APPLY THE CONCEPTS: Determining benefits of negotiated transfer price

Assume that Selling Division and Buying Division are both owned by Overall Corporation. Selling Division sells a product that is used by Buying Division and outside customers. Selling Division has 18,000 units of excess capacity. Selling Division currently sells the product for $60 per unit and Buying Division currently buys 18,000 units of the product from an outside source for $60 per unit. Variable costs of the product are $12, of which $3 is the cost of selling the product to an outside customer.

Using Selling price less avoidable costs as the minimum price, fill in the following formula for the desired transfer price: $-------- < transfer price < $-------.

Using Variable costs as the minimum price, fill in the following formula for the desired transfer price: $--------- < transfer price < $--------.

Assume there are no avoidable costs with an internal sale (variable costs equal $12) and that Buying Division buys 18,000 units from Selling Division. Complete the table for each transfer price:

	Transfer Price	Transfer Price
	$55	$19
Increase in net income of Selling Division	$	$
Increase in net income of Buying Division	$	$
Increase in net income of Overall Corporation	$	$

Return on Investment (ROI)

The manager of an investment center should be evaluated based on revenues, costs, and investments. An evaluation based on net income ignores the amount of investment the investment center required. One way to measure operating profit in relation to investment is a calculation called the return on investment.

One formula for calculating return on investment is:

Income from Operations Invested Assets

ROI is effective because it takes into consideration the three factors under the control of an investment center manager: revenues, costs, and investments. ROI measures the income (or return) earned on each dollar of investment.

APPLY THE CONCEPTS: Calculating return on investment

The divisional income statements for three divisions of the Chung Company are shown.

Chung Company
Divisional Income Statements
For the Year Ending December 31, 2013
	Division A			Division B			Division C
Sales Revenue	$2,352,000			$1,356,000			$906,200
Operating expenses	1,387,680			1,017,000			480,286
Income from operations before service-department charges	$964,320			$339,000			$425,914
Service-department charges	470,400			40,680			335,294
Income from operations	$493,920			$298,320			$90,620

Additional financial data from the three divisions of the Chung Company are shown.

	Division A		Division B		Division C
Invested assets		$1,120,000		$678,000		$460,000

Calculate the return on investment for each division. When required, round the ROI to the nearest hundredth of a percent (for example, 16.943% would be rounded to 16.94%).

	Division A	Division B	Division C
Return on investment	%------	%-------	%--------

Margin and Turnover

APPLY THE CONCEPTS: Calculating margin and turnover

Calculate the margin and the turnover for each division. When required, round margin to the nearest tenth of a percent (for example, 14.6%) and turnover to two decimal places (for example, 0.82).

	Division A		Division B		Division C
Margin:		-------%		--------%		-------%
Turnover:		-------		--------		---------

The division showing the highest operating profitability is Division SelectABCCorrect 7 of Item 3.

The division showing the highest operating efficiency is Division SelectBACCorrect 8 of Item 3.

APPLY THE CONCEPTS: Using margin and turnover to calculate return on investment

A second way to calculate return on investment (ROI) is Return on Investment = Margin x Turnover. Using the margins and turnovers you recorded above, calculate the return on investment for each division. When required, round the return on investment to the nearest hundredth of a percent (for example, 16.94%).

Calculate the return on investment for each division. Round the ROI to the nearest hundredth of a percent (for example, 16.94%).

	Division A	Division B	Division C
Return on investment	%	%	%

TRANSFER PRICING

One reason for companies to set transfer pricing policy is to move profits from one division to another. This may be done for competitive reasons, when the goal is to challenge division management to act as a standalone company in order to compare a division with its competitors. Another reason to move profits is for tax purposes or other cost savings for the company as a whole.

Selling Division sells 20,800 units to Buying Division. Selling Division's tax rate is 15%, and Buying Division's tax rate is 25%. Market price is $74.20 per unit, and it costs Selling Division $28.90 to produce each unit.

Overall Corporation abides by tax authority guidelines and can support the use of market-based transfer pricing and cost plus 20% transfer pricing.

Which transfer pricing method should Overall Corporation use when Selling Division sells to Buying Division to take advantage of the best tax rate?

- Select your answer -Cost plus 20% transfer pricingMarket-basedCorrect 1 of Item 2

What is the savings when this method is used?

$------

The profit of a company as a whole is affected by internal transfers when the selling division has excess capacity that can be used for an internal transfer.