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sion would be desirable for the company as a whole?

2. Suppose that if the selling price for the intermediate product were dropped to $195, sales to external
parties could be increased to 900 units. Division B wants to acquire as many as 200 units if the transfer
price is acceptable. For simplicity, assume that there is no external market for the final 100 units of division As capacity.
Transfer
Pricing
Exercise
a. Using the
general guideline,
what is (are)
the minimum transfer price(s) that should lead to the correct economic decision? Ignore performance-evaluation considerations.
b. Compare the total contributions under the alternatives to show why the transfer price(s) recommended lead(s) to the optimal economic decision.

Crango Products is a cranberry cooperative that operates two divisions, a harvesting


division and a processing
of harvestings
output
converted
22-30 Effectdivision.
of alternativeCurrently,
transfer-pricingall
methods
on division operating
income.isCrango
Products is a
into cranberry juice
by
the
processing
division,
and
the
juice
is
sold
to
large
beverage
cranberry cooperative that operates two divisions, a harvesting division and a processing division. Currently, all
companies that produce cranberry juice blends. The processing division has a yield of
of harvestings output is converted into cranberry juice by the processing division, and the juice is sold to large
500 gallons of juice per 1,000 pounds of cranberries. Cost and market price data for
beverage
companies that produce cranberry juice blends. The processing division has a yield of 500 gallons of
the two divisions are
as follows:

juice per 1,000 pounds of cranberries. Cost and market price data for the two divisions are as follows:

Harvesting Division
2 Variable cost per pound of cranberries
3 Fixed cost per pound of cranberries
4 Selling price per pound of cranberries in outside market

$0.10
$0.25
$0.60

Processing Division
Variable processing cost per gallon of juice produced
Fixed cost per gallon of juice produced
Selling price per gallon of juice

$0.20
$0.40
$2.10


Required:
1. Compute Crangos operating income from harvesting 400,000 pounds of
cranberries during June 2012 and processing them into juice.
2. Crango rewards its division managers with a bonus equal to 5% of
operating income. Compute the bonus earned by each division manager in
June 2012 for each of the following transfer pricing methods: a. 200% of
full cost b. Market price
3. Which transfer-pricing method will each division manager prefer? How
might Crango resolve any conflicts that may arise on the issue of transfer
pricing?












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22-30 (3035 min.) Effect of alternative transfer-pricing methods on division operating


Answer:
income.

1.
Pounds of cranberries harvested
Gallons of juice processed (500 gals per 1,000 lbs.)
Revenues (200,000 gals. $2.10 per gal.)
Costs
Harvesting Division
Variable costs (400,000 lbs. $0.10 per lb.)
Fixed costs (400,000 lbs. $0.25 per lb.)
Total Harvesting Division costs
Processing Division
Variable costs (200,000 gals. $0.20 per gal.)
Fixed costs (200,000 gals. $0.40 per gal.)
Total Processing Division costs
Total costs
Operating income

400,000
200,000
$420,000
$ 40,000
100,000
140,000
$ 40,000
80,000
120,000
260,000
$160,000

2.
Transfer price per pound (($0.10 + $0.25)

2; $0.60)

1. Harvesting Division
Revenues (400,000 lbs. $0.70; $0.60)
Costs
Division variable costs (400,000 lbs. $0.10 per lb.)
Division fixed costs (400,000 lbs. $0.25 per lb.)
Total division costs
Division operating income
Harvesting Division manager's bonus (5% of operating income)
2. Processing Division
Revenues (200,000 gals. $2.10 per gal.)
Costs
Transferred-in costs
Division variable costs (200,000 gals. $0.20 per gal.)
Division fixed costs (200,000 gals. $0.40 per gal.)
Total division costs
Division operating income
Processing Division managers bonus (5% of operating income)

200% of
Full Costs
$0.70

Market
Price
$0.60

$280,000

$240,000

40,000
100,000
140,000
$140,000
$7,000

40,000
100,000
140,000
$100,000
$5,000

$420,000

$420,000

280,000
40,000
80,000
400,000
$ 20,000
$ 1,000

240,000
40,000
80,000
360,000
$ 60,000
$ 3,000

22-27

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3.
Bonus paid to division managers at 5% of division operating income is computed above
and summarized below:
Internal Transfers
at 200% of Full Costs

Internal Transfers
at Market Prices

Harvesting Division managers bonus


(5% $140,000; 5% $100,000)

$7,000

$5,000

Processing Division managers bonus


(5% $20,000; 5% $60,000)

$1,000

$3,000

The Harvesting Division manager will prefer to transfer at 200% of full costs because this
method gives a higher bonus. The Processing Division manager will prefer transfer at market
price for its higher resulting bonus.
Crango may resolve or reduce transfer pricing conflicts by:
Basing division managers bonuses on overall Crango profits in addition to division
operating income. This will motivate each manager to consider what is best for
Crango overall and not be concerned with the transfer price alone.
Letting the two divisions negotiate the transfer price between themselves. However,
this may result in constant re-negotiation between the two managers each accounting
period.
Using dual transfer prices However, a cost-based transfer price will not motivate cost
control by the Harvesting Division manager. It will also insulate that division from
the discipline of market prices.

22-28

Exercise:

1. British Columbia Lumber has a raw lumber division and a finished lumber division.
The variable costs are as follows:

Raw lumber division: $100 per 100 board-feet of raw lumber

Finished lumber division: $125 per 100 board-feet of finished lumber

Assume that there is no board-feet loss in processing raw lumber into finished lumber.
Raw lumber can be sold at $200 per 100 board-feet. Finished lumber can be sold at
$275 per 100 board-feet.
a. Should British Columbia Lumber process raw lumber into its finished
form? Show your calculations.
b. Assume that internal transfers are made at 110% of variable cost.Will each
division maximize its division operating-income contribution by adopting
the action that is in the best interest of British Columbia Lumber as a
whole? Explain.
c. Assume that internal transfers are made at market prices. Will each
division maximize its division operating-income contribution by adopting
the action that is in the best interest of British Columbia Lumber as a
whole? Explain.

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22-20 (30 min.) Transfer-pricing methods, goal congruence.


1.

Alternative 1: Sell as raw lumber for $200 per 100 board feet:
Revenue
Variable costs
Contribution margin

$200
100
$100 per 100 board feet

Alternative 2: Sell as finished lumber for $275 per 100 board feet:
Revenue
Variable costs:
Raw lumber
Finished lumber
Contribution margin

$275
$100
125

225
$ 50 per 100 board feet

British Columbia Lumber will maximize its total contribution margin by selling lumber in its raw
form.
An alternative approach is to examine the incremental revenues and incremental costs in
the Finished Lumber Division:
Incremental revenues, $275 $200
Incremental costs
Incremental loss
2.

$ 75
125
$ (50) per 100 board feet

Transfer price at 110% of variable costs:


= $100 + ($100 0.10)
= $110 per 100 board feet
Sell as
Raw Lumber

Raw Lumber Division


Division revenues
Division variable costs
Division operating income
Finished Lumber Division
Division revenues
Transferred-in costs
Division variable costs
Division operating income

Sell as
Finished Lumber

$200
100
$100

$110
100
$ 10

$ 0

$275
110
125
$ 40

The Raw Lumber Division will maximize reported division operating income by selling
raw lumber, which is the action preferred by the company as a whole. The Finished Lumber
Division will maximize division operating income by selling finished lumber, which is contrary
to the action preferred by the company as a whole.


22-8

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3.

Transfer price at market price = $200 per 100 board feet.

Raw Lumber Division


Division revenues
Division variable costs
Division operating income
Finished Lumber Division
Division revenues
Transferred-in costs
Division variable costs
Division operating income

Sell as
Raw Lumber

Sell as
Finished Lumber

$200
100
$100

$200
100
$100

$275
200
125
$ (50)

$ 0

Since the Raw Lumber Division will be indifferent between selling the lumber in raw or finished
form, it would be willing to maximize division operating income by selling raw lumber, which is
the action preferred by the company as a whole. The Finished Lumber Division will maximize
division operating income by not further processing raw lumber and this is preferred by the
company as a whole. Thus, transfer at market price will result in division actions that are also in
the best interest of the company as a whole.



2. Ajax Corporation has two divisions. The mining division makes toldine, which is
then transferred to the metals division. The toldine is further processed by the
metals division and is sold to customers at a price of $150 per unit. The mining
division is currently required by Ajax to transfer its total yearly output of 200,000
units of toldine to the metals division at 110% of full manufacturing cost.
22 MANAGEMENT CONTROL SYSTEMS, TRANSFER PRICING, AND MULTINATIONAL CONSIDERATIONS
Unlimited quantities of toldine can be purchased and sold on the outside market at
$90 per unit.
200,000 units of toldine to the metals division at 110% of full manufacturing cost. Unlimited quantities of toldine can beThe
purchased
and table
sold on
the outside
market at $90cost
per per
unit.unit in the mining and metals
following
gives
the manufacturing
The following
table
the manufacturing cost per unit in the mining and metals divisions for 2012:
divisions
forgives
2012:

equired

Direct material cost


Direct manufacturing labor cost
Manufacturing overhead cost
Total manufacturing cost per unit

Mining Division
$12
16
32a
$60

Metals Division
$ 6
20
25b
$51

aManufacturing overhead costs in the mining division are 25% fixed and 75% variable.
bManufacturing overhead costs in the metals division are 60% fixed and 40% variable.

1. Calculate the operating incomes for the mining and metals divisions for the 200,000 units of toldine transferred under the following transfer-pricing methods:22-9
(a) market price and (b) 110% of full manufacturing cost.
a.
Calculate
the
operating
incomes
the mining
and as
metals
for
2. Suppose Ajax rewards each division manager with for
a bonus,
calculated
1% ofdivisions
division operating
the What
200,000
of of
toldine
transferred
under
the division
following
transferincome (if positive).
is theunits
amount
bonus that
will be paid
to each
manager
under the
pricing
methods:
(a)
market
price
and
(b)
110%
of
full
manufacturing
cost.
transfer-pricing methods in requirement 1? Which transfer-pricing method will each division manager
b. Suppose Ajax rewards each division manager with a bonus, calculated as
prefer to use?
1%would
of division
operating
income
(if positive).
Whatmake
is thetoamount
bonus
3. What arguments
Brian Jones,
manager
of the
mining division,
supportofthe
transferthat
will
be
paid
to
each
division
manager
under
the
transfer-pricing
pricing method that he prefers?

22-22 Transfer pricing, general guideline, goal congruence. (CMA, adapted). Quest Motors, Inc., operates
as a decentralized multidivision company. The Vivo division of Quest Motors purchases most of its airbags from
the airbag division. The airbag divisions incremental cost for manufacturing the airbags is $90 per unit. The
airbag division is currently working at 80% of capacity. The current market price of the airbags is $125 per unit.

methods in requirement 1? Which transfer-pricing method will each


division manager prefer to use?
To download
more slides,
ebook,
solutions
test bank,of
visitthe
http://downloadslide.blogspot.com
c. What
arguments
would
Brian
Jones,andmanager
mining division, make
to support the transfer-pricing method that he prefers?

22-21 (30 min.) Effect of alternative transfer-pricing methods on division operating income.
Method A
Internal Transfers
at Market Prices
1. Mining Division
Revenues:
$90, $661 200,000 units
Costs:
Division variable costs:
$522 200,000 units
Division fixed costs:
$83 200,000 units
Total division costs
Division operating income
Metals Division
Revenues:
$150 200,000 units
Costs:
Transferred-in costs:
$90, $66 200,000 units
Division variable costs:
$364 200,000 units
Division fixed costs:
$155 200,000 units
Total division costs
Division operating income

Method B
Internal Transfers at
110% of Full Costs

$18,000,000

$13,200,000

10,400,000

10,400,000

1,600,000
12,000,000
$ 6,000,000

1,600,000
12,000,000
$ 1,200,000

$30,000,000

$30,000,000

18,000,000

13,200,000

7,200,000

7,200,000

3,000,000
28,200,000
$ 1,800,000

3,000,000
23,400,000
$ 6,600,000

$66 = Full manufacturing cost per unit in the Mining Division, $60 110%
Variable cost per unit in Mining Division = Direct materials + Direct manufacturing labor + 75% of manufacturing
overhead = $12 + $16 + (75% $32) = $52
3
Fixed cost per unit = 25% of manufacturing overhead = 25% $32 = $8
4
Variable cost per unit in Metals Division = Direct materials + Direct manufacturing labor + 40% of manufacturing
overhead = $6 + $20 + (40% $25) = $36
5
Fixed cost per unit in Metals Division = 60% of manufacturing overhead = 60% $25 = $15
2

22-10

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2.

Bonus paid to division managers at 1% of division operating income will be as follows:


Method A
Internal Transfers
at Market Prices

Mining Division managers bonus


(1% $6,000,000; 1% $1,200,000)
Metals Division managers bonus
(1% $1,800,000; 1% $6,600,000)

Method B
Internal Transfers at
110% of Full Costs

$60,000

$ 12,000

18,000

66,000

The Mining Division manager will prefer Method A (transfer at market prices) because
this method gives $60,000 of bonus rather than $12,000 under Method B (transfers at 110% of
full costs). The Metals Division manager will prefer Method B because this method gives
$66,000 of bonus rather than $18,000 under Method A.
3.
Brian Jones, the manager of the Mining Division, will appeal to the existence of a
competitive market to price transfers at market prices. Using market prices for transfers in these
conditions leads to goal congruence. Division managers acting in their own best interests make
decisions that are also in the best interests of the company as a whole.
Jones will further argue that setting transfer prices based on cost will cause Jones to pay
no attention to controlling costs since all costs incurred will be recovered from the Metals
Division at 110% of full costs.

22-11

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