Chapter 15 Transfer Pricing: True / False Questions

Chapter 15 Transfer Pricing
True / False Questions
1. A transfer price is the value assigned to the transfer of goods or services between divisions
within the same organization.
TRUE
2. Transfer prices are not used to record the exchange between two cost centers within the same
organization.
TRUE
Transfer prices are used for profit and investment centers. Cost centers are not concerned
with profits.
3. Transfer prices cannot be used for decision making, product costing, or performance
evaluation.
FALSE
Transfer pricing is used in decision making, product costing, and performance evaluation.
4. From an organization's viewpoint, transfer prices have no effect on total profits assuming the
transfer occurs between the two responsibility centers.

TRUE
Total profits are unaffected, divisional profits will have effects but they off-set.
5. If a transfer has no effect on divisional profit, risk-neutral managers will be indifferent between
making the transfer or not.

TRUE
Since there is no effect on profit, there is no risk.
6. If an intermediate market exists but divisions are prohibited from buying or selling from the
outside, the intermediate market can be ignored in determining the optimal transfer price.
TRUE
Since the divisions are prohibited, the outside price is irrelevant.
7. A perfect intermediate market exists if buyers can buy and sellers can sell outside of the
organization.
FALSE
A perfect market exists when buyers and sellers can have unlimited transactions with no
impact on prices.
8. When a perfect intermediate market exists, the optimal transfer price is the intermediate
market price.
TRUE
In a perfect market, the market price is optimal.
9. In general, the optimal transfer price for a division is the sum of its outlay costs and the
opportunity cost of not transferring its goods to another division.
FALSE
It is the opportunity cost of the resource at the point of the transfer. Normally this is the lost
contribution by not selling outside.
10. The use of an optimal transfer price eliminates potential conflicts between an organization's
interests and the divisional manager's interest.
FALSE
Conflicts may be reduced, but will not be eliminated.
11. A market price-based transfer price policy allows the selling division to determine the price for
transfers between divisions within the same organization.
FALSE
The market determines the price, not the division.
12. A selling division at capacity is indifferent between selling to outsiders and transferring inside
at the market price.

TRUE
The profit would be the same in either case.
13. When actual costs are used as the basis for a transfer, inefficiencies of the selling division are
transferred to the buying division.
TRUE
The selling division has no incentive to minimize the inefficiencies since they can all be passed
on.
14. A transfer made at cost does not motivate the selling division to transfer its goods or services
internally.
TRUE
There is no profit for the selling division.
15. In general, negotiated transfer prices fall in a range between the selling division's differential
costs and the buying division's market price.
TRUE
The seller's differential costs are the lowest the seller would accept; the buyer's market price is
the highest the buyer would be willing to pay.
16. In the United States, more companies use cost-based transfer prices than market-based
transfer prices.
TRUE
Numerous surveys have shown this to be true.
17. In interstate transactions, transfers can reduce an organization's tax liability when the selling
division is in a lower tax jurisdiction than the buying division.
TRUE
The transfers can in effect move profits from one jurisdiction to another.
18. Tax avoidance is unethical when inflated transfer prices are used in international transactions
to shift profits from a division in one country to a division in another country.
TRUE
The key is "inflated" prices. Market based prices would not be unethical.
19. An organization that has significant foreign operations must disclose how its transfer prices
are established between domestic and foreign divisions.
TRUE
This is a requirement of GAAP.
20. The GAAP financial reporting rules for segments require that all companies use transfer prices
based on market prices.
FALSE
GAAP does not specify what method must be used for transfer pricing except for the oil and
gas industry.
Multiple Choice Questions
21. Which of the following statements is(are) false?

(A) From an organization's viewpoint, transfer prices have no effect on total profits assuming
the transfer occurs between the two responsibility centers.
(B) A transfer price is the value assigned to the transfer of goods or services between
divisions within the same organization.
A. Only A is false.
B. Only B is false.
C. Both A and B are false.
D. Neither A nor B is false.
Transfer prices do not affect total profits, (B) is the definition of transfer price.
22. Which of the following responsibility centers is affected by the use of market-based transfer
prices?
A. Cost center.
B. Profit center.
C. Revenue center.
D. Production center.
Transfer prices affect only profit or investment centers.
23. Transfer prices would not be used by:

A. production centers.
B. investment centers.
C. profit centers.
D. cost centers.
Cost centers are not responsible for profits and don't have transfer pricing issues.
24. A division can sell externally for $60 per unit. Its variable manufacturing costs are $35 per unit,
and its variable marketing costs are $12 per unit. What is the opportunity cost of transferring
internally, assuming the division is operating at capacity?

A. $13.
B. $25.
C. $35.
D. $47.
($60 - $35 - $12) = $13
and its variable marketing costs are $12 per unit. What is the optimal transfer price for
transferring internally, assuming the division is operating at capacity?

A. $12.
B. $35.
C. $47.
D. $60.
Operating at capacity: market price = $60
26. Division A has variable manufacturing costs of $50 per unit and fixed costs of $10 per unit.
Assuming that Division A is operating at capacity, what is the opportunity cost of an internal
transfer when the market price is $75?
A. $20.
B. $25.
C. $50.
D. $60.
$75 - $50 = $25
Assuming that Division A is operating at capacity, what is the optimal transfer price of an
internal transfer when the market price is $75?

A. $20.
B. $25.
C. $50.
D. $75.
Operating at capacity: market price = $75
Assuming that Division A is operating significantly below capacity, what is the optimal transfer
price of an internal transfer when the market price is $75?

A. $20.
B. $25.
C. $50.
D. $60.
Below capacity: variable cost = $50
29. Division B has variable manufacturing costs of $50 per unit and fixed costs of $10 per unit.
Assuming that Division B is operating significantly below capacity, what is the opportunity cost
of an internal transfer when the market price is $75?
A. $0.
B. $25.
C. $50.
D. $60.
There are no opportunity costs when operating below capacity.
30. Dockside Enterprises Inc., operates two divisions: (1) a management division that owns and
manages bulk carriers on the Great Lakes and (2) a repair division that operates a dry dock in
Tampa, Florida. The repair division works on company ships, as well as other large-hull ships.
The repair division has an estimated variable cost of $37 per labor-hour. The repair division
has a backlog of work for outside ships. They charge $70.00 per hour for labor, which is
standard for this type of work. The management division complained that it could hire its own
repair workers for $45.00 per hour, including leasing an adequate work area.
What is the minimum transfer price per hour that the repair division should obtain for its
services, assuming it is operating at capacity?
A. $33.00.
B. $37.00.
C. $45.00.
D. $70.00.
When at capacity, the market price of $70 is the appropriate transfer price.
What is the maximum transfer price per hour that the management division should pay?
A. $33.00.
B. $37.00.
C. $45.00.
D. $70.00.
Outside price of $45
If the repair division had idle capacity, what is the minimum transfer price that the repair
division should obtain?

A. $33.00.
B. $37.00.
C. $45.00.
D. $70.00.
The selling division's variable cost of $37 is the appropriate transfer price.
33. You have been provided with the following information for Division X of a decentralized
company:
Selling price $90
Variable cost per unit 66
Fixed cost per unit 20
Sales volume (units) 22,500
Capacity (units) 25,000
Division Y of the same company would like to purchase all of its units internally. Division Y
needs 6,000 units each period and currently pays $84 per unit to an outside firm. What is the
lowest price that Division X could accept from Division Y? (Assume that Division Y wants to
use a sole supplier and will not purchase less than 6,000 from a supplier.)
A. $90.
B. $84.
C. $80.
D. $66.
[$66(2,500) + $90(3,500)]/6,000 = $80
34. When the selling division in an internal transfer has unsatisfied demand from outside
customers for the product that is being transferred, then the lowest acceptable transfer price
as far as the selling division is concerned is:
A. the variable cost of producing a unit of product.
B. the full absorption cost of producing a unit of product.
C. the market price charged to outside customers, less costs saved by transferring internally.
D. the amount that the purchasing division would have to pay an outside seller to acquire a
similar product for its use.
Unsatisfied demand is the key for the division and firm to maximize profits.
35. Division A makes a part that it sells to customers outside of the company. Data concerning this
part appear below:
Selling price to outside customers $75
Variable cost per unit $50
Total fixed costs $400,000
Capacity in units 25,000
Division B of the same company would like to use the part manufactured by Division A in one
of its products. Division B currently purchases a similar part made by an outside company for
$70 per unit and would substitute the part made by Division A. Division B requires 5,000 units
of the part each period. Division A can already sell all of the units it can produce on the outside
market. What should be the lowest acceptable transfer price from the perspective of Division
A?
A. $75.
B. $66.
C. $16.
D. $50.
See calculation below.

Since Division A can sell all of the units it can produce on the outside market ($75 per unit), it
would unfairly penalize Division A to be required to sell to Division B at any price less than it
can sell for on the outside.
36. Part 43X costs the Southern Division of Norris Corporation $26 to make - direct materials are
$10, direct labor is $4, variable manufacturing overhead is $9, and fixed manufacturing
overhead is $3. Southern Division sells Part 43X to other companies for $30. The Northern
Division of Norris Corporation can use Part 43X in one of its products. The Southern Division
has enough idle capacity to produce all of the units of Part 43X that the Northern Division
would require. What is the lowest transfer price at which the Southern Division should be
willing to sell Part 43X to the Northern Division?
A. $30.
B. $26.
C. $23.
D. $27.

The lowest price the part should be sold for is the total amount of variable costs that would be
incurred ($10 + $4 + $9 = $23).
37. The Wheel Division of Frankov Corporation has the capacity for making 75,000 wheel sets per
year and regularly sells 60,000 each year on the outside market. The regular sales price is
$100 per wheel set, and the variable production cost per unit is $65. The Retail Division of
Frankov Corporation currently buys 30,000 wheel sets (of the kind made by the Wheel
Division) yearly from an outside supplier at a price of $90 per wheel set. If the Retail Division
were to buy the 30,000 wheel sets it needs annually from the Wheel Division at $87 per wheel
set, the change in annual net operating income for the company as a whole, compared to what
it is currently, would be:
A. $600,000.
B. $225,000.
C. $750,000.
D. $135,000.

Price paid by the Retail Division for
$2,700,000
30,000 wheel sets
Less: Cost for Wheel Division to

(1,950,000)
produce 30,000 wheel sets × $65
Less: Lost profit for the Wheel Division
to cut back production ($100 - $65 ×

(525,000)
15,000 wheel sets)
Change in net annual operating

$225,000
income for the company as a whole
38. Division X makes a part that it sells to customers outside of the company. Data concerning this
part appear below:
Selling price to outside

$50
customers
Division Y of the same company would like to use the part manufactured by Division X in one
of its products. Division Y currently purchases a similar part made by an outside company for
$49 per unit and would substitute the part made by Division X. Division Y requires 5,000 units
of the part each period. Division X has ample excess capacity to handle all of Division Y's
needs without any increase in fixed costs and without cutting into outside sales. According to
the formula in the text, what is the lowest acceptable transfer price from the standpoint of the
selling division?
A. $50.
B. $49.
C. $46.
D. $30.

Since Division X has ample excess capacity, the lowest price the part should be sold for is the
total amount of variable costs that would be incurred, or $30 per unit.
39. Division A makes a part that it sells to customers outside of the company. Data concerning this
part appear below:
Selling price to outside

$40
customers
Division B of the same company would like to use the part manufactured by Division A in one
of its products. Division B currently purchases a similar part made by an outside company for
$38 per unit and would substitute the part made by Division A. Division B requires 5,000 units
of the part each period. Division A has ample capacity to produce the units for Division B
without any increase in fixed costs and without cutting into sales to outside customers. If
Division A sells to Division B rather than to outside customers, the variable cost be unit would
be $1 lower. What should be the lowest acceptable transfer price from the perspective of
Division A?
A. $40.
B. $38.
C. $30.
D. $29.

Since Division X has ample excess capacity, the lowest price the part should be sold for is the
total amount of variable costs that would be incurred, or $29 per unit ($30 - $1).
40. The Raisin Division of Trail Mix Foods, Inc. had the following operating results last year:
Sales (150,000 pounds of raisins) $60,000
Variable expenses 37,500
Contribution margin 22,500
Fixed expenses 12,000
Profit $10,500
Raisin expects identical operating results this year. The Raisin Division has the ability to
produce and sell 200,000 pounds of raisins annually.
Assume that the Peanut Division of Trail Mix Foods wants to purchase an additional 20,000
pounds of raisins from the Raisin Division. Raisin will be able to increase its profit by accepting
any transfer price above:
A. $0.40 per pound.
B. $0.08 per pound.
C. $0.15 per pound.
D. $0.25 per pound.

Variable expenses of $37,500 ÷ 150,000 pounds = $0.25 per pound.
41. The Raisin Division of Trail Mix Foods, Inc. had the following operating results last year:
Sales (150,000 pounds of raisins) $60,000
Variable expenses 37,500
Profit $10,500
Raisin expects identical operating results this year. The Raisin Division has the ability to
produce and sell 200,000 pounds of raisins annually.
Assume that the Raisin Division is currently operating at its capacity of 200,000 pounds of
raisins. Also assume again that the Peanut Division wants to purchase an additional 20,000
pounds of raisins from the Raisin Division. Under these conditions, what amount per pound of
raisins would the Raisin Division have to charge Peanut in order to maintain its current profit?
A. $0.40 per pound.
B. $0.08 per pound.
C. $0.15 per pound.
D. $0.25 per pound.

Sales (200,000 pounds of raisins × $0.40) $80,000
Variable expenses ($0.25 per pound) 50,000
Profit $18,000
Since the Raisin Division is already operating at capacity, it would have to charge the Peanut.
Division $0.40 per pound to maintain its current profit.
42. The Gear Division makes a part with the following characteristics:
Production capacity 25,000 units
Fixed cost, total $100,000
Motor Division of the same company would like to purchase 10,000 units each period from the
Gear Division. The Motor Division now purchases the part from an outside supplier at a price
of $17 each.
Suppose the Gear Division has ample excess capacity to handle all of the Motor Division's
needs without any increase in fixed costs and without cutting into sales to outside customers.
If the Gear Division refuses to accept the $17 price internally and the Motor Division continues
to buy from the outside supplier, the company as a whole will be:
A. worse off by $70,000 each period.
B. better off by $10,000 each period.
C. worse off by $60,000 each period.
D. worse off by $20,000 each period.
See calculations below.

Differential of 10,000 units at the outside customer price ($17) and the cost price ($11) of $6,
for a total of $60,000 worse off each period.

43. The Gear Division makes a part with the following characteristics:
Production capacity 25,000 units
Fixed cost, total $100,000
Motor Division of the same company would like to purchase 10,000 units each period from the
Gear Division. The Motor Division now purchases the part from an outside supplier at a price
of $17 each.
Suppose that the Gear Division is operating at capacity and can sell all of its output to outside
customers. If the Gear Division sells the parts to Motor Division at $17 per unit, the company
as a whole will be:

A. better off by $10,000 each period.
B. worse off by $20,000 each period.
C. worse off by $10,000 each period.
D. There will be no change in the status of the company as a whole.

Differential of 10,000 units at the outside supplier price ($18) and the price to Motor Division
($17) of $1, for a total of $10,000 worse off each period.

44. Division A produces a part with the following characteristics:
Selling price per unit $30
Variable costs per unit $18
Fixed costs per unit $3
Division B, another division in the company, would like to buy this part from Division A.
Division B is presently purchasing the part from an outside source at $28 per unit. If Division A
sells to Division B, $1 in variable costs can be avoided.
Suppose Division A is currently operating at capacity and can sell all of the units it produces
on the outside market for its usual selling price. From the point of view of Division A, any sales
to Division B should be priced no lower than:
A. $27.
B. $29.
C. $20.
D. $28.

Since Division A is already operating at capacity, it would have to charge Division B $29 per
unit ($30 less the $1 in variable cost that can be avoided).

45. Division A produces a part with the following characteristics:
Selling price per unit $30
Variable costs per unit $18
Fixed costs per unit $3
Division B, another division in the company, would like to buy this part from Division A.
Division B is presently purchasing the part from an outside source at $28 per unit. If Division A
sells to Division B, $1 in variable costs can be avoided.
Suppose that Division A has ample idle capacity to handle all of Division B's needs without
any increase in fixed costs and without cutting into its sales to outside customers. From the
point of view of Division A, any sales to Division B should be priced no lower than:
A. $29.
B. $30.
C. $18.
D. $17.

Since Division A has excess operating capacity, it should charge Division B $17 per unit ($18
variable cost per unit less the $1 in variable cost that can be avoided).
46. The Pillar Division of the Gothic Building Company produces basic pillars which can be sold to
outside customers or sold to the Lantern Division of the Gothic Company. Last year, the
Lantern Division bought all of its 25,000 pillars from Pillar at $1.50 each. The following data
are available for last year's activities of the Pillar Division:
300,000
Capacity in units
pillars
Selling price per pillar to outside

$1.75
customers
Variable costs per pillar $0.90
Fixed costs, total $150,000

The total fixed costs would be the same for all the alternatives considered below.
Suppose there is ample capacity so that transfers of the pillars to the Lantern Division do not
cut into sales to outside customers. What is the lowest transfer price that would not reduce the
profits of the Pillar Division?

A. $0.90.
B. $1.35.
C. $1.41.
D. $1.75.

Since the Pillar Division has excess operating capacity, it should charge the Lantern Division
the variable cost of $0.90 per unit.
300,000
Capacity in units
pillars

$1.75
customers
Suppose the transfers of pillars to the Lantern Division cut into sales to outside customers by
15,000 units. What is the lowest transfer price that would not reduce the profits of the Pillar
Division?
A. $0.90.
B. $1.35.
C. $1.41.
D. $1.75.
Loss of existing outside sales at a
contribution margin of $0.85 ($1.75 - $12,750
$0.90) × 15,000 units
÷ Units to be supplied to the Lantern

25,000
Division
Additional cost per unit for the Lantern $0.51
Division
Current cost ($0.90) + Additional costs

$1.41
($0.51)
300,000
Capacity in units
pillars

$1.75
customers
Suppose the transfers of pillars to the Lantern Division cut into sales to outside customers by
15,000 units. Further suppose that an outside supplier is willing to provide the Lantern Division
with basic pillars at $1.45 each. If the Lantern Division had chosen to buy all of its pillars from
the outside supplier instead of the Pillar Division, the change in net operating income for the
company as a whole would have been:

A. $1,250 decrease.
B. $10,250 increase.
C. $1,000 decrease.
D. $13,750 decrease.

The incremental change in net operating income to the company as a whole would be 25,000
units @ $0.04 per unit, for a total of $1,000 in decreased profits.
49. The Stake Division of the Outdoor Lumination Company produces stakes which can be sold to
outside customers or transferred to the Solar Light Division of the Outdoor Lumination
Company. Last year, the Solar Light Division bought 50,000 stakes from the Stake Division at
$2.50 each. The following data are available for last year's activities in the Stake Division:
400,000
Capacity in units
stakes
350,000
Quantity sold to outside customers
stakes
Selling price per stake to outside

$3.00
customers
Total variable costs per stake $2.00
Fixed operating costs $200,000
In order to sell 50,000 stakes to the Solar Light Division, the Stake Division must give up
sales of 30,000 stakes to outside customers. That is, the Stake Division could sell 380,000
stakes each year to outside customers (rather than only 350,000 stakes as shown above) if it
were not making sales to the Solar Light Division.
According to the formula in the text, what is the lowest acceptable transfer price from the
viewpoint of the selling division?
A. $2.50.
B. $2.00.
C. $2.60.
D. $3.00.
Loss of existing outside sales at a $30,000
contribution margin of $1 ($3.00 - $2.00) ×
30,000 units
÷ Units to be supplied to the Solar Light

50,000
Division
Additional cost per unit for the Solar Light

$0.60
Division
Current cost ($2.00) + Additional costs

$2.60
($0.60)
50. The Stake Division of the Outdoor Lumination Company produces stakes which can be sold to
outside customers or transferred to the Solar Light Division of the Outdoor Lumination
Company. Last year, the Solar Light Division bought 50,000 stakes from the Stake Division at
$2.50 each. The following data are available for last year's activities in the Stake Division:
400,000
Capacity in units
stakes
350,000
Quantity sold to outside customers
stakes
Selling price per stake to outside

$3.00
customers
Total variable costs per stake $2.00
Fixed operating costs $200,000
In order to sell 50,000 stakes to the Solar Light Division, the Stake Division must give up
sales of 30,000 stakes to outside customers. That is, the Stake Division could sell 380,000
stakes each year to outside customers (rather than only 350,000 stakes as shown above) if it
were not making sales to the Solar Light Division.
Suppose that last year an outside supplier would have been willing to provide the Solar Light
Division with the basic stakes at $2.10 each. If the Solar Light Division had chosen to buy all of
its stakes from the outside supplier instead of the Stake Division, the change in net operating
income for the company as a whole would have been:
A. $45,000 increase.
B. $20,000 decrease.
C. $20,000 increase.
D. $25,000 increase.
Additional unit cost ($0.10) of purchasing from outside vendor × 50,000 units ($5,000)
Additional profit on 30,000 units that would have been made to outside customers that had to
be foregone by servicing the requirements of the Solar Light Division at a contribution margin
30,000
of $1 ($3.00 - $2.00) × 30,000 units
Increase in net income for the company as a whole $25,000
51. Division X makes a part that it sells to customers outside of the company. Data concerning this
part appear below:
Division Y of the same company would like to use the part manufactured by Division X in one
of its products. Division Y currently purchases a similar part made by an outside company for
$49 per unit and would substitute the part made by Division X. Division Y requires 5,000 units
of the part each period. Division X can sell all of the units it makes to outside customers. What
is the lowest acceptable transfer price from the standpoint of the selling division?
A. $50.
B. $49.
C. $46.
D. $30.

(Note: Due to limitations in fonts and word processing software, > and < signs must be used in
this solution rather than "greater than or equal to" and "less than or equal to" signs.)
From the perspective of the selling division, profits would increase as a result of the transfer if,
and only if:
Transfer price > Variable cost + Opportunity cost
The opportunity cost is the contribution margin on the lost sales, divided by the number of
units transferred:
Opportunity cost = [($50 - $30) × 5,000] ÷ 5,000 = $20

Therefore, Transfer price > $30 + $20 = $50.
52. Division X of Operandi Corporation makes and sells a single product which is used by
manufacturers of fork lift trucks. Presently it sells 12,000 units per year to outside customers at
$24 per unit. The annual capacity is 20,000 units and the variable cost to make each unit is
$16. Division Y of Operandi Corporation would like to buy 10,000 units a year from Division X
to use in its products. There would be no cost savings from transferring the units within the
company rather than selling them on the outside market. What should be the lowest
acceptable transfer price from the perspective of Division X?
A. $24.00.
B. $21.40.
C. $17.60.
D. $16.00.

(Note: Due to limitations in fonts and word processing software, > and < signs must be used
in this solution rather than "greater than or equal to" and "less than or equal to" signs.)
and only if:
units transferred:
Opportunity cost = [($24 - $16) × 2,000*] ÷ 10,000 = $1.60

*10,000 - (20,000 - 12,000) = 2,000
Therefore, Transfer price > $16 + $1.60 = $17.60.
53. Division A of Chappelle Company has the capacity for making 3,000 motors per month and
regularly sells 1,950 motors each month to outside customers at a contribution margin of $62
per motor. The variable cost per motor is $35.70. Division B of Chappelle Company would like
to obtain 1,400 motors each month from Division A. What should be the lowest acceptable
transfer price from the perspective of Division A?
A. $26.57.
B. $51.20.
C. $35.70.
D. $62.00.

and only if:
Transfer price > Variable cost per unit + Opportunity cost
units transferred:
Opportunity cost = [$62 × 350*] ÷ 1,400 = $15.50
*1,400 - (3,000 - 1,950) = 350
Therefore, Transfer price > $35.70 + $15.50 = $51.20.
54. Which of the following statements is(are) true?

(A) If a transfer has no effect on divisional profit, managers will be indifferent between making
the transfer or not.
(B) If an intermediate market exists but divisions are prohibited from buying or selling from the
outside, the intermediate market can be ignored in determining the optimal transfer price.
A. Only A is true.
B. Only B is true.
C. Both A and B are true.
D. Neither A nor B is true.
Both are true statements.
55. In general, if a potential transfer has no effect on divisional profits:

A. no transfer will take place between the divisions.
B. managers will be indifferent between making the transfer or not.
C. the organization should not intervene to force a transfer.
D. the optimal transfer price is the opportunity cost for the buying division.
Managers are motivated by the profits of their division. If there is no effect, managers will be
indifferent.
56. An intermediate market is perfect when:

A. there are no quality differences between inside and outside suppliers.
B. there are quality differences between inside and outside customers.
C. buyers and sellers can sell any quantity without affecting the market price.
D. buyers and sellers are motivated to make decisions that are consistent with those of the
organization.
57. When there is no intermediate market:

A. there is no optimal transfer price.
B. the selling division cannot transfer its goods internally.
C. the buying division cannot purchase its goods externally.
D. there is no reason for top management to intervene in transfer pricing disputes.
The intermediate market is an external market for the goods.
58. The general principle on setting transfer prices that are in the organization's best interests is:
A. outlay cost plus opportunity cost of the resource at the point of transfer.
B. variable costs plus opportunity cost of the resource at the point of transfer.
C. lost contribution margin less the allocated fixed costs for the selling division.
D. gross margin for the buying division plus the gross margin for the selling division.
Incremental fixed costs may also occur and would be included in outlay costs.
59. If the selling division has excess capacity, the transfer price should be set at its:
A. differential outlay costs.
B. differential outlay costs plus the foregone contribution to the organization of making the
transfer internally.
C. selling price less the variable costs.
D. selling price less the variable costs plus the foregone contribution to the organization of
making the transfer internally.
The opportunity cost would be zero.
60. Given a competitive outside market for identical intermediate goods, what is the best transfer
price, assuming all relevant information is readily available?
A. Standard production cost per unit.
B. Market price of the intermediate goods.
C. Actual full cost per unit plus a normal markup.
D. Market price of the final goods less any opportunity costs.
The best price is the market price if it exists.
61. The optimal transfer price when there are intermediate markets is:
A. full cost.
B. outlay costs.
C. variable cost.
D. market prices.
If markets exist the market price is the optimal transfer price.
and its variable marketing costs are $6 per unit. What is the opportunity cost of transferring
internally, assuming the division is operating at capacity?
A. $15.
B. $19.
C. $21.
D. $25.
($40 - $15 - $6) = $19
Division A is operating at capacity, what is the opportunity cost of an internal transfer when the
market price is $35?

A. $5.
B. $10.
C. $25.
D. $30.
$35 - $25 = $10
64. Lock Division of Morgantown Corp. sells 80,000 units of part Z-25 to the outside market. Part
Z-25 sells for $40, has a variable cost of $22, and a fixed cost per unit of $10. The Lock
Division has a capacity to produce 100,000 units per period. The Cabinet Division currently
purchases 10,000 units of part Z-25 from the Lock Division for $40. The Cabinet Division has
been approached by an outside supplier willing to supply the parts for $36. What is the effect
on Morgantown's overall profit if the Lock Division refuses the outside price and the Cabinet
Division decides to buy outside?
A. No change in Morgantown's profits.
B. $140,000 decrease in Morgantown's profits.
C. $80,000 decrease in Morgantown's profits.
D. $40,000 increase in Morgantown's profits.
($36 - $22) × 10,000 = $140,000 decrease in profits
65. The Lock Division of Morgantown Corp. sells 80,000 units of part Z-25 to the outside market.
Part Z-25 sells for $40, has a variable cost of $22, and a fixed cost per unit of $10. The Lock
Division has a capacity to produce 100,000 units per period. The Cabinet Division currently
purchases 10,000 units of part Z-25 from the Lock Division for $40. The Cabinet Division has
been approached by an outside supplier willing to supply the parts for $36. What is the effect
on Morgantown's overall profit if the Lock Division accepts the outside price and the Cabinet
Division continues to buy inside?
A. No change in Morgantown's profits.
B. $140,000 decrease in Morgantown's profits.
C. $80,000 decrease in Morgantown's profits.
D. $40,000 increase in Morgantown's profits.
No change since costs have not changed for the Lock Division.
66. Concrete Corporation has two producing centers, Contractor and Retailer. The Contractor
Division has a variable cost of $12 for its products and a total fixed cost of $120,000. The
Contractor Division also has idle capacity for up to 50,000 units per month. The Retailer
Division would like to purchase 20,000 units of the Contractor Division's products per month,
but is unable to convince the Contractor Division to transfer units to the Retailer Division at
$16 per unit. The Contractor Division has consistently argued that the market price of $20 is
nonnegotiable. What is The Contractor Division's opportunity cost of not transferring units to
the Retailer Division?
A. $20.
B. $12.
C. $8.
D. $4.
$16 - $12 = $4
67. You have been provided with the following information for the Wool Division of a decentralized
company:
Selling price $45
Fixed cost per unit 12
Sales volume (units) 22,500
Capacity (units) 25,000
The Blanket Division would like to purchase all of its units internally. The Blanket Division
needs 6,000 units each period and currently pays $42 per unit to an outside firm. What is the
lowest price that Wool Division could accept from the Blanket Division? Assuming that the
Blanket Division wants to use a sole supplier and will not purchase less than 6,000 from a
supplier, what is the lowest price that Wool Division could accept from the Blanket Division?
A. $45.
B. $42.
C. $40.
D. $38.
[$33(2,500) + $45(3,500)]/6,000 = $40
68. Given the following data for Keyboard Division:
Fixed cost – Total 50,000
Capacity (in units) 125,000
The Computer Division would like to purchase 15,000 units each period from the Keyboard
Division. The Keyboard Division has ample excess capacity to handle all of the Computer
Division's needs. The Computer Division now purchases from an outside supplier at a price of
$20. If the Keyboard Division refuses to accept an $18 price internally, the company, as a
whole, will be worse off by:
A. $30,000.
B. $75,000.
C. $90,000.
D. $120,000.
($20 - 12) × 15,000 = $120,000
69. Given the following data for Electrical Cord Division:

Fixed cost – Total 10,000
Assume that Electrical Cord Division is selling all it can produce to outside customers. If it
sells to the Appliance Division, $1 can be avoided in variable cost per unit. The Appliance
Division is presently purchasing from an outside supplier at $38 per unit. From the point of
view of the company as a whole, any sales to the Appliance Division should be priced at:
A. $40.
B. $39.
C. $38.
D. The company would not want the transfer to take place.
The company as a whole would lose if the transfer was made. It is better off to buy from
outside at $38 and to sell outside at $40. The $1 savings is not enough to make up this
differential.
70. Given the following data for Handle Division:
Fixed cost per unit (based on capacity) 30
Cabinet Division would like to purchase 10,000 units from the Handle Division at a price of
$125 per unit. Handle Division has no excess capacity to handle the Cabinet Division's
requirements. The Cabinet Division currently purchases from an outside supplier at a price of
$140. If the Handle Division accepts a $125 price internally, the company, as a whole, will be
better or worse off by:
A. $600,000
B. $(100,000)
C. $115,000
D. $250,000
($150 - 140) × 10,000 = $(100,000)

71. Altoona Corporation has two divisions, Hinges and Doors, which are both organized as profit
centers; the Hinge Division produces and sells hinges to the Door Division and to outside
customers. The Hinge Division has total costs of $35, $20 of which are variable. The Hinge
Division is operating significantly below capacity and sells the hinges for $50.
The Door Division has received an offer from an outsider vendor to supply all the hinges it
needs (20,000 hinges) at a cost of $45. The manager of the Door Division is considering the
offer but wants to approach the Hinge Division first.
What would be the profit impact to Altoona Corporation as a whole if the Door Division
purchased the 20,000 hinges it needs from the outside vendor for $45?
A. No change in profit to Altoona.
B. $100,000 increase in profits.
C. $100,000 decrease in profits.
D. $500,000 decrease in profits.
Outside price $45 - Selling division's variable costs $20 = $25 higher costs × 20,000 units =
$500,000 increase in costs which leads to a $500,000 decrease in profits
What is the minimum transfer price from the Hinge Division to the Door Division?
A. $20.
B. $35.
C. $45.
D. $50.
Selling division's variable costs = $20

What is the maximum transfer price from the Hinge Division to the Door Division?
A. $20.
B. $35.
C. $45.
D. $50.
Maximum price would be the market price the buyer would pay: $45
74. Retro Rides Inc., operates two divisions: (1) a management division that owns and manages
classic automobile rentals in Miami, Florida and (2) a repair division that restores classic
automobiles in Clearwater, Florida. The repair division works on classic motorcycles, as well
as other classic automobiles.
The Repair division has an estimated variable cost of $28.50 per labor-hour. The Repair
division has a backlog of work for automobile restoration. They charge $48.00 per hour for
labor, which is standard for this type of work. The Management division complained that it
could hire its own repair workers for $30.00 per hour, including leasing an adequate work
area.
What is the minimum transfer price per hour that the Repair division should obtain for its
A. $28.50.
B. $30.00.
C. $39.00.
D. $48.00.
When at capacity, the market price of $48 is the appropriate transfer price.
area.
What is the maximum transfer price per hour that the Management division should pay?
A. $28.50.
B. $30.00.
C. $39.00.
D. $46.50.
$30, what the management division can purchase from outside.
area.
If the Repair division had idle capacity, what is the minimum transfer price that the Repair
A. $28.50.
B. $30.00.
C. $39.00.
D. $46.50.
The selling division's variable cost of $28.50 is the appropriate transfer price.
77. Frocks and Gowns Inc., has two divisions, Day Wear and Night Wear. The Day Wear Division
has an investment base of $750,000 and produces (and sells) 100,000 units of Collars at a
market price of $10.00 per unit. Variable costs total $3.50 per unit, and fixed charges are
$4.00 per unit (based on a capacity of 120,000 units). The Night Wear Division wants to
purchase 25,000 units of Collars from The Day Wear Division. However, the Night Wear
Division is only willing to pay $6.75 per unit.
What is the contribution margin for the Day Wear Division without the transfer to the Night
Wear Division?
A. $250,000.
B. $650,000.
C. $675,000.
D. $1,000,000.
100,000 units × ($10 - $3.50) = $650,000
What is the contribution margin for the Day Wear Division if it transfers 25,000 units to the
Night Wear Division at $6.75 per unit?
A. $250,000.
B. $650,000.
C. $675,000.
D. $698,750.
(95,000 × $6.50) + [25,000 × ($6.75 - $3.50)] = $698,750

What is the minimum transfer price for the 25,000 unit order that the Day Wear Division would
accept if it wishes to maintain its pre-order contribution?
A. $3.50.
B. $4.00.
C. $4.80.
D. $6.00.
Opportunity cost = 5,000 × $6.50 = $32,500; transfer price: $3.50 + (32,500/25,000) = $4.80
80. A company is highly centralized. The Cutting Division, which is operating at capacity, produces
a component that it currently sells in a perfectly competitive market for $13 per unit. At the
current level of production, the fixed cost of producing this component is $4 per unit and the
variable cost is $7 per unit. Grinding Division would like to purchase this component from the
Cutting Division. The price that the Cutting Division should charge the Grinding Division per
unit for this component is:
A. $7.
B. $11.
C. $13.
D. $15.
Since The Cutting Division is at full capacity, the appropriate transfer price is its market price.
81. A company has two divisions, Softwoods and Hardwoods, each operating as a profit center.
The Softwood Division charges the Hardwood Division $35 per unit (for each unit transferred
to the Hardwood Division). Other data for the Softwood Division are as follows:
Variable Cost per unit $30

Fixed Costs $10,000
Annual Sales to the Hardwood

5,000 units
Division
50,000
Annual Sales to Outsiders
units
The Softwood Division is planning to raise its transfer price to $50 per unit. The Hardwood
Division can purchase units at $40 per unit from outsiders, but doing so would idle the
Softwood Division's facilities (now committed to producing units for the Hardwood Division).
The Softwood Division cannot increase its sales to outsiders. From the perspective of the
company as a whole, from who should the Hardwood Division acquire the units, assuming the
Hardwood Division's market is unaffected?
A. Outside vendors.
B. The Softwood Division, but only at the variable cost per unit.
C. The Softwood Division, but only until fixed costs are covered, then should purchase from
outside vendors.
D. The Softwood Division, in spite of the increased transfer price.
The company as a whole only pays the $30 variable cost which is less than the $40 outside
price. The overall company would like an internal transfer.
82. Given the following information for Camping Division:
The Lantern Division would like to purchase internally from the Camping Division. The
Lantern Division now purchases 5,000 units each period from outside suppliers at $49 per
unit. The Camping Division has ample excess capacity to handle all of the Lantern Division's
needs. What is the lowest price that Camping Division could accept?
A. $50.00.
B. $49.00.
C. $46.00.
D. $30.00.
The minimum transfer price is the variable costs of the selling division when the selling division
has excess capacity.
83. Accutron, a large manufacturing company, has several autonomous divisions that sell their
products in perfectly competitive external markets as well as internally to the other divisions of
the company. Top management expects each of its divisional managers to take actions that
will maximize the organization's goal as well as their own goals. Top management also
promotes a sustained level of management effort of all of its divisional managers. Under these
circumstances, for products exchanged between divisions, the transfer price that will generally
lead to optimal decisions for Accutron would be a transfer price equal to the: (CIA adapted)
A. full cost of the product.
B. full cost of the product plus a markup.
C. variable cost of the product plus a markup.
D. market price of the product.
Since the market is perfect, market price is the best.
84. Martin Company currently manufactures all component parts used in the manufacture of
various hand tools. The Extruding Division produces a steel handle used in three different
tools. The budget for these handles is 120,000 units with the following unit cost.
Direct material $.60
Direct labor .40
Variable overhead .10
Fixed overhead .20
Total unit cost $1.30
Polishing Division purchases 20,000 handles from the Extruding Division and completes the
hand tools. An outside supplier, Venture Steel, has offered to supply 20,000 units of the
handle to Polishing Division for $1.25 per unit. The Extruding Division currently has idle
capacity that cannot be used.
What is the cost impact to Martin as a whole of purchasing from Venture Steel? (CMA
adapted)
A. increase the handle unit cost by $0.05.
B. increase the handle unit cost by $0.15.
C. decrease the handle unit cost by $0.15.
D. decrease the handle unit cost by $0.25.
Make: $0.60 + 0.40 + 0.10 = $1.10; Buy: $1.25; Differential: Buy $1.25 - Make $1.10 = $0.15
more cost if buying outside
Direct labor .40
Fixed overhead .20
If Martin would like to develop a range of transfer prices, what would be the maximum transfer
price that Polishing would be willing to pay?
A. $1.00.
B. $1.10.
C. $1.25.
D. $1.30.
Maximum price would be the market price = $1.25

Direct labor .40
Fixed overhead .20
If Martin would like to develop a range of transfer prices, what would be the minimum transfer
price that Extruding would be willing to accept?
A. $1.00.
B. $1.10.
C. $1.25.
D. $1.30.
The minimum price would be variable costs plus any opportunity costs: $1.10
87. The Alpha Division of a company, which is operating at capacity, produces and sells 1,000
units of a certain electronic component in a perfectly competitive market. Revenue and cost
data are as follows: (CIA adapted)
Sales $50,000
Variable costs 34,000
Fixed costs 12,000
The minimum transfer price that should be charged to the Beta Division of the same company
for each component is:
A. $12.
B. $34.
C. $46.
D. $50.
Since it is a perfect market at full capacity, transfer price is the market price: $50,000/1,000 =
$50
88. The Hinges Division of Altoona Corp. sells 80,000 units of part Z-25 to the outside market.
Part Z-25 sells for $40, has a variable cost of $22, and a fixed cost per unit of $10. The Hinges
Division has a capacity to produce 100,000 units per period. The Door Division currently
purchases 10,000 units of part Z-25 from the Hinges Division for $40. The Door Division has
been approached by an outside supplier willing to supply the parts for $36. If Altoona uses a
negotiated transfer pricing system, what is the maximum transfer price that should be charged
for this transaction?
A. $40.
B. $36.
C. $32.
D. $22.
Maximum price is the outside market price for the buying division: $36
89. The Hinges Division of Altoona Corp. sells 80,000 units of part Z-25 to the outside market.
Part Z-25 sells for $40, has a variable cost of $22, and a fixed cost per unit of $10. The Hinges
Division has a capacity to produce 100,000 units per period. The Door Division currently
purchases 10,000 units of part Z-25 from the Hinges Division for $40. The Door Division has
been approached by an outside supplier willing to supply the parts for $36. If Altoona uses a
negotiated transfer pricing system, what is the minimum transfer price that should be charged
for this transaction?
A. $40.
B. $36.
C. $32.
D. $22.
Minimum price is the outlay cost plus any opportunity costs: $22
90. The Eastern Division sells goods internally to the Western Division at Tennessee Company.
The quoted external price in industry publications from a supplier near Eastern is $200 per ton
plus transportation. It costs $20 per ton to transport the goods to Western. Eastern's actual
market cost per ton to buy the direct materials to make the transferred product is $100. Actual
per-ton direct labor is $50. Other actual costs of storage and handling are $40. Tennessee
Company's president selects a $220 transfer price. This is an example of: (CIA adapted)
A. market-based transfer pricing.
B. cost-based transfer pricing.
C. negotiated transfer pricing.
D. cost plus 20% transfer pricing.
Since the market is perfect, market price is the best.
91. Which of the following is the most significant disadvantage of a cost-based transfer price?
(CIA adapted)
A. Requires internally developed information.
B. Imposes market effects on company operations.
C. Requires externally developed information.
D. May not promote long-term efficiencies.
Cost-based transfer prices pass on inefficiencies from the selling division so there is no
incentive for improvement.
92. An appropriate transfer price between two divisions of The Fathom Company can be
determined from the following data: (CIA adapted)
Fabricating Division
Market price of
$50
subassembly
Variable cost of
$20
subassembly
Excess capacity (in
1,000
units)
Assembling Division
Number of units needed 900
What is the natural bargaining range for the two divisions?

A. Between $20 and $50.
B. Between $50 and $70.
C. Any amount less than $50.
D. $50 is the only acceptable transfer price.
The minimum is the variable cost, while the maximum is the market price.
93. A limitation of transfer prices based on actual cost is that they: (CIA adapted)
A. charge inefficiencies to the department that is transferring the goods.
B. charge inefficiencies to the department that is receiving the goods.
C. must be adjusted by some markup.
D. lack clarity and administrative convenience.
There is no motivation for the supplier to work on efficiency since all costs are passed on.
94. Which of the following is not an appropriate use of transfer pricing?

A. Product costing.
B. Decision making.
C. Establishing standards.
D. Evaluating performance.
Transfer prices do not affect standard costs.
95. An internal transfer between two divisions is in the best economic interest of the entire
organization when:
A. the variable costs plus the opportunity cost of the selling division is greater than the
external price for the buying division.
B. the variable costs plus the opportunity cost of the selling division is less than the external
price for the buying division.
C. there is excess capacity in the buying division with no alternative use.
D. there is no established market prices for the buying division.
If the variable cost plus opportunity cost is less than the external price, the company will show
a higher profit.
96. Top management intervention in settling transfer pricing disputes between two divisions
should be avoided unless
A. there is no intermediate markets.
B. the intermediate market is imperfect.
C. there is an extraordinarily large order.
D. there is no opportunity costs.
Intervention removes authority from the decentralized units.
97. The transfer price that should be used by top management in evaluating whether a division
should buy within the company or from an outside supplier is:
A. negotiated transfer price.
B. transfer price based on full cost.
C. transfer price based on variable cost.
D. transfer price based on an open market price.
If there is an open market, that price should be used.
98. Some managers prefer to use cost rather than market price in controlling transfers between
divisions. If cost is to be used, then it should be:

A. full cost.
B. direct cost.
C. variable cost.
D. standard cost.
A standard cost will not pass along inefficiencies.
99. Cost-based transfer prices that include a normal markup to the costs act as a surrogate for:
A. negotiated market prices.
B. opportunity costs.
C. differential costs.
D. market prices.
The goal is to approximate market prices.
100. Multinational firms often face conflicting pressures when developing transfer pricing policies.
Tax avoidance results when:
A. inflated transfer prices are used to reduce the profits of divisions in high tax-rate countries.
B. inflated transfer prices are used to reduce the profits of divisions in low tax-rate countries.
C. cost-based transfer prices are used instead of market transfer prices in high tax-rate
countries.
D. cost-based transfer prices are used instead of negotiated market transfer prices in low tax-
rate countries.
Taxes are avoided when profits are reduced in a high tax country (and by extension profits
would be higher in a low tax country).
101. Which of the following transfer pricing methods must be used in segment reporting by the oil
and gas industry?
A. Absorption cost.
B. Differential cost.
C. Negotiated market price.
D. Market price.
This is a GAAP requirement.
Essay Questions
102. Galena Corp. manufactures RD34 in its City Division. This output is sold to the Urban Division
as raw material in Urban's product. City also further processes the RD34 into RD35, and then
sells it to other companies.
The City Division's variable costs for the basic ingredient are $15 per unit. The Urban
Division's variable costs are $5 per unit in addition to what it pays the City Division. The Urban
Division has a capacity of 400,000 units and it can sell everything it produces. The market
price for the finished additive is $40 per unit. If the City Division converts the RD34 into RD35,
it can receive $25 per unit on the open market, but it incurs an additional $4 per unit for this
processing.
Required:
a. What is the lowest price the City Division should be willing to transfer RD34 to the Urban
Division, assuming the City Division is not at full capacity?
b. What is the lowest price the City Division should be willing to transfer RD34 to the Urban
Division, assuming the City Division is at full capacity?
c. Ignore parts (a) and (b). Assume that the City Division has a capacity of 500,000 units, but
can only sell 300,000 on the open market. How many units should the City Division sell
externally and how many units should it sell to Urban Division at a transfer price of $20?
a. Since City is operating at less than full capacity, the lowest price is the variable cost of $15.
b. Opportunity cost: $25 for RD35 - $15 - $4 = $6. Optimal transfer price = outlay cost $15 +
opportunity cost $6 = $21.
c. Contribution margin is higher for outside sales ($25 - $15 - $4 = $6) than it is for internal
($20 - $15 = $5). Therefore, sell as much outside as possible. Open market 300,000 × $6 =
$1,800,000; internal (500,000 - 300,000) = 200,000 × ($20 - $15) = $1,000,000.
103. Shipping Industries is a decentralized company that evaluates its divisions based on ROI. The
North Division has the capacity to produce 2,000 units of a component. The North Division's
variable costs are $85 per unit; fixed costs are $70 per unit.
The South Division can use the product as a component in one of its products. The South
Division would incur $65 of variable costs to convert the component into its own product which
sells for $310.

Required:
(consider each question independent of each other):
a. Assume the North Division can sell all that it produces for $185 each. The South Division
needs 100 units. What is the appropriate transfer price?
b. Assume the North Division can sell 1,800 units at $265. Any excess capacity will be unused
unless the units are purchased by the South Division (which can use up to 100 units). What
are the minimum and maximum transfer prices?
a. North is at full capacity: market price = $185
b. North is at less than full capacity. Minimum price = variable cost of North = $85; Maximum
price = incoming market price to South, but this is unknown. The most South will pay is the
selling price of the final product $310 less incremental variable costs of $65 = $245.
104. Trevor Company operates several investment centers. The manager of the Genesis Division
expects the following results for the coming year.
Sales (50,000 units at $20) $1,000,000
Contribution margin $400,000
Fixed costs 250,000
Profit $150,000
Included in the Genesis Division's variable cost is $7 for a component it buys from an outside
supplier. One of these components is required in each unit of the Genesis Division's product.
The manager of the Genesis Division has just found that she can buy the component from the
Solar Division, another division of Trevor Company. The Solar Division sells 300,000 units of
the component to outsiders at $8 and its variable cost is $4 per unit. The Solar Division offers
to sell the component to Genesis at a price of $6. Solar is operating well below capacity.
Required:
a. If Genesis accepts the offer, what will happen to the income of the Solar Division?
b. If Genesis accepts the offer, what will happen to the income of the Genesis Division?
c. If Genesis accepts the offer, what will happen to the income of the Trevor Company?
a. 50,000 units × ($6 transfer price - $4 variable cost) = 50,000 × $2 = $100,000 increase in
profit.
b. 50,000 units × ($7 old price - $6 new price) = 50,000 × $1 savings = $50,000 increase in
profit.
c. 50,000 units × ($7 outside price - $4 variable cost) = 50,000 × $3 savings = $150,000
increase.
105. The Trevor Company operates several investment centers. The manager of the Genesis
Division expects the following results for the coming year.
Sales (50,000 units at $20) $1,000,000
Contribution margin $400,000
Fixed costs 250,000
Profit $150,000
Included in the Genesis Division's variable cost is $7 for a component it buys from an outside
supplier. One of these components is required in each unit of the Genesis Division's product.
The manager of the Genesis Division has just found that she can buy the component from the
Solar Division, another division of Trevor Company. The Solar Division sells 300,000 units of
the component to outsiders at $8 and its variable cost is $4 per unit. Solar offers to sell the
component to Genesis at a price of $6.
Solar has a capacity of 330,000 units. Assume that Genesis wants to buy all of its needs from
one source, so that Solar must supply all or none of the Genesis Division's need for 50,000
units.
Required:
a. Determine the change in income of the Solar Division of supplying the component to
Genesis at $6 as opposed to not supplying Genesis.
b. Determine the change in income of Trevor Company if Solar supplies Genesis at $6.
a. Lost sales [300,000 - (330,000 - 50,000)] × ($8 - $4) = $80,000 opportunity cost; 50,000
units × [$6 - $4] - $80,000 opportunity cost = $20,000 increase in profit.
b. 50,000 units × ($7 outside price - $4 variable cost) = 50,000 × $3 savings = $150,000 -
$80,000 opportunity cost = $70,000 increase.
106. The Barrel Division of Chemco Inc. has a capacity of 200,000 units and expects the following
results.
Sales (160,000 units at $4) $640,000
Variable costs, at $2 320,000
Fixed costs 260,000
Income $60,000
Tank Division of Chemco Inc. currently purchases 50,000 units of a part for one of its products
from an outside supplier for $4 per unit. The Tank Division's manager believes he could use a
minor variation of the Barrel Division's product instead, and offers to buy the units from the
Barrel Division at $3.50. Making the variation desired by the Tank Division would cost the
Barrel Division an additional $0.50 per unit and would increase the Barrel Division's annual
cash fixed costs by $20,000. Barrel's manager agrees to the deal offered by Tank's manager.
Required:
a. What is the effect of the deal on the Tank Division's income?
b. What is the effect of the deal on the Barrel Division's income?
c. What is the effect of the deal on the income of Chemco Inc. as a whole?
a. 50,000 units × ($4 current price - $3.50 new price) = 50,000 × $0.50 = $25,000 increase in
profit.
b. Lost sales [(160,000 + 50,000) -200,000] × ($4 - $2) = $20,000 opportunity cost; 50,000
units × [$3.50 - ($2.00 + $0.50)] - $20,000 increase in fixed - $20,000 opportunity cost =
$10,000 increase in profit.
c. $25,000 + $10,000 = $35,000 increase.

107. Division A of Spangler Company expects the following results:
To To
Division B Outsiders
Sales (5,000 × $60) $300,000
(25,000 × $72) $1,800,000
Variable costs at $36 180,000 900,000
Contribution margin $120,000 $900,000
Fixed costs, all common,
allocated on the basis of 60,000 300,000
relative units
Profit $60,000 $600,000
Division B has the opportunity to buy its needs of 5,000 units from an outside supplier at $45
each.
Required:
a. Division A refuses to meet the $45 price, sales to outsiders cannot be increased, and
Division B buys from the outside supplier. Compute the effect on the income of Spangler.
b. Division A cannot increase its sales to outsiders, does meet the $45 price, and Division B
continues to buy from A. Compute the effect on the income of Spangler.
a. 5,000 units × ($45 outside price - $36 variable cost) = $45,000 decrease.
b. No change. Division A will show less profit, but B will show an equal amount of increased
profit.
108. Veritron Division of Argos Inc. has a capacity of 100,000 units and expects the following
results for the year.
Sales (90,000 units at $30) $2,700,000
Variable costs, at $20 1,800,000
Fixed costs 700,000

Income $200,000
Magnatron Division of Argos Inc. currently purchases 20,000 units of a part for one of its
products from an outside supplier at $32 per unit. Magnatron's manager believes she could
use a minor variation of Veritron's product instead, and offers to buy the units from Veritron at
$26. Making the variation desired by Magnatron would cost Veritron an additional $5 per unit
and would increase Veritron's annual cash fixed costs by $80,000. Veritron's manager agrees
to the deal offered by Magnatron's manager.
Required:
a. Find the effect of the deal on Magnatron's income.
b. Find the effect of the deal on Veritron's income.
c. Find the effect of the deal on the income of Argos Inc. as a whole.
a. 20,000 units × (old price $32 - new price $26) = $120,000 increase.
b. Lost sales by Veritron: 10,000 units × ($30 - $20) = $100,000 opportunity cost; 20,000 units
× [$26 - ($20 + $5)] - added fixed of $80,000 - opportunity cost $100,000 = $160,000
decrease.
c. Argos = Magnatron + Veritron = $120,000 - $160,000 = $40,000 decrease.
109. Division A of Spangler Company expects the following results:

To To
Division B Outsiders
Sales (5,000 × $60) $300,000
(25,000 × $60) $1,500,000
Variable costs at $36 180,000 900,000
Fixed costs, all common,

allocated on the basis of 60,000 300,000
relative units
Profit $60,000 $300,000
Division B has the opportunity to buy its needs of 5,000 units from an outside supplier at $45
each. Assume that Division A cannot increase sales to outsiders.
Required:
a. What would be the optimal transfer price?
b. Assume that Spangler allows the divisional managers to negotiate transfer prices. What
would the maximum transfer price be?
c. Assume that Spangler allows the divisional managers to negotiate transfer prices. What
would the minimum transfer price be?
a. Division A operating at less than capacity, optimal transfer price = variable cost $36.
b. Maximum price is the outside vendor price of $45.
c. The minimum price would be the outlay cost to Division A: variable costs = $36.
110. Winton Industries evaluates its divisions based on residual income. The Springfield Division
has the capacity to produce 20,000 units of a component. The Springfield Division's variable
costs are $150 per unit; fixed costs are $110 per unit.
The Monnett Division can use the product as a component in one of its products. The Monnett
Division would incur $75 of variable costs to convert the component into its own product which
sells for $300.
Required:
a. Assume the Springfield Division can sell all that it produces for $285 each. The Monnett
Division needs 1,000 units. What is the appropriate transfer price?
b. Assume the Springfield Division can sell 18,000 units at $285. Any excess capacity will be
unused unless the units are purchased by the Monnett Division (which can use up to 1,000
units). What are the minimum and maximum transfer prices?
a. Springfield is at full capacity: market price = $285.
b. Springfield is at less than full capacity. Minimum price = variable cost of Springfield = $150;
Maximum price = incoming market price to Monnett, but this is unknown. The most Monnett
will pay is the selling price of the final product $300 less incremental variable costs of $75 =
$225.
111. Table Lake Cruises Inc., operates two divisions: (1) a recreational division that owns and
manages charter boats on the lake and (2) a repair division that operates a division at Rogers.
The repair division works on small gasoline crafts, as well medium size diesel engine boats.
has a backlog of work for diesel engines. They charge $125 per hour for labor & overhead,
which is standard for this type of work. The recreational division complained that it could hire
its own repair workers for $85 per hour, including leasing an adequate work area.
Required:
a. What is the minimum transfer price per hour that the repair division should obtain for its
b. What is the maximum transfer price per hour that the recreational division should pay?
c. If the repair division had idle capacity, what is the minimum transfer price that the repair
a. Repair is operating at capacity, transfer price = market price = $125/hr.
b. The maximum that recreational will pay is the "incoming" price of $85/hr. It is in the best
interest of the company profits for the recreational division to buy outside and repair to
continue with its high rates selling to outsiders.
c. If repair has excess capacity, the minimum transfer price is the variable cost of $45.
112. The Counter Division can sell externally for $60 per unit. Its variable manufacturing costs are
$35 per unit, and its fixed costs are $12 per unit.
Required:
a. What is the optimal transfer price for transferring internally, assuming the division is
operating at capacity?
b. What is the optimal transfer price for transferring internally, assuming the division is
operating at well below capacity?
a. Operating at capacity: transfer price = market price = $60.
b. Below capacity: optimal price = outlay cost = $35. Fixed costs are not outlay costs.
113. Salamander Company expects the following results:
Division A Division B
Sales A: (10,000 × $160) $1,600,000
B: (25,000 × $72) $1,800,000
Variable costs 1,360,000 900,000
Fixed costs 160,000 360,000
Profit $80,000 $540,000
Included in Division A's costs are 10,000 units of a subcomponent purchased from an outside
supplier for $45. The managers have recently initiated negotiations for Division B to supply the
components to Division A. Division B has a total capacity of 40,000 units.
Required:
a. Would the Salamander Company prefer the subcomponent used by A to be purchased
internally from B or from the outside vendor?

b. What would be the maximum and minimum transfer prices?
a. Division B variable cost = $900,000/25,000 = $36. Internal purchase: inside cost 10,000
units × variable cost $36 = $360,000; outside: 10,000 × $45 = $450,000.
b. Minimum = variable cost $36; maximum incoming market $45.
114. The Salamander Company expects the following results:
Sales A: (10,000 × $160) $1,600,000
B: (25,000 × $72) $1,800,000
Variable costs 1,360,000 900,000
Fixed costs 160,000 360,000
Profit $80,000 $540,000
Included in Division A's costs are 10,000 units of a subcomponent purchased from an outside
supplier for $45. The managers have recently initiated negotiations for Division B to supply the
components to Division A. Division B has a total capacity of 40,000 units.

Required:
a. Prepare a new segment reporting statement for the Salamander Company, assuming an
internal transfer at the maximum transfer price.
b. Prepare a new segment reporting statement for the Salamander Company, assuming an
internal transfer at the minimum transfer price.
a. Division A Division B
Sales A: (10,000 × $160) $1,600,000
B: (25,000 × $72) $1,800,000
B transfer (10,000 ×
450,000
$45)
Variable costs 1,360,000 1,260,000
Fixed costs 160,000 360,000
Profit $80,000 $630,000
b. Division A Division B
Sales A: (10,000 × $160) $1,600,000
B: (25,000 × $72) $1,800,000
B transfer (10,000 ×
360,000
$36)
Variable costs 1,270,000 1,260,000
Fixed costs 160,000 360,000
Profit $170,000 $540,000
a. Maximum price = $45; new variable costs for B: ($900,000/25,000) × 35,000 = $1,260,000;
no change in variable cost to A.
b. Minimum price = variable cost = $36; new variable costs for A: $1,360,000 - old cost
(10,000 × $45) + new cost (10,000 × $36) = $1,360,000 - $90,000 = $1,270,000.
115. Thai Company has two divisions organized as profit centers: Redmon and Tomlin. Thai
expects the following results:
Redmon Tomlin
Sales
Redmon: (10,000 × $16) $1,600,000
Tomlin: (250,000 ×
$1,800,000
$7.20)
Variable costs 1,360,000 1,000,000
Fixed costs 160,000 460,000
Profit $80,000 $340,000
Included in Redmon's costs are 100,000 units of a subcomponent purchased from an outside
supplier for $4.50. The managers have recently initiated negotiations for Tomlin to supply the
components to Redmon. Tomlin has a total capacity of 400,000 units.
Required:
a. Would Thai Company prefer the subcomponent used by Redmon to be purchased internally
from Tomlin or from the outside vendor? What would be the profit impact?
b. What would be the maximum and minimum transfer prices?
a. Internal cost = variable cost = $1,000,000/250,000 units = $4; external price = $4.50; prefer
internal: 100,000 units × ($4.50 - $4) = $50,000 more profit.
b. Maximum = outside price $4.50; minimum = variable cost = $4.
116. Macon Motor Works has just acquired a new Battery Division. The Battery Division produces a
standard 12-volt battery that it sells to retail outlets at a competitive price of $20. The retail
outlets purchase about 800,000 batteries a year. Since the Battery Division has a capacity of
1,000,000 batteries a year, top management is thinking that it might be wise for the company's
Automotive Division to start purchasing batteries from the newly acquired Battery Division.
The Automotive Division now purchases 300,000 batteries a year from an outside supplier, at
a price of $18 per battery. The discount from the competitive $20 price is a result of the large
quantity purchased.
The Battery Division's cost per battery is shown below:

Direct materials $8
Direct labor 4
Variable overhead 2
Fixed overhead 2
Total cost $16
Fixed costs are based on 1,000,000 batteries.
Both divisions are to be treated as investment centers, and their performance is to be

evaluated by the ROI formula.
Required:
a. What transfer price would you recommend and why?
b. What transfer price would you recommend if the Battery Division is now selling 1,000,000
batteries a year to retail outlets?
c. Suppose the manager of the Battery Division can increase its capacity to 1,500,000 units
for $1,200,000. She then has the option of (a) cutting the retail price to $17.50 with the
certainty that sales will increase to 1,500,000 batteries, or (b) maintaining the outside price of
$20.00 for the 800,000 batteries and transferring the 300,000 batteries to the Automotive
Division at some price that would produce the same income for the Battery Division as option
(a). What is the minimum transfer price you would recommend in this situation?
a. Any price between the selling division's variable cost ($14 per unit) and the buying division's
external market price ($18).
b. There is no price that's acceptable in this case since the selling division's external market
price ($20) is greater than the buying division's external market price ($18).
c. [($17.50 - $14) × 1,500,000] = [($20 - $14) × 800,000] + [($X - $14) × 300,000]; X = $15.50
(Note: The increased fixed costs of $1,200,000 are irrelevant to this decision.)
117. Chattanooga Inc., has two divisions for its metal fabrication business. The Stamp Division
stamps the objects and then transfers them to the Finish Division, which finishes and sells
them. Last year, the Stamp Division had administrative expenses of $40,000. The Finish
Division incurred additional production costs of $120,000 (exclusive of amounts paid to the
Stamp Division for the stamped steel) to process 120,000 units. The Finish Division sold the
finished goods for $500,000 and incurred $80,000 in variable selling and administrative
expenses.
Required:
a. Prepare income statements for each division. Use a transfer price of the Stamp Division's
total cost plus 5%. Assume Cost of Goods Sold for the Finish Division is $351,000.
b. Repeat (a), using a transfer price of $2.00 per unit; this is also the market price.
c. Repeat (a), using a negotiated transfer price of $1.90 per unit.
d. Which transfer price results in higher income to Chattanooga Inc.?
a. Cost Plus Stamp Division Finish Division
Sales $231,000 $500,000
Cost of Goods Sold 180,000 351,000
Other Costs 40,000 80,000
Operating Profit $11,000 $69,000
b. Transfer = $2 Stamp Division Finish Division
Sales $240,000 $500,000
c. Transfer = $1.90 Stamp Division Finish Division
Sales $228,000 $500,000

d. In terms of total company income, transfer prices have no impact; i.e., the total profit is
$80,000 regardless of how it is allocated between the two divisions. However, different pricing
systems can provide managers with different incentives, which may have an impact on profits.
a. The Stamp Division = The Finish Division COGS $351,000 - $120,000 added costs =
$231,000; $231,000 = 105% of the Stamp Division costs; The Stamp Division cost =
$231,000/105% = $220,000; $220,000 - $40,000 other costs = $180,000 Stamp Division

COGS.
118. Division S sells its product to unrelated parties at a price of $20 per unit. It incurs variable
costs of $7 per unit and has fixed costs of $50,000 per month. Monthly production is generally
10,000 units.
Division B uses Division S's product in its operations. It can purchase the units from Division S
at $20 per unit, but must pay a $1.50 per unit in shipping costs. Alternatively, Division B can
buy from Division S's competition at a delivered price of $21 per unit.
Required:
a. From the company's perspective, should Division B purchase the units internally or
externally? Assume Division S has ample capacity to handle all of Division B's needs.
b. Would your answer change if Division S can sell everything it produces to outside
customers?
a. External $21, internal $7 variable cost + $1.50 shipping = $8.50; savings = $21 - $8.50 =
$12.50 × 10,000 units = $125,000 (internal transfer since Division A has ample capacity).
b. Purchase internal: $20 + $1.50 = $21.50 versus $21 external (better to have external
supply).
119. Calvin Machinery Company manufactures heavy-duty equipment used in foundries, mining
operations, and similar operations. The company is very decentralized, with various division
managers having control over capital investments and most production decisions. The
Cylinder Division fabricates a component which is used by the Press Division in its production
of metal presses. The Cylinder Division has been selling to the Press Division at a price of
$3,000 per unit. Because of a cost increase, the Cylinder Division wants to increase its price to
$3,200, even though the Press Division can still purchase an equivalent component externally
for $3,000. The following information has been gathered regarding this issue:
Press Division’s annual purchases 100 units
Cylinder Division’s variable costs $2,400 per unit
Cylinder Division’s fixed costs $600 per unit
Required:
a. If the Press Division buys its units externally, the Cylinder Division will have idle capacity for
which there are no alternative uses. Will the company as whole benefit if the Press Division
purchases its units externally for $3,000 per unit?
b. If the Press Division buys its units externally, the Cylinder Division will have idle capacity
which can be used to generate a positive cash flow of $40,000. Will the company as whole
benefit if the Press Division purchases its units externally for $3,000 per unit?
c. Refer to (b). Will your answer change if the price at which the Press Division can buy
externally decreases to $2,700 per unit? Support your answer.
a. External purchase: 100 × $3,000 = $300,000; internal purchase: 100 × $2,400 variable cost
= $240,000; differential in profit = $60,000 decrease. No, the company as a whole will earn
$60,000 in less profit if there is an external transfer.
b. External purchases $300,000 - $40,000 usage of capacity = $260,000; internal = $240,000;

differential = $20,000 decrease. No, the company will still earn $20,000 less profit with an
external transfer.
c. External purchase: 100 × $2,700 = $270,000 - $40,000 = $230,000 versus $240,000

internal; differential $10,000 increase in profit. The company would prefer an external
purchase as profits will increase by $10,000.
120. The GrowPro Manufacturing Company has a division (Division P) that produces an essential
ingredient used by the Lawn Division in making lawn fertilizer. Historically, 75% of Division P's
output has been purchased by Division L and 25% has been sold to other fertilizer companies.
The transfer price between Division P and Division L has been based on the outside sales
price less selling and administrative expenses directly applicable to the outside sales. Last
year, the transfer price was $35 per ton; Division P would like the same transfer price this
year. However, the general manager of Division L has found an outside supplier who will sell
the ingredient for $30 per ton. She would like to continue buying from Division P, but Division
P's manager does not want to match the $30 price because he thinks that the margin is too
small. Top management does not get involved in transfer pricing disputes, but rather, allows
division managers to make their own decisions concerning internal or external purchases and
sales.
The following information has been gathered regarding Division P's operations last year:
Sales to L External
Sales $4,200,000 $2,000,000
Variable costs 3,000,000 1,000,000
Fixed costs 360,000 120,000
The information presented above is based on selling 120,000 tons internally and 40,000 tons
externally.
Required:
a. If Division L buys externally, Division P can increase its current external sales by only
20,000 tons. What arguments can the general manager of Division L make to help Division P
to match the $30 price?
b. Division L wants to use only one supplier, so Division P will either sell 120,000 tons to
Division L or nothing. If Division L's capacity is 160,000 tons, how many units does Division P
need to sell to outsiders at $50 per ton before it is better off selling to outsiders? Ignore any
additional marketing costs which would be incurred to increase sales.

a. Drop price internally, overall profit = $1,120,000; lose inside sales, increase outside, overall
profit = $1,020,000.
b. 64,000 tons.
a. internal
Sales to L External Total
price = $30
Sales $3,600,000 $2,000,000
Variable costs 3,000,000 1,000,000
Contribution
$600,000 $1,000,000 $1,600,000
margin
Fixed costs 360,000 120,000 480,000
Operating
$240,000 $880,000 $1,120,000
profit
No internal sales, external increases by 20,000.

External Total
Sales $3,000,000
Variable costs 1,500,000
Contribution
$1,500,000 $1,500,000
margin
Fixed costs 480,000 480,000
Operating profit $1,020,000 $1,020,000
b. There needs to be $1,600,000 in contribution margin. The contribution margin per ton is $50
- $25 = $25. Volume needed is $1,600,000/$25 = 64,000 tons.
121. The Measurement Division of Flow Co. produces pumps which it sells for $20 each to outside
customers. The Measurement Division's cost per pump, based on normal volume of 500,000
units per period, is shown below:
Variable costs $12
Fixed overhead 3
Total $15
Flow has recently purchased a small company which makes sprinkler systems. This new
company is presently purchasing 100,000 pumps each year from another manufacturer. Since
the Measurement Division has a capacity of 600,000 pumps per year and is now selling only
500,000 pumps to outside customers, management would like the new Sprinkler Division to
begin purchasing its pumps internally. The Sprinkler Division is now paying $20 per pump,
less a 10% quantity discount. The Measurement Division could avoid $1 per unit in variable
costs on any sales to the Sprinkler Division.
Required:
a. Treating each division as an independent profit center, within what price range should the
internal sales price fall?
b. Now assume that the Measurement Division is selling 600,000 pumps per year on the
outside. Determine the appropriate transfer price. Show all computations.
a. Current price being paid by the Sprinkler Division:
$20 - (10% × $20) = $18
Using the transfer pricing formula, the minimum transfer price is:
Transfer Price > Variable Costs + Lost Contribution Margin > $11 + $0 = $11.
Therefore, the transfer price would be between $11 and $18 per unit.
b. In this case, there is no idle capacity. Therefore, the appropriate transfer price would be:
Transfer Price > Variable Costs + Lost Contribution Margin > $11 + ($20 - $12) = $11 + $8 =
$19.
122. Finnish Corporation has a Supply Division that does work for other Divisions in the company
as well as for outside customers. The company's Custodial Products Division has asked the
Supply Division to provide it with 10,000 special items each year. The special items would
require $15.00 per unit in variable production costs.
The Custodial Products Division has a bid from an outside supplier for the special items at
$29.00 per unit. In order to have time and space to produce the special items, the Supply
Division would have to cut back production of another product - the H56 that it presently is
producing. The H56 sells for $32.00 per unit, and requires $19.00 per unit in variable
production costs. Packaging and shipping costs of the H56 are $3.00 per unit. Packaging and
shipping costs for the new special part would be only $1.00 per unit. The Supply Division is
now producing and selling 40,000 units of the H56 each year. Production and sales of the H56
would drop by 20% if the new special item is produced for the Custodial Products Division.
Required:
a. What is the range of transfer prices within which both the Divisions' profits would increase
as a result of agreeing to the transfer of 10,000 special parts per year from the Supply Division
to the Custodial Products Division?
b. Is it in the best interests of Finnish Corporation for this transfer to take place? Explain.
a. From the perspective of the Supply Division, profits would increase as a result of the
transfer if, and only if:
units transferred:
Opportunity cost = [($32.00 - $19.00 - $3.00) × 8,000*]/10,000 = $8.00
*20% × 40,000 = 8,000
Therefore, Transfer price > ($15.00 + $1.00) + $8.00 = $24.00. From the viewpoint of the
Custodial Products Division, the transfer price must be less than the cost of buying the units
from the outside supplier. Therefore, Transfer price < $29.00.
Combining the two requirements, we get the following range of transfer prices: $24.00 <
Transfer price < $29.00.
b. Yes, the transfer should take place. From the viewpoint of the entire company, the cost of
transferring the units within the company is $24.00, but the cost of purchasing the special
parts from the outside supplier is $29.00. Therefore, the company's profits increase on
average by $5.00 for each of the special items that is transferred within the company, even
though this would cut into production and sales of another product.
123. Division N has asked Division M of the same company to supply it with 10,000 units of part
P782 this year to use in one of its products. Division N has received a bid from an outside
supplier for the parts at a price of $25.00 per unit. Division M has the capacity to produce
50,000 units of part P782 per year. Division M expects to sell 46,000 units of part P782 to
outside customers this year at a price of $26.00 per unit. To fill the order from Division N,
Division M would have to cut back its sales to outside customers. Division M produces part
P782 at a variable cost of $17.00 per unit. The cost of packing and shipping the parts for
outside customers is $1.00 per unit. These packing and shipping costs would not have to be
incurred on sales of the parts to Division N.
Required:
as a result of agreeing to the transfer of 10,000 parts this year from Division N to Division M?
b. Is it in the best interests of the overall company for this transfer to take place? Explain.
a. From the perspective of Division N, profits would increase as a result of the transfer if, and
only if:
units transferred:
Opportunity cost = [($26.00 - $17.00 - $1.00) × 6,000*]/10,000 = $4.80
*
Demand from outside customers 46,000
Units required by Division N 10,000
Total requirements 56,000
Capacity 50,000
Required reduction in sales to outside

6,000
customers
Therefore, Transfer price > $17.00 + $4.80 =

$21.80.
From the viewpoint of Division M, the transfer price must be less than the cost of buying the
units from the outside supplier. Therefore,
Transfer price < $25.00. Combining the two requirements, we get the following range of
transfer prices:
$21.80 < Transfer price < $25.00.
b. Yes, the transfer should take place. From the viewpoint of the entire company, the cost of
transferring the units within the company is $21.80, but the cost of purchasing them from the
outside supplier is $25.00. Therefore, the company's profits increase on average by $3.20 for
each of the special parts that is transferred within the company.
124. Farris Yard Equipment Corporation manufactures lawn mowers and snow blowers. It also
manufactures engines that are used by the Lawn Mower Assembly Division (LMAD). The
Engine Division (ED) also sells about 40% of its output to the outside market (these are
multipurpose engines). Its annual capacity is 150,000 units and annual output 135,000 units.
All engines sold internally to the LMAD are priced at cost plus 20% markup.
In January 2016, the Snow Blower Assembly Division (SBAD) approached the ED to 'buy'
20,000 engines. Diane Rogers, the controller of ED, computed the costs of manufacturing
these engines as follows
Total Per unit
Materials $300,000 $15.00
Labor 400,000 20.00
Special equipment 36,000 1.80
Quality inspection 24,000 1.20
Other manufacturing costs 350,000 17.50
Total costs $1,110,000 $55.50
Rogers quoted a price of $66.60 for each engine transferred to the SBAD. Jackson White, the
manager of SBAD, was furious to note that the ED was "trying to make money off a sister
division." He argued that the price must include only the cost of materials, as all other costs
will be incurred irrespective of whether or not SBAD places the order for 20,000 engines.
Morton Downey, the production manager of ED, pointed out that the special equipment will be
purchased only for fulfilling this internal order. Moreover, he argued that inspection must also
be done just like on all other engines; therefore, the inspection costs must also be included.
Labor is paid a flat monthly salary. Other manufacturing costs include both variable and fixed
components (in roughly equal proportion).
Required:
(a) Given that excess capacity exists, what is the minimum price that the ED must charge to
the SBAD?
(b) What are the pros and cons of internal sourcing?
(a) The costs that are explicitly associated with the manufacture of engines required by the
SBAD are as follows:
Materials: $300,000
Special equipment: 36,000
Inspection: 24,000
Other manufacturing
175,000
costs:
$26.75 per
Total $535,000
unit
Therefore, the minimum price at which the ED can 'sell' to the SBAD would be $32.10 ($26.75
× 1.20).
It is important to note that excess capacity exists; therefore, the ED does not have any
opportunity costs associated with the SBAD's order.
(b) The pros of internal sourcing are as follows:
• Productive use of excess capacity.
• Potential cost savings.
• Protection of proprietary knowledge.
The cons of internal sourcing are as follows:
• Setting internal pricing policies and refereeing disputes.

• Supporting inefficient operations with artificially high internal prices.
It is important to note that any policy stated as "cost plus 20 percent" is asking for trouble,
because "cost" is undefined. If market prices are available, the company probably should use
these for internal sales, with a policy of sourcing internally at the market price. Using cost-
based internal prices may be necessary, but creates complications of creating the price that
motivates managers to benefit themselves and the company as a whole.
125. Allentown Division of Sparks Inc. transfers its product to the Youngstown Division. The
Youngstown Division can either buy the item internally or externally (cost = $73 each). The
Allentown Division has just completed its annual cost update as follows:
Direct material $25.00
Direct labor 18.00
Variable manufacturing
6.00
overhead
Fixed manufacturing
3.50
overhead
Variable selling
4.00
expenses
Fixed selling and

8.50
administrative expenses
Total costs $65.00
Desired return 14.00

Sales price $79.00
The Allentown Division is operating at 60 percent of its 400,000 unit capacity.
Required:
1) What is the minimum transfer price the Allentown Division should charge for internal
transfers?
2) What is the maximum price the Youngstown Division would be willing to pay?
3) Why should the Allentown Division reduce its price to the Youngstown Division?
1) The minimum transfer price should be total variable cost = $25 + $18 + $6 + $4 = $53.
2) The maximum transfer price = market price = $73.
3) The Allentown Division should reduce its price because it has excess capacity. Under the
general rule, even though it doesn't work well with excess capacity, only costs incurred
because of production necessitated by the internal transfer should be considered—
therefore, only variable costs should make up the transfer price. The price also
does not reflect that actual fixed cost per unit will decrease as more units are
produced and, with an internal sale, variable selling expense might be eliminated
or, at least, reduced.
4) The following costs exist for Wiring Division of Corriander Corp.

Direct material $67,500
Direct labor 45,000
Manufacturing overhead (25%

45,000
variable)
Operating expenses (30% variable) 75,000
Output 30,000 Units

The output of the Wiring Division, which sells for $10/unit externally, is used by the Electrical
Harness Division.
Required:
Compute the transfer price for a unit of the Wiring Division's output using:
1) market price
2) variable production cost plus 30 percent
3) absorption cost plus 25 percent
4) variable cost
5) total cost plus 10 percent
1) $10 per unit.

2) 1.3($67,500 + $45,000 + .25($45,000))/30,000 = 1.3($123,750)/30,000 = $160,875/30,000
= $5.3625.
3) 1.25($67,500 + $45,000 + $45,000)/30,000 = 1.25($157,500)/30,000 = $196,875/30,000 =
$6.5625.
4) ($67,500 + $45,000 + .25($45,000) + .3($75,000))/30,000 = ($67,500 + $45,000 + $11,250
+ $22,500)/30,000 = $146,250/30,000 = 4.875.
5) 1.1($67,500 + $45,000 + $45,000 + $75,000)/30,000 = 1.1($232,500)/30,000 =
$255,750/30,000 = $8.525.
126. SEMO Inc. has a division located in Spain and another in the U.S. The Spanish division
produces a part needed for the product made by the U.S. division. There is substantial excess
capacity in the Spanish division. The tax rate of the Spanish division is 35% and U.S. division
tax rate is 30%.
The part sells externally for $75 and the Spanish division's manufacturing costs are:
Direct material $32
Direct labor 12
Variable overhead 6
Fixed overhead 19
Required:
1) What would be the lowest acceptable transfer price for the Spanish division?
2) What would be the highest acceptable transfer price for the U.S. division?
3) What would be the transfer price that would be the best for SEMO Inc. and why?
1) Minimum transfer price = $32 + $12 + $6 = $50 variable production cost.
2) Maximum transfer price = $75 market.
3) A transfer price of $50 would be the best for SEMO, Inc. It would minimize U.S. income tax
overall since less would be taxed at the 35% level and, while there would be more profit for the
U.S. division, the U.S. tax rate is lower.
127. The following information is available for the two divisions of MAC Co.:
Division A
Selling price to outside market $55
Standard unit-level costs 35
Division B
Selling price of finished product $95
Standard unit-level costs for Division B 25
Division A has no excess production capacity.
Required:
1) In order to ensure the best use of the productive capacity of A, what transfer price should
be set by Division A and what effect does this transfer price have on the overall margin for the
company? Is the answer goal congruent under the general rule?
2) Should Division B accept a special order for its product if the selling price is reduced to
$70. Use your answer from #1 and explain.
3) Would your answer to #2 change if Division A had excess capacity? Explain.

1)
Company (after transfer to

Division A
Division B)
Selling price $55 Retail selling price $95
Standard unit- Standard unit-level

35
level cost costs
Contribution
$20 Division A $35
Margin
Division B 25 60
Contribution $35
Margin
The appropriate transfer price should be $55 which fits in with the transfer price from the
general rule so it is goal congruent. This would be in the best interest of the company and
would still encourage Division B to purchase internally. B's contribution margin would be $15
($95 - $55 - $25).
2)
Division Company-after
B transfer
Selling price-special
$70 $70
order
Standard unit-level
costs
Division A $55 $35
Division B 25 80 25 60
Contribution Margin ($10) $10

No. Division B would lose $10 per unit if the special order were accepted. The company will
make more if Division A would sell directly to the external market with a $20 contribution. A
decision to sell the part externally is still goal congruent under the general rule.
(3) Under the general rule the transfer price when there is excess capacity would be $35. The
overall contribution would be $10 per unit and Division B's contribution would also be $10. It
would be in the best interests of the company to accept the special order and under the
general rule goal congruent behavior still continues.
128. Division X has asked Division K of the Easton Company to supply it with 5,000 units of part
L433 this year to use in one of its products. Division X has received a bid from an outside
supplier for the parts at a price of $26.00 per unit. Division K has the capacity to produce
30,000 units of part L433 per year. Division K expects to sell 26,000 units of part L433 to
outside customers this year at a price of $30.00 per unit. To fill the order from Division X,
Division K would have to cut back its sales to outside customers. Division K produces part
L433 at a variable cost of $21.00 per unit. The cost of packing and shipping the parts for
outside customers is $2.00 per unit. These packing and shipping costs would not have to be
incurred on sales of the parts to Division X.
Required:
as a result of agreeing to the transfer of 5,000 parts this year from Division X to Division K?
b. Is it in the best interests of the overall Easton Company for this transfer to take place?
Explain.
this solution rather than "greater than or equal to" and "less than or equal to" signs).
a. From the perspective of Division X, profits would increase as a result of the transfer if, and
only if:
Transfer price > Variable cost + Opportunity cost.
units transferred:
Opportunity cost = [($30.00 per unit - $21.00 per unit - $2.00 per unit) × 1,000 units*]/5,000
units = $1.40 per unit.
* Demand from outside customers 26,000
Units required by Division X 5,000
Total requirements 31,000
Capacity 30,000
Required reduction in sales to outside

customers 1,000
Therefore, Transfer price > $21.00 per unit + $1.40 per unit = $22.40 per unit.
From the viewpoint of Division K, the transfer price must be less than the cost of buying the
units from the outside supplier. Therefore,
Transfer price < $26.00.
Combining the two requirements, we get the following range of transfer prices:
$22.40 < Transfer price < $26.00.
b. Yes, the transfer should take place. From the viewpoint of the Easton Company, the cost of
transferring the units within the company is $22.40, but the cost of purchasing them from the
outside supplier is $26.00. Therefore, the company's profits increase on average by $3.60 for
each of the special parts that is transferred within the Easton Company.
129. Pomme Corporation has a Motor Division that does work for other Divisions in the company as
well as for outside customers. The company's Equipment Division has asked the Motor
Division to provide it with 2,000 special motors each year. The special motors would require
$17.00 per unit in variable production costs. The Equipment Division has a bid from an outside
supplier for the special motors at $28.00 per unit. In order to have time and space to produce
the special motor, the Motor Division would have to cut back production of another motor - the
J789 that it presently is producing. The J789 sells for $34.00 per unit, and requires $22.00 per
unit in variable production costs. Packaging and shipping costs of the J789 are $4.00 per unit.
Packaging and shipping costs for the new special motor would be only $0.50 per unit. The
Motor Division is now producing and selling 10,000 units of the J789 each year. Production
and sales of the J789 would drop by 10% if the new special motor is produced for the
Equipment Division.
Required:
as a result of agreeing to the transfer of 2,000 special motors per year from the Motor Division
to the Equipment Division?
b. Is it in the best interests of Pomme Corporation for this transfer to take place? Explain.
a. From the perspective of the Motors Division, profits would increase as a result of the
transfer if, and only if:
Transfer price > Variable cost + Opportunity cost.
units transferred:
Opportunity cost = [($34.00 per unit - $22.00 per unit - $4.00 per unit) × 1,000 units*]/2,000
units = $4.00 per unit.
*10% × 10,000 units = 1,000 units.
130. Randolph Company has two divisions organized as profit centers: Redmon and Tomlin.
Randolph expects the following results:
Redmon Tomlin
Sales
Redmon: (10,000 × $16) $1,600,000
Tomlin: (250,000 ×
$1,800,000
$7.20)
Variable costs 1,360,000 1,000,000
Fixed costs 160,000 460,000
Profit $80,000 $340,000

Included in Redmon's costs are 100,000 units of a subcomponent purchased from an outside
supplier for $4.50. The managers have recently initiated negotiations for Tomlin to supply the
components to Redmon. Tomlin has a total capacity of 400,000 units.
Required:
a. Prepare a new segment reporting statement for Randolph, assuming an internal transfer at
the maximum transfer price.
b. Prepare a new segment reporting statement for Randolph, assuming an internal transfer at
the minimum transfer price.
a. Redmon Tomlin
Sales
Redmon: (10,000 × $16) $1,600,000
Tomlin: (250,000 ×
$1,800,000
$7.20)
Transfer (100,000 ×
450,000
$4.50)
a. Maximum price = $4.50; new variable
Variable costs 1,360,000 1,400,000 costs for B: ($1,000,000/250,000) × 350,000
=
$1,400,000; no change in variable cost to A.
Fixed costs 160,000 460,000
b. Minimum price = variable cost =
Profit $80,000 $340,000 $4.00; new variable costs for A:
$1,360,000 - old cost (100,000 ×
b. Redmon Tomlin
$4.50) + new cost (100,000 × $4) =
Sales
$1,360,000 - $50,000 = $1,310,000.
Redmon: (10,000 × $16) $1,600,000
131. Why is transfer pricing only a
Tomlin: (250,000 ×
$1,800,000 concern for profit or investment
$7.20)
centers and not for cost or revenue
Transfer (100,000 × $4) 400,000
centers?
Variable costs 1,310,000 1,400,000
A cost center is not concerned with making
a profit, only with controlling costs.
Fixed costs 160,000 460,000 Similarly, a revenue center is also not
concerned with profits, only with revenues. Transfer prices consider the profit impact of
Profit $130,000 $340,000 making a decision as to the source of a
product.
132. Explain the general principle for determining the optimal transfer price.
The general principle for an optimal transfer price is to set the price equal to the outlay cost for
the supplier up to the point of transfer and opportunity cost of the resources of the supplier.
This principle should result in a transfer price that leads managers to make decisions in the
firm's best interests.
133. What is meant by a dual transfer pricing system? What are some advantages and
disadvantages of it?
A dual transfer pricing system is one where the selling division is awarded a price that includes
profits while the buying division is charged only for costs. The advantage is this type of system
encourages transfers. Disadvantages include the transfer price will not serve as a signal as to
the value of the good to the firm. Performance evaluation is also more difficult under this
system.
134. What are the limitations of market-based transfer prices?
A perfect intermediate market may not exist, there may be differences between the internal
products and those available on the market with respect to distribution costs, quality, or
product characteristics.
135. What are the advantages and disadvantages of using a negotiated transfer price?
The major advantage of a negotiated transfer price is that it preserves the autonomy of the
divisional managers. The disadvantages include 1) a great deal of management time may be
consumed by the negotiating process and 2) the final price and its implications for
performance measurement could depend more on the manager's ability to negotiate than on
what is best for the company.
136. Why is transfer pricing important in tax accounting?
Transfer pricing is important in tax accounting, because transfers of goods or services often
occurs across different tax jurisdictions (countries, for example). The transfer price affects the
revenue (income) and cost (income) that are reported in the different jurisdictions. If the
different jurisdictions have different income tax rates, the total tax liability across all
jurisdictions will depend on the transfer price.
137. What are the principal items that must be disclosed about each segment and how does this
differ if a company has significant foreign operations?
The following are the principal items that must be disclosed about each segment:
• Segment revenue, from both internal and external customers.
• Interest revenue and expense.
• Segment operating profit or loss.
• Identifiable segment assets.

• Depreciation and amortization.
• Capital expenditures.
• Certain specialized items.
In addition, if a company has significant foreign operations, it must disclose rev-enues,
operating profits or losses, and identifiable assets by geographical region.
138. Hartland Company has used market price as its transfer price for the Sterling Division for
many years with no problems. This year, because of changes in the economy, the demand for
its final product has dropped along with the price.
Required:
Explain the problems of basing the transfer prices on distress market prices and possible
solutions to the problems.
Under such extreme situations, basing transfer prices on market prices can lead to decisions
that are not in the best interests of the overall company. Basing transfer prices on artificially
low "distress" prices can lead the producing division to sell or close the productive resources
devoted to producing the product for transfer to switch to a more profitable product. This might
provide a short-run improvement in divisional profit but might not be in the best interests of the
company overall. The company might be better off if no productive resources are sold off and
it rides out the period of market distress. To encourage managers to act in this more
appropriate way of transfer pricing, some companies set the transfer prices equal to a long-run
average external market price rather than the current market price.
139. Midland Inc. has two divisions: production and marketing, which it treats as profit centers.
Because the production division has no marketing capabilities, it does not have a traditional
market price to consider and the company does not want to use negotiation.
Required:
Discuss the following cost-based transfer prices along with problems that might exist for each.
1) Standard unit-level cost.

2) Absorption (full) cost.
3) Actual cost.
1) Standard unit-level cost: the selling division's contribution margin would be zero which
would give no incentive to make the transfer. This problem can be avoided by using standard
unit-level cots plus a markup to give the selling division a positive contribution margin.
2) Absorption (full) cost: unit-level cost plus an assigned portion of higher-level costs. This can
lead to dysfunctional decision making behavior. Full cost-based transfer prices leads the
buying division to view costs that are non-unit-level costs for the company as a whole as unit-
level costs to the buying division which can cause problems with decision making.
3) Actual cost: actual cost-based transfer prices allow an inefficient producing division to pass
the excess production costs on to the buying division via the transfer price. Also, the selling
division has no incentives to control costs since the cost of inefficiency are passed on.
Standard-based transfer prices avoid these problems.
140. Mr. Massee, the Vice President of Production is looking at two of the Divisions that report to
him. These divisions are viewed as profit centers by the company. He has called in the head
of Brake Division A, which provides a part used by Wheel Division, because he has noticed
that Wheel Division is going to an external supplier for the part. Mr. Omsby, the head of the
Brake Division, tells him that he has set the transfer price at $38 per part even though the
external price is $33 per part. The standard unit-level cost is $22. "I have set the $38 price
because I am operating with no excess capacity and do not want to have the internal transfer
to the Wheel Division. I have some good external customers and do not want to lose them by
selling internally. If I had excess capacity, I would be willing sell to the Wheel Division at a
lower price."
Mr. Massee says that he has to think about this situation because something doesn't seem
right to him. After Mr. Omsby leaves the office, he calls his friend in the controller's department
for some help.
Required:
You are that friend. Explain to Mr. Massee the differences in transfer pricing when there is no
excess capacity and when there is excess capacity and what Mr. Omsby is doing wrong.
When there is no excess capacity, sales to third parties are given up in order to make the
internal transfers so a transfer price equal to outlay costs plus opportunity cost is appropriate.
This usually is market price or very close to market price. The market-based transfer price
allows both divisions to be no worse off with the transfer inasmuch as the same dollar figures
are involved as if they each went to outside parties. Mr. Omsby, in charging as a transfer price
$38 instead of $33 is not operating in a goal congruent manner. It is in the company's best
interests to have the internal transfer. The most he should be charging the Wheel Department
is $33. Where there is excess capacity, the transfer price usually is set around variable cost. If
one can use the results of the general rule in this situation, the opportunity cost would be
equal to zero because no sales to third-parties would be given up and only the variable costs
increase as more units are produced.

141. Ms. Clarke, one of the marketing managers, has come to the meeting with a number of reports
about one of her products. The Vice President of Marketing sees her agitation and asks her
what the problem is. "Well, the product made by the East Coast Division is losing sales even
after the price had been lowered drastically. The manager of the division is threatening to
close because of the reduced demand."
The Vice President of Marketing asks why the lowered prices are a problem and Ms. Clarke
says that, according to the manager, the price used to transfer the goods to Southern Division
are based on market price and, with the lowered market price, the unit-level costs are no
longer being covered and he is losing money on every transfer as well as every third-party
sale.
Required:
Explain further to the Vice President of Marketing the issues involved in transfer pricing when
there are distressed market prices.
Under such extreme situations, basing transfer prices on market prices can lead to decisions
that are not in the best interests of the overall company. Basing transfer prices on artificially
low "distress" prices can lead the producing division to sell or close the productive resources
devoted to producing the product for transfer or to switch to a more profitable product. This
might provide a short-run improvement in divisional profit but might not be in the best interests
of the company overall. The company might be better off if no productive resources are sold
off and it rides out the period of market distress. To encourage managers to act in this more
appropriate way of transfer pricing, some companies set the transfer price equal to a long-run
average external market price rather than the current market price.
142. Briefly discuss some of the general issues of multinational transfer pricing.
In international transactions, transfer prices may affect tax liabilities, royalties, and other
payments because of different laws in different countries (or states). Because tax rates vary
among countries, companies have incentives to set transfer prices that will increase revenues
(and profits) in low-tax countries and increase costs (thereby reducing profits) in high-tax
countries. There is a feeling by some that the tax avoidance caused by foreign companies
selling goods to their U.S. subsidiaries at inflated transfer prices artificially reduces the profits
of the U.S. subsidiaries and reduces the taxes collected in the U.S. International taxing
authorities look closely at transfer prices for companies engaged in related-party transactions
that cross national boundaries and frequently companies have to support the transfer price
they have chosen.
143. During the current year Tuesday Company's foreign Division A incurred production costs of $4
million for units that are transferred to its other foreign Division, B. Costs in Division B, outside
of the costs of production of the final product are $8 million. These are third-party costs. Sales
revenue for the final product for Division B is $30 million. Other companies in the same
country import a similar type of part as Division B at a cost of $7 million. Tuesday has set its
transfer price at $14 million, justifying this price because of the special controls it has on the
operations in Division A as well as its special manufacturing method. The tax rate in the
country where Division A is located is 40% while the tax rate for Division B's country is 70%.
Required:
1) What would Tuesday's total tax liability for both divisions be if it used the $7 million transfer
price?
2) What would the liability be if it used the $14 million transfer price?
1)
Revenue $7,000,000 $30,000,000
Third-party costs (4,000,000) (8,000,000)
Transferred goods costs (7,000,000)
Taxable income $3,000,000 $15,000,000
Tax Rate × 40% × 70%
Tax Liability $1,200,000 $10,500,000
Total Tax liability $11,700,000
2)
Revenue $14,000,000 $30,000,000

Third-party costs (4,000,000) (8,000,000)
Transferred goods costs (14,000,000)
Taxable income $10,000,000 $8,000,000
Tax Rate × 40% × 70%
Tax Liability $4,000,000 $5,600,000
Total Tax liability $9,600,000
144. How do import duties affect transfer pricing?
Import duties, or tariffs, are fees charged to an importer, generally on the basis of reported
value of the goods being imported. If a company has divisions in two countries and Country A
imposes an import duty on goods transferred in from Country B, the company has an incentive
to set a relatively low transfer price on the transferred goods. This will minimize the duty to be
paid and maximize the overall profit for the company as a whole. Countries sometimes pass
laws to limit a multinational ability in setting transfer prices for the purpose of maximizing
import duties.
145. Space Inc. has just purchased a foreign subsidiary that makes a component used by one of
the domestic divisions. Ms. Jenner, the controller, has been asked about issues that should be
considered in establishing a transfer price for the new subsidiary. Since this is Space's first
foray into the multinational arena, there is little to no expertise in international issues in the
company. Ms. Jenner has told her boss that she will get back to him with a report as to the
issues to be considered. She then calls a friend of hers at a branch of one of the big-4 CPA
firms that deals with international issues for some help.
Required:
What is the basic information that Ms. Jenner will be given by her friend?
In international transactions, transfer prices may affect tax liabilities, royalties, and other
payments because of different laws in different countries (or states). Because tax rates vary
among countries, companies have incentives to set transfer prices that will increase revenues
(and profits) in low-tax countries and increase costs (thereby reducing profits) in high-tax
countries. There is a feeling by some that the tax avoidance caused by foreign companies
selling goods to their U.S. subsidiaries at inflated transfer prices artificially reduces the profits
of the U.S. subsidiaries and reduces the taxes collected in the U.S. International taxing
authorities look closely at transfer prices for companies engaged in related-party transactions
that cross national boundaries and frequently companies have to support the transfer price
they have chosen.
Import duties, or tariffs, are fees charged to an importer, generally on the basis of reported
value of the goods being imported. If a company has divisions in two countries and Country A
imposes an import duty on goods transferred in from Country B, the company has an incentive
to set a relatively low transfer price on the transferred goods. This will minimize the duty to be
paid and maximize the overall profit for the company as a whole. Countries sometimes pass
laws to limit a multinational firm's ability in setting transfer prices for the purpose of maximizing
import duties.
146. Briefly discuss transfer prices in relation to external segment reporting under GAAP.
The FASB requires companies engaged in different lines of business to report certain
information about segments that meet the FASB's technical requirements. This reporting
requirement is intended to provide a measure of the performance of those segments of a
business that are significant to the company as a whole. Among the principal items that must
be reported are segment revenue and segment operating profits or loss.
Negotiated transfer prices are not generally acceptable for external segment reporting. In
general, the accounting profession has indicated a preference for market-based transfer prices
because the purpose of the segment disclosure is to enable an investor to evaluate a
company's divisional sales as though they were free-standing enterprises. While this is sound
conceptually, in reality it may not work because the segments are interdependent and market
prices may not really reflect the same risk in an intracompany sale that they do in third-party
sales.
Chapter 16 Fundamentals of Variance Analysis Answer Key
True / False Questions
1. In essence, the terms "master budget" and "operating budget" mean the same thing and can
be used interchangeably.
FALSE
The operating budget is part of the master budget, along with financial budgets.
2. Variances are the difference between actual results and budgeted results.
TRUE
3. In general, and holding all other things constant, an unfavorable variance decreases operating
profits.
TRUE
Just as a favorable variance increases profits, an unfavorable variance decreases profits.
4. A favorable variance is not necessarily good, and an unfavorable variance is not necessarily
bad.
TRUE
A favorable or unfavorable variance in one period may have long term impacts in the opposite
direction.
5. The terms "master budget" and "flexible budget" mean the same thing and can be used
interchangeably.
FALSE
A master budget and a static budget mean the same thing.
6. A flexible budget adjusts the static budget to reflect the actual activity level achieved during
the period.
TRUE
This is a basic principle of a flexible budget.
7. If the budgeted activity level is greater than the actual activity level, then the total budgeted
16-1
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.
costs of the master budget will be greater than the total budgeted costs of the flexible budget.
TRUE
The master budget is based on the budgeted activity level, while the flexible budget is based
on the actual activity level.
8. The difference between operating profits in the master budget and operating profits in the
flexible budget is called a sales price variance.
FALSE
This is a sales activity variance.
9. The sales activity variance is the result of a difference between budgeted units sold and actual
units sold.
TRUE
This is the definition of the sales activity variance.
10. The sales price variance is the actual selling price per unit times the difference between
budgeted number of units and the actual number of units sold.
FALSE
Sales price variance is the difference between actual and budgeted selling price times the
actual number sold.
11. Production cost variances are input variances, while sales activity variances are output
variances.
TRUE
Costs are based on inputs, revenues are based on outputs.
12. The flexible and master budget amounts are the same for fixed marketing and administrative
costs.
TRUE
Fixed costs do not change with changes in activity level within the relevant range.
13. The standard cost for a unit of output is the standard price per unit of input times the standard
number of inputs per one unit of output.
TRUE
16-2
14. Both the actual material used and the standard quantity allowed for material is based on the
actual output attained.

TRUE
Standard quantity allowed = standard per unit × actual output.
15. It is possible to have a favorable direct material price variance and an unfavorable direct
material efficiency variance.
TRUE
Purchasing a lower quality material will yield a favorable price variance (since it is less costly)
but may result in an unfavorable efficiency because of higher than expected waste due to poor
quality.
16. The materials price variance is computed by multiplying the difference between the actual
price and the standard price by the actual quantity of materials used in production.
FALSE
The materials price variance is computed by multiplying the difference between the actual and
standard price by the actual quantity of materials purchased.
17. The direct labor efficiency variance can be the result of poor supervision or poor scheduling by
divisional managers.
TRUE
Poor scheduling may cause wasted time.
18. Variance analysis for fixed production costs is virtually the same as for variable production
costs.
FALSE
There are no efficiency variances for fixed production costs.
19. The budget (or spending) variance for fixed production costs is the difference between the
actual fixed costs and the budgeted fixed costs on the master budget.
TRUE
20. The production volume variance is the difference between fixed costs on the flexible budget
and the fixed costs on the master budget.

FALSE
The production volume variance is the difference between the fixed costs on the flexible
16-3
budget and the fixed overhead applied to production.
21. When using standard costing, costs are transferred through the production process at their
standard costs.
TRUE
22. Standards and budgets are the same thing.
FALSE
A standard is related to a cost per unit; budgets focus on totals.
16-4
23. A standard cost system may be used in: (CPA adapted)
A. job-order costing but not process costing.
B. either job-order costing or process costing.
C. process costing but not job-order costing.
D. neither process costing nor job-order costing.
Standard costing is an option in either.
24. Which of the following statements is(are) true?

(A) A favorable variance is not necessarily good, and an unfavorable variance is not
necessarily bad.
(B) The master budget includes operating budgets (e.g., production budget) and financial
budgets (e.g., cash budget).
A. Only A is true.
B. Only B is true.
C. Both A and B are true.
D. Neither A nor B is true.
Both statements are true.
25. An operating budget would not include a:

A. cash budget.
B. sales budget.
C. labor budget.
D. production budget.
The cash budget is a financial budget.
26. A variance can best be described as:

A. benchmarks common to other firms in the same industry.
B. differences between planned results and actual results.
C. useful for performance evaluations but not making decisions.
D. generally accepted accounting principles when standards are used.
Variances are internal to a company and are useful for decision making as well as
16-5
performance evaluation. The statement is a basic explanation of a variance.
27. The most fundamental variance analysis compares:

A. standard material prices with actual material prices.
B. standard direct labor rates with actual direct labor rates.
C. budgeted sales revenue with actual sales revenue.
D. budgeted operating income with actual operating income.
The most fundamental variance is comparing incomes rather than components of income.
28. In general, the terms favorable and unfavorable are used to describe the effect of a variance
on:
A. net income.
B. sales revenue.
C. production costs.
D. operating expenses.
What impact does a variance have on profit?
29. Which of the following statements regarding variances is(are) false?

(A) In general and holding all other things constant, an unfavorable variance decreases
operating profits.
(B) A favorable variance is not always good, and an unfavorable variance is not always bad.
A. Only A is false.
B. Only B is false.
C. Both A and B are false.
D. Neither A nor B is false.
Both statements are true.
30. Which of the following variances will always be favorable when actual sales exceeds budgeted
sales?
A. Variable cost.
B. Fixed cost.
C. Sales activity.
16-6
D. Operating profit.
The question asks about sales; therefore, the answer should be expressed in terms of sales.
31. Which of the following organizational policies is most likely to result in undesirable managerial
behavior? (CMA adapted)
A. Raj Chemicals sponsors television coverage of cricket matches between national teams
representing India and Pakistan. The expenses of such media sponsorship are not
allocated to its various divisions.
B. Felix Eagle, the chief executive officer of Eagle Rock Brewery, wrote a memorandum to his
executives stating, "Operating plans are contracts and they should be met without fail."
C. The budgeting process at Lawrence Manufacturing starts with operating managers

providing goals for their respective departments.
D. Gallen Lighting holds quarterly meetings of departmental managers to consider possible

changes in the budgeted targets due to changing conditions.
(a) The television sponsorship costs are not controllable by the divisions. (b) Operating plans
need to be adjusted for actual output. Treating them as static contracts may cause managers
to play games. (c) Participative budgeting is a good thing. (d) Participating in changing
quarterly targets will keep the budgets current.
32. When a manager is concerned with monitoring total cost, total revenue, and net profit
conditioned upon the level of productivity, an accountant should normally recommend: (CPA
adapted)
Flexible Budgeting Standard Costing
A. Yes Yes
B. Yes No
C. No Yes
D. No No
A. Option A
B. Option B
C. Option C
16-7
D. Option D
Standard costing focuses on costs only; flexible budgeting focuses on both costs & revenues
and thus profits.
33. Based on past experience, Moss Company has developed the following budget formula for
estimating its shipping expenses. The company's shipments average 12 lbs. per shipment:
Shipping costs = $16,000 + ($0.50 × lbs. shipped).
The planned activity and actual activity regarding orders and shipments for the current month
are given in the following schedule:
Plan Actual
Sales orders 800 780
Shipments 800 820
Units shipped 8,000 9,000
Sales $120,000 $144,000
Total pounds shipped 9,600 12,300
The actual shipping costs for the month amounted to $21,000. The appropriate monthly
flexible budget allowance for shipping costs for the purpose of performance evaluation would
be: (CMA adapted)
A. $20,680.
B. $20,920.
C. $20,800.
D. $22,150.
$16,000 + ($0.50 × 12,300) = $22,150
34. The purpose of the flexible budget is to:

A. allow management some latitude in meeting goals.
B. eliminate cyclical fluctuations in production reports by ignoring variable costs.
C. compare actual and budgeted results at virtually any level of production.
D. reduce the total time in preparing the annual budget.
16-8
The budget is restated to actual output level, along with the variable costs, to make the budget
and actual results comparable.
35. The basic difference between a master budget and a flexible budget is that a:
A. flexible budget considers only variable costs but a master budget considers all costs.
B. flexible budget allows management latitude in meeting goals whereas a master budget is
based upon a fixed standard.
C. master budget is for an entire production facility but a flexible budget is applicable to single
departments only.
D. master budget is based on one specific level of production and a flexible budget can be
prepared for any production level within a relevant range.
The master budget is a benchmark, calculated at one specific level of activity, which allows the
flexible budget tool to be used, adjusting variable costs, to allow for a comparison of actual
and budget amounts.
36. The slope of the flexible budget-line is the:

A. selling price per unit.
B. variable cost per unit.
C. fixed cost per unit.
D. contribution margin per unit.
The slope of the line indicates the additional variable cost per unit as additional units are sold.
The line itself is considered the total cost curve.
37. The intercept of the flexible budget-line is total:

A. sales.
B. variable costs.
C. fixed costs.
D. contribution margin.
This is a carry-over from CVP. The fixed cost is the a intercept on the y axis. Even at zero
activity fixed cost are incurred.
38. When using a flexible budget, what will happen to variable costs on a per-unit basis as
production increases within the relevant range?

16-9
A. Decrease.
B. Increase.
C. Remain unchanged.
D. Fixed costs are not considered in flexible budgeting.
The cost behavior of a variable unit cost is to remain constant within the relevant range.
39. The Valenti Company uses flexible budgeting for cost control. Valenti produced 10,800 units of
product during October, incurring indirect material costs of $13,000. Its master budget for the
reflected indirect material costs of $180,000 at a production volume of 144,000 units. What
was the flexible budget variance for the indirect material costs in October?
A. $1,100 favorable.
B. $1,100 unfavorable.
C. $2,000 favorable.
D. $500 favorable.
($180,000/144,000) × 10,800 = $13,500; $13,500 - 13,000 = $500 favorable
40..
Flexible Sales
Actual Master
Budget Flexible Activity
Results Budget
Variance Budget Variance
Units 13,000 ? 2000U ?
Sales revenue ? 13,000F ? ? ?
Less:
<Variable mfg.
$87,750 $91,000 ? $105,000
Costs>
<Variable
? $3,250U ? $4,000F 30,000
mktg/adm.costs>
Contribution
$52,000 ? ? $6,000U ?
margin
What is the actual sales revenue?
16-10
A. $156,000.
B. $169,000.
C. $180,000.
D. $191,000.
Solve for variable marketing & administrative costs $30,000 - $4,000 + $3,250 = $29,250. Add
$29,250 to actual contribution margin of $52,000 and actual variable costs of $87,750 = sales
revenue of $169,000
41.
Flexible Sales
Actual Master
Results Budget
Units 13,000 ? 2000U ?
Less:
<Variable mfg.
$87,750 $91,000 ? $105,000
Costs>
<Variable
? $3,250U ? $4,000F 30,000
mktg/adm.costs>
Contribution
$52,000 ? ? $6,000U ?
margin
What is the sales revenue in the flexible budget?

A. $139,000.
B. $156,000.
C. $169,000.
D. $180,000.
$169,000 (actual sales from previous question) - $13,000 = $156,000
16-11
42.
Flexible Sales
Actual Master
Results Budget
Units 13,000 ? 2000U ?
Less:
<Variable mfg.
$87,750 $91,000 ? $105,000
Costs>
<Variable
? $3,250U ? $4,000F 30,000
mktg/adm.costs>
Contribution
$52,000 ? ? $6,000U ?
margin
What is the flexible budget contribution margin?

A. $39,000.
B. $45,000.
C. $52,000.
D. $58,000.
$156,000 - $91,000 - ($29,250 - $3,250 = $26,000) = $39,000
16-12
43.
Flexible Sales
Actual Master
Results Budget
Units 13,000 ? 2000U ?
Less:
<Variable mfg.
$87,750 $91,000 ? $105,000
Costs>
<Variable
? $3,250U ? $4,000F 30,000
mktg/adm.costs>
Contribution
$52,000 ? ? $6,000U ?
What is the master budget sales revenue?

A. $124,000.
margin
B. $148,000.
C. $156,000.
D. $180,000.
($156,000/13,000) = $12 selling price; $12 × (13,000 units + 2,000 units) = $180,000
16-13
44.
Flexible Sales
Actual Master
Results Budget
Units 13,000 ? 2000U ?
Less:
<Variable mfg.
$87,750 $91,000 ? $105,000
Costs>
<Variable
? $3,250U ? $4,000F 30,000
mktg/adm.costs>
Contribution
$52,000 ? ? $6,000U ?
margin
What is the master budget contribution margin?

A. $52,000.
B. $47,500.
C. $45,000.
D. $39,000.
$180,000 - $105,000 - $30,000 = $45,000
16-14
45.
Flexible Sales
Actual Master
Results Budget
Units 13,000 ? 2000U ?
Less:
<Variable mfg.
$87,750 $91,000 ? $105,000
Costs>
<Variable
? $3,250U ? $4,000F 30,000
mktg/adm.costs>
Contribution
$52,000 ? ? $6,000U ?
margin
What is the activity variance for the variable manufacturing costs?

A. $4,000.
B. $14,000.
C. $24,000.
D. $34,000.
$105,000 - $91,000 = $14,000
16-15
46.
Flexible Sales
Actual Master
Results Budget
Units 13,000 ? 2000U ?
Less:
<Variable mfg.
$87,750 $91,000 ? $105,000
Costs>
<Variable
? $3,250U ? $4,000F 30,000
mktg/adm.costs>
Contribution
$52,000 ? ? $6,000U ?
margin
Is the activity variance for the variable manufacturing costs favorable or unfavorable?
A. Favorable.
B. Unfavorable.
Less was spent than was budgeted so the variance is favorable.
47. In analyzing company operations, the controller of the Carson Corporation found a $250,000
favorable flexible budget revenue variance. The variance was calculated by comparing the
actual results with the flexible budget. This variance can be wholly explained by: (CMA
adapted)
A. the total flexible budget variance.
B. the total static budget variance.
C. changes in unit selling prices.
D. changes in the number of units sold.
Since the flexible budget is based on actual output, the variation could only come from the
selling price.
16-16
48. The difference between operating profits in the master budget and operating profits in the
flexible budget is called:
A. sales activity variance.
B. flexible budget variance.
C. production volume variance.
D. total operating profit variance.
49. Which of the following statements is(are) true regarding the sales activity variance?
(A) The sales activity variance is the actual selling price per unit times the difference between
the budgeted units and actual units.
(B) If the sales activity variance for sales revenue is unfavorable, then the contribution margin
sales activity variance will be unfavorable.
A. Only A is true.
B. Only B is true.
C. Neither A and B is true.
D. Both A and B are true.
(A) The sales activity variance uses budgeted selling price. (B) is true—a unfavorable variance
is the result of actual sales being less than budgeted.
50. The sales price variance is the difference between the actual sales revenues and the:
A. budgeted selling price multiplied by the budgeted number of units sold.
B. budgeted selling price multiplied by the actual number of units sold.
C. actual selling price multiplied by the budgeted number of units sold.
D. actual selling price multiplied by the actual number of units sold.
The sales price variance is derived from the difference between the actual revenue and
budgeted selling price multiplied by the actual number of units sold.
51. Which of the following statements is not true regarding the fixed production cost variance?
A. The fixed production cost variance is the difference between actual and bud-geted costs.
B. With respect to this variance, fixed costs are affected by activity levels within a relevant
range.
C. The flexible budget's fixed costs equal the master budget's fixed costs.
16-17
D. Fixed costs are treated as period costs for purposes of this variance.
With respect to this variance, fixed costs are not affected by activity levels within a relevant
range.
52. Which of the following is the name of a form providing standard quantities of inputs used to
produce a unit of output and the standard prices for the inputs?
A. A static budget.
B. A standard cost sheet.
C. A variance account.
D. A master budget.
A standard cost sheet is the form providing standard quantities of inputs used to produce a
unit of output and the standard prices for the inputs.
53. If the total materials variance for a given operation is favorable, why must this variance be
further evaluated as to price and usage?
A. There is no need to further evaluate the total materials variance if it is favorable.
B. Generally accepted accounting principles require that all variances be analyzed in three
stages.
C. All variances must appear in the annual report to equity owners for proper disclosure.
D. A further evaluation lets management evaluate the activities of the purchasing and
production functions.
A breakdown between price and usage is necessary because the remedies are different, and
it's important to determine whether both components or only one component needs corrective
action.
54. Which department is customarily held responsible for an unfavorable materials quantity
variance?
A. Quality control.
B. Purchasing.
C. Engineering.
16-18
D. Production.
The production department may initially be looked at for correction of this variance, but the
cause might be a result of purchasing buying inferior materials.
55. When are the following direct materials variances ideally reported?
Quantity Price
A. Purchase Date Purchase Date
B. Time of Use Time of Use
C. Purchase Date Time of Use
D. Time of Use Purchase Date
A. Option A
B. Option B
C. Option C
D. Option D
Most frequently, material price variance is recorded when materials are received followed in
frequency by when shipped (F.O.B point of origin), and then when used.
56. In the general model, a price variance is calculated as:

A. (AP × AQ) - (AP × SQ)
B. (AP × SQ) - (SP × SQ)
C. (AP × AQ) - (SP × AQ)
D. (AP × AQ) - (SP × SQ)
(AP × AQ) - (SP × AQ) or (AP - SP) × AQ
57. In the general model, an efficiency variance is calculated as:

A. (SP × AQ) - (SP × SQ)
B. (AP × SQ) - (SP × SQ)
C. (AP × AQ) - (SP × SQ)
D. (AP × AQ) - (SP × AQ)
16-19
(SP × AQ) - (SP × SQ) or SP × (AQ - SQ)
58. Which of the following direct labor variances uses the standard hours allowed for the actual
number of units produced?
Rate Efficiency
A. Yes Yes
B. No No
C. Yes No
D. No Yes
A. Option A
B. Option B
C. Option C
D. Option D
The efficiency variance is derived by comparing standard price ( SP ) multiplied by actual
quantity of input ( AQ ), with standard price ( SP ) multiplied by standard quantity of input
allowed for actual good output produced ( SQ ).
59. Which of the following is the most probable reason a company would experience an
unfavorable labor rate variance and a favorable labor efficiency variance?
A. The mix of workers assigned to the particular job was heavily weighted towards the use of
higher paid experienced individuals.
B. The mix of workers assigned to the particular job was heavily weighted towards the use of
new relatively low paid unskilled workers.
C. Because of the production schedule, workers from other production areas were assigned
to assist this particular process.
D. Defective materials caused more labor to be used in order to produce a standard unit.
The average pay rate is higher than standard, but more experienced workers are more
efficient since they have more experience, are more intelligent, or have more training.
16-20
60. Which variance will be unfavorable due to employees working more hours than allowed for the
actual number of units produced?
A. Price (rate).
B. Efficiency.
C. Sales activity.
D. Production volume.
Efficiency variance is the difference of actual hours and standard hours.
61. In general, the direct labor efficiency variance is the responsibility of the:
A. purchasing agent.
B. company president.
C. production manager.
D. industrial engineering.
The production manager would be the first place to turn followed by the purchasing manager
(inferior material), the facilities manager (dangerous or hostile work environment).
62. The variable overhead price variance is due to:

A. price items only.
B. efficiency items only.
C. both price and efficiency items.
D. neither price or efficiency items.
The main focus is price of actual items versus the budgeted price, but price can indirectly be
impacted by efficiency.
63. If overhead is applied to production using direct labor hours and the direct labor efficiency
variance is favorable, then the variable overhead efficiency variance is:

A. favorable.
B. unfavorable.
C. either favorable or unfavorable.
D. neither favorable nor unfavorable.
If labor and overhead are both measured in actual hours of labor the two efficiency variances
16-21
move in the same direction.
64. TaskMaster Enterprises employs a standard cost system in which direct materials inventory is
carried at standard cost. TaskMaster has established the following standards for the prime
costs of one unit of product.
Standard Standard Standard
Quantity Price Cost
Direct 8 $1.80 per

$14.40
Materials pounds pound
Direct Labor .25 hour $8.00 per hour 2.00
$16.40
During November, TaskMaster purchased 160,000 pounds of direct materials at a total cost of
$304,000. The total factory wages for November were $42,000, 90% of which were for direct
labor. TaskMaster manufactured 19,000 units of product during November using 142,500
pounds of direct materials and 5,000 direct labor hours.
What is the direct materials price variance for November?

A. $14,250.
B. $14,400.
C. $16,000.
D. $17,100.
[(304,000/160,000) = $1.90 - $1.80] × 160,000 = $16,000 unfavorable
Quantity Price Cost
Direct 8 $1.80 per

$14.40
16-22
$16.40
Is the direct materials price variance favorable or unfavorable?

A. Favorable.
B. Unfavorable.
The actual price was greater than standard so the variance was unfavorable.
Quantity Price Cost
Direct 8 $1.80 per

$14.40
$16.40
What is the direct materials efficiency (quantity) variance for November?

A. $14,250.
B. $14,400.
C. $16,000.
D. $17,100.
[(142,500 - (19,000 × 8)] × $1.80 = $17,100 favorable
16-23
Quantity Price Cost
Direct 8 $1.80 per

$14.40
$16.40
Is the direct materials efficiency (quantity) variance favorable or unfavorable?

A. Favorable.
B. Unfavorable.
Fewer materials were used than standard so the variance was favorable.
Quantity Price Cost
Direct 8 $1.80 per

$14.40
$16.40
16-24
What is the direct labor price (rate) variance for November?

A. $1,800.
B. $1,900.
C. $2,000.
D. $2,200.
[$42,000 × 90% = $37,800 ÷ 5,000 direct labor hours = $7.56]; ($7.56 - $8) × 5,000 = $2,200
favorable
Quantity Price Cost
Direct 8 $1.80 per

$14.40
$16.40
Is the direct labor price (rate) variance favorable or unfavorable?

A. Favorable.
B. Unfavorable.
The actual wage rate was less than standard so the variance is favorable.

16-25
Quantity Price Cost
Direct 8 $1.80 per

$14.40
$16.40
What is the direct labor efficiency variance for November?

A. $1,800.
B. $1,900.
C. $2,000.
D. $2,090.
[5,000 - (19,000 × .25) = 250 hours] × $8.00 = $2,000 unfavorable
Quantity Price Cost
Direct 8 $1.80 per

$14.40
$16.40
16-26
Is the direct labor efficiency variance favorable or unfavorable?
A. Favorable.
B. Unfavorable.
Actual hours were greater than standard so the variance was unfavorable.
72. The following information summarizes the standard cost for producing one metal tennis racket
frame at Spaulding Industries. In addition, the variances for one month's production are given.
Assume that all inventory accounts have zero balances at the beginning of the month.
Standard Standard
Cost Monthly
Per Unit Costs
Materials $4.00 $8,400
Direct Labor 2 hrs. @

5.20 10,920
$2.60
Factory Overhead:
Variable 1.80 3,780
Fixed 5.00 10,500
$16.00 $33,600
Variances:
Material price 244.75 unfavorable
Material quantity 500.00 unfavorable
Labor rate 520.00 favorable
Labor efficiency 2,080.00 unfavorable
What were the actual direct labor hours worked during the month?
A. 5,000.
B. 4,800.
C. 4,200.
D. 4,000.
$10,920 + $2,080 = $13,000 ÷ $2.60 = 5,000 direct labor hours
16-27
Standard Standard
Cost Monthly
Per Unit Costs

5.20 10,920
$2.60
Factory Overhead:
Variable 1.80 3,780
Fixed 5.00 10,500
$16.00 $33,600
Variances:
What was the actual quantity of materials used during the month?
A. 2,156.
B. 2,100.
C. 2,225.
D. 1,975.
$8,400 + $500 = $8,900 ÷ $4.00 = 2,225
16-28
Standard Standard
Cost Monthly
Per Unit Costs

5.20 10,920
$2.60
Factory Overhead:
Variable 1.80 3,780
Fixed 5.00 10,500
$16.00 $33,600
Variances:
What was the actual price paid for the direct material during the month, assuming all materials
purchased were put into production?
A. $4.34.
B. $4.22.
C. $4.11.
D. $4.00.
$8,400 + $500 + $244.75 = $9,144.75 ÷ 2,225 = $4.11
16-29
75. Data on Gantry Company's direct-labor costs are given below:
Standard direct-labor hours 30,000
Actual direct-labor hours 29,000
Direct-labor efficiency variance-favorable $4,000
Direct-labor rate variance-favorable $5,800
Total direct labor payroll $110,200
What was Gantry's actual direct-labor rate?

A. $3.60.
B. $3.80.
C. $4.00.
D. $5.80.
$110,200/29,000 = $3.80
76. Data on Gantry Company's direct-labor costs are given below:

Standard direct-labor hours 30,000
Actual direct-labor hours 29,000
Direct-labor efficiency variance-favorable $4,000
Direct-labor rate variance-favorable $5,800
What was Gantry's standard direct-labor rate?

A. $3.54.
B. $3.80.
C. $4.00.
D. $5.80.
(29,000 - 30,000) × SR = 4,000; SR = $4.00
16-30
77. Batson Company produces Trivets. Based on its master budget, the company should produce
1,000 Trivets each month, working 2,500 direct labor hours. During May, only 900 Trivets were
produced. The company worked 2,400 direct labor hours. The standard hours allowed for May
production would be:
A. 2,500 hours.
B. 2,400 hours.
C. 2,250 hours.
D. 1,800 hours.
2,500/1,000 = 2.5 hours per unit; 2.5 × 900 = 2,250
78. Information on Kimble Company's direct labor costs for the month of January is as follows:
Actual direct labor hours 34,500
Standard direct labor hours 35,000
Direct labor efficiency variance-favorable $3,200
What is Kimble's direct labor price (rate) variance?

A. $17,250.
B. $20,700.
C. $18,750.
D. $21,000.
Actual rate = ($241,500/34,500) = $7/hr; (34,500 - 35,000) × SR = 3,200; SR = $6.40 per hour;
($7 - $6.40) × 34,500 = $20,700 unfavorable
79. Information on Kimble Company's direct labor costs for the month of January is as follows:
Standard direct labor hours 35,000
Direct labor efficiency variance-favorable $3,200
Is the direct labor price (rate) variance favorable or unfavorable?

A. Favorable.
16-31
B. Unfavorable.
Actual wage rate was higher than standard so the variance is unfavorable.
80. The following data pertains to the direct materials cost for the month of October:
Standard costs 5,000 units allowed at $20 each
Actual costs 5,050 units input at $19 each
What is the direct materials efficiency (quantity) variance?

A. $950 favorable.
B. $950 unfavorable.
D. $1,000 unfavorable.
(5,050 - 5,000) × $20 = $1,000 unfavorable
81. The Fellowes Company has developed standards for labor. During June, 75 units were
scheduled and 100 were produced. Data related to labor are:
Standard hours
3 hours per unit
allowed
Standard wages
$4.00 per hour
allowed
310 hours (total cost

Actual direct labor
$1,209)
What is the labor rate variance for June?

A. $30 unfavorable.
B. $31 favorable.
C. $31 unfavorable.
D. $30 favorable.
[($1,209/310) = $3.90 - $4.00] × 310 = $31 favorable
82. When computing standard cost variances, the difference between actual and standard price
multiplied by actual quantity yields a(n): (CMA adapted)
A. combined price and quantity variance.

16-32
B. efficiency variance.
C. price variance.
D. quantity variance.
Materials price variance = AQ(AP - SP)
83. Shawn Inc. planned to produce 3,000 units of its single product, Megatron, during November.
The standard specifications for one unit of Megatron include six pounds of material at $0.30
per pound. Actual production in November was 3,100 units of Megatron. The accountant
computed a favorable materials purchase price variance of $380 and an unfavorable materials
quantity variance of $120. Based on these variances, one could conclude that: (CMA
adapted)
A. more materials were purchased than were used.
B. more materials were used than were purchased.
C. the actual cost of materials was less than the standard cost.
D. the actual usage of materials was less than the standard allowed.
Materials quantity variance = SP(AQ - SQ)
(SP × AQ - $5,580*) = $120 U
SP × AQ = $5,580 + $120 = $5,700
*6 pounds × 3,100 units × $0.30 = $5,580
(AQ × AP - $5,700) = $(380)
AQ × AP = $5,700 - $380 = $5,320
84. Miller Company planned to produce 3,000 units of its single product, Tallium, during
November. The standards for one unit of Tallium specify six pounds of materials at $0.30 per
pound. Actual production in November was 3,100 units of Tallium. There was a favorable
materials price variance of $380 and an unfavorable materials quantity variance of $120.
16-33
Based on these variances, one could conclude that: (CMA adapted)
A. more materials were purchased than were used.
B. more materials were used than were purchased.
C. the actual cost per pound for materials was less than the standard cost per pound.
D. the actual usage of materials was less than the standard allowed.
(SP × AQ - $5,580*) = $120 U
SP × AQ = $5,580 + $120 = $5,700
*6 pounds × 3,100 units × $0.30 = $5,580
(AQ × AP - $5,700) = $(380)
AQ × AP = $5,700 - $380 = $5,320
85. An unfavorable direct labor efficiency variance could be caused by: (CMA adapted)
A. an unfavorable materials quantity variance.
B. an unfavorable variable overhead rate variance.
C. a favorable materials quantity variance.
D. a favorable variable overhead rate variance.
Labor efficiency variance = SR(AH - SH)
86. Variable manufacturing overhead is applied to products on the basis of standard direct labor-
hours. If the direct labor efficiency variance is unfavorable, the variable overhead efficiency
variance will be: (CMA adapted)
A. favorable.
B. unfavorable.
C. either favorable or unfavorable.
D. zero.
16-34
See solution below.
Variable overhead efficiency variance = SR(AH - SH)
87. Given the following information in standard costing:

Standard 16,000 hours at $4.00
Actual 15,800 hours at $4.20
What is the labor rate variance?

A. $3,160 favorable.
D. $2,360 unfavorable.
(15,800 × $4.00) - (15,800 × $4.20) = $3,160 unfavorable
88. Information for Bonanza Company's direct labor cost for February is as follows:
Efficiency variance $6,400 F
Rate variance $41,400 U
What were the standard direct labor hours for February?

A. 70,000.
B. 69,000.
C. 72,000.
D. 71,400.
(69,000 - SH) × SR = $6,400 favorable; [($483,000/69,000) - SR] × 69,000 = $41,400
unfavorable; SR = $6.40; SH = 70,000
89. The standard unit cost is used in the calculation of which of the following variances? (CPA
adapted)
16-35
Materials Price Materials Usage
Variance Variance
A. No No
B. No Yes
C. Yes No
D. Yes Yes
A. Option A
B. Option B
C. Option C
D. Option D
The standard unit cost is used for both price and usage variances. The price variance
emphasizes the standard price; the usage uses both standard usage and price.
90. A favorable materials price variance coupled with an unfavorable materials usage variance
would most likely result from: (CMA adapted)

A. machine efficiency problems.
B. product mix production changes.
C. labor efficiency problems.
D. the purchase of lower-than-standard-quality materials.
Lower material price may be due to lower quality, causing a higher quantity to be used.
Efficiency and mix do not depend on material prices.
91. Excess direct labor wages resulting from overtime premium will be disclosed in which type of
variance? (CPA adapted)

A. Yield.
B. Quantity.
C. Labor efficiency.
D. Labor rate.
Overtime just changes the wage rate so it would be the labor rate. Workers are not necessarily
more or less efficient when working overtime.
16-36
92. The budget for the month of May was for 9,000 units at a direct materials cost of $15 per unit.
Direct labor was budgeted at 45 minutes per unit for a total of $81,000. Actual output for the
month was 8,500 units with $127,500 in direct materials and $77,775 in direct labor expense.
The direct labor standard of 45 minutes was obtained throughout the month. Variance analysis
of the performance for the month of May would show a(n): (CMA adapted)
A. favorable materials efficiency (quantity) variance of $7,500.
B. favorable direct labor efficiency variance of $1,275.
C. unfavorable direct labor efficiency variance of $1,275.
D. unfavorable direct labor price (rate) variance of $1,275.
There is no information to compute material variances. Since the labor hour/unit did not
change, there is no labor efficiency. The labor rate variance is: $81,000/9,000 = $9.00
standard labor cost per unit; $77,775 - ($9 × 8,500) = $1,275 unfavorable direct labor rate
variance
93. Jackson Company uses a standard cost system. The following information pertains to direct
labor for product B for the month of October:
Standard hours allowed for actual

2,000
production
Actual rate paid per hour $8.40
Standard rate per hour $8.00
Labor efficiency variance $1,600 U
What were the actual hours worked for the month of October?
A. 1,800.
B. 1,810.
C. 2,190.
D. 2,200.
(AH - 2,000) × $8.00 = $1,600 unfavorable; AH = 2,200
94. The fixed factory overhead application rate is a function of a predetermined activity level. If
standard hours allowed for good output equal this predetermined activity level for a given
period, the volume variance will be: (CPA adapted)

16-37
A. zero.
B. favorable.
C. unfavorable.
D. either favorable or unfavorable, depending on the budgeted overhead.
There is no volume variance when output = planned
95.. Actual machine hours 840
Standard machine hours allowed 900
Denominator activity (machine hours) 1,000
Actual fixed overhead costs $3,800
Budgeted fixed overhead costs $4,000
Predetermined overhead rate ($1 variable +

$5
$4 fixed)
What is the fixed overhead spending (budget) variance?

A. $200.
B. $400.
C. $300.
D. $240.
$3,800 - $4,000 = $200 favorable
96. Actual machine hours 840

$5
$4 fixed)
Is the fixed overhead spending (budget) variance favorable or unfavorable?
16-38
A. Favorable.
B. Unfavorable.
Less was spent than budgeted so the variance is favorable.
97.97. Actual machine hours 840

$5
$4 fixed)
What is the production volume variance?

A. $200.
B. $400.
C. $300.
D. $240.
$4,000 - ($4 × 900) = $400 unfavorable
98.98. Actual machine hours 840

$5
$4 fixed)
Is the production volume variance favorable or unfavorable?

A. Favorable.
B. Unfavorable.
Fewer units were produced than budgeted.

16-39
99.99.
Denominator hours for May 15,000
Actual hours worked during May 14,000
Standard hours allowed for May 12,000
Flexible budget fixed overhead cost $45,000
Actual fixed overhead costs for May $48,000
Danske Company had total underapplied overhead of $15,000. Additional information is as
follows:
Variable Overhead:
Applied based on standard direct labor

$42,000
hours allowed
Budgeted based on standard direct labor

38,000
hours
Fixed Overhead:

$30,000
hours allowed

27,000
hours
What is the actual total overhead for the period?

A. $50,000.
B. $45,000.
C. $80,000.
D. $87,000.
($30,000 + $42,000) + $15,000 = $87,000
100.100.
16-40
follows:
Variable Overhead:

$42,000
hours allowed

38,000
hours
Fixed Overhead:

$30,000
hours allowed

27,000
hours
What is the fixed overhead spending (budget) variance for May?

A. $1,000 unfavorable.
C. $2,000 unfavorable.
D. $2,000 favorable.
$48,000 - $45,000 = $3,000 unfavorable
101.101.
follows:
Variable Overhead:

$42,000
hours allowed
16-41
38,000
hours
Fixed Overhead:

$30,000
hours allowed

27,000
hours
What is the production volume variance for May?

A. $2,000.
B. $3,000.
C. $6,000.
D. $9,000.
$45,000 - [($45,000/15,000) × 12,000] = $9,000 unfavorable
102.102.
follows:
Variable Overhead:

$42,000
hours allowed

38,000
hours
Fixed Overhead:

$30,000
hours allowed
16-42
27,000
hours
Is the production volume variance favorable or unfavorable?

A. Favorable.
B. Unfavorable.
Standard hours were less than denominator hours.
103. Which one of the following variances is of least significance from a behavioral control
perspective? (CMA adapted)
A. Unfavorable materials quantity variance amounting to 20% of the quantity allowed for the
output attained.
B. Unfavorable labor efficiency variance amounting to 10% more than the budgeted hours for
the output attained.
C. Favorable materials price variance obtained by purchasing raw materials from a new
vendor.
D. Fixed factory overhead volume variance resulting from management's decision midway
through the fiscal year to reduce its budgeted output by 20%.
Fixed production volume variances are affected by changes in production and in general are
not controllable to the manager.
104. The production volume variance is computed by the difference between the:
A. actual fixed overhead and applied fixed overhead.
B. actual fixed overhead and budget at actual level of activity reached.
C. actual fixed overhead and budget at denominator level of activity planned.
D. budget at actual levels of activity reached and fixed overhead applied.
Production volume = budget - applied.
105. Which of the following is not an alternative name for the production volume variance?
A. Capacity variance.
B. Idle capacity variance.
C. Denominator variance.
16-43
D. Fixed overhead efficiency variance.
The production volume variance is not related to efficiency (volume flowing through the
facility)—it is related to the capacity of the facility.
106. The production volume variance must be computed when a company uses:
A. activity-based costing.
B. process costing.
C. job-order costing.
D. full-absorption costing.
Full absorption costing treats fixed production overhead as a product cost and applies it to
production. Variable costing treats fixed costs as period costs.
107. Which of these variances is least significant for cost control?

A. Labor price variance.
B. Material quantity variance.
C. Fixed overhead price variance.
D. Production volume variance.
The production volume variance is created when actual outputs did not match the planned
outputs. This is less controllable than inputs.
108. A debit balance in the labor-efficiency variance account indicates that:

A. standard hours exceed actual hours.
B. actual hours exceed standard hours.
C. standard rate and standard hours exceed actual rate and actual hours.
D. actual rate and actual hours exceed standard rate and standard hours.
A debit balance would be an unfavorable variance. Since it is efficiency, actual hours must
have exceeded standard hours.
109. If materials are carried in the direct materials inventory account at standard cost, then it is
reasonable to assume that the:
A. raw materials inventory account is understated.

16-44
B. price variance is recognized when materials are purchased.
C. company does not follow generally accepted accounting principles.
D. price variance is recognized when materials are placed into production.
If materials are at standard then the price variance has been recognized when inventory has
been shipped by the supplier with terms of F.O.B point of origin, or inventory has been
physically received into Raw Materials Inventory.
16-45
110. The Elon Company had great difficulty in controlling overhead costs. At a recent convention,
the president heard about a control device for overhead costs known as a flexible budget and
she has hired you to implement this budgeting program. After some effort, you develop the
following cost formulas for the company's machining department. These costs are based on a
normal operating range of 15,000 to 23,000 machine-hours per month:
Machine setup $0.20 per machine-hour
Lubricants $1.00 per machine-hour plus $8,000 per month
Utilities $0.70 per machine-hour
Indirect labor $0.60 per machine-hour plus $20,000 per month
Depreciation $32,000 per month
During March, the first month after your preparation of the above data, the machining
department worked 18,000 machine-hours and produced 9,000 units of product. The actual
costs of this production were:
Machine set-up $4,800
Lubricants 24,500
Utilities 12,000
Indirect labor 32,500
Depreciation 32,500
$106,300
The department had originally been budgeted to work 19,000 machine-hours during March.
Required:
Prepare a performance report for the machining department for the month of March including
columns for the (a) actual results, (b) flexible budget, (c) flexible budget variance, (d) master
budget, and (e) sales activity variance.
16-46
Sales
Flexible Flex B Master
Actual Activity
Budget Variance Budget
V
Machine
4,800 3,600 1,200 U 3,800 200 F
set-up
Lubricants 24,500 26,000 1,500 F 27,000 1,000 F
Utilities 12,000 12,600 600 F 13,300 700 F
Indirect
32,500 30,800 1,700 U 31,400 600 F
labor
Depreciation 32,500 32,000 500 U 32,000 0
Total Costs 106,300 105,000 1,300 U 107,500 2,500 F
Master
Variable Fixed Total
Budget:
Machine $0.20 ×
3,800 0 3,800
setup 19,000
$1.00 ×
Lubricants 19,000 8,000 27,000
19,000
$0.70 ×
Utilities 13,300 0 13,300
19.000
$0.60 ×
Indirect labor 11,400 20,000 31,400
19,000
Depreciation 0 32,000 32,000
Total 47,500 60,000 107,500
Flexible
Variable Fixed Total
Budget:
Machine $0.20 ×
3,600 0 3,600
setup 18,000
16-47
$1.00 ×
Lubricants 18,000 8,000 26,000
18,000
$0.70 ×
Utilities 12,600 0 12,600
18,000
$0.60 ×
Indirect labor 10,800 20,000 30,800
18,000
Depreciation 0 32,000 32,000
Total 45,000 60,000 105,000
111. The Ornate Company has the following information pertaining to the month of March:
Units of output, actual $21,000
Fixed costs, actual $497,000
Operating profit, master budget $220,000
Sales price variance $84,000 U
Beginning and ending inventories 0
Sales volume variance, revenue $300,000 U
Budgeted selling price per unit $100
Variable costs, master budget $1,680,000
Contribution margin, actual $516,000
Required:
Prepare a performance report for March including columns for the (a) actual results, (b)
flexible budget, (c) flexible budget variance, (d) master budget, and (e) sales activity
variance.
Flexible Flex B Master Sales

Actual Budget Variance Budget Activity V
Units 21,000 21,000 0 24,000 3,000 U
Sales $2,016,000 $2,100,000 $84,000 U $2,400,000 $300,000 U
Var Costs 1,500,000 1,470,000 30,000 U 1,680,000 210,000 F
Cont
516,000 630,000 114,000 U 720,000 90,000 U
Margin
16-48
Fixed
497,000 500,000 3,000 F 500,000 0
Costs
Operating 19,000 130,000 111,000 U 220,000 90,000 U
Profit
Feedback: Budgeted sales volume = Actual volume + (Sales Activity Variance-
Revenue/Selling price) = 21,000 + (300,000/100) = 24,000 units
Master budget sales revenue = 24,000 × $100 = $2,400,000
Master budget fixed cost = $2,400,000 - 1,680,000 = CM $720,000 - 220,000 profit =
$500,000
Flexible budget sales revenue = 21,000 × $100 = $2,100,000
Actual sales = $2,100,000 - $84,000 sales price variance = $2,016,000
Variable cost/unit = $1,680,000/24,000 = $70 × 21,000 units = $1,470,000
Actual variable costs = $2,016,000 revenue - $516,000 CM = $1,500,000
112. Fargo Company manufactures special electrical equipment and parts. Eastern employs a
standard cost accounting system with separate standards established for each product.
A special transformer is manufactured in the Transformer Department. Production volume is

measured by direct labor hours in this department and a flexible budget system is used to plan
and control department overhead. Standard costs for the special transformer are determined
annually in September for the coming year. The standard cost of a transformer was computed
at $67.00 as shown below.
Direct materials:
Iron 5 sheets @ $2.00 $10.00
Copper 3 spools @ $3.00 9.00
Direct labor 4 hours @ $7.00 28.00
Variable overhead 4 hours @ $3.00 12.00
Fixed overhead 4 hours @ $2.00 8.00
Total $67.00
16-49
Overhead rates were based upon normal and expected monthly capacity, both of which were
4,000 direct labor hours. Practical capacity for this department is 5,000 direct labor hours per
month. Variable overhead costs are expected to vary with the number of direct labor hours
actually used. During October, 800 transformers were produced. This was below expectations
because a work stoppage occurred at the copper supplier and shipments were delayed.
The following costs were incurred in October:

Direct materials:
purchased 4,200 sheets,

Iron:
total cost $8,750
Used: 4,200 sheets
purchased 2,600 spools,

Copper:
total cost $7,890
Used: 2,600 spools
Direct labor: 3,400 hours
Total payroll: $24,080
Required:
Compute each of the following variances, showing all your work. Be sure to indicate whether
the variances are favorable or unfavorable.
a. Direct materials price variance for both iron and copper.

b. Direct material efficiency (quantity) variance for both iron and copper.
c. Direct labor rate variance.
d. Direct labor efficiency variance.
a. Iron: $350 unfavorable; Copper: $90 unfavorable
b. Iron: $400 unfavorable; Copper: $600 unfavorable
c. $280 unfavorable
d. $1,400 unfavorable
16-50
Feedback: a. Iron: $8,750 - ($2.00 × 4,200) = $350 unfavorable; Copper: $7,890 - ($3.00 ×
2,600) = $90 unfavorable
b. Iron: [4,200 - (5 × 800)] × $2.00 = $400 unfavorable; Copper: [2,600 - (3 × 800)] × $3.00 =
$600 unfavorable
c. $24,080 - ($7.00 × 3,400) = $280 unfavorable

d. [3,400 - (4 × 800)] × $7.00 = $1,400 unfavorable
113. Jemco Corporation makes automotive engines. For the most recent month, budgeted
production was 6,000 engines. The standard power cost is $8.80 per machine-hour. The
company's standards indicate that each engine requires 6.1 machine-hours. Actual production
was 6,400 engines. Actual machine-hours were 38,730 machine-hours. Actual power cost
totaled $350,628.
Required:
Determine the rate and efficiency variances for the variable overhead item power cost and
indicate whether those variances are unfavorable or favorable. Show your work!
Standard machine-hours allowed for the actual output = 6.1 × 6,400 = 39,040
Variable overhead rate variance = (AH × AR) - (AH × SR)
= $350,628 - (38,730 hours × $8.80 per hour)
= $350,628 - $340,824
= $9,804 U
= $8.80 per hour (38,730 hours - 39,040 hours*)
= $340,824 - $343,552
= $2,728 F
*6,400 units × 6.1 hours = 39,040 hours
114. The Rogers Company uses a standard cost accounting system and estimates production for
the year to be 60,000 units. At this volume, the company's variable overhead costs are $0.50
per direct labor hour.
The company's single product has a standard cost of $30.00 per unit. Included in the $30.00
is $13.20 for direct materials (3 yards) and $12.00 of direct labor (2 hours). Production
16-51
information for the month of March follows:
Number of units produced 6,000
Materials purchased (18,500 yards) $88,800
Materials used in production (yards) 18,500
Direct labor cost incurred ($6.50/hour) $75,400
Required:
(Be sure to indicate whether the variances are favorable or unfavorable.)
a. Compute the direct material price variance.
b. Compute the direct material efficiency variance.
c. Compute the direct labor price (rate) variance.

d. Compute the direct labor efficiency variance.
a. $7,400 unfavorable
b. $2,200 unfavorable
c. $5,800 unfavorable
d. $2,400 favorable
Feedback: a. $88,800 - [($13.20/3) × 18,500] = $88,800 - [$4.40 × 18,500] = $7,400
unfavorable
b. [18,500 - (3 × 6,000)] × $4.40 = $2,200 unfavorable
c. $75,400 - [$6.00 × ($75,400/$6.50)] = $5,800 unfavorable
d. [11,600 - (2 × 6,000)] × $6.00 = $2,400 favorable
115. The Atlas Company has developed standard overhead costs based upon a capacity of
180,000 direct labor hours:
Standard costs per unit:
Variable portion 2 hours @ $3 = $6
Fixed portion 2 hours @ $5 = 10
$16
16-52
During April, 85,000 units were scheduled for production; however, only 80,000 units were
actually produced. The following data relate to April:
Actual direct labor cost incurred was $644,000 for 165,000 actual hours of work.
Actual overhead incurred totaled $1,378,000; $518,000 variable and $860,000 fixed.
All inventories are carried at standard cost.
Required:
a. Compute the variable overhead price variance.
b. Compute the variable overhead efficiency variance.
Feedback: a. $518,000 - ($3 × 165,000) = $23,000 unfavorable
b. ($3 × 165,000) - ($3 × 2 × 80,000) = $15,000 unfavorable
116. Horton Company adopted a standard cost system several years ago. The standard costs for
the prime costs of its single product are as follows:
Material: 8 kilograms @ $5 per kilogram $40.00
Labor: 6 hours @ $8.20 per hour $49.20
The following operating data were taken from the records for November:
Units completed 5,600 units
Budgeted output 6,000 units
Purchase of materials 50,000 kilograms
Total actual labor costs $300,760
Actual labor hours 36,500 hours
Material efficiency (quantity) $1,500
variance unfavorable
16-53
Total material variance $750 unfavorable
Required:
a. What is the direct labor price (rate) variance for November?
b. What is the direct labor efficiency variance for November?
c. What is the actual kilograms of material used in the production process during November?
d. Assume the purchasing department is responsible for the material price variance, what is
the actual price paid per kilogram of material during November (assume no increase/decrease
in inventory during the month)?
c. 45,100 kilograms
d. $4.985
Feedback: a. ($300,760/36,500 - $8.20) × 36,500 = $1,460 unfavorable

b. [36,500 - (6 × 5,600)] × $8.20 = $23,780 unfavorable
c. [AQ-used - (8 × 5,600)] × $5.00 = $1,500 unfavorable; AQ-used = 45,100

d. 750 U = $1,500 U + Price variance; Price variance = $750 F; (AP - $5.00) × 50,000 =
$750 favorable; AP = $4.985
117. The following standards have been established for a raw material used to make product JN36:
Standard quantity of the material

6.3 pounds
per unit of output
per
Standard price of the material $15.50
pound
16-54
The following data pertain to a recent month's operations:
Actual material
6,700 pounds
purchased
Actual cost of material

$100,500
purchased
Actual material used in

6,400 pounds
production
units of product
Actual output 920
JN36
Required:
a. What is the materials price variance for the month?
b. What is the materials quantity variance for the month?
a. Materials price variance = (AQ × AP) - (AQ × SP)
= $100,500 - (6,700 pounds × $15.50 per pound)
= $100,500 - $103,850
= $3,350 F
b. Materials quantity variance = SP(AQ - SQ)
= $15.50 per pound (6,400 pounds - 5,796 pounds*)
= $99,200 - $89,838
= $9,362 U
*920 units × 6.3 pounds = 5,796 pounds
16-55
118. The data below relate to a product of Bellingham Company.
Standard costs:
Materials, 2 pounds at $6 per per

$12
pound unit
per
Labor, 3 hours at $15 per hour $45
unit
Actual results were:
Production 3,600 Units
Material purchased & used,

$42,340
7,300 pounds
Labor, 10,360 hours $160,580
Required:
a. Compute the direct material price variance.
b. Compute the direct material usage variance.

c. Compute the direct labor rate variance.
d. Compute the direct labor efficiency variance.
a. $1,460 favorable
b. $600 unfavorable
d. $6,600 favorable
Feedback: a. $42,340 - (7,300 × $6) = $1,460 favorable
b. (7,300 × $6) - (3,600 × 2 × $6) = $600 unfavorable
c. $160,580 - (10,360 × $15) = $5,180 unfavorable
d. (10,360 × $15) - (3,600 × 3 × $15) = $6,600 favorable
16-56
119. The following data have been provided by Vegas Corporation:
Budgeted production 8,300 units
Standard machine-hours machine-

4.5
per unit hours
per machine-
Standard lubricants $5.10
hour
per machine-
Standard supplies $2.90
hour
Actual production 8,600 units
machine-
Actual machine-hours 38,270
hours
Actual lubricants (total) $211,801
Actual supplies (total) $107,566
Required:
Compute the variable overhead rate variances for lubricants and for supplies. Indicate
whether each of the variances is favorable (F) or unfavorable (U). Show your work!
Lubricants:
= $211,801 - (38,270 hours × $5.10 per hour)
= $211,801 - $195,177
= $16,624 U
Supplies:
= $107,566 - (38,270 hours × $2.90 per hour)

= $107,566 - $110,983
= $3,417 F
16-57
120. The following data for November have been provided by Mazzio Corporation, a producer of
precision drills for oil exploration:
Budgeted production 4,000 drills
Standard machine-hours
8.4 machine-hours
per drill
per machine-
Standard indirect labor $9.40
hour
per machine-
Standard power $2.90
hour
Actual production 4,300 drills
Actual machine-hours 36,530 machine-hours
Actual indirect labor $362,756
Actual power $97,693
Required:
Compute the variable overhead rate variances for indirect labor and for power for November.
Indicate whether each of the variances is favorable (F) or unfavorable (U). Show your work!
Indirect labor:
= $362,756 - (36,530 hours × $9.40 per hour)

= $362,756 - $343,382
= $19,374 U
Power:
= $97,693 - (36,530 hours × $2.90 per hour)
= $97,693 - $105,937
= $8,244 F
16-58
121. Shum Company manufactures special electrical equipment and parts. Shum employs a
standard cost accounting system with separate standards established for each product.

Direct materials:
Iron 5 sheets @ $2.00 $10.00
Total $67.00
actually used. During October, 800 transformers were produced. This was below expectations
because a work stoppage occurred at the copper supplier and shipments were delayed.
Direct
materials:
purchased 5,000 sheets @

Iron:
$2.00/sheet
Used: 3,900 sheets
Copper: purchased 2,200 spools @ $3.10
Used: 2,600 spools
Direct labor: 3,400 hours
Total payroll: $24,080
16-59
Overhead:
Variable $10,000
Fixed $8,800
Required:
a. Variable overhead spending variance.
b. Variable overhead efficiency variance.
c. Fixed overhead spending (budget) variance.
d. Production volume variance.
a. $200 favorable
b. $600 unfavorable
c. $800 unfavorable
Feedback: a. $10,000 - ($3.00 × 3,400) = $200 favorable
b ($3.00 × 3,400) - [$3.00 × (4 × 800)] = $600 unfavorable
c. $8,800 - ($2.00 × 4,000) = $800 unfavorable

d. ($2.00 × 4,000) - ($2.00 × 3,200) = $1,600 unfavorable
122. Ole Company manufactures special electrical equipment and parts. Ole employs a standard
cost accounting system with separate standards established for each product.

Direct materials:
16-60
Total $57.00
actually used.
During October, 900 transformers were produced. This was below expectations because a
work stoppage occurred during contract negotiations with the labor force. Once the contract
was settled, the wage rate was increased to $7.25/hour and overtime was scheduled in an
attempt to catch up to expected production levels.
The following costs were incurred in October:
Direct
materials:
purchased 2,600 spools @

Copper:
$3.08/spool
Used: 2,600 spools
Direct labor:
Regular time 2,000 hours @ $7.00
Overtime 1,400 hours @ $7.25
600 of the 1,400 hours were subject to overtime premium. The total overtime premium is
included in variable overhead in accordance with company accounting practices.
Overhead:
Variable $16,670
Fixed $8,800
16-61
Required:
a. Direct materials price variance.
b. Direct material efficiency (quantity) variance.
e. Variable overhead spending variance.
f. Variable overhead efficiency variance.

g. Fixed overhead spending (budget) variance.
h. Production volume variance.
a. $208 unfavorable
b. $300 favorable
c. $350 unfavorable
d. $1,400 favorable
e. $6,470 unfavorable
f. $600 favorable
g. $800 unfavorable
h. $800 unfavorable
Feedback: a. ($3.08 - $3.00) × 2,600 = $208 unfavorable

b. [2,600 - (3 × 900)] × $3.00 = $300 favorable
c. [($7.00 × 2,000) + ($7.25 × 1,400)] - ($7.00 × 3,400) = $350 unfavorable
d. [3,400 - (4 × 900)] × $7.00 = $1,400 favorable
e. $16,670 - ($3.00 × 3,400) = $6,470 unfavorable

f. ($3.00 × 3,400) - [$3.00 × (4 × 900)] = $600 favorable
g. $8,800 - ($2.00 × 4,000) = $800 unfavorable
h. ($2.00 × 4,000) - [$2.00 × (4 × 900)] = $800 unfavorable
16-62
123. The Bartok Company uses a standard cost accounting system and estimates production for
Variable overhead costs incurred $6,380
Fixed overhead costs incurred $20,400
Required:
a. Compute the predetermined overhead rate/hr used for the year.
b. Compute the budgeted fixed costs for the month.
c. Compute the variable overhead spending variance.
d. Compute the variable overhead efficiency variance.
e. Compute the fixed overhead spending (budget) variance.
f. Compute the production volume variance.
a. $2.40 per DLH
b. $19,000
c. $580 unfavorable
d. $200 favorable
e. $1,400 unfavorable
f. $3,800 favorable
16-63
Feedback: a. $30.00 - $13.20 - $12.00 = $4.80/unit or $2.40 per DLH
b. $4.80 × 60,000 = $288,000; Total OH; $0.50 × (2 × 60,000) = $60,000 Variable OH;
Budgeted fixed OH = $288,000 - $60,000 = $228,000; per month $228,000/12 = $19,000
c. $6,380 - ($0.50 × 11,600) = $580 unfavorable
d. ($0.50 × 11,600) - [$0.50 × (2 × 6,000)] = $200 favorable
e. $20,400 - ($228,000/12) = $1,400 unfavorable
f. ($228,000/12) - [($228,000/120,000) × (2 × 6,000)] = $3,800 favorable
124. The condensed flexible budget of the Evergreen Company for the year is given below:
Direct labor-hours
Direct labor- hours
Overhead costs: 30,000 40,000 50,000
Variable costs $75,000 ? ?
Fixed costs ? ? $320,000
The company produces a single product that requires 2.5 direct labor-hours to complete. The
direct labor wage rate is $7.50 per hour. Three yards of raw material are required for each unit
of product, at a cost of $5 per yard.
Assume that the company chooses 50,000 direct labor-hours as the denominator level of
activity, but actually worked 48,000 hours during the year, producing 18,500 units.
Actual overhead costs for the year are:
Variable costs $124,800
Fixed costs 321,700
Total overhead costs $446,500
Required:
a. Compute the variable overhead price variance and the variable overhead efficiency
variance.
b. Compute the fixed overhead spending (budget) variance and the production volume
variance.
a. Price: $4,800 unfavorable; efficiency: $4,375 unfavorable

16-64
b. Budget: $1,700 unfavorable; production volume: $24,000 unfavorable
Feedback: Variable OH rate = $75,000/30,000 = $2.50 per DLH; Fixed OH rate =
$320,000/50,000 = $6.40 per DLH
a. $124,800 - ($2.50 × 48,000) = $4,800 unfavorable; ($2.50 × 48,000) - ($2.50 × 18,500 ×
2.5) = $4,375 unfavorable
b. $321,700 - $320,000 = $1,700 unfavorable; $320,000 - ($6.40 × 18,500 × 2.5) = $24,000
unfavorable
125. The condensed flexible budget of the Texas Company for the year is given as $160,000 +
$1.25/direct labor hour. The company produces a single product that requires 2.5 direct labor-
hours to complete.
Assume that the company chooses 100,000 direct labor-hours as the denominator level of
activity, but actually worked 96,000 hours during the year producing 37,000 units.
Actual overhead costs for the year are:

Variable costs $124,800
Fixed costs 158,800
Total overhead costs $283,600
Required:
a. Compute the variable overhead price variance and the variable overhead efficiency
variance.
b. Compute the fixed overhead spending (budget) variance and the production volume
variance.
16-65
a. Price: $4,800 unfavorable; efficiency: $4,375 unfavorable
b. Budget: $1,200 favorable; production volume: $12,000 unfavorable
Feedback: Fixed OH rate = $160,000/100,000 = $1.60 per DLH
a. $124,800 - ($1.25 × 96,000) = $4,800 unfavorable; ($1.25 × 96,000) - ($1.25 × 37,000 ×
2.5) = $4,375 unfavorable

b. $158,800 - $160,000 = $1,200 favorable; $160,000 - ($1.60 × 37,000 × 2.5) = $12,000
unfavorable
126. The following information relates to the month of April for The Trolley Manufacturing Company,
which uses a standard cost accounting system.
Actual direct labor hours used 7,000
Standard hours allowed for good output 7,500
Fixed overhead spending variance –

$300
unfavorable
Actual total overhead $16,000
Budgeted fixed costs $4,500
Normal activity in hours 6,000
Total overhead application rate per DLH $2.25
Required:
a. What is the variable overhead efficiency variance?
b. What is the variable overhead price variance?
c. What is the fixed production volume variance?
a. $750 favorable
b. $700 unfavorable
c. $1,125 favorable
Feedback: Fixed overhead rate: $4,500/6,000 = $0.75/DLH; Variable rate: $2.25 - $0.75 =
$1.50
a. (7,000 × $1.50) - (7,500 × $1.50) = $750 favorable
b. Actual fixed overhead: $4,500 + $300 unfavorable spending variance = $4,800; actual
16-66
variable overhead: $16,000 - $4,800 = $11,200; Price: $11,200 - ($1.50 × 7,000) = $700
unfavorable
c. $4,500 - (7,500 × $0.75) = $1,125 favorable
127. The data below relate to a product of AirWay Company.
Standard costs:
Labor, 3 hours at $15 per hour $45 per unit
Variable overhead at $8 per

$24 per unit
labor hour
per
Budgeted fixed production costs $140,000
year
Budgeted production for the

4,000 units
year
Actual results were:
Production 3,600 Units
Labor, 10,360 hours $160,580
Overhead incurred ($142,700

$222,200
fixed)
Required:
b. What is the variable overhead price variance?
c. What is the fixed overhead budget variance?

d. What is the fixed production volume variance?
a. $3,380 favorable
b. $3,520 favorable
Feedback: Actual variable overhead: $222,200 - $142,700 = $79,50
16-67
Fixed rate: $140,000/4,000 = $35/unit
a. $79,500 - (10,360 × $8) = $3,380 favorable
b. (10,360 × $8) - (3,600 × 3 × $8) = $3,520 favorable
c. $142,700 - $140,000 = $2,700 unfavorable
d. $140,000 - (3,600 × $35) = $14,000 unfavorable
128. The Matten Company has developed standard overhead costs based upon a capacity of
180,000 direct labor hours:
Standard costs per unit:
Variable portion 2 hours @ $3 = $6
Fixed portion 2 hours @ $5 = 10
$16
During April, 85,000 units were scheduled for production; however, only 80,000 units were actually
produced. The following data relate to April:
Actual direct labor cost incurred was $644,000 for 165,000 actual hours of work. Actual
overhead incurred totaled $1,378,000; $518,000 variable and $860,000 fixed. All inventories
are carried at standard cost.
Required:
a. Compute the fixed overhead spending (budget) variance.
b. Compute the production volume variance.
a. $40,000 favorable
Feedback: a. $860,000 - ($5 × 180,000) = $40,000 favorable b. ($5 ×
180,000) - ($5 × 2 × 80,000) = $100,000 unfavorable
16-68
129. The following information relates to the month of April for The Kennedy Manufacturing
Company, which uses a standard cost accounting system.
Actual total direct labor $43,400
Actual direct labor hours

14,000
used
Standard hours allowed

15,000
for good output
Variable overhead price

$1,400
variance – unfavorable
Actual total overhead $32,000
Budgeted fixed costs $9,000
Normal activity in hours 12,000
Total overhead
$2.25
application rate per DLH
Required:
b. What is the fixed overhead spending variance?
c. What is the fixed production volume variance?
a. $1,500 favorable
b. $600 unfavorable
c. $2,250 favorable
Feedback: Fixed overhead rate: $9,000/12,000 = $0.75/DLH; Variable rate: $2.25 - $0.75 =
$1.50
a. (14,000 × $1.50) - (15,000 × $1.50) = $1,500 favorable
16-69
b. Actual variable overhead: (14,000 × $1.50) + 1,400 unfavorable price variance = $22,400;
actual fixed overhead: $32,000 - $22,400 = $9,600; Spending: $9,600 - $9,000 = $600
unfavorable
c. $9,000 - (15,000 × $0.75) = $2,250 favorable
130. The Fort Company produces and sells a single product. Standards have been established for
the product as follows:
Direct materials: 5 pounds @ $3.50 per pound = $17.50
Direct labor: 3 hours @ $5.50 per hour = $16.50
Actual cost and usage figures for the past month follow:
Units produced 750
Direct materials used 4,000 pounds
Direct materials purchased (4,500

$14,400
pounds)
Direct labor cost (2,000 hours) $11,200
Required:
Prepare journal entries to record:
a. The purchase of raw materials.
b. The usage of raw materials in production.
c. The incurrence of direct labor cost.
Raw materials ($3.50 × 4,500

a. 15,750
pounds)
Material Price variance

($14,400 - [4,500 pounds × 1,350
$3.50])
Accounts Payable 14,400
Work-in-Process ($3.50 × 3,750

b. 13,125
pounds*)
16-70
Materials quantity variance
($3.50 × [4,000 pounds - 3,750 875
pounds*])
Raw material ($3.50 × 4,000

14,000
pounds)
*750 units × 5 pounds = 3,750
pounds
Work-in-Process ($5.50 × 2,250

c. 12,375
hours*)
Labor rate variance (2,000 hours

200
× [$5.60 - $5.50])
Labor efficiency variance
$5.50 × [2,000 hours - 2,250 1,375
hours*]
Wages Payable 11,200
*750 units × 3 pounds = 2,250
pounds
131. The following standards have been established for a raw material used in the production of
product U98:
Standard quantity of the material

2.6 pounds
per unit of output
per
Standard price of the material $14.50
pound
The following data pertain to a recent month's operations:
Actual material
7,600 Pounds
purchased
Actual cost of material

$110,960
purchased
Actual material used in

7,300 Pounds
production
16-71
units of
Actual output 2,800
product U98
Required:
c. Prepare journal entries to record the purchase and use of the raw material during the
month. (All raw materials are purchased on account.)
= $110,960 - (7,600 pounds × $14.50 per pound)

= $110,960 - $110,200
= $760 U
b. Materials quantity variance = SP(AQ - SQ)
= $14.50 per (7,300 pounds - 7,280 pounds*)
= $105,850 - $105,560 = $290 U
*2,800 units × 2.6 pounds = 7,280
c. Journal entries to record the purchase and use of the raw material:
Raw materials 110,200
Materials price variance 760
Accounts payable 110,960
Work-in-process 105,560
Materials quantity variance 290
16-72
132. The standards for product J42 call for 3.6 feet of a raw material that costs $14.00 per feet.
Last month, 5,500 feet of the raw material were purchased for $76,175. The actual output of
the month was 1,260 units of product J42. A total of 4,800 feet of the raw material were used
to produce this output.
Required:
c. Prepare journal entries to record the purchase and use of the raw material during the
month. (All raw materials are purchased on account.)
= $76,175 - (5,500 feet × $14 per foot)
= $76,175 - $77,000
= $825 F
b. Materials quantity variance = (AQ - SQ*) SP
= $14 per foot (4,800 feet - 4,536 feet*)
= $67,200 - $63,504
= $3,696 U
*3.6 feet × 1,260 units = 4,536 feet
c. Journal entries to record the purchase and use of the raw material:
Materials price variance 825
Materials quantity variance 3,696
16-73
133. Compound Y23Z is used by Overton Corporation to make one of its products. The standard
cost of compound Y23Z is $38.70 per ounce and the standard quantity is 4.6 per unit of
output. Data concerning the compound in the most recent month appear below:
Cost of material purchased in November,

$39.20
per ounce
Material purchased in November, ounces 2,800
Material used in production in November,

2,360
ounces
Actual output in November, units 500
The raw material was purchased on account.
Required:
a. Record the purchase of the raw material in a journal entry.
b. Record the use of the raw material in production in a journal entry.
a. Entry to record purchase of materials:

108,360
ounces)
Materials price variance (2,800

1,400
ounces × [$39.20 - $38.70])
Accounts payable ($39.20 ×

109,760
2,800 ounces)
b. Entry to record use of materials:
Work-in-process ($38.70 × 2,300

89,010
ounces*)
Materials quantity variance ($38.70
× [2,360 ounces – 2,300 ounces*]) 2,322

91,332
ounces)
16-74
*500 units at 4.6 ounces = 2,300 ounces
134. The standards for product A22G specify 8.2 direct labor-hours per unit at $11.90 per direct
labor-hour. Last month 200 units of product A22G were produced using 1,700 direct labor-
hours at a total direct labor wage cost of $20,060.
Required:
a. What was the labor rate variance for the month?
b. What was the labor efficiency variance for the month?
c. Prepare a journal entry to record direct labor costs during the month, including the direct
labor variances.
a. Labor rate variance = (AH × AR) - (AH × SR)

= $20,060 - (1,700 hours × $11.90)
= $20,060 - $20,230
= $170 F
b. Labor efficiency variance = SR(AH - SH)
= $11.90 per hour × (1,700 hours - 1,640 hours*)
=$20,230 - $19,516
= $714 U
*8.2 hours × 200 units = 1,640 hours
c. Journal entry to record the direct labor costs:

Labor rate variance 714
Labor efficiency variance 170
Wages payable 20,060
16-75
135. Angler Corporation has provided the following data concerning its direct labor costs for
November:
Standard wage rate $14.70 per DLH
Standard hours 2.4 DLHs per unit
Actual wage rate $14.80 per DLH
Actual hours 5,990 DLHs
Actual output 2,600 units
Required:
Prepare the journal entry to record the incurrence of direct labor costs.
Work-in-process ($14.70 × 6,240

91,728
DLHs*)
Labor rate variance (5,990 DLHs ×

599
[$14.80 - $14.70])
Labor efficiency variance ($14.70

3,675
× [5,990 DLHs - 6,240 DLHs*])
Wages payable ($14.80 × 5,990

88,652
DLHs)
*2,600 units × 2.4 DLHs = 6,240 DLHs
136. The Norris Company uses a standard cost accounting system and estimates production for
16-76
Required:
Prepare the journal entries to record the following:
a. Purchase and use of direct materials (Assume materials are used as purchased and no
inventory is maintained).
b. Recognition of direct labor.
a.
Work-in Process (6,000 × $13.20) 79,200
Material price variance 7,400
Material efficiency variance 2,200
b.
Work-in Process (6,000 × $12) 72,000
Direct labor rate variance 5,800
Direct labor efficiency variance 2,400
Feedback: a. DM Price: $88,800 - [($13.20/3) × 18,500] = $88,800 - [$4.40 × 18,500] = $7,400
unfavorable; DM Efficiency: [18,500 - (3 × 6,000)] × $4.40 = $2,200 unfavorable
b. DL rate: $75,400 - [$6.00 × ($75,400/$6.50)] = $5,800 unfavorable, DL efficiency: [11,600 -
(2 × 6,000)] × $6.00 = $2,400 favorable
16-77
137. Darren Company adopted a standard cost system several years ago. The standard costs for
the prime costs of its single product are as follows:
Material: 8 kilograms @ $5 per kilogram $40.00
Labor: 6 hours @ $8.20 per hour $49.20
The following operating data were taken from the records for November:
Units completed 5,600 units
Budgeted output 6,000 units
Purchase of materials 50,000 kilograms
Total actual labor costs $300,760
Actual labor hours 36,500 hours
Material efficiency (quantity) $1,500
variance unfavorable
Total material variance $750 unfavorable
Required:
a.
Work-in Process (5,600 ×

224,000
$40.00)
Material efficiency variance 1,500
Material price variance 750
16-78
b.

275,520
$49.20)
Feedback: a. Total material variance $750 unfavorable - $1,500 efficiency = price $750
favorable
c. Price: ($300,760/36,500 - $8.20) × 36,500 = $1,460 unfavorable; efficiency: [36,500 - (6 ×

5,600)] × $8.20 = $23,780 unfavorable
138. The Fox Company uses a standard cost accounting system and estimates production for the
year to be 60,000 units. At this volume, the company's variable overhead costs are $0.50 per
direct labor hour.
Required:
a. Incurring actual overhead.
b. Application of overhead to production.
c. Closing of overhead accounts and recognizing variances.
d. Transferring production to finished goods.
16-79
a. Variable overhead (actual) 6,380
Fixed overhead (actual) 20,400
Miscellaneous accounts 26,780

b. 28,800
$4.80)
Variable Overhead 6,000
(applied) (6,000 × 2 × $0.50)
Fixed Overhead (applied)

22,800
(6,000 × $3.80)
c. Variable Overhead (applied) 6,000
Variable Overhead price

580
variance
Variable Overhead
200
efficiency variance
Variable Overhead (actual) 6,380
Fixed Overhead (applied) 22,800
Fixed Overhead price variance 1,400
Fixed Overhead production

3,800
volume variance
Fixed Overhead (actual) 20,400
d. Finished Goods (6,000 × $30) 180,000
Work-in Process 180,000
Feedback: Overhead rates: $30.00 - $13.20 - $12.00 = $4.80; Variable = 2 hr × $0.50 = $1;
Fixed $3.80
Fixed overhead: $4.80 × 60,000 = $288,000; Total OH; $0.50 × (2 × 60,000) = $60,000
Variable OH; Budgeted fixed OH = $288,000 - $60,000 = $228,000; per month $228,000/12 =
$19,000
16-80
c. Variable price: $6,380 - ($.50 × 11,600) = $580 unfavorable; variable efficiency: ($0.50 ×
11,600) - [$0.50 × (2 × 6,000)] = $200 favorable
Fixed price: $20,400 - ($228,000/12) = $1,400 unfavorable; fixed prod volume: ($228,000/12)
- [($228,000/120,000) × (2 × 6,000)] = $3,800 favorable
139. The Morroco Company uses a standard cost accounting system and estimates production for
Required:
c. Incurring actual overhead.
d. Application of overhead to production.
e. Closing of overhead accounts and recognizing variances.
f. Transferring production to finished goods.

a. 59,400
$13.20)
Material price variance 3,080
16-81
Material efficiency
880
variance

b. 54,000
$12.00)
c. Variable Overhead (actual) 4,380
Miscellaneous accounts 24,780

d. 21,600
$4.80)
Variable Overhead
4,500
(applied) (4,500 × 2 × $0.50)
Fixed Overhead (applied)

17,100
(4,500 × $3.80)
e. Variable Overhead (applied) 4,500
Variable Overhead efficiency

120
variance
Variable Overhead price

240
variance
Variable Overhead (actual) 4,380
Fixed Overhead (applied) 17,100
Fixed Overhead price variance 1,400
Fixed Overhead production

1,900
volume variance
f. Finished Goods (4,500 × $30) 135,000
Work-in Process 135,000
16-82
Feedback: a. DM Price: $61,600 - [($13.20/3) × 13,300] = $3,080 unfavorable; DM Efficiency:
[13,300 - (3 × 4,500)] × $4.40 = $880 favorable
b. DL rate: $57,750 - [$6.00 × ($57,750/$6.25)] = $2,310 unfavorable, DL efficiency: [9,240 -

(2 × 4,500)] × $6.00 = $1,440 unfavorable
d. Overhead rates: $30.00 - $13.20 - $12.00 = $4.80; Variable = 2 hr × $0.50 = $1; Fixed
$3.80; Fixed overhead: $4.80 × 60,000 = $288,000; Total OH; $0.50 × (2 × 60,000) = $60,000
Variable OH; Budgeted fixed OH = $288,000 - $60,000 = $228,000; per month $228,000/12 =
$19,000
e. Variable price: $4,380 - ($0.50 × 9,240) = $240 favorable; variable efficiency: ($0.50 ×
9,240) - [$0.50 × (2 × 4,500)] = $120 unfavorable
Fixed price: $20,400 - ($228,000/12) = $1,400 unfavorable; fixed prod volume: ($228,000/12)
- [($228,000/120,000) × (2 × 4,500)] = $1,900 unfavorable
140. Explain two reasons for preparing a variance analysis.
Variance analysis is used to (1) evaluate the performance of individuals and business units,
and (2) to identify possible sources of deviations between budgeted and actual performance.
141. Explain the difference between operating budgets, financial budgets, and flexible budgets.
Operating budgets and financial budgets are part of the master budget and are prepared for a
single activity level. The operating budgets include the budgeted income statement, the
production budget, and the cost of goods sold budget and reflect the organization's operations.
Financial budgets forecast the financial resources and needs due to the operating budget and
include the cash budget and the budgeted balance sheet. A flexible budget on the other hand
is an after the fact budget that is adjusted for the actual level of output.
142. Explain the difference between the sales volume variance and the production volume
variance.
The sales activity or sales volume variance measures the difference between budgeted profits
on the master budget versus budgeted profits at the actual sales output level. The variance is
due solely to the difference in the sales volume. The production volume variance is the
difference between actual production in units and the capacity used to develop the fixed
overhead rates. The production volume variance is due to production volume differences, not
sales volume differences. Furthermore, the sales volume variance is measuring a difference in
16-83
profits while the production volume variance is measuring a difference in fixed costs only.
143. Explain how standards and budgets are different.
Standards are an estimate of what a unit should cost to produce, given efficient operating
conditions. Standards are normally developed on a per unit basis. Budgets are based on an
expected level of activity and present the results of plans.
144. Explain two reasons why splitting production costs into price and efficiency variances is
beneficial for management control.
One reason is there are different causes of a price variance than there are for an efficiency
variance. By splitting the costs into the two there is more information as to why the variance
may have occurred. A second reason is different managers are responsible for the different
variances. Purchasing is normally responsible for material price variances while the production
manager is responsible for efficiency variances.
145. The Tennison Company uses a standard cost system in which manufacturing overhead costs
are applied to units of the company's single product on the basis of standard direct labor-hours
(DLHs). The standard cost card for the product follows:
Standard Cost Card-per unit of product
Direct Materials, 4 yards at $3.50 per yard $14
Direct Labor, 1.5 DLHs at $8 per DLH 12
Variable Overhead, 1.5 DLHs at $2 per DLH 3
Fixed Overhead, 1.5 DLHs at $6 per DLH 9
Standard cost per unit $38
The following data pertain to last year's activities:
• The company manufactured 18,000 units of product during the year. A total of 70,200 yards of materia
• The company worked 29,250 direct labor-hours during the year at a cost of $7.80 per hour.
• The denominator activity level was 22,500 direct labor-hours.
• Budgeted fixed manufacturing overhead costs were $135,000 while actual manufacturing overhead co
• Actual variable overhead costs were $61,425.
16-84
Required:
a. Compute the direct materials price and quantity variances for the year.
b. Compute the direct labor rate and efficiency variances for the year.
c. Compute the variable overhead rate and efficiency variances for the year.
d. Compute the fixed manufacturing overhead budget and volume variances for the year.
a. Direct materials price and quantity variances:
= 70,200 yards ($3.75 per yard × $3.50 per yard)
= $263,250 - $245,700
= $17,550 U
= $3.50 per yard (70,200 yards - 72,000 yards*)
= $245,700 - $252,000
= $6,300 F
*18,000 units × 4 yards = 72,000 yards
b. Direct labor rate and efficiency variances:
Labor rate variance = AH(AR - SR)
= 29,250 hours ($7.80 per hour - $8 per hour)
= $228,150 - $234,000
= $5,850 F
= $8 per hour (29,250 hours - 27,000 hours*)
= $234,000 - $216,000
= $18,000 U
*18,000 units × 1.5 hours = 27,000 DLH
16-85
c. Computation of variable overhead variances:
= $61,425 - (29,250 hours × $2 per hour)
= $61,425 - $58,500
= $2,925 U
= $2 per hour (29,250 hours - 27,000 hours)
= $58,500 - $54,000 = $4,500 U

*18,000 units × 1.5 hours = 27,000 DLH
d. Computation of the fixed manufacturing overhead variances:
Budget variance = Actual fixed overhead - Budgeted fixed overhead cost
= $133,200 - $135,000
= $1,800 F
Volume variance = Budgeted fixed overhead cost - Fixed overhead applied to work in process
= $135,000 - (27,000 hours × $6 per MH*)
= $135,000 - $162,000
= $27,000 F
*18,000 units × 1.5 hours = 27,000 hours
16-86
146. Angie Manufacturing uses a standard cost system in which manufacturing overhead is applied
to units of product on the basis of standard machine-hours. At standard, each unit of product
requires one machine-hour to complete. The standard variable overhead is $1.75 per
machine-hour and Budgeted Fixed Manufacturing Costs are $300,000 per year. The
denominator level of activity is 150,000 machine-hours, or 150,000 units. Actual data for the
year were as follows:
Actual variable overhead cost $211,680
Actual fixed manufacturing overhead

$315,000
cost
Actual machine-hours 126,000
Units produced 120,000
Required:
a. What are the predetermined variable and fixed manufacturing overhead rates for the year?
b. Compute the variable overhead rate and efficiency variances for the year.
c. Compute the fixed manufacturing overhead budget and volume variances for the year.
a. Predetermined variable overhead rate = $1.75 MH (given)
Predetermined fixed overhead rate = $300,000 ÷ 150,000 MH
= $2 hour
b. Variable overhead rate variance = AH(AR - SR)
= 126,000 ($1.68 per hour* - $1.75 per hour)
= $211,680 - $220,500
= $8,820 F
*$211,680 ÷ 126,000 MHs = $1.68 per machine hour
= $220,500 - $210,000
16-87
= $10,500 U
*120,000 units × 1 hour = 120,000 hours
c. Budget variance = Actual fixed overhead - Budgeted fixed overhead cost
= $315,000 - $300,000
= $15,000 F
Volume variance = Budgeted fixed overhead cost - Fixed overhead applied to work in process
= $2 per hour (150,000 hours - 120,000 hours)
= $300,000 - $240,000
= $60,000 U
147. Upton Company uses a standard cost system for its single product. The following data are
available:
Actual experience for the current year:
Purchases of raw materials (15,000

$195,000
yards at $13 per yard)
12,000
Raw materials used
yards
Direct labor costs (10,200 hours at $10

$102,000
per hour)
12,600
Units produced
units
Standards per unit of product:
Raw materials 1.1 yards at $15 per yard
Direct labor 0.80 hours at $9.50 per hour
Variable overhead $8 per direct labor hour
Required:
Compute the following variances for raw materials, direct labor, and variable overhead,
assuming that the price variance for materials is recognized at point of purchase:
16-88
a. Direct materials price variance.
b. Direct materials quantity variance.

e. Variable overhead rate variance.
f. Variable overhead efficiency variance.
a. & b. Raw Materials:

= 15,000 yards ($13 per yard × $15 per yard)
= $195,000 - $225,000
= $30,000 F
= $15.00 per yard (12,000 yards - 13,860 yards*)

= $180,000 - $207,900
= $27,900 F
*12,600 units × 1.1 yards = 13,860 yards
c. & d. Direct Labor:
Labor rate variance = AH(AR - SR)

= 10,200 hours ($10 per hour × $9.50 per hour)
= $102,000 - $96,900
= $5,100 U

= $96,900 - $95,760
= $1,140 U
*12,600 units × .8 hour per unit = 10,080 hours
16-89
e. & f. Variable Overhead:
= $84,150 - (10,200 hours × $8 per hour)
= $84,150 - $81,600
= $2,550 U
= $81,600 - $80,640
= $960 U
*12,600 units × .8 hours = 10,080 hours
148. Ralston Corporation makes a product with the following standard costs:

Quantity Price Cost
Inputs
or Hours or Rate Per Unit
Direct $5.00 per

6.9 liters $34.50
materials liter
$17.00 per
Direct labor 0.3 hours $5.10
hour
Variable $6.00 per

0.3 hours $1.80
overhead hour
16-90
The company reported the following results concerning this product in August.
Originally budgeted output 8,600 units
Raw materials used in production 58,330 liters
Actual direct labor-hours 2,310 hours
Purchases of raw materials 62,500 liters
Actual price of raw materials $4.90 per liter
Actual direct labor rate $17.10 per hour
Actual variable overhead rate $5.50 per hour
The materials price variance is recognized when materials are purchased. Variable overhead
is applied on the basis of direct labor-hours.
Required:
a. Compute the materials quantity variance.
b. Compute the materials price variance.
c. Compute the labor efficiency variance.
d. Compute the direct labor rate variance.
e. Compute the variable overhead efficiency variance.

f. Compute the variable overhead rate variance.
a. Materials quantity variance = SP(AQ - SQ)
= $5.00 per liter (58,330 liters - 57,960 liters*)

= $291,650 - $289,800
= $1,850 U
*8,400 units × 6.9 liters = 57,960 liters
16-91
b. Materials price variance = AQ(AP - SP)
= 62,500 liters ($4.90 per liter - $5 per liter)
= $306,250 - $312,500
= $6,250 F
c. Labor efficiency variance = SR(AH - SH)
= $39,270 - $42,840
= $3,570 F
d. Labor rate variance = AH(AR - SR)
= $39,501 - $39,270
= $231 U
e. Variable overhead efficiency variance = SR(AH - SH)
= $13,860 - $15,120
= $1,260 F
f. Variable overhead rate variance = AH(AR - SR)

= $12,705 - $13,860
= $1,155 F
16-92
149. Pure Corporation makes a product with the following standard costs:
Quantity Price Cost

Inputs
or Hours or Rate Per Unit
Direct $6.00 per

4.3 pounds $25.80
materials pound
$20.00 per
Direct labor 0.7 hours $14.00
hour
Variable $2.00 per

0.7 hours $1.40
overhead hour
The company reported the following results concerning this product in September.
Originally budgeted output 1,900 units
7,210
Raw materials used in production
pounds
7,600
Purchases of raw materials
pounds
Actual cost of raw materials

$43,320
purchases
Actual direct labor cost $25,578
The company applies variable overhead on the basis of direct labor-hours. The direct
materials purchases variance is computed when the materials are purchased.
Required:
16-93
= $6.00 per pound (7,210 pounds - 7,310 pounds*)
= $43,260 - $43,860
= $600 F
*1,700 units × 4.3 pounds = 7,310 pounds
b. Materials price variance = (AQ × AP) - (AQ × SP)
= $43,320 - (7,600 pounds × $6 per pound)

= $43,320 - $45,600
= $2,280 F
= $25,200 - $23,800
= $1,400 U
d. Labor rate variance = (AH × AR) - (AH × SR)

= $25,578 - (1,260 hours × $20 per hour)
= $25,578 - $25,200
= $378 U
= $2,520 - $2,380
= $140 U
16-94
f. Variable overhead rate variance = (AH × AR) - (AH × SR)
= $2,394 - (1,260 hours × $2 per hour)
= $2,394 - $2,520
= $126 F
150. Photo Corporation makes a product with the following standard costs:
Standard
Standard Price
Quantity
Inputs or Rate
or Hours
Direct materials 7.8 kilos $1.00 per kilo
$18.00 per
Direct labor 0.4 hours
hour
Variable
0.4 hours $3.00 per hour
overhead
The company reported the following results concerning this product in August.
Raw materials used in production 65,550 kilos
Purchases of raw materials 69,000 kilos
Actual cost of raw materials

$75,900
purchases
Actual direct labor cost $66,495
The company applies variable overhead on the basis of direct labor-hours. The direct
materials purchases variance is computed when the materials are purchased.
Required:


16-95
= $1.00 per kilo (65,550 kilos - 66,300 kilos*)
= $65,550 - $66,300
= $750 F
*8,500 units × 7.8 kilos = 66,300 kilos
= $75,900 - (69,000 kilos × $1 per kilo)
= $75,900 - $69,000
= $6,900 U
= $61,380 - $61,200
= $180 U
= $66,495 - (3,410 hours × $18 per hour)
= $66,495 - $61,380
= $5,115 U
= $10,230 - $10,200
= $30 U
= $9,889 - (3,410 hours × $3 per hour)
= $9,889 - $10,230
= $341 F
16-96
151. Meera Corporation makes a product with the following standard costs:
Standard
Standard Price
Quantity
Inputs or Rate
or Hours
$3.00 per
Direct materials 8.1 ounces
ounce
$18.00 per
Direct labor 0.5 hours
hour
Variable
0.5 hours $2.00 per hour
overhead
In December the company produced 4,200 units using 34,870 ounces of the direct material
and 1,900 direct labor-hours. During the month, the company purchased 39,700 ounces of the
direct material at a total cost of $111,160. The actual direct labor cost for the month was
$35,530 and the actual variable overhead cost was $3,990. The company applies variable
overhead on the basis of direct labor-hours. The direct materials purchases variance is
computed when the materials are purchased.
Required:

= $3 per ounce (34,870 ounces - 34,020 ounces*)
= $104,610 - $102,060
= $2,550 U
*4,200 units × 8.1 ounces = 34,020 ounces
16-97
= $111,160 - (39,700 ounces × $3 per ounce)
= $111,160 - $119,100
= $7,940 F
= $34,200 - $37,800
= $3,600 F

= $35,530 - (1,900 hours × $18 per hour)
= $35,530 - $34,200
= $1,330 U

= $3,800 - $4,200
= $400 F
= $3,990 - (1,900 hours × $2 per hour)

= $3,990 - $3,800
= $190 U
152. Al-Shabad Company produces a single product. The company has set the following standards
for materials and labor:
Standard quantity Standard
or price
hours per unit or rate
16-98
Direct
? pounds per unit $? per pound
materials
Direct labor 3.0 hours per unit $10 per hour
During the past month, the company purchased 7,000 pounds of direct materials at a cost of
$17,500. All of this material was used in the production of 1,300 units of product. Direct labor
cost totaled $36,750 for the month The following variances have been computed:
Materials quantity variance $1,375 U
Total materials variance $375 F
Labor efficiency variance $4,000 F
Required:
1. For direct materials:
a. Compute the standard price per pound of materials.
b. Compute the standard quantity allowed for materials for the month's production.
c. Compute the standard quantity of materials allowed per unit of product.
2. For direct labor:

a. Compute the actual direct labor cost per hour for the month.
b. Compute the labor rate variance.
1. a. Materials Price Variance = AQ(AP - SP)

7,000 pounds ($2.50** - SP) = $1,750 F*
$17,500 - 7,000 pounds × SP = $(1,750)
7,000 pounds × SP = $19,250
SP = $2.75
*$1,375U + $375 F = $1,750 F

**17,500 ÷ 7,000 pounds = $2.50 per pound
b. Materials Quantity Variance = SP(AQ - SQ)
$2.75 (7,000 pounds - SQ) = $1,375 U

$19,250 - $2.75 × SQ = $1,375
$2.75 × SQ = $17,875
SQ = 6,500 pounds
16-99
c. 6,500 pounds ÷ 1,300 units = 5 pounds per unit.
2. a. Labor Efficiency Variance = SR(AH - SH)
$10 (AH - 3,900*) = $4,000 F
$(4,000) = $10 × AH - $39,000 = $(4,000)
$10 × AH = $35,000
AH = 3,500
Therefore, $36,750 total labor cost ÷ 3,500 hours = $10.50/hour.
*1,300 units × 3 hours/unit = 3,900 hours.
b. Labor Rate Variance = AH(AR - SR)
= 3,500 ($10.50 - $10.00) = $1,750 U
153. In the new cost management scheme of things, what are some of the disadvantages of the
traditional standard cost system (list at least four)?
(1) The variances are at too aggregate a level and are not timely enough to be useful.
(2) The variances are too aggregated in that they are not tied to specific product lines,
production batches, or flexible manufacturing system cells.
(3) There is too much focus on the cost and efficiency of direct labor which is becoming a
relatively insignificant factor of production.
(4) Successful standard cost systems rely on stable production processes, under flexible
manufacturing systems this stability is reduced because of frequent switching among a variety
of products on the same production line.
(5) The standards are relevant for only a short time because of shorter product life cycles.
(6) Traditional standard costing systems tend to focus too much on cost minimization, rather
than on increasing product quality or customer service.
(7) Variances from standards tend to be small or nonexistent under automated manufacturing
processes.
(8) Traditional standard costs are not defined broadly enough to capture various important
aspects of performance, e.g., the costs of ownership for direct materials.
16-100
154. Market Manufacturing Inc. has developed the following standards for one of its products. The
materials are not substitutable.
Material 1 5 yards $6/yard $30
Material 2 6 pieces $5/piece $30
Direct labor 3 hours $24/hour $72
Total variable cost per unit $132
The records for March showed the following actual results:
10,000 yards for

Material 1 Purchased
$58,000
Used 9,500 yards
15,000 pieces for

Material 2 Purchased
$78,750
Used 12,100 pieces
5,900 hours for

Direct labor
$147,500
Units
2,000 units
produced
Required:
(1) Calculate the following variances:
(a) Material purchase price variance for material 1.
(b) Material quantity variance for material 1.

(c) Material purchase price variance for material 2.
(d) Material quantity variance for material 2.
(e) Labor rate variance.
(f) Labor efficiency variance.
(2) Give at least one possible cause for each of the following variances:
16-101
(a) material 2 quantity variance.
(b) labor rate variance.
(c) labor efficiency variance.
(1)
(a) $2,000 favorable = $58,000 - 10,000($6) = $58,000 - $60,000
(b) $3,000 favorable = $6[9,500 - 5(2,000)] = $6(9,500 - 10,000)
(c) $3,750 unfavorable = $78,750 - $5(15,000) = $78,750 - $75,000

(d) $500 unfavorable = $5[12,100 - 6(2,000)] = $5(12,100 - 12,000)
(e) $5,900 unfavorable = $147,500 - $24(5,900) = $147,500 - $141,600

(f) $2,400 favorable = $24[5,900 - 3(2,000)] = $24(5,900 - 6000)
(2)
(a) Use of too many pieces on some of the output, lower quality material.
(b) Use of more skilled employees, use of employees with greater seniority and higher wages.
(c) Use of more skilled employees, use of more efficient machinery, use of higher quality
materials.
155. Easton Industries developed the following standards for one of its products:
Material 5 feet $15/foot $75
Labor 10 hours $15/hour 150
Total variable cost $225
Actual results for September were:

Units produced 12,000
Material purchased 40,000 feet for $14.25/foot
Material used 70,000 feet
Direct Labor 119,500 hours at $15.10/hour
Required:
(1) Calculate the following variances:
(a) Material purchase price variance.
(b) Material quantity variance.
(c) Labor rate variance.
(d) Labor efficiency variance.

16-102
(2) Why would it be inappropriate to calculate the Material price variance at the time the
material is used; might there be a situation when it might be all right to do so?
(1)
(a) $30,000 favorable 40,000($14.25 - $15.00) = 40,000($0.75)
(b) $150,000 unfavorable $15(70,000 - 5(12,000)
(c) $11,950 unfavorable 119,500(15.10 - 15.00)

(d) $7,500 favorable $15(119,500 - 10(12,000)
(2) Calculating the material price variance at the time of use provides information too late for
timely corrective action. Since the price variance relates to the purchasing function,
identification of significant variances should occur at that level. If there is very little reason for
the purchase price to vary beyond some highly insignificant amount, e.g., $0.01, then it might
be all right to delay calculation of the price variance until the material is used.
156. Megham Company manufactures a single product. The following standards have been
developed for it:
Direct Material 6 pounds $4/pound
Direct Labor 2 hours $15/hour
During May, the following actual activities occurred: Material purchased, 12,000 pounds for
$45,600; material used in the production of 2,000 units of product, 13,000 pounds; direct labor,
3,500 hours costing $56,000.
Required:
(1) Compute the following variances:
(a) material quantity variance.
(b) labor rate variance.
(c) labor efficiency variance.
(2) Give one possible explanation for each of the 3 variances computed.
(1)
(a) $4,000 unfavorable = $4[13,000 - 6(2,000)]
(b) $3,500 unfavorable = $56,000 - $15(3,500)

(c) $7,500 favorable $15[3,500 - 2(2,000)]
16-103
(2)
(a) Low quality materials, less efficient machinery, theft.
(b) Higher skilled workers, workers with greater seniority and higher wages.
(c) Higher skilled workers, workers with greater seniority (more experience), higher quality
materials, more efficient machinery
16-104
16-105
15
Transfer Pricing
Solutions to Review Questions
15-1.
A transfer price is used to record the revenue or the cost from a sale between units (e.g.,
divisions) of a firm. It allows the completion of separate financial statements within the
firm.
15-2.
Yes, transfer prices exist in centralized organizations to record the transfer of goods and
services from one unit to another for the same reasons such organizations allocate costs
(e.g., inventory valuation, cross-department monitoring).
15-3.
Market-based transfer pricing is considered optimal under many circumstances because it
preserves divisional autonomy, yet encourages division managers to make economically
optimal decisions for the company if divisions operate at capacity and there are no market
transaction costs.
15-4.
The key limitation is that market prices are often not readily available. The limitations of
market-based transfer prices exist when the market price does not reflect the opportunity
cost of the goods and services, for example when idle capacity is present. Also, temporary
short-run fluctuations in market prices could lead to suboptimal long-run decisions.
The limitation of cost-based transfer pricing is that it requires the computation of cost. The
resulting transfer price might distort decision-making and lead to disputes between
divisions.
15-5.
Direct intervention might be preferable when transfers between units are rare or where the
decision resulting from decentralized decision-making is considered too harmful to allow.
The advantage of direct intervention is it promotes short-run profits by ensuring proper
action. The disadvantages of such a practice are that top management will become too
involved in pricing disputes, and division managers will lose flexibility and autonomy in
their decision making. The company also loses the other advantages of decentralization.
©The McGraw-Hill Companies, Inc., 2017

Solutions Manual, Chapter 15 697
15-6.
Reasons not to use market prices include situations where: (1) market prices are not
readily available, (2) market prices lead to suboptimal behavior (for example, when the
supplier division has idle capacity), or (3) the company is not otherwise indifferent between
internal and external buying.
15-7.
When actual costs are used as a basis for the transfer, any variances or inefficiencies in
the selling division are passed along to the buying division. To promote responsibility in
the selling division and to isolate variances within divisions, standard costs are usually
used as a basis for transfer pricing in cost-based systems. (Note: Standard cost transfer
pricing is only appropriate if standard costs are up to date and reflect reasonable
estimates of cost.)
15-8.
The advantage of negotiated transfer prices is that they can be used when market prices
are not easily available (for example, with unique products) or when relevant costs are
difficult to compute. The disadvantages of a negotiated transfer price system are that a
great deal of management effort might be wasted on the negotiating process and that the
negotiated price might be based more upon the managers’ ability to negotiate rather than
economic factors.
15-9.
The general transfer pricing rule is:
Transfer Price = Outlay Cost + Opportunity Cost of the Resource at the Point of Transfer
a) If there is a perfect market for the intermediate product, the transfer price should be the
market price.
b) If the selling division has idle capacity that cannot be used for other purposes, the
transfer price should be at least the variable costs incurred to produce the goods.
15-10.
Transfer pricing is important in tax accounting, because transfers of goods or services
often occurs across different tax jurisdictions (countries, for example). The transfer price
affects the revenue (income) and cost (income) that are reported in the different
jurisdictions. If the different jurisdictions have different income tax rates, the total tax
liability across all jurisdictions will depend on the transfer price.
15-11.
Transfer pricing is important in segment reporting, because it affects the reported
revenues and costs, and therefore income, shown for the different segments.

698 Fundamentals of Cost Accounting
Solutions to Critical Analysis and Discussion Questions
15-12.
Three goals of transfer pricing in a decentralized organization are (1) to coordinate the
activities of various responsibility centers, (2) to motivate managers to perform in the
company’s best interest and (3) to serve as a performance measure for responsibility
centers.
15-13.
A cost-based or negotiated cost-based transfer pricing method would be necessary. We
recommend using differential standard costs to the supplier plus supplier’s opportunity
costs of the internal transfer, if any. If a dual transfer pricing system is used, the supplier
could be given a markup without charging it to the buyer.
15-14.
Alpha Division should be a cost center because the Alpha Division manager has no
decision authority with respect to revenues. Beta Division should remain a profit center,
because it sells externally and at least some of its costs are direct costs of the division.
15-15.
Most likely Weyerhaeuser uses a market price, because the products are commodity
products (wood, pulp, and so on) with well-established markets.
15-16.
The transfer price becomes revenue for the selling segment and a cost to the buying
segment. An increase (decrease) in the transfer price increases (decreases) the selling
segment’s operating profit and decreases (increases) the buying segment’s operating
profit.
The choice of a transfer price is important because it affects managers’ decisions about
buying and selling between divisions.
15-17.
Because transfer prices can affect the assignment of income from one jurisdiction to
another, there is a tendency to set a cross-jurisdictional transfer price in such a manner
that income is shifted to the jurisdiction with a lower tax burden. Of course, management
needs to be aware of differences in tax laws, currency controls and other factors when
establishing a transfer price. Moreover, taxing authorities might challenge a transfer price
that is deemed unreasonable.

15-18.
Transfer prices are similar to cost allocations in that they assign costs (and profit) to two or
more cost objects. In fact, if we think about the service department cost allocations in
Chapter 11, these could be considered transfer prices from service departments to
production departments. They are different primarily in that they allocate more than cost.
15-19.
Corporate cost allocation is similar to transfer pricing where the “service” being transferred
is a corporate service, such as personnel, finance, or information technology services. The
solution in Chapter 12 to use a two-part allocation based on standard fixed and variable
costs is exactly the same as the optimal transfer pricing solution discussed in this chapter
in the case where there is no external market. In the case of corporate costs, there might
be suppliers of these services, but the firm has decided to provide these internally.

Solutions to Exercises
15-20. (20 min.) Apply Transfer Pricing Rules: Best Practices, Inc.
a. The minimum transfer price that the Corporate Division should obtain is $600 per hour,
the market price for these services.
b. The maximum transfer price that the Government Division should pay is $200 per hour,
the cost of the best alternative.
c. Answer (a) would be $200 per labor hour. Answer (b) would not be affected.
15-21. (15 min.) Evaluate Transfer Pricing System: Clinton Corporation

a. If Alpha Division buys from outsiders because the transfer price is greater than $90,
this would cost the company $72,000. The difference between the price paid for the
units from an outside supplier ($90) and the differential costs of producing in Beta
Division ($84) multiplied by the 12,000 units in the order = $72,000.
b. If Beta Division sells to Alpha instead of outside customers, the cost to Clinton is
$360,000. The difference between the price paid for the units from an outside supplier
($90) and the forgone revenue in Beta Division ($120) multiplied by the 12,000 units in
the order = $360,000.
15-22. (15 min.) Evaluate Transfer Pricing System

With the possibility of increased production, Maryland Division has an opportunity cost of
transferring to Virginia Division of $230 per square foot, which is the appropriate transfer
price. However, the opportunity cost of acquiring the warehouse space is $190 per square
foot for Virginia Division. Therefore, it would be in the company’s best interest if Virginia
Division rented the space from the outside company. [This assumes no additional costs
such as moving expenses to Virginia Division in using outside facilities.]

15-23. (20 min.) Evaluate Transfer Pricing System.
a. Northeast Southwest Company
Transfer internally Pays $32 Receives $30 Pays $ 2
Pays $11 Pays 11
Pays $13
Sell externally Pays $31 Receives $30 Pays $ 1
Pays 11 Pays 11
Pays $12
Optimal to transfer externally.
b. Northeast Southwest Company

Transfer internally Pays $32 Receives $30 Pays $ 2
Pays 11 Pays 11
Pays $13
Sell externally Pays $31 Receives and pays –0– Pays $31
Optimal to transfer internally.
15-24. (25 min.) Evaluate Transfer Pricing System: Seattle Transit Ltd.
a. Different prices:
(1) The opportunity cost might be considered the regular fare of $2.00 less the $0.50
fee collected.
(2) The full cost is $4.00 less the $0.50 fee collected.
(3) One might suggest that if the transit vehicles are not running at capacity, the
opportunity cost is zero because the senior citizens are riding in seats that would
otherwise be empty.
b. Seattle Transit would prefer to be reimbursed at the full cost of $4.00 (less the $0.50
fee) because it would receive more revenue.
c. The state government would prefer a rate of zero so it would pay no money to the
transit authority.
d. The difference is $525,000 per month, which equals 150,000 rides at $3.50 per ride.
The $3.50 is the difference between the full cost and the $0.50 fare collected.

15-25. (25 min.) Evaluate Transfer Pricing System: BGTS.
Ms. Seville’s Mr. Turco’s

Total Shares Shares
(60% and (40% and
20%) 60%)
Decrease in profits at BGTS .............................. $(11,200)a $(6,720) $(4,480)
Increase in profits at Big City Developers ......... 11,200 2,240 6,720
Net change in profits ..........................................$ 0 $(4,480) $2,240
a$11,200 = $40 per hour x 10% x 2,800 hours.

15-26. (25 min.) International Transfer Prices–Ethical Issues: Trans Atlantic
Metals.
a. Analyze the tax liabilities in each jurisdiction using the alternative transfer prices. If the
transfer price is $30 million, the tax liabilities are:
Finland U.S.
$30,000,000 $150,000,000
Sales revenue ....................................................
Third-party costs .................................................
20,000,000 60,000,000
Transferred goods costs ..................................... 30,000,000
Total costs ..........................................................
$20,000,000 $90,000,000
Taxable income ..................................................
$10,000,000 $60,000,000
Tax rate ..............................................................
60% 40%
Tax liability..........................................................
$6,000,000 $ 24,000,000
Total tax liability .................................................. $30,000,000
If the transfer price is $40 million, the tax liabilities are computed as follows:
Finland U.S.
Sales revenue ....................................................

$40,000,000 $150,000,000
Third-party costs .................................................
20,000,000 60,000,000
Transferred goods costs ..................................... 40,000,000
Total costs ..........................................................
$ 20,000,000 $100,000,000
Taxable income ..................................................
$ 20,000,000 $50,000,000
Tax rate ..............................................................
60% 40%
Tax liability..........................................................
$12,000,000 $ 20,000,000
Total tax liability .................................................. $32,000,000
The total tax liability is higher if profits are shifted to the country with the higher tax
rate.
b. Answers will vary. In general, most people will view the choice as ethical. Obviously,
misstating costs simply to avoid taxes is unethical (and illegal).

15-27. (20 min.) Transfer Pricing Policies – Ethical Issues: Best Practices, Inc.
a. As in 15-20, the minimum transfer price that the Corporate Division should obtain is
$600 per hour, the market price for these services. This reflects the (opportunity) cost
of the Corporate Division and is ethical.
b. The transfer price that maximizes the profit of Best Practices is $600 per hour. The
transfer price does not affect the profit of the Government Division (it charges cost plus
a fixed fee). Many (probably most) would view this as an ethical price, because it
reflects the value of the resource in the market.
15-28. (20 min.) Evaluate Transfer Pricing System: San Jose Company.
a. $160. Manufacturing is operating below capacity, so the optimal transfer price is the
variable cost. The Assembly order will not exceed the current capacity.
b. $400. Manufacturing is operating at capacity. For each unit shipped to Assembly,
Manufacturing (and Mountain Industries) loses $400 from the sale of a unit to an
outside firm.
c. $280. Manufacturing is not operating at capacity, but if it fulfills the order for Assembly
it will exceed capacity. It can transfer 20,000 units before it reaches capacity (at $160
per unit – see part a) plus another 20,000. For each unit shipped to Assembly,
Manufacturing (and San Jose Company) loses $400 from the sale of a unit to an
outside firm. Therefore, the transfer cost for the 40,000 units is:
20,000 x $160 + 20,000 x $400 = $11,200,000
or, $280 (= $11,200,000 ÷ 40,000 cases) per case.
15-29. (20 min.) International Transfer Prices: San Jose Company.

This exercise is designed to illustrate the conflict between the use of a transfer price to
motivate managerial decision making and the desire to minimize corporate taxes.
Ignoring the tax issues, leads to the same answers as in Exercise 15-28. However,
from a tax perspective, the company would prefer to be taxed in Country B (with a tax
rate of 40%) instead of Country A (with a tax rate of 60%). From a tax perspective,
then, the best transfer is $160, which will result in zero profits on the transferred units.
This might, in cases, result in a conflict with the managerial decision making role of
transfer prices. This suggests that there is not a “correct” answer.
a. $160. In this case, the best tax answer is consistent with motivating good managerial
decisions.
b. Answers may vary. As shown in Exercise 15-28, the best answer to motivate good
decisions is $400. However, this will lead to a higher tax bill for the company.
c. Answers may vary. As shown in Exercise 15-28, the best answer to motivate good
decisions is $280. However, this will lead to a higher tax bill for the company.

15-30. (20 min.) Evaluate Transfer Pricing System: Dual Rates: Atascadero
Industries.
a. $560. Manufacturing is operating below capacity, so the optimal transfer price is the
variable cost. The Marketing order will not exceed the current capacity.
b. $1,400. Manufacturing is operating at capacity. For each unit shipped to Marketing,
Manufacturing (and Atascadero Industries) loses $1,400 from the sale of a unit to an
outside firm.
c. Although the dual-rate system allows both Division managers to show relatively high
profits, it suffers from the following defects. First, the total profit to the two divisions will
be higher than the profit for the firm. Although this can be dealt with in the accounting
system, it makes evaluation of alternatives (and divisions) difficult. Second, and more
important, it can lead to dysfunctional decisions. For example, Manufacturing Division
is indifferent to selling a unit to Marketing or an outside customer for $1,400. However,
if Marketing has a customer willing to pay, for example, $1,000 (before the additional
work in Marketing), Marketing will want to make the sale. In this case, Marketing only
pays $560, so makes a profit (on the Manufacturing part of the sale) of $440 (= $1,000
– $560). The firm, however, gives up a sale of $1,400.
15-31. (20 min.) International Transfer Prices: Atascadero Industries.

This exercise is designed to illustrate the conflict between the use of a transfer price to
motivate managerial decision making and the desire to minimize corporate taxes.
Ignoring the tax issues, leads to the same answers as in Exercise 15-30 (a) and (b).
However, from a tax perspective, the company would prefer to be taxed in Country Y
(with a tax rate of 35%) instead of Country X (with a tax rate of 65%). From a tax
perspective, then, the best transfer is $560, which will result in zero profits on the
transferred units. This might, in cases, result in a conflict with the managerial decision
making role of transfer prices. This suggests that there is not a “correct” answer.
a. $560. In this case, the best tax answer is consistent with motivating good managerial
decisions.
b. Answers may vary. As shown in Exercise 15-30, the best answer to motivate good
decisions is $1,400. However, this will lead to a higher tax bill for the company.
c. Answers will vary. As shown below, the best answer to motivate good decisions is
$728. However, this will lead to a higher tax bill for the company.
Manufacturing is not operating at capacity, but if it fulfills the order for Marketing, it will
exceed capacity. It can transfer 80,000 units before it reaches capacity (at $560 per
unit – see part a) plus another 20,000. For each unit shipped to Marketing,
Manufacturing (and Atascadero Industries) loses $1,400 from the sale of a unit to an
outside firm. Therefore, the transfer cost for the 100,000 units is:
80,000 x $560 + 20,000 x $1,400 = $72,800,000
or, $728 (= $72,800,000 ÷ 100,000 cases) per case.

15-32. (30 min.) Segment Reporting: Leapin’ Larry’s Pre-Owned Cars
($ in millions)
a. Using a $2 million transfer price:
Operation Financing
Item Division Division
Outside sales revenue .......................................
$17 $4
Transfer price..................................................... 2
Total revenue .....................................................
$17 $6
Less:
Outside costs .................................................
13 5
Transfer .........................................................
2
Total costs .........................................................
$15 $ 5
Operating profit before tax .................................
$ 2 $1
b. Using a $1 million transfer price:

Operation Financing
$17 $4
Transfer price..................................................... 1
Total revenue .....................................................
$17 $5
Less:
Outside costs .................................................
13 5
Transfer ..........................................................
1
Total costs .........................................................
$14 $ 5
Operating profit before tax .................................
$3 $0
c. If the commercial rate for loan fees is really $1 million and assuming that Financing is
not at capacity (since this is the market for money, that would be unlikely), the optimal
transfer price is $1 million. This assumes that the loans the company will be making
and the services for the fees will be the same as for other firms in the market. By
charging higher fees, Larry is in danger of making too few loans to customers.

15-33. (30 min.) Segment Reporting: Perth Corporation.
($000)
Item Casino Hotel
Revenue:
Outside revenue .............................................
$32,000 $22,000
Transfer price ..................................................
4,800 2,000
Total revenue ..................................................
$36,800 $24,000
Less:
Outside costs ..................................................
$18,000 $16,000
Transfer ..........................................................
2,000 4,800
Total costs ......................................................
$20,000 $20,800
Operating profit before tax ..................................
$16,800 $3,200

Solutions to Problems
15-34. (30 min.) Transfer Pricing With Imperfect Markets—ROI Evaluation, Normal
Costing: Oxford Company.
a. ROI for Thames Division.

Income: [900,000 x ($140 – $40)] – [$70 x 1,000,000] = $20,000,000
$20,000,000
ROI = = 25%
$80,000,000
b. Note: Capacity is 1,000,000 units, so regular sales would be reduced to 800,000 units
(1,000,000 units capacity – 200,000 units to Lakes Division).
(800,000 x $100) + [200,000 x ($80 – $40)] – $70,000,000
= $80,000,000 + $8,000,000 – $70,000,000 = $18,000,000.
$18,000,000
ROI = = 22.5%
$80,000,000
c. Because the investments will not change, we can determine the price by setting the
two incomes equal:
(800,000 x $100) + [200,000 x (TP – $40)] – $70,000,000 = $20,000,000
$80,000,000 + 200,000 TP – $8,000,000 – $70,000,000 = $20,000,000
200,000 TP = $18,000,000
$18,000,000
TP = = $90.00
200,000 units
where TP = transfer price per unit.
Proof
$80,000,000 + [200,000 x ($90 – $40)] – $70,000,000
= $80,000,000 + $10,000,000 – $70,000,000
= $20,000,000.
$20,000,000
ROI = = 25%
$80,000,000

15-35. (30 min.) Transfer Pricing With Imperfect Markets—RI Evaluation, Normal
Costing: Oxford Company.
a. RI for Thames Division.

[900,000 x ($140 – $40)] – ($70 x 1,000,000) – (0.13 x $80,000,000) = $9,600,000
b. Note: Capacity is 1,000,000 units, so regular sales would be reduced to 800,000 units
(1,000,000 units capacity – 200,000 units to Lakes Division).
(800,000 x $100) + [200,000 x ($80 – $40)] – $70,000,000) – (0.13 x $80,000,000)
= $7,600,000
c. Because the investments will not change, we can determine the price by setting the
two incomes equal:
(800,000 x $100) + [200,000 x (TP – $40)] – $70,000,000 = $20,000,000
$80,000,000 + 200,000 TP – $8,000,000 – $70,000,000 = $20,000,000
200,000 TP = $18,000,000
$18,000,000
TP = = $90.00
200,000 units
where TP = transfer price per unit.
Proof
$80,000,000 + [200,000 x ($90 – $40)] – $70,000,000
= $80,000,000 + $10,000,000 – $70,000,000
= $20,000,000.
[800,000 x ($140 – $40)] + [200,000 x ($90 – $40)] – ($70 x 1,000,000) – (0.13 x $80,000,000)
= $9,600,000

15-36. (50 min.) Evaluate Profit Impact of Alternative Transfer Decisions: Amazon
Beverages.
(All calculations are in $000.)
a. 1. The Container Division profits

Sales revenue ....................................................
$6,480 (= 1,200 x $5.40)
Cost ....................................................................
5,600 [= $800 + ($4 x 1,200)]
Profit ...................................................................
$ 880
2. The Mixing Division profits

Sales revenue ....................................................
$18,000 (= 1,200 x $15)
Cost ....................................................................
9,880 (= $6,480 [transfer] + $3,400)
Profit ...................................................................
$ 8,120
3. The corporation profits

Sales revenue ....................................................
$18,000 (= 1,200 x $15)
Cost ....................................................................
9,000 (= $5,600 + $3,400)
Profit ...................................................................
$ 9,000

15-36. (continued)
b. 1. No
Container Division Volumes
Cases .................................................................
400 800 1,200
Sales revenue ....................................................
$ 2,880 $ 5,000 $6,480
Cost....................................................................
2,400 4,000 5,600
Profit...................................................................
$ 480 $ 1,000 $ 880
2. Yes
Mixing Division Volumes
Cases .................................................................
400 800 1,200
Sales revenue ....................................................
$8,000 $14,400 $18,000
a
Cost ..................................................................
4,680 7,600 9,880
Profit...................................................................
$3,320 $ 6,800 $ 8,120
aProduction costs plus market price for the bottles.
3. Yes
Corporation Volumes
Cases .................................................................
400 800 1,200
Sales revenue ....................................................
$8,000 $14,400 $18,000
Cost....................................................................
4,200 6,600 9,000
Profit...................................................................
$ 3,800 $ 7,800 $ 9,000
The Mixing Division and the corporation are the most profitable at the 1,200,000 volume
and the Container Division is most profitable at the 800,000 volume. Based on a market-
based transfer price, the divisions achieve maximum profit for themselves at different
levels of sales based on the market price at the various levels relative to the division costs
at these various levels. The corporation achieves maximum profit based on the selling
price to outsiders relative to the total cost of making the product.

15-37. (40 min.) International Transfer Prices: Skane Shipping, Ltd.
All revenues and costs are in millions of dollars.

 Malaysian basis for transfer price:
Shipping Dock
Item Company Facility
Sales revenue:
Outside sales revenue....................................
$ 45 $ 10
Transfer price ................................................. 9
Total revenue .................................................
$ 45 $ 19
Less:
Outside costs .................................................
30 11
Transfer ..........................................................
9
Total costs ......................................................
$ 39 $11
Operating profit before tax
(Revenue – costs) .........................................
$ 6 $8
Tax rate..............................................................
x .75 x .30
Income taxes .....................................................
$4.5 $2.4
Total taxes ......................................................... $6.9
 Sweden basis for transfer price:
Shipping Dock
Item Company Facility
$ 45 $10
Transfer price..................................................... 13
Total revenue .....................................................
$ 45 $ 23
Less:
Outside costs .................................................
30 11
Transfer ..........................................................
13
Total costs .........................................................
$43 $11
(Revenues-costs) ..........................................
$ 2 $ 12
Tax rate .............................................................
x .75 x .30
Income taxes .....................................................
$1.5 $ 3.6
Total taxes ......................................................... $5.1
The difference in taxes is $1,800,000 ($6,900,000 – $5,100,000).

15-38. (40 min.) International Transfer Prices: Badger Air.
All revenues and costs are in millions of dollars.

 Philippine basis for transfer price:
Cargo Maintenance
Sales revenue:
Outside sales revenue ....................................
$ 95 $ 26
Transfer price .................................................. 22
Total revenue ..................................................
$ 95 $ 48
Less:
Outside costs ..................................................
47 16
Transfer ..........................................................
22
Total costs ......................................................
$ 69 $16
(Revenue – costs) ..........................................
$26 $32
Tax rate ..............................................................
x .40 x .25
Income taxes ......................................................
$10.4 $8.0
Total taxes .......................................................... $18.4
 US basis for transfer price:
Cargo Maintenance
Outside sales revenue ........................................
$ 95 $26
Transfer price ..................................................... 35
Total revenue .....................................................
$ 95 $ 61
Less:
Outside costs ..................................................
47 16
Transfer ..........................................................
35
Total costs ..........................................................
$82 $16
(Revenues-costs) ...........................................
$13 $ 45
Tax rate ..............................................................
x .40 x .25
Income taxes ......................................................
$5.2 $
11.25
Total taxes .......................................................... $16.45
The difference in taxes is $1,950,000 ($18,400,000 – $16,450,000).

15-39. (60 min.) Analyze Transfer Pricing Data: Elsinore Electronics.
a. If Home sells 87,500 units to outside
Outside sales revenue 87,500 @ $72.00........... $6,300,000

Less material and out-of-pocket costs for outside
sales (87,500 @ $7.20) ............................... 630,000 $5,670,000
Leftover DLH [375,000 – (87,500 x 3)]  4

= 28,125. 28,125 units transferred @ $81 ....... 2,278,125
Less material and out-of-pocket costs for units
transferred (28,125 @ $7.20) ...................... 202,500 2,075,625
$7,745,625
Labor costs 375,000 hrs. @ $14.40 ................... 5,400,000
Total contribution margin ............................ $2,345,625
b. If Home sells 75,000 units to Mobile
Units transferred 75,000 @ $81 ......................... $6,075,000
Less material and out-of-pocket costs for units
transferred (75,000 @ $7.20) ...................... 540,000 5,535,000
Leftover DLH [375,000 – (75,000 x 4)]  3

= 25,000 units sold outside x $72 ............... $1,800,000
Less material and out-of-pocket costs for outside
sales (25,000 @ $7.20) ............................... 180,000 1,620,000
$7,155,000
Labor costs 375,000 hrs. @ $14.40 ................... 5,400,000
Contribution margin ........................................ $1,755,000

15-39. (continued)
c. and d.a
Home Mobile Company

Sales by Home to outside (87,500 x $72) .......... $6,300,000 $6,300,000
Sales by Home to Mobile (28,125 x $81) ........... 2,278,125 2,278,125
Sales by Mobile to outside (75,000 x $204) ....... $15,300,000 15,300,000
Total sales ..........................................................
$8,578,125 $15,300,000 $23,878,125
Cost of materials, etc. in Home
(115,625 units x $7.20) ................................832,500 832,500
Cost of labor in Home ......................................... 5,400,000 5,400,000
Cost of units transferred to Mobile ...................... 2,278,125 2,278,125
Cost of units purchased from outside
by Mobile (75,000 – 28,125) x $84 ................. 3,937,500 3,937,500
Conversion cost in Mobile $36 x 75,000 ............. 2,700,000 2,700,000
Contribution ....................................................
$ 2,345,625 $6,384,375 $8,730,000
a This is based on the optimal company policy. If Home sold 75,000 units to Mobile,
Home’s total contribution would be $1,755,000. Mobile’s contribution if 75,000 units were
transferred to it would be $6,525,000 (= $15,300,000 – $6,075,000 – $2,700,000).
Company contributions would be only $8,280,000 (= $1,755,000 + $6,525,000), a
difference of $450,000 (= $8,730,000 – 8,280,000).

15-39 (continued)
Alternative approach.
The following is an alternative approach to determining the optimal company policy that
uses the concepts of chapter 4.
The scarce resource in this company is labor-hours. Regardless of the production plan,
the company will use 375,000 labor-hours (the maximum) because Home production for
both their own market and the Mobile market is profitable.
If all Home demand is met first (300,000 hours = 75,000 units x 4 hours per unit), there will
be 75,000 hours available for regular Home production. Because regular Home production
requires 262,500 labor-hours (= 87,500 units x 3 hours per unit), regular Home production
will have to be curtailed by 187,500 hours (= 62,500 units).
As discussed in chapter 4, we can look at the contribution margin per unit of constraining
resource (labor-hours here) to determine the optimal policy. Because all labor will be used,
only the material and out-of-pocket cost is relevant in the decision (labor and any fixed
cost will be the same regardless of the policy). The only relevant factor is what a unit sold
in the regular market will earn in revenue ($72) or what it allows the company to avoid
paying another supplier ($84), less the material and out-of-pocket cost ($7.20 per unit).
The value of a labor-hour used in the two alternatives is:
Used in Units
Used in Regular Transferred to
Home Units Mobile
Value of 1 unit ....................................................
$72.00 $84.00
Material and out-of-pocket cost ..........................7.20 7.20
Contribution per unit $64.80 $76.80
Hours to make 1 unit .......................................... ÷ 3 ÷4
Contribution per hour ....................................
= $21.60 = $19.20
Because labor is more valuable producing the regular units, the optimal company policy is
to use labor to make units for sales through the regular Home channels (262,500 hours)
and the remaining labor for the Mobile units (112,500 hours or 28,125 units).
The value of using the optimal policy is $450,000 = 187,500 hours x ($21.60 – $19.20),
which is what was shown in the earlier analysis.

15-40. (40 min.) Transfer Pricing—Performance Evaluation Issues: Pima
Corporation.
a. Border would not supply Metro with the thermal switch for the $60 per unit price.
Border is operating at capacity and would lose $30 ($90 – $60) for each switch sold to
Metro. The management performance of Border is measured by return on investment
and dollar profits; selling to Metro at $60.00 per unit would adversely affect those
performance measures.
b. Pima would be $66 better off, in the short run, if Border supplied Metro the switch for
$60 and the kitchen appliance was sold for $594 plus markup. Assuming the $96 per
unit for fixed overhead and administration represents an allocation of cost Metro incurs
regardless of the appliance order, Pima would lose $30 in cash flow for each switch
sold to Metro but gain $96 (the fixed overhead that will be charged as part of the price,
although it is not an incremental cost) plus markup from each switch sold by Metro.
This assumes there is no other source for the switch.
c. In the short run there is an advantage to Pima of transferring the switch at the $60
price and, thus, selling the kitchen appliance for $594 plus markup. In order to make
this happen, Pima will have to overrule the decision of the Border management.
This action would be counter to the purposes of decentralized decision making. If such
action were necessary on a regular basis the decentralized decision making inherent in
the divisionalized organization would be a sham. Then the organization structure is
inappropriate for the situation.
On the other hand, if this is an occurrence of relative infrequency, the intervention of
corporate management will not indicate inadequate organization structure. It might,
however, create problems with division managements. In the case at hand, if Pima
management requires that the switch be transferred at $60, the result will be to
enhance Metro’s operating results at the expense of Border. This certainly is not in
keeping with the concept that a manager’s performance should be measured on the
results achieved by the decisions he or she controls.
In this case, it appears that Border and Metro serve different markets and do not
represent closely related operating units. Border operates at capacity, Metro does not;
no mention is made of any other interdivisional business. Therefore, the Pima
controller should recommend that each division should be free to act in accordance
with its best interests. The company is better served in the long run if Border is
permitted to continue dealing with its regular customers at the market price. If Metro is
having difficulties, the solution does not lie with temporary help at the expense of
another division but with a more substantive course of action.
Note that Metro can still make the sale if it changes its allocation of fixed overhead and
administration to $66 per unit. In that case, it can pay Border (or a competitor) $90 for the
part and still arrive at a total cost of $594. Because it is not operating at capacity, it should
be willing to try this.
CMA adapted.

15-41. (30 min.) Evaluate Transfer Price System: Weaver, Inc.
The purpose of this problem is to illustrate possible problems that can arise when
applying static rules, such as determining the optimal transfer price in a series of
decisions over time.
a. $10. Gamma is operating below capacity. Therefore, the optimal transfer price is
the incremental cost, or $10 per carton.
b. The manager of Gamma Division is unlikely to be satisfied with this policy as he

or she will see an increase in activity with no increase in profit and will argue
that the policy is not “fair.” You might respond by noting that the purpose of the
system is designed to promote good decision making and that he or she is not
being punished for the increased activity; the impact on profits is zero.
c. With the additional 7,500 cases, the capacity constraint in Gamma Division
becomes binding. This suggests that 2,500 cases should be priced above the
incremental costs. The question is which cases? If we focus only on the last
cases, the company might miss a better opportunity. This is an example where
applying the idea of incremental decision making might lead to bad decisions if
we do not step back and consider all the options in each case. Without more
information here, we do not know what is “best.” If we decide to re-price the
cases for Nu Division, we run the risk that the business developed by the
manager of Nu Division will now not show a profit.

15-42. (40 min.) Evaluate transfer price system: Western States Supply.
a. Northwest division management’s attitude at the present time should be positive to

each of these prices in decreasing order (obviously preferring a higher to lower price)
because Northwest has unused capacity. Northwest division management
performance is evaluated based on return on investment (ROI) and each of these
prices exceed variable costs, which will increase Northwest’s ROI.
At a time when all existing capacity is being used, Northwest division management
would want the intracompany transfer price to generate the same amount of profit as
outside business in order to maximize division ROI.
b. Negotiation between the two divisions is the best method to settle on a transfer price.
Western States Supply, Inc. is organized on a highly decentralized basis and each of
the four conditions necessary for negotiated transfer prices exists. These conditions
are:
 An outside market exists that provides both parties with an alternative.
 Both parties have access to market price information.
 Both parties are free to buy and sell outside the corporation.
 Top management supports the continuation of the decentralized management
concept.
c. No, the management of Western States Supply should not become involved in this
controversy. The company is organized on a highly decentralized basis which top
management must believe will maximize long-term profits. Imposing corporate
restrictions will adversely affect the current management evaluation system because
division management would no longer have complete control of profits. Also, the
addition of corporate restrictions could have a negative impact on division
management who are accustomed to an autonomous working environment.
CMA adapted.

15-43. (30 min.) Transfer Prices and Tax Regulations—Ethical Issues: Gage
Corporation.
a. The transfer price economically optimal for Gage Corporation is $12 per unit. As
illustrated below, this is due to the difference in tax rates between the U.S. and
England. It would thus be advantageous to Gage to charge as high a transfer price as
possible so as to generate income in the U.S. and avoid the higher tax rate of 70% in
England.
Profit after tax at the transfer price of $5 per unit
Adams Division, U.S. Bute Division, England

Selling Price .......................................................
$23.00
Transfer Price.....................................................
$5 Transfers from U.S. ............................................
$5.00
Variable Cost .....................................................
5 Shipping costs ....................................................
3.00
Profit ...............................................................
$0 Additional processing costs ................................
2.00 10.00
Profit before tax ..................................................
$13.00
Tax @ 70% ........................................................9.10
Profit after tax .................................................
$ 3.90
Total Profit after tax for Gage = $3.90 per unit
Profit after tax at the transfer price of $12 per unit

Adams Division, U.S. Bute Division, England
Transfer Price.....................................................
$12.00 Selling Price .......................................................
$23.00
Variable Cost .....................................................
5.00 Transfers from U.S. ............................................
$12.00
Profit ...............................................................
$7.00 Shipping costs ....................................................
3.00
Tax @ 40% ........................................................
2.80 Additional processing costs ................................
2.00 17.00
Profit after tax .....................................................
$4.20 Profit before tax ..................................................
$ 6.00
Tax @ 70% ........................................................4.20
Profit after tax .................................................
$ 1.80
Total profit after tax for Gage Corporation = $4.20 + $1.80 = $6 per unit
b. Answers will vary. Most people will find it ethical because there are
two different decisions involved.
c. Answers will vary. Most likely, the tax authorities will not accept it if
they discover the practice.

15-44. (40 min.) Segment Reporting: Midwest Entertainment.
a. ($ thousands)
Bus Ticket
Charters Lodging Concerts Services
Outside revenue .................................................
$12,250 $5,300 $4,450 $1,600
Hotel award coupons ..........................................
1,300
Concert discounts (bus) ..................................... 350
Concert discounts 150
(Lodging) ...........................................................
Crew lodging ......................................................650
Ticket commissions:
Bus ................................................................. 200
Lodging ........................................................... 100
Concerts ......................................................... 50
Total revenues....................................................
$13,550 $5,950 $4,950 $1,950
Outside costs......................................................
$7,850 $3,550 $3,300 $1,500
Hotel award coupons .......................................... 1,300
Concert discounts (bus) .....................................
350
Concert discounts
(Lodging) ...........................................................150
Crew lodging ......................................................
650
Ticket commissions:
Bus .................................................................
200
Lodging ...........................................................100
Concerts ......................................................... 50
Total costs ..........................................................
$9,050 $5,100 $3,350 $1,500
Operating profits .................................................
$4,500 $ 850 $1,600 $ 450

15-44. (continued)
b. Adjust the operating profits in requirement a for the changed transfer prices.
Ticket
Bus Charters Lodging Concerts Services
Operating profits (a) ..........................................
$4,500 $850 $1,600 $450
(1,050)a
Hotel awards ......................................................
1,050
300b
Concert discounts .............................................. (300)
Operating profits (b) ..........................................
$3,750 $1,900 $1,300 $450
a $1,050 = $1,300 retail value – $250 differential cost.
b $300 = $350 retail value – $50 differential cost.
c. Divide the operating profits in requirements a and b by division assets, which are given
in the problem. The following rankings result:
For (a):
Ticket services ...............................................
13.85% = ($450 ÷ $3,250)
Concerts .........................................................
9.97 = ($1,600 ÷ $16,050)
Bus .................................................................
9.42 = ($4,500 ÷ $47,750)
Lodging ..........................................................
4.42 = ($850 ÷ $19,250)
For (b):
Ticket services ...............................................
13.85% = ($450 ÷ $3,250)
Lodging ..........................................................
9.87 = ($1,900 ÷ $19,250)
Concerts .........................................................
8.10 = ($1,300 ÷ $16,050)
Bus .................................................................
7.85 = ($3,750 ÷ $47,750)
Lodging moves from last place in the rankings to second, while the bus and concerts each
drop in ranking. The transfer pricing method chosen does have an effect on the ROI-
based rankings.
(Of course, ROI comparisons between units of this firm are suspect, because each unit
operates in a different industry with different cost structures.)

15-45. (20 min.) Two-Part Transfer Prices: Mathes Corporation.
a.
Mathes should transfer at the Landfill's variable cost of receiving and processing the
material. Because the Landfill has excess capacity after satisfying all market demand that
exists for its services, accepting loads from plants does not cause it to forgo any "profits"
from outside businesses. If plants pay variable costs, the Landfill is indifferent between
accepting and rejecting the business. However, because there are substantial fixed costs
of running the Landfill, it is in the company's best interest to motivate maximum utilization
of the existing capacity. The plants will have the greatest motivation to use the internal
Landfill rather than outside parties when the "price" is set at variable cost.
The optimal transfer price is $40 per ton (= $60,000 ÷ 1,500 tons) plus $200 per load
(= $60,000 ÷ 300 loads). It is important to use a two-part transfer price. A single price of
$180 (= $270,000 ÷ 1,500 tons, for example) will provide no incentive to plant managers to
send full trucks to the landfill, thereby increasing the number of loads and the costs of
preparing the landfill.
b.
Based on budgeted Landfill Costs:
Other Variable Costs.......................................... $40 per ton  4 tons $160

Preparation Costs ..............................................$200 per load  1 load 200
Total Variable Costs of Landfill Operations ...... $360
15-46. (20 min.) Budget Versus Actual Costs: Mathes Corporation.
Although the actual variable costs are different from budget ($42 per ton and $180 per
load), the transfer price should be based on the budgeted costs. This gives the operator of
the landfill the incentive to keep costs low. Otherwise, any inefficiency is simply passed on
to the plants.

15-47. (20 min.) Two-Part Transfer Prices: CHS.
a.
This is a complicated problem, because of the requirement for a new server that would not
exist without the demands of Optics. (It is made less complicated by the fact that Health
Services leases the machine.) There is excess capacity on the machine, so the optimal
transfer-pricing rule is to use incremental cost. The incremental costs consist of two parts.
The additional cost of the lease and the additional cost of the support person do not
depend on the time used by Optics. This should be charged as a fixed fee. The other
incremental cost is the maintenance cost. But here, because maintenance is based on
hourly use, the incremental cost is not the $1 per hour charged for the maintenance. The
new server requires less use by Health Services for non-Optics business. Thus, there is a
fixed savings of $800 [(2,800 hours – 2,000 hours) x $ 1] that reduces the fixed fee from
the incremental lease cost. The variable cost that is incremental is the $1 in maintenance
cost.
Therefore, the optimal transfer price consists of two parts:
Fixed:
Incremental lease cost ............... ($5,000 – $3,200) $1,800
Incremental support cost ............ 20,000
$21,800
Less maintenance savings ......... 800
Total fixed fee ................................. $ 21,000
Variable cost .................................. (Maintenance) $1 per hour
b.
Fixed fee ............................................................ $21,000
Variable costs .....................................................
(1,000 hours x $1) 1,000
Total transfer costs ........................................... $22,000
Average hourly cost............................................
($22,000 ÷ 1,000 hours) $22.00 per hour

15-47. (continued)
c.
Fixed fee ............................................................ $21,000
Variable costs ....................................................
(100 hours x $1) 100
Total transfer costs .......................................... $21,100
Average hourly cost ...........................................
($21,100 ÷ 100 hours) $211.00 per hour
15-48. (20 min.) Two-Part Transfer Prices: CHS.
a.
This case is much simpler. The optimal transfer price is $30 per hour, the market price.
This provides the correct signal to both Health Services and Optics about the use of the
server.
b. $30 per hour.
c. $30 per hour.

Solutions to Integrative Cases
15-49. Custom Freight Systems (A): Transfer Pricing.
a. The Logistics division should accept the bid from Forwarders division. Custom Freight
Systems is $72 (= $185 – $113) better off if the Logistics division uses the Forwarders
division for this contract. See detail calculations below.
Option I: Purchase Internally
Air Cargo Forwarders Logistics

Division Division Division
Sales revenue ..................................... $155 $ 210 –0–
Variable Costs ....................................
($155 x 60%) ............................... 93
($175 – $155) ............................. 20
(From Forwarders Div.)................ 155
(Given) ........................................ $210
Operating Profit (Cost) ........................ $ 62 $ 35 $(210)
Total Company Cost ........................... $(113 )
Option II: Purchase externally (United Systems)

Total Company Cost = $(185)
b. If we assume it is optimal for the transfer to be made internally, then the question
arises as to the appropriate transfer price. The economic transfer pricing rule for
making transfers to maximize a company’s profits is to transfer at the differential outlay
cost to the selling division plus the opportunity cost to the company of making the
internal transfers.
Differential + Opportunity Cost of = Transfer
Outlay Cost Transferring Internally Price
If the seller (the division
supplying the goods or
services) has idle capacity .................. $175 + $ 0 = $175
If the seller has no idle capacity .......... $175 + $35 = $210
($210 selling price –
$175 variable cost)

15-49. (continued)
c. Espinosa has many alternatives to intervention or to forcing the manager of the

Forwarders division to lower his price below $210. Each has advantages and
disadvantages.
 Espinosa must trade off the benefits of intervention on this particular transaction
against the impact of intervention on decentralization as a policy. Too much
intervention by Espinosa will eliminate the benefits of decentralization.
 Tell the Logistics and Forwarders divisions that the transfer price will be between
differential cost ($113) and the lowest outside market price ($185) and allow them
to negotiate the profit.
 Espinosa could reorganize the company combining the divisions into one operating
company. However, Custom Freight Systems would lose all of the benefits of
decentralization.
 Espinosa could simply do nothing and let the managers maintain their autonomy.
This would not be in the best interests of Custom Freight Systems. However, it
might be better to suboptimize for this transaction and obtain more general benefits
from decentralizing.
d. The reward system at Custom Freight Systems creates an environment that
encourages managers to act in the best interests of their division rather than for the
corporation. Managers are rewarded on their return on assets and profits, which
discourages discounting to other divisions of Custom Freight Systems and ultimately
costs the corporation more.

15-50. (30 min.) Custom Freight Systems (B): Transfer Pricing.
Similar to Case A, the Logistics division should accept the bid from the Forwarders
division. However, if we eliminate the Forwarders Division from the bidding process, the
bid from World should be accepted. Emphasize that even though World’s bid is $10 per
hundred pounds higher than United’s, the overall cost to Custom Freight Systems is lower
because other divisions of Customer Freight Systems are included in the bid. See detailed
calculations below.
Option I: (from 15-49) Purchase internally

Sales revenue ..................................... $155 $210 –0–
Variable Costs ....................................
($155 x 60%) ............................... 93
($175 – $155) ............................. 20
(From Forwarders Div.)................ 155
(Given) ........................................ $210
Operating Profit/(Cost) ........................ $ 62 $ 35 $(210)
Total Company Cost ........................... $(113)
Option II: (from 15-49) Purchase externally (United Systems)

Total Company Cost = $(185)
Option III: Purchase Externally (World Systems)

Sales revenue ..................................... $155 –0– –0–
Variable Costs .................................... 93 $195
Operating Profit (Cost) ........................ $ 62 –0– $(195)
Total Company Cost ........................... $(133)

16
Fundamentals of Variance Analysis
Solutions to Review Questions
16-1.
For performance evaluation purposes, the costing format should identify the actual costs
for comparison with expected costs during the relevant period. Under absorption costing,
the manufacturing fixed costs are allocated on a per unit basis. An increase in production
results in a lower per unit cost. If all of the production is sold, all of the fixed cost will be
charged against profit. However, if some of the costs are assigned to inventory, the result
can be a deferral of costs that should be evaluated at this time. This problem is highlighted
by the suggestion that one can increase production in times of declining sales in order to
―help the bottom line by spreading fixed costs over more units.‖ Because variable costing
excludes fixed overhead for inventory valuation (fixed overhead is treated as a period
expense), there is no motivation to produce goods for inventory.
16-2.
The budget can be used as a benchmark against which to evaluate actual results. It can
be used in the same way that actual results of competitors or the actual results from
previous years can be used.
16-3.
False. Only variable costs and revenues ―flex‖ with changes in activity. Fixed costs are
expected to remain the same when operations are in the relevant range.
16-4.
(d) Appropriate for any level of activity.
16-5.
The standard cost sheet provides the quantities of each input required to produce a unit
output along with the budgeted unit prices for each input.
16-6.
(b) A master budget is based on a predicted level of activity, while a flexible budget is
based on the actual level of activity.
16-7.
False. A standard is related to a cost per unit. Budgets focus on totals.

16-8.
The three primary sources of variances are:
a. price variances, which arise because actual material prices differ from standards;
b. efficiency variances which occur when the relationship between the usage of input
factors (labor, materials, variable overhead) differs from that which would be expected
to produce a given level of output; and
c. activity variances, which represent differences between, planned (master budget)
output levels and the output levels actually attained during the period.
16-9.
The fixed cost variances differ from variable cost variances because fixed costs do not
vary with the level of production activity. Therefore, the fixed costs in the flexible budget
will be the same as in the master budget (within the relevant range). Additionally, there are
no efficiency variances for fixed costs because there is no input-output relationship that
can be applied.

Solutions to Critical Analysis and Discussion Questions
16-10.
Preparation of the ex-post budget allows management to compare actual results with the
budget that would have been instituted if certain ex-ante factors were known. The most
significant of these is, typically, volume of activity. By controlling for the difference
between ex-ante expectations and the ex-post volumes, comparisons between actual
results and plans can be more meaningful. The controllable factors (e.g., costs per unit,
efficiency, sales prices) can be isolated and evaluated.
16-11.
A flexible budget indicates budgeted revenues, costs and profits for virtually all feasible
levels of activity. Managers can use the flexible budget to determine what costs should be
assuming different levels of activity. Because changes in volume of production might not
be within the particular manager’s control, the flexible budget allows supervisory
managers to isolate the effect of changes in volume on the overall costs of a department
in question. The flexible budget also separates fixed and variable costs. Generally, fixed
costs are less controllable in the short run than variable costs.
16-12.
Selling more units of a product or service (assuming the price is not changed) might be
―good‖ news. Having managers offer significant incentives (or, in the extreme, offering to
buy back unused product) might be an example of ―bad‖ news, because these incentives
might result in lower profits.
16-13.
Answers will vary. A common theme might be that the organization used resources that
were not as productive and, as a result, organizational results suffer. The reason might be
the quality of the input (coffee, food, and so on) or the talent of the input (in the case of an
entertainment business or a sports team). This is why it is important to look at variance
analyses in total and not just the individual elements.
16-14.
The action that management can take in response to price variances is probably quite
different than the action that can be taken in response to efficiency variances. The latter is
generally more subject to management control. Also, different departments might be
responsible for each variance. For example, purchasing might be responsible for the
materials price variance and production for the materials efficiency variance.

16-15.
This problem arises more frequently than one would hope. Because costs are
accumulated in responsibility centers usually according to where the cost is incurred, it is
quite likely that the production department will be charged with a cost that originated by
the action of some other (e.g., sales) department. In accepting the rush order, the sales
department would either have raised the selling price to compensate for the special
delivery or undertaken the rush order to avoid losing a sale. The extra costs incurred in
other departments as a direct result of the sales department's action should be chargeable
back to the sales department.
16-16.
Typically, the labor price variances are relatively small since the rates are usually
determined in advance through the union negotiation process. However, if a line manager
uses workers that are more skilled (and thus higher paid) than the labor that was
considered when preparing the budget, an unfavorable price variance would arise that
would be the responsibility of the line manager. Presumably, the manager would do this
only when the manager expected efficiency improvements at least equal to the
unfavorable price variance. If overtime premiums are not accounted for separately, then
unbudgeted overtime premiums could be the cause of price variances.
16-17.
False. The production volume variance arises because fixed overhead is applied over a
greater or lesser number of units than were used in deriving the fixed overhead application
rate. Hence, the production volume variance does not tell us whether we spent more or
less, but rather only that we produced more or less than expected.
16-18.
It is necessary to investigate the reasons why volume fell short of expectations. If
marketing was unable to sell the production then the marketing manager might be held
responsible. However, if production were operating inefficiently and, hence, not producing
at the level which marketing could handle then the matter could be turned around and
production should be held responsible for the shortfall. The point of the question is that
variances in one department (e.g., production) might arise due to activities in other
departments. While this occurs infrequently, it is worthy of investigation if managers
continue to argue that their performance is adversely affected by other’s actions.

16-19.
There are two reasons why this view is not a good one. First, the fact that the division is
routinely delivering profits greater than expected suggests the budgeting process should
be reviewed to ensure the budget is reasonable. If the budgeting process seems to be
working, it is still worthwhile reviewing the results, because the firm might be able to learn
from what the manager is doing.
A second, more important, reason to review the operations is that any variance suggests
something is unexpected. The variance might be favorable due to good decisions by the
manager, chance, or, of more concern, actions by the manager to make the results look
better. It is not uncommon for fraudulent behavior to be masked for several periods,
because the manager involved reports good results and his or her superior, who might
also indirectly benefit from positive performance reviews, does not want to disturb things.
16-20.
Disagree. Variances are based on the difference between actual and budgeted results.
The budget does not have to be based on the same unit inputs (or unit prices) for all
output levels. If there is a more complicated (nonlinear) relation between inputs and
outputs, the budget can reflect that. For example, if a firm is experiencing important
learning economies, it can use learning curves (see Appendix B of Chapter 5) to use in
budgeting its labor inputs.

Solutions to Exercises
16-21. (20 min.) Flexible Budgeting: Western Company.

Calculations: Master budget dollar amount
Sales revenue ....................................................
225,000 units x $9.00 per unit = $2,025,000
Variable costs .....................................................
225,000 units x $3.75 per unit = $843,750
Fixed costs ......................................................... $ 225,000
Western Company
Flexible Budget
Sales revenue ....................................................
$2,070,000 (= $9.00 x 230,000)
Less:
Variable manufacturing costs .........................
862,500 (= $3.75 x 230,000)
Contribution margin ...........................................
$1,207,500
Less:
Fixed manufacturing costs .............................
225,000
Operating profits ................................................
$982,500
16-22. (30 min.) Sales Activity Variance: Western Company.

Master Budget
Flexible Budget Sales (based on
(based on actual Activity budgeted
of 230,000 units) Variance 225,000 units)
Sales revenue ....................................................
$2,070,000 $45,000 F $2,025,000
Less:
Variable manufacturing costs ......................... 862,500 18,750 U 843,750
$1,207,500 $26,250 F $1,181,250
Less:
Fixed costs .....................................................
225,000 ______ 225,000
$982,500 $26,250 F $ 956,250

16-23. (30 min.) Profit Variance Analysis: Western Company
Actual
(230,000 Manufacturing Sales Price Flexible Budget Activity Master Budget
Units) Variances Variance (230,000 Units) Variance (225,000 Units)
a
Sales revenue....................................................
$2,093,000 $23,000 F $2,070,000b $45,000 F $2,025,000c
Less:
1,035,000d
Variable manufacturing costs .......................... $172,500 U _______ 862,500e 18,750 U 843,750f
1,058,000 172,500 U $23,000 F $1,207,500 26,250 F 1,181,250
Less:
Fixed manufacturing costs...............................
225,000 ________ _______ 225,000 _______ 225,000
$ 833,000 $172,500 U $23,000 F $982,500 $26,250 F $ 956,250
Total Variance from Flexible Budget
$149,500 U (= $833,000 – $982,500)
Total Variance from Master Budget

$123,250 U (= $833,000 – $956,250)
a 230,000 units x $9.10
b 230,000 units x $9.00
c 225,000 units x $9.00
d 230,000 units x $4.50
e 230,000 units x $3.75
f 225,000 units x $3.75

16-24. (20 min.) Flexible Budget.
a. $40,000
b. $8 per unit VC = (TC – FC) ÷ X

= ($120,000 – $40,000) ÷ 10,000 units
c. $104,000 TC = F + VX
= $40,000 + ($8 x 8,000 units)
d. $168,000 TC = F + VX
= $40,000 + ($8 x 16,000 units)

16-25. (25 min.) Fill In Amounts On Flexible Budget Graph.
Computations:
(a) Profit = (P – V)X – FC
$32,000 = (P – V)(2,000 units) – $200,000
$232,000
(P – V) = = $116 per unit
2,000 units
(b) $90,000 = $116 X – $200,000

$116X = $90,000 + $200,000
$290,000
X= = 2,500 units
$116

16-26. (25 min.) Flexible Budget.
Computations:
(a) Profit = (P – V)X – FC
$(6,000) = $4X – $70,000
$4X = ($6,000) + $70,000
$64,000
X= = 16,000 units
$4
(b) $36,000 = $4X – $70,000

$4X = $36,000 + $70,000
$106,000
X= = 26,500 units
$4

16-27. (35 min.) Prepare Flexible Budget: Osage, Inc.
Flexible
Budget
(based on
actual of Calculations
450,000 units) (000 omitted for units)
Sales revenue ....................................................$4,500,000 $4,800,000 x (450 ÷ 480)
Variable costs:
Materials .........................................................1,350,000 1,440,000 x (450 ÷ 480)
Direct labor ..................................................... 315,000 336,000 x (450 ÷ 480)
Variable overhead .......................................... 585,000 624,000 x (450 ÷ 480)
Variable marketing and administrative ............ 450,000 480,000 x (450 ÷ 480)
Total variable costs ............................................ $2,700,000
Contribution margin ............................................ $1,800,000
Fixed costs:
Manufacturing overhead ................................. $ 960,000
Marketing ........................................................ 288,000
Administrative ................................................. 180,000
Total fixed costs .................................................
$1,428,000
Operating profits................................................. $ 372,000

16-28. (45 min.) Sales Activity Variance: Osage, Inc.
Flexible Master
Budget Budget
(based on (based on
actual of Sales Activity budgeted
450,000 Variance 480,000
units) units)
Sales revenue ....................................................
$4,500,000 $300,000 U $4,800,000
Variable costs:
Materials ........................................................
1,350,000 90,000 F 1,440,000
Direct labor .....................................................
315,000 21,000 F 336,000
Variable overhead .......................................... 585,000 39,000 F 624,000
Variable marketing and administrative ........... 450,000 30,000 F 480,000
Total variable costs ............................................
$2,700,000 $180,000 F $2,880,000
$1,800,000 $120,000 U $1,920,000
Fixed costs:
Manufacturing overhead ................................ $ 960,000 — $ 960,000
Marketing .......................................................
288,000 — 288,000
Administrative................................................. 180,000 — 180,000
$1,428,000 — $1,428,000
$ 372,000 $120,000 U $ 492,000

16-29. (30 min.) Profit Variance Analysis: Osage, Inc.
Flexible Master
Actual Marketing and Budget Budget
(based on Administrative (based on Sales (based on
450,000 Manufacturing Variances Sales Price 450,000 Activity 480,000
units) Variances Variance units) Variance units)
Sales revenue ....................................................
$4,968,000 $468,000 F $4,500,000 $300,000 U $4,800,000
Materials ............................................................
1,440,000 $90,000 U 1,350,000 90,000 F 1,440,000
Direct labor .........................................................
276,000 39,000 F 315,000 21,000 F 336,000
Variable overhead ..............................................
674,400 89,400 U 585,000 39,000 F 624,000
Variable marketing and
administrative .................................................
468,000 $18,000 U 450,000 30,0000 F 480,000
$2,858,400 $140,400 U $18,000 U $2,700,000 $180,000 F $2,880,000
Contribution margin ............................................
$2,109,600 $140,400 U $18,000 U $468,000 F $1,800,000 $120,000 U 1,920,000
Fixed costs:
Manufacturing 988,800 28,800 U $ 960,000 $ 960,000
Overhead ...........................................................
Marketing ........................................................
288,000 –0– 288,000 288,000
Administrative .................................................
204,000 24,000 U 180,000 180,000
$1,480,800 $28,800 U $24,000 U –0– $1,428,000 –0– $1,428,000
$ 628,800 $169,200 U $42,000 U $468,000 F $ 372,000 $120,000 U $ 492,000

16-30. (20 min.) Sales Activity Variance: Slacker & Sons.
a. 157,500 actual units sold.

Flexible budget revenue = $2,500,000 + $125,000 = $2,625,000, which is a 5%
increase. Note that as a budgeted amount, the sales price is the same between the
master budget and the flexible budget.
Therefore, actual sales units = 150,000 x 1.05 = 157,500.
b. Flexible Budget.
Flexible Master Budget
Budget (based on
(based on 150,000 units
157,500 units Sales Activity budgeted
actual sales) Variance sales)
Sales revenue ....................................................

$2,625,000 (a) $125,000 F $2,500,000
Variable costs:
Materials ........................................................
892,500 (a) 42,500 U 850,000
Direct labor .....................................................
656,250 (a) 31,250 U 625,000
Variable manufacturing and admin................. 131,250 (a) 6,250 U 125,000
$1,680,000 $ 80,000 U $1,600,000
Contribution margin ........................................... $945,000 $45,000 F $900,000
Fixed costs:
Manufacturing overhead and admin ............... $ 300,000 (b) — $ 300,000
$ 300,000 — $ 300,000
$ 645,000 $45,000 F $ 600,000
Notes:
a. 5% greater than master budget.
b. No change, because these are fixed costs.

16-31. (20 min.) Sales Activity Variance: Rio Vista Company.
a. 15,000 units budgeted sales.
Master budget variable overhead = $20,500 + $4,500 = $25,000. (Because the variance is
favorable, the actual variable overhead was less than the master budget variable
overhead.) Therefore, actual production was 18% (=$4,500 ÷ $25,000) below master
budget production.
Budgeted units = 12,300 = 15,000 x 0.82.
Flexible Master Budget

Budget (based on 15,000
(based on units budgeted
12,300 units Sales Activity sales)
actual sales) Variance
Sales revenue ....................................................
$116,850 $25,650 U $142,500 (a)
Variable costs:
Materials .........................................................40,180 8,820 F 49,000 (a)
Direct labor .....................................................30,750 6,750 F 37,500 (a)
Variable overhead ..........................................20,500 4,500 F 25,000 (a)
Total variable costs ............................................$ 91,430 $20,070 F $111,500
Contribution margin ............................................ $ 25,420 $5,580 U $31,000
Fixed costs:
Manufacturing and administrative ................... $ 17,000 — $ 17,000 (b)
$ 17,000 — $17,000
Operating profits.................................................
$ 8,420 $5,580 U $ 14,000
Notes:
a. Equal to flexible budget amounts multiplied by (15,000 ÷ 12,300).
b. No change, because these are fixed costs.

16-32. (15 min.) Assigning Responsibility: Wallace Manufacturing.
Answers will vary. This situation is a normal part of a production department’s business
and would probably be charged to the production department. In the future, it would be
beneficial for the production department to be able to rely on the purchasing department’s
work with reasonable assurance. The purchasing department should be charged for the
rework if the mistake was due to negligence on the part of the purchasing department to
give them incentives to do the job right.
16-33. (15 min.) Assigning Responsibility: Davidson Communications.

It appears that the Building 404 manager acted against the best interests of the company
by refusing to shut down production temporarily. This refusal cost the company $75,000
and much time and effort including the opportunity cost of lost profits due to returns and
warranty repair costs. However, management is also to blame for giving the Building 404
manager the wrong incentives. Hopefully this incident will not happen again and
production managers will be given proper incentives to cooperate, so the $75,000 could
be written off as an abnormal expense for the period.
16-34. (10 min.) Variable Cost Variances.
Flexible Budget
Actual Inputs
Actual Price Efficiency (Standard Inputs
at Standard
Costs Variance Variance Allowed for Good
Price
Output)
$14 x 9,600 $14 x 1.5 x 5,600

$136,500
= $134,400 = $117,600
$2,100 U $16,800 U

16-35. (20 min.) Variable Cost Variances: Vickers Corporation.
Direct labor:
Flexible Budget
Actual Inputs (Standard
Actual Price Efficiency
at Standard Inputs Allowed
Costs Variance Variance
Price for Good
Output)
a
$655,200 + 23,400 $18 x 36,500
$655,200
= $678,600 = $657,000
$23,400 F $21,600 U
Variable overhead:
$4.20 x 37,700 $4.20 x 36,500

$157,120
= $158,340 = $153,300
$1,220 F $5,040 U
aStandard labor wage rate
= (Actual Direct Labor + Direct Labor Price Variance) ÷ Actual hours worked
= ($655,200 + $23,400) ÷ 37,700 hrs. = $18

16-36. (20 min.) Variable Cost Variances: Norton, Inc..
Direct labor:
Flexible Budget
Price for Good
Output)
a
a $30 x 1.2 x
$30 x 73,600
$2,370,000 60,000
= $2,208,000
= $2,160,000
$162,000 U $48,000 U
Variable overhead:
$45 x 1.2 x
$45 x 73,600
$3,072,000 60,000
= $3,312,000
= $3,240,000
$240,000 F $72,000 U
aStandard labor wage rate
= [(Direct labor efficiency variance) ÷ Variable overhead efficiency variance)] x $45.

= [$48,000 ÷ $72,000] x $45 = $30

16-37. (15 min.) Variable Cost Variances: Bowgie Chemicals.
a.
Flexible Budget
Price for Good
Output)
$4.20 x 30,000
$131,400 $119,700
= $126,000
$5,400 U $6,300 U
Report to management:
The total variance from the flexible budget is $11,700 unfavorable. This variance was
caused by higher than expected prices ($5,400) and the use of more units than
expected ($6,300).
b.
Work-in-Process Inventory .................................

119,700
Materials Price Variance ....................................
5,400
Materials Efficiency Variance .............................
6,300
Accounts Payable .............................. 131,400
To record the purchase and use of 30,000 units of
materials at an actual cost of $131,400 and the transfer to
work in process at a standard cost of $4.20 per unit.

16-38. (20 min.) Variable Cost Variances: Grand Corporation. (Appendix used in
Part b.)
a.
Flexible Budget
Price for Good
Output)
$22.50 x 19,200 $22.50 x 17,600

$425,000
= $432,000 = $396,000
$7,000 F $36,000 U
b.
Work-in-Process Inventory .................................

396,000
Materials Efficiency Variance .............................
36,000
Materials Price Variance ............................ 7,000
Accounts Payable ....................................... 425,000
To record the purchase and use of 19,200gallons of
chemical Y at an actual cost of $425,000 and the transfer
to work in process at a standard cost of $22.50 per gallon.

16-39. (20 min.) Fixed Cost Variances: Carney Co.
Production
Actual Price
Budget Volume Applied
Costs Variance
Variance
$385,500 $369,000 $360,000
$16,500 U $9,000 U
$25,500 U
16-40. (15 min.) Graphical Presentation: Carney Co.

16-41. (20 min.) Fixed Cost Variances: Lihue, Inc.
a.
Production
Actual Price
Costs Variance
Variance
$2.20 x 345,000
$760,000 $770,000
= $759,000
$10,000 F $11,000 U
$1,000 U
b. 350,000 units.
Budgeted production is 5,000 units (= $11,000 ÷ $2.20) greater than actual production. (It
is more than actual production, because the production volume variance is unfavorable.)
Therefore, budgeted production volume is 350,000 units (= 345,000 + 5,000).

16-42. (20 min.) Fixed Cost Variances: Mint Company.
Production
Actual Price
Costs Variance
Variance
a b
c $1.50 x 403,000 $1.50 x 400,000
$589,500
$604,500 = $600,000
$15,000 F $4,500 U
$10,500 F
a. Budgeted volume = $604,500 ÷ $1.50 per unit = 403,000 units.
b. Overhead applied = Budgeted overhead – Production volume variance

= $604,500 – $4,500 = $600,000.
Actual volume = $600,000 ÷ $1.50 per unit = 400,000 units.
c. Actual fixed overhead = Budgeted overhead + Overhead price variance

= $604,500 – $15,000 = $589,500

16-43. (45 min.) Comprehensive Cost Variance Analysis: Maple Leaf Production.
a. Variable cost:
Direct materials:
Flexible Budget
Actual Inputs
at Standard
Price
Output)
(AP x AQ) (SP x AQ) (SP x SQ)
$1.80 x 384,000 $2.00 x 384,000 $2 x 4 lbs x 92,000

= $691,200 = $768,000 = $736,000
$76,800 F $32,000 U
Direct labor:
$18.00 x 0.4 hrs x

$18.40 x 35,200 $18.00 x 35,200
92,000
= $647,680 = $633,600
= $662,400
$14,080 U $28,800 F
Variable overhead:
$10 x 17,280 $10 x 0.18 hrs x 92,000

$176,256
= $172,800 = $165,600
$3,456 U $7,200 U

16-43. (continued)
b. Fixed overhead variances:
Production
Actual Price
Costs Variance
Variance
$15 x 92,000
$1,360,000 $1,350,000
= $1,380,000
$10,000 U $30,000 F
$20,000 F

16-43. (continued)
c.
Record Costs
Direct materials:
Work-in-Process Inventory................................. 736,000
Materials Efficiency Variance ............................. 32,000
Materials Price Variance ................. 76,800
Accounts Payable ........................... 691,200
Direct labor:
Work-in-Process Inventory................................. 662,400
Direct Labor Price Variance ............................... 14,080
Direct Labor Efficiency Variance ....... 28,800
Wages Payable ................................ 647,680
Variable overhead:
Work-in-Process Inventory ................................ 165,600

Variable Overhead Applied ............ 165,600
Variable Overhead (Actual) ............................... 176,256

Miscellaneous Payables and Inventory
Accounts ............................................... 176,256
Variable Overhead (Applied) ............................. 165,600

Variable Overhead Price Variance .................... 3,456
Variable Overhead Efficiency Variance ............. 7,200
Variable Overhead (Actual)....... 176,256
Fixed overhead:
Work-in-Process Inventory ................................ 1,380,000

Fixed Overhead Applied ................. 1,380,000
Fixed Overhead (Actual).................................... 1,360,000

Miscellaneous Payables and Inventory
Accounts ................................................. 1,360,000
Fixed Overhead (Applied) .................................. 1,380,000

Fixed Overhead Price Variance ......................... 10,000
Fixed Overhead Production
Volume Variance ............... 30,000
Fixed Overhead (Actual) ................ 1,360,000

16-43. (continued)
Transfer to Finished Goods
Finished Goods Inventory .......................................... 2,944,000

Work-in-Process Inventory ............................ 2,944,000
Record the sale of 92,000 tires at $40.
Accounts Receivable .................................................. 3,680,000

Sales Revenue ................................................. 3,680,000
Cost of Goods Sold ..................................................... 2,944,000
Finished Goods Inventory ................................ 2,944,000
Record the disposition of variances.
Materials Price Variance .................................................. 76,800

Direct Labor Efficiency Variance ...................................... 28,800
Fixed Overhead Production Volume Variance ................. 30,000
Materials Efficiency Variance............................ 32,000
Direct Labor Price Variance .............................. 14,080
Variable Overhead Price Variance ................... 3,456
Variable Overhead Efficiency Variance ............ 7,200
Fixed Overhead Price Variance ........................ 10,000
Cost of Goods Sold .......................................... 68,864
To close the variance accounts to Cost of Goods Sold.
Total cost of goods sold is $2,875,136 (= $2,944,000 – $68,864). Total actual costs are
$2,875,136 (= $691,200 + 647,680 + 176,256 + $1,360,000).

16-44. (30 min.) Comprehensive Cost Variance Analysis: NSF Lube.
a. Variable cost variances:
Oil specialist:
Flexible Budget
Actual Inputs
at Standard
Price
Output)
a b
$26 x 95,040 $24 x 95,040 hrs $24 x 79,200
= $2,471,040 = $2,280,960 = $1,900,800
$190,080 U $380,160 U
Variable overhead:
$15 x 0.14 hrs $16 x 0.14 hrs c
$16 x 59,400 hours
x 475,200 x 475,200
= $950,400
= $997,920 = $1,064,448
$66,528 F $114,048 U
a 95,040 = 0.20 hours x 475,200 changes.

b 79,200 = 1/6 hour x 475,200 changes.
c 59,400 = 0.125 hour x 475,200 changes.

16-44. (continued)
b. Fixed overhead variances:
Production
Actual Price
Costs Variance
Variance
$2.40 x 475,200
$1,200,000 $1,036,000
= $1,140,480
$164,000 U $104,480 F
$59,520 U

16-45. (20 min.) Overhead Variances: Brice Corporation.
Variable overhead:
Flexible Budget
Actual Inputs
at Standard
Price Output)
$30 x 26,100 $30 x 25,200

$774,000
= $783,000 = $756,000
$9,000 F $27,000 U
Fixed overhead:
Actual Price
Budget
Costs Variance
$276,000 $280,800
$4,800 F

Solutions to Problems
16-46. (30 min.) Solve for Master Budget Given Actual Results: Gibson
Corporation.
a.
Master Budget Computations
Sales volume .....................................................
108,000 units
Sales revenue ....................................................

$540,000 108,000 units x $5
Variable costs:
Manufacturing ................................................
106,000 $540,000 – $54,000 – $380,000
Marketing and administrative .........................
54,000 10% x $540,000
$ 380,000 (given)
Fixed costs:
Manufacturing ................................................
216,000 $2 x 108,000 units
Marketing and administrative .........................
56,000 $380,000 – $216,000 – $108,000
Operating profit ..................................................
$ 108,000 $1 x 108,000 units

16-46. (continued)
b.
Marketing Flexible Master
Actual Manu- and Adminis- Sales Price Budget Sales Activity Budget
(120,000 facturing trative Variance (120,000 Variance (108,000
Units) Variances Variances Units) Units)
Sales revenue ....................................................
$672,000 $72,000 F $600,000a $60,000 F $540,000
Variable costs:
Manufacturing ..................................................
147,200 $29,422 U 117,778d 11,778 U 106,000
Marketing and admin. ......................................
61,400 _______ $ 1,400 U ______ 60,000c 6,000 U 54,000
$463,400 $29,422 U $ 1,400 U $72,000 F $422,222b $42,222 F $380,000
Fixed costs:
Manufacturing .................................................
205,000 11,000 F 216,000 — 216,000e
Marketing and admin. .....................................
113,200 _______ 57,200 U ______ 56,000 — 56,000g
$145,200 $18,422 U $58,600 U $72,000 F $150,222 $42,222 F $108,000f
a 120,000 units x $5
b $380,000
x 120,000 units
108,000 units
c 10% x $600,000
d Solved after determining flexible budget sales revenue, contribution margin, and variable marketing and administrative.
Also, $117,778 = $106,000 x (120,000 units ÷ 108,000 units).
e $2 x 108,000.
f $1 x 108,000.
g $380,000 – $216,000 – $108,000.

16-47. (30 min.) Find missing data for profit variance analysis.
Reported
Income Marketing Flexible Master
Statementl Manu- & Adminis- Sales Budget Sales Budget
(2,250 facturing trative Price (2,250a Activity (2,400
Units) Variance Variance Variance Units) Variance Units)
Sales revenue ....................................................
$117,000 $4,500 Ub $121,500 $8,100 Uc $129,600d
Variable manufacturing costs ............................. 30,600e $3,600 F 34,200f 2,280 F 36,480g
Variable marketing and administrative ............... 12,000h $1,500 Fi 13,500j 900 Fk 14,400
$74,400 l m
$3,600 F $1,500 F $4,500 U n o
$73,800 $4,920 U p $78,720q
Note: See computations on next page.

16-47. (continued)
(a) 2,250 units from actual column.
(b) $4,500 U = $121,500 – $117,000.
(c), (d) Budgeted sales price per unit = $121,500 ÷ 2,250 units = $54.
Master budget = $54 x 2,400 units = $129,600 (d).
Activity variance = $129,600 – $121,500 = $8,100 U (c).
(e), (f), (g) Budgeted variable manufacturing cost per unit = $2,280 ÷ (2,400 – 2,250 units)
= $15.20.
Flexible budget variable manufacturing costs = $15.20 x 2,250 units = $34,200 (f)
[= ($2,280 ÷ $8,100) x $121,500].
Master budget variable manufacturing costs = $15.20 x 2,400 units = $36,480 (g)
[= ($2,280 ÷ $8,100) x $129,600].
Actual variable manufacturing costs = $34,200 – $3,600 = $30,600 (e).
(h) Variable marketing and administrative costs = $117,000 – $30,600 – $74,400 =
$12,000.
(i), (j), (k) Budgeted variable marketing and administrative costs per unit = $14,400 ÷
2,400 units = $6.00.
Flexible budget marketing and administrative costs = $6.00 x 2,250 units = $13,500 (j).
Variable marketing and admin. costs that are part of the activity variance = $6.00 x 150
units = $900 F (k) = $14,400 – $13,500.
Marketing and administrative cost variance = $13,500 – $12,000 = $1,500 F (i).
(l), (m), (n), (o), (p), and (q) are column totals.

16-48. (40 min.) Find Data for Profit Variance Analysis.
Flexible Master
Budget Budget
Reported (based (based on
(based on Manufac- Marketing and Sales on actual Sales budgeted
actual sales turing Administrative Price sales Activity sales
volume) Variance Variance Variance volume) Variance volume)
24,000 a
Units ................................................................... 24,000 b 4,000 F 20,000
$39,600 g
Sales revenue .................................................... $3,600 F $36,000 h $6,000 F i $30,000
Less:
Variable
21,000 n $1,800 U o
manufacturing costs ...................................... 19,200 3,200 U j 16,000
Variable marketing
and
p c
administrative costs .....................................
4,320 $480 F 4,800 800 U 4,000
$14,280 q
$1,800 U $480 F s $3,600 F x $12,000 $2,000 F k $10,000
Less:
Fixed manufacturing
4,600 r
costs .............................................................
400 F 5,000 m 5,000 d
Fixed marketing and
administrative costs ......................................
3,600 600 U v 3,000 3,000 e
$ 6,080 t 1,400 U u
Operating profits................................................. $120 U w $3,600 F $ 4,000 $2,000 F l $ 2,000 f
Note: See computations on next page.

16-48. (continued)
Computations:
a. 24,000 units. see b.
b. 24,000 units. 20,000 units* + 4,000 F units.
c. $4,000 $30,000* – $16,000* – $10,000*.
d. $5,000 Same as m.
e. $3,000 Fixed costs in master budget are the same as the fixed costs in the
flexible budget.
f. $2,000 $10,000* – $5,000 (d) – $3,000 (e).
g. $39,600 $36,000 (h) + $3,600*.
h. $36,000 24,000 units (b) x ($30,000* ÷ 20,000 units*).
Alternative computation:
$19,200* + $4,800* + $12,000*.
i. $6,000 F $36,000 (h) – $30,000*.
4,000 F units* x $1.50 selling price (= $30,000 ÷ 20,000 units).
j. $3,200 U $19,200* – $16,000*.
k. $2,000 F $12,000* – $10,000*.
$6,000 F (i) – $3,200 U (j) – $800 U*.
l. $2,000 F Same as k.
m. $5,000 $12,000* – $3,000* – $4,000*.
n. $21,000 $19,200* + $1,800 (o).
o. $1,800 U Total manufacturing variance on the contribution margin line.
p. $480 F $4,800* – $4,320*.
q. $14,280 $39,600 (g) – $21,000 (n) – $4,320*.
r. $4,600 $5,000 (m) – $400 F*.
s. $480 F Same as p.
t. $6,080 $14,280 (q) – $4,600 (r) – $3,600*.
u. $1,400 U $1,800 U* – $400 F*.
v. $600 U $3,600* – $3,000*.
w. $120 U $480 F (s) – $600 U (v).
x. $3,600 F Sales price variance.
*Given

16-49. (20 min.) Ethical Issues In Managing Reported Profits: Doak Industries.
Ray is trying to improve the profit on next year’s income statement. He knows that a
revised budget to reflect changes in product lines might make it harder to get a bonus next
year. Since he has reached a plateau on this year’s bonus, anything he can do to increase
next year’s profit will help him get a bonus next year. This is an unethical practice. Ray
must perform his professional duties with competence. He must prepare reports in
accordance with technical standards and generally accepted accounting principles.
Revenues and expenses must be matched to the correct period to which they belong.
Ray faces a conflict of interest between communicating information fairly and objectively
and achieving high bonuses. He should meet with his superiors, point out the conflict, and
try to change the incentive system. If this is not possible, he should communicate his
performance truthfully.

16-50. (20 min.) Prepare Flexible Budget: Odessa, Inc.
Flexible
Budgeta Calculations
Sales revenue ....................................................
$86,400 $96,000 x (540 ÷ 600)
Variable costs:
Manufacturing costs
Direct labor ..................................................
12,960 14,400 x (540 ÷ 600)
Materials......................................................
12,096 13,440 x (540 ÷ 600)
Variable overhead .......................................
8,640 9,600 x (540 ÷ 600)
Marketing .........................................................
5,184 5,760 x (540 ÷ 600)
Administrative ..................................................
4,320 4,800 x (540 ÷ 600)
$43,200
$43,200
Less fixed costs: ...............................................
Manufacturing ..............................................
4,800
Marketing .....................................................
9,600
Administrative...............................................
9,600
$24,000
$19,200
a Sales revenue and the variable costs are 90 percent (540 units ÷ 600 units x 100%) of
the master budget amounts.

16-51. (20 min.) Sales Activity Variance: Odessa, Inc.
Flexible
Budget Master Budget
(based on (based on
actual of Sales Activity budgeted 600
540 units) Variance units)
Sales revenue ....................................................

$86,400 $9,600 U $96,000
Less variable costs:
Manufacturing costs:
Direct labor ....................................................
12,960 1,440 F 14,400
Materials ........................................................
12,096 1,344 F 13,440
Variable overhead ..........................................
8,640 960 F 9,600
Marketing .........................................................
5,184 576 F 5,760
Administrative ..................................................
4,320 480 F 4,800
$43,200 $ 4,800 F $48,000
$43,200 $ 4,800 U $48,000
Less fixed costs:
Manufacturing ................................................
4,800 -0- 4,800
Marketing .......................................................
9,600 -0- 9,600
Administrative ................................................
9,600 -0- 9,600
$24,000 -0- $24,000
Operating profits.................................................
$19,200 $4,800 U $24,000

16-52. (30 min.) Profit Variance Analysis: Odessa, Inc.
Manu- Marketing & Flexible Sales Master

Actual facturing Administrative Sales Price Budget Activity Budget
(360 Units) Variance Variance Variance (360 Units) Variance (400 Units)
Sales revenue ....................................................

$88,320 $1,920 F $86,400 $9,600 U $96,000
Variable costs:
Manufacturing
Direct labor..................................................
13,632 $672 U 12,960 1,440 F 14,400
Materials .....................................................
11,520 576 F 12,096 1,344 F 13,440
Overhead ....................................................
7,872 768 F 8,640 960 F 9,600
Marketing ........................................................
5,088 $96 F 5,184 576 F 5,760
Administrative .................................................
4,800 480 U 4,320 480 F 4,800
$45,408 $672 F $384 U $1,920 F $43,200 $4,800 U $48,000
Fixed costs:
Manufacturing .................................................
4,665 135 F 4,800 — 4,800
Marketing ........................................................
9,984 384 U 9,600 — 9,600
Administrative .................................................
9,561 39 F 9,600 — 9,600
$21,198 $807 F $729 U $1,920 F $19,200 $4,800 U $24,000

16-53. (20 min.) Prepare Flexible Budget: Brahms & Sons.
Flexible Budgeta Calculations

Sales revenue ....................................................
$504,000 $480,000 x (58,800 ÷ 56,000)
Variable costs:
Manufacturing costs
Direct materials ............................................
50,400 48,000 x (58,800 ÷ 56,000)
Direct Labor ............................................
67,200 64,000 x (58,800 ÷ 56,000)
Variable overhead........................................
67,200 64,000 x (58,800 ÷ 56,000)
Marketing .........................................................
21,000 20,000 x (58,800 ÷ 56,000)
Administration ..................................................
21,000 20,000 x (58,800 ÷ 56,000)
$226,800
$277,200
Less fixed costs: ................................................
Manufacturing ...............................................
100,000
Marketing ......................................................
20,000
Administration ................................................
80,000
$200,000
$77,200
a Sales revenue and the variable costs are 105 percent (58,800 units ÷ 56,000 units x
100%) of the master budget amounts.

16-54. (20 min.) Sales Activity Variance: Brahms & Sons.
Flexible
Budget Master Budget
(based on (based on
actual of Sales Activity budgeted
58,800 units) Variance 56,000 units)
Sales revenue ....................................................

$504,000 $24,000 F $480,000
Less variable costs:
Manufacturing costs:
Direct labor ....................................................
50,400 2,400 U 48,000
Materials ........................................................
67,200 3,200 U 64,000
Variable overhead .........................................
67,200 3,200 U 64,000
Marketing .........................................................
21,000 1,000 U 20,000
Administration ..................................................
21,000 1,000 U 20,000
$226,800 $10,800 U $216,000
$277,200 $ 13,200 F $264,000
Less fixed costs:
Manufacturing................................................
100,000 -0- 100,000
Marketing.......................................................
20,000 -0- 20,000
Administration................................................
80,000 -0- 80,000
$200,000 -0- $200,000
$77,200 $13,200 F $64,000

16-55. (30 min.) Profit variance analysis: Brahms & Sons.
Manu- Marketing & Flexible Sales Master

Actual facturing Administration Sales Price Budget Activity Budget
(58,800 Units) Variance Variance Variance (58,800 Variance (56,000
Units) Units)
Sales revenue ....................................................

$462,000 $42,000 U $504,000 $24,000 F $480,000
Variable costs:
Manufacturing
Direct labor ..................................................
58,800 $ 8,400 U 50,400 2,400 U 48,000
Materials .....................................................
54,600 12,600 F 67,200 3,200 U 64,000
Overhead ....................................................
63,400 3,800 F 67,200 3,200 U 64,000
Marketing ........................................................
20,400 $600 F 21,000 1,000 U 20,000
Administration .................................................
18,800 2,200 F 21,000 1,000 U 20,000
$246,000 $8,000 F $2,800 F $42,000 U $277,200 $13,200 F $264,000
Fixed costs:
Manufacturing .................................................
102,400 2,400 U 100,000 — 100,000
Marketing ........................................................
22,800 2,800 U 20,000 — 20,000
Administration .................................................
81,200 1,200 U 80,000 — 80,000
$39,600 $5,600 F $1,200 U $42,000 U $77,200 $13,200 F $64,000

16-56. (15 min.) Direct Materials.
Actual Inputs
Actual Price
at Standard
Costs Variance
Price
$16 x 2,250
AP x 2,250
= $36,000
$14,400 F
2,250 x AP = $36,000 – $14,400

AP = $9.60

16-57. (20 min.) Solve for Direct Labor Hours: Williams Corporation.
Set up variance model:
Flexible Budget
Price for Good
Output)
$31.50 x 44,800
$32.40 x AQ $31.50 x AQ
= $1,411,200
?? $201,600 F
Solve for actual input at standard prices:

$1,411,200 – $201,600 favorable efficiency variance = $1,209,600.
Solve for AQ:
$31.50 x AQ = $1,209,600
AQ = $1,209,600 ÷ $31.50
AQ = 38,400 hours
Solve for labor price variance:

Labor price variance = ($32.40 x 38,400 hours) – $1,209,600
= $1,244,160 – $1,209,600
Labor price variance = $34,560 U

16-58. (20 min.) Overhead Variances: Rexford Components.
Variable overhead:
Flexible Budget
Actual Inputs
at Standard
Price Output)
a $27 x 2,640 $27 x 2,820

$70,560
= $71,280 = $76,140
$720 F $4,860 F
Fixed overhead:
Actual Price
Budget
Costs Variance
b
$35,280 $31,104
$4,176 U
a
$70,560 = (2/3) x $105,840.
b
$35,280 = (1/3) x $105,840.

16-59. (40 min.) Manufacturing Variances: Delta Products.
Direct materials:
Flexible Budget
Actual Inputs
at Standard
Price Output)
$1.80 x 15,120 $2 x 15,120 $2 x 6 gallons x 2,280

gallons gallons units
= $27,216 = $30,240 = $27,360
$3,024 F $2,880 U
Direct labor:
$40 x 6,400 $36 x 6,400 $36 x 3 hours x 2,280

= $256,000 = $230,400 = $246,240
$25,600 U $15,840 F
Variable overhead:
$9 x 6,400 $9 x 3 hours x 2,280

$60,750
= $57,600 = $61,560
$3,150 U $3,960 F

16-60. (20 min.) Overhead Cost and Variance Relationships: McDormand Inc.
a. Variable overhead:
Flexible Budget
Actual Inputs
at Standard
Price
Output)
a
$30 x 33,920
$30 x 34,240 hours
$1,019,200 hours
= $1,027,200
= $1,017,600
$1,600 U $9,600 F
a $30 =
$1,027,200 flexible budget
34,240 hours
b. Fixed overhead:
Production
Actual Price
Costs Variance
Variance
c
a b $21 x 34,240
$755,200 $739,200
= $719,040
$16,000 U $20,160 U
a $755,200 = $1,774,400 – $1,019,200
b $739,200 = $755,200 – $16,000 U price variance.
c $21 =
$739,200
35,200 hours

16-61. (20 min.) Analysis of Cost Reports: Cabot Plant.
Three possible changes that could make the cost information more meaningful are:
a. Use a flexible budget rather than a static master budget for measuring performance so
that changed conditions, volume changes, and fixed versus variable costs are
recognized in the reporting process.
b. Use standard costs.
c. Identify those elements of the report for which the production manager is directly
responsible.
16-62. (25 min.) Change Of Policy To Improve Productivity: Orange Electronics.

Currently the soldering personnel rarely complete the operations in less time than the
standard allows. Assuming that the soldering department is working efficiently, it is not
likely that the tightening of the standards (reducing the allowed time per operation) will
result in increased productivity. More likely the soldering personnel will resent having the
standards tightened without their input into the decision making process. They currently
view the standards as achievable since they do, although rarely, complete the operations
in less than the standard time. Tightening the standards will result in decreased motivation
and morale as they strive for what they will view as an unrealistic standard.
Improved profit margins will not be achieved. The production manager fails to understand
that by tightening the standards (all other things being equal) she will simply increase the
unfavorable variances. Simply lowering the standard time allowed per operation does not
reduce the cost of manufacturing the product, unless an actual reduction in processing
time occurs on the shop floor. As stated above, the tightening of the standards will
probably decrease morale and motivation resulting in an increased processing time. This
will decrease productivity and increase the costs of production.
16-63. (20 min.) Ethics and Standard Costs: Farmer Frank’s.

Margaret's behavior is unethical. Margaret has an obligation to communicate information
fairly and objectively. She must prepare complete and clear reports and
recommendations. By misrepresenting the costs of the blueberries she is hoping to benefit
her friend's blueberry farm at the expense of Farmer Frank’s. Margaret should avoid such
conflicts of interest, and advise all parties of any potential conflicts. She should not be
setting the standards and mandating from whom Frank’s should purchase the goods.

16-64. (40 min.) Comprehensive Variance Problem: Chambers Company.
Direct materials:
Flexible Budget
Actual Inputs
at Standard
Price Output)
$2.05 x 228,000 $2.00 x 228,000 $2.00 x 40 yards x

yards yards 5,000 units
= $467,400 = $456,000 = $400,000
$11,400 U $56,000 U
Direct labor:
$20.40 x 25,200 $20 x 25,200 $20 x 5 hours

hours hours x 5,000 units
= $514,080 = $504,000 = $500,000
$10,080 U $4,000 U

16-64. (continued)
Variable overhead:
Flexible Budget
Actual Inputs
Efficiency (Standard Inputs
at Standard
Variance Allowed for
Price
Good Output)
a
$12 x 25,200 $12 x 5 hours x
hours 5,000 units
= $302,400 = $300,000
?? $2,400 U
Fixed overhead:
Production
Variance
b
$4 x 28,800 $4 x 5 hours x
hours 5,000 units
= $115,200 = $100,000
?? $15,200 U
a $12 per hour = $60 standard overhead per unit ÷ 5 direct labor hours per unit.
b $4 per hour = $20 standard overhead per unit ÷ 5 direct labor hours per unit.
Note: The variable overhead and fixed overhead price variances cannot be determined.
The total overhead price variance is $26,400 U (= $444,000 – $302,400 – $115,200).

16-65. (25 min.) Find Actual And Budget Amounts From Variances: J&W
Corporation.
a. Direct materials:
Flexible Budget
Actual Inputs
at Standard
Price Output)
$8* x 2.25 kgs

$8* x 112,500 kgs*
$945,000 x 48,000 units*
= $900,000
= $864,000
$45,000 U* $36,000 U*
Direct labor:
$16.80 x 34,200* $16 x 34,200* $16 x 0.75* hours

hours hours x 48,000* units
= $574,560* = $547,200 = $576,000
$27,360 U* $28,800 F
Standard cost sheet:

Direct materials, 2.25 kilograms at $8 per kilogram $18 per game
Direct labor, 0.75 hours at $16 per hour ................ 12 per game
Overhead, 0.75 hours at $12 per hour .................. 9 per game
Total costs ........................................................ $39* per game
* Given

16-65. (continued)
b. Overhead:
Actual
Applied
Costs
$9 x 48,000*
$432,000 + $18,000
units
= $450,000
= $432,000
$18,000 U*
* Given

16-66. (40 min.) Variance Computations With Missing Data: Studio Company.
Note: The calculation of the fixed overhead budget amount makes this a challenging
problem. (Footnotes follow the calculations.)
Direct materials:
Flexible Budget
Actual Inputs
at Standard
Price Output)
a
$1.85 x 81,600 $1.65 x 81,600 $1.65 x 2 gallons
gallons gallons x 42,000 units
= $150,960 = $134,640 = $138,600
$16,320 U $3,960 F
Direct labor:
b
$13.05 x 8,560 $14 x 8,560 $14 x 0.2 hours
= $111,708 = $119,840 = $117,600
$8,132 F $2,240 U
Variable overhead:
$11.90 x 8,560 $11.90 x 0.2 hours

61% x $163,200
hours x 42,000 units
= $99,552
= $101,864 = $99,960
$2,312 F $1,904 U

16-66. (continued)
Fixed overhead:
Production
Actual Price
Costs Variance
Variance
d
39% x $163,200 c $1.60 x 42,000
$64,000
= $63,648 = $67,200
$352 F $3,200 F
a $1.85
$150,960
=
81,600 gallons
b $13.05
$111,708
=
8,560 hours
c There are 40,000 units in the master production budget, computed by dividing total
master budget costs by standard unit cost as follows:
Materials: 132,000  ($1.65 x 2 gallons)
= $132,000  $3.30 = 40,000 units.
Labor: $112,000  ($14.00 x 0.2 hour)
= $112,000  $2.80 = 40,000 units.
This means the master budget variable overhead amount is $95,200 = $11.90 x 0.2 hour x
40,000 units. So the fixed overhead budget is $64,000 = $159,200 – $95,200.
d $1.60
$64,000 budget
=
40,000 units

16-67. (50 min.) Comprehensive Variance Problem: Sweetwater Company.
Mountain Mist:
Flexible Budget
Actual Inputs
at Standard
Price
Output)
$13.50 x 3,100 $15 x 3,100 $15 x 3 ounces

ounces ounces x 1,000 units
= $41,850 = $46,500 = $45,000
$4,650 F $1,500 U
Direct labor:
$60.75 x 4,900 $60 x 4,900 $60 x 5 hours

= $297,675 = $294,000 = $300,000
$3,675 U $6,000 F
Variable overhead:
$48 x 4,900 $48 x 5 hours

$242,550 hours x 1,000 units
= $235,200 = $240,000
$7,350 U $4,800 F

16-67. (continued)
b. Fixed overhead:
Production
Actual Price
Costs Variance
Variance
($335,340 ÷ 5,750)
a
$313,950 $335,340 x 5,000
= $291,600
$21,390 F $43,740 U
a
5,000 hours allowed = 1,000 units produced x 5 hours per unit.

16-67. (continued)
Valley Stream:
Flexible Budget
Actual Inputs
at Standard
Price Output)
$17.25 x 4,700 $16.50 x 4,700 $16.50 x 4 ounces

ounces ounces x 1,200 units
= $81,075 = $77,550 = $79,200
$3,525 U $1,650 F
Direct labor:
$76.50 x 7,400 $75 x 7,400 $75 x 6 hours

= $566,100 = $555,000 = $540,000
$11,100 U $15,000 U
Variable overhead:
$52.50 x 7,400 $52.50 x 6 hours

$378,510 hours x 1,200 units
= $388,500 = $378,000
$9,990 F $10,500 U

16-67. (continued)
b. Fixed overhead:
Production
Actual Price
Costs Variance
Variance
($397,800 ÷ 7,800)
a
$396,000 $397,800 x 7,200
= $367,200
$1,800 F $30,600 U
a
7,200 hours allowed = 1,200 units produced x 6 hours per unit.

Integrative Case
16-68. (60 min to 90 min) Performance Measurement and Variances: agm.com.
a.
The following variances can be computed to understand better why actual income fell
short of budgeted income.
Factor:
($88,760 – $6,800)
Initial income variance ....................................... 81,960 U
Sales variances
$176,000 – (8,000  $25)
Sales price variance...................................... 24,000 U
(8,000 – 8,000) x $25
Sales volume variance .................................. –0–
Total sales variance ................................. 24,000 U
Production cost variances

Price variances
$11,520 – (2,400  $5)

Reed ........................................................ 480 F
$31,200 – (8,000  $4.10)
Handle ..................................................... 1,600 F
$65,280 – (4,800  $12)
Labor........................................................ 7,680 U 5,600 U
Efficiency variances
[2,400 – (8,000  .4)]  $5
Reed ........................................................ 4,000 F
[4,800 – (8,000  .5 )]  $12
Labor........................................................ 9,600 U 5,600 U
Variable overhead
$5,760 – (4,800  $1)
Spending .................................................. 960 U
[4,800 – (8,000  .5)] x $1
Efficiency ................................................. 800 U 1,760 U
Fixed overhead ........................................... –0–
Marketing variance ............................................ 45,000 U

Total variances .......................................... $81,960 U

16-68. (continued)
b.
The two specific items in the case that deal directly with this are the material savings and
the strike. The estimated cost of the strike can be computed as:
Lost sales ...........................................................

400 baskets x $12.40 (budgeted contribution margin) $ 4,960
Shipping ............................................................. 13,000
Marketing ........................................................... 32,000
Total ................................................................ $49,960
We can think about including lost sales even though she sold the planned 8,000. She
might have been able to sell (and produce) more if there was no strike.
The materials savings of $8,000 (= 20%  $5  8,000 units) are already incorporated in
the total material efficiency variance. There is no reason she should receive credit for
these and not be held responsible for the other efficiency losses.
c.
Certainly Mary is not responsible (in the sense of control) for the strike. However, she is
responsible for designing operations and selecting suppliers. Strikes are not unknown and
if she is not held accountable for the effect of strikes (or fires, or floods, etc.), she will not
include the possible costs in her decisions.
Should the contract be re-negotiated? This is a much more difficult question. There are (at
least) two factors that need to be considered here. First, since this is the first year of
operations, the budget against which Mary is evaluated is subject to a great deal of
uncertainty. That is, the benchmark might have been ―wrong.‖ On the other hand, if the
contract is re-negotiated for this event, how effective can the budget be in the future?


Chapter 15 Transfer Pricing: True / False Questions

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Chapter 15 Transfer Pricing: True / False Questions

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Chapter 15 Transfer Pricing

True / False Questions

transfer occurs between the two responsibility centers.

making the transfer or not.

contribution by not selling outside.

at the market price.

Multiple Choice Questions

21. Which of the following statements is(are) false?

the transfer occurs between the two responsibility centers.

C. Both A and B are false.

D. Neither A nor B is false.

Transfer prices affect only profit or investment centers.

23. Transfer prices would not be used by:

internally, assuming the division is operating at capacity?

($60 - $35 - $12) = $13

transferring internally, assuming the division is operating at capacity?

Operating at capacity: market price = $60

transfer when the market price is $75?

$75 - $50 = $25

internal transfer when the market price is $75?

Operating at capacity: market price = $75

price of an internal transfer when the market price is $75?

Below capacity: variable cost = $50

There are no opportunity costs when operating below capacity.

services, assuming it is operating at capacity?

Outside price of $45

division should obtain?

Selling price $90

Variable cost per unit 66

Fixed cost per unit 20

Sales volume (units) 22,500

Capacity (units) 25,000

[$66(2,500) + $90(3,500)]/6,000 = $80

as far as the selling division is concerned is:

A. the variable cost of producing a unit of product.

B. the full absorption cost of producing a unit of product.

Selling price to outside customers $75

Variable cost per unit $50

Total fixed costs $400,000

Capacity in units 25,000

See calculation below.

can sell for on the outside.

See calculation below.

incurred ($10 + $4 + $9 = $23).

it is currently, would be:

See calculation below.

Less: Cost for Wheel Division to

Less: Lost profit for the Wheel Division

to cut back production ($100 - $65 ×

Change in net annual operating

Selling price to outside

Variable cost per unit $30

Total fixed costs $400,000

Capacity in units 25,000

See calculation below.

Selling price to outside

Variable cost per unit $30

Total fixed costs $10,000

Capacity in units 20,000

See calculation below.

Variable expenses 37,500

Contribution margin 22,500

Fixed expenses 12,000