Transfer Pricing Activity

Problem 1:

Division A manufactures plastic tubes. The tubes can be sold to Division B of the same company or to outside customers. Last year, the following activity was recorded in Division A: Selling price per tube, P175; Production and other costs per tube, P120, 75% of which is variable; Number of tubes: Normal capacity and actual production during the year, 20,000; Sold to outside customers, 16,000; Sold to division B, 4,000, Sales to Division B were at the same price as sales to outside customers. B incurred P300 in additional cost per unit and then sold the final product for P600 each.

Required:

1. Prepare the income statements for last year for Division A, Division B, and company as a whole.

2. Assume that Division A's manufacturing capacity is 20,000 tubes per year. Next year, Division B wants to purchase 5,000 tubes from Division A, rather than only 4,000 in the last year. (Tubes of this kind are not available from outside sources.) From the standpoint of the company as a whole, should Division A sell the 1,000 additional tubes to Division B, or should it continue to sell them to outside customers? Show the effect on the income statements if A sold the 1,000 units to B versus is A did not sell the 1,000 units to B.

3. Assume that Division A is able to sell all 20,000 tubes to outside customers at P175 per tube. Next year, Division B's production requirement is 6,000 units. Another company offered to supply a similar product to Division B at P110 per tube. How much is the minimum acceptable transfer price for Division A?

4. Assume that Division A is able to sell only 10,000 tubes to outside customers at P175 per tube. Next year, Division B's production requirement is 6,000 units. Another company offered to supply a similar product to Division B at P110 per tube. How much is the minimum acceptable transfer price for Division A?

5. Assume that Division A is able to sell only 17,000 tubes to outside customers at P175 per tube. Next year, Division B's production requirement is 6,000 units. Another company offered to supply a similar product to Division B at P110 per tube. How much is the minimum acceptable transfer price for Division A and the maximum acceptable transfer price for Division B?

Problem 2:

In cases 1 - 3 below, assume that Division A has a product that can be sold either to Division B of the same company or to outside customers. The managers of both divisions are evaluated based on their own division's return on investment. The managers are free to decide if they will participate in any internal transfers. Ail transfer prices are negotiated. Treat each chase independently.

Case 1 Case 2 Case 3 Case 4

Division A:

Capacity in units 50,000 300,000 100,000 200,000

Units sold to outside customers 50,000 300,000 75,000 200,000

Selling price per unit P100 P40 P60 P45

Variable cost per unit P63 P19 P35 P30

Fixed cost per unit (based on capacity) P25 P8 P17 P6

Division B:

Units needed for production 10,000 70,000 20,000 60,000

Prices per unit from outside supplier P92 P39 P60 N/A

Required:

6. Refer to case 1. A study has indicated that division A can avoid P5 per unit in variable costs on any sales to Division B. Will the managers agree to a transfer and if so, within what range will the transfer price be? Explain.

7. Refer to case 2. Assuming Division A can avoid P4 per unit in variable costs on any sales to Division B.

a. Would you expect any disagreement between the two divisional managers over what the transfer price should be? Explain.

b. Assume that Division A offers to sell 70,000 units to Division B for P38 per unit and that Division B refuses this price. What will be the loss in potential profits for the company as a whole?

8. Refer to case 3. Assuming Division B is now receiving 5% quantity discount from the outside supplier.

a. Will the managers agree to a transfer? If so, within what range will the transfer price be?

b. Assuming Division B offers to purchase 20,000 units from Division A at P52 per unit. If Division A accepts this price, would you expect its ROI to increase, decrease, or remain unchanged? Why?

9. Refer to case 4. Assume that Division B wants Division A to provide it with 60,000 units of a different product from the one that Division A is producing. The new product would require P25 per unit in variable cost and would require that Division A cut back production of its present product by 30,000 units annually. What is the lowest acceptable transfer price from Division A's perspective?