Coffee Maker's Incorporated (CMI).
Two divisions of the CMI are involved in a argument. Division A purchases Part 101 and Division B purchases Part 201 from the third division, C. Both divisions require the parts for products which they assemble. Intercompany transactions have remained constant for several years.
In recent times, outside suppliers have lowered their prices, but Division C is not lowering its prices. Additionally, all division managers are feeling pressure to increase profit. Managers of divisions A and B will like flexibility to purchase parts they require from external parties to lower cost and increase profitability.
The present 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 external supplier. 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 external supplier. Note that both divisions A and B purchase the required supplies from both internal source and an external source at the same time.
The managers for divisions A and B are preparing the new proposal for consideration.
• Division C would continue to produce Parts 101 and 201. All of its production would be sold to Divisions A and B. No other customers are likely to found for these products in short term given that supply is greater than demand in the market.
• Division C would manufacture 2,000 units of Part 101 for the Division A and 500 units of Part 201 for the Division B.
• Division A would buy 2,000 units of Part 101 from Division C and 2,000 units from the external supplier at $900 per unit.
• Division B would buy 500 units of Part 201 from Division C and 1,500 units from external supplier at $1,900 per unit.
Division C Data 2012 Based on 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:
• Compute the increase or decrease in profits for three divisions and company as a whole (four separate computations) if the agreement is enforced. Describe your thought process, comment on the situation, and make a suggestion based on computations you have made.
• Evaluate and discuss implications of the following transfer pricing policies:
Transfer price = cost plus a mark-up for the selling division
Transfer price = fair market value
Transfer price = price negotiated by the managers
• Why is transfer pricing such a important issue both from the financial and managerial perspective?
Modular Case Assignment Expectations
It is significant to answer questions as posed. The discussion must be from 3 to 5 pages and written in a clear and concise manner. Support your discussion with references in APA format. You can use Excel or other compatible spreadsheet when computations are involved.
Approaches and objective of Transfer Pricing Policies
The fundamental purpose in setting transfer prices is to motivate managers to act in best interests of the organization, and not just their division. A good transfer price is one that encourages division managers to do whatever is in the best interest of the entire organization.
There are three main approaches to setting transfer prices, namely (1) negotiated transfer prices, (2) transfers at market price transfers, and (3) transfers at cost (or cost plus set profit) to the selling division.
The objectives of domestic transfer pricing include:
• Creating greater divisional autonomy.
• Providing greater motivation for managers.
• Enabling better performance evaluation.
• Establishing better goal congruence.
The purpose of international transfer pricing include:
• Lowering taxes, duties, and tariffs.
• Lowering foreign exchange risks.
• Improving competitive position.
• Improving relations with foreign governments.