Transfer Pricing

Problem-01:
Sako Company’s Audio Division produces a speaker that is used by manufacturers of various
audio products. Sales and cost data on the speaker follow:
Selling price per unit on the intermediate market $60
Variable costs per unit $42
Fixed costs per unit (based on capacity) $8
Capacity in units 25,000

Sako Company has a Hi-Fi Division that could use this speaker in one of its products. The Hi-
Fi Division will need 5,000 speakers per year. It has received a quote of $57 per speaker from
another manufacturer. Sako Company evaluates division managers on the basis of divisional
profits.

Required:
1. Assume that the Audio Division is now selling only 20,000 speakers per year to outside
customers.
a. From the standpoint of the Audio Division, what is the lowest acceptable transfer price for
speakers sold to the Hi-Fi Division? 42
b. From the standpoint of the Hi-Fi Division, what is the highest acceptable transfer price for
speakers acquired from the Audio Division? 57
c. If left free to negotiate without interference, would you expect the division managers to
voluntarily agree to the transfer of 5,000 speakers from the Audio Division to the Hi-Fi Division?
Why or why not? 57
d. From the standpoint of the entire company, should the transfer take place? Why or why not?

2. Assume that the Audio Division is selling all of the speakers it can produce to outside
customers.
a. From the standpoint of the Audio Division, what is the lowest acceptable transfer price for
speakers sold to the Hi-Fi Division? 60
b. From the standpoint of the Hi-Fi Division, what is the highest acceptable transfer price for
speakers acquired from the Audio Division? 57
c. If left free to negotiate without interference, would you expect the division managers to
voluntarily agree to the transfer of 5,000 speakers from the Audio Division to the Hi-Fi
Division? Why or why not? no
d. From the standpoint of the entire company, should the transfer take place? Why or why not?

Problem-02:
Hrubec Products, Inc., operates a Pulp Division that manufactures wood pulp for use in the
production of various paper goods. Revenue and costs associated with a ton of pulp follow:

Selling price $70

Expenses:
Variable $42
Fixed (capacity of 50,000 tons per year) 18
Net operating income $10
Hrubec Products has just acquired a small company that manufactures paper cartons. This
company will be treated as a division of Hrubec with full profit responsibility. The newly formed
Carton Division is currently purchasing 5,000 tons of pulp per year from a supplier at a cost of
$70 per ton, less a 10% purchase discount. Hrubec’s president is anxious for the Carton Division
to begin purchasing its pulp from the Pulp Division if an acceptable transfer price can be worked
out.
Required:
For (1) and (2) on the following page, assume that the Pulp Division can sell all of its pulp to
outside customers for $70 per ton.
1. Are the managers of the Carton and Pulp Divisions likely to voluntarily agree to a transfer
price for 5,000 tons of pulp next year? Why or why not?
2. If the Pulp Division meets the price that the Carton Division is currently paying to its supplier
and sells 5,000 tons of pulp to the Carton Division each year, what will be the effect on the
profits of the Pulp Division, the Carton Division, and the company as a whole?
For (3)–(6) below, assume that the Pulp Division is currently selling only 30,000 tons of pulp
each year to outside customers at the stated $70 price.
3. Are the managers of the Carton and Pulp Divisions likely to voluntarily agree to a transfer
price for 5,000 tons of pulp next year? Why or why not?
4. Suppose that the Carton Division’s outside supplier drops its price (net of the purchase
discount) to only $59 per ton. Should the Pulp Division meet this price? Explain. If the Pulp
Division does not meet the $59 price, what will be the effect on the profits of the company
as a whole?
5. Refer to (4) above. If the Pulp Division refuses to meet the $59 price, should the Carton
Division be required to purchase from the Pulp Division at a higher price for the good of the
company as a whole? no
6. Refer to (4) above. Assume that due to inflexible management policies, the Carton Division
is required to purchase 5,000 tons of pulp each year from the Pulp Division at $70 per ton.
What will be the effect on the profits of the company as a whole?

Problem-03:
Stavos Company’s Cabinet Division manufactures a standard cabinet for television sets. The
cost per cabinet is:
Variable cost per cabinet $ 70
Fixed cost per cabinet* 30
Total cost per cabinet $100
*Based on a capacity of 10,000 cabinets per year.
Part of the Cabinet Division’s output is sold to outside manufacturers of television sets and part
is sold to Stavos Company’s Quark Division, which produces a TV set under its own name.
The Cabinet Division charges $140 per cabinet for all sales.
The costs, revenue, and net operating income associated with the Quark Division’s TV set are
given below:
Selling price per TV set $480
Variable cost per TV set:
Cost of the cabinet $140
Variable cost of electronic parts 210
 Total variable cost 350
Contribution margin 130
Fixed costs per TV set* 80
Net operating income per TV set $ 50
*Based on a capacity of 3,000 sets per year.
The Quark Division has an order from an overseas source for 1,000 TV sets. The overseas
source wants to pay only $340 per set.
Required:
1. Assume that the Quark Division has enough idle capacity to fill the 1,000-set order. Is the
division likely to accept the $340 price or to reject it? Explain.
2. Assume that both the Cabinet Division and the Quark Division have idle capacity. Under
these conditions, would it be advantageous for the company as a whole if the Quark Division
rejects the $340 price? Show computations to support your answer.
3. Assume that the Quark Division has idle capacity but that the Cabinet Division is operating
at capacity and could sell all of its cabinets to outside manufacturers. Compute the profit
impact to the Quark Division of accepting the 1,000-set order at the $340 unit price.
4. What conclusions do you draw concerning the use of market price as a transfer price in
intracompany transactions?

Problem-04:
Weller Industries is a decentralized organization with six divisions. The company’s Electrical
Division produces a variety of electrical items, including an X52 electrical fitting. The Electrical
Division (which is operating at capacity) sells this fitting to its regular customers for $7.50 each;
the fitting has a variable manufacturing cost of $4.25.
The company’s Brake Division has asked the Electrical Division to supply it with a large quantity
of X52 fittings for only $5 each. The Brake Division, which is operating at 50% of capacity, will
put the fitting into a brake unit that it will produce and sell to a large commercial airline
manufacturer. The cost of the brake unit being built by the Brake Division follows:
Purchased parts (from outside vendors) $22.50
Electrical fitting X52 5.00
Other variable costs 14.00
Fixed overhead and administration 8.00
Total cost per brake unit $49.50
Although the $5 price for the X52 fitting represents a substantial discount from the regular $7.50
price, the manager of the Brake Division believes that the price concession is necessary if his
division is to get the contract for the airplane brake units. He has heard “through the grapevine”
that the airplane manufacturer plans to reject his bid if it is more than $50 per brake unit. Thus,
if the Brake Division is forced to pay the regular $7.50 price for the X52 fitting, it will either not
get the contract or it will suffer a substantial loss at a time when it is already operating at only
50% of capacity. The manager of the Brake Division argues that the price concession is
imperative to the well-being of both his division and the company as a whole.
Weller Industries uses return on investment (ROI) to measure divisional performance.
Required:
1. Assume that you are the manager of the Electrical Division. Would you recommend that your
division supply the X52 fitting to the Brake Division for $5 each as requested? Why or why
not? Show all computations.
2. Would it be profitable for the company as a whole for the Electrical Division to supply the
fittings to the Brake Division if the airplane brakes can be sold for $50? Show all
computations, and explain your answer.
3. In principle, should it be possible for the two managers to agree to a transfer price in this
particular situation? If so, within what range would that transfer price lie?
4. Discuss the organizational and manager behavior problems, if any, inherent in this situation.
What would you advise the company’s president to do in this situation?

Problem-05:
The Slate Company manufactures and sells television sets. Its assembly division (AD) buys
television screens from the screen division (SD) and assembles the TV sets. The SD, which is
operating at capacity, incurs an incremental manufacturing cost of $65 per screen. The SD can
sell all its output to the outside market at a price of $100 per screen, after incurring a variable
marketing and distribution cost of $8 per screen. If the AD purchases screens from outside
suppliers at a price of $100 per screen, it will incur a variable purchasing cost of $7 per screen.
Slate’s division managers can act autonomously to maximize their own division’s operating
income.
Required:
1. What is the minimum transfer price at which the SD manager would be willing to sell
screens to the AD?
2. What is the maximum transfer price at which the AD manager would be willing to purchase
screens from the SD?
3. Now suppose that the SD can sell only 70% of its output capacity of 20,000 screens per
month on the open market. Capacity cannot be reduced in the short run. The AD can
assemble and sell more than 20,000 TV sets per month.
a. What is the minimum transfer price at which the SD manager would be willing to sell
screens to the AD?
b. From the point of view of Slate’s management, how much of the SD output should be
transferred to the AD?
c. If Slate mandates the SD and AD managers to “split the difference” on the minimum and
maximum transfer prices they would be willing to negotiate over, what would be the
resulting transfer price? Does this price achieve the outcome desired in requirement 3b?

Problem-06:
Revco Electronics is a division of International Motors, an automobile manufacturer. Revco
produces car radio/CD players. Revco sells its products to International Motors, as well as to
other car manufacturers and electronics distributors. The following information is available
regarding Revco’s car radio/CD player.
Selling price of car radio/CD player to external customers Tk. 49
Variable cost per unit Tk. 28
Capacity 200,000 units
Required:
Determine whether the goods should be transferred internally or purchased externally and
what the appropriate transfer price should be under each of the following independent
situations.
(i) Revco Electronics is operating at full capacity. There is a saving of Tk.4 per unit for
variable cost if the car radio is made for internal sale. International Motors can
purchase a comparable car radio from an outside supplier for Tk.47.
(ii) Revco Electronics has sufficient existing capacity to meet the needs of International
Motors. International Motors can purchase a comparable car radio from an outside
supplier for Tk.47.
(iii) International Motors wants to purchase a special-order car radio/CD player with
additional features. It needs 15,000 units. Revco Electronics has determined that the
additional variable cost would be Tk.12 per unit. Revco Electronics has no spare
capacity. It will have to forgo sales of 15,000 units to external parties in order to provide
this special order.

Problem-07:
RaceFest Inc. has two operating divisions. The Ski Division makes water and snow skis, and the
Binding Division makes rubber boots for water skis. The Binding Division estimates that
800,000 pairs of boots will be produced in 2010; of those, 600,000 pairs will be sold to the Ski
Division and 200,000 pairs will be sold externally. Managers of the two divisions are in the
process of determining a transfer price for a pair of boots. The following information for the
Binding Division is available:
Direct material: Tk 27
Direct labor: 12
Variable overhead: 7
Variable S&A (both for external and internal sales) 4
Total variable cost 50
Fixed overhead (rate based on estimated annual production) Tk. 10
Fixed selling and administrative (rate based on estimated annual sales) Tk. 5
Total fixed cost Tk. 15
Total cost per pair of boots: Tk. 65
Markup on total variable cost (40%): Tk. 20
List price to external customers: Tk. 85
Required:
i. Determine a transfer price based on variable production cost.
ii. Determine a transfer price based on total variable cost plus normal markup.
iii. Determine a transfer price based on full production cost.
iv. Determine a transfer price based on total cost per pair of boots.
v. Prepare the journal entries for the Binding (selling) and Ski (buying) segments if the transfer
is made at the external selling price for the selling division and the full production cost for the
buying division.
vi. Assume that the Binding Division has no alternative use for the facilities that make the rubber
boots for internal transfer. Also assume that the Ski Division can buy equivalent boots externally
for Tk. 80. Calculate the upper and lower limits for which the transfer price should be set.
vii. Compute a transfer price that divides the “profit” between the two divisions equally.
viii. In contrast to the assumption in part (vi), assume that a large portion of the facilities in
which boots are produced can be rented for Tk. 600,000 if the Binding Division makes boots
only for external sale. Determine the lower limit of the transfer price.

Problem-08:
M3M Ltd. manufactures advanced technical components for the computer hardware industry.
The company’s MUnu Division manufactures a special subcomponent at a variable cost of Tk.70
per unit. This division’s maximum monthly production capacity is 27,000 units, but its actual
production each month is 25,000 units. Of this actual monthly production, 15,000 units are sold
to external customers (at a price of Tk.100 each) while the remaining 10,000 units are transferred
to the company’s MDu Division at the same price.
The MDu Division’s maximum production capacity is 13,500 units per month. However, market
demand for the division’s product is only 10,000 units and therefore production is carried out at
this level. In producing one unit of its product, MDu Division uses one unit of the subcomponent
purchased from MUnu Division and incurs additional variable costs of Tk.90 per unit. The
selling price of MDu Division’s product is Tk.200 per unit.
The MDu Division recently received an enquiry from a new customer, who has offered to
purchase 3,000 units of that division’s product each month at a price of Tk.185 per unit.
Required:
(i) Prepare calculations to indicate the increase in the monthly profits of M3M Ltd., if the new
customer’s offer is accepted.
(ii) Prepare calculations to indicate whether the existing transfer pricing arrangements would
motivate each of the two divisions to cooperate in transferring the 3,000 subcomponents needed
in order to manufacture the new customer’s order.
(iii) Identify the minimum transfer prices which would be acceptable to MUnu Division and
identify the maximum transfer prices which would be acceptable to MDu Division. Then,
suggest a transfer price per unit for the 3,000 subcomponents which would achieve the following:
- The incremental profits from doing business with the new customer are to be shared equally
between the two divisions.

Problem-09:
The Components Division produces a part that is used by the Goods Division. The cost of
manufacturing the part is as follows:
Direct materials $10
Direct labor 2
Variable overhead 3
Fixed overhead* 5
Total cost 20
*Based on a practical volume of 200,000 parts.

Other costs incurred by the Components Division are as follows:

Fixed selling and administrative $500,000, Variable selling $1.5 per unit

The part usually sells for between $28 and $30 in the external market. Currently, the Components
Division is selling it to external customers for $29. The division is capable of producing 200,000
units of the part per year; however, because of a weak economy, only 150,000 parts are expected
to be sold during the coming year. The variable selling expenses are avoidable if the part is sold
internally. The Goods Division has been buying the same part from an external supplier for $28.
It expects to use 50,000 units of the part during the coming year. The manager of the Goods
Division has offered to buy 50,000 units from the Components Division for $18 per unit.

Required:
(i) Determine the minimum transfer price that the Components Division would accept.
(ii) Determine the maximum transfer price that the manager of the Goods Division would pay.
(iii) Should an internal transfer take place? Why or why not? If you were the manager of the
Components Division, would you sell the 50,000 components for $18 each? Explain.
(iv) Suppose that the average operating assets of the Components Division total $10 million.
Compute the ROI for the coming year, assuming that the 50,000 units are transferred to the
Goods Division for $21 each.

Problem-10:
Grameen Resources Company (GRC) has several divisions. However, only two divisions
transfer products to other divisions. The Mining Division refines metals, which is then
transferred to the Metals Division. The product of Mining Division is processed into an alloy by
the Metals Division and then the alloy is sold to customers at a price of Tk. 150 per unit.
The Mining Division is currently required by GRC to transfer its total yearly output of 4,000
units of the products to the Metals Division at total actual manufacturing cost plus 10 percent.
Unlimited quantities of the products can be purchased and sold on the open market at Tk. 90 per
unit. While the Mining Division could sell all the products it produces at Tk. 90 per unit on the
open market, it would incur a variable selling cost of Tk. 5 per unit.

Amzad Hossain, manager of the Mining Division, is unhappy with having to transfer the entire
output of products to the Metals Division at 110 percent of cost

Cost Information:

Particulars Mining Division Metals Division

(Tk.) (Tk.)
Transfer price from Mining Division 66
Direct material cost 12 6
Direct labor cost 16 20
Manufacturing overhead 32 25
Total unit cost 60 117
Manufacturing overhead cost in the Mining Division is 25 percent fixed and 75 percent
variable. While Manufacturing overhead cost in the Metals Division is 60 percent fixed and 40
percent variable.
Required:
(i) Explain why transfer prices based on total actual costs are not appropriate as the basis for
divisional performance measurement.
(ii) Using the market price as the transfer price, determine the contribution margin for both the
Mining Division and Metals Division.
(iii) If the Grameen Resources Company were to institute the use of negotiable transfer price and
allow divisions to buy and sell on the open market, determine the price range for the products
that would be acceptable to both the Mining Division and the Metals Division. Explain your
answer.
(iv) Use the general transfer pricing rule to compute the lowest transfer price that would be
acceptable to the Mining Division. Is your answer consistent with your conclusion in req. (iii)?
Explain.
(v) Identify which one of the three types of transfer prices most likely to elicit desirable
management behavior at GRC. Explain your answer.

Problem-11:
The Bengal Manufacturing Corporation has a number of divisions including a furniture division
and a motel division. The Motel Division owns and operates a line of budget motels located
along major highways. Each year, the Motel Division purchases furniture for the motel rooms.
Currently, it purchases a basic dresser from an outside supplier for Tk.80. Mr. Karim Biswas,
manager of the Furniture Division, has approached Hasanath Ali, manager of the Motel Division,
about selling dressers to the Motel Division.
Biswas has researched the dressers costs and determined the following costs:
Direct materials Tk. 16.00
Direct Labor 8
Variable overhead 6
Fixed overhead 24
Total manufacturing cost 54
Currently, the Furniture Division has capacity to produce 75,000 dressers but is only producing
60,000. The Motel Division needs 10,000 dressers per year.
Required:
(i) What is the maximum transfer price? The minimum transfer price? Should the transfer occur?
(ii) Suppose that Biswas and Hashanah agree on a transfer atTk.60. What is the benefit to each
division? What is the benefit to the company as a whole?
(iii) Suppose that the Furniture Division were operating at capacity. What would be the
maximum transfer price? The minimum transfer price? Should the transfer take place in this
case? Why or why not?