TRANSFER PRICING

• PART OF RESPONSIBILITY ACCOUNTING

• PRICE CHARGED BY ONE SEGMENT/DEPARTMENT TO ANOTHER
DEPARTMENT/SEGMENT
• IN SHORT, IT IS THE PRICE ON INTERDEPARTMENTAL TRANSFERS
IT CAN BE:
MARKET PRICE
VARIABLE COSTS
PRODUCTION COSTS
NEGOTIATED PRICE
 Department B
Customers

S B
E U
L Y
L

Supplier
Department A
 OBJECTIVE: TO HIT GOAL CONGRUENCE PRICE
(DEFINED AS CONSISTENCY OR AGREEMENT OF INDIVIDUAL GOALS WITH COMPANY GOALS

MAXIMUM PRICE SELLING/MARKET PRICE

GENERAL RULE
WITH EXCESS CAPACITY: VARIABLE COSTS
MINIMUM PRICE
W/O EXCESS CAPACITY: VC + CM = SELLING PRICE
OPPORTUNITY COST
• MINIMUM TRANSFER PRICE
 INCREMENTAL COSTS (VC) IN THE SELLING DIVISION

VS

• MAXIMUM TRANSFER PRICE

 LOWEST OUTSIDE PRICE FOR THE GOOD
ILLUSTRATION:
ABC CORPORATION PRODUCES VARIOUS PRODUCT USED IN THE CONSTRUCTION INDUSTRY. DIVISION A
PRODUCES 100,000 COPPER FITTINGS EACH MONTH. RELEVANT INFORMATION FOR THE LAST MONTH FOLLOWS

TOTAL SALES (ALL EXTERNAL) PHP 250,000 (2.50/UNIT)

EXPENSES (ALL ON A UNIT BASE)
VARIABLE MANUFACTURING COSTS 0.50
FIXED MANUFACTURING COSTS 0.25
VARIABLE SELLING 0.30
FIXED SELLING 0.40
VARIABLE GENERAL AND ADMIN 0.15
FIXED GENERAL AND ADMIN 0.50
TOTAL 2.10
THE TOP-LEVEL MANAGEMENT ARE TRYING TO DETERMINE HOW A TRANSFER PRICE CAN BE SET ON A TRANSFER
OF 10,000 OF THE COPPER FITTINGS FROM DIVISION A TO DIVISION B.
REQUIRED:
1. TRANSFER PRICE BASED ON VARIABLE COSTS?
A. 0.50 C. 0.95 Variable Manufacturing
Variable Costs
B. 0.80 D. 0.75
Variable Selling and Admin

2. TRANSFER PRICE BASED ON FULL PRODUCTION COSTS?

A. 2.10 C. 1.45
Variable Manufacturing
B. 1.60 D. 0.75 FULL PROD’N COSTS
Fixed Manufacturing

3. IF DIVISION A SELLS 100,000 UNITS PER MONTH TO OUTSIDE CUSTOMERS, THE PER UNIT TRANSFER PRICE
IS NOT LIKELY TO BE BELOW
A. 0.75 C. 2.50
B. 1.60 D. 2.10
ILLUSTRATION:
DIVISION A OF CDC COMPANY MAKES A PART THAT CAN EITHER BE SOLD TO OUTSIDE
CUSTOMERS OR TRANSFERRED INTERNALLY TO DIVISION B FOR FURTHER PROCESSING.
ANNUAL DATA RELATING TO THIS PART ARE AS FOLLOWS:
ANNUAL PRODUCTION CAPACITY 80,000 UNITS
SELLING PRICE OF THE ITEM TO OUTSIDE CUSTOMER PHP 35.00
VARIABLE COST PER UNIT 23.00
FIXED COST PER UNIT 5.00
DIVISION B OF CDC COMPANY REQUIRES 15,000 UNITS PER YEAR AND IS CURRENTLY
PAYING AN OUTSIDE SUPPLIER PHP 33.00 PER UNIT.

ANSWER THE FOLLOWING INDEPENDENT CASES

1. IF OUTSIDE CUSTOMERS DEMAND ONLY 50,000 UNITS PER YEAR, WHAT IS THE LOWEST ACCEPTABLE
TRANSFER PRICE FROM VIEWPOINT OF THE SELLING DIVISION?
A. 35 C. 28
B. 33 D. 23 With Excess Capacity

2. IF OUTSIDE CUSTOMERS DEMAND ONLY 80,000 UNITS PER YEAR, WHAT IS THE LOWEST ACCEPTABLE
TRANSFER PRICE FROM VIEWPOINT OF THE SELLING DIVISION?
A. 35 C. 28
Without Excess
B. 33 D. 23 Capacity
3. IF OUTSIDE CUSTOMERS DEMAND 80,000 UNITS AND IF, BY SELLING TO DIVISION B, DIVISION A COULD
AVOID PHP 4.00 PER UNIT IN VARIABLE SELLING EXPENSE, WHAT WILL BE THE LOWEST ACCEPTABLE
TRANSFER PRICE FROM THE VIEWPOINT OF THE SELLING DIVISION?
A. 35 C. 31 Incremental Cost or VC 23 Selling Price 35
Avoidable Costs on VC (4) Avoidable Costs (4)
B. 21 D. 33 Opportunity Cost or CM 12 TP 31
TP 31

4. IF OUTSIDE CUSTOMERS DEMAND 70,000 UNITS, WHAT IS THE LOWEST ACCEPTABLE TRANSFER PRICE
FROM THE VIEWPOINT OF THE SELLING DIVISION FOR EACH OF THE 15,000 UNITS NEEDED BY DIVISION B?
A. 33 C. 28
Total Capacity 80,000 units
B. 27 D. 29 Sales to Outsider (70,000) units
Excess Capacity 10,000 units @VC or @23
W/o Excess Capacity 5,000 units @SP or @35
TP = (23 * 10k/15k) + (35*5k/15k) Needed Capacity of B 15,000 units
TP = 27