Problem:
The current pattern is that Division A purchases 3,000 units of product part 101 from Division C (the supplying division) and another 1,000 units from an external supplier. The market price for part 101 is $900 per unit. Division B purchases 1,000 units of part 201 from Division C and another 1,000 units from an external supplier. Note that both divisions A and B purchase the needed supplies from both the internal source and an external source at the same time.
The mangers for Divisions A and B are preparing a new proposal for consideration.
• Division C will continue to produce parts 101 and 201. All of its production will be sold to Divisions A and B. No other customers are likely to found for these products in the short term given that supply is greater than demand in the market.
• Division C will manufacture 2,000 units of part 101 for the Division A and 500 units of part 201 for the Division B.
• Division A will buy 2,000 units of part 101 from Division C and 2,000 units from an external supplier at $900 per unit.
• Division B will buy 500 units of part 201 from Division C and 1,500 units from an external supplier at $1,900 per unit.
Division C Data 2012 Based on the Current Agreement
|
Part
|
101
|
201
|
|
Direct materials
|
$200
|
$300
|
|
Direct labor
|
$200
|
$300
|
|
Variable overhead
|
$300
|
$600
|
|
Transfer price
|
$1,000
|
$2,000
|
|
Annual Volume
|
3,000 units
|
1,000 units
|
Required:
• Calculate the increase or decrease in profits for the three divisions and the company as a whole (four separate computations) if the agreement is enforced. Explain your thought process, comment on the situation, and make a suggestion based on the computations you have made.
• Evaluate and discuss the implications of the following transfer pricing policies:
o Transfer price = cost plus a mark-up for the selling division
o Transfer price = fair market value
o Transfer price = price negotiated by the managers
• Why is transfer pricing such a significant issue both from a financial and managerial perspective?