Problem $30-$Transfer Pricing

Part A

TAA, a multidivisional telecommunications corporation, has two completely independent

profit centers considering a transfer. TAA subsidiaries operates within a decentralized

environment. TAA will not dictate transfers or impose a transfer pricing policy on the

divisions. They must be free to decide whether they should transfer, and if so$,$ they must

negotiate a transfer price. Further, the TAA reward system must be based on the total

divisional profits reparted by the profit cenfers.

One of TAA's divisions; Southwestern Ringer, produces telephone sets that it sells for

$$30$ each. The standard absorptive manufacturing cost is $$24,$ which includes $$6$ per unit

in fixed overhead. The fixed overhead is allocated over its annual sales forecast of $50,000$

telephone sets its maximum production capacity is $75,000,$ sets aniually.

Another division, Northeastern Tell, can use the telephone sets in an answering machine$-$

telephone$-$radio product it markets As an alternative to buying telephone sets from

Southwestern, Northeastern can enter into a contract for the $20,000$ sets needed from a

Mexican company, OLA, Inc. OLA has quoted a price of $$25$ per set for the same quality

telephone.

Required:

a$.$ Determine whether a transfer should take place between Southwestern Ringer and

Northeastern Tell.

b$.$ Should a transfer occur if Southwestern can increase sales and production

volumes to $75,000$ sets annually by dropping the sales price to $$27\mathrm{.}50?$

Pard B

Rcfer to Part A$.$ Northeastern Tell wants its name imprinted on the telephene set. Its

Mexican supplier has quoted a price of $$31\mathrm{.}00$ per set. Southwestern Ringer will have to

buy a stamping machine at a net cost of $$20,000.$ Southwestern no longer ca$$ pro$$uce at

full capacity by dropping its sales price to $$27\mathrm{.}50$; so the manager has abandoned that

idea.

Required:

Determine whether there should now be a transfer. What transfer price will result in the

managers benefiting equally from the transfer?

Part C

Continuing the TAA example from the previous part, the Northeastem marketing staff

has decided against imprinting its name on the phone. However, they believe that if the

color is changed to fucbsia, $30,000$ specialty phone$-$answering machine$-$radios can be

sold in the greater. Toronto area. The Mexican supplier has quoted a price of $$26\mathrm{.}50$ for

an order of this size due to the higher cost of fuchsin. Southwestern already produces

fuchsia$-$colored phones for its Vancouver market and will incur no extra costs in

changing the color.

Required:

Calculate whether this transfer should occur. If so$,$ what transfer price will share the

differential profits equally between the two managers?

Part D

The Northeastern marketing staff has always been known for their creativity. Now they

are considering changing the color of their specialty phone product to paisley. The

Mexican supplier will not even bid on this, and no other supplier has been found.

Northeastern believes that $27,500$ of these specialty phone products can be sold at $$200$

edch in the Ottawa market. The costs to produce this product, other than the cost of the

Southwestern phone set are $$183$ each.

Required:

Determine whether a transfer is profitable for TAA. If so$,$ suggest a transfer price that

shares TAA's differential profit $75\%$ for Northeastern and $25\%$ for Southwestern.