Exercise 11A-2 Transfer Pricing Situations [LO6]

In each of the cases below, assume that Division X has a product that can be sold either to outside customers or to Division Y of the same company for use in its production process. The managers of the divisions are evaluated based on their divisional profits:

Case

ABDivision X:Capacity in units100,000100,000Number of units being sold to outside customers100,00080,000Selling price per unit to outside customers$50$35Variable costs per unit$30$20Fixed costs per unit (based on capacity)$8$6Division Y:Number of units needed for production20,00020,000Purchase price per unit now being paid to an outside supplier$47$34

Required:

1-a.Refer to the data in case A above. Assume that $2 per unit in variable selling costs can be avoided on intracompany sales. Determine the transfer price of the selling division.

1-b.If the managers are free to negotiate and make decisions on their own, will a transfer take place?

• Yes
• No

2-a.Refer to the data in case B above. In this case there will be no reduction in variable selling costs on intracompany sales. Determine the transfer price of the selling division.

2-b.If the managers are free to negotiate and make decisions on their own, will a transfer take place?

• Yes
• No

2-c.What is the range of transfer price the managers of both divisions should agree?