Income taxes (0.40 × $6)
2.40
Increase in division income per unit after tax
$ 3.60
From Castor:
Revenue per unit
$120.00
Transfer price per unit
70.00
Contribution margin per unit
50.00
Income taxes (0.30 × $50)
15.00
Increase in division income per unit after tax
$ 35.00
Increase in Gemini’s income = $3.60 + $35.00 = $38.60
This net income is greater than the $33.70 net income that Gemini would earn if Pollux
accepted the special order. It is less than the $39.20 that Gemini would earn if Pollux had
transferred IP-2014 at $64 per unit. Of course, if the transfer price is set at $64 per unit, Pollux
would accept the special order, which would lead to a lower net income of $33.70. If Gemini
wants to get the benefits of decentralization, it must be willing to suffer the consequences of
higher taxes that Pollux would have to pay.
Note that Gemini would not want to set the transfer price any higher than $70, the
minimum transfer price that would induce Pollux to transfer internally to Castor. Why? Because
setting the transfer price any higher would result in exactly the same action (transferring IP–2014
internally) but at a higher cost because of the higher taxes that Pollux would have to pay in
Canada. Consider for example a transfer price of $75 per unit. The increase in Gemini’s income
will be as follows:
From Pollux:
Revenue per unit
$75.00
Variable cost per unit
64.00
Contribution margin per unit
11.00
Income taxes (0.4 × $11)
4.40
Increase in division income per unit after tax
$ 6.60
From Castor:
Revenue per unit
$120.00
Transfer price per unit
75.00
Contribution margin per unit
45.00
Income taxes (0.30 × $45)
13.50
Increase in division income per unit after tax
$ 31.50
Increase in Gemini’s income is $6.60 + $31.50 = $38.10, which is less than the $38.60 Gemini
earns if the transfer price is set at $70 per unit. A transfer price of $70 is the most tax-efficient
transfer price consistent with Gemini operating as a decentralized organization. Note also that
the transfer price cannot be set above $77 per unit because then Castor would buy a product
similar to IP-2014 in the United States rather than from Pollux.
22-34 (20 min.) Transfer pricing, goal congruence, ethics.
Sustainable Industries manufactures cardboard containers (boxes) made from recycled paper
products. The company operates two divisions, paper recycling and box manufacturing, as
decentralized entities. The recycling division is free to sell recycled paper to outside buyers, and
the box manufacturing division is free to purchase recycled paper from other sources. Currently,
however, the recycling division sells all of its output to the manufacturing division, and the
manufacturing division does not purchase materials from outside suppliers.
The recycled paper is transferred from the recycling division to the manufacturing division at
110% of full cost. The recycling division purchases recyclable paper products for $0.075 per
pound. The recycling division uses 100 pounds of recyclable paper products to produce one roll
of recycled paper. The division’s other variable costs equal $6.35 per roll, and fixed costs at a
monthly production level of 10,000 rolls are $2.15 per roll. During the most recent month, 10,000
rolls of recycled paper were transferred between the two divisions. The recycling division’s
capacity is 15,000 rolls.
