Required information Exercise 11A-3 Transfer Pricing Situations [LO11-5] The fol

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Required information Exercise 11A-3 Transfer Pricing Situations [LO11-5] The following information applies to the questions displayed below.] In each of the cases below, assume Division X has a product that can be sold either to outside customers or to Division Y of the same company for use in its production process. The managers of the divisions are evaluated based on their divisional profits Case Division X Capacity in units Number of units being sold to outside customers Selling price per unit to outside customers Variable costs per unit Fixed costs per unit (based on capacity) 94,000 109,000 90,000 31 16 94,000 56 $ $24 $ 10 $ Division Y: 19,000 19,000 Number of units needed for production Purchase price per unit now being paid to an outside supplier 51 $ 32

Explanation / Answer

Data in case of A:

.a. Lowest acceptable transfer price from the perspective of selling division:

Selling price=$56

Less: Reduction in variable cost=$2

Lowest acceptable transfer price=$54

.b. Highest acceptable transfer price from perspective of buying division:

Purchase price paid to outside supplier=$51

Buying division cannot accept more than $51 and the selling division cannot sell below $54

.c. Hence transfer is not likely to take place, if the managers are free to negotiate on their own.

Since the capacity is fully utilized for the selling division, it will be better for the buying division to purchase from outside supplier at cheaper rate

Data in case of A:

.a.Lowest price acceptable from the perspective of the selling division:

There is excess capacity which will get utilized. There will be no lost sales due to transfer.

Hence the minimum acceptable price=marginal cost of production=$16(Variable cost per unit)

The capacity of selling division is =109,000 units

Current sales=90,000 units

Any sales at a price above $16 will be welcome by the selling division , since it will add to his profit.

Lowest acceptable price from perspective of selling division=$16

.b. Highest price acceptable from the perspective of the buying division:

Buying division is currently purchasing from outside supplier at $32 per unit

For buying division any price below $32 will be welcome

Highest price acceptable by buying division=$32

.c.Range of acceptable transfer price between two divisions is : $16 to $32

If managers are free to negotiate and decide , transfer is likely to take place.

Both will negotiate to a win-win situation

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