132. The manager of the processing division of XYZ Corporation is considering the purchase of
new equipment, which would modernize an aging plant. Currently, the division has an asset base
of $8,000,000 and net operating income of $1,200,000. The new equipment is expected to cost
$1,000,000; it supports the corporate strategy of competing on the basis of quality and customer
response time (CRT). The new investment is also expected to increase operating income by
$100,000 next year, which is an acceptable return on investment (ROI) from the standpoint of
corporate management.
Required:
1. What is the current ROI for the processing division of XYZ Corporation? (Show calculations.)
2. What will be the divisional ROI if the new investment is undertaken?
3. Suppose that the compensation contract for the manager of the processing division consists of
a base salary plus a bonus that is proportional to the ROI earned by the division. Is this
manager’s total compensation higher with or without the new investment? (Show calculations.)
4. What changes to the divisional manager’s compensation contract might corporate
management make that would better align divisional manager’s compensation (and performance
evaluation) with overall corporate goals?
133. The following questions pertain to the process of transfer pricing.
1. Define the term “transfer price.”
2. What the three general alternatives for setting domestic transfer prices?
3. What is meant by the term “dual pricing,” as used within the context of the transfer pricing
decision? Give one example of “dual pricing.”
4. What criteria can be used to judge a particular transfer pricing alternative? (
Hint
: think about
the different objectives of transfer pricing, including objectives in an international setting.)
5. What is meant by the term “advance pricing agreement” (APA)? What is the essential purpose
of an APA?
134. The text presents what it calls a “general transfer-pricing” rule that can be used to help
set an appropriate transfer price. The following questions pertain to this general rule.
Required:
1. Present, in equation form, the general transfer-pricing rule presented in the chapter. Briefly
describe the elements of the model.
2. In what sense is the model presented in the chapter a
general
transfer-pricing rule?
3. Evaluate the general transfer-pricing rule in light of the objectives for transfer pricing that are
presented in the chapter.
4. What are some of the major implementation issues associated with applying the general
transfer-pricing rule in practice?
135. What special problems
and
opportunities arise in setting transfer prices in an
international setting (i.e., for transfers between subunits that operate in different countries)?
Hint: In terms of special problems, make sure you reference OECD requirements and practical
implementation alternatives for general OECD requirements.)
136. What are the principal advantages and disadvantages of using cost-based transfer
prices? (Give a short explanation of each item you list.)
137. The text notes that there are various objectives of transfer pricing. This raises the
possibility of using multiple transfer pricing alternatives. For example, an organization could use
one transfer pricing alternative for domestic transfers and another alternative for transnational
transfers.
Required:
1. Provide a reason why an organization might choose a particular transfer pricing alternative for
domestic transfers and a different transfer pricing alternative for international transfers.
2. Provide a reason why an organization may
not
want to use two different transfer pricing
systems, one for domestic transfers and another for international transfers.
138. As noted in the text (Chapter 19), the use of market price can be used to set the transfer
price associated with interdivisional transfers of goods and services.
Required:
1. What are the primary
advantages
of using market price as the transfer price?
2. What are the primary
disadvantages
of using market price as the transfer price?
139. Assume the following facts regarding a product that Division P can sell internally (to
Division B) or externally on the open market. Incremental (i.e., out–of-pocket) cost to Division P
for each unit produced = $12. External purchase price, to be paid by Division B = $13.50. Total
units needed (annually) by Division B = 1,000.
Required:
1. Assume that there are no alternative uses for Division P‘s facilities. Determine whether the
company as a whole will benefit if Division B purchases the product externally. At what amount
should the transfer price be set such that each divisional manager, acting in the best interest of
his or her own division, take actions that are in the best interest of the company as a whole?
2. Assume that Division P’s facilities would not otherwise be idle if it didn’t produce the product
for Division B. By not producing the product for Division B, the freed-up facilities would be used
to generate a net cash benefit of $1,800. Should Division B purchase from suppliers? (Show
calculations.)
3. Assume that for the foreseeable future there are no alternative uses for Division P’s facilities,
and that the outside supplier’s cost to Division B drops by $2. Under this circumstance, should
Division B purchase externally? At what amount should the transfer price be set such that each
divisional manager, acting in the best interest of his or her division, would take actions that are in
the best interest of the company as a whole?
140. Assume two divisions, P (producing) and B (buying) of a company are both treated as
investment centers for performance-evaluation purposes. Division B requires 1,000 units of
product that it can either purchase externally on the open market for $13.50 per unit, or obtain
internally from Division P. The incremental (i.e., out–of-pocket) costs to Division P are estimated
at $12.00 per unit. Because of spot shortages of this product in the open market, it is sometimes
possible for Division P to sell at a price higher than the normal market price. Such is currently the
case: Division P has an offer to sell 1,000 units at a gross selling price of $15.50 per unit. In
addition to the normal incremental production costs, Division P would have to pay a $0.50 sales
commission cost for each unit sold externally.
Required:
1. If Division B purchased the units externally, would the firm as a whole benefit or lose (in terms
of a short-term financial impact)? Show calculations.
2. Apply the general transfer-pricing model to this situation. What is the minimum transfer price
indicated for each of the 1,000 units in question? Show calculations.
3. What is the likely consequence, from a decision standpoint, if the transfer price is set at the
amount stipulated by the general transfer-pricing rule?
141. Assume two divisions of a company, P (producing) and B (buying), that are treated as
investment centers for performance-evaluation purposes. As the management accountant, you’ve
been asked to provide input to the determination of the appropriate transfer price for an
exchange of product between these two divisions. In case #1, Division P is experiencing a
capacity constraint, while in case #2 it is assumed that Division P has excess capacity. The
incremental production cost incurred by Division P, to the point of transfer, is $80.00 per unit.
Division P can sell its output externally for $120.00 per unit, less a sales commission charge of
$5.00 per unit. Currently, Division B is purchasing the product from an external supplier at
$120.00 per unit, plus a $3.00 transportation charge per unit.
Required:
1. Assume that Division P has limited capacity. Thus, for each unit it sells internally, it loses the
opportunity to sell that unit externally. Use the general transfer-pricing rule to determine the
minimum
transfer price for internal transfers of units, that Division P would charge Division B.
From the standpoint of Division P, why is the figure you calculated considered an acceptable
transfer price?
2. What is the
maximum
transfer price that Division B would be willing to pay per unit on any
internal transfers?
3. If top management of the company allows the managers of Divisions P and B to negotiate a
transfer price, what is the likely range of possible transfer prices?
4. Assume now that Division P has excess capacity. Use the general transfer-pricing rule to
determine the
minimum
transfer price that Division P would be willing to accept from Division B
for any internal transfers. Would this transfer price motivate the correct economic decision
(internal versus external transfer) from the standpoint of the company as a whole? Explain.
5. Given the situation described above in (4), would top management of the company want the
transfer to take place internally? Why? (Show calculations, if appropriate.) How could top
management ensure that an internal transfer would take place?