Exam 15: Transfer Pricing

The Eastern Division sells goods internally to the Western Division at Tennessee Company.The quoted external price in industry publications from a supplier near Eastern is $200 per ton plus transportation.It costs $20 per ton to transport the goods to Western.Eastern's actual market cost per ton to buy the direct materials to make the transferred product is $100.Actual per-ton direct labor is $50.Other actual costs of storage and handling are $40.Tennessee Company's president selects a $220 transfer price.This is an example of: (CIA adapted)

Transfer prices are not used to record the exchange between two cost centers within the same organization.

Midland Inc.has two divisions: production and marketing,which it treats as profit centers.Because the production division has no marketing capabilities,it does not have a traditional market price to consider and the company does not want to use negotiation.Required: Discuss the following cost-based transfer prices along with problems that might exist for each.1)Standard unit-level cost.2)Absorption (full)cost.3)Actual cost.

The optimal transfer price when there are intermediate markets is:

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).Its annual capacity is 150,000 units and annual output 135,000 units.All engines sold internally to the LMAD are priced at cost plus 20% markup.In January 2016,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 Total costs 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?

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 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:

Finnish Corporation has a Supply Division that does work for other Divisions in the company as well as for outside customers.The company's Custodial Products Division has asked the Supply Division to provide it with 10,000 special items each year.The special items would require $15.00 per unit in variable production costs.The Custodial Products Division has a bid from an outside supplier for the special items at $29.00 per unit.In order to have time and space to produce the special items,the Supply Division would have to cut back production of another product - the H56 that it presently is producing.The H56 sells for $32.00 per unit,and requires $19.00 per unit in variable production costs.Packaging and shipping costs of the H56 are $3.00 per unit.Packaging and shipping costs for the new special part would be only $1.00 per unit.The Supply Division is now producing and selling 40,000 units of the H56 each year.Production and sales of the H56 would drop by 20% if the new special item is produced for the Custodial Products 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 10,000 special parts per year from the Supply Division to the Custodial Products Division? b.Is it in the best interests of Finnish Corporation for this transfer to take place? Explain.(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. )

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.Last year,the Lantern Division bought all of its 25,000 pillars from Pillar at $1.50 each.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 \ 1.75 customers Variable costs per pillar \ 0.90 Fixed costs, total \ 150,000 The total fixed costs would be the same for all the alternatives considered below.Suppose there is ample capacity so that transfers of the pillars to the Lantern Division do not cut into sales to outside customers.What is the lowest transfer price that would not reduce the profits of the Pillar Division?

A market price-based transfer price policy allows the selling division to determine the price for transfers between divisions within the same organization.

Division X makes a part that it sells to customers outside of the company.Data concerning this part appear below: Selling price to outside \ 50 customers 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 cutting into outside sales.According to the formula in the text,what is the lowest acceptable transfer price from the standpoint of the selling division?

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

Dockside Enterprises Inc. ,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,as well as other large-hull ships.The repair division has an estimated variable cost of $37 per labor-hour.The repair division has a backlog of work for outside ships.They charge $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.If the repair division had idle capacity,what is the minimum transfer price that the repair division should obtain?

Division X of Operandi Corporation makes and sells a single product which is used by manufacturers of fork lift trucks.Presently it sells 12,000 units per year to outside customers at $24 per unit.The annual capacity is 20,000 units and the variable cost to make each unit is $16.Division Y of Operandi Corporation would like to buy 10,000 units a year from Division X to use in its products.There would be no cost savings from transferring the units within the company rather than selling them on the outside market.What should be the lowest acceptable transfer price from the perspective of Division X?

Space Inc.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-4 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?

Why is transfer pricing only a concern for profit or investment centers and not for cost or revenue centers?

Accutron,a large manufacturing company,has several autonomous divisions that sell their products in perfectly competitive external markets as well as internally to the other divisions of the company.Top management expects each of its divisional managers to take actions that will maximize the organization's goal as well as their own goals.Top management also promotes a sustained level of management effort of all of its divisional managers.Under these circumstances,for products exchanged between divisions,the transfer price that will generally lead to optimal decisions for Accutron would be a transfer price equal to the: (CIA adapted)

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 without the transfer to the Night Wear Division?

The following information is available for the two divisions of MAC Co.: Division A Selling price to outside market \ 55 Standard unit-level costs 35 Dwision B Selling price of finished product \9 5 Standard unit-level costs for Division B 25 Division A has no excess production capacity.Required: 1)In order to ensure the best use of the productive capacity of A,what transfer price should be set by Division A and what effect does this transfer price have on the overall margin for the company? Is the answer goal congruent under the general rule? 2)Should Division B accept a special order for its product if the selling price is reduced to $70.Use your answer from #1 and explain.3)Would your answer to #2 change if Division A had excess capacity? Explain.

Dockside Enterprises Inc. ,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,as well as other large-hull ships.The repair division has an estimated variable cost of $37 per labor-hour.The repair division has a backlog of work for outside ships.They charge $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?

Galena Corp.manufactures RD34 in its City Division.This output is sold to the Urban Division as raw material in Urban's product.City 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 at full 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 at full 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?