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Trident University
Jenny.Jaboninniss@my.trident.edu
ACC501
Abstract
The use of transfer prices allows company to generate separate profit figures for each
division and to evaluate the performance of each division separately. In a recent dispute
for Coffee Maker's Incorporated (CMI), one must calculate the increase or decrease in
in charge of their own profits, they are also responsible for their own "Return on Invested
Capital". When divisions are required to transact with each other, a transfer price is used
firms is the creation of responsibility centers (e.g. cost, profit, or investment centers).
various accounting numbers, such as standard and actual cost, divisional profit or return
therefore is to evaluate (i.e. attach a dollar figure to) the transactions between the
different responsibility centers. Under the subject cost allocation one studied alternative
methods to charge user departments for the services rendered by service departments
Transfer prices are used to evaluate the goods and services exchanged between
profit centers (divisions) of a decentralized firm. Hence, the transfer price is the price
that the division of a company charges another division of the same company for a
product transferred between the two divisions. In this case two divisions of a CMI are
involved in a dispute. Division A purchases Part 101 and Division B purchases Part 201
from a third division, C. Both divisions need the parts for products that they assemble.
The intercompany transactions have remained steady for several years. Recently, outside
suppliers have lessened their prices, but Division C is not lowering its prices. In addition,
all division managers are feeling the weight to increase profit. Managers of divisions A
and B would like the flexibility to purchase the parts they need from external parties to
Module 5 Case: Accounting for Decision and Transfer Pricing 4
Division C Data
2013 in Profit
Change 2013 Proposed
Cost Lost
Division A
Part DM DL VOH TP AnVol $900,000
Unit Unit Profit Total Profit Vol Profit Profit
Division B $950,000
101 $200 $200 $300 $1,000 3000 $700 $300 $900,000 2000 $600,000 $300,000
Division C ($700,000)
201 $300 $300 $600 $2,000 1000 $1,200 $800 $800,000 500 $400,000 $400,000
Total Company $1,150,000
$1,700,000 $1,000,000 $700,000
UT.
101 201 Outside Req. Cost Outside $ Profit
Current A 3000 1000 4000 $900 $900,000
B 1000 1000 2000 $1,900 $1,900,000
C 3000 1000 4000
Proposed A 2000 2000 4000 $1,800,000 $900,000
B 500 1500 2000 $2,850,000 $950,000
C 2000 500 2500
Module 5 Case: Accounting for Decision and Transfer Pricing 6
Analysis of Computations
Depending on the production capacity and the market for each divisions goods or
services, a transfer price could be based on cost, market prices, or some other amount
(Accounting Tools, 2013). Given that one have the operating costs of Division C, one can
calculate their loss from reduced output. In the case of Division A and Division B, the
reduction in cost related to lower outside cost would be considered profit change. The
proposal increases profit, but leaves Division C under-utilized. The fixed cost of under
utilization would have to be considered before one would suggest Coffee Maker's
Incorporated go to the new proposal. One recommends to go ahead with the new proposal
Transfer pricing policies should include a fixed cost portion of the internal
supplier to identify the true cost (Accounting Tools, 2013). A concern of transfer pricing
is whether the amount of the transfer price will cause a divisional manager to take action
that is not consistent with the action that is best for the company as a whole. Profit taken
by the internal supplier is overall company profit. By using a standard costing process,
the internal supplier would be expected to keep efficiency at standard. In this case.
Division C had profit from part 101 at $300 per unit and part 201 at $800 per unit. If the
fixed cost of Division C were included in the transfer price, it would not be necessary to
Transfer price = cost plus a mark-up for the selling division. This policy provides
contribution to the cost of the selling division. The mark up must be fitting to
Module 5 Case: Accounting for Decision and Transfer Pricing 7
abolish the cost of the selling department, but not to make the selling department
Transfer price = fair market value. This policy will force profit to be declared
within the selling division and may or may not provide a means of tracking
productivity. If the fair market value produces a lot of profit for the company this
should be used.
Transfer price = price negotiated by the managers. This is a policy that can create
negotiated, the outcome would be beneficial for the company and would
From a financial perspective, transfer pricing can help improve profits and allows
the company more control of quality which would improve profits. It does cause
additional financial reporting for the selling division. From a managerial perspective
transfer pricing can create a competitive environment within the company resulting in
lower cost and higher profit (Investopedia, 2013). At the same it can cause complications
if one department is making more profit than another, unless it is clearly identified as
entity company are in charge of their own profits, they are also a responsible for their
own "Return on Invested Capital". Consequently, when divisions are required to transact
with each other, a transfer price is used to determine costs. Transfer prices tend not to
disagree much from the price in the market because one of the entities in such a
Module 5 Case: Accounting for Decision and Transfer Pricing 8
transaction will lose out: they will either be buying for more than the existing market
price or selling below the market price, and this will affect their performance.
Module 5 Case: Accounting for Decision and Transfer Pricing 9
Reference
http://www.accountingtools.com/transfer-pricing
fromhttp://www.valuebasedmanagement.net/methods_eva.html
http://www.investopedia.com/terms/t/transferprice.asp#axzz2N4CWBPen
Dear Jenny,
The case study for Module 5 provides information concerning a dispute between
three divisions and the company with comments and suggestions regarding
the situation. Also requested was the evaluation and discussion of four types
Although your discussion is very nice, I believe there are several changes which will
Your discussion concerning transfer pricing policies and the view from the
If you will copy, paste, and go to the following URL in your web browser, I give a
http://www.screencast.com/t/eJA0R7JCp8
Current Scenario
Lets look at the problem with Coffeemaker International. First we will look at the
part 101 from Division C and 1,000 units of part 101 from outside vendors.
Division B purchases 1,000 units of part 102 from Division C and 1,000 units
Under the current purchase agreement, Division A purchases the 3,000 units of part
101 from Division C at a cost of $1,000 per unit for a total cost of $3,000,000
(3,000 units x $1,000 per unit). Division A acquires an additional 1,000 units
of part 101 from outside vendors at a cost of $900 per unit for a total cost of
$900,000 (1,000 units x $900 per unit). Division A spends a total of $3,900,000
for part 101 ($3,000,000 + $900,000). Division B purchases the 1,000 units of
part 201 from Division C at a cost of $2,000 per unit for a total cost of
1,000 units of part 201 from outside vendors at a cost of $1,900 per unit for a
Module 5 Case: Accounting for Decision and Transfer Pricing 11
total cost of $1,900,000 (1,000 units x $1,900 per unit). Division B spends a
Divisions A and B are acquiring parts in the open market at a total cost of
Now lets take a look at the contribution margin of Division C under the current
subtract the variable cost of $700 from the $1,000 transfer price the resultant
$300 per unit, the total contribution margin is $900,000. With respect to part
201, the transfer price is $2,000. If the $1,200 variable cost is subtracted from
the $2,000 transfer price, the contribution margin for part 201 is $800.
Division C sells 1,000 units to Division B so, the $800 contribution margin
times the 1,000 units of part 201 yields a total contribution margin of
$800,000. The sum of the contribution margin for part 101 and part 201 for
Proposed Scenario
The managers of the Divisions have met and are considering a new scenario where
Division A purchases 2,000 units of part 101 from Division C and 2,000 units
of part 101 from outside vendors. And, Division B purchases 500 units of part
Module 5 Case: Accounting for Decision and Transfer Pricing 12
201 from Division C and 1,500 units of part 201 from outside vendors.
Under the proposed purchase agreement, Division A purchases the 2,000 units of
part 101 from Division C at a cost of $900 per unit for a total cost of
2,000 units of part 101 from outside vendors at a cost of $900 per unit for a
total cost of $1,800,000 (2,000 units x $900 per unit). Division A spends a total
the 500 units of part 201 from Division C at a cost of $1,900 per unit for a
total cost of $950,000 (500 units x $1,900 per unit). Division B acquires an
additional 1,500 units of part 201 from outside vendors at a cost of $1,900 per
unit for a total cost of $2,850,000 (1,500 units x $1,900 per unit). Division B
B. Divisions A and B are acquiring parts in the open market at a total cost of
Lets take a look at the contribution margin of Division C under the proposed
scenario. Considering part 101 first, the transfer price is $900. If we subtract
the variable cost of $700 from the $900 transfer price the resultant
$200 per unit, the total contribution margin is $400,000. With respect to part
201, the transfer price is $1,900. If the $1,200 variable cost is subtracted from
Module 5 Case: Accounting for Decision and Transfer Pricing 13
the $1,900 transfer price, the contribution margin for part 201 is $700.
Division C sells 500 units to Division B so, the $700 contribution margin
times the 500 units of part 201 yields a total contribution margin of $350,000.
The sum of the contribution margin for part 101 and part 201 for Division C
Contrast
Division A has a current cost for part 101 of $3,900,000 however, under the proposed
Division B has a current cost for part 201 of $3,900,000 but, under the
From a corporate perspective the effect is composed the savings of Division A and
have to be made to account for the transfer pricing as indicated above. If you
Kind Regards,