127) 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
$
32
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?
102
128) The following information is available for the two divisions of MAC Company:
Division A:
Selling price to outside market
$
55
Standard unit-level costs
35
Division B:
Selling price of finished product
$
95
Standard unit-level costs
25
Division A has no excess production capacity.
Required:
a) In order to ensure the best use of the productive capacity of Division 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?
b) Should Division B accept a special order for its product if the selling price is reduced to $70.
Use your answer from (a) and explain.
c) Would your answer to (b) change if Division A had excess capacity? Explain.
104
129) Division X has asked Division K of the Easton Company to supply it with 5,000 units of
part L433 this year to use in one of its products. Division X has received a bid from an outside
supplier for the parts at a price of $26.00 per unit. Division K has the capacity to produce 30,000
units of part L433 per year. Division K expects to sell 26,000 units of part L433 to outside
customers this year at a price of $30.00 per unit. To fill the order from Division X, Division K
would have to cut back its sales to outside customers. Division K produces part L433 at a
variable cost of $21.00 per unit. The cost of packing and shipping the parts for outside customers
is $2.00 per unit. These packing and shipping costs would not have to be incurred on sales of the
parts to Division X.
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 5,000 parts this year from Division K to Division X?
b. Is it in the best interest of the Easton Company overall for this transfer to take place? Explain.
106
130) 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 is currently 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 currently 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 interest of Pomme Corporation for this transfer to take place? Explain.
131) Randolph Company has two divisions organized as profit centers: Redmon and Tomlin.
107
Randolph expects the following results in the coming period:
Redmon
Tomlin
sales
Redmon: (10,000 × $16)
$
1,600,000
Tomlin: (250,000 × $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.
132) Why is transfer pricing only a concern for profit or investment centers and not for cost or
revenue centers?
133) Explain the general principle for determining the optimal transfer price.
134) What is meant by a dual transfer pricing system? What are some advantages and
disadvantages of it?
135) What are the limitations of market-based transfer prices?
136) What are the advantages and disadvantages of using a negotiated transfer price?
137) Why is transfer pricing important in tax accounting?
111
138) What are the principal items that must be disclosed about each segment and how does this
differ if a company has significant foreign operations?
139) 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.
140) Midland Incorporated 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.
a) Standard cost.
b) Full absorption cost.
c) Actual cost.
141) Mr. Massee, 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
the Brake Division, which provides a part used by the Wheel Division, because he has noticed
that the 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:
Assume you are the friend that Mr. Massee calls. 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.
142) Ms. Clarke, one of the marketing managers, has come to the meeting with a number of
reports about one of her products. The Vice President of Marketing sees her agitation and asks
her what the problem is. “Well, the product made by the East Coast Division is losing sales even
after the price had been lowered drastically. The manager of the division is threatening to close
because of the reduced demand.”
The Vice President of Marketing asks why the lowered prices are a problem and Ms. Clarke says
that, according to the manager, the price used to transfer the goods to the Southern Division are
based on market price and, with the lowered market price, the unit-level costs are no longer
being covered and he is losing money on every transfer as well as every third-party sale.
Required:
Explain further to the Vice President of Marketing the issues involved in transfer pricing when
there are distressed market prices.
143) Briefly discuss some of the general issues of multinational transfer pricing.
144) During the current year, Tuesday Company’s foreign Division A incurred production costs
of $4 million for units that are transferred to its other foreign Division B. Costs in Division B,
outside of the costs of production of the final product, are $8 million. These are third-party costs.
Sales revenue for the final product for Division B is $30 million. Other companies in the same
country import a similar type of part as Division B at a cost of $7 million. Tuesday has set its
transfer price at $14 million, justifying this price because of the special controls it has on the
operations in Division A as well as its special manufacturing method. The tax rate in the country
where Division A is located is 40% while the tax rate for Division B’s country is 70%.
Required:
a) What would Tuesday’s total tax liability for both divisions be if it used the $7 million transfer
price?
b) What would the total tax liability be if it used the $14 million transfer price?
145) How do import duties affect transfer pricing?
146) 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?
147) Briefly discuss transfer prices in relation to external segment reporting under GAAP.