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Chapter 11 - Appendix A Transfer Pricing

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Chapter 11 Appendix A Transfer Pricing True / False Questions

1. When a division is operating at full capacity, the transfer price to other divisions should include opportunity costs. True False

2. When an intermediate market price for a transferred item exists, it represents a lower limit on the charge that should be made on transfers between divisions. True False

3. A transfer price is the price charged when one segment of a company provides goods or services to another segment of the company. True False

Multiple Choice Questions

4. When the selling division in an internal transfer has unsatisfied demand from outside customers for the product that is being transferred, then the lowest acceptable transfer price as far as the selling division is concerned is: A. variable cost of producing a unit of product. B. the full absorption cost of producing a unit of product. C. the market price charged to outside customers, less costs saved by transferring internally. D. the amount that the purchasing division would have to pay an outside seller to acquire a similar product for its use.

11-4


5. Division X makes a part that it sells to customers outside of the company. Data concerning this part appear below:

Division Y of the same company would like to use the part manufactured by Division X in one of its products. Division Y currently purchases a similar part made by an outside company for $70 per unit and would substitute the part made by Division X. Division Y requires 5,000 units of the part each period. Division X can already sell all of the units it can produce on the outside market. What should be the lowest acceptable transfer price from the perspective of Division X? A. $75 B. $66 C. $16 D. $50

6. Part WY4 costs the Eastern Division of Tyble Corporation $26 to make-direct materials are $10, direct labor is $4, variable manufacturing overhead is $9, and fixed manufacturing overhead is $3. Eastern Division sells Part WY4 to other companies for $30. The Western Division of Tyble Corporation can use Part WY4 in one of its products. The Eastern Division has enough idle capacity to produce all of the units of Part WY4 that the Western Division would require. What is the lowest transfer price at which the Eastern Division should be willing to sell Part WY4 to the Central Division? A. $30 B. $26 C. $23 D. $27

11-5


7. Division P of Turbo Corporation has the capacity for making 75,000 wheel sets per year and regularly sells 60,000 each year on the outside market. The regular sales price is $100 per wheel set, and the variable production cost per unit is $65. Division Q of Turbo Corporation currently buys 30,000 wheel sets (of the kind made by Division P) yearly from an outside supplier at a price of $90 per wheel set. If Division Q were to buy the 30,000 wheel sets it needs annually from Division P at $87 per wheel set, the change in annual net operating income for the company as a whole, compared to what it is currently, would be: A. $600,000 B. $225,000 C. $750,000 D. $135,000


Division Y of the same company would like to use the part manufactured by Division X in one of its products. Division Y currently purchases a similar part made by an outside company for $49 per unit and would substitute the part made by Division X. Division Y requires 5,000 units of the part each period. Division X has ample excess capacity to handle all of Division Y's needs without any increase in fixed costs and without cutting into outside sales. According to the formula in the text, what is the lowest acceptable transfer price from the standpoint of the selling division? A. $50 B. $49 C. $46 D. $30

11-6


9. Division A makes a part that it sells to customers outside of the company. Data concerning this part appear below:

Division B of the same company would like to use the part manufactured by Division A in one of its products. Division B currently purchases a similar part made by an outside company for $38 per unit and would substitute the part made by Division A. Division B requires 5,000 units of the part each period. Division A has ample capacity to produce the units for Division B without any increase in fixed costs and without cutting into sales to outside customers. If Division A sells to Division B rather than to outside customers, the variable cost be unit would be $1 lower. What should be the lowest acceptable transfer price from the perspective of Division A? A. $40 B. $38 C. $30 D. $29

The Milk Chocolate Division of Mmmm Foods, Inc. had the following operating results last year:

Milk Chocolate expects identical operating results this year. The Milk Chocolate Division has the ability to produce and sell 200,000 pounds of chocolate annually.

11-7


10. Assume that the Peanut Butter Division of Mmmm Foods wants to purchase an additional 20,000 pounds of chocolate from the Milk Chocolate Division. Milk Chocolate will be able to increase its profit by accepting any transfer price above: A. $0.40 per pound B. $0.08 per pound C. $0.15 per pound D. $0.25 per pound

11. Assume that the Milk Chocolate Division is currently operating at its capacity of 200,000 pounds of chocolate. Also assume again that the Peanut Butter Division wants to purchase an additional 20,000 pounds of chocolate from Milk Chocolate. Under these conditions, what amount per pound of chocolate would Milk Chocolate have to charge Peanut Butter in order to maintain its current profit? A. $0.40 per pound B. $0.08 per pound C. $0.15 per pound D. $0.25 per pound

Division X makes a part with the following characteristics:

Division Y of the same company would like to purchase 10,000 units each period from Division X. Division Y now purchases the part from an outside supplier at a price of $17 each.

11-8


12. Suppose Division X has ample excess capacity to handle all of Division Y's needs without any increase in fixed costs and without cutting into sales to outside customers. If Division X refuses to accept the $17 price internally and Division Y continues to buy from the outside supplier, the company as a whole will be: A. worse off by $70,000 each period. B. better off by $10,000 each period. C. worse off by $60,000 each period. D. worse off by $20,000 each period.

13. Suppose that Division X is operating at capacity and can sell all of its output to outside customers. If Division X sells the parts to Division Y at $17 per unit, the company as a whole will be: A. better off by $10,000 each period. B. worse off by $20,000 each period. C. worse off by $10,000 each period. D. There will be no change in the status of the company as a whole.

Division A produces a part with the following characteristics:

Division B, another division in the company, would like to buy this part from Division A. Division B is presently purchasing the part from an outside source at $28 per unit. If Division A sells to Division B, $1 in variable costs can be avoided.

14. Suppose Division A is currently operating at capacity and can sell all of the units it produces on the outside market for its usual selling price. From the point of view of Division A, any sales to Division B should be priced no lower than: A. $27 B. $29 C. $20 D. $28

11-9


15. Suppose that Division A has ample idle capacity to handle all of Division B's needs without any increase in fixed costs and without cutting into its sales to outside customers. From the point of view of Division A, any sales to Division B should be priced no lower than: A. $29 B. $30 C. $18 D. $17

The Post Division of the M.T. Woodhead Company produces basic posts which can be sold to outside customers or sold to the Lamp Division of the M.T. Woodhead Company. Last year the Lamp Division bought all of its 25,000 posts from Post at $1.50 each. The following data are available for last year's activities of the Post Division:

The total fixed costs would be the same for all the alternatives considered below.

16. Suppose there is ample capacity so that transfers of the posts to the Lamp Division do not cut into sales to outside customers. What is the lowest transfer price that would not reduce the profits of the Post Division? A. $0.90 B. $1.35 C. $1.41 D. $1.75

17. Suppose the transfers of posts to the Lamp Division cut into sales to outside customers by 15,000 units. What is the lowest transfer price that would not reduce the profits of the Post Division? A. $0.90 B. $1.35 C. $1.41 D. $1.75

11-10


18. Suppose the transfers of posts to the Lamp Division cut into sales to outside customers by 15,000 units. Further suppose that an outside supplier is willing to provide the Lamp Division with basic posts at $1.45 each. If the Lamp Division had chosen to buy all of its posts from the outside supplier instead of the Post Division, the change in net operating income for the company as a whole would have been: A. $1,250 decrease B. $10,250 increase C. $1,000 decrease D. $13,750 decrease

The Pole Division of Hillyard Company produces poles which can be sold to outside customers or transferred to the Flag Division of Hillyard Company. Last year the Flag Division bought 50,000 poles from Pole at $2.50 each. The following data are available for last year's activities in the Pole Division:

In order to sell 50,000 poles to the Flag Division, the Pole Division must give up sales of 30,000 poles to outside customers. That is, the Pole Division could sell 380,000 poles each year to outside customers (rather than only 350,000 poles as shown above) if it were not making sales to the Flag Division.

19. According to the formula in the text, what is the lowest acceptable transfer price from the viewpoint of the selling division? A. $2.50 B. $2.00 C. $2.60 D. $3.00

11-11


20. Suppose that last year an outside supplier would have been willing to provide the Flag Division with the basic poles at $2.10 each. If Flag had chosen to buy all of its poles from the outside supplier instead of the Pole Division, the change in net operating income for the company as a whole would have been: A. $45,000 increase B. $20,000 decrease C. $20,000 increase D. $25,000 increase

Essay Questions

21. Division X has asked Division K of the same company to supply it with 5,000 units of part L433 this year to use in one of its products. Division X has received a bid from an outside supplier for the parts at a price of $26.00 per unit. Division K has the capacity to produce 30,000 units of part L433 per year. Division K expects to sell 26,000 units of part L433 to outside customers this year at a price of $30.00 per unit. To fill the order from Division X, Division K would have to cut back its sales to outside customers. Division K produces part L433 at a variable cost of $21.00 per unit. The cost of packing and shipping the parts for outside customers is $2.00 per unit. These packing and shipping costs would not have to be incurred on sales of the parts to Division X. Required: a. What is the range of transfer prices within which both the Divisions' profits would increase as a result of agreeing to the transfer of 5,000 parts this year from Division X to Division K? b. Is it in the best interests of the overall company for this transfer to take place? Explain.

11-12


22. Leontif Corporation has a Parts Division that does work for other Divisions in the company as well as for outside customers. The company's Equipment Division has asked the Parts Division to provide it with 2,000 special parts each year. The special parts would require $17.00 per unit in variable production costs. The Equipment Division has a bid from an outside supplier for the special parts at $28.00 per unit. In order to have time and space to produce the special part, the Parts Division would have to cut back production of another part-the J789 that it presently is producing. The J789 sells for $34.00 per unit, and requires $22.00 per unit in variable production costs. Packaging and shipping costs of the J789 are $4.00 per unit. Packaging and shipping costs for the new special part would be only $0.50 per unit. The Parts Division is now producing and selling 10,000 units of the J789 each year. Production and sales of the J789 would drop by 10% if the new special part is produced for the Equipment Division. Required: a. What is the range of transfer prices within which both the Divisions' profits would increase as a result of agreeing to the transfer of 2,000 special parts per year from the Parts Division to the Equipment Division? b. Is it in the best interests of Leontif Corporation for this transfer to take place? Explain.

11-13


Chapter 11 Appendix A Transfer Pricing Answer Key

True / False Questions

1. When a division is operating at full capacity, the transfer price to other divisions should include opportunity costs. TRUE

AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement Bloom's: Comprehension Learning Objective: 11A-05 Determine the range; if any; within which a negotiated transfer price should fall Level: Medium

2. When an intermediate market price for a transferred item exists, it represents a lower limit on the charge that should be made on transfers between divisions. FALSE

AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement Bloom's: Comprehension Learning Objective: 11A-05 Determine the range; if any; within which a negotiated transfer price should fall Level: Hard

3. A transfer price is the price charged when one segment of a company provides goods or services to another segment of the company. TRUE

AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement Bloom's: Knowledge Learning Objective: 11A-05 Determine the range; if any; within which a negotiated transfer price should fall Level: Easy

Multiple Choice Questions

11-14


4. When the selling division in an internal transfer has unsatisfied demand from outside customers for the product that is being transferred, then the lowest acceptable transfer price as far as the selling division is concerned is: A. variable cost of producing a unit of product. B. the full absorption cost of producing a unit of product. C. the market price charged to outside customers, less costs saved by transferring internally. D. the amount that the purchasing division would have to pay an outside seller to acquire a similar product for its use.

AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement Bloom's: Comprehension Learning Objective: 11A-05 Determine the range; if any; within which a negotiated transfer price should fall Level: Medium


Division Y of the same company would like to use the part manufactured by Division X in one of its products. Division Y currently purchases a similar part made by an outside company for $70 per unit and would substitute the part made by Division X. Division Y requires 5,000 units of the part each period. Division X can already sell all of the units it can produce on the outside market. What should be the lowest acceptable transfer price from the perspective of Division X? A. $75 B. $66 C. $16 D. $50 Because there is no opportunity cost, the selling division should not accept any transfer price less than its variable cost of $75 per unit.

AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement Bloom's: Application Learning Objective: 11A-05 Determine the range; if any; within which a negotiated transfer price should fall Level: Medium

11-15


6. Part WY4 costs the Eastern Division of Tyble Corporation $26 to make-direct materials are $10, direct labor is $4, variable manufacturing overhead is $9, and fixed manufacturing overhead is $3. Eastern Division sells Part WY4 to other companies for $30. The Western Division of Tyble Corporation can use Part WY4 in one of its products. The Eastern Division has enough idle capacity to produce all of the units of Part WY4 that the Western Division would require. What is the lowest transfer price at which the Eastern Division should be willing to sell Part WY4 to the Central Division? A. $30 B. $26 C. $23 D. $27 Because the selling division has ample idle capacity there is no opportunity cost and therefore the lowest price the part should be sold for is the total amount of variable costs that would be incurred, which is $23 per unit (= $10 per unit + $4 per unit + $9 per unit).

AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement Bloom's: Application Learning Objective: 11A-05 Determine the range; if any; within which a negotiated transfer price should fall Level: Easy

11-16


7. Division P of Turbo Corporation has the capacity for making 75,000 wheel sets per year and regularly sells 60,000 each year on the outside market. The regular sales price is $100 per wheel set, and the variable production cost per unit is $65. Division Q of Turbo Corporation currently buys 30,000 wheel sets (of the kind made by Division P) yearly from an outside supplier at a price of $90 per wheel set. If Division Q were to buy the 30,000 wheel sets it needs annually from Division P at $87 per wheel set, the change in annual net operating income for the company as a whole, compared to what it is currently, would be: A. $600,000 B. $225,000 C. $750,000 D. $135,000

AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement Bloom's: Application Learning Objective: 11A-05 Determine the range; if any; within which a negotiated transfer price should fall Level: Hard

11-17



Division Y of the same company would like to use the part manufactured by Division X in one of its products. Division Y currently purchases a similar part made by an outside company for $49 per unit and would substitute the part made by Division X. Division Y requires 5,000 units of the part each period. Division X has ample excess capacity to handle all of Division Y's needs without any increase in fixed costs and without cutting into outside sales. According to the formula in the text, what is the lowest acceptable transfer price from the standpoint of the selling division? A. $50 B. $49 C. $46 D. $30 Since Division X has ample excess capacity and consequently there is no opportunity cost, the lowest price the part should be sold for is the variable cost of $30 per unit.


11-18


9. Division A makes a part that it sells to customers outside of the company. Data concerning this part appear below:

Division B of the same company would like to use the part manufactured by Division A in one of its products. Division B currently purchases a similar part made by an outside company for $38 per unit and would substitute the part made by Division A. Division B requires 5,000 units of the part each period. Division A has ample capacity to produce the units for Division B without any increase in fixed costs and without cutting into sales to outside customers. If Division A sells to Division B rather than to outside customers, the variable cost be unit would be $1 lower. What should be the lowest acceptable transfer price from the perspective of Division A? A. $40 B. $38 C. $30 D. $29 Since Division X has ample excess capacity and consequently there is no opportunity cost, the lowest price the part should be sold for is the variable cost that would be incurred or $29 per unit (= $30 per unit - $1 per unit).


11-19


The Milk Chocolate Division of Mmmm Foods, Inc. had the following operating results last year:

Milk Chocolate expects identical operating results this year. The Milk Chocolate Division has the ability to produce and sell 200,000 pounds of chocolate annually.

10. Assume that the Peanut Butter Division of Mmmm Foods wants to purchase an additional 20,000 pounds of chocolate from the Milk Chocolate Division. Milk Chocolate will be able to increase its profit by accepting any transfer price above: A. $0.40 per pound B. $0.08 per pound C. $0.15 per pound D. $0.25 per pound Because the Milk Chocolate Division has ample excess capacity and consequently there is no opportunity cost, the profit of the division would be increased by any transfer price in excess of its variable cost of $0.25 per pound (= $37,500 ÷ 150,000 pounds).


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11. Assume that the Milk Chocolate Division is currently operating at its capacity of 200,000 pounds of chocolate. Also assume again that the Peanut Butter Division wants to purchase an additional 20,000 pounds of chocolate from Milk Chocolate. Under these conditions, what amount per pound of chocolate would Milk Chocolate have to charge Peanut Butter in order to maintain its current profit? A. $0.40 per pound B. $0.08 per pound C. $0.15 per pound D. $0.25 per pound Since the Milk Chocolate Division is already operating at capacity, it would have to charge the Peanut Butter Division its current selling price on the outside market of $0.40 per pound to maintain its current profit.


Division X makes a part with the following characteristics:

Division Y of the same company would like to purchase 10,000 units each period from Division X. Division Y now purchases the part from an outside supplier at a price of $17 each.

11-21


12. Suppose Division X has ample excess capacity to handle all of Division Y's needs without any increase in fixed costs and without cutting into sales to outside customers. If Division X refuses to accept the $17 price internally and Division Y continues to buy from the outside supplier, the company as a whole will be: A. worse off by $70,000 each period. B. better off by $10,000 each period. C. worse off by $60,000 each period. D. worse off by $20,000 each period. Instead of incurring a cost of $11 per unit, the company would have to incur a cost of $17 per unit to purchase from an outside supplier. Therefore, the company would be worse off by $60,000 per period = ($17 per unit - $11 per unit) × 10,000 units per period.


13. Suppose that Division X is operating at capacity and can sell all of its output to outside customers. If Division X sells the parts to Division Y at $17 per unit, the company as a whole will be: A. better off by $10,000 each period. B. worse off by $20,000 each period. C. worse off by $10,000 each period. D. There will be no change in the status of the company as a whole. Instead of being able to sell the units for $18 per unit on the outside market, the company would save $17 per unit transferring them internally. The net effect is a reduction of $10,000 per period = ($18 per unit - $17 per unit) × 10,000 units per period.


11-22


Division A produces a part with the following characteristics:

Division B, another division in the company, would like to buy this part from Division A. Division B is presently purchasing the part from an outside source at $28 per unit. If Division A sells to Division B, $1 in variable costs can be avoided.

14. Suppose Division A is currently operating at capacity and can sell all of the units it produces on the outside market for its usual selling price. From the point of view of Division A, any sales to Division B should be priced no lower than: A. $27 B. $29 C. $20 D. $28 Because Division A is already operating at capacity, it would have to charge Division B at least $29 per unit ($30 per unit less the $1 per unit in variable cost that can be avoided by transferring internally rather than selling on the external market).


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15. Suppose that Division A has ample idle capacity to handle all of Division B's needs without any increase in fixed costs and without cutting into its sales to outside customers. From the point of view of Division A, any sales to Division B should be priced no lower than: A. $29 B. $30 C. $18 D. $17 Because Division A has excess operating capacity, the opportunity cost is zero. Hence, Division A would make money charging Division B anything more than $17 per unit ($18 variable cost per unit less the $1 in variable cost that can be avoided by transferring internally rather than selling on the outside market).


The Post Division of the M.T. Woodhead Company produces basic posts which can be sold to outside customers or sold to the Lamp Division of the M.T. Woodhead Company. Last year the Lamp Division bought all of its 25,000 posts from Post at $1.50 each. The following data are available for last year's activities of the Post Division:

The total fixed costs would be the same for all the alternatives considered below.

11-24


16. Suppose there is ample capacity so that transfers of the posts to the Lamp Division do not cut into sales to outside customers. What is the lowest transfer price that would not reduce the profits of the Post Division? A. $0.90 B. $1.35 C. $1.41 D. $1.75 Since the Post Division has excess operating capacity, the opportunity cost is zero. Therefore, the Post Division's profits would not be reduced if the transfer price is at least the variable cost of $0.90 per unit.


17. Suppose the transfers of posts to the Lamp Division cut into sales to outside customers by 15,000 units. What is the lowest transfer price that would not reduce the profits of the Post Division? A. $0.90 B. $1.35 C. $1.41 D. $1.75 Total contribution margin on lost sales = ($1.75 per unit - $0.90 per unit) × 15,000 units = $0.85 per unit × 15,000 units = $12,750 Opportunity cost = Total contribution margin on lost sales ÷ Number of units transferred = $12,750 ÷ 25,000 units = $0.51 per unit Transfer price > Variable cost per unit + Opportunity cost per unit = $0.90 per unit + $0.51 per unit = $1.41 per unit


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18. Suppose the transfers of posts to the Lamp Division cut into sales to outside customers by 15,000 units. Further suppose that an outside supplier is willing to provide the Lamp Division with basic posts at $1.45 each. If the Lamp Division had chosen to buy all of its posts from the outside supplier instead of the Post Division, the change in net operating income for the company as a whole would have been: A. $1,250 decrease B. $10,250 increase C. $1,000 decrease D. $13,750 decrease

The incremental change in net operating income to the company as a whole would be 25,000 units @ $0.04 per unit, for a total of $1,000 in decreased profits. AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement Bloom's: Application Learning Objective: 11A-05 Determine the range; if any; within which a negotiated transfer price should fall Level: Hard

11-26


The Pole Division of Hillyard Company produces poles which can be sold to outside customers or transferred to the Flag Division of Hillyard Company. Last year the Flag Division bought 50,000 poles from Pole at $2.50 each. The following data are available for last year's activities in the Pole Division:

In order to sell 50,000 poles to the Flag Division, the Pole Division must give up sales of 30,000 poles to outside customers. That is, the Pole Division could sell 380,000 poles each year to outside customers (rather than only 350,000 poles as shown above) if it were not making sales to the Flag Division.

19. According to the formula in the text, what is the lowest acceptable transfer price from the viewpoint of the selling division? A. $2.50 B. $2.00 C. $2.60 D. $3.00 From the perspective of the selling division, profits would increase as a result of the transfer if and only if: Transfer price > Variable cost per unit + Opportunity cost per unit where Opportunity cost per unit = Total contribution margin on lost sales ÷ Number of units transferred Total contribution margin on lost sales = ($3 per unit - $2 per unit) × 30,000 units = $30,000 Opportunity cost per unit = Total contribution margin on lost sales ÷ Number of units transferred = $30,000 ÷ 50,000 units = $0.60 per unit


11-27


20. Suppose that last year an outside supplier would have been willing to provide the Flag Division with the basic poles at $2.10 each. If Flag had chosen to buy all of its poles from the outside supplier instead of the Pole Division, the change in net operating income for the company as a whole would have been: A. $45,000 increase B. $20,000 decrease C. $20,000 increase D. $25,000 increase

The cost would be lower by $25,000 if the poles were purchased from the outside supplier. Hence, the net operating income would be higher by $25,000. AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement Bloom's: Application Learning Objective: 11A-05 Determine the range; if any; within which a negotiated transfer price should fall Level: Hard

Essay Questions

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21. Division X has asked Division K of the same company to supply it with 5,000 units of part L433 this year to use in one of its products. Division X has received a bid from an outside supplier for the parts at a price of $26.00 per unit. Division K has the capacity to produce 30,000 units of part L433 per year. Division K expects to sell 26,000 units of part L433 to outside customers this year at a price of $30.00 per unit. To fill the order from Division X, Division K would have to cut back its sales to outside customers. Division K produces part L433 at a variable cost of $21.00 per unit. The cost of packing and shipping the parts for outside customers is $2.00 per unit. These packing and shipping costs would not have to be incurred on sales of the parts to Division X. Required: a. What is the range of transfer prices within which both the Divisions' profits would increase as a result of agreeing to the transfer of 5,000 parts this year from Division X to Division K? b. Is it in the best interests of the overall company for this transfer to take place? Explain. (Note: Due limitations in fonts and word processing software, > and < signs must be used in this solution rather than "greater than or equal to" and "less than or equal to" signs.) a. From the perspective of Division X, profits would increase as a result of the transfer if and only if: Transfer price > Variable cost + Opportunity cost The opportunity cost is the contribution margin on the lost sales, divided by the number of units transferred: Opportunity cost = [($30.00 per unit - $21.00 per unit - $2.00 per unit) × 1,000 units*]/5,000 units = $1.40 per unit

Therefore, Transfer price > $21.00 per unit + $1.40 per unit = $22.40 per unit. From the viewpoint of Division K, the transfer price must be less than the cost of buying the units from the outside supplier. Therefore, Transfer price < $26.00. Combining the two requirements, we get the following range of transfer prices: $22.40 < Transfer price < $26.00. b. Yes, the transfer should take place. From the viewpoint of the entire company, the cost of transferring the units within the company is $22.40, but the cost of purchasing them from the outside supplier is $26.00. Therefore, the company's profits increase on average by $3.60 for each of the special parts that is transferred within the company.

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22. Leontif Corporation has a Parts Division that does work for other Divisions in the company as well as for outside customers. The company's Equipment Division has asked the Parts Division to provide it with 2,000 special parts each year. The special parts would require $17.00 per unit in variable production costs. The Equipment Division has a bid from an outside supplier for the special parts at $28.00 per unit. In order to have time and space to produce the special part, the Parts Division would have to cut back production of another part-the J789 that it presently is producing. The J789 sells for $34.00 per unit, and requires $22.00 per unit in variable production costs. Packaging and shipping costs of the J789 are $4.00 per unit. Packaging and shipping costs for the new special part would be only $0.50 per unit. The Parts Division is now producing and selling 10,000 units of the J789 each year. Production and sales of the J789 would drop by 10% if the new special part is produced for the Equipment Division. Required: a. What is the range of transfer prices within which both the Divisions' profits would increase as a result of agreeing to the transfer of 2,000 special parts per year from the Parts Division to the Equipment Division? b. Is it in the best interests of Leontif Corporation for this transfer to take place? Explain. (Note: Due limitations in fonts and word processing software, > and < signs must be used in this solution rather than "greater than or equal to" and "less than or equal to" signs.) a. From the perspective of the Parts Division, profits would increase as a result of the transfer if and only if: Transfer price > Variable cost + Opportunity cost The opportunity cost is the contribution margin on the lost sales, divided by the number of units transferred: Opportunity cost = [($34.00 per unit - $22.00 per unit - $4.00 per unit) × 1,000 units*]/2,000 units = $4.00 per unit * 10%× 10,000 units = 1,000 units Therefore, Transfer price > ($17.00 per unit + $0.50 per unit) + $4.00 per unit = $21.50 per unit. From the viewpoint of the Equipment Division, the transfer price must be less than the cost of buying the units from the outside supplier. Therefore, Transfer price < $28.00. Combining the two requirements, we get the following range of transfer prices: $21.50 < Transfer price < $28.00. b. Yes, the transfer should take place. From the viewpoint of the entire company, the cost of transferring the units within the company is $21.50, but the cost of purchasing the special parts from the outside supplier is $28.00. Therefore, the company's profits increase on average by $6.50 for each of the special parts that is transferred within the company, even though this would cut into production and sales of another product.

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Chapter 11 - Appendix A Transfer Pricing AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement Bloom's: Application Learning Objective: 11A-05 Determine the range; if any; within which a negotiated transfer price should fall Level: Hard

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Chap011A

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