Transfer Pricing Problem : Lambda Company

Case 6-1 Transfer Pricing Problems 1. Division A of Lambda Company manufactures Product X, which is sold to Division B as a component of Product Product Y is sold to Division C which uses it as a component in Product Z. Product Z is sold to customers outside of the company. The intracompany pricing rule is that products are transferred between divisions at standard cost plus a 10 percent return on inventories and fixed assets. From the information provided below, calculate the transfer price for Products X and Y and the standard cost of Product Z Standard Cost per Unit Product X Product Y Product Z Material purchased outside $ 2.00 $ 3.00 $ 1.00 Direct labor 1.00 1.00 2.00 Variable overhead. 1.00 1.00 2.00 Fixed overhead per unit 3.00 4.00 1.00 Standard volume 10,000 10,000 10,000 Inventories (average) 570,000 $15,000 $30,000 Fixed assets (net) 30,000 45,000 16,000 2. Assume the same facts as stated in Problem 1, except that the transfer price rule is as follows: Goods are transferred among divisions at the standard variable cost per unit transferred plus a monthly charge. This charge is equal to the fixed costs assigned to the product plus a 10 percent return on the average inventories and fixed assets assignable to the product. Caleu- late the transfer price for Products X and Y and calculate the unit standard cost for Products Y and Z 3. The present selling price for Product Z is $28.00. Listed below is a series of possible price reductions by competition and the probable impact of these re- ductions on the volume of sales if Division does not also reduce its price. Possible competitive price: $27.00, $26.00; $25.00; $23.00; 822.00 Sales volume if price of Product Z is maintained at $28.00: 9,000; 7,000; 5,000; 2,000; 0. Sales volume if price of Product Z is reduced to competitive levels: 10,000, 10,000; 10,000; 10,000, 10,000 Questions a. With transfer price calculated in Problem 1, is Division C better advised to maintain its price at $28.00 or to follow competition in each of the instances above? 6. With the transfer prices calculated in Problem 2, is Division C better advised to maintain its present price at $28.00 or to follow competition in each of the instances above? c. Which decisions are to the best economie interests of the company other things being equal? d. Using the transfer prices calculated in Problem 1, is the manager of Division making a decision contrary to the overall interests of the company? If so, what is the opportunity loss to the company in each of the competitive pricing actions described above? 4. Division C is interested in increasing the sales of Product Z. The present selling price of Product Z is $28.00. A survey is made and sales increases resulting from increases in television advertising are estimated. The results of this survey are provided below. (Note that this particular type of adver: tising can be purchased only in units of $100,000.) (in thousands) $200 $300 $400 $100 $500 Advertising expenditures Additional volume resulting from additional advertising 10 19 27 34 40 Questions a. As manager of Division , how much television advertising would you use if you purchased Product Y at the transfer price calculated in Problem 1? b. How much television advertising would you use if you purchased Product Y for the transfer price calculated in Problem ?? c. Which is correct from the overall company viewpoint? d. How much would the company lose in suboptimum profits from using the first transfer price? Case 6-1 Transfer Pricing Problems 1. Division A of Lambda Company manufactures Product X, which is sold to Division B as a component of Product Product Y is sold to Division C which uses it as a component in Product Z. Product Z is sold to customers outside of the company. The intracompany pricing rule is that products are transferred between divisions at standard cost plus a 10 percent return on inventories and fixed assets. From the information provided below, calculate the transfer price for Products X and Y and the standard cost of Product Z Standard Cost per Unit Product X Product Y Product Z Material purchased outside $ 2.00 $ 3.00 $ 1.00 Direct labor 1.00 1.00 2.00 Variable overhead. 1.00 1.00 2.00 Fixed overhead per unit 3.00 4.00 1.00 Standard volume 10,000 10,000 10,000 Inventories (average) 570,000 $15,000 $30,000 Fixed assets (net) 30,000 45,000 16,000 2. Assume the same facts as stated in Problem 1, except that the transfer price rule is as follows: Goods are transferred among divisions at the standard variable cost per unit transferred plus a monthly charge. This charge is equal to the fixed costs assigned to the product plus a 10 percent return on the average inventories and fixed assets assignable to the product. Caleu- late the transfer price for Products X and Y and calculate the unit standard cost for Products Y and Z 3. The present selling price for Product Z is $28.00. Listed below is a series of possible price reductions by competition and the probable impact of these re- ductions on the volume of sales if Division does not also reduce its price. Possible competitive price: $27.00, $26.00; $25.00; $23.00; 822.00 Sales volume if price of Product Z is maintained at $28.00: 9,000; 7,000; 5,000; 2,000; 0. Sales volume if price of Product Z is reduced to competitive levels: 10,000, 10,000; 10,000; 10,000, 10,000 Questions a. With transfer price calculated in Problem 1, is Division C better advised to maintain its price at $28.00 or to follow competition in each of the instances above? 6. With the transfer prices calculated in Problem 2, is Division C better advised to maintain its present price at $28.00 or to follow competition in each of the instances above? c. Which decisions are to the best economie interests of the company other things being equal? d. Using the transfer prices calculated in Problem 1, is the manager of Division making a decision contrary to the overall interests of the company? If so, what is the opportunity loss to the company in each of the competitive pricing actions described above? 4. Division C is interested in increasing the sales of Product Z. The present selling price of Product Z is $28.00. A survey is made and sales increases resulting from increases in television advertising are estimated. The results of this survey are provided below. (Note that this particular type of adver: tising can be purchased only in units of $100,000.) (in thousands) $200 $300 $400 $100 $500 Advertising expenditures Additional volume resulting from additional advertising 10 19 27 34 40 Questions a. As manager of Division , how much television advertising would you use if you purchased Product Y at the transfer price calculated in Problem 1? b. How much television advertising would you use if you purchased Product Y for the transfer price calculated in Problem ?? c. Which is correct from the overall company viewpoint? d. How much would the company lose in suboptimum profits from using the first transfer price