1st Term, A.Y 2020 - 2021
STRATEGIC COST MANAGEMENT
Self-Test (not graded)
Topic: Transfer pricing
Part III.
Bronx Corporation's Gauge Division manufactures and sells product no. 24, which is used in
refrigeration systems. Per-unit variable manufacturing and selling costs amount to $20 and $5,
respectively. The Division can sell this item to external domestic customers for $36 or, alternatively,
transfer the product to the company's Refrigeration Division. Refrigeration is currently purchasing a
similar unit from Taiwan for $33. Assume use of the general transfer-pricing rule.
Required:
A. What is the most that the Refrigeration Division would be willing to pay the Gauge
Division for one unit?
B. If Gauge had excess capacity, what transfer price would the Division's management set?
C. If Gauge had no excess capacity, what transfer price would the Division's management
set?
D. Repeat part "C," assuming that Gauge was able to reduce the variable cost of internal
transfers by $4 per unit.
Answers:
A. Refrigeration would be willing to pay a maximum of $33, its current outside purchase
price.
B. The general rule holds that the transfer price be set at the sum of outlay cost and
opportunity cost. Thus, ($20 + $5) + $0 = $25.
C. In this case, the transfer price would amount to $36: ($20 + $5) + ($36 - $20 - $5).
D. The transfer price would be $32: ($20 + $5 - $4) + ($36 - $20 - $5).
Part IV.
Gamma Division of Vaughn Corporation produces electric motors, 20% of which are sold to Vaughan's
Omega Division and 80% to outside customers. Vaughn treats its divisions as profit centers and allows
division managers to choose whether to sell to or buy from internal divisions. Corporate policy requires
that all interdivisional sales and purchases be transferred at variable cost. Gamma Division's estimated
sales and standard cost data for the year ended December 31, based on a capacity of 60,000 units,
1
are as follows:
Omega
Sales
Less: Variable costs
Contribution margin
Less: Fixed costs
Operating income (loss)
Unit sales
Outsiders
$ 660,000
$5,760,000
660,000
2,640,000
$
----
$3,120,000
175,000
900,000
$ (175,000)
$2,220,000
12,000
48,000
Gamma has an opportunity to sell the 12,000 units shown above to an outside customer at
$80 per unit. Omega can purchase the units it needs from an outside supplier for $92 each.
Required:
A. Assuming that Gamma desires to maximize operating income, should it take on the new
customer and discontinue sales to Omega? Why? (Note: Answer this question from
Gamma's perspective.)
B. Assume that Vaughn allows division managers to negotiate transfer prices. The
managers agreed on a tentative price of $80 per unit, to be reduced by an equal sharing
of the additional Gamma income that results from the sale to Omega of 12,000 motors at
$80 per unit. On the basis of this information, compute the company's new transfer price.
Answers:
A. Yes. Gamma is currently selling motors to Omega at a transfer price of $55 per unit
($660,000 ÷ 12,000 units). A price of $80 to the new customer will increase Gamma
Division's operating income by $300,000 [($80 - $55) x 12,000 units].
B. The additional operating income to Gamma is $300,000 [($80 - $55) x 12,000 units].
Splitting this amount equally results in a new transfer price of $67.50, calculated as
follows:
Transfer price before reduction
$80.00
Less: Omega's per-unit share of additional income
[($300,000 x 50%) ÷ 12,000 units]
New transfer price
12.50
$67.50
Part V.
STRATEGIC COST MANAGMENT 2
Sonoma Corporation is a multi-divisional company whose managers have been delegated full profit
responsibility and complete autonomy to accept or reject transfers from other divisions. Division X
produces 2,000 units of a subassembly that has a ready market. One of these subassemblies is
currently used by Division Y for each final product manufactured, the latter of which is sold to outsiders
for $1,600. Y's sales during the current period amounted to 2,000 completed units. Division X charges
Division Y the $1,100 market price for the subassembly; variable costs are $850 and $600 for Divisions
X and Y, respectively.
The manager of Division Y feels that X should transfer the subassembly at a lower price because Y is
currently unable to make a profit.
Required:
A. Calculate the contribution margins (total dollars and per unit) of Divisions X and Y, as well
as the company as a whole, if transfers are made at market price.
B. Assume that conditions have changed and X can sell only 1,000 units in the market at
$900 per unit. From the company's perspective, should X transfer all 2,000 units to Y or
sell 1,000 in the market and transfer the remainder? Note: Y's sales would decrease to
1,000 units if the latter alternative is pursued.
Answer:
A.
Division X
Division Y
Sales at $1,600
$ 3,200,000
Transfers at
$1,100
$ 2,200,000
Company
$ 3,200,000
(2,200,000)
Less: Variable
costs
at $850
(1,700,000)
at $600
(1,200,000)
Contribution
margin
Unit contribution
margin
B.
$ 500,000
$
250
(2,900,000)
$ (200,000)
$
300,000
(100)
$
150
$
Alternative no. 1: Transfer 2,000 units to Division Y:
Company sales (2,000 x $1,600)
$3,200,000
Less: Variable costs [2,000 x $850) + (2,000 x $600)]
Contribution margin
2,900,000
$ 300,000
STRATEGIC COST MANAGMENT 3
Alternative no. 2: Sell 1,000 units in the open market and transfer 1,000 units to Y:
Company sales [(1,000 x $900) + (1,000 x $1,600)]
$2,500,000
Less: Variable costs [(2,000 x $850) + (1,000 x $600)]
2,300,000
Contribution margin
$ 200,000
Division X should transfer all 2,000 units to Division Y to produce an additional
$100,000 ($300,000 - $200,000) of contribution margin.
Part VI.
Kendall Corporation has two divisions: Phoenix and Tucson. Phoenix currently sells a condenser to
manufacturers of cooling systems for $520 per unit. Variable costs amount to $380, and demand for
this product currently exceeds the division's ability to supply the marketplace.
Kendall is considering another use for the condenser, namely, integration into an enhanced refrigeration
system that would be made by Tucson. Related information about the refrigeration system follows.
Selling price of refrigeration system:
$1,285
Additional variable manufacturing costs required:
$820
Transfer price of condenser:
$490
Top management is anxious to introduce the refrigeration system; however, unless the transfer is
made, an introduction will not be possible because of the difficulty of obtaining condensers in the
quality and quantity desired. The company uses responsibility accounting and ROI in measuring
divisional performance, and awards bonuses to divisional management.
Required:
A. How would Phoenix's divisional manager likely react to the decision to transfer
condensers to Tucson? Show computations to support your answer.
B. How would Tucson's divisional management likely react to the $490 transfer price? Show
computations to support your answer.
C. Assume that a lower transfer price is desired. What parties should be involved in setting
the new price?
D. From a contribution margin perspective, does Kendall benefit more if it sells the
condensers externally or transfers the condensers to Tucson? By how much?
Answer:
A.
The Phoenix divisional manager will likely be opposed to the transfer. Currently, the
division is selling all the units it produces at $520 each. With transfers taking place at $490,
Phoenix will suffer a $30 drop in sales revenue and profit on each unit that is sent to
Tucson.
STRATEGIC COST MANAGMENT 4
B.
Although Tucson is receiving a $30 "price break" on each unit purchased from Phoenix, the
$490 transfer price would probably be deemed too high. The reason: Tucson will lose $25
on each refrigeration system produced and sold.
Sales revenue
Less: Variable manufacturing costs
Transfer price paid to Phoenix
Income (loss)
$1,285
$820
490
$
1,310
(25)
C.
Kendall uses a responsibility accounting system, awarding bonuses based on divisional
performance. The two divisional managers (or their representatives) should negotiate a
mutually agreeable price.
D.
Kendall would benefit more if it sells the condenser externally. Observe that the transfer
price is ignored in this evaluation—one that looks at the firm as a whole.
Sales revenue
Less: Variable cost
$380; $380 + $820
Contribution margin
Produce
Condenser; Sell
Externally
$520
Produce Condenser;
Transfer; Sell
Refrigeration System
$1,285
380
$140
1,200
$ 85
Part VII.
The Chemical Division of Bill Company produces lawn-care chemicals. One-third of Chemical's output
is sold to the Lawn Services Division of Bill; the remainder is sold to outside customers. The Chemical
Division's estimated sales and standard cost data for the year follow:
Sales .................................................................................................
Variable cost......................................................................................
Fixed cost ..........................................................................................
Gross profit ........................................................................................
Gallons sold.......................................................................................
Lawn Services
$ 15,000
(10,000)
(3,000 )
$ 2,000
5,000
Outsiders
$40,000
(20,000)
(6,000)
$14,000
10,000
The Lawn Services Division has an opportunity to purchase 5,000 gallons of identical quality from an
outside supplier at a cost of $1.75 per gallon on a continuing basis. Assume that the Chemical Division
cannot sell any additional products to outside customers, that the fixed costs cannot be reduced, and
that no alternative use of facilities is available.
Required: Should Bill allow its Lawn Services Division to purchase the chemicals from the outside
supplier? Support your answer by computing the increase or decrease in Bill Company operating
costs.
Answers:
STRATEGIC COST MANAGMENT 5
Yes, because buying the chemicals would save Bill Company $1,250 determined as follows:
Variable cost to manufacture by Chemical Division
Outside supplier cost
$ ..... 10,000
($1.75 x 5,000) ...........
8,750
Savings to Bill if the Lawn Services Division purchases from the outside supplier $ 1,250
Part VIII.
Wire Division of XS Steel Corporation produces “bales” of steel wire that are used in various commercial
applications. The bales sell for an average of $20 each and Wire Division has the capacity to produce
10,000 bales per month. Consumer Products Division of XS Steel uses approximately 2,000 bales of
steel wire each month in its production of various appliances. The operating information for Wire
Division at its present level of operations (8,000 bales per month) follows:
Sales (all external)
Variable costs per bale:
Production
Selling
G&A
Fixed costs per bale (based on a 10,000 unit capacity):
Production
Selling
G&A
$160,000
$5
2
3
$2
3
4
Consumer Products Division currently pays $15 per bale for wire obtained from its external supplier.
Required.
a. If 2,000 bales are transferred in one month to Consumer Products Division at $10 per bale,
what would be the profit/loss of Wire Products Division?
b. For the Wire Products Division to operate at break-even level, what would it need to charge
for the production and transfer of 2,000 bales to the Consumer Products Division? Assume all
variable costs indicated will be incurred by the Wire Division.
c.
d.
e.
If Wire Products Division transferred 2,000 wire bales to the Consumer Products Division at
200 percent of full absorption cost, what would be the transfer price?
If Consumer Products Division agrees to pay Wire Products Division $16 for 2,000 bales this
month, what would be Consumer’s change in total profits?
Assuming, for this question only, that Wire Products Division would not incur any variable G&A
costs on internal sales, what is the minimum price that it would consider accepting for sales of
bales to Consumer Products Division?
Answers:
a. The $10 per unit would equal the Division’s variable costs ($5 + 2 + 3 = $10), so the contribution
margin per unit is zero. Thus, only the 8,000 units of external sales would generate a contribution
margin of $80,000 (8,000 × $10) to cover fixed costs of $90,000 (10,000 × $9). So the Division would
show a $10,000 loss.
b. Total fixed costs to Wire are:
STRATEGIC COST MANAGMENT 6
Production
Selling
G&A
Total
$2 × 10,000 =
$3 × 10,000 =
$4 × 10,000 =
Less: Contrib.Margin on Regular Business
[$20 – (5 + 2 + 3)] × 8,000
Unrecovered Fixed Costs
$20,000
30,000
40,000
$90,000
(80,000 )
$10,000
which must be covered by CM of inside sales =
Trans.Price × Vol. = SP – [(5 + 2 + 3) × 2,000]
SP = $15
a. Full absorption cost:
Variable Production Cost =
Fixed Production Cost =
Total full absorption cost
Doubled
Transfer price
d. Proposed transfer price per unit
Consumer’s current market purchase price per unit
Increase in cost per unit of wire to Consumer’s
Times units purchased
Decrease in profit due to increased costs
f.
$ 5
2
$ 7
× 2
$ 14
$
16
15
$
1
× 2,000
$ 2,000
Wire Division must cover its out of pocket costs or the relevant variable costs; the fixed costs
are irrelevant since they will be incurred regardless of this extra inside business. Thus, the
total cost to be covered is $7 (production, $5; selling, $2).
Part IX.
Carpet Division of Building Products Inc. manufactures a single grade of residential grade carpeting.
The division has the capacity to produce 500,000 square yards of carpet each year. Its current costs
and revenues are shown here:
Sales (400,000 square yards)
Variable costs per square yard:
Production
SG&A
Fixed costs per square yard (based on 500,000 yard capacity)
Production
SG&A
$2,000,000
$2.00
1.00
$0.50
1.00
The Housing Division currently purchases 40,000 yards of carpeting (of the grade produced by the
Carpet Division) each year at a cost of $6.50 per square yard from an outside vendor.
Required:
a. If the autonomous Housing and Carpet Divisions enter negotiations on the internal transfer of
40,000 square yards of carpeting, what is the maximum price that will be considered?
b. If the autonomous Housing and Carpet Divisions enter negotiations on the internal transfer of
40,000 square yards of carpeting, what is the Carpet Division’s minimum price?
STRATEGIC COST MANAGMENT 7
c.
If the Housing and Carpet Divisions agree on the internal transfer of 40,000 square yards of
carpet at a price of $4.50 per square yard, how will the profits of the Housing Division be
affected?
d. If the Housing and Carpet Divisions agree on the internal transfer of 40,000 square yards of
carpet at a price of $4.00 per square yard, how will overall corporate profits be affected?
e. Assume, for this question only, that Carpet Division is producing and selling 500,000 square
yards of carpet to external buyers at a price of $5 per square yard. What would be the effect
on overall corporate profits if Carpet Division reduces external sales of carpet by 40,000 square
yards and transfers the 40,000 square yards of carpet to the Housing Division?
Answers:
a. The maximum price or ceiling is the current purchase price of the buying division or $6.50 per
yard.
b. The minimum price acceptable to Carpet is its incremental cost of $3
($2 + $1) per square yard.
c.
Current external purchase price
$6.50
Proposed transfer price
4.50
Reduction in purchase price per yard
$2.00
Times yards acquired
×40,000
Increase in profits
$80,000
d.
Current outside purchase price per square yard
Carpet’s variable cost per square yard
$6.50
3.00
Savings per square yard to Housing Division
& corporate
$3.50
Times number square yards bought
× 40,000
Savings to corporate and increase in profits
$140,000
e.
Since Carpet is operating at full capacity, it would lose the contribution margin on the 40,000
square `yards. However, the Housing Division would not have to buy externally. Thus,
Lost CM
($2 × 40,000 yd) =
Gained CM
($3.50 × 40,000 yd) =
Net increase in corporate profits
$(80,000 )
140,000
$ 60,000
Part X.
The Hampton Division of Long Island Company sells all of its output to the Finishing Division of the
company. The only product of the Hampton 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 2018 are as follows:
STRATEGIC COST MANAGMENT 8
Chair legs
Direct materials
Direct labor
Factory overhead (25% is variable)
30,000
$135,000
$90,000
$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 percent.
c. full cost plus 20 percent markup.
d. variable costs.
e. full cost plus 10 percent markup.
Answers:
a. $20
b. 1.20 × [$135,000 + $90,000 + (0.25 × $90,000)]/30,000 = $9.90
c. 1.20 × ($135,000 + $90,000 + $90,000)/30,000 = $12.60
d. [$135,000 + $90,000 + (0.25 × $90,000) +
(0.20 × $150,000)]/30,000 = $9.25
e. [1.10 × ($135,000 + $90,000 + $90,000 + $150,000)]/30,000 = $17.05
Part XI.
Benjamin 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 2018. During the year, Division X prepared 80,000 lbs. of steel at a cost of
$800,000. All the steel was transferred to Division Y where additional operating costs of $5 per lb.
were incurred. The final product was sold for $3,000,000.
Required:
b. Determine the gross profit for each division and for the company as a whole if the transfer
price is $8 per lb.
c. Determine the gross profit for each division and for the company as a whole if the transfer
price is $12 per lb.
Answers:
a.
Sales
Cost of goods sold
Gross profit
Division X
$ 640,000
800,000
Division Y
$ 3,000,000
1,040,000*
Total
$3,640,000
1,840,000
$(160,000)
$ 1,960,000
$1,800,000
*$640,000 + $5(80,000)
STRATEGIC COST MANAGMENT 9
b.
Division X
Sales
Cost of goods sold
Gross profit
Division Y
Total
$960,000
$ 3,000,000
$3,960,000
800,000
1,360,000*
2,160,000
$160,000
$1,640,000
$1,800,000
*$960,000 + $5(80,000)
Galacia 6:1
Kaya ng, samantalang tayo’y may pagkakataon, ay magsigawa tayo ng mabuti sa lahat, at
lalong lalo na sa mga kasangbahay sa pananampalataya.
Kawikaan 15:29
Ang Panginoon ay malayo sa masama: nguni’t Kaniyang dinidinig ang dalangin ng matuwid.
Kawikaan 24:16
Sapagka’t ang matuwid ay nabubuwal na makapito, at bumabangon uli: nguni’t ang masama
ay nabubuwal sa kasakunaan.
Awit 37:23 – 24
Ang lakad ng tao ay itinatatag ng Panginoon; at siya’y nasasayahan sa kaniyang lakad.
Bagaman siya’y mabuwal, hindi siya lubos na mapapahiga: Sapagka’t inaalalayan siya ng
Panginoon ng Kaniyang kamay.
STRATEGIC COST MANAGMENT 10
STRATEGIC COST MANAGMENT 11
STRATEGIC COST MANAGMENT 12
STRATEGIC COST MANAGMENT 13