16.5 Transfer Pricing Flashcards
The Eastern division sells goods internally to the Western division of the same 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. The company president selects a $220 transfer price. This is an example of
A. Market-based transfer pricing
B. Cost-based transfer pricing
C. Negotiated transfer pricing
D. Cost plus 20% transfer pricing
A. Market-based transfer pricing
Market $200 + Transportation $20 = $220
- Cost plus 20% transfer pricing
Total cost = (20 + 100 + 50 + 40) x 120%
= 210 x 120% = $252 - Cost-based transfer pricing
Total cost = 20 + 100 + 50 _ 40 = $210
Advantages of the full-cost method for determining transfer prices include all of the following except that it
A. Leads to goal congruence among departments
B. Leads to better external pricing based on cost behaviors
C. Is the least costly method to administer
D. Represents relevant costs for long-run decisions
A. Leads to goal congruence among departments
The most fundamental responsibility center affected by the use of market-based transfer prices is a(n)
A. Production center
B. Investment center
C. Cost center
D. Profit center
D. Profit center
Transfer prices are often used by profit centers and investment centers. Profit centers are the more fundamental of these two centers because investment centers are responsible not only for revenues and costs but also for invested capital.
An appropriate transfer price between two divisions of a manufacturer can be determined from the following data:
Fabricating Division:
* Market price of subassembly: $50
* Variable cost of subassembly: $20
* Excess capacity (in units): 1,000
Assembling Division:
* Number of units needed: 900
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 price.
A. Between $20 and $50.
An ideal transfer price should permit each division to operate independently and achieve its goal while functioning in the overall best interest of the firm. The production capacity of the selling division is always a consideration in setting transfer price. If Fabricating had no excess capacity, it would charge Assembling the regular market price. However, since Fabricating has excess capacity of 1,000 units, negotiation is possible because any transfer price greater than the variable cost of $20 would absorb some of the fixed costs and result in increased divisional profits. Thus, any price between $20 and $50 is acceptable to Fabricating. Any price under $50 is acceptable to Assembling because that is the price that would be paid to an outside supplier.
Manhattan Corporation has several divisions that operate as decentralized profit centers. At the present time, the Fabrication Division has excess capacity of 5,000 units with respect to the UT-371 circuit board, a popular item in many digital applications. Information about the circuit board follows.
- Market price: $48
- Variable selling/distribution costs on external sales: 5
- Variable manufacturing cost: 21
- Fixed manufacturing cost: 10
Manhattan’s Electronic Assembly Division wants to purchase 4,500 circuit boards either internally, or else use a similar board in the marketplace that sells for $46. The Electronic Assembly Division’s management feels that if the first alternative is pursued, a price concession is justified, given that both divisions are part of the same firm.
The best process for Manhattan to determine the price ultimately charged by the Fabrication Division to the Assembly Division for the circuit board is to
A. Establish the price through negotiations between the Fabrication’s and Electronic Assembly’s division management
B. Establish the price by an arbitration committee
C. Establish the price by top management
D. Set the price equal to the price that would be charged if the Fabrication Department had no excess capacity
A. Establish the price through negotiations between the Fabrication’s and Electronic Assembly’s division management
The divisions involved in the transfer are the most motivated and informed parties for determining a fair transfer price. The outcome of this negotiation process will necessarily be the optimum for the organization as a whole.
A limitation of transfer prices based on actual cost is that they
A. Can lead to suboptimal decisions for the company as a whole
B. Lack clarity and administrative convenience
C. Must be adjusted by some markup
D. Charge inefficiencies to the department that is transferring the goods
A. Can lead to suboptimal decisions for the company as a whole
The optimal transfer price of a selling division should be set at a point that will have the most desirable economic effect on the firm as a whole while at the same time continuing to motivate the management of every division to perform efficiently. Setting the transfer price based on actual costs rather than standard costs would give the selling division little incentive to control costs.
A company has two operating segments. Segment A of the company has been operating at 70% capacity for the last two years. It produces a single product, which it sells to external customers for $17 per unit. Variable costs to produce one unit are $11 and the allocated fixed overhead costs are $3 per unit. Segment B purchases the same product produced by Segment A from an outside vendor for $15. Management is considering obtaining the product from Segment A. If Segment A begins to manufacture enough product to sell to its external customers, as well as to Segment B, Segment A will be operating at 94% capacity. What is the minimum price that Segment A should charge Segment B?
A. $15 per unit
B. $11 per unit
C. $17 per unit
D. $14 per unit
B. $11 per unit
To ensure overall goal congruence and maximize company profitability, the transfer price should be at least equal to the variable cost of production. This assumes that Segment A has excess capacity, which it does.
The price that one division of a company charges another division for goods or services provided is called the
A. Transfer price
B. Distress price
C. Outlay price
D. Market price
A. Transfer price
A transfer prices is the price charged by one segment of an organization for a product or service supplied to another segment of the same organization.
A corporation maintains a manufacturing division that manufactures printed circuit boards and an assembly division that produces final products. Currently, the manufacturing division has sufficient capacity to manufacture an additional 5,000 circuit boards. An external market exists for circuit boards. The market price for one circuit board is $80 and the cost to sell is $10. The fixed manufacturing cost per circuit board is $15 and the unit variable cost is $50. The assembly division plans to purchase 4,500 circuit boards. Management of the assembly division thinks that it can purchase from the manufacturing division at a lower price since both divisions are under common control of the corporation. What is the minimum transfer price between the manufacturing division and the assembly division?
A. $50
B. $65
C. $70
D. $80
A. $50
By allowing the buyer to purchase at the selling division’s variable cost, unused production capacity will be utilized. This method should only be used when the selling division has excess capacity. The minimum transfer price between the manufacturing division and the assembly division is the unit variable cost of $50.
Division A of a company is currently operating at 50% capacity. It produces a single product and sells all its production to outside customers for $13 per unit. Variable costs are $7 per unit, and fixed costs are $6 per unit at the current production level. Division B, which currently purchases this product from an outside supplier for $12 per unit, would like to purchase the product from Division A. Division A will operate at 80% capacity to meet outside customers’ and Division B’s demand. What is the minimum price that Division A should charge Division B for this product?
A. $13.00 per unit
B. $7.00 per unit
C. $9.60 per unit
D. $12.00 per unit
B. $7.00 per unit
From the seller’s perspective, the price should reflect at least its incremental cash outflow (outlay cost) plus the contribution from an outside sale (opportunity cost). Because A has idle capacity, the opportunity cost is $0. Thus, the minimum price Division A should charge Division B is $7.00
A company uses negotiated transfer prices between divisions. All of the following are advantages for this type of transfer pricing model except that negotiated transfer prices
A. Allow divisions to make their own decisions
B. Are useful for evaluating individual division performance
C. Are simple and quick to implement
D. Achieve goal congruence
C. Are simple and quick to implement
Due to the nature of negotiations, both parties involved in the transfer must discuss options and come to an agreement about the appropriate transfer price. Thus, negotiated transfer prices take longer to implement than most other transfer prices.
Which one of the following is an incorrect description of transfer pricing?
A. It measures exchanges between a company and external customers
B. If no market price exists, the transfer price may be based on cost
C. It measures the value of goods or services furnished by a profit center to other responsibility centers within a company
D. If a market price exists, this price may be used as a transfer price
A. It measures exchanges between a company and external customers
Transfer prices are the amounts charged by one segment of an organization for goods and services it provides to another segment of the same organization. They are not for exchanges with external customers.
A manufacturer has several divisions and evaluates performance using segment income. Since sales include transfers to other divisions, the manufacturer has established a price for internal sales as cost plus 10%. Red Division has requested 10,000 units of Green Division’s product. Green Division is selling its product externally at a 60% markup over cost. The corporate policy will encourage the Green Division to
A. Transfer the product to the Red Division if it does not require the Green Division to give up any external sales
B. Accept the sale to the Red Division if it is operating at full capacity and the sale will contribute to fixed costs
C. Reject the sale to the Red Division because it does not provide the same markup as external sales
D. Transfer the product to the Red Division because all costs are being covered and the division will earn a 10% profit
A. Transfer the product to the Red Division if it does not require the Green Division to give up any external sales
External sales are clearly more profitable to the company because of the large markup the Green Division charges outside customers. Thus, the modest profit made on product transferred to the Red Division is acceptable only if no outside (i.e., more profitable) sales are given up.
Manhattan Corporation has several divisions that operate as decentralized profit centers. At the present time, the Fabrication Division has excess capacity of 5,000 units with respect to the UT-371 circuit board, a popular item in many digital applications. Information about the circuit board follows.
- Market price: $48
- Variable selling/distribution costs on external sales: 5
- Variable manufacturing cost: 21
- Fixed manufacturing cost: 10
Manhattan’s Electronic Assembly Division wants to purchase 4,500 circuit boards either internally, or else use a similar board in the marketplace that sells for $46. The Electronic Assembly Division’s management feels that if the first alternative is pursued, a price concession is justified, given that both divisions are part of the same firm.
To optimize the overall goals of Manhattan, the minimum price to be charged for the board from the Fabrication Division to the Electronic Assembly Division should be
A. $31
B. $46
C. $21
D. $26
C. $21
For a manufacturing division with excess capacity, variable costs are the only costs that the division can demand be covered by the purchasing division.
In theory, the optimal method for establishing a transfer price is
A. Flexible budget cost.
B. Market price.
C. Incremental cost.
D. Budgeted cost with or without a markup.
B. Market price.
Transfer prices should promote congruence of subunit goals with those of the organization, subunit autonomy, and managerial effort. Although no rule exists for determining the transfer price that meets these criteria in all situations, a starting point is to calculate the sum of the additional outlay costs and the opportunity cost to the supplier. Given no idle capacity and a competitive external market (all goods transferred internally can be sold externally), the sum of the outlay and opportunity costs will be the market price.
