division and is debating whether to use the market price of $4, the division's cost of $2.14, or another figure. Any excess from the division not sold internally can be sold externally at $4 per liter.
Question 1:
Compute the operating income for the olive oil division using a transfer price of $4.
Question 2:
Compute the operating income for the olive oil division using a transfer price of $2.14.
Question 3:
What transfer price(s) do you recommend? Compute the operating income for the olive oil division using your recommended transfer price(s).
Additional question (not fully provided):
1. (TCO 7) Short-run pricing decisions include (Points: 3)
Paper For Above instruction
The following comprehensive analysis addresses the financial and managerial decision-making considerations for Nancy Company and Better Food Company, focusing on pricing strategies, cost management, and transfer pricing policies. The discourse explores the calculation of markup percentages based on different cost bases, evaluates transfer pricing methods considering divisional profitability, and discusses short-term pricing decisions with strategic implications.
Introduction
The importance of accurately determining pricing strategies and transfer prices cannot be overstated in managerial accounting. These decisions directly influence profitability, competitive positioning, and internal control. This paper aims to dissect the specific calculations in the provided scenarios, including markup percentages relative to different cost bases and transfer pricing strategies within internal divisions, offering insights into optimal managerial practices.
Part 1: Markup Percentage Calculations for Nancy Company
Nancy Company's overall sales are projected at $300,000, with various costs categorized as direct materials, labor, factory overhead, and selling/admin expenses. To compute markup percentages, we first determine the total costs and then analyze as a percentage of relevant costs.
Full Cost of the Product
The total costs are derived by summing direct materials ($60,000), direct labor ($40,000), factory overhead ($30,000 + $50,000), and selling & administrative expenses ($20,000 + $30,000). Therefore:
- Factory overhead (total): $80,000
- Total manufacturing costs: $60,000 + $40,000 + $80,000 = $180,000
- Total costs including selling and admin expenses: $180,000 + $50,000 + $20,000 + $30,000 = $280,000
However, for markup calculations, separating manufacturing and non-manufacturing costs is crucial.
Full production cost (manufacturing only) = direct materials + direct labor + factory overhead = $60,000 + $40,000 + $80,000 = $180,000.
Cost per unit (assuming sales of $300,000 and proportional costs) is not explicitly provided in units, but for percentage calculations, we assume costs and sales are aligned proportionally for the purpose of calculating markup percentages.
Question 1: Full Cost Markup
The markup percentage based on full cost is calculated as:
Markup percentage = (Selling Price - Full Cost) / Full Cost × 100%
Since the full cost per product is assumed proportionally, and the sales are $300,000, the markup as a percentage of full cost is:
Markup % = [(Sales price per unit) - (Cost per unit)] / (Cost per unit) × 100%
Given that the market and actual sale price structure is not explicitly detailed, for simplicity, the markup percentage on full cost is computed assuming the selling price is set at some amount covering costs plus profit margin. Alternatively, considering the desired markup rate, the calculation involves the total costs ($180,000) and total sales ($300,000).
Therefore, the gross profit margin is: (Sales - Costs) / Sales = ($300,000 - $180,000) / $300,000 = 40%.
The markup percentage related to full costs is thus approximately 66.67%, calculated as: (Gross profit) / (Cost of Goods Sold) = ($120,000 / $180,000) = 66.67%.
Question 2: Variable Cost Markup
The variable costs total $60,000 (materials) + $40,000 (labor) + $30,000 (variable overhead) = $130,000.
Similarly, the markup percentage based on variable costs is:
Markup % = (Selling price - Variable costs) / Variable costs × 100%
Gross profit from variable costs is $300,000 - $130,000 = $170,000, representing roughly 130.77% markup over variable costs.
Question 3: Variable Manufacturing Costs Markup
Variable manufacturing costs are $60,000 + $40,000 + $30,000 (variable overhead) = $130,000.
Using this as the basis, the markup percentage is approximately 130.77%, similar to the calculation above, assuming the same sales revenue basis.
Part 2: Transfer Pricing Strategies for Better Food Company
The core discussion centers around appropriate transfer pricing between the olive oil division and the cooking division, where decisions significantly impact division performance and overall profitability.
Question 1: Transfer Price at Market Price ($4)
At the transfer price of $4, which is the external market rate, the olive oil division's operating income is calculated by considering the volume sold internally and externally. Since the division processed 1,400,000 liters, with 800,000 liters supplied to the cooking division, the remaining 600,000 liters are sold externally at market price.
The operating income is computed as:
Operating Income = (Transfer Price × Internal Transfer Volume) - (Variable Costs × Internal Transfer Volume) - Fixed Costs.
Assuming all units are sold at $4, and the division's costs are $2.14 per liter, the division's revenue from internal transfer is:
$4 × 800,000 liters = $3,200,000.
The total variable costs for the 800,000 liters are:
$2.14 × 800,000 = $1,712,000.
The fixed costs are allocated over total capacity, but for simplicity, the fixed overhead is $0 at the marginal level, or can be ignored for this analysis. The operating income then is:
=$3,200,000 - $1,712,000 = $1,488,000.
Question 2: Transfer Price at Cost ($2.14)
Using the cost of $2.14 per liter as transfer price, the calculation for division's operating income becomes:
Revenue: $2.14 × 800,000 = $1,712,000.
Variable costs: $1,712,000.
Since revenue equals variable costs, division's contribution margin is zero, and fixed overhead allocation affects overall income. The operating income remains neutral, indicating no profit gains from internal transfer at cost price unless fixed costs are reduced or additional synergies are realized.
Question 3: Recommended Transfer Price(s)
From an internal managerial perspective, a transfer price between the variable cost ($2.14) and the market price ($4) balances divisional interests and overall profitability. A common approach is to set the transfer price at cost plus some markup or at the marginal revenue relevant for decision-making.
Suppose a transfer price of $3 per liter, the division's income would be:
Revenue: $3 × 800,000 = $2,400,000.
Variable costs: $1,712,000.
Operating income: $2,400,000 - $1,712,000 = $688,000, illustrating profitable internal transfer while maintaining external market competitiveness.
Divisional cooperation improves, and overall company profitability increases with such a transfer price.
Conclusion
Accurate calculations of markup percentages and strategic transfer pricing are vital for effective managerial decisions. Managers should consider the implications of costing methods, external market conditions, fixed costs allocations, and divisional incentives when setting transfer prices. The most balanced approach often involves setting a transfer price within the range of variable cost and market price, enabling division profitability and organizational synergy.
References
- Drury, C. (2013). Management and Cost Accounting. Cengage Learning.
- Horngren, C. T., Datar, S. M., & Rajan, M. (2015). Cost Accounting: A Managerial Emphasis. Pearson.
- Garrison, R. H., Noreen, E. W., & Brewer, P. C. (2018). Managerial Accounting. McGraw-Hill Education.
- Langfield-Smith, K., Thorne, H., & Hilton, R. W. (2018). Management Accounting: Information for Creating and Managing Value. McGraw-Hill Education.
- Kaplan, R. S., & Atkinson, A. A. (2015). Advanced Management Accounting. Pearson.
- Anthony, R. N., & Govindarajan, V. (2007). Management Control Systems. McGraw-Hill Education.
- Horngren, C. T., Harrison, W. T., & Oliver, M. (2014). Financial & Managerial Accounting. Pearson.
- Blocher, E., Stout, D., Juras, P., & Cokins, G. (2019). Cost Management: A Strategic Emphasis. McGraw-Hill Education.
- Anthony, R. N., Dearden, J., & Bromwich, M. (2014). Management Control Systems. Pearson.
- Woodward, D. (2018). Managerial Accounting: Creating Value in a Dynamic Business Environment. McGraw-Hill Education.