Question 7:

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. (a) Define the term transfer price.

(b) What are the three general alternatives for setting domestic transfer prices?

(c)What is meant by the term dual pricing, as used within the context of the transfer pricing decision? Give one example of dual pricing.

(d) What criteria can be used to judge a particular transfer pricing alternative? (Hint: think about the different objectives of transfer pricing, including objectives in an international setting.)

2. 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?

3. What is the maximum transfer price that Division B would be willing to pay per unit on any internal transfers? 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. 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?

Please show work and explain, will rate.