Exam 15: Transfer Pricing

In the United States,more companies use cost-based transfer prices than market-based transfer prices.

The Barrel Division of Chemco Inc.has a capacity of 200,000 units and expects the following results. Sales (160,000 units at \ 4) \ 640,000 Variable costs, at \ 2 320,000 Fixed costs Income \ 60,000 Tank Division of Chemco Inc.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 at $3.50.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.Barrel's manager agrees to the deal offered by Tank'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 Inc.as a whole?

A selling division at capacity is indifferent between selling to outsiders and transferring inside at the market price.

A limitation of transfer prices based on actual cost is that they: (CIA adapted)

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 a $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?

Which of the following statements is(are)false? (A)From an organization's viewpoint,transfer prices have no effect on total profits assuming the transfer occurs between the two responsibility centers.(B)A transfer price is the value assigned to the transfer of goods or services between divisions within the same organization.

The GrowPro Manufacturing Company has a division (Division P)that produces an essential ingredient used by the Lawn Division in making lawn fertilizer.Historically,75% of Division P's output has been purchased by Division L and 25% has been sold to other fertilizer companies.The transfer price between Division P and Division L has been based on the outside sales price less selling and administrative expenses directly applicable to the outside sales.Last year,the transfer price was $35 per ton;Division P would like the same transfer price this year.However,the general manager of Division L has found an outside supplier who will sell the ingredient for $30 per ton.She would like to continue buying from Division P,but Division P's manager does not want to match the $30 price because he thinks that the margin is too small.Top management does not get involved in transfer pricing disputes,but rather,allows division managers to make their own decisions concerning internal or external purchases and sales.The following information has been gathered regarding Division P's operations last year: The information presented above is based on selling 120,000 tons internally and 40,000 tons externally. Sales to L Extemal Sales \ 4,200,000 \ 2,000,000 Variable costs 3,000,000 1,000,000 Fixed costs 360,000 120,000 Required: a.If Division L buys externally,Division P can increase its current external sales by only 20,000 tons.What arguments can the general manager of Division L make to help Division P to match the $30 price? b.Division L wants to use only one supplier,so Division P will either sell 120,000 tons to Division L or nothing.If Division L's capacity is 160,000 tons,how many units does Division P need to sell to outsiders at $50 per ton before it is better off selling to outsiders? Ignore any additional marketing costs which would be incurred to increase sales. a.Drop price internally,overall profit = $1,120,000;lose inside sales,increase outside,overall profit = $1,020,000.b.64,000 tons.

Given the following information for Camping Division: Selling price to outside customers \ 50 Variable cost per unit \ 30 Total fixed costs \ 400,000 Capacity in units 25,000 The Lantern Division would like to purchase internally from the Camping Division.The Lantern Division now purchases 5,000 units each period from outside suppliers at $49 per unit.The Camping Division has ample excess capacity to handle all of the Lantern Division's needs.What is the lowest price that Camping Division could accept?

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;fixed costs are $110 per unit.The Monnett Division can use the 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 independent of each other): 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?

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.

The general principle on setting transfer prices that are in the organization's best interests is:

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

Transfer prices cannot be used for decision making,product costing,or performance evaluation.

The Counter Division can sell externally for $60 per unit.Its variable manufacturing costs are $35 per unit,and its fixed costs are $12 per unit.Required: a.What is the optimal transfer price for transferring internally,assuming the division is operating at capacity? b.What is the optimal transfer price for transferring internally,assuming the division is operating at well below capacity?

Hartland Company has used market price as its transfer price for the Sterling Division for many years with no problems.This year,because of changes in the economy,the demand for its final product has dropped along with the price.Required: Explain the problems of basing the transfer prices on distress market prices and possible solutions to the problems.

The Wheel Division of Frankov Corporation has the capacity for making 75,000 wheel sets per year and regularly sells 60,000 each year on the outside market.The regular sales price is $100 per wheel set,and the variable production cost per unit is $65.The Retail Division of Frankov Corporation currently buys 30,000 wheel sets (of the kind made by the Wheel Division)yearly from an outside supplier at a price of $90 per wheel set.If the Retail Division were to buy the 30,000 wheel sets it needs annually from the Wheel Division at $87 per wheel set,the change in annual net operating income for the company as a whole,compared to what it is currently,would be:

Frocks and Gowns Inc. ,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 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?

Retro Rides Inc. ,operates two divisions: (1)a management division that owns and manages classic automobile rentals in Miami,Florida and (2)a repair division that restores classic automobiles in Clearwater,Florida.The repair division works on classic motorcycles,as well as other classic automobiles.The Repair division has an estimated variable cost of $28.50 per labor-hour.The Repair division has a backlog of work for automobile restoration.They charge $48.00 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 $30.00 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?

Randolph Company has two divisions organized as profit centers: Redmon and Tomlin.Randolph expects the following results: Reckon Tomlin Sales Redmon: (10,000\times\ 16) \ 1,600,000 Tomlin: (250,000\times\ 7.20) \ 1,800,000 Variable costs 1,360,000 1,000,000 Contribution margin \ 240,000 \ 800,000 Fixed costs 160,000 460,000 Profit \ 80,000 \ 340,000 Included in Redmon's costs are 100,000 units of a subcomponent purchased from an outside supplier for $4.50.The managers have recently initiated negotiations for Tomlin to supply the components to Redmon.Tomlin has a total capacity of 400,000 units.Required: a.Prepare a new segment reporting statement for Randolph,assuming an internal transfer at the maximum transfer price.b.Prepare a new segment reporting statement for Randolph,assuming an internal transfer at the minimum transfer price.

Which of the following responsibility centers is affected by the use of market-based transfer prices?