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B. TRANSFER PRICING
THEORIES:
Nature
5. Transfer prices are charges for
A. transportation of goods outside units of an organization.
B. goods sold by subunits to outside customers.
C. goods exchanged among subunits.
D. goods stored within a subunit.
Irrelevant costs
29. Which item is usually not relevant to a decision by a divisional manager to reduce a transfer
price to meet a price offered to another division by an outside supplier?
A. opportunity cost
B. variable manufacturing costs
C. fixed divisional overhead
D. the price offered by the outside supplier
36. Which of the following is a key factor to consider in deciding whether to make internal
transfers, and, if so, in setting the transfer price?
A. Is there an outside supplier?
B. Is the seller's variable cost less than the market price/
C. Is the selling unit operating at full capacity?
D. All of the above are key factors.
32. From the standpoint of the company, the important question in transfer pricing is
A. what is fair to the divisions
B. how to determine the profit of the divisions
C. whether or not the transfer should take place
D. when the transfer should be made
Objectives
1. The objective of a transfer pricing system should be to
A. maximize the transfer price
A.
B.
C.
D.
C. negotiation
D. all of the above
14. A selling division produces components for a buying division that is considering accepting a
special order for the products it produces. The selling division has excess capacity. The
minimum price the selling division would be willing to accept is the
A. selling divisions variable costs
B. buying divisions outside purchase price
C. price that would allow the buying division to cover its incremental cost of the special order
D. price that would allow the selling division to maintain its current ROI
Market price
10. If a firm operates at capacity, the transfer price should be the:
A. external market price.
C. actual cost.
B. differential cost.
D. standard cost.
12. To avoid waste and maximize efficiency when transferring products among divisions in a
competitive economy, a large diversified corporation should base transfer prices on:
A. full cost
C. replacement cost
B. variable cost
D. market price
Full cost
18. If full cost is used in transfer pricing, it is preferable to use
A. standard full cost because the buyer does not wish to be stuck with unknowns
B. standard full cost because the seller does not wish to pass along the variations in cost
C. actual full cost because the buyer is well-advised to deal with the real rather than
anticipated costs
D. actual full costs because the seller is well-advised to deal with the real rather than
anticipated costs
33. Which transfer price is ideal for the company when the selling division is at capacity?
A. Market price
B. Incremental cost
C. Budgeted full cost
D. Actual variable cost plus a percentage profit
Actual costs
6. Disadvantages of transfer prices based on actual cost include:
A. reducing the incentive of managers of supplying divisions to control their costs.
B. passing on efficiencies or inefficiencies of supplying divisions to receiving divisions.
C. both a and b.
D. none of the above.
Negotiated
11. Negotiated transfer prices are appropriate when:
A. there are cost savings to the selling division.
B. there is no external market price.
C. the internal market price reflects a bargain price.
D. all of the above.
15. Which of the following types of transfer prices do not encourage the selling division to be
efficient?
A. transfer prices based upon market prices
B. transfer prices based upon actual costs
C. transfer prices based upon standard costs
D. transfer prices based upon standard costs plus a markup for profit
Variable costing
21. Variable costing method of transfer pricing is
A. easy to implement
B. intuitive and easily understood
C. more logical when there is excess capacity
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D. c or b
Capacity in units
Number of units being sold on the intermediate market
Selling price per unit on the intermediate market
Variables costs per unit
Fixed costs per unit (based on capacity)
PROBLEMS:
Residual income
i. Marsh Company that had current operating assets of one million and net income of P200,000
had an opportunity to invest in a project that requires an additional investment of P250,000
and increased net income by P40,000. The company's required rate of return is 12%. After the
investment, the company's residual income will amount to
A. 80,000
C. 90,000
B. 85,000
D. 95,000
Division Y:
Number of units needed for production
Purchase price per unit now being paid to an outside supplier
The minimum transfer price to be charged by the Division X should be:
A. P60
C. P68
B. P75
D. P74
200,000
160,000
P75
60
8
40,000
P74
vi. Bearing Division of XYZ Corp. sells 80,000 units of Part X to the outside market. Part X sells
for P10.00 and has a variable cost of P5.50 and a fixed cost per unit of P2.50. Bearing has a
capacity to produce 100,000 units per period. Motor Division currently purchases 10,000 units
of Part X from Bearing for P10.00. Motor has been approached by an outside supplier willing
to supply the parts for P9.00. What is the effect on XYZs overall profit if Bearing refuses the
outside price and Motor decides to buy inside?
A. no change
C. P35,000 decrease in XYZ profits
B. P20,000 decrease in XYZ profits
D. P10,000 increase in XYZ profits
iv. Assume that Division X has a product that can be sold either to outside customers on an
intermediate market or to Division Y of the same company for use in its production process.
The managers of the division are evaluated based on their divisional profits.
Division X:
At capacity
Minimum transfer price
vii. Company Y is highly decentralized. Division X, which is operating at capacity, produces a
component that it currently sells in a perfectly competitive market for P13 per unit. At the
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current level of production, the 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 Division
X. What would be the price that Division X should charge Division Z?
A. P 7
C. P 11
B. P 13
D. P 9
intermediate market or to Fabrication Division of the same company for use in its production
process. The managers of the division are evaluated based on their divisional profits.
Steel Division:
Capacity in units
200,000
Number of units being sold on the intermediate market
200,000
Selling price per unit on the intermediate market
P90
Variables costs per unit (including P3 of avoidable selling expense)
70
Fixed costs per unit (based on capacity)
13
viii. The Black Division of Pluma Company produces a high quality marker. Unit production
costs (based on capacity production of 100,000 units per year) follow:
Direct materials
P 60
Direct labor
25
Overhead (20% variable)
15
Other information
Sales price
120
The Black Division is producing and selling at capacity.
What is the minimum selling price that the division would consider as a transfer price to the
Red Division on which no variable period costs would be incurred?
A. P120
C. P 88
B. P 91
D. P117 (?)
Fabrication Division:
Number of units needed for production
Purchase price per unit now being paid to an outside supplier
The appropriate transfer price should be:
A. P90
C. P70
B. P87
D. P86
40,000
P86
ix. Harem Corporation consists of two divisions, Mining and Builders. The Mining makes black
steel, a product that can be used in the product that the Builders division makes. Both
divisions are considered profit centers. The following data are available concerning black
steel and the two divisions:
Mining
Builders
Average units produced
150,000
Average units sold
150,000
Variable mfg cost per unit
P2
Variable finishing cost per unit
P5
Fixed divisional costs
P75,000
P125,000
The Mining Division can sell all of its output outside the company for P4 per unit. The
Builders Division can buy the black steel from other firms for P4. The Builders Division sells
its product for P12.
What is the optimal transfer price in this case?
A. P2 per unit
C. P7 per unit
B. P4 per unit
D. P9 per unit
P125
90
20,000
16,000
4,000
Sales to Compo Division were at the same price as sales to outside customers. The circuit
boards purchased by Compo Division were used in an electronic instrument manufactured
by that division (one board per instrument). Compo Division incurred P100 in additional cost
per instrument and then sold the instrument for P300 each.
Assume that Chips Divisions manufacturing capacity is 20,000 circuit 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 available from outside sources.)
x. Assume that Steel Division has a product that can be sold either to outside customers on an
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Should Chips Division sell 1,000 additional circuit boards to Compo Division or continue to
sell them outside customers?
A. No, because the overall profit will decrease by P35,000.
B. Yes, because the overall profit will decrease by P35,000.
C. No, because there is no change in the overall profit.
D. Yes, because the overall profit will increase by P75,000.
anticipated to be produced. Actual cost, however, amounts to P50 for variable costs. Fixed costs
were same as budget. However, actual output was twice as many.
xiii. Actual cost per unit amounts to
A. P90
B. P92
C. P115
D. P120
xiv. The transfer price based on actual variable costs plus 130% markup amounts to
A. P90
C. P115
B. P92
D. P120
xv. The transfer price based on budgeted full cost plus 30% markup amounts to
A. P117
C. P150
B. P140
D. P156
i.
Sales to Compo Division were at the same price as sales to outside customers. The circuit
boards purchased by Compo Division were used in an electronic instrument manufactured
by that division (one board per instrument). Compo Division incurred P100 in additional cost
per instrument and then sold the instrument for P300 each.
Answer: C
New Operating Profit
Less Required Returns
New Residual Income
(P200,000 + P40,000)
(P1,250,000 x 0.12)
P240,000
150,000
P 90,000
ii. Answer: D
The Fabrication division has excess capacity, therefore the division can transfer the units at
a minimum transfer price of P50
Assume that Chips Divisions manufacturing capacity is 20,000 circuit 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 available from outside sources.)
iii. Answer: D
The minimum Davy would accept is the opportunity cost to make the product, which would be
the variable cost of P25.
Chips Division proposed that a transfer for additional 1,000 units be produced by requiring
its workers to work overtime. Chips Division indicated that the transfer price may be
unreasonably high because of the overtime premium.
iv. Answer: A
The minimum transfer price is P60 because the Division X has excess capacity
What is the maximum transfer that Compo Division will accept for the additional 1,000 units?
A. P 90
C. P200
B. P125
D. P300
v. Answer: C
The profit of the company will decrease by P35,000 which is the difference between the
variable (relevant) cost and the purchase price.
(P9.00 P5.5) x 10,000 units = P35,000
xii. Answer: C
Final selling price by Compo
P300
Less additional processing cost
100
Maximum material cost (transfer price)
P200
At a transfer price of P200, Compo will not realize any profit on the additional 1,000 units
vi. Answer: A
There is no change in the profit because the Motor Division did not buy from the outside
supplier
vii. Answer: B
The division is operating at capacity (zero excess capacity). Any quantity of production to
be transferred to the Division Z must be at P13; Any price below P13, as transfer price,
would decrease its profit.
viii. Answer: D
Selling price (market price)
Less avoidable selling expense 15 x 20%
Minimum transfer price
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
Markup (P50 x 1.3)
Transfer price
P120
3
P117
ix. Answer: B
The optimal transfer price is P4 per unit, which represents the value of using the black steel
in the Builders Division because the black steel will cost P2 to manufacture and each unit
used internally is a unit that cannot be sold to external buyers. If an intermediate market
exists, the optimal transfer price is the market price.
xv. Answer: D
Budgeted full cost
Markup
Transfer price
x. Answer: B
The division is operating at capacity, therefore, the minimum transfer price must be the
amount of selling price, less avoidable selling expense.
Selling price
P90
Avoidable selling expense
3
Net Price
87
xi. Answer: D
Selling price charged by Compo Division
Selling price charge by Chips Division
Additional selling price
Less additional processing cost by Compo
Additional profit per unit
Additional profit:
1,000 x P75
P300
125
P175
100
P 75
P75,000
399
P 50
65
P115
P40 + (P8,000 100)
(P120 x 0.3)
P120
36
P156