STRATEGIC COST MANAGEMENT

TRANSFER PRICING

1. Definition & Classification

Transfer Pricing It means the price charged for a transfer of goods
or services between units of the same
organization, such as two departments or
divisions. Transfer pricing are needed for
performance evaluation purposes.
Minimum Transfer Price Transfer price that would leave the selling
division no worse off if the good is sold to an
internal division.

Formulae:

Variable cost / unit + Lost Contribution Margin

per unit on outside sales (opportunity cost)

Maximum Transfer Price Transfer price that would leave the buying
division no worse off if an input is purchased
from internal division.
Market-Based Price Transfer price is selling price of the product to
the outside market.
Cost-Based Price Transfer price is based either on variable cost, full
cost, price cost or other basis chosen by
management.
Negotiated Price or Cost Plus Transfer Price Transfer price is the sum of costs incurred by the
producing divisions plus an agreed-on profit
percentage.

2. Important Notes about Cost-Based Transfer Pricing

Benefits Disadvantages
Easy to understand and implementation Little incentive for cost control
Highly convenient Leads to poor decisions whether transfer should
be made
Easy to measure Rate or return difficult to evaluate

3. Important Notes for Market Based Transfer Pricing

Benefits Disadvantages
It will set the actual conditions in the market Costly to implement
Leads to overall efficiency in the operation

4. Objective of Responsibility Accounting

The objective of responsibility accounting is to provide incentives for the organization’s subunit
managers to strive toward achieving the organization’s goals.

5. Define Management By Objectives (MBO)

It is a philosophy in which the managers participate in setting goals that they thrive to achieve. These
goals may be expressed in financial or other quantitative terms, and the responsibility accounting is
used to evaluate performance in achieving them.
Multiple Choice Exercise Questions (Answer Keys)

Quarantine Corporation’s microprocessor division sells a computer module to the company’s Guidance Assembly Division, which
assembles completed guidance systems. The microprocessor division has no excess capacity. The computer module cots P
10,000 to manufacture, and it can be sold in the external market to companies in the computer industry for P13,500.

1. What is the transfer price for the computer module using the general transfer-pricing rule?
a. P 13,500 c. P 3,500
b. P 10,000 d. P 10,500

Maker and Design are the only two divisions of Kobe Corporation. Maker division makes and sells wheel which can either be
sold to outside customers to sold to Design division. The following data are available from last month:

Maker Division -
Selling price per wheel to outside customers P45.00
Variable cost per wheel when sold to outside customers P 30.00
Capacity in wheels 12,000
Wheels sold to outside customers 6,000

Design Division –
Number of wheels needed per month 4,000
Price per wheel paid to an outside supplier P 42

If Maker division sells wheels to Design division, Maker division can avoid P2 per wheel in sales commissions.

1. Given the situation cited above, what transfer price would be used according to the transfer pricing formula?
a. P28 c. P 42
b. P 30 d. P 45

2. Given the situation cited above, what is the maximum price per wheel that Design division should be willing to pay
Maker division if a transfer were to take place?
a. P28 b. P30 c. P 42 d. P 45

3. Suppose that Design division sells 9,000 wheels each month to outside consumers. If transfer pricing formula is used
to find the transfer price, what is the appropriate price per wheel?
a. P 29.50 b. P 31.75 c. P 39.25 d. P 42.00
GBS Corp. has only two divisions: Post and Lamps. The post division produces basic posts which can be sold to outside
customers or sold to the Lamp division. Last year, Lamp bought all its posts from Post at P1.50 each. The following data are
available for last year’s activities:

Post Division –
Capacity in units 300,000 posts
Quantity sold to outside customers 275,000 posts
Quantity demanded by outside customers 290,000 posts
Selling price per posts to outside customers P1.75
Variable cost per post P0.90
Fixed operating costs (unavoidable) P 140,000

Lamp Division –
Lamps sold to outside customers 25,000
Selling price per lamp P 40.00
Variable cost per lamp ( not including the cost of the post) P 21.50
Fixed operating costs ( unavoidable) P 200,000
Machine hour P 5.25 P5.00

* Each lamp requires one post.

1. Last year, the net operating income reported by the Post Division was
a. P 94,000 c. P 108,750
b. P 106,500 d. P 34,000

2. Last year, the net operating income reported by the Lamp Division was
a. P 225,000 c. P 322,500
b. P 262,500 d. P 285,000

3. Last year, the net operating income reported by the GBS Corp. was
a. P 371,250 c. P 365,500
b. P 333,750 d. P 402,000

4. What is the variable overhead efficiency variance?

a. P 0.90 c. P 1.41
b. P 1.35 d. P 1.50