Assume two divisions of a company,P (producing)and B (buying),that are treated as investment centers for performance-evaluation purposes.As the management accountant,you've been asked to provide input to the determination of the appropriate transfer price for an exchange of product between these two divisions.In case #1,Division P is experiencing a capacity constraint,while in case #2 it is assumed that Division P has excess capacity.The incremental production cost incurred by Division P,to the point of transfer,is $80.00 per unit.Division P can sell its output externally for $120.00 per unit,less a sales commission charge of $5.00 per unit.Currently,Division B is purchasing the product from an external supplier at $120.00 per unit,plus a $3.00 transportation charge per unit.
Required:
1.Assume that Division P has limited capacity.Thus,for each unit it sells internally,it loses the opportunity to sell that unit externally.Use the general transfer-pricing rule to determine the minimum transfer price for internal transfers of units,that Division P would charge Division B.From the standpoint of Division P,why is the figure you calculated considered an acceptable transfer price?
2.What is the maximum transfer price that Division B would be willing to pay per unit on any internal transfers?
3.If top management of the company allows the managers of Divisions P and B to negotiate a transfer price,what is the likely range of possible transfer prices?
4.Assume now that Division P has excess capacity.Use the general transfer-pricing rule to determine the minimum transfer price that Division P would be willing to accept from Division B for any internal transfers.Would this transfer price motivate the correct economic decision (internal versus external transfer)from the standpoint of the company as a whole? Explain.
5.Given the situation described above in (4),would top management of the company want the transfer to take place internally? Why? (Show calculations,if appropriate. )How could top management ensure that an internal transfer would take place?

Question

Quizplus · Accepted Answer

Feedback: 1.Minimum selling price to Division B = incremental costs incurred by Division P,up to the point of transfer + opportunity cost on any external sales foregone (expressed per unit of internal transfer)= $80.00 + [$120.00 - $5.00 - $80.00] = $115.00 per unit.Note that at an internal transfer price of $115.00 per unit,the producing division (Division P)would be indifferent between selling internally and selling to an external party.
2.The maximum transfer price that Division B would be willing to offer Division B is its own total cost for purchasing externally,$123 per unit (i.e. ,$120 plus $3 per unit).
3.The likely range of possible transfer prices is $115.00 to $123.00 per unit.The general transfer-pricing rule provides the floor or minimum likely transfer price while the external market price (above in [2])establishes the ceiling.Thus,there is likely an $8.00 per unit range that would be subject to negotiation between the two divisional managers.
4.If the producing division has excess capacity,then by definition its opportunity cost for internal transfers is $0.Thus,based on the original data,the general transfer-pricing rule provides a minimum transfer price of $80.00 per unit,that is,the incremental cost incurred by the producing division to the point of transfer.At a transfer price of $80.00 per unit,the producing division would realize zero profit on any internal transfers.Thus,the divisional manager may not be motivated to produce/sell at this transfer price.Also,setting the transfer price at this amount complicates top management's effort to evaluate the short-term financial performance of Division P.If top management allows the divisional managers to negotiate a transfer price,then the likely range is from $80.00 (minimum)to $123.00 (maximum).
5.From the point of view of the top management of the company,all of the producing division's output should be transferred internally to the buying division.All such transfers would avoid the $3 per unit transportation cost that is incurred by the buying division when it purchases units from the outside;such transfers would also save the $5 sales commission cost the SD would incur to sell each screen on the outside market.It would be possible at this point that top management could dictate the transfer price,which would,in effect,force an internal transfer.However,the downside of this approach (which maximizes short-term financial performance for the company as a whole),is that it decreases divisional autonomy.

Assume Two Divisions of a Company,P (Producing)and B (Buying),that Are