Exercise 12A-2 Transfer Pricing from the Viewpoint of the Entire Company [LO12-5
ID: 2412396 • Letter: E
Question
Exercise 12A-2 Transfer Pricing from the Viewpoint of the Entire Company [LO12-5] Division A manufactures electronic circuit boards. The boards can be sold either to Division B of the same company or to outside customers. Last year, the following activity occurred in Division A: Selling price per circuit board Variable cost per circuit board $125 90 Number of circuit boards Produced during the year Sold to outside customers 20,000 16,000 4,000 Sold to Division B Sales to Division B were at the same price as sales to outside customers. The circuit boards purchased by Division B were used in an electronic instrument manufactured by that division (one board per instrument). Division B incurred $100 in additional variable cost per instrument and then sold the instruments for $300 each Required 1. Prepare income statements for Division A, Division B, and the company as a whole Division A Division B Total Company Sales Expenses Added by the division Transfer price paid Total expenses 0 Net operating incomeExplanation / Answer
Answer
Division A
Division B
Total Company
Sales
$ 25,00,000.00
$ 12,00,000.00
$ 37,00,000.00
Expenses:
Added by the division
$ 18,00,000.00
$ 4,00,000.00
$ 22,00,000.00
Transfer Price paid
$ -
$ 5,00,000.00
$ 5,00,000.00
Total expenses
$ 18,00,000.00
$ 9,00,000.00
$ 27,00,000.00
Net Operating income
$ 7,00,000.00
$ 3,00,000.00
$ 10,00,000.00
Working with calculation:
Division A
Division B
Total Company
Sales
=20000*125
=4000*300
=2500000+1200000
Expenses:
Added by the devision
=20000*90
=4000*100
=1800000+400000
Transfer Price paid
0
=4000*125
500000
Total expenses
=1800000+0
=400000+500000
=2200000+500000
Net Operating income
=2500000-1800000
=1200000-900000
=3700000-2700000
The correct answer is Option 2: Sell the 1,000 additional circuit boards to division B. This is because:
---Division A’s revenue will not be affected whether it sells units to outside market or to division B because the sales price and transfer price to division B are same ($125)
---These circuit boards are not available to be purchased from outside sources, and if Division A does not transfer these, Division B will not be able to sell its final product. This will lead to fall in Division B’s sales and for a company as a whole resulting in Lower Net Incomes.
Division A
Division B
Total Company
Sales
$ 25,00,000.00
$ 12,00,000.00
$ 37,00,000.00
Expenses:
Added by the division
$ 18,00,000.00
$ 4,00,000.00
$ 22,00,000.00
Transfer Price paid
$ -
$ 5,00,000.00
$ 5,00,000.00
Total expenses
$ 18,00,000.00
$ 9,00,000.00
$ 27,00,000.00
Net Operating income
$ 7,00,000.00
$ 3,00,000.00
$ 10,00,000.00
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