Responsibility Accounting and Transfer Pricing

(B. Transfer Pricing)

B. TRANSFER PRICING Objectives

1. The objective of a transfer pricing system should be to
THEORIES: A. maximize the transfer price
Nature B. minimize the transfer price
5. Transfer prices are charges for C. maintain goal congruence between the divisions and the entire firm
A. transportation of goods outside units of an organization. D. none of the above
B. goods sold by subunits to outside customers.
C. goods exchanged among subunits. 2. The objective(s) of transfer pricing are
D. goods stored within a subunit. A. to motivate managers
B. to provide an incentive for managers to make decisions consistent with
23. A transfer price is a price charged the firm's goals (i.e., goal congruence)
A. to outside customers C. to provide a basis for fairly rewarding the managers
B. when one division sells its goods or services to another division D. all of the above
C. by the selling division to the buying division when outside market does not
exist 4. A transfer pricing system should satisfy which of the following objectives?
D. a and b A. accurate performance evaluation C. goal congruence
B. preservation of divisional autonomy D. all of the above
24. Transfer prices are
A. necessary to calculate costs in a cost, profit, or investment center 34. The market price method satisfy a key objective of transfer pricing, namely:
B. preferred by buying divisions are the lowest possible A. objectivity C. consistency
C. do not make any difference for the company's bottom-line no matter what B. usability D. reliability
number is used
D. all of the above Irrelevant costs
29. Which item is usually not relevant to a decision by a divisional manager to
36. Which of the following is a key factor to consider in deciding whether to make reduce a transfer price to meet a price offered to another division by an
internal transfers, and, if so, in setting the transfer price? outside supplier?
A. Is there an outside supplier? A. opportunity cost
B. Is the seller's variable cost less than the market price/ B. variable manufacturing costs
C. Is the selling unit operating at full capacity? C. fixed divisional overhead
D. All of the above are key factors. D. the price offered by the outside supplier

32. From the standpoint of the company, the important question in transfer Minimum & Maximum Transfer Price
pricing is General rule
A. what is fair to the divisions 9. The general rule in establishing transfer prices consistent with economic
B. how to determine the profit of the divisions decision making is the
C. whether or not the transfer should take place A. differential cost plus opportunity cost if goods are transferred internally.
D. when the transfer should be made B. actual cost plus opportunity cost if goods are transferred internally.
C. standard cost plus opportunity cost if goods are transferred internally.

393
 Responsibility Accounting and Transfer Pricing
(B. Transfer Pricing)

D. all of the above. A. market price.

B. actual cost plus markup.
Seller’s standpoint (minimum price) C. standard cost plus markup.
26. The minimum transfer price should be: D. all of the above.
A. opportunity cost for selling division
B. opportunity cost for buying division 27. Transfer prices are set by:
C. opportunity cost for the company as a whole A. cost or cost plus C. negotiation
D. only variable cost for the selling division B. market prices D. all of the above

14. A selling division produces components for a buying division that is 35. Which of the following are transfer pricing models?
considering accepting a special order for the products it produces. The A. Variable cost method C. Market cost method
selling division has excess capacity. The minimum price the selling division B. Average price method D. All of the above
would be willing to accept is the
A. selling division’s variable costs Market price
B. buying division’s outside purchase price 10. If a firm operates at capacity, the transfer price should be the:
C. price that would allow the buying division to cover its incremental cost of A. external market price. C. actual cost.
the special order B. differential cost. D. standard cost.
D. price that would allow the selling division to maintain its current ROI
12. To avoid waste and maximize efficiency when transferring products among
25. The minimum transfer price from the seller's standpoint is divisions in a competitive economy, a large diversified corporation should
A. market price when excess capacity exists base transfer prices on:
B. market price when excess capacity does not exist A. full cost C. replacement cost
C. incremental costs when excess capacity exists B. variable cost D. market price
D. b and c
13. If an intermediate market exists, the optimal transfer price is the:
Buyer’s standpoint (maximum price) A. outlay cost for producing the goods.
7. Generally, the outside market price would be B. opportunity cost of not selling to the outside market.
A. a floor for internal transfer price. C. market price.
B. a ceiling for internal transfer price. D. variable costs associated with producing the product.
C. both a and b
D. none of the above. 16. If there is no excess capacity, the transfer price is often
A. market price
Methods of transfer pricing B. opportunity cost plus incremental cost
3. The basic methods used in transfer pricing are C. variable cost or variable cost plus profit
A. variable or full costs C. market price or negotiated price D. a or b
B. dual prices D. all of the above
20. Market pricing approach in transfer pricing
8. An example of a transfer price policy is A. helps to preserve unit autonomy

394
 Responsibility Accounting and Transfer Pricing
(B. Transfer Pricing)

B. provides incentive for the selling unit to be competitive with outside D. transfer prices based upon standard costs plus a markup for profit
suppliers
C. may be the most practical approach when there is significant conflict 31. The worst transfer-pricing method is to base the prices on
D. both a and b A. market prices C. budgeted variable costs
B. budgeted total costs D. actual total costs
28. The best transfer price is usually
A. actual cost plus a percentage markup Variable costing
B. a reliable market price 21. Variable costing method of transfer pricing is
C. budgeted full cost plus a percentage markup A. easy to implement
D. budgeted variable cost plus a percentage markup B. intuitive and easily understood
C. more logical when there is excess capacity
30. Market-based transfer prices are best for the D. all of the above
A. company when the selling division is operating below capacity.
B. company when the selling division is operating at capacity. 22. A company may consider using variable costs in transfer pricing when there
C. buying division if it is operating at capacity. is
D. buying division. A. excess capacity because variable costs would stay the same
B. no excess capacity because variable costs would not stay the same
33. Which transfer price is ideal for the company when the selling division is at C. excess capacity because fixed costs would stay the same
capacity? D. no excess capacity because fixed costs would stay the same
A. Market price
B. Incremental cost Full cost
C. Budgeted full cost 18. If full cost is used in transfer pricing, it is preferable to use
D. Actual variable cost plus a percentage profit A. standard full cost because the buyer does not wish to be stuck with
unknowns
Actual costs B. standard full cost because the seller does not wish to pass along the
6. Disadvantages of transfer prices based on actual cost include: variations in cost
A. reducing the incentive of managers of supplying divisions to control their C. actual full cost because the buyer is well-advised to deal with the real
costs. rather than anticipated costs
B. passing on efficiencies or inefficiencies of supplying divisions to receiving D. actual full costs because the seller is well-advised to deal with the real
divisions. rather than anticipated costs
C. both a and b.
D. none of the above. Negotiated
11. Negotiated transfer prices are appropriate when:
15. Which of the following types of transfer prices do not encourage the selling A. there are cost savings to the selling division.
division to be efficient? B. there is no external market price.
A. transfer prices based upon market prices C. the internal market price reflects a bargain price.
B. transfer prices based upon actual costs D. all of the above.
C. transfer prices based upon standard costs

395
 Responsibility Accounting and Transfer Pricing
(B. Transfer Pricing)

17. A negotiated transfer pricing system is set up where B. Any amount less than P50 D. P50 is the only acceptable price
A. the two sides cannot agree on a price and the difference between the two
sides is absorbed by the home office Minimum transfer price
B. a ready market price is not available and the two sides must come up with iii. Family Enterprises has two divisions: Davy and Johnny. Davy Division has a
an agreeable price capacity to produce 2,000 units and is expecting to sell 1,500 units. Johnny
C. the buyer buys at variable cost and the seller only sells at full cost Division wants to purchase 100 units of a product Davy produces. Davy sells
D. the two sides agree to use a cost basis for transfer pricing the product at a selling price of P100 per unit, the variable cost per unit is P25
and the fixed costs total P30,000. The minimum transfer price that Davy will
Multinational transfer pricing accept is?
19. To minimize taxes, some multinational companies set low transfer prices A. P100 C. P43.75
when goods are shipped from B. P45 D. P25
A. low tax countries to other low tax countries
B. low tax countries to high tax countries iv. Assume that Division X has a product that can be sold either to outside
C. high tax countries to low tax countries customers on an intermediate market or to Division Y of the same company
D. c or b for use in its production process. The managers of the division are
evaluated based on their divisional profits.
PROBLEMS: Division X:
Residual income Capacity in units 200,000
i. Marsh Company that had current operating assets of one million and net Number of units being sold on the intermediate market 160,000
income of P200,000 had an opportunity to invest in a project that requires an Selling price per unit on the intermediate market P75
additional investment of P250,000 and increased net income by P40,000. Variables costs per unit 60
The company's required rate of return is 12%. After the investment, the Fixed costs per unit (based on capacity) 8
company's residual income will amount to
A. 80,000 C. 90,000 Division Y:
B. 85,000 D. 95,000 Number of units needed for production 40,000
Purchase price per unit now being paid to an outside supplier P74
With excess capacity The minimum transfer price to be charged by the Division X should be:
Bargaining range A. P60 C. P68
ii. An appropriate transfer price between two divisions of the Reno Corporation B. P75 D. P74
can be determined from the following data:
Fabrication Division Effect on profit of make decision
Market price of subassembly P50 v. Bearing Division of Phantom Corp. sells 80,000 units of Part X to the outside
Variable cost of subassembly P20 market. Part X sells for P10.00 and has a variable cost of P5.50 and a fixed
Excess capacity (in units) 1,000 cost per unit of P2.50. Bearing has a capacity to produce 100,000 units per
Assembling Division period. Motor Division currently purchases 10,000 units of Part X from
Number of units needed 900 Bearing for P10.00. Motor has been approached by an outside supplier
What is the natural bargaining range for the two divisions? willing to supply the parts for P9.00. What is the effect on XYZ’s overall profit
A. Between P20 and P50 C. Between P50 and P70 if Bearing refuses the outside price and Motor decides to buy outside?

396
 Responsibility Accounting and Transfer Pricing
(B. Transfer Pricing)

A. no change be incurred?
B. P20,000 decrease in Phantom profits A. P120 C. P 88
C. P35,000 decrease in Phantom profits B. P 91 D. P117 (?)
D. P10,000 increase in Phantom profits
ix. Harem Corporation consists of two divisions, Mining and Builders. The
vi. Bearing Division of XYZ Corp. sells 80,000 units of Part X to the outside Mining makes black steel, a product that can be used in the product that the
market. Part X sells for P10.00 and has a variable cost of P5.50 and a fixed Builders division makes. Both divisions are considered profit centers. The
cost per unit of P2.50. Bearing has a capacity to produce 100,000 units per following data are available concerning black steel and the two divisions:
period. Motor Division currently purchases 10,000 units of Part X from Mining Builders
Bearing for P10.00. Motor has been approached by an outside supplier Average units produced 150,000
willing to supply the parts for P9.00. What is the effect on XYZ’s overall profit Average units sold 150,000
if Bearing refuses the outside price and Motor decides to buy inside? Variable mfg cost per unit P2
A. no change C. P35,000 decrease in XYZ profits Variable finishing cost per unit P5
B. P20,000 decrease in XYZ profits D. P10,000 increase in XYZ profits Fixed divisional costs P75,000 P125,000
The Mining Division can sell all of its output outside the company for P4 per
At capacity unit. The Builders Division can buy the black steel from other firms for P4.
Minimum transfer price The Builders Division sells its product for P12.
vii. Company Y is highly decentralized. Division X, which is operating at What is the optimal transfer price in this case?
capacity, produces a component that it currently sells in a perfectly A. P2 per unit C. P7 per unit
competitive market for P13 per unit. At the current level of production, the B. P4 per unit D. P9 per unit
fixed cost of producing this component is P4 per unit and the variable cost
is P7 per unit. Division Z would like to purchase this component from x. Assume that Steel Division has a product that can be sold either to outside
Division X. What would be the price that Division X should charge Division customers on an intermediate market or to Fabrication Division of the same
Z? company for use in its production process. The managers of the division are
A. P 7 C. P 11 evaluated based on their divisional profits.
B. P 13 D. P 9 Steel Division:
Capacity in units 200,000
viii. The Black Division of Pluma Company produces a high quality marker. Unit Number of units being sold on the intermediate market 200,000
production costs (based on capacity production of 100,000 units per year) Selling price per unit on the intermediate market P90
follow: Variables costs per unit (including P3 of avoidable selling expense)
Direct materials P 60 70
Direct labor 25 Fixed costs per unit (based on capacity) 13
Overhead (20% variable) 15
Other information Fabrication Division:
Sales price 120 Number of units needed for production 40,000
The Black Division is producing and selling at capacity. Purchase price per unit now being paid to an outside supplier P86
What is the minimum selling price that the division would consider as a The appropriate transfer price should be:
“transfer price” to the Red Division on which no variable period costs would

397
 Responsibility Accounting and Transfer Pricing
(B. Transfer Pricing)

A. P90 C. P70 Selling price per circuit board P125

B. P87 D. P86 Production cost per circuit board 90
Numbers of circuit boards:
Partial excess capacity Produced during the year 20,000
Decision Sold to outside customers 16,000
xi. Chips Division manufacturers electronic circuit boards. The boards can be Sold to Compo Division 4,000
sold either to Compo Division of the same company or to outside customers.
Last year, the following activity occurred in division A: Sales to Compo Division were at the same price as sales to outside
customers. The circuit boards purchased by Compo Division were used in
Selling price per circuit board P125 an electronic instrument manufactured by that division (one board per
Production cost per circuit board 90 instrument). Compo Division incurred P100 in additional cost per instrument
Numbers of circuit boards: and then sold the instrument for P300 each.
Produced during the year 20,000
Sold to outside customers 16,000 Assume that Chips Division’s manufacturing capacity is 20,000 circuit
Sold to Compo Division 4,000 boards. Next year Compo Division wants to purchase 5,000 circuits board
from Chips Division rather than 4,000. (Circuit boards of this type are not
Sales to Compo Division were at the same price as sales to outside available from outside sources.)
customers. The circuit boards purchased by Compo Division were used in
an electronic instrument manufactured by that division (one board per Chips Division proposed that a transfer for additional 1,000 units be
instrument). Compo Division incurred P100 in additional cost per instrument produced by requiring its workers to work overtime. Chips Division
and then sold the instrument for P300 each. indicated that the transfer price may be unreasonably high because of the
overtime premium.
Assume that Chips Division’s manufacturing capacity is 20,000 circuit
boards. Next year Compo Division wants to purchase 5,000 circuits board What is the maximum transfer that Compo Division will accept for the
from Chips Division rather than 4,000. (Circuit boards of this type are not additional 1,000 units?
available from outside sources.) A. P 90 C. P200
B. P125 D. P300
Should Chips Division sell 1,000 additional circuit boards to Compo Division
or continue to sell them outside customers? Use the following data to answer questions 11 through 13.
A. No, because the overall profit will decrease by P35,000. N & R Company transfers a product from division N to division R. Variable cost of
B. Yes, because the overall profit will decrease by P35,000. this product is anticipated to be P40 a unit and total fixed costs amount to P8,000.
C. No, because there is no change in the overall profit. A total of 100 units are anticipated to be produced. Actual cost, however,
D. Yes, because the overall profit will increase by P75,000. amounts to P50 for variable costs. Fixed costs were same as budget. However,
actual output was twice as many.
Maximum transfer price
xii. Chips Division manufacturers electronic circuit boards. The boards can be xiii. Actual cost per unit amounts to
sold either to Compo Division of the same company or to outside customers. A. P90 C. P115
Last year, the following activity occurred in division A: B. P92 D. P120

398
 Responsibility Accounting and Transfer Pricing
(B. Transfer Pricing)

xiv. The transfer price based on actual variable costs plus 130% markup amounts vii. Answer: B
to The division is operating at capacity (zero excess capacity). Any quantity of
A. P90 C. P115 production to be transferred to the Division Z must be at P13; Any price
B. P92 D. P120 below P13, as transfer price, would decrease its profit.

xv. The transfer price based on budgeted full cost plus 30% markup amounts to viii.Answer: D
A. P117 C. P150 Selling price (market price) P120
B. P140 D. P156 Less avoidable selling expense 15 x 20% 3
Minimum transfer price P117

ix. Answer: B
i. Answer: C The optimal transfer price is P4 per unit, which represents the value of
New Operating Profit (P200,000 + P40,000) P240,000 using the black steel in the Builders Division because the black steel will
Less Required Returns (P1,250,000 x 0.12) 150,000 cost P2 to manufacture and each unit used internally is a unit that cannot be
New Residual Income P 90,000 sold to external buyers. If an intermediate market exists, the optimal transfer
price is the market price.
ii. Answer: D
The Fabrication division has excess capacity, therefore the division can x. Answer: B
transfer the units at a minimum transfer price of P50 The division is operating at capacity, therefore, the minimum transfer price
must be the amount of selling price, less avoidable selling expense.
iii. Answer: D Selling price P90
The minimum Davy would accept is the opportunity cost to make the product, Avoidable selling expense 3
which would be the variable cost of P25. Net Price 87

iv. Answer: A xi. Answer: D

The minimum transfer price is P60 because the Division X has excess Selling price charged by Compo Division P300
capacity Selling price charge by Chips Division 125
Additional selling price P175
v. Answer: C Less additional processing cost by Compo 100
The profit of the company will decrease by P35,000 which is the difference Additional profit per unit P 75
between the variable (relevant) cost and the purchase price. Additional profit: 1,000 x P75 P75,000
(P9.00 – P5.5) x 10,000 units = P35,000
xii. Answer: C
vi. Answer: A Final selling price by Compo P300
There is no change in the profit because the Motor Division did not buy from Less additional processing cost 100
the outside supplier Maximum material cost (transfer price) P200

399
 Responsibility Accounting and Transfer Pricing
(B. Transfer Pricing)

At a transfer price of P200, Compo will not realize any profit on the
additional 1,000 units

xiii.Answer: A
The actual cost is the sum of unit variable cost plus fixed cost divided by
actual units produced.
50 + (8000 ÷ 200) = P90

xiv.Answer: C
Variable cost P 50
Markup (P50 x 1.3) 65
Transfer price P115

xv. Answer: D
Budgeted full cost P40 + (P8,000 ÷ 100) P120
Markup (P120 x 0.3) 36
Transfer price P156

400