Exam 15: Transfer Pricing

Division A produces a part with the following characteristics: Capacity in units 50,000 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 currently 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 impacting sales to outside customers. From the point of view of Division A, any sales to Division B should be priced no lower than:

The Raisin Division of Trail Mix Foods, Incorporated 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:

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 Variable costs 600,000 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 Solar must supply all or none of the Genesis Division's needs for 50,000 units. Required: (a) Determine the change in income of the Solar Division of supplying the component to Genesis for $6 per unit as opposed to not supplying the component to Genesis. (b) Determine the change in income of Trevor Company if Solar supplies the component to Genesis for $6 per unit.

The Barrel Division of Chemco Incorporated has a capacity of 200,000 units and expects the following results in the coming period: Sales (160,000 urits at \ 4) \ 640,000 Variable costs, at \ 2 320,000 Fixed costs Income The Tank Division of Chemco Incorporated 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 for $3.50 per unit. 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. The Barrel Division's manager agrees to the deal offered by the Tank Division'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 Incorporated as a whole?

Given a competitive outside market for identical intermediate goods, what is the best transfer price, assuming all relevant information is readily available?

Why is transfer pricing important in tax accounting?

Mr. Massee, 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 the Brake Division, which provides a part used by the Wheel Division, because he has noticed that the 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: Assume you are the friend that Mr. Massee calls. 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.

Cost-based transfer prices that include a normal markup to the costs act as a surrogate for:

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. The Lantern Division wants to buy 25,000 pillars from the Pillar Division. The following data are available for last year's activities of the Pillar Division: Capacity in units 300,000 pillars Selling price per pillar to outside customers \ 1.75 Variable costs per pillar \ 0.90 Fixed costs, total \ 150,000 The total fixed costs would be the same for all the alternatives considered. - Suppose the transfers of pillars to the Lantern Division would reduce 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:

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 and fixed costs are $110 per unit. The Monnett Division can use the Springfield Division's 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 (consider each question independently): (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?

Briefly discuss some of the general issues of multinational transfer pricing.

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: a) What would Tuesday's total tax liability for both divisions be if it used the $7 million transfer price? b) What would the total tax liability be if it used the $14 million transfer price?

An internal transfer between two divisions is in the best economic interests of the entire organization when:

Division A produces a part with the following characteristics: Capacity in units 50,000 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 currently 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:

Division X makes a part that it sells to customers outside of the company. Data concerning this part appear below: Selling price to outside customers \ 50 Variable cost per unit \ 30 Total fixed costs \ 400,000 Capacity in units 25,000 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 impacting outside sales. What is the lowest acceptable transfer price from the standpoint of the selling division?

Given the following data for Handle Division: Selling price to outside customers \ 150 Variable cost per unit 80 Fixed cost per unit (based on capacity) 30 Capacity (in units) 50,000 The 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:

When there is no intermediate market:

Division A of Spangler Company expects the following results: To Division B To Outsiders Sales (5,000\times\ 60) \3 00,000 (\ 25,000\times\ 72) \ 1,800,000 Variable costs at \ 36 Contribution margin \ 120,000 \ 900,000 Fixed costs, all common, allocated on the basis of relative units profit \6 0,000 \ 600,000 Division B has the opportunity to buy the 5,000 units it needs from an outside supplier at $45 each. Required (consider each question independently): (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 Company. (b) Division A cannot increase its sales to outsiders, does meet the $45 price, and Division B continues to buy from Division A. Compute the effect on the income of Spangler Company.

Dockside Enterprises Incorporated 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 and outside large-hull ships. The repair division has an estimated variable cost of $37 per labor-hour, has a backlog of work for outside ships, and charges $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?

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 per 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 per 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 (c1) cutting the retail price to $17.50 with the certainty that sales will increase to 1,500,000 batteries, or (c2) 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 (c1). What is the minimum transfer price you would recommend in the (c2) option?