Exam 15: Transfer Pricing

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

SEMO Incorporated has a division located in Spain and another in the United States. 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 materials \3 2 Direct labor 12 Variable overhead 6 Fixed overhead 19 Required: a) What would be the lowest acceptable transfer price for the Spanish division? b) What would be the highest acceptable transfer price for the U.S. division? c) What would be the transfer price that would be the best for SEMO Incorporated and why?

Allentown Division of Sparks Incorporated transfers its product to the Youngstown Division. The Youngstown Division can either buy the item internally or externally. The cost of purchasing the item externally is $73 per unit. The Allentown Division has just completed its annual cost update as follows: Direct materials \ 25.00 Direct labor 18.00 Variable manufacturing overhead 6.00 Fixed manufacturing overhead 3.50 Variable selling expenses 4.00 Fixed selling and administrative expenses 8.50 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: a) What is the minimum transfer price the Allentown Division should charge for internal transfers? b) What is the maximum price the Youngstown Division would be willing to pay? c) Why should the Allentown Division reduce its price to the Youngstown Division?

Chattanooga, Incorporated, 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 Incorporated?

An intermediate market is perfect when:

Frocks and Gowns, Incorporated, 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 for the Collars 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 if it transfers 25,000 units to the Night Wear Division at $6.75 per unit?

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.

Frocks and Gowns, Incorporated, 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 for the Collars 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?

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 subassembly \5 0 Variable cost of subassembly \2 0 Excess capacity (in units) 1,000 Assembling Division Number of units needed 900 What is the natural bargaining range for the two divisions?

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. The 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:

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:

Galena Corporation manufactures RD34 in its City Division. This output is sold to the Urban Division as a raw material in the Urban Division's product. The City Division 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 operating at 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 operating at 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 market price-based transfer pricing policy allows the selling division to determine the price for transfers between divisions within the same organization.

Space Incorporated 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-four 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?

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 $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?

How do import duties affect transfer pricing?

When a perfect intermediate market exists, the optimal transfer price is the intermediate market price.

An organization that has significant foreign operations must disclose how its transfer prices are established between domestic and foreign divisions.

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). ED's annual capacity is 155,000 units and annual output is currently 135,000 units. All engines sold internally to the LMAD are priced at cost plus 20% markup. In January 2020, 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?

The Gear Division makes a part with the following characteristics: Production capacity 25,000 units Selling price to outside customers \ 18 Variable cost per unit \ 11 Fixed cost, total \ 100,000 The 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 impacting 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: