An appropriate transfer price between two divisions of The Fathom Company can be determined from the following data: (CIA adapted) \[\begin{array} { | l | r | } \hline \text { Fabricating Division } & \\ \hline \text { Market price of } & \$ 50 \\ \text { subassembly } & \$ 20 \\ \hline \text { Variable cost of } \\ \text { subassembly } & 1,000 \\ \hline \text { Excess capacity (in units) } & \\ \hline \text { Assembling Division } & 900 \\ \hline \text { Number of units needed } & \$ \\ \hline \end{array}\]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. A) Between $20 and $50. B) Between $50 and $70. C) Any amount less than $50. D) $50 is the only acceptable transfer price. A

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:\[\begin{array} { | l c | } \hline \text { Direct materials } & \$ 8 \\ \hline \text { Direct labor } & 4 \\ \hline \text { Variable overhead } & 2 \\ \hline \text { Fixed overhead } &\underline{ 2} \\ \hline \text { Total cost } & \$ 16 \\ \hline \end{array}\] 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

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: \[\begin{array} { | l | r | } \hline \text { Variable Cost per unit } & \$ 30 \\ \hline \text { Fixed Costs } & \$ 10,000 \\ \hline \text { Annual Sales to the Hardwood Division } & 5,000 \text { units } \\ \hline \text { Annual Sales to Outsiders } & 50,000 \text { units } \\ \hline \end{array}\]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. 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.

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.\[\begin{array} { | l | r | } \hline \text { Direct material } & \$ .60 \\ \hline \text { Direct labor } & .40 \\ \hline \text { Variable overhead } & .10 \\ \hline \text { Fixed overhead } &\underline{ .20 }\\ \hline \text { Total unit cost } & \$ 1.30 \\ \hline \end{array}\]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. 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.

Exam 15: Transfer Pricing

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 \ 20 Variable cost of subassembly 1,000 Excess capacity (in units) Assembling Division 900 Number of units needed \ What is the natural bargaining range for the two divisions?

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Question 1

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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.?

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$\begin{array} { | l | r | r | } \hline \text { a. Cost Plus } & \text { Stamp Dirision } & \text { Finish Division } \\\hline \text { Sales } & \$ 231,000 & \$ 500,000 \\\hline \text { Cost of Goods Sold } & 180,000 & 351,000 \\\hline \text { Other Costs } & \underline { 40,000 } & \underline { 80,000 } \\\hline \text { Operating Profit } & \$ 11,000 & \$ 69,000 \\\hline \text { b. Transter = } \$ 2 & \text { Stamp Dirision } & \text { Finish Division } \\\hline \text { Sales } & \$ 240,000 & \$ 500,000 \\\hline \text { Cost of Goods Sold } & 180,000 & 360,000 \\\hline \text { Other Costs } & 40,000 & 80,000 \\\hline \text { Operating Profit } & \$ 20,000 & \$ 60,000 \\\hline \text { c. Transter = } \$ 1.90 & \text { Stamp Dirision } & \text { Finish Division } \\\hline \text { Sales } & \$ 228,000 & \$ 500,000 \\\hline \text { Cost of Goods Sold } & 180,000 & 348,000 \\\hline \text { Other Costs } & \underline { 40,000 } & \underline { 80,000 } \\\hline \text { Operating Profit } & \$ 8,000 & \$ 72,000 \\\hline\end{array}$ 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.

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: 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 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.

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(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. )
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.
The opportunity cost is the contribution margin on the lost sales,divided by the number of 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.
Therefore,Transfer price > ($17.00 per unit + $0.50 per unit)+ $4.00 per unit = $21.50 per unit.
From the viewpoint of the Equipment Division,the transfer price must be less than the cost of buying the units from the outside supplier.Therefore,Transfer price < $28.00.
Combining the two requirements,we get the following range of transfer prices: $21.50 < Transfer price < $28.00.
b.Yes,the transfer should take place.From the viewpoint of the entire company,the cost of transferring the units within the company is $21.50,but the cost of purchasing the special parts from the outside supplier is $28.00.Therefore,the company's profits increase on average by $6.50 for each of the special motors that is transferred within the company,even though this would cut into production and sales of another product.