Problems in Transfer Pricing
Problem 1
The Levis Company has two divisions, Production and Marketing. Production
manufactures designer pants, which it sells to both the Marketing Division and to other
retailers (to the latter under a different brand name). Marketing operates numerous
pants, stores, and it sells both Levis pants and other brands. The following facts also
pertain to the Levis Company:
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Sales price to retailers if sold by Production Department; P 380 per pair.
Variable costs to produce, P 190 per pair
Fixed costs: P2,000,000 per month
Production is operating at far below its capacity.
Sales price to customers if sold by Marketing, P 500 per pair
Variable marketing costs: 5 percent of sales price
Marketing has decided to reduce the sales price of Levis pants. The company’s variable
manufacturing and marketing costs are differential to this decision, whereas fixed
manufacturing and marketing costs are not.
Questions:
1. Determine the minimum price that can be charged for the pants and still cover
differential manufacturing and marketing costs.
2. What is the appropriate transfer price for this decision?
Problem 2
The Speakers Division of Mega World Corporation supplies speakers to outside
customers at a price of P350 each. The company has just acquired a radio assembly
company. The president believes this newly acquired Radio Division should purchase
speakers from the company’s own Speakers Division because this division has excess
capacity. Until the acquisition, the radio assembly company had purchased transistors
for P350 less a 10 percent discount.
Assume no additional machines or supervisors will be acquired for the internal transfers
and the Speakers Division’s unit cost is
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Direct materials
Direct labor
Variable overhead
Fixed overhead (now operating at 1,000,000 units activity level)
Total costs
Determine the transfer price based on:
A. Differential costs
B. Full costs
C. Market price
D. Full costs plus markup
E. Prime costs
F. Negotiated price
P
P
100
115
50
30
295
Problem 3
CY Company’s Electrical Division produces a high- quality transformer. Sales and cost
data on the transformer follows:
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Selling price per unit on the outside market
Variable costs per unit
Fixed costs per unit (based on capacity)
Capacity in units
P 400
P 210
P 90
60,000 units
CY Company has a Motor Division that would like to begin purchasing this transformer
from the Electrical Division. The Motor Division is currently purchasing 10,000
transformers each year from another company at a cost of P380 per transformer. CY
Company evaluates its division managers on the basis of divisional profits.
Questions:
A. Assume that the Electrical Division is now selling only 50,000 transformers each
year to outside customers:
a. From the standpoint of the Electrical Division, what is the lowest
acceptable transfer price to the Motor Division?
b. From the standpoint of the Motor Division, what is the highest acceptable
transfer price for transformers acquired from the Electrical Division?
c. If left free to negotiate without interference, would you expect the division
managers to voluntarily agree to transfer of 10,000 transformers from the
Electrical Division to the Motor Division? Explain.
B. Assume that the Electrical Division is now selling all the transformers it can
produce to outside customers:
a. From the standpoint of the Electrical Division, what is the lowest
acceptable transfer price to the Motor Division?
b. From the standpoint of the Motor Division, what is the highest acceptable
transfer price for transformers acquired from the Electrical Division?
c. If left free to negotiate without interference, would you expect the division
managers to voluntarily agree to transfer of 10,000 transformers from the
Electrical Division to the Motor Division? Explain.