Timestamp Untitled Question

TRANSFER P
SG 10 Group 06:
Daniel Chia Ming Jun
Tan Tammie
Tan Xin Rong
Teo Wei Sheng
Yeo Shu Qi
SFER PRICING
10 Group 06:
iel Chia Ming Jun

Wei Sheng
Question 1
1(a) Division A wants to buy all 25,000 units from division B at $75 per unit. Should division B accept or reject the proposal? Division A requires al
Operating capacity: 80% 50,000
Maximum capacity 100% 62,500

If Division B were to accept the internal transfer to Division A at $75,

Contribution Margin
Division B Outside customers
Selling price $75 $130
Less variable manufacturing costs ($60) ($70)
Less variable marketing costs - ($8)
CM per unit $15 $52
Units transferred / forgone 25,000 12,500
Total CM earned / forgone $375,000 $650,000
Incremental gain / (loss) ($275,000)
-> Division B should reject the proposal as it reduces Division B's operating income
by $275,000. Since divisional management are compensated based on division's
operating income, Division B's manager will not be motivated to accept the internal
transfer.

1(b) Division A wants to buy all 25,000 units from division B at $75 per unit. Should division B accept or reject the proposal? Division A would acce
If Division B were to accept the partial internal transfer of 12,500 units to Division A at $75 and the
remaining 12,500 units purchased externally,
Contribution Margin
Division B
Selling price $75
Less variable manufacturing costs ($60)
Less variable marketing costs -
CM per unit $15
Units transferred 12,500
Total CM earned $187,500
-> Division B should accept the proposal as it increases Division B's operating
income by $187,500. Since divisional management are compensated based on
division's operating income, Division B's manager will be motivated to accept the
internal transfer.

2 What is the range of transfer prices over which the divisional managers might negotiate a final transfer price? Provide a rationale for the rang
If partial shipment is not permitted,
Upper limit = costs of buying from outside supplier $80
Lower limit = VC + OC $86
-> No room for negotiation since the minimum price seller is willing to sell at (lower
limit) is higher than minimum price the buyer is willing to buy at (upper limit).
ccept or reject the proposal? Division A requires all 25,000 units in the order to be shipped by the same supplier.

To produce 25,000 units, Division B has to forgo 12,500 units that can be sold to outside customers at $130 per unit.

Transfer Pricing
Division B
Incremental cost/unit 60 Variable manufacturing cost
Opportunity cost/unit 26 [12500 x (130 - 78)] / 25000
Minimum transfer price 86 Incremental cost/unit + Opportunity cost/unit
Division A's offer price 75
Difference 11 Offer price - Minimum transfer price

-> Since the minimum transfer price is higher than Division A's
offer price, Division B should reject the proposal as by accepting,
Division B will make a loss when the costs are greater than
revenue.

ccept or reject the proposal? Division A would accept partial shipment from division B?

Transfer Pricing
Division B
Incremental cost/unit 60 Variable manufacturing cost
Opportunity cost/unit 0 No opportunity cost because of partial payment
Minimum transfer price 60 Incremental cost/unit + Opportunity cost/unit
Division A's offer price 75
Difference 15 Offer price - Minimum transfer price

187500
-> Since the minimum transfer price is lower than Division A's offer
price, Division B should accept the proposal as by accepting,
Division B will make a profit when the costs are lower than
revenue.

inal transfer price? Provide a rationale for the range you provide.
If partial shipment is permitted,
Upper limit = costs of buying from outside supplier $80
Lower limit = VC $60
-> Price range between $60 to $80. Division B (selling) hopes for the highest possible
price while Division A (buying) aims to reduce its costs. Division B accepts minimally $60 to
at least cover its VC and hoping to cover part of FC if price >$60. However, $80 is the
maximum price that Division A will pay. Any amount <$80 results in cost savings for Division
A and the firm. Any amount >$80, Divsion A will purchase externally.
Note from Prof:
Company's perspective
$2,150,000 vs $2,000,000

-->Loss of $150,000 to the firm. Hence, reject proposal.

Question 2
1 Explain whether transfer prices based on cost are appropriate as a divisional performance measure and why.
Inappropriate as divisional performance measure because the Selling Division (Mining Div) has less incentive to control cost since cost is tran
inclusion of fixed costs in short term decision making can cause goal incongruence.

2 Using the market price as the transfer price, determine the contribution margin for both divisions for the year ended May 31, 2019.
Mining Division (sell) Metal Division (buy)
Selling price $90 $150
Less DM ($12) ($6)
Less DL ($16) ($20)
Less VMOH ($24) ($10)
Less transfer price from Mining - -90
CM per unit $38 $24
Units transferred 400,000
Total CM $15,200,000 $9,600,000

3 If Ajax were to institute the use of negotiated transfer prices and allow divisions to buy and sell on the open market, determine the price range
No excess capacity,
Upper limit = costs of buying from outside supplier $90

VC $52
OC is the CM forgone if sold to open market $33
Lower limit $85

4 Identify which of the three types of transfer prices—cost-based, market-based, or negotiated—is most likely to elicit desirable management b
-> Negotiated transfer price.

Market-based transfer pricing would be preferred by Mining Division (sell) as it can charge a higher price and thus enabling it to report a
Metal Division (buy) would prefer cost-based transfer pricing (referring to case facts CM $19 million VS CM $5m).
Negotiated transfer pricing benefits both Metal & Mining Divisions as well as the company as a whole:
where Metal Division buys at a cheaper price than on open market below $90
and Mining Division is able to cover at least its VC & OC and also encourage it to control costs.
ess incentive to control cost since cost is transferred to Buyer's (Metal Div) Unit. Also,

s for the year ended May 31, 2019.

n the open market, determine the price range for toldine that both divisions would accept. Explain your answer.

Price range between $85 to $90. Mining Division (selling) hopes for
the highest possible price while Metals Division (buying) aims to
reduce its costs. Mining Division accepts minimally $85 to at least
cover its VC and CM forgone and hoping to cover part of FC if price
>$85. However, $90 is the maximum price that Metals Division will
pay. Any amount <$90 results in cost savings for Metals Division and
the firm. Any amount >$90, Divsion A will purchase externally.

most likely to elicit desirable management behavior at Ajax and thus benefit overall operations. Explain your answer.

higher price and thus enabling it to report a higher divisional profits (referring to part 2).
million VS CM $5m).
Question 3
Assume that both country X and country Y have corporate income tax rates of 40% and that no special tax treaties or benefits apply to Zen. W
1 burden if the manufacturing unit raises its price from $300,000 to $360,000?
Country X Country Y Effects on total tax burden
Additional tax / (tax savings) $24,000 ($24,000) $0

->No effects on total tax burden as both countries have the same tax rate of 40%.
2 What would be the effect on Zen’s total taxes if the manufacturing unit raised its price from $300,000 to $360,000 and the tax rates in country
Country X Country Y Effects on total tax burden
Additional tax / (tax savings) $12,000 ($24,000) ($12,000)

->Net decrease in total tax burden by $12,000.

3 Comment on any ethical issues you observe in this case.

Transfer pricing manipulation by the firm to shift income from higher tax jurisdiction (Country Y) to lower tax jurisdiction (Country X) with th
share of taxes and no countries would want its tax base to suffer because of transfer pricing. As a result of this potential loss of tax revenue, m
Singapore Income Tax Act S34D and OECD, transfer prices should be based on the arm's length principle. The arm's length principle requires t
would have charged in the same or similar circumstances.

http://www.oecd.org/countries/singapore/transfer-pricing-country-profile-singapore.pdf
https://www.iras.gov.sg/irashome/Businesses/Companies/Working-out-Corporate-Income-Taxes/Specific-topics/Transfer-Pricing/Introduc
tax treaties or benefits apply to Zen. What would be the effect on Zen’s total tax

o $360,000 and the tax rates in country X and country Y are 20% and 40%, respectively?

wer tax jurisdiction (Country X) with the aim of reducing overall tax liability is unethical. This can deprive countries of their fair
of this potential loss of tax revenue, most countries have laws prohibiting transfer price manipulation. For example, regulated by
e. The arm's length principle requires that transfer prices between related parties are equivalent to prices that unrelated parties

cific-topics/Transfer-Pricing/Introduction-to-Transfer-Pricing/
Question 4
4(a) From the corporate perspective of Sapporo Foods, given all the information provided, which order should Benri Division accept wh

Ignore transfer prices between the various divisions

Accept internal order from Oishi Local Catering

Kori Division Kori Division

Meat costs for 2000 Gyoza Meals Meat costs for 2000 Ez
Meat costs for 2500 Me
Meals

Benri Division Benri Division

Processing costs for 2000 Gyoza Processing costs for 25

Meals Meals

Oishi Division

Soko

Catering revenue

Customers

Assuming revenue from Oishi's catering orders to be $x

Accept internal order from Oishi Local Catering

Firm's perspective:
Revenue (Oishi catering) $x
Less: variable costs
Meat costs (2000 Gyoza Meals) ($20,000) $2 per kg*5 kg per package*2000 packages
Processing costs (2000 Gyoza Meals) ($80,000) $40 per package*2000 packages
Total variable costs incurred ($100,000)

Total Contribution margin $x - $100,000

 *Benri Division should accept external order of Ready Meatball Meals to Soko as the total contribution margin is $21,500 grea

4(b) Since the managers of Benri Division and Oishi Division are given the autonomy to decide, is it likely that they will be able to agree to the inter
Upper limit = costs of buying from outside supplier $60

VC/unit $55
OC/unit (CM forgone/unit) $6.25
Lower limit $61.25

->Hence, not likely that they will be able to agree to the internal transfer of Ready Gyoza Meals.

4(c) What strategic factors may be of concern to Sapporo’s top management with regards to the above decisions?

Loss in future sales

Oishi Division prefers to buy the Ready Meals from Benri Division as its customer has indicated a preference for those meals. By accepting the
sales for Sapporo and thus a lower company operating profit.

Possibility of future business

If Benri Division fulfills Soko's order, it may lead to future regular business with Soko which becomes another source of revenue for Sapporo a

Sapporo's reputation
On one hand, if Soko is a reputable customer, it helps Sapporo to gain marketing mileage when Soko buys their products and that could lower
hand, as a result of customer dissatisfaction from Oishi selling Ezy meals instead of the Ready meals, Sapporo's reputation will be adversely af
of-mouth about Sapporo Foods, causing Sapporo may miss out on new and existing customers, hence decreasing their profitability.

Benri Division appears to be facing growing demand for its Ready Meals which is unable to fully meet with its existing capacity. Yet the manag
4(d) production costs and improve its profitability. The projected ROI of the investment is 18%, which is above the target rate of 15% required by t

As an investment center, Benri Division performance is assumed to be evaluated based on divisional ROI, meaning the manager's compensatio
though it is beneficial to the firm (18%>15%), which consequently lowers the manager's compensation.
der should Benri Division accept which is in the best interest of Sapporo? Explain your recommendation and support it with appropriate computations.

Accept external order from Soko

Kori Division

Meat costs for 2000 EzyMeals

Meat costs for 2500 Meatball Revenue from selling
Meals frozen meat for 2000 Ezy
Meals

Benri Division

Processing costs for 2500 Meatball

Tiffin Foods
Meals
Cost of buying
2000 Ezy Meals
Revenue from selling
2500 Meatball Meals
Oishi Division

Soko

Catering revenue

Customers

Accept external order from Soko

Firm's perspective:
Revenue (Oishi catering) $x
Revenue (Soko order) (2500 Meatball Meals) $162,500 $65 per package*2500 packages
Revenue (Tiffin meat order) (2000 Ezy Meals) $30,000 $3.75 per kg*4 kg per package*2000 packages
Total Revenue $x + $192,500
Less: variable costs + avoidable costs
Meat costs (2000 Ezy Meals) ($16,000) $2 per kg*4 kg per package*2000 packages
Purchase cost (2000 Ezy Meals) ($120,000) $60 per package*2000 packages
 Meat costs (2500 Meatball Meals) ($28,750) $2.3 per kg*5 kg per package*2500 packages
Processing costs (2500 Meatball Meals) ($106,250) $42.5 per package*2500 packages
Total variable costs incurred ($271,000)

Total Contribution margin $x - $78500

ntribution margin is $21,500 greater than if Benri Division accepted the internal order

they will be able to agree to the internal transfer of Ready Gyoza Meals? Explain your view and support it with appropriate computations.

Variable Cost = 40 + 3*5 = 55

[Selling price (65) - Variable Cost (42.5 + 3.5*5)]*2500/2000

nce for those meals. By accepting the external order from Soko and rejecting the internal order from Oishi, this could lead to customer dissatisfaction resulting in loss in future

ther source of revenue for Sapporo and in turn lead to greater profitability in the long term. This may cause Sapporo to go with Soko instead of Oishi Division.

their products and that could lower the marketing costs for Sapporo in the long term as it strengthens their reputation in the market, hence increasing profitability. On the other
poro's reputation will be adversely affected as a result of meeting Soko's orders at the expense of their existing customers. This could be done when customers spread bad word-
reasing their profitability.

h its existing capacity. Yet the manager of Benri Division has recently turned down a proposal to invest in new machinery that will increase the plant capacity, reduce its unit
the target rate of 15% required by the company for new investments. Provide an explanation for the manager’s decisions, stating your assumptions.

meaning the manager's compensation is assumed to be evaluated upon the divisional ROI as well. Hence, accepting the project may lower the division's current ROI (>18%) even
e computations.
ssatisfaction resulting in loss in future

Note from Prof:

Consider the reliability of Tiffin Foods as a supplier
tead of Oishi Division. - Quality of meals provided

- Timeliness of deliveries

ence increasing profitability. On the other

done when customers spread bad word-

ase the plant capacity, reduce its unit

assumptions.

er the division's current ROI (>18%) even