Question Tag: Pricing methods

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  • 20 Marks

MI – May 2024 – L1 – SB – Q3 – Costing Methods

Compute the price of store issues and the value of closing stocks using FIFO and LIFO methods.

From the information given below, you are required to compute the price of store issues and the value of closing stocks using:
i. First-In-First-Out (FIFO) basis
ii. Last-In-First-Out (LIFO) basis

  • January 2nd: Purchased 500 Units of XYZ at N40 per unit
  • January 7th: Purchased 200 Units at N45 per unit
  • January 10th: Issued 300 Units
  • January 12th: Purchased 350 Units at N42 per unit
  • January 15th: Issued 500 Units
  • January 18th: Purchased 200 Units at N38 per unit

a. Pricing using FIFO:

  • On January 10, 300 units are issued at N40 (first purchase price).
  • On January 15, 200 units are issued at N40 (from remaining January 2 stock) and 200 units at N45 (from January 7 stock), and 100 units at N42 (from January 12 purchase).
  • Closing stock: The closing stock consists of 250 units at N42 and 200 units at N38.

The closing stock value using FIFO is N18,100.

b. Pricing using LIFO:

  • On January 10, 300 units are issued at N45 (most recent purchase).
  • On January 15, 350 units are issued at N42 (from January 12 purchase), and 150 units at N40 (from January 2 stock).
  • Closing stock: The closing stock consists of 250 units at N40 and 200 units at N38.

The closing stock value using LIFO is N17,600.

Explanation: FIFO assumes that the first goods purchased are the first ones sold, so the closing stock reflects the most recent purchases. LIFO assumes that the last goods purchased are the first ones sold, so the closing stock reflects the older purchase prices.

  • 6 Marks

MA – May 2017 – L2 – Q1d – Transfer pricing

Describe three methods of transfer pricing and discuss their limitations.

Transfer pricing is the method used to sell a product from one subsidiary to another within a company. It impacts the purchasing behavior of the subsidiaries and may have income tax implications for the company as a whole.

Required:

Describe any THREE methods of transfer pricing and discuss their limitations.

(6 marks)

  1. Market-Based Transfer Prices:
    • Description: Transfer prices are based on readily determinable and available market prices. This method is particularly applicable under competitive and efficient market conditions where there is an open market for the intermediate product of the selling division.
    • Limitations:
      • Appropriate Market Price May Not Exist: Suitable market prices may not be available for the intermediate product.
      • Excess Production Capacity: The method may not be effective if there is excess capacity, as market prices may not reflect the true cost.
  2. Marginal Cost Transfer Prices:
    • Description: Transfer prices are based on variable costs, applicable in the short term and for one-off transactions, especially where the division is purely a cost centre.
    • Limitations:
      • Long-term Pricing: The method is unacceptable for long-term price setting as it does not cover fixed expenses.
      • Ignores Market Prices: Prices set too low could miss out on potential margins if set near market rates.
      • Customer Loss: Raising prices later may drive away price-sensitive customers.
  3. Full Cost Transfer Prices (Absorption Costing):
    • Description: Transfer prices are based on total costs, including both fixed and variable costs. This method is suitable when dealing with purely cost centres and for routine transactions.
    • Limitations:
      • Ignores Competition: May result in pricing that does not align with market rates.
      • Ignores Price Elasticity: May lead to pricing that is too high or too low compared to what customers are willing to pay.
      • Product Cost Overruns: Lacks incentives for cost control during product development, potentially leading to higher costs.
  4. Cost-Plus a Mark-Up Transfer Prices:
    • Description: Prices are based on costs plus a profit element, applicable when dealing with profit centres where divisional profitability is also an objective.
    • Limitations:
      • Product Cost Overruns: No incentives for engineering departments to control costs during product design.
      • Contract Cost Overruns: May lead to excessive costs in contracts where the supplier is reimbursed based on cost-plus pricing.
      • Ignores Replacement Costs: Based on historical costs, not current replacement costs, which may not reflect true expenses.
  5. Negotiated Transfer Price:
    • Description: A price established through discussions between buying and selling divisions, where both agree only if their respective profits increase.
    • Limitations:
      • Sub-optimal Pricing: The final price may depend on the negotiation skills of managers, potentially leading to sub-optimal outcomes.
      • Conflicts: May lead to conflicts between divisions, requiring top-management mediation.
      • Time and Cost: Negotiations can be time-consuming and costly, particularly with frequent transactions.

(3 marks for description, 3 marks for limitations)

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