Chapter 20 – Transfer pricing in divisionalized companies
MULTIPLE CHOICE
1. Transfer pricing is used when:
a.
multiple cost centres are conducting business within the company.
b.
a decentralized company has profit centres or investment centres.
c.
the return on investment ratio cannot be computed.
d.
a company is transferring goods to the government.
2. When an outside market exists for an intermediate product that is perfectly competitive, the ideal
method of transfer pricing is often:
a.
market price.
b.
the one that creates the highest margin to the selling unit.
c.
one that is higher than what the outside market is quoting.
d.
based on management accounting numbers.
3. A transfer pricing system should satisfy which of the following objectives?
a.
accurate performance evaluation
b.
goal congruence
c.
preservation of divisional autonomy
d.
all of the above
4. The opportunity cost approach to setting a transfer price would set the minimum transfer price as
a.
the opportunity cost of the firm as a whole.
b.
the opportunity cost of the selling division.
c.
the opportunity cost of the buying division.
d.
none of the above.
5. The opportunity cost approach to setting a transfer price would set the maximum transfer price as
a.
the opportunity cost of the firm as a whole.
b.
the opportunity cost of the selling division.
c.
the opportunity cost of the buying division.
d.
none of the above.
6. The optimal transfer price from the viewpoint of the company is
a.
variable cost.
b.
absorption cost plus markup.
c.
variable cost plus opportunity cost.
d.
absorption cost plus selling expenses.
7. When there is an outside market for an intermediate product which is perfectly competitive, the most
equitable method of transfer pricing is
a.
market price.
b.
production cost pricing.
c.
variable cost pricing.
d.
cost plus markup pricing.
8. If it is available, the correct transfer price is
a.
the market price from a perfectly competitive market.
b.
the negotiated transfer price.
c.
the variable production costs of the firm.
d.
none of the above.
9. A selling division produces components for a buying division that is considering accepting a special
order for the products it produces. The selling division has excess capacity. The minimum price the
selling division would be willing to accept is
a.
the selling division’s variable costs.
b.
the buying division’s outside purchase price.
c.
the price that would allow the buying division to cover its incremental cost of the special
order.
d.
the price that would allow the selling division to maintain its current ROI.
10. A selling division produces components for a buying division that is considering accepting a special
order for the products it produces. The selling division has excess capacity. The maximum price the
buying division would be willing to accept is
a.
the selling division’s variable costs.
b.
the buying division’s outside purchase price.
c.
the price that would allow the buying division to cover its incremental cost of the special
order.
d.
the price that would allow the selling division to maintain its current ROI.
11. Which of the following types of transfer prices do NOT encourage the selling division to be efficient?
a.
transfer prices based upon market prices
b.
transfer prices based upon actual costs
c.
transfer prices based upon standard costs
d.
transfer prices based upon standard costs plus a markup for profit
12. Which of the following is a legitimate disadvantage of negotiated transfer pricing?
a.
Negotiated based transfer pricing fails to provide adequate autonomy to divisional
managers.
b.
Negotiated based transfer prices will always be higher than market price.
c.
Negotiated based transfer prices usually fail to allow the seller to cover variable costs.
d.
Negotiated prices may lead to some less than optimal decisions.
13. In a negotiated transfer price,
a.
market prices may not be suitable.
b.
opportunity costs could be used to set boundaries.
c.
buyers and sellers influence the transfer price set.
d.
All of the above are true.
14. Negotiated prices transfer prices are:
a.
determined between a division and corporate headquarters.
b.
negotiated with external customers.
c.
used when supplying and buying divisions independently agree on a price.
d.
agreed to by division management and unions.
15. ____ is when the transfer price is computed equal to a sales price received by the reseller less an
appropriate markup.
a.
Advance pricing agreement
b.
Comparable uncontrolled price approach
c.
Cost-plus approach
d.
Resale price method
Figure 20-1
Universe Industries has two divisions: the Haley Division and the Comet Division. Information about a
component that the Haley Division produces is as follows:
Sales
£120 per unit
Variable manufacturing costs
£30 per unit
Fixed manufacturing overhead
£20 per unit
Expected sales in units
4,000 units
The Haley Division can produce up to 5,000 components per year. The Comet Division needs 200
units of the component for a product it manufactures.
16. Refer to Figure 20-1. The maximum transfer price that the Comet Division would be willing to pay is
a.
£120.
b.
£70.
c.
£50.
d.
£30.
17. Refer to Figure 20-1. The minimum transfer price that the Haley Division would be willing to accept is
a.
£120.
b.
£70.
c.
£50.
d.
£30.
18. Refer to Figure 20-1. If the selling division did NOT have excess capacity, the minimum transfer price
the selling division would be willing to accept is
a.
£120.
b.
£75.
c.
£50.
d.
£30.
Figure 20-2
Klaehn Industries is a decentralized company that evaluates its divisions based on ROI. The Fahl
Division has the capacity to make 1,000 units of a component. The Fahl Division’s variable costs are
£40 per unit.
The Melton Division can use the component in one of its products. The Melton Division would incur
£50 of variable costs to convert the component into its own product that sells for £160.
19. Refer to Figure 20-2. Assume the Fahl Division can sell all that it produces for £100 each. The Melton
Division needs 100 units. What is the correct transfer price?
a.
£120
b.
£110
c.
£100
d.
£60
20. Refer to Figure 20-2. Assume the Fahl Division can sell 800 units at £120 each. Any excess capacity
will be unused unless the units are purchased by the Melton Division, which could use up to 100 units.
The minimum transfer price that the Fahl Division would be willing to accept would be
a.
£120.
b.
£110.
c.
£100.
d.
£40.
21. Refer to Figure 20-2. Assume the Fahl Division can sell 800 units at £120 each. Any excess capacity
will be unused unless the units are purchased by the Melton Division, which could use up to 100 units.
The maximum transfer price that the Melton Division would be willing to pay would be
a.
£120.
b.
£110.
c.
£100.
d.
£60.
Figure 20-3
The Adam Division produces a component that is used by the West Division. The cost of
manufacturing the component is as follows:
Direct materials
Direct labour
Variable overhead
Fixed overheada
Total cost
aBased on a practical volume of 250,000 components
Other costs incurred by the Adam Division are as follows:
Fixed selling and administrative
Variable selling
The component usually sells for £90 in the external market. The Adam Division is capable of
producing 250,000 components per year; however, only 200,000 components are expected to be sold
next year. The variable selling expenses are avoidable if the component is sold internally.
The West Division has been buying the same component from an external supplier for £80 each. The
West Division expects to use 40,000 units of the component next year. The manager of the West
Division has offered to buy 40,000 units from the Adam Division for £56 each.
22. Refer to Figure 20-3. The minimum transfer price that the Adam Division would accept is
a.
£60.
b.
£50.
c.
£48.
d.
£30.
23. Refer to Figure 20-3. The maximum transfer price that the West Division would be willing to pay is
a.
£90.
b.
£60.
c.
£48.
d.
£38.
24. Refer to Figure 20-3. The effect on firmwide income if 40,000 components are transferred internally at
£56 each instead of purchased from an external supplier at £80 per unit would be a
a.
£1,920,000 decrease.
b.
£1,280,000 increase.
c.
£960,000 decrease.
d.
£960,000 increase.
Figure 20-4
The Simonds Division produces a component that is used by the Allen Division. The cost of
manufacturing the component is as follows:
Direct materials
£10
Direct labour
6
Variable overhead
4
Fixed overheada
__5
Total cost
£25
aBased on a practical volume of 400,000 components
Other costs incurred by the Simonds Division are as follows:
Fixed selling and administrative
£400,000
Variable selling
£1.50 per unit
The component usually sells for £35 in the external market. The Simonds Division is capable of
producing 500,000 components per year; however, only 400,000 components are expected to be sold
next year. The variable selling expenses are avoidable if the component is sold internally.
The Allen Division has been buying the same component from an external supplier for £34 each. The
Allen Division expects to use 50,000 units of the component next year. The manager of the Allen
Division has offered to buy 50,000 units from the Simonds Division for £22.50 each.
25. Refer to Figure 20-4. The minimum transfer price that the Simonds Division would accept is
a.
£25.
b.
£21.
c.
£20.
d.
£16.
26. Refer to Figure 20-4. The maximum transfer price that the Allen Division would be willing to pay is
a.
£20.00.
b.
£25.00.
c.
£26.50.
d.
£34.00.
27. Refer to Figure 20-4. The effect on firmwide income if 50,000 components are transferred internally at
£22.50 each instead of purchased from an external supplier at £34 per unit would be a
a.
£700,000 increase.
b.
£700,000 decrease.
c.
£575,000 increase.
d.
£575,000 decrease.
Figure 20-5
Allied Industries has two divisions: the Bradley Division and the Rommel Division. Information about
the component that the Bradley Division produces is as follows:
Sales
£180 per unit
Variable manufacturing costs
£80 per unit
Fixed manufacturing overhead
£50 per unit
Expected sales in units
10,000 units
The Bradley Division can produce up to 12,000 components per year. The Rommel Division needs
800 units of the component for a product it manufactures.
28. Refer to Figure 20-5. The minimum transfer price that the Bradley Division would be willing to accept
is
a.
£50.
b.
£80.
c.
£130.
d.
£180.
29. Refer to Figure 20-5. The maximum transfer price that the Rommel Division would be willing to pay
is
a.
£50.
b.
£80.
c.
£130.
d.
£180.
30. Refer to Figure 20-5. If the selling division did NOT have excess capacity, the minimum transfer price
the selling division would be willing to accept would be
a.
£50.
b.
£80.
c.
£130.
d.
£180.
Figure 20-6
Callahan Industries is a decentralized company that evaluates its divisions based on ROI. The Jones
Division has the capacity to make 5,000 units of a component. The Jones Division’s variable costs are
£200 per unit.
The Thomas Division can use the component in one of its products. The Thomas Division would incur
£100 of variable costs to put the component in its own product that sells for £500.
31. Refer to Figure 20-6. The Jones Division can sell all that it produces for £360 each. The Jones
Division needs 200 units. What is the correct transfer price?
a.
£400
b.
£200
c.
£420
d.
£360
32. Refer to Figure 20-6. Assume the Jones Division can sell 4,000 units at £420. Any excess capacity will
be unused unless the units are purchased by the Thomas Division, which could use up to 200 units.
The minimum transfer price that the Jones Division would be willing to accept would be
a.
£400.
b.
£200.
c.
£420.
d.
£360.
33. Refer to Figure 20-6. Assume the Jones Division can sell 4,000 units at £420. Any excess capacity will
be unused unless the units are purchased by the Thomas Division, which could use up to 200 units.
The maximum transfer price that the Thomas Division would be willing to pay would be
a.
£400.
b.
£200.
c.
£420.
d.
£360.
Figure 20-7
The Engine Division provides engines for the Tractor Division of a company. The standard unit costs
for Engine Division are as follows:
Direct materials
£ 600
Direct labour
1,200
Variable overhead
300
Fixed overhead
150
Market price per unit
2,730
34. Refer to Figure 20-7. What is the best transfer price to avoid transfer price problems?
a.
£2,730
b.
£600
c.
£1,800
d.
£2,100
35. Refer to Figure 20-7. The engine department has excess capacity. What is the best transfer price to
avoid transfer price problems?
a.
£1,350
b.
£300
c.
£900
d.
£2,100
Figure 20-8
Pautner Company had the following historical accounting data per unit:
Direct materials
£60
Direct labour
30
Variable overhead
15
Fixed overhead
24
Variable selling expenses
45
Fixed selling expenses
9
The units are normally transferred internally from Division A to Division B. The units also may be
sold externally for £210 per unit. The minimum profit level accepted by the company is a markup of
30 per cent. There were no beginning or ending inventories.
36. Refer to Figure 20-8. What would be the transfer price if Division X uses full cost plus markup?
a.
£167.70
b.
£198.90
c.
£136.50
d.
£129.00
37. Refer to Figure 20-8. If variable manufacturing costs without a fixed fee are used as the transfer price,
Division A’s transfer price would be
a.
£60.
b.
£90.
c.
£105.
d.
£144.
Figure 20-9
Miggs Manufacturing has one plant located in Belgium and another plant located in the United States.
The Belgium plant manufactures a component used in a finished product manufactured at the U.S.
plant. Currently, the Belgium plant is operating at 70 per cent capacity. In Belgium, the income tax
rate is 42 per cent; in the United States, the corporate income tax rate is 35 per cent.
The market price of the component is £200 and the Belgium plant’s costs to manufacture the
component are as follows:
Direct materials
£20
Direct labour
40
Variable overhead
10
Fixed overhead
30
38. Refer to Figure 20-9. What is the minimum transfer price that the Belgium division would be willing
to accept?
a.
£70
b.
£110
c.
£120
d.
£200
39. Refer to Figure 20-9. What is the maximum transfer price that the U.S. division would be willing to
pay?
a.
£70
b.
£110
c.
£120
d.
£200
40. Refer to Figure 20-9. Which transfer price would be in the best interest of the overall company?
a.
£70
b.
£110
c.
£120
d.
£200
41. Conner Manufacturing has one plant located in Italy and another plant located in the United States.
The Italian plant manufactures a component used in a finished product manufactured at the U.S. plant.
Currently, the Italian plant is operating at 75 per cent capacity. In Italy, the income tax rate is 32 per
cent; in the United States, the corporate income tax rate is 35 per cent.
The market price of the component is £240 and the Italian plant’s costs to manufacture the component
are as follows:
Direct materials
£60
Direct labour
40
Variable overhead
20
Fixed overhead
30
Which transfer price would be in the best interest of the overall company?
a.
£120
b.
£100
c.
£150
d.
£240
Figure 20-10
Gregg Manufacturing has one plant located in Belgium and another plant located in the United States.
The Belgium plant manufactures a component used in a finished product manufactured at the U.S.
plant. Currently, the Belgium plant is operating at 70 per cent capacity. In Belgium, the income tax
rate is 30 per cent; in the United States, the corporate income tax rate is 35 per cent.
The market price of the component is £280 and the Belgium plant’s costs to manufacture the
component are as follows:
Direct materials
£30
Direct labour
50
Variable overhead
12
Fixed overhead
56
42. Refer to Figure 20-10. What is the minimum transfer price that the Belgium division would be willing
to accept?
a.
£280
b.
£148
c.
£136
d.
£92
43. Refer to Figure 20-10. What is the maximum transfer price that the U.S. division would be willing to
pay?
a.
£280
b.
£148
c.
£136
d.
£92
44. British International has a division in the United States that produces tires for automobiles. These tires
are transferred to an automobile division in Germany. The tires can be (and are) sold externally in the
United States for £60 each. The cost to produce a tire is £40. It costs £3 per tire for shipping and £5 per
tire for import duties. When the tires are sold externally, British International spends £2 per tire for
commissions and an average of £1 per tire for advertising. An acceptable markup is 30 per cent of
costs.
What is the transfer price if the cost-plus method is used?
a.
£78.00
b.
£60.00
c.
£84.50
d.
£52.00
45. In most cases, ____ transfer prices achieve the optimal outcome for both the divisions and the
company as a whole.
a.
cost-based
b.
market-based
c.
negotiated
d.
all of the above
46. If the divisions exchanging goods are located in different countries with different tax rate structures,
the key determinant of transfer prices could be based largely on:
a.
variable costs.
b.
negotiations.
c.
market prices.
d.
tax minimization strategy.
PROBLEM
1. Chantilly Industries has two divisions: the Triangle Division and the Square Division. The Triangle
Division produces a component that is used by the Square Division. Information about that component
is as follows:
Sales
£200 per unit
Variable manufacturing costs
£80 per unit
Fixed manufacturing overhead
£50 per unit
Expected sales in units
12,000 units
The Triangle Division can produce up to 15,000 components per year. The Square Division needs
1,500 units of the component for a product it manufactures.
Required:
a.
Determine the minimum transfer price that the Triangle Division would accept.
b.
Determine the maximum transfer price that the Square Division would pay.
c.
If the Triangle Division produces and sells 15,000 units in a highly competitive market, what
would be the correct transfer price?
2. Halber Industries is a decentralized company that evaluates its divisions based on ROI. The Brock
Division has the capacity to make 2,000 units of a component. The Brock Division’s variable costs
are £80 per unit.
The Cliff Division can use the Brock component in the manufacturing of one of its own products.
The Cliff Division would incur £60 of variable costs to convert the component into its own product,
which sells for £300.
Required:
The following requirements are independent of each other:
a.
Assume the Brock Division can sell all of the components that it produces for £180 each. The
Cliff Division needs 100 units. What is the correct transfer price?
b.
Assume the Brock Division can sell 1,800 units at £260. Any excess capacity will be unused
unless the units are purchased by the Cliff Division, which could use up to 100 units.
Determine the minimum transfer price that the Brock Division would be willing to accept.
Determine the maximum transfer price that the Cliff Division would be willing to pay.
a.
£180 The market price
b.
Minimum: £80 Variable manufacturing cost
Maximum: £240 The transfer price that results in a zero contribution
margin on the goods for the buying division (£300 – £60)
3. Brown Industries has two divisions: the Hank Division and the Murray Division. Information about a
component that the Hank Division produces is as follows:
Sales
£150 per unit
Variable manufacturing costs
£60 per unit
Fixed manufacturing overhead
£40 per unit
£80 The variable manufacturing cost
b.
£200 The market price
Expected sales in units
20,000 units
The Hank Division can produce up to 22,000 components per year. The Murray Division needs 1,000
units of the component for a product it manufactures.
Required:
a.
Determine the minimum transfer price that the selling division would be willing to accept.
b.
Determine the maximum transfer price that the buying division would be willing to pay.
c.
If the Hank Division did not have excess capacity, what would be the correct transfer price?
4. The Kelly Division of Zimmer Company sells all of its output to the Finishing Division of the
company. The only product of the Kelly Division is chair legs that are used by the Finishing Division.
The retail price of the legs is £20 per leg. Each chair completed by the Finishing Division requires four
legs. Production quantity and cost data for 2011 are as follows:
Chair legs
£30,000
Direct materials
£135,000
Direct labour
£90,000
Factory overhead (25% is variable)
£90,000
Operating expenses (20% is variable)
£150,000
Required:
Compute the transfer price for a chair leg using:
a.
market price.
b.
variable product costs plus a fixed fee of 20 per cent.
c.
full cost plus 20 per cent markup.
d.
variable costs.
e.
full cost plus 10 per cent markup.
a.
£20
1.20 [£135,000 + £90,000 + (0.25 £90,000)]/30,000 = £9.90
1.20 (£135,000 + £90,000 + £90,000)/30,000 = £12.60
(0.20 £150,000)]/30,000 = £9.25
[1.10 (£135,000 + £90,000 + £90,000 + £150,000)]/30,000 = £17.05
a.
£60
The variable manufacturing cost per unit
b.
£150
The market price
c.
£150
The market price
5. The Bat Division of Baseball Company has just revised its actual cost data for 2011. Bat Division
transfers goods to the Sport Division. Sport Division can buy the same goods in the open market for
£122 each. Bat’s new cost data are as follows:
Direct materials
£ 40
Direct labour
30
Variable overhead
10
Fixed overhead
16
Variable selling expenses
6
Fixed selling and administrative expenses
__12
Total costs
£114
Desired return
__20
Sales price
£134
Current production is 200,000 units, and the Bat Division has a capacity of 300,000 units.
Required:
a.
What is the lowest price the Bat Division should charge for the internal transfers of its goods?
b.
What is the highest price the Sport Division should pay for the units?
c.
Give the primary reason why the Bat Division should reduce its price.
6. Bernie Manufacturing Company has two divisions, X and Y. Division X prepares the steel for
processing. Division Y processes the steel into the final product. No inventories exist in either division
at the beginning or end of 2011. During the year, Division X prepared 80,000 kgs. of steel at a cost of
£800,000. All the steel was transferred to Division Y where additional operating costs of £5 per kg.
were incurred. The final product was sold for £3,000,000.
Required:
a.
Determine the gross profit for each division and for the company as a whole if the transfer
price is £8 per kg.
b.
Determine the gross profit for each division and for the company as a whole if the transfer
price is £12 per kg.
Sales
Cost of goods sold
Gross profit
a.
Lowest price would be total variable costs per unit; (£40 + £30 + £10 + £6) = £86.
b.
Highest price would be the open market price: £122.
which amounts to a 29.5 per cent contribution margin ratio on the £122 open market price.
7. Flugel Enterprises is a decentralized company that evaluates its divisions based on their reported return
on investment. One of Flugel’s divisions, the Pipe division, manufactures pipe fittings that are used by
the Equipment division as well as other users outside the organization. Pipe has the capacity to make
only 3,000 of these fittings at a variable cost of £12 per fitting. Fixed costs of the Pipe division are
£90,000 per period and include costs that are common to other products the Pipe division makes. Fixed
costs allocated to the fittings sold to the Equipment division are £24,000 per period.
The Equipment division uses the fittings and incurs £100 per unit of additional variable costs to make
the equipment that sells on the open market for £150. Equipment expects to sell 1,000 pieces of
equipment this period. Fixed costs of this division related to depreciation on past expenditures are
estimated at £30,000.
Fittings like those transferred from Pipe to Equipment sell on the open market for £25 each.
Top management of the organization allows divisions to negotiate transfer prices and has a policy of
not inferring with the negotiation process.
Required:
a.
What is the absolute minimum price Pipe would accept from Equipment for the fittings if Pipe
has excess capacity? State any assumptions necessary to answer the question.
b.
What is the maximum price Equipment would pay the Pipe division for the fittings?
c.
What is the minimum price Pipe would accept if Pipe is operating at capacity to fill orders for
these fittings on the open market?
incurred in making the fittings. This assumes there is no opportunity cost or usage for the
excess capacity and that all fixed costs (included those allocated to this product) are sunk.
are sunk. Therefore, it is advantageous to them to pay £25 for the fittings even if they fail to
cover all fixed costs this period.
internally to Equipment, it foregoes the opportunity to sell the fitting for £25 on the open
ESSAY
1. What is the role of transfer pricing in a decentralized firm?