Ke did a pretty good job of giving an overview of the pricing methods, so I’ll try and build some examples to help you. Here is a really simple problem that I created to help you understand the basics of transfer pricing.  

 

A car manufacturing company can either buy its tires from an unrelated company for $100, or buy from its rubber department, which also makes tires. It costs the rubber department $50 in VC and $10 in FC to make the tire. How much would you pay to the other department for the tires under each Method? 

 

Market Based Transfer:

If you used market based transfer pricing, you would pay $100 to the other department of your company for every tire you bought because this is the fair market value of the tires. 

 

Cost Based Transfer: 

Under this method, you would pay $50 for the tires, because this is the VC of the unit. 

 

Negotiated Transfer: 

Under this method you would have to calculate the minimum and maximum transfer price to start. 

Min TP= $50, because the rubber division would not be willing to lo
se money on the deal

Max TP = $100, because the company would not pay itself more than if it were to buy the tires on the open market. 

Therefore, the negotiated transfer price would be anywhere from $50-100. 

 

Hope this helps you understand a little bit better the foundation of transfer pricing! 

 

As mentioned from Conrad, companies are not allowed to use variable costing so it will not be possible to find a company as an example who does so. However, companies do use variable costing just for internal references. 

 

To break down some reasons why variable costing is not allowed and it does not comply with GAAP principles include; lower taxable income, and recognition for costs of product are not expensed correctly. 

 

To further grasp an understanding of the difference between absorption of variable costing, in the textbook there is an explanation of the different methods of costing on page 329. There you will see the key differences between the two methods, and page 332 to see the difference of how those methods are reported on the Statement of Comprehensive Income. (Exhibit 9-5). Looking at the financial statement, you will also see how under variable costing it produces a lower taxable income.

But many different industries use variable costing for internal purposes. This is to help them with cost-volume-profit analysis.

Hey Oliver, 

On a really high level, the main difference between absorption costing and variable costing is where the fixed manufacturing overhead is placed. In absorption costing, we would generally apply FMOH at a pre-determined rate for every unit we produce as part of the cost to make the product, where as in in variable costing, we would ignore these costs until after we have found the contribution margin, then apply all of the fixed costs at once. Shannon gave us a really good summary sheet on Slide 10 on the first power point that you should check out for a more visual explanation of this if you’re still having trouble. 

I know you were struggling with the FOH variances so i'll explain that and maybe someone else will continue with VOH variances. 

FMOH variances are a little tricky because fixed costs generally don’t change throughout the year. I’ll try and use the example of rent through out my explanation to help you understand. Starting with why a FMOH sales variance doesn’t exist. If you rented a factory, you will have a contract and pay the same amount of rent each month. If you sell 1 unit, or 1000 units, you will still owe your landlord the same amount of rent. Therefore, the budgeted rent and the actual rent will always be equal and you will have a 0 sales-volume variance.  The same reason would apply for your FMOH efficiency variance. The amount of rent (input) you use will not vary in quantity. i.e. you cant waste some rent or have poor quality rent you can’t use. 

 

The only 2 ways of getting a FMOH variance come from a budget variance, or a volume variance. Budget variances arise when your FOH are not the same as your actual costs. For example, you budget $1000 a month for rent for the year. In the middle of June you find out your landlord is raising your rent to $1100. At the end of the year, this will result in a budget variance because you had to pay more for rent than you originally expected. A FMOH volume variance arises when your production is different than previously expected. This will cause you FOH to change because you are now dividing the FOH over more units. Ex: your rent is 1000 per month and you produce 1000 units, normally you would apply $1 of FOH for every unit your produce. If at the end of the month you find out you produced 1100 units, you would have applied $1100 in FOH, you will have a FOH volume variance of $100.

 

Hope this helped!  

 

The Flexible Budget Variance is the difference between your actual results and your flexible budget amount Nicoleta also explained what the flexible budget is so you can refer back to her post in case you’ve forgotten! :) This is the difference between actual prices at actual levels of output and budgeted prices at actual levels of output. The difference (variance) that results from this comparison can either be favourable or unfavourable. A favourable result means that the operating income exceeds the budgeted amount. An unfavourable variance means the operating income will not exceed the budgeted amount. 

 

Let me give you a brief example. In a manufacturing company for clothes, the actual units of production/sales are 1000 units, this means that the flexible budget units of production also have to be 1000 units because it has to match actual level of output. The actual variable manufacturing costs is $20 per unit, but the flexible budget variable manufacturing costs was $30. This means that $20(1000) - $30(1000) will give you $10,000 Favourable because you budgeted to pay more for variable manufacturing costs than what you actually paid. Paying less than what you had anticipated seems like a pretty favourable situation to me!

Standard costing a method of costing that applies predetermined rates to a process to come up with a cost for a particular item. Standard costs are usually found on initial budget as these rates are generally calculated based on previous and expected future costs. The standard cost of an item would be found by using adding the standard rates for direct materials, direct labour and a standard overhead rate to find a unit cost

Normal Costing traces all the direct costs to a particular cost object and allocates indirect costs based on a budgeted cost rate multiplied by a cost allocation quantity. Basically this means Normal Costing uses actual direct material, direct labour costs and a predetermined overhead rate to find the total cost of a unit. 

Now the overall difference is that Standard Costing will give you a general idea on if you use X amount of inputs you will get X amount of outputs and it will cost you $X when you’re done. Whereas Normal Costing will say this is how much you actually used and this is how much you actually produced and it actually cost $X. 

To help reinforce the idea here is a helpful link that talks about the difference between the two types of costs. http://www.accountingcoach.com/blog/normal-costing-standard-costing

When you have these two types of costs and combine them together you can start to find out how well your company is performing with different variances. These variances will be explained by a few of my group mates as there are a lot of them!

Let me start off by explaining the difference between the static budget and the flexible budget.

The static budget is also known as the master budget. The static budget is set at the beginning of a period for a specific level of output. The budget stays the same for the entire period, regardless of changes in output. Static budgets can be useful for providing businesses with fixed guidelines. They are good for businesses that operate in a relatively unchanging environment and follow stable production levels.

The flexible budget is just as it sounds. It adjusts according to changes in the actual levels of output, actual revenue and cost drivers. At the end of the period, the flexible budget shifts the budgeted revenues and costs up and down based on changes in activity. It is beneficial because it can allow businesses to respond quickly to changes in their environment. The flexible budget allows for the adaptability that the static budget cannot offer. This is especially useful for businesses in changing environments and businesses that are more complex in their operations.

I hope this helps. Next, one of my team mates will help you understand the difference between standard and normal costing.

Activity based costing is much more effective when there are:

-        High overhead costs

-        Many different products 

-        Complex products

 

Some examples of companies that would use activity based costing are:

-        Manufacturing companies

-        Construction companies

-        Health care companies

 

http://yourbusiness.azcentral.com/types-businesses-activitybased-costing-28437.html

-Aside-
Question to the group, I was reading the rubric for this Oliver stuff and it said: "Works as a team and builds answers together (not segmented answers and repetitive)". It mentions not being segmented, so does that mean at the end we have to combine all our answers into a google docs document or something and post it here?

 Regarding you question about
 traditional costing and activity based costing (ABC), as we learned in Shannon's lecture,  one of the key characteristics of traditional costing is that it uses one overhead allocation rate. ABC costing, on the other hand, uses several different rates associated with their respective activities. Since only one rate is used under traditional costing, it results in a situation where costs are allocated very arbitrarily.

 

A general example is let’s say Carleton Co. has a project that requires three activities, maintenance, construction and design. The percentage break down of these activities used by Carleton Co. is 10% maintenance, 70% Construction and 20% Design. Evidently, the activities are in different portions and one single allocation rate might not be ideal. Let's say that Design is very expensive and Construction is actually relatively cheap. If this were a very large and costly project, it would be more cost effective. for Carleton Co. to calculate individual allocation rates under ABC for each of the three activities.  

 

I hope this gives a very general understanding of Activity Based Costing vs. Traditional Costing. It would be very much appreciated if my colleagues help me expand on this. 

Keep that in mind while we do another example.

Let's say that Carleton Co. uses the same predetermined rate of $40 per hour of forklift use. In a given week they estimate it will only be used for 30 hours as it is usually a quiet week according to seasonal patterns. So, they allocate $1200 for the use of their forklift ($40 x 30hrs). 

During the week, they get an unexpected large order and have to move a lot of materials through the factory. The actual amount of hours that the forklift was used was 55 hours. This cost Carleton Co. $2200 in MOH ($40 x 55hrs).

The difference between the actual MOH and the the estimated MOH is $1000 ($2200 - $1200). They assigned too little to the MOH Allocated account resulting in underapplied manufacturing overhead.

Overapplied MOH:

Underapplied MOH:

I’m going to get the ball rolling on your questions. I’m going to start off by giving you an example of what over applied overhead means. Now we all know that Manufacturing Overead (MOH) is budgeted for a specific period of time. A company will use a normal costing method to determine how much MOH should be applied during a specific period. For example, the company, Carleton Co. has a forklift and they determine that every hour the forklift is used it will cost them $40 in overhead. They then figure that the forklift should be used for 40 hours a week. This means that it will cost them $1,600 ($40x40hours) a week in overhead costs. Carleton Co. will allocate $1,600 to their MOH account. 

At the end of the week they find that they only used the forklift for 36 hours. This will give them an actual MOH of $1,440. Wait a minute the numbers don’t add up! They are off by $160 ($1,600-$1,440). This means that Carleton Co. over applied their MOH. 

Now my next colleague will tell you what under applied overhead means. 

A few interesting facts about me: 

I'm the Vice President for the Carleton University Badminton Team (Note: if you're interested in joining give me a shout!) 

I am am working part time as a barber and will be working part time in retail at GAP. 

I am looking forever to working with everyone. :)