Transfer Pricing: True / False Questions

Chapter 15
Transfer Pricing

True / False Questions

1. A transfer price is the value assigned to the transfer of goods or services between divisions within the same
organization.

True False

2. Transfer prices are not used to record the exchange between two cost centers within the same organization.

True False

3. Transfer prices cannot be used for decision making, product costing, or performance evaluation.

True False

4. From an organization's viewpoint, transfer prices have no effect on total profits assuming the transfer
occurs between the two responsibility centers.

True False

5. If a transfer has no effect on divisional profit, risk-neutral managers will be indifferent between making the
transfer or not.

True False

6. If an intermediate market exists but divisions are prohibited from buying or selling from the outside, the
intermediate market can be ignored in determining the optimal transfer price.

True False

7. A perfect intermediate market exists if buyers can buy and sellers can sell outside of the organization.

True False

8. When a perfect intermediate market exists, the optimal transfer price is the intermediate market price.

True False

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9. In general, the optimal transfer price for a division is the sum of its outlay costs and the opportunity cost of
not transferring its goods to another division.

True False

10. The use of an optimal transfer price eliminates potential conflicts between an organization's interests and
the divisional manager's interest.

True False

11. A market price-based transfer price policy allows the selling division to determine the price for transfers
between divisions within the same organization.

True False

12. A selling division at capacity is indifferent between selling to outsiders and transferring inside at the market
price.

True False

13. When actual costs are used as the basis for a transfer, inefficiencies of the selling division are transferred to
the buying division.

True False

14. A transfer made at cost does not motivate the selling division to transfer its goods or services internally.

True False

15. In general, negotiated transfer prices fall in a range between the selling division's differential costs and the
buying division's market price.

True False

16. In the United States, more companies use cost-based transfer prices than market-based transfer prices.

True False

17. In interstate transactions, transfers can reduce an organization's tax liability when the selling division is in a
lower tax jurisdiction than the buying division.

True False

18. Tax avoidance is unethical when inflated transfer prices are used in international transactions to shift profits
from a division in one country to a division in another country.

True False

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19. An organization that has significant foreign operations must disclose how its transfer prices are established
between domestic and foreign divisions.

True False

20. The GAAP financial reporting rules for segments require that all companies use transfer prices based on
market prices.

True False

Multiple Choice Questions

21. Which of the following statements is(are) false?
(A) From an organization's viewpoint, transfer prices have no effect on total profits assuming the transfer
(B) A transfer price is the value assigned to the transfer of goods or services between divisions within the
same organization.

A. Only A is false.
B. Only B is false.
C. Both A and B are false.
D. Neither A nor B is false.

22. Which of the following responsibility centers is affected by the use of market-based transfer prices?

A. Cost center.
B. Profit center.
C. Revenue center.
D. Production center.

23. Transfer prices would not be used by:

A. production centers.
B. investment centers.
C. profit centers.
D. cost centers.

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24. A division can sell externally for $60 per unit. Its variable manufacturing costs are $35 per unit, and its
variable marketing costs are $12 per unit. What is the opportunity cost of transferring internally, assuming
the division is operating at capacity?

A. $13.
B. $25.
C. $35.
D. $47.

variable marketing costs are $12 per unit. What is the optimal transfer price for transferring internally,
assuming the division is operating at capacity?

A. $12.
B. $35.
C. $47.
D. $60.

26. Division A has variable manufacturing costs of $50 per unit and fixed costs of $10 per unit. Assuming that
Division A is operating at capacity, what is the opportunity cost of an internal transfer when the market
price is $75?

A. $20.
B. $25.
C. $50.
D. $60.

Division A is operating at capacity, what is the optimal transfer price of an internal transfer when the
market price is $75?

A. $20.
B. $25.
C. $50.
D. $75.

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Division A is operating significantly below capacity, what is the optimal transfer price of an internal
transfer when the market price is $75?

A. $20.
B. $25.
C. $50.
D. $60.

29. Division B has variable manufacturing costs of $50 per unit and fixed costs of $10 per unit. Assuming that
Division B is operating significantly below capacity, what is the opportunity cost of an internal transfer
when the market price is $75?

A. $0.
B. $25.
C. $50.
D. $60.

30. Dockside Enterprises Inc., operates two divisions: (1) a management division that owns and manages bulk
carriers on the Great Lakes and (2) a repair division that operates a dry dock in Tampa, Florida. The repair
division works on company ships, as well as other large-hull ships. The repair division has an estimated
variable cost of $37 per labor-hour. The repair division has a backlog of work for outside ships. They
charge $70.00 per hour for labor, which is standard for this type of work. The management division
complained that it could hire its own repair workers for $45.00 per hour, including leasing an adequate
work area.
What is the minimum transfer price per hour that the repair division should obtain for its services,
assuming it is operating at capacity?

A. $33.00.
B. $37.00.
C. $45.00.
D. $70.00.

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work area.
What is the maximum transfer price per hour that the management division should pay?

A. $33.00.
B. $37.00.
C. $45.00.
D. $70.00.

work area.
If the repair division had idle capacity, what is the minimum transfer price that the repair division should
obtain?

A. $33.00.
B. $37.00.
C. $45.00.
D. $70.00.

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33. You have been provided with the following information for Division X of a decentralized company:
Selling price $90

Variable cost per unit 66
Fixed cost per unit 20
Sales volume (units) 22,500
Capacity (units) 25,000
Division Y of the same company would like to purchase all of its units internally. Division Y needs 6,000
units each period and currently pays $84 per unit to an outside firm. What is the lowest price that Division
X could accept from Division Y? (Assume that Division Y wants to use a sole supplier and will not
purchase less than 6,000 from a supplier.)

A. $90.
B. $84.
C. $80.
D. $66.

34. When the selling division in an internal transfer has unsatisfied demand from outside customers for the
product that is being transferred, then the lowest acceptable transfer price as far as the selling division is
concerned is:

A. the variable cost of producing a unit of product.

B. the full absorption cost of producing a unit of product.
C. the market price charged to outside customers, less costs saved by transferring internally.
D. the amount that the purchasing division would have to pay an outside seller to acquire a similar product
for its use.

15-7
35. Division A makes a part that it sells to customers outside of the company. Data concerning this part appear
below:
Selling price to outside customers $75

Variable cost per unit $50
Total fixed costs $400,000
Capacity in units 25,000
Division B of the same company would like to use the part manufactured by Division A in one of its
products. Division B currently purchases a similar part made by an outside company for $70 per unit and
would substitute the part made by Division A. Division B requires 5,000 units of the part each period.
Division A can already sell all of the units it can produce on the outside market. What should be the lowest
acceptable transfer price from the perspective of Division A?

A. $75.
B. $66.
C. $16.
D. $50.

36. Part 43X costs the Southern Division of Norris Corporation $26 to make - direct materials are $10, direct
labor is $4, variable manufacturing overhead is $9, and fixed manufacturing overhead is $3. Southern
Division sells Part 43X to other companies for $30. The Northern Division of Norris Corporation can use
Part 43X in one of its products. The Southern Division has enough idle capacity to produce all of the units
of Part 43X that the Northern Division would require. What is the lowest transfer price at which the
Southern Division should be willing to sell Part 43X to the Northern Division?

A. $30.
B. $26.
C. $23.
D. $27.

37. The Wheel Division of Frankov Corporation has the capacity for making 75,000 wheel sets per year and
regularly sells 60,000 each year on the outside market. The regular sales price is $100 per wheel set, and
the variable production cost per unit is $65. The Retail Division of Frankov Corporation currently buys
30,000 wheel sets (of the kind made by the Wheel Division) yearly from an outside supplier at a price of
$90 per wheel set. If the Retail Division were to buy the 30,000 wheel sets it needs annually from the
Wheel Division at $87 per wheel set, the change in annual net operating income for the company as a
whole, compared to what it is currently, would be:

A. $600,000.
B. $225,000.
C. $750,000.
D. $135,000.

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38. Division X makes a part that it sells to customers outside of the company. Data concerning this part appear
below:
Selling price to outside

$50
customers
Division Y of the same company would like to use the part manufactured by Division X in one of its
products. Division Y currently purchases a similar part made by an outside company for $49 per unit and
would substitute the part made by Division X. Division Y requires 5,000 units of the part each period.
Division X has ample excess capacity to handle all of Division Y's needs without any increase in fixed
costs and without cutting into outside sales. According to the formula in the text, what is the lowest
acceptable transfer price from the standpoint of the selling division?

A. $50.
B. $49.
C. $46.
D. $30.

39. Division A makes a part that it sells to customers outside of the company. Data concerning this part appear
below:

$40
customers
products. Division B currently purchases a similar part made by an outside company for $38 per unit and
would substitute the part made by Division A. Division B requires 5,000 units of the part each period.
Division A has ample capacity to produce the units for Division B without any increase in fixed costs and
without cutting into sales to outside customers. If Division A sells to Division B rather than to outside
customers, the variable cost be unit would be $1 lower. What should be the lowest acceptable transfer price
from the perspective of Division A?

A. $40.
B. $38.
C. $30.
D. $29.

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40. The Raisin Division of Trail Mix Foods, Inc. had the following operating results last year:

Sales (150,000 pounds of raisins) $60,000
Variable expenses 37,500
Contribution margin 22,500
Fixed expenses 12,000
Profit $10,500
Raisin expects identical operating results this year. The Raisin Division has the ability to produce and sell
200,000 pounds of raisins annually.
Assume that the Peanut Division of Trail Mix Foods wants to purchase an additional 20,000 pounds of
raisins from the Raisin Division. Raisin will be able to increase its profit by accepting any transfer price
above:

A. $0.40 per pound.

B. $0.08 per pound.
C. $0.15 per pound.
D. $0.25 per pound.


Profit $10,500
Raisin expects identical operating results this year. The Raisin Division has the ability to produce and sell
200,000 pounds of raisins annually.
Assume that the Raisin Division is currently operating at its capacity of 200,000 pounds of raisins. Also
assume again that the Peanut Division wants to purchase an additional 20,000 pounds of raisins from the
Raisin Division. Under these conditions, what amount per pound of raisins would the Raisin Division have
to charge Peanut in order to maintain its current profit?

A. $0.40 per pound.

B. $0.08 per pound.
C. $0.15 per pound.
D. $0.25 per pound.

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42. The Gear Division makes a part with the following characteristics:

Production capacity 25,000 units
Fixed cost, total $100,000
Motor Division of the same company would like to purchase 10,000 units each period from the Gear
Division. The Motor Division now purchases the part from an outside supplier at a price of $17 each.
Suppose the Gear Division has ample excess capacity to handle all of the Motor Division's needs without
any increase in fixed costs and without cutting into sales to outside customers. If the Gear Division refuses
to accept the $17 price internally and the Motor Division continues to buy from the outside supplier, the
company as a whole will be:

A. worse off by $70,000 each period.

B. better off by $10,000 each period.
C. worse off by $60,000 each period.
D. worse off by $20,000 each period.


Suppose that the Gear Division is operating at capacity and can sell all of its output to outside customers. If
the Gear Division sells the parts to Motor Division at $17 per unit, the company as a whole will be:

A. better off by $10,000 each period.

B. worse off by $20,000 each period.
D. There will be no change in the status of the company as a whole.

15-11
44. Division A produces a part with the following characteristics:

Selling price per unit $30
Variable costs per unit $18
Fixed costs per unit $3
Division B, another division in the company, would like to buy this part from Division A. Division B is
presently purchasing the part from an outside source at $28 per unit. If Division A sells to Division B, $1 in
variable costs can be avoided.
Suppose Division A is currently operating at capacity and can sell all of the units it produces on the outside
market for its usual selling price. From the point of view of Division A, any sales to Division B should be
priced no lower than:

A. $27.
B. $29.
C. $20.
D. $28.


presently purchasing the part from an outside source at $28 per unit. If Division A sells to Division B, $1 in
variable costs can be avoided.
Suppose that Division A has ample idle capacity to handle all of Division B's needs without any increase in
fixed costs and without cutting into its sales to outside customers. From the point of view of Division A,
any sales to Division B should be priced no lower than:

A. $29.
B. $30.
C. $18.
D. $17.

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46. The Pillar Division of the Gothic Building Company produces basic pillars which can be sold to outside
customers or sold to the Lantern Division of the Gothic Company. Last year, the Lantern Division bought
all of its 25,000 pillars from Pillar at $1.50 each. The following data are available for last year's activities of
the Pillar Division:

Capacity in units 300,000 pillars
Selling price per pillar to outside
$1.75
customers
Variable costs per pillar $0.90
Fixed costs, total $150,000
The total fixed costs would be the same for all the alternatives considered below.
Suppose there is ample capacity so that transfers of the pillars to the Lantern Division do not cut into sales
to outside customers. What is the lowest transfer price that would not reduce the profits of the Pillar
Division?

A. $0.90.
B. $1.35.
C. $1.41.
D. $1.75.


$1.75
customers
Suppose the transfers of pillars to the Lantern Division cut into sales to outside customers by 15,000 units.
What is the lowest transfer price that would not reduce the profits of the Pillar Division?

A. $0.90.
B. $1.35.
C. $1.41.
D. $1.75.

15-13

$1.75
customers
Suppose the transfers of pillars to the Lantern Division cut into sales to outside customers by 15,000 units.
Further suppose that an outside supplier is willing to provide the Lantern Division with basic pillars at
$1.45 each. If the Lantern Division had chosen to buy all of its pillars from the outside supplier instead of
the Pillar Division, the change in net operating income for the company as a whole would have been:

A. $1,250 decrease.
B. $10,250 increase.
C. $1,000 decrease.
D. $13,750 decrease.

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49. The Stake Division of the Outdoor Lumination Company produces stakes which can be sold to outside
customers or transferred to the Solar Light Division of the Outdoor Lumination Company. Last year, the
Solar Light Division bought 50,000 stakes from the Stake Division at $2.50 each. The following data are
available for last year's activities in the Stake Division:

Capacity in units 400,000 stakes
Quantity sold to outside customers 350,000 stakes
Selling price per stake to outside
$3.00
customers
Total variable costs per stake $2.00
Fixed operating costs $200,000
In order to sell 50,000 stakes to the Solar Light Division, the Stake Division must give up sales of 30,000
stakes to outside customers. That is, the Stake Division could sell 380,000 stakes each year to outside
customers (rather than only 350,000 stakes as shown above) if it were not making sales to the Solar Light
Division.
According to the formula in the text, what is the lowest acceptable transfer price from the viewpoint of the
selling division?

A. $2.50.
B. $2.00.
C. $2.60.
D. $3.00.

15-15
Solar Light Division bought 50,000 stakes from the Stake Division at $2.50 each. The following data are
available for last year's activities in the Stake Division:

$3.00
customers
In order to sell 50,000 stakes to the Solar Light Division, the Stake Division must give up sales of 30,000
stakes to outside customers. That is, the Stake Division could sell 380,000 stakes each year to outside
customers (rather than only 350,000 stakes as shown above) if it were not making sales to the Solar Light
Division.
Suppose that last year an outside supplier would have been willing to provide the Solar Light Division
with the basic stakes at $2.10 each. If the Solar Light Division had chosen to buy all of its stakes from the
outside supplier instead of the Stake Division, the change in net operating income for the company as a
whole would have been:

A. $45,000 increase.
B. $20,000 decrease.
C. $20,000 increase.
D. $25,000 increase.

51. Division X makes a part that it sells to customers outside of the company. Data concerning this part appear
below:

products. Division Y currently purchases a similar part made by an outside company for $49 per unit and
would substitute the part made by Division X. Division Y requires 5,000 units of the part each period.
Division X can sell all of the units it makes to outside customers. What is the lowest acceptable transfer
price from the standpoint of the selling division?

A. $50.
B. $49.
C. $46.
D. $30.

15-16
52. Division X of Operandi Corporation makes and sells a single product which is used by manufacturers of
fork lift trucks. Presently it sells 12,000 units per year to outside customers at $24 per unit. The annual
capacity is 20,000 units and the variable cost to make each unit is $16. Division Y of Operandi Corporation
would like to buy 10,000 units a year from Division X to use in its products. There would be no cost
savings from transferring the units within the company rather than selling them on the outside market.
What should be the lowest acceptable transfer price from the perspective of Division X?

A. $24.00.
B. $21.40.
C. $17.60.
D. $16.00.

53. Division A of Chappelle Company has the capacity for making 3,000 motors per month and regularly sells
1,950 motors each month to outside customers at a contribution margin of $62 per motor. The variable cost
per motor is $35.70. Division B of Chappelle Company would like to obtain 1,400 motors each month from
Division A. What should be the lowest acceptable transfer price from the perspective of Division A?

A. $26.57.
B. $51.20.
C. $35.70.
D. $62.00.

54. Which of the following statements is(are) true?
(A) If a transfer has no effect on divisional profit, managers will be indifferent between making the
transfer or not.
(B) If an intermediate market exists but divisions are prohibited from buying or selling from the outside,
the intermediate market can be ignored in determining the optimal transfer price.

A. Only A is true.
B. Only B is true.
C. Both A and B are true.
D. Neither A nor B is true.

55. In general, if a potential transfer has no effect on divisional profits:

A. no transfer will take place between the divisions.

B. managers will be indifferent between making the transfer or not.
C. the organization should not intervene to force a transfer.
D. the optimal transfer price is the opportunity cost for the buying division.

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56. An intermediate market is perfect when:

A. there are no quality differences between inside and outside suppliers.

B. there are quality differences between inside and outside customers.
C. buyers and sellers can sell any quantity without affecting the market price.
D. buyers and sellers are motivated to make decisions that are consistent with those of the organization.

57. When there is no intermediate market:

A. there is no optimal transfer price.

B. the selling division cannot transfer its goods internally.
C. the buying division cannot purchase its goods externally.
D. there is no reason for top management to intervene in transfer pricing disputes.

58. The general principle on setting transfer prices that are in the organization's best interests is:

A. outlay cost plus opportunity cost of the resource at the point of transfer.
B. variable costs plus opportunity cost of the resource at the point of transfer.
C. lost contribution margin less the allocated fixed costs for the selling division.
D. gross margin for the buying division plus the gross margin for the selling division.

59. If the selling division has excess capacity, the transfer price should be set at its:

A. differential outlay costs.

B. differential outlay costs plus the foregone contribution to the organization of making the transfer
internally.
C. selling price less the variable costs.
D. selling price less the variable costs plus the foregone contribution to the organization of making the
transfer internally.

60. Given a competitive outside market for identical intermediate goods, what is the best transfer price,
assuming all relevant information is readily available?

A. Standard production cost per unit.

B. Market price of the intermediate goods.
C. Actual full cost per unit plus a normal markup.
D. Market price of the final goods less any opportunity costs.

15-18
61. The optimal transfer price when there are intermediate markets is:

A. full cost.
B. outlay costs.
C. variable cost.
D. market prices.

variable marketing costs are $6 per unit. What is the opportunity cost of transferring internally, assuming
the division is operating at capacity?

A. $15.
B. $19.
C. $21.
D. $25.

63. Division A has variable manufacturing costs of $25 per unit and fixed costs of $5 per unit. Division A is
operating at capacity, what is the opportunity cost of an internal transfer when the market price is $35?

A. $5.
B. $10.
C. $25.
D. $30.

64. Lock Division of Morgantown Corp. sells 80,000 units of part Z-25 to the outside market. Part Z-25 sells
for $40, has a variable cost of $22, and a fixed cost per unit of $10. The Lock Division has a capacity to
produce 100,000 units per period. The Cabinet Division currently purchases 10,000 units of part Z-25 from
the Lock Division for $40. The Cabinet Division has been approached by an outside supplier willing to
supply the parts for $36. What is the effect on Morgantown's overall profit if the Lock Division refuses the
outside price and the Cabinet Division decides to buy outside?

A. No change in Morgantown's profits.

B. $140,000 decrease in Morgantown's profits.
C. $80,000 decrease in Morgantown's profits.
D. $40,000 increase in Morgantown's profits.

15-19
65. The Lock Division of Morgantown Corp. sells 80,000 units of part Z-25 to the outside market. Part Z-25
sells for $40, has a variable cost of $22, and a fixed cost per unit of $10. The Lock Division has a capacity
to produce 100,000 units per period. The Cabinet Division currently purchases 10,000 units of part Z-25
from the Lock Division for $40. The Cabinet Division has been approached by an outside supplier willing
to supply the parts for $36. What is the effect on Morgantown's overall profit if the Lock Division accepts
the outside price and the Cabinet Division continues to buy inside?



66. Concrete Corporation has two producing centers, Contractor and Retailer. The Contractor Division has a
variable cost of $12 for its products and a total fixed cost of $120,000. The Contractor Division also has
idle capacity for up to 50,000 units per month. The Retailer Division would like to purchase 20,000 units of
the Contractor Division's products per month, but is unable to convince the Contractor Division to transfer
units to the Retailer Division at $16 per unit. The Contractor Division has consistently argued that the
market price of $20 is nonnegotiable. What is The Contractor Division's opportunity cost of not
transferring units to the Retailer Division?

A. $20.
B. $12.
C. $8.
D. $4.

67. You have been provided with the following information for the Wool Division of a decentralized company:

Selling price $45
The Blanket Division would like to purchase all of its units internally. The Blanket Division needs 6,000
units each period and currently pays $42 per unit to an outside firm. What is the lowest price that Wool
Division could accept from the Blanket Division? Assuming that the Blanket Division wants to use a sole
supplier and will not purchase less than 6,000 from a supplier, what is the lowest price that Wool Division
could accept from the Blanket Division?

A. $45.
B. $42.
C. $40.
D. $38.

15-20
68. Given the following data for Keyboard Division:

Fixed cost – Total 50,000
Capacity (in units) 125,000
The Computer Division would like to purchase 15,000 units each period from the Keyboard Division. The
Keyboard Division has ample excess capacity to handle all of the Computer Division's needs. The
Computer Division now purchases from an outside supplier at a price of $20. If the Keyboard Division
refuses to accept an $18 price internally, the company, as a whole, will be worse off by:

A. $30,000.
B. $75,000.
C. $90,000.
D. $120,000.

69. Given the following data for Electrical Cord Division:

Assume that Electrical Cord Division is selling all it can produce to outside customers. If it sells to the
Appliance Division, $1 can be avoided in variable cost per unit. The Appliance Division is presently
purchasing from an outside supplier at $38 per unit. From the point of view of the company as a whole, any
sales to the Appliance Division should be priced at:

A. $40.
B. $39.
C. $38.
D. The company would not want the transfer to take place.

15-21
70. Given the following data for Handle Division:

Fixed cost per unit (based on capacity) 30
Cabinet Division would like to purchase 10,000 units from the Handle Division at a price of $125 per unit.
Handle Division has no excess capacity to handle the Cabinet Division's requirements. The Cabinet
Division currently purchases from an outside supplier at a price of $140. If the Handle Division accepts a
$125 price internally, the company, as a whole, will be better or worse off by:

A. $600,000
B. $(100,000)
C. $115,000
D. $250,000

71. Altoona Corporation has two divisions, Hinges and Doors, which are both organized as profit centers; the
Hinge Division produces and sells hinges to the Door Division and to outside customers. The Hinge
Division has total costs of $35, $20 of which are variable. The Hinge Division is operating significantly
below capacity and sells the hinges for $50.
The Door Division has received an offer from an outsider vendor to supply all the hinges it needs (20,000
hinges) at a cost of $45. The manager of the Door Division is considering the offer but wants to approach
the Hinge Division first.
What would be the profit impact to Altoona Corporation as a whole if the Door Division purchased the
20,000 hinges it needs from the outside vendor for $45?

A. No change in profit to Altoona.

B. $100,000 increase in profits.
C. $100,000 decrease in profits.
D. $500,000 decrease in profits.

15-22
What is the minimum transfer price from the Hinge Division to the Door Division?

A. $20.
B. $35.
C. $45.
D. $50.

What is the maximum transfer price from the Hinge Division to the Door Division?

A. $20.
B. $35.
C. $45.
D. $50.

15-23
74. Retro Rides Inc., operates two divisions: (1) a management division that owns and manages classic
automobile rentals in Miami, Florida and (2) a repair division that restores classic automobiles in
Clearwater, Florida. The repair division works on classic motorcycles, as well as other classic automobiles.
The Repair division has an estimated variable cost of $28.50 per labor-hour. The Repair division has a
backlog of work for automobile restoration. They charge $48.00 per hour for labor, which is standard for
this type of work. The Management division complained that it could hire its own repair workers for $30.00
per hour, including leasing an adequate work area.
What is the minimum transfer price per hour that the Repair division should obtain for its services,

A. $28.50.
B. $30.00.
C. $39.00.
D. $48.00.

What is the maximum transfer price per hour that the Management division should pay?

A. $28.50.
B. $30.00.
C. $39.00.
D. $46.50.

15-24
If the Repair division had idle capacity, what is the minimum transfer price that the Repair division should
obtain?

A. $28.50.
B. $30.00.
C. $39.00.
D. $46.50.

77. Frocks and Gowns Inc., has two divisions, Day Wear and Night Wear. The Day Wear Division has an
investment base of $750,000 and produces (and sells) 100,000 units of Collars at a market price of $10.00
per unit. Variable costs total $3.50 per unit, and fixed charges are $4.00 per unit (based on a capacity of
120,000 units). The Night Wear Division wants to purchase 25,000 units of Collars from The Day Wear
Division. However, the Night Wear Division is only willing to pay $6.75 per unit.
What is the contribution margin for the Day Wear Division without the transfer to the Night Wear
Division?

A. $250,000.
B. $650,000.
C. $675,000.
D. $1,000,000.

What is the contribution margin for the Day Wear Division if it transfers 25,000 units to the Night Wear
Division at $6.75 per unit?

A. $250,000.
B. $650,000.
C. $675,000.
D. $698,750.

15-25
What is the minimum transfer price for the 25,000 unit order that the Day Wear Division would accept if it
wishes to maintain its pre-order contribution?

A. $3.50.
B. $4.00.
C. $4.80.
D. $6.00.

80. A company is highly centralized. The Cutting Division, which is operating at capacity, produces a
component that it currently sells in a perfectly competitive market for $13 per unit. At the current level of
production, the fixed cost of producing this component is $4 per unit and the variable cost is $7 per unit.
Grinding Division would like to purchase this component from the Cutting Division. The price that the
Cutting Division should charge the Grinding Division per unit for this component is:

A. $7.
B. $11.
C. $13.
D. $15.

15-26
81. A company has two divisions, Softwoods and Hardwoods, each operating as a profit center. The Softwood
Division charges the Hardwood Division $35 per unit (for each unit transferred to the Hardwood Division).
Other data for the Softwood Division are as follows:

Variable Cost per unit $30
Fixed Costs $10,000
Annual Sales to the Hardwood Division 5,000 units
Annual Sales to Outsiders 50,000 units
The Softwood Division is planning to raise its transfer price to $50 per unit. The Hardwood Division can
purchase units at $40 per unit from outsiders, but doing so would idle the Softwood Division's facilities
(now committed to producing units for the Hardwood Division). The Softwood Division cannot increase
its sales to outsiders. From the perspective of the company as a whole, from who should the Hardwood
Division acquire the units, assuming the Hardwood Division's market is unaffected?

A. Outside vendors.
B. The Softwood Division, but only at the variable cost per unit.
C. The Softwood Division, but only until fixed costs are covered, then should purchase from outside
vendors.
D. The Softwood Division, in spite of the increased transfer price.

82. Given the following information for Camping Division:

The Lantern Division would like to purchase internally from the Camping Division. The Lantern Division
now purchases 5,000 units each period from outside suppliers at $49 per unit. The Camping Division has
ample excess capacity to handle all of the Lantern Division's needs. What is the lowest price that Camping
Division could accept?

A. $50.00.
B. $49.00.
C. $46.00.
D. $30.00.

15-27
83. Accutron, a large manufacturing company, has several autonomous divisions that sell their products in
perfectly competitive external markets as well as internally to the other divisions of the company. Top
management expects each of its divisional managers to take actions that will maximize the organization's
goal as well as their own goals. Top management also promotes a sustained level of management effort of
all of its divisional managers. Under these circumstances, for products exchanged between divisions, the
transfer price that will generally lead to optimal decisions for Accutron would be a transfer price equal to
the: (CIA adapted)

A. full cost of the product.

B. full cost of the product plus a markup.
C. variable cost of the product plus a markup.
D. market price of the product.

84. Martin Company currently manufactures all component parts used in the manufacture of various hand
tools. The Extruding Division produces a steel handle used in three different tools. The budget for these
handles is 120,000 units with the following unit cost.

Direct material $.60
Direct labor .40
Variable overhead .10
Fixed overhead .20
Total unit cost $1.30
Polishing Division purchases 20,000 handles from the Extruding Division and completes the hand tools.
An outside supplier, Venture Steel, has offered to supply 20,000 units of the handle to Polishing Division
for $1.25 per unit. The Extruding Division currently has idle capacity that cannot be used.
What is the cost impact to Martin as a whole of purchasing from Venture Steel? (CMA adapted)

A. increase the handle unit cost by $0.05.

B. increase the handle unit cost by $0.15.
C. decrease the handle unit cost by $0.15.
D. decrease the handle unit cost by $0.25.

15-28

Direct labor .40
Fixed overhead .20
If Martin would like to develop a range of transfer prices, what would be the maximum transfer price that
Polishing would be willing to pay?

A. $1.00.
B. $1.10.
C. $1.25.
D. $1.30.


Direct labor .40
Fixed overhead .20
If Martin would like to develop a range of transfer prices, what would be the minimum transfer price that
Extruding would be willing to accept?

A. $1.00.
B. $1.10.
C. $1.25.
D. $1.30.

15-29
87. The Alpha Division of a company, which is operating at capacity, produces and sells 1,000 units of a
certain electronic component in a perfectly competitive market. Revenue and cost data are as follows: (CIA
adapted)

Sales $50,000
Variable costs 34,000
Fixed costs 12,000
The minimum transfer price that should be charged to the Beta Division of the same company for each
component is:

A. $12.
B. $34.
C. $46.
D. $50.

88. The Hinges Division of Altoona Corp. sells 80,000 units of part Z-25 to the outside market. Part Z-25 sells
for $40, has a variable cost of $22, and a fixed cost per unit of $10. The Hinges Division has a capacity to
produce 100,000 units per period. The Door Division currently purchases 10,000 units of part Z-25 from
the Hinges Division for $40. The Door Division has been approached by an outside supplier willing to
supply the parts for $36. If Altoona uses a negotiated transfer pricing system, what is the maximum transfer
price that should be charged for this transaction?

A. $40.
B. $36.
C. $32.
D. $22.

89. The Hinges Division of Altoona Corp. sells 80,000 units of part Z-25 to the outside market. Part Z-25 sells
for $40, has a variable cost of $22, and a fixed cost per unit of $10. The Hinges Division has a capacity to
produce 100,000 units per period. The Door Division currently purchases 10,000 units of part Z-25 from
the Hinges Division for $40. The Door Division has been approached by an outside supplier willing to
supply the parts for $36. If Altoona uses a negotiated transfer pricing system, what is the minimum transfer
price that should be charged for this transaction?

A. $40.
B. $36.
C. $32.
D. $22.

15-30
90. The Eastern Division sells goods internally to the Western Division at Tennessee Company. The quoted
external price in industry publications from a supplier near Eastern is $200 per ton plus transportation. It
costs $20 per ton to transport the goods to Western. Eastern's actual market cost per ton to buy the direct
materials to make the transferred product is $100. Actual per-ton direct labor is $50. Other actual costs of
storage and handling are $40. Tennessee Company's president selects a $220 transfer price. This is an
example of: (CIA adapted)

A. market-based transfer pricing.

B. cost-based transfer pricing.
C. negotiated transfer pricing.
D. cost plus 20% transfer pricing.

91. Which of the following is the most significant disadvantage of a cost-based transfer price? (CIA adapted)

A. Requires internally developed information.

B. Imposes market effects on company operations.
C. Requires externally developed information.
D. May not promote long-term efficiencies.

92. An appropriate transfer price between two divisions of The Fathom Company can be determined from the
following data: (CIA adapted)

Fabricating Division
Market price of subassembly $50
Variable cost of
$20
subassembly
Excess capacity (in units) 1,000
Assembling Division
Number of units needed 900
What is the natural bargaining range for the two divisions?

A. Between $20 and $50.

B. Between $50 and $70.
C. Any amount less than $50.
D. $50 is the only acceptable transfer price.

93. A limitation of transfer prices based on actual cost is that they: (CIA adapted)

A. charge inefficiencies to the department that is transferring the goods.

B. charge inefficiencies to the department that is receiving the goods.
C. must be adjusted by some markup.
D. lack clarity and administrative convenience.

15-31
94. Which of the following is not an appropriate use of transfer pricing?

A. Product costing.
B. Decision making.
C. Establishing standards.
D. Evaluating performance.

95. An internal transfer between two divisions is in the best economic interest of the entire organization when:

A. the variable costs plus the opportunity cost of the selling division is greater than the external price for
B. the variable costs plus the opportunity cost of the selling division is less than the external price for the
buying division.
C. there is excess capacity in the buying division with no alternative use.
D. there is no established market prices for the buying division.

96. Top management intervention in settling transfer pricing disputes between two divisions should be avoided
unless

A. there is no intermediate markets.

B. the intermediate market is imperfect.
C. there is an extraordinarily large order.
D. there is no opportunity costs.

97. The transfer price that should be used by top management in evaluating whether a division should buy
within the company or from an outside supplier is:

A. negotiated transfer price.

B. transfer price based on full cost.
C. transfer price based on variable cost.
D. transfer price based on an open market price.

98. Some managers prefer to use cost rather than market price in controlling transfers between divisions. If cost
is to be used, then it should be:

A. full cost.
B. direct cost.
C. variable cost.
D. standard cost.

15-32
99. Cost-based transfer prices that include a normal markup to the costs act as a surrogate for:

A. negotiated market prices.

B. opportunity costs.
C. differential costs.
D. market prices.

100. Multinational firms often face conflicting pressures when developing transfer pricing policies. Tax
avoidance results when:

A. inflated transfer prices are used to reduce the profits of divisions in high tax-rate countries.
B. inflated transfer prices are used to reduce the profits of divisions in low tax-rate countries.
C. cost-based transfer prices are used instead of market transfer prices in high tax-rate countries.
D. cost-based transfer prices are used instead of negotiated market transfer prices in low tax-rate countries.

101. Which of the following transfer pricing methods must be used in segment reporting by the oil and gas
industry?

A. Absorption cost.
B. Differential cost.
C. Negotiated market price.
D. Market price.

Essay Questions

15-33
102. Galena Corp. manufactures RD34 in its City Division. This output is sold to the Urban Division as raw
material in Urban's product. City also further processes the RD34 into RD35, and then sells it to other
companies.
The City Division's variable costs for the basic ingredient are $15 per unit. The Urban Division's variable
costs are $5 per unit in addition to what it pays the City Division. The Urban Division has a capacity of
400,000 units and it can sell everything it produces. The market price for the finished additive is $40 per
unit. If the City Division converts the RD34 into RD35, it can receive $25 per unit on the open market, but
it incurs an additional $4 per unit for this processing.
Required:
a. What is the lowest price the City Division should be willing to transfer RD34 to the Urban Division,
assuming the City Division is not at full capacity?
b. What is the lowest price the City Division should be willing to transfer RD34 to the Urban Division,
assuming the City Division is at full capacity?
c. Ignore parts (a) and (b). Assume that the City Division has a capacity of 500,000 units, but can only sell
300,000 on the open market. How many units should the City Division sell externally and how many units
should it sell to Urban Division at a transfer price of $20?

15-34
103. Shipping Industries is a decentralized company that evaluates its divisions based on ROI. The North
Division has the capacity to produce 2,000 units of a component. The North Division's variable costs are
$85 per unit; fixed costs are $70 per unit.
The South Division can use the product as a component in one of its products. The South Division would
incur $65 of variable costs to convert the component into its own product which sells for $310.
Required:
(consider each question independent of each other):
a. Assume the North Division can sell all that it produces for $185 each. The South Division needs 100
units. What is the appropriate transfer price?
b. Assume the North Division can sell 1,800 units at $265. Any excess capacity will be unused unless the
units are purchased by the South Division (which can use up to 100 units). What are the minimum and
maximum transfer prices?

15-35
104. Trevor Company operates several investment centers. The manager of the Genesis Division expects the
following results for the coming year.

Sales (50,000 units at $20) $1,000,000
Contribution margin $400,000
Fixed costs 250,000
Profit $150,000
Included in the Genesis Division's variable cost is $7 for a component it buys from an outside supplier.
One of these components is required in each unit of the Genesis Division's product. The manager of the
Genesis Division has just found that she can buy the component from the Solar Division, another division
of Trevor Company. The Solar Division sells 300,000 units of the component to outsiders at $8 and its
variable cost is $4 per unit. The Solar Division offers to sell the component to Genesis at a price of $6.
Solar is operating well below capacity.
Required:
a. If Genesis accepts the offer, what will happen to the income of the Solar Division?
b. If Genesis accepts the offer, what will happen to the income of the Genesis Division?
c. If Genesis accepts the offer, what will happen to the income of the Trevor Company?

15-36
105. The Trevor Company operates several investment centers. The manager of the Genesis Division expects
the following results for the coming year.

Sales (50,000 units at $20) $1,000,000
Fixed costs 250,000
Profit $150,000
Genesis Division has just found that she can buy the component from the Solar Division, another division
of Trevor Company. The Solar Division sells 300,000 units of the component to outsiders at $8 and its
variable cost is $4 per unit. Solar offers to sell the component to Genesis at a price of $6.
Solar has a capacity of 330,000 units. Assume that Genesis wants to buy all of its needs from one source,
so that Solar must supply all or none of the Genesis Division's need for 50,000 units.
Required:
a. Determine the change in income of the Solar Division of supplying the component to Genesis at $6 as
opposed to not supplying Genesis.
b. Determine the change in income of Trevor Company if Solar supplies Genesis at $6.

15-37
106. The Barrel Division of Chemco Inc. has a capacity of 200,000 units and expects the following results.
Sales (160,000 units at $4) $640,000

Variable costs, at $2 320,000
Fixed costs 260,000
Income $60,000
Tank Division of Chemco Inc. currently purchases 50,000 units of a part for one of its products from an
outside supplier for $4 per unit. The Tank Division's manager believes he could use a minor variation of
the Barrel Division's product instead, and offers to buy the units from the Barrel Division at $3.50. Making
the variation desired by the Tank Division would cost the Barrel Division an additional $0.50 per unit and
would increase the Barrel Division's annual cash fixed costs by $20,000. Barrel's manager agrees to the
deal offered by Tank's manager.
Required:
a. What is the effect of the deal on the Tank Division's income?

b. What is the effect of the deal on the Barrel Division's income?
c. What is the effect of the deal on the income of Chemco Inc. as a whole?

15-38
107. Division A of Spangler Company expects the following results:
To To

Division B Outsiders
Sales (5,000 × $60) $300,000
(25,000 × $72) $1,800,000
Variable costs at $36 180,000 900,000
Contribution margin $120,000 $900,000
Fixed costs, all common,
allocated on the basis of 60,000 300,000
relative units
Profit $60,000 $600,000
Division B has the opportunity to buy its needs of 5,000 units from an outside supplier at $45 each.
Required:
a. Division A refuses to meet the $45 price, sales to outsiders cannot be increased, and Division B buys
from the outside supplier. Compute the effect on the income of Spangler.
b. Division A cannot increase its sales to outsiders, does meet the $45 price, and Division B continues to
buy from A. Compute the effect on the income of Spangler.

15-39
108. Veritron Division of Argos Inc. has a capacity of 100,000 units and expects the following results for the
year.

Sales (90,000 units at $30) $2,700,000
Variable costs, at $20 1,800,000
Fixed costs 700,000
Income $200,000
Magnatron Division of Argos Inc. currently purchases 20,000 units of a part for one of its products from an
outside supplier at $32 per unit. Magnatron's manager believes she could use a minor variation of
Veritron's product instead, and offers to buy the units from Veritron at $26. Making the variation desired
by Magnatron would cost Veritron an additional $5 per unit and would increase Veritron's annual cash
fixed costs by $80,000. Veritron's manager agrees to the deal offered by Magnatron's manager.
Required:
a. Find the effect of the deal on Magnatron's income.

b. Find the effect of the deal on Veritron's income.
c. Find the effect of the deal on the income of Argos Inc. as a whole.

15-40
To To

Sales (5,000 × $60) $300,000
(25,000 × $60) $1,500,000
relative units
Profit $60,000 $300,000
Assume that Division A cannot increase sales to outsiders.
Required:
a. What would be the optimal transfer price?

b. Assume that Spangler allows the divisional managers to negotiate transfer prices. What would the
maximum transfer price be?
c. Assume that Spangler allows the divisional managers to negotiate transfer prices. What would the
minimum transfer price be?

15-41
110. Winton Industries evaluates its divisions based on residual income. The Springfield Division has the
capacity to produce 20,000 units of a component. The Springfield Division's variable costs are $150 per
unit; fixed costs are $110 per unit.
The Monnett Division can use the product as a component in one of its products. The Monnett Division
would incur $75 of variable costs to convert the component into its own product which sells for $300.
Required:
a. Assume the Springfield Division can sell all that it produces for $285 each. The Monnett Division needs
1,000 units. What is the appropriate transfer price?
b. Assume the Springfield Division can sell 18,000 units at $285. Any excess capacity will be unused
unless the units are purchased by the Monnett Division (which can use up to 1,000 units). What are the
minimum and maximum transfer prices?

15-42
111. Table Lake Cruises Inc., operates two divisions: (1) a recreational division that owns and manages charter
boats on the lake and (2) a repair division that operates a division at Rogers. The repair division works on
small gasoline crafts, as well medium size diesel engine boats. The repair division has an estimated
variable cost of $45 per labor-hour. The repair division has a backlog of work for diesel engines. They
charge $125 per hour for labor & overhead, which is standard for this type of work. The recreational
division complained that it could hire its own repair workers for $85 per hour, including leasing an
adequate work area.
Required:
a. What is the minimum transfer price per hour that the repair division should obtain for its services,
b. What is the maximum transfer price per hour that the recreational division should pay?
c. If the repair division had idle capacity, what is the minimum transfer price that the repair division
should obtain?

112. The Counter Division can sell externally for $60 per unit. Its variable manufacturing costs are $35 per unit,
and its fixed costs are $12 per unit.
Required:
a. What is the optimal transfer price for transferring internally, assuming the division is operating at
capacity?
b. What is the optimal transfer price for transferring internally, assuming the division is operating at well
below capacity?

15-43
113. Salamander Company expects the following results:
Division A Division B
Sales A: (10,000 × $160) $1,600,000
B: (25,000 × $72) $1,800,000
Variable costs 1,360,000 900,000
Fixed costs 160,000 360,000
Profit $80,000 $540,000
Included in Division A's costs are 10,000 units of a subcomponent purchased from an outside supplier for
$45. The managers have recently initiated negotiations for Division B to supply the components to
Division A. Division B has a total capacity of 40,000 units.
Required:
a. Would the Salamander Company prefer the subcomponent used by A to be purchased internally from B
or from the outside vendor?
b. What would be the maximum and minimum transfer prices?

15-44
114. The Salamander Company expects the following results:

Sales A: (10,000 × $160) $1,600,000
B: (25,000 × $72) $1,800,000
Fixed costs 160,000 360,000
Profit $80,000 $540,000
Included in Division A's costs are 10,000 units of a subcomponent purchased from an outside supplier for
$45. The managers have recently initiated negotiations for Division B to supply the components to
Required:
a. Prepare a new segment reporting statement for the Salamander Company, assuming an internal transfer
at the maximum transfer price.
b. Prepare a new segment reporting statement for the Salamander Company, assuming an internal transfer
at the minimum transfer price.

15-45
115. Thai Company has two divisions organized as profit centers: Redmon and Tomlin. Thai expects the
following results:

Redmon Tomlin
Sales
Redmon: (10,000 × $16) $1,600,000
Tomlin: (250,000 × $7.20) $1,800,000
Variable costs 1,360,000 1,000,000
Fixed costs 160,000 460,000
Profit $80,000 $340,000
Included in Redmon's costs are 100,000 units of a subcomponent purchased from an outside supplier for
$4.50. The managers have recently initiated negotiations for Tomlin to supply the components to Redmon.
Tomlin has a total capacity of 400,000 units.
Required:
a. Would Thai Company prefer the subcomponent used by Redmon to be purchased internally from Tomlin
or from the outside vendor? What would be the profit impact?

15-46
116. Macon Motor Works has just acquired a new Battery Division. The Battery Division produces a standard
12-volt battery that it sells to retail outlets at a competitive price of $20. The retail outlets purchase about
800,000 batteries a year. Since the Battery Division has a capacity of 1,000,000 batteries a year, top
management is thinking that it might be wise for the company's Automotive Division to start purchasing
batteries from the newly acquired Battery Division.
The Automotive Division now purchases 300,000 batteries a year from an outside supplier, at a price of
$18 per battery. The discount from the competitive $20 price is a result of the large quantity purchased.
The Battery Division's cost per battery is shown below:

Direct materials $8
Direct labor 4
Variable overhead 2
Fixed overhead 2
Total cost $16
Fixed costs are based on 1,000,000 batteries.

Both divisions are to be treated as investment centers, and their performance is to be evaluated by the ROI
formula.
Required:
a. What transfer price would you recommend and why?

b. What transfer price would you recommend if the Battery Division is now selling 1,000,000 batteries a
year to retail outlets?
c. Suppose the manager of the Battery Division can increase its capacity to 1,500,000 units for $1,200,000.
She then has the option of (a) cutting the retail price to $17.50 with the certainty that sales will increase to
1,500,000 batteries, or (b) maintaining the outside price of $20.00 for the 800,000 batteries and transferring
the 300,000 batteries to the Automotive Division at some price that would produce the same income for the
Battery Division as option (a). What is the minimum transfer price you would recommend in this situation?
15-47
117. Chattanooga Inc., has two divisions for its metal fabrication business. The Stamp Division stamps the
objects and then transfers them to the Finish Division, which finishes and sells them. Last year, the Stamp
Division had administrative expenses of $40,000. The Finish Division incurred additional production costs
of $120,000 (exclusive of amounts paid to the Stamp Division for the stamped steel) to process 120,000
units. The Finish Division sold the finished goods for $500,000 and incurred $80,000 in variable selling
and administrative expenses.
Required:
a. Prepare income statements for each division. Use a transfer price of the Stamp Division's total cost plus
5%. Assume Cost of Goods Sold for the Finish Division is $351,000.
b. Repeat (a), using a transfer price of $2.00 per unit; this is also the market price.
c. Repeat (a), using a negotiated transfer price of $1.90 per unit.
d. Which transfer price results in higher income to Chattanooga Inc.?

118. Division S sells its product to unrelated parties at a price of $20 per unit. It incurs variable costs of $7 per
unit and has fixed costs of $50,000 per month. Monthly production is generally 10,000 units.
Division B uses Division S's product in its operations. It can purchase the units from Division S at $20 per
unit, but must pay a $1.50 per unit in shipping costs. Alternatively, Division B can buy from Division S's
competition at a delivered price of $21 per unit.
Required:
a. From the company's perspective, should Division B purchase the units internally or externally? Assume
Division S has ample capacity to handle all of Division B's needs.
b. Would your answer change if Division S can sell everything it produces to outside customers?

15-48
119. Calvin Machinery Company manufactures heavy-duty equipment used in foundries, mining operations,
and similar operations. The company is very decentralized, with various division managers having control
over capital investments and most production decisions. The Cylinder Division fabricates a component
which is used by the Press Division in its production of metal presses. The Cylinder Division has been
selling to the Press Division at a price of $3,000 per unit. Because of a cost increase, the Cylinder Division
wants to increase its price to $3,200, even though the Press Division can still purchase an equivalent
component externally for $3,000. The following information has been gathered regarding this issue:

Press Division’s annual purchases 100 units
Cylinder Division’s variable costs $2,400 per unit
Cylinder Division’s fixed costs $600 per unit
Required:
a. If the Press Division buys its units externally, the Cylinder Division will have idle capacity for which
there are no alternative uses. Will the company as whole benefit if the Press Division purchases its units
externally for $3,000 per unit?
b. If the Press Division buys its units externally, the Cylinder Division will have idle capacity which can
be used to generate a positive cash flow of $40,000. Will the company as whole benefit if the Press
Division purchases its units externally for $3,000 per unit?
c. Refer to (b). Will your answer change if the price at which the Press Division can buy externally
decreases to $2,700 per unit? Support your answer.

15-49
120. The GrowPro Manufacturing Company has a division (Division P) that produces an essential ingredient
used by the Lawn Division in making lawn fertilizer. Historically, 75% of Division P's output has been
purchased by Division L and 25% has been sold to other fertilizer companies. The transfer price between
Division P and Division L has been based on the outside sales price less selling and administrative
expenses directly applicable to the outside sales. Last year, the transfer price was $35 per ton; Division P
would like the same transfer price this year. However, the general manager of Division L has found an
outside supplier who will sell the ingredient for $30 per ton. She would like to continue buying from
Division P, but Division P's manager does not want to match the $30 price because he thinks that the
margin is too small. Top management does not get involved in transfer pricing disputes, but rather, allows
division managers to make their own decisions concerning internal or external purchases and sales.
The following information has been gathered regarding Division P's operations last year:

Sales to L External
Sales $4,200,000 $2,000,000
Variable costs 3,000,000 1,000,000
Fixed costs 360,000 120,000
The information presented above is based on selling 120,000 tons internally and 40,000 tons externally.
Required:
a. If Division L buys externally, Division P can increase its current external sales by only 20,000 tons.
What arguments can the general manager of Division L make to help Division P to match the $30 price?
b. Division L wants to use only one supplier, so Division P will either sell 120,000 tons to Division L or
nothing. If Division L's capacity is 160,000 tons, how many units does Division P need to sell to outsiders
at $50 per ton before it is better off selling to outsiders? Ignore any additional marketing costs which would
be incurred to increase sales.

15-50
121. The Measurement Division of Flow Co. produces pumps which it sells for $20 each to outside customers.
The Measurement Division's cost per pump, based on normal volume of 500,000 units per period, is shown
below:

Variable costs $12
Fixed overhead 3
Total $15
Flow has recently purchased a small company which makes sprinkler systems. This new company is
presently purchasing 100,000 pumps each year from another manufacturer. Since the Measurement
Division has a capacity of 600,000 pumps per year and is now selling only 500,000 pumps to outside
customers, management would like the new Sprinkler Division to begin purchasing its pumps internally.
The Sprinkler Division is now paying $20 per pump, less a 10% quantity discount. The Measurement
Division could avoid $1 per unit in variable costs on any sales to the Sprinkler Division.
Required:
a. Treating each division as an independent profit center, within what price range should the internal sales
price fall?
b. Now assume that the Measurement Division is selling 600,000 pumps per year on the outside.
Determine the appropriate transfer price. Show all computations.
(Note: Due to limitations in fonts and word processing software, > and < signs must be used in this
solution rather than "greater than or equal to" and "less than or equal to" signs.)

15-51
122. Finnish Corporation has a Supply Division that does work for other Divisions in the company as well as for
outside customers. The company's Custodial Products Division has asked the Supply Division to provide it
with 10,000 special items each year. The special items would require $15.00 per unit in variable production
costs.
The Custodial Products Division has a bid from an outside supplier for the special items at $29.00 per unit.
In order to have time and space to produce the special items, the Supply Division would have to cut back
production of another product - the H56 that it presently is producing. The H56 sells for $32.00 per unit,
and requires $19.00 per unit in variable production costs. Packaging and shipping costs of the H56 are
$3.00 per unit. Packaging and shipping costs for the new special part would be only $1.00 per unit. The
Supply Division is now producing and selling 40,000 units of the H56 each year. Production and sales of
the H56 would drop by 20% if the new special item is produced for the Custodial Products Division.
Required:
a. What is the range of transfer prices within which both the Divisions' profits would increase as a result of
agreeing to the transfer of 10,000 special parts per year from the Supply Division to the Custodial Products
Division?
b. Is it in the best interests of Finnish Corporation for this transfer to take place? Explain. (Note: Due to
limitations in fonts and word processing software, > and < signs must be used in this solution rather than
"greater than or equal to" and "less than or equal to" signs.)

15-52
123. Division N has asked Division M of the same company to supply it with 10,000 units of part P782 this year
to use in one of its products. Division N has received a bid from an outside supplier for the parts at a price
of $25.00 per unit. Division M has the capacity to produce 50,000 units of part P782 per year. Division M
expects to sell 46,000 units of part P782 to outside customers this year at a price of $26.00 per unit. To fill
the order from Division N, Division M would have to cut back its sales to outside customers. Division M
produces part P782 at a variable cost of $17.00 per unit. The cost of packing and shipping the parts for
outside customers is $1.00 per unit. These packing and shipping costs would not have to be incurred on
sales of the parts to Division N.
Required:
agreeing to the transfer of 10,000 parts this year from Division N to Division M?
b. Is it in the best interests of the overall company for this transfer to take place? Explain. (Note: Due to
limitations in fonts and word processing software, > and < signs must be used in this solution rather than
"greater than or equal to" and "less than or equal to" signs.)

15-53
124. Farris Yard Equipment Corporation manufactures lawn mowers and snow blowers. It also manufactures
engines that are used by the Lawn Mower Assembly Division (LMAD). The Engine Division (ED) also
sells about 40% of its output to the outside market (these are multipurpose engines). Its annual capacity is
150,000 units and annual output 135,000 units. All engines sold internally to the LMAD are priced at cost
plus 20% markup.
In January 2016, the Snow Blower Assembly Division (SBAD) approached the ED to 'buy' 20,000
engines. Diane Rogers, the controller of ED, computed the costs of manufacturing these engines as
follows:

Total Per unit
Materials $300,000 $15.00
Labor 400,000 20.00
Special equipment 36,000 1.80
Quality inspection 24,000 1.20
Other manufacturing costs 350,000 17.50
Total costs $1,110,000 $55.50
Rogers quoted a price of $66.60 for each engine transferred to the SBAD. Jackson White, the manager of
SBAD, was furious to note that the ED was "trying to make money off a sister division." He argued that
the price must include only the cost of materials, as all other costs will be incurred irrespective of whether
or not SBAD places the order for 20,000 engines. Morton Downey, the production manager of ED, pointed
out that the special equipment will be purchased only for fulfilling this internal order. Moreover, he argued
that inspection must also be done just like on all other engines; therefore, the inspection costs must also be
included. Labor is paid a flat monthly salary. Other manufacturing costs include both variable and fixed
components (in roughly equal proportion).
Required:
(a) Given that excess capacity exists, what is the minimum price that the ED must charge to the SBAD?
(b) What are the pros and cons of internal sourcing?

15-54
125. Allentown Division of Sparks Inc. transfers its product to the Youngstown Division. The Youngstown
Division can either buy the item internally or externally (cost = $73 each). The Allentown Division has just
completed its annual cost update as follows:

Direct material $25.00
Direct labor 18.00
Variable manufacturing
6.00
overhead
Fixed manufacturing
3.50
overhead
Variable selling expenses 4.00
Fixed selling and
8.50
administrative expenses
Total costs $65.00
Desired return 14.00
Sales price $79.00
The Allentown Division is operating at 60 percent of its 400,000 unit capacity.
Required:
1) What is the minimum transfer price the Allentown Division should charge for internal transfers?
2) What is the maximum price the Youngstown Division would be willing to pay?
3) Why should the Allentown Division reduce its price to the Youngstown Division?

15-55
126. The following costs exist for Wiring Division of Corriander Corp.

Direct material $67,500
Direct labor 45,000
Manufacturing overhead (25% variable) 45,000
Operating expenses (30% variable) 75,000
Output 30,000 Units
The output of the Wiring Division, which sells for $10/unit externally, is used by the Electrical Harness
Division.
Required:
Compute the transfer price for a unit of the Wiring Division's output using:
1) market price
2) variable production cost plus 30 percent
3) absorption cost plus 25 percent
4) variable cost
5) total cost plus 10 percent

15-56
127. SEMO Inc. has a division located in Spain and another in the U.S. The Spanish division produces a part
needed for the product made by the U.S. division. There is substantial excess capacity in the Spanish
division. The tax rate of the Spanish division is 35% and U.S. division tax rate is 30%.
The part sells externally for $75 and the Spanish division's manufacturing costs are:

Direct material $32
Direct labor 12
Variable overhead 6
Fixed overhead 19
Required:
1) What would be the lowest acceptable transfer price for the Spanish division?
2) What would be the highest acceptable transfer price for the U.S. division?
3) What would be the transfer price that would be the best for SEMO Inc. and why?

15-57
128. The following information is available for the two divisions of MAC Co.:

Division A
Selling price to outside market $55
Standard unit-level costs 35
Division B
Selling price of finished product $95
Standard unit-level costs for Division B 25
Division A has no excess production capacity.
Required:
1) In order to ensure the best use of the productive capacity of A, what transfer price should be set by
Division A and what effect does this transfer price have on the overall margin for the company? Is the
answer goal congruent under the general rule?
2) Should Division B accept a special order for its product if the selling price is reduced to $70. Use your
answer from #1 and explain.
3) Would your answer to #2 change if Division A had excess capacity? Explain.

15-58
129. Division X has asked Division K of the Easton Company to supply it with 5,000 units of part L433 this
year to use in one of its products. Division X has received a bid from an outside supplier for the parts at a
price of $26.00 per unit. Division K has the capacity to produce 30,000 units of part L433 per year.
Division K expects to sell 26,000 units of part L433 to outside customers this year at a price of $30.00 per
unit. To fill the order from Division X, Division K would have to cut back its sales to outside customers.
Division K produces part L433 at a variable cost of $21.00 per unit. The cost of packing and shipping the
parts for outside customers is $2.00 per unit. These packing and shipping costs would not have to be
incurred on sales of the parts to Division X.
Required:
agreeing to the transfer of 5,000 parts this year from Division X to Division K?
b. Is it in the best interests of the overall Easton Company for this transfer to take place? Explain.

15-59
130. Pomme Corporation has a Motor Division that does work for other Divisions in the company as well as for
outside customers. The company's Equipment Division has asked the Motor Division to provide it with
2,000 special motors each year. The special motors would require $17.00 per unit in variable production
costs. The Equipment Division has a bid from an outside supplier for the special motors at $28.00 per unit.
In order to have time and space to produce the special motor, the Motor Division would have to cut back
production of another motor - the J789 that it presently is producing. The J789 sells for $34.00 per unit,
and requires $22.00 per unit in variable production costs. Packaging and shipping costs of the J789 are
$4.00 per unit. Packaging and shipping costs for the new special motor would be only $0.50 per unit. The
Motor Division is now producing and selling 10,000 units of the J789 each year. Production and sales of
the J789 would drop by 10% if the new special motor is produced for the Equipment Division.
Required:
agreeing to the transfer of 2,000 special motors per year from the Motor Division to the Equipment
Division?
b. Is it in the best interests of Pomme Corporation for this transfer to take place? Explain.

15-60
131. Randolph Company has two divisions organized as profit centers: Redmon and Tomlin. Randolph expects
the following results:

Redmon Tomlin
Sales
Redmon: (10,000 × $16) $1,600,000
Tomlin: (250,000 × $7.20) $1,800,000
Variable costs 1,360,000 1,000,000
Fixed costs 160,000 460,000
Profit $80,000 $340,000
Included in Redmon's costs are 100,000 units of a subcomponent purchased from an outside supplier for
$4.50. The managers have recently initiated negotiations for Tomlin to supply the components to Redmon.
Tomlin has a total capacity of 400,000 units.
Required:
a. Prepare a new segment reporting statement for Randolph, assuming an internal transfer at the maximum
transfer price.
b. Prepare a new segment reporting statement for Randolph, assuming an internal transfer at the minimum
transfer price.

132. Why is transfer pricing only a concern for profit or investment centers and not for cost or revenue centers?
15-61
133. Explain the general principle for determining the optimal transfer price.

134. What is meant by a dual transfer pricing system? What are some advantages and disadvantages of it?

135. What are the limitations of market-based transfer prices?

136. What are the advantages and disadvantages of using a negotiated transfer price?

15-62
137. Why is transfer pricing important in tax accounting?

138. What are the principal items that must be disclosed about each segment and how does this differ if a
company has significant foreign operations?

139. Hartland Company has used market price as its transfer price for the Sterling Division for many years with
no problems. This year, because of changes in the economy, the demand for its final product has dropped
along with the price.
Required:
Explain the problems of basing the transfer prices on distress market prices and possible solutions to the
problems.

15-63
140. Midland Inc. has two divisions: production and marketing, which it treats as profit centers. Because the
production division has no marketing capabilities, it does not have a traditional market price to consider
and the company does not want to use negotiation.
Required:
Discuss the following cost-based transfer prices along with problems that might exist for each.
1) Standard unit-level cost.

2) Absorption (full) cost.
3) Actual cost.

141. Mr. Massee, the Vice President of Production is looking at two of the Divisions that report to him. These
divisions are viewed as profit centers by the company. He has called in the head of Brake Division A,
which provides a part used by Wheel Division, because he has noticed that Wheel Division is going to an
external supplier for the part. Mr. Omsby, the head of the Brake Division, tells him that he has set the
transfer price at $38 per part even though the external price is $33 per part. The standard unit-level cost is
$22. "I have set the $38 price because I am operating with no excess capacity and do not want to have the
internal transfer to the Wheel Division. I have some good external customers and do not want to lose them
by selling internally. If I had excess capacity, I would be willing sell to the Wheel Division at a lower
price."
Mr. Massee says that he has to think about this situation because something doesn't seem right to him.
After Mr. Omsby leaves the office, he calls his friend in the controller's department for some help.
Required:
You are that friend. Explain to Mr. Massee the differences in transfer pricing when there is no excess
capacity and when there is excess capacity and what Mr. Omsby is doing wrong.

15-64
142. Ms. Clarke, one of the marketing managers, has come to the meeting with a number of reports about one of
her products. The Vice President of Marketing sees her agitation and asks her what the problem is. "Well,
the product made by the East Coast Division is losing sales even after the price had been lowered
drastically. The manager of the division is threatening to close because of the reduced demand."
The Vice President of Marketing asks why the lowered prices are a problem and Ms. Clarke says that,
according to the manager, the price used to transfer the goods to Southern Division are based on market
price and, with the lowered market price, the unit-level costs are no longer being covered and he is losing
money on every transfer as well as every third-party sale.
Required:
Explain further to the Vice President of Marketing the issues involved in transfer pricing when there are
distressed market prices.

143. Briefly discuss some of the general issues of multinational transfer pricing.

15-65
144. During the current year Tuesday Company's foreign Division A incurred production costs of $4 million for
units that are transferred to its other foreign Division, B. Costs in Division B, outside of the costs of
production of the final product are $8 million. These are third-party costs. Sales revenue for the final
product for Division B is $30 million. Other companies in the same country import a similar type of part as
Division B at a cost of $7 million. Tuesday has set its transfer price at $14 million, justifying this price
because of the special controls it has on the operations in Division A as well as its special manufacturing
method. The tax rate in the country where Division A is located is 40% while the tax rate for Division B's
country is 70%.
Required:
1) What would Tuesday's total tax liability for both divisions be if it used the $7 million transfer price?
2) What would the liability be if it used the $14 million transfer price?

145. How do import duties affect transfer pricing?

15-66
146. Space Inc. has just purchased a foreign subsidiary that makes a component used by one of the domestic
divisions. Ms. Jenner, the controller, has been asked about issues that should be considered in establishing
a transfer price for the new subsidiary. Since this is Space's first foray into the multinational arena, there is
little to no expertise in international issues in the company. Ms. Jenner has told her boss that she will get
back to him with a report as to the issues to be considered. She then calls a friend of hers at a branch of one
of the big-4 CPA firms that deals with international issues for some help.
Required:
What is the basic information that Ms. Jenner will be given by her friend?

147. Briefly discuss transfer prices in relation to external segment reporting under GAAP.

15-67
Chapter 15 Transfer Pricing Answer Key
True / False Questions

1. A transfer price is the value assigned to the transfer of goods or services between divisions within the
same organization.

TRUE
This is the definition of transfer pricing.

AACSB: Analytical Thinking
AICPA: FN Decision Making
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 15-01 Explain the basic issues associated with transfer pricing.
Topic: What is Transfer Pricing and Why is it Important?

2. Transfer prices are not used to record the exchange between two cost centers within the same
organization.

TRUE
Transfer prices are used for profit and investment centers. Cost centers are not concerned with profits.

Blooms: Remember
Difficulty: 2 Medium

3. Transfer prices cannot be used for decision making, product costing, or performance evaluation.

FALSE
Transfer pricing is used in decision making, product costing, and performance evaluation.

Blooms: Remember
Difficulty: 1 Easy
15-68

4. From an organization's viewpoint, transfer prices have no effect on total profits assuming the transfer

TRUE
Total profits are unaffected, divisional profits will have effects but they off-set.

Blooms: Remember

5. If a transfer has no effect on divisional profit, risk-neutral managers will be indifferent between making
the transfer or not.

TRUE
Since there is no effect on profit, there is no risk.

Blooms: Remember
Learning Objective: 15-02 Explain the general transfer pricing rules and understand the underlying basis for them.
Topic: Determining the Optimal Transfer Price

6. If an intermediate market exists but divisions are prohibited from buying or selling from the outside, the
intermediate market can be ignored in determining the optimal transfer price.

TRUE
Since the divisions are prohibited, the outside price is irrelevant.

Blooms: Remember

15-69
7. A perfect intermediate market exists if buyers can buy and sellers can sell outside of the organization.

FALSE
A perfect market exists when buyers and sellers can have unlimited transactions with no impact on
prices.

Blooms: Remember

8. When a perfect intermediate market exists, the optimal transfer price is the intermediate market price.

TRUE
In a perfect market, the market price is optimal.

Blooms: Remember
Difficulty: 1 Easy

9. In general, the optimal transfer price for a division is the sum of its outlay costs and the opportunity cost
of not transferring its goods to another division.

FALSE
It is the opportunity cost of the resource at the point of the transfer. Normally this is the lost contribution
by not selling outside.

Blooms: Remember
Difficulty: 3 Hard
Topic: Optimal Transfer Price: A General Principle

15-70
10. The use of an optimal transfer price eliminates potential conflicts between an organization's interests
and the divisional manager's interest.

FALSE
Conflicts may be reduced, but will not be eliminated.

Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 15-03 Identify the behavioral issues and incentive effects of negotiated transfer prices, cost-based transfer prices, and
market-based transfer prices.
Topic: How to Help Managers Achieve Their Goals While Achieving the Organization's Goals

11. A market price-based transfer price policy allows the selling division to determine the price for transfers
between divisions within the same organization.

FALSE
The market determines the price, not the division.

Blooms: Remember
Difficulty: 1 Easy
Topic: Centrally Established Transfer Price Policies

12. A selling division at capacity is indifferent between selling to outsiders and transferring inside at the
market price.

TRUE
The profit would be the same in either case.

Blooms: Remember
Difficulty: 1 Easy

15-71
13. When actual costs are used as the basis for a transfer, inefficiencies of the selling division are
transferred to the buying division.

TRUE
The selling division has no incentive to minimize the inefficiencies since they can all be passed on.

Blooms: Remember
Difficulty: 1 Easy

14. A transfer made at cost does not motivate the selling division to transfer its goods or services
internally.

TRUE
There is no profit for the selling division.

Blooms: Remember
Difficulty: 1 Easy

15. In general, negotiated transfer prices fall in a range between the selling division's differential costs and
the buying division's market price.

TRUE
The seller's differential costs are the lowest the seller would accept; the buyer's market price is the
highest the buyer would be willing to pay.

Blooms: Remember
Topic: Negotiating the Transfer Price

15-72
16. In the United States, more companies use cost-based transfer prices than market-based transfer prices.

TRUE
Numerous surveys have shown this to be true.

Blooms: Understand
Difficulty: 1 Easy
Learning Objective: 15-04 Explain the economic consequences of multinational transfer prices.
Topic: Global Practices

17. In interstate transactions, transfers can reduce an organization's tax liability when the selling division is
in a lower tax jurisdiction than the buying division.

TRUE
The transfers can in effect move profits from one jurisdiction to another.

Blooms: Remember
Topic: Multinational Transfer Pricing

18. Tax avoidance is unethical when inflated transfer prices are used in international transactions to shift
profits from a division in one country to a division in another country.

TRUE
The key is "inflated" prices. Market based prices would not be unethical.

Blooms: Remember
Difficulty: 1 Easy

15-73
19. An organization that has significant foreign operations must disclose how its transfer prices are
established between domestic and foreign divisions.

TRUE
This is a requirement of GAAP.

AICPA: FN Measurement
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 15-05 Describe the role of transfer prices in segment reporting.
Topic: Segment Reporting

20. The GAAP financial reporting rules for segments require that all companies use transfer prices based on
market prices.

FALSE
GAAP does not specify what method must be used for transfer pricing except for the oil and gas
industry.

Blooms: Remember
Difficulty: 1 Easy

Multiple Choice Questions

15-74
21. Which of the following statements is(are) false?
(A) From an organization's viewpoint, transfer prices have no effect on total profits assuming the
transfer occurs between the two responsibility centers.
(B) A transfer price is the value assigned to the transfer of goods or services between divisions within
the same organization.

A. Only A is false.

B. Only B is false.
C. Both A and B are false.
D. Neither A nor B is false.
Transfer prices do not affect total profits, (B) is the definition of transfer price.

Blooms: Remember
Difficulty: 1 Easy

22. Which of the following responsibility centers is affected by the use of market-based transfer prices?

A. Cost center.

B. Profit center.
C. Revenue center.
D. Production center.
Transfer prices affect only profit or investment centers.

Blooms: Remember
Difficulty: 1 Easy

15-75
23. Transfer prices would not be used by:

A. production centers.

B. investment centers.
C. profit centers.
D. cost centers.
Cost centers are not responsible for profits and don't have transfer pricing issues.

Blooms: Remember
Difficulty: 1 Easy

variable marketing costs are $12 per unit. What is the opportunity cost of transferring internally,

A. $13.
B. $25.
C. $35.
D. $47.
($60 - $35 - $12) = $13

Blooms: Analyze
Difficulty: 1 Easy
Topic: Applying the General Principle

15-76
variable marketing costs are $12 per unit. What is the optimal transfer price for transferring internally,

A. $12.
B. $35.
C. $47.
D. $60.
Operating at capacity: market price = $60

Blooms: Analyze
Difficulty: 1 Easy

26. Division A has variable manufacturing costs of $50 per unit and fixed costs of $10 per unit. Assuming
that Division A is operating at capacity, what is the opportunity cost of an internal transfer when the
market price is $75?

A. $20.
B. $25.
C. $50.
D. $60.
$75 - $50 = $25

Blooms: Analyze
Difficulty: 1 Easy

15-77
that Division A is operating at capacity, what is the optimal transfer price of an internal transfer when
the market price is $75?

A. $20.
B. $25.
C. $50.
D. $75.
Operating at capacity: market price = $75

Blooms: Analyze
Difficulty: 1 Easy

that Division A is operating significantly below capacity, what is the optimal transfer price of an
internal transfer when the market price is $75?

A. $20.
B. $25.
C. $50.
D. $60.
Below capacity: variable cost = $50

Blooms: Analyze
Difficulty: 1 Easy

15-78
29. Division B has variable manufacturing costs of $50 per unit and fixed costs of $10 per unit. Assuming
that Division B is operating significantly below capacity, what is the opportunity cost of an internal
transfer when the market price is $75?

A. $0.
B. $25.
C. $50.
D. $60.
There are no opportunity costs when operating below capacity.

Blooms: Analyze
Difficulty: 1 Easy

30. Dockside Enterprises Inc., operates two divisions: (1) a management division that owns and manages
bulk carriers on the Great Lakes and (2) a repair division that operates a dry dock in Tampa, Florida.
The repair division works on company ships, as well as other large-hull ships. The repair division has an
estimated variable cost of $37 per labor-hour. The repair division has a backlog of work for outside
ships. They charge $70.00 per hour for labor, which is standard for this type of work. The management
division complained that it could hire its own repair workers for $45.00 per hour, including leasing an
adequate work area.
What is the minimum transfer price per hour that the repair division should obtain for its services,

A. $33.00.
B. $37.00.
C. $45.00.
D. $70.00.
When at capacity, the market price of $70 is the appropriate transfer price.

Blooms: Analyze
Difficulty: 1 Easy

15-79
adequate work area.
What is the maximum transfer price per hour that the management division should pay?

A. $33.00.
B. $37.00.
C. $45.00.
D. $70.00.
Outside price of $45

Blooms: Analyze
Difficulty: 1 Easy

adequate work area.
If the repair division had idle capacity, what is the minimum transfer price that the repair division
should obtain?

A. $33.00.
B. $37.00.
C. $45.00.
D. $70.00.
The selling division's variable cost of $37 is the appropriate transfer price.

Blooms: Analyze
Difficulty: 1 Easy
15-80

33. You have been provided with the following information for Division X of a decentralized company:
Selling price $90

Division Y of the same company would like to purchase all of its units internally. Division Y needs
6,000 units each period and currently pays $84 per unit to an outside firm. What is the lowest price that
Division X could accept from Division Y? (Assume that Division Y wants to use a sole supplier and
will not purchase less than 6,000 from a supplier.)

A. $90.
B. $84.
C. $80.
D. $66.
[$66(2,500) + $90(3,500)]/6,000 = $80

Blooms: Analyze
Difficulty: 3 Hard

34. When the selling division in an internal transfer has unsatisfied demand from outside customers for the
product that is being transferred, then the lowest acceptable transfer price as far as the selling division is
concerned is:

A. the variable cost of producing a unit of product.

B. the full absorption cost of producing a unit of product.
C. the market price charged to outside customers, less costs saved by transferring internally.
D. the amount that the purchasing division would have to pay an outside seller to acquire a similar
product for its use.
Unsatisfied demand is the key for the division and firm to maximize profits.

AACSB: Reflective Thinking
Blooms: Remember
15-81

35. Division A makes a part that it sells to customers outside of the company. Data concerning this part
appear below:

products. Division B currently purchases a similar part made by an outside company for $70 per unit
and would substitute the part made by Division A. Division B requires 5,000 units of the part each
period. Division A can already sell all of the units it can produce on the outside market. What should be
the lowest acceptable transfer price from the perspective of Division A?

A. $75.
B. $66.
C. $16.
D. $50.
See calculation below.
Since Division A can sell all of the units it can produce on the outside market ($75 per unit), it would
unfairly penalize Division A to be required to sell to Division B at any price less than it can sell for on
the outside.

Blooms: Apply

15-82
36. Part 43X costs the Southern Division of Norris Corporation $26 to make - direct materials are $10,
direct labor is $4, variable manufacturing overhead is $9, and fixed manufacturing overhead is $3.
Southern Division sells Part 43X to other companies for $30. The Northern Division of Norris
Corporation can use Part 43X in one of its products. The Southern Division has enough idle capacity to
produce all of the units of Part 43X that the Northern Division would require. What is the lowest
transfer price at which the Southern Division should be willing to sell Part 43X to the Northern
Division?

A. $30.
B. $26.
C. $23.
D. $27.
The lowest price the part should be sold for is the total amount of variable costs that would be incurred
($10 + $4 + $9 = $23).

Blooms: Apply
Difficulty: 1 Easy

15-83
37. The Wheel Division of Frankov Corporation has the capacity for making 75,000 wheel sets per year and
regularly sells 60,000 each year on the outside market. The regular sales price is $100 per wheel set, and
the variable production cost per unit is $65. The Retail Division of Frankov Corporation currently buys
30,000 wheel sets (of the kind made by the Wheel Division) yearly from an outside supplier at a price of
$90 per wheel set. If the Retail Division were to buy the 30,000 wheel sets it needs annually from the
Wheel Division at $87 per wheel set, the change in annual net operating income for the company as a
whole, compared to what it is currently, would be:

A. $600,000.
B. $225,000.
C. $750,000.
D. $135,000.
Price paid by the Retail Division for

$2,700,000
30,000 wheel sets
Less: Cost for Wheel Division to produce
(1,950,000)
30,000 wheel sets × $65
Less: Lost profit for the Wheel Division to
cut back production ($100 - $65 × 15,000
(525,000)
wheel sets)
Change in net annual operating income for
$225,000
the company as a whole

Blooms: Apply
Difficulty: 3 Hard

15-84
38. Division X makes a part that it sells to customers outside of the company. Data concerning this part
appear below:

$50
customers
products. Division Y currently purchases a similar part made by an outside company for $49 per unit
and would substitute the part made by Division X. Division Y requires 5,000 units of the part each
period. Division X has ample excess capacity to handle all of Division Y's needs without any increase in
fixed costs and without cutting into outside sales. According to the formula in the text, what is the
lowest acceptable transfer price from the standpoint of the selling division?

A. $50.
B. $49.
C. $46.
D. $30.
Since Division X has ample excess capacity, the lowest price the part should be sold for is the total
amount of variable costs that would be incurred, or $30 per unit.

Blooms: Apply
Difficulty: 3 Hard

15-85
39. Division A makes a part that it sells to customers outside of the company. Data concerning this part
appear below:

$40
customers
products. Division B currently purchases a similar part made by an outside company for $38 per unit
and would substitute the part made by Division A. Division B requires 5,000 units of the part each
period. Division A has ample capacity to produce the units for Division B without any increase in fixed
costs and without cutting into sales to outside customers. If Division A sells to Division B rather than to
outside customers, the variable cost be unit would be $1 lower. What should be the lowest acceptable
transfer price from the perspective of Division A?

A. $40.
B. $38.
C. $30.
D. $29.
Since Division X has ample excess capacity, the lowest price the part should be sold for is the total
amount of variable costs that would be incurred, or $29 per unit ($30 - $1).

Blooms: Apply
Difficulty: 3 Hard

15-86

Profit $10,500
Raisin expects identical operating results this year. The Raisin Division has the ability to produce and
sell 200,000 pounds of raisins annually.
Assume that the Peanut Division of Trail Mix Foods wants to purchase an additional 20,000 pounds of
raisins from the Raisin Division. Raisin will be able to increase its profit by accepting any transfer price
above:

A. $0.40 per pound.

B. $0.08 per pound.
C. $0.15 per pound.
D. $0.25 per pound.
Variable expenses of $37,500 ÷ 150,000 pounds = $0.25 per pound.

Blooms: Apply

15-87

Profit $10,500
Raisin expects identical operating results this year. The Raisin Division has the ability to produce and
sell 200,000 pounds of raisins annually.
Assume that the Raisin Division is currently operating at its capacity of 200,000 pounds of raisins. Also
assume again that the Peanut Division wants to purchase an additional 20,000 pounds of raisins from the
Raisin Division. Under these conditions, what amount per pound of raisins would the Raisin Division
have to charge Peanut in order to maintain its current profit?

A. $0.40 per pound.

B. $0.08 per pound.
C. $0.15 per pound.
D. $0.25 per pound.

Sales (200,000 pounds of raisins × $0.40) $80,000

Variable expenses ($0.25 per pound) 50,000
Profit $18,000
Since the Raisin Division is already operating at capacity, it would have to charge the Peanut Division
$0.40 per pound to maintain its current profit.

Blooms: Apply

15-88

Suppose the Gear Division has ample excess capacity to handle all of the Motor Division's needs
without any increase in fixed costs and without cutting into sales to outside customers. If the Gear
Division refuses to accept the $17 price internally and the Motor Division continues to buy from the
outside supplier, the company as a whole will be:

A. worse off by $70,000 each period.

B. better off by $10,000 each period.
D. worse off by $20,000 each period.
See calculations below.
Differential of 10,000 units at the outside customer price ($17) and the cost price ($11) of $6, for a total
of $60,000 worse off each period.

Blooms: Apply

15-89

Suppose that the Gear Division is operating at capacity and can sell all of its output to outside
customers. If the Gear Division sells the parts to Motor Division at $17 per unit, the company as a
whole will be:

A. better off by $10,000 each period.

B. worse off by $20,000 each period.
D. There will be no change in the status of the company as a whole.
Differential of 10,000 units at the outside supplier price ($18) and the price to Motor Division ($17) of
$1, for a total of $10,000 worse off each period.

Blooms: Apply

15-90

presently purchasing the part from an outside source at $28 per unit. If Division A sells to Division B,
$1 in variable costs can be avoided.
Suppose Division A is currently operating at capacity and can sell all of the units it produces on the
outside market for its usual selling price. From the point of view of Division A, any sales to Division B
should be priced no lower than:

A. $27.
B. $29.
C. $20.
D. $28.
Since Division A is already operating at capacity, it would have to charge Division B $29 per unit ($30
less the $1 in variable cost that can be avoided).

Blooms: Apply

15-91

presently purchasing the part from an outside source at $28 per unit. If Division A sells to Division B,
$1 in variable costs can be avoided.
Suppose that Division A has ample idle capacity to handle all of Division B's needs without any
increase in fixed costs and without cutting into its sales to outside customers. From the point of view of
Division A, any sales to Division B should be priced no lower than:

A. $29.
B. $30.
C. $18.
D. $17.
Since Division A has excess operating capacity, it should charge Division B $17 per unit ($18 variable
cost per unit less the $1 in variable cost that can be avoided).

Blooms: Apply

15-92
customers or sold to the Lantern Division of the Gothic Company. Last year, the Lantern Division
bought all of its 25,000 pillars from Pillar at $1.50 each. The following data are available for last year's
activities of the Pillar Division:

$1.75
customers
Suppose there is ample capacity so that transfers of the pillars to the Lantern Division do not cut into
sales to outside customers. What is the lowest transfer price that would not reduce the profits of the
Pillar Division?

A. $0.90.
B. $1.35.
C. $1.41.
D. $1.75.
Since the Pillar Division has excess operating capacity, it should charge the Lantern Division the
variable cost of $0.90 per unit.

Blooms: Apply

15-93

$1.75
customers
Suppose the transfers of pillars to the Lantern Division cut into sales to outside customers by 15,000
units. What is the lowest transfer price that would not reduce the profits of the Pillar Division?

A. $0.90.
B. $1.35.
C. $1.41.
D. $1.75.
Loss of existing outside sales at a contribution

$12,750
margin of $0.85 ($1.75 - $0.90) × 15,000 units
÷ Units to be supplied to the Lantern Division 25,000
Additional cost per unit for the Lantern
$0.51
Division
Current cost ($0.90) + Additional costs ($0.51) $1.41

Blooms: Apply
Difficulty: 3 Hard

15-94

$1.75
customers
Suppose the transfers of pillars to the Lantern Division cut into sales to outside customers by 15,000
units. Further suppose that an outside supplier is willing to provide the Lantern Division with basic
pillars at $1.45 each. If the Lantern Division had chosen to buy all of its pillars from the outside supplier
instead of the Pillar Division, the change in net operating income for the company as a whole would
have been:

A. $1,250 decrease.

B. $10,250 increase.
C. $1,000 decrease.
D. $13,750 decrease.
The incremental change in net operating income to the company as a whole would be 25,000 units @
$0.04 per unit, for a total of $1,000 in decreased profits.

Blooms: Apply
Difficulty: 3 Hard

15-95
Solar Light Division bought 50,000 stakes from the Stake Division at $2.50 each. The following data
are available for last year's activities in the Stake Division:

$3.00
customers
In order to sell 50,000 stakes to the Solar Light Division, the Stake Division must give up sales of
30,000 stakes to outside customers. That is, the Stake Division could sell 380,000 stakes each year to
outside customers (rather than only 350,000 stakes as shown above) if it were not making sales to the
Solar Light Division.
According to the formula in the text, what is the lowest acceptable transfer price from the viewpoint of
the selling division?

A. $2.50.
B. $2.00.
C. $2.60.
D. $3.00.
Loss of existing outside sales at a contribution

$30,000
margin of $1 ($3.00 - $2.00) × 30,000 units
÷ Units to be supplied to the Solar Light
50,000
Division
Additional cost per unit for the Solar Light
$0.60
Division
Current cost ($2.00) + Additional costs ($0.60) $2.60

Blooms: Apply
Difficulty: 3 Hard

15-96
Solar Light Division bought 50,000 stakes from the Stake Division at $2.50 each. The following data
are available for last year's activities in the Stake Division:

$3.00
customers
In order to sell 50,000 stakes to the Solar Light Division, the Stake Division must give up sales of
30,000 stakes to outside customers. That is, the Stake Division could sell 380,000 stakes each year to
outside customers (rather than only 350,000 stakes as shown above) if it were not making sales to the
Solar Light Division.
Suppose that last year an outside supplier would have been willing to provide the Solar Light Division
with the basic stakes at $2.10 each. If the Solar Light Division had chosen to buy all of its stakes from
the outside supplier instead of the Stake Division, the change in net operating income for the company
as a whole would have been:

A. $45,000 increase.

B. $20,000 decrease.
C. $20,000 increase.
D. $25,000 increase.
Additional unit cost ($0.10) of purchasing from outside vendor × 50,000 units ($5,000)
Additional profit on 30,000 units that would have been made to outside customers that had to be
foregone by servicing the requirements of the Solar Light Division at a contribution margin of $1 ($3.00
- $2.00) × 30,000 units 30,000
Increase in net income for the company as a whole $25,000

Blooms: Apply
Difficulty: 3 Hard

15-97
51. Division X makes a part that it sells to customers outside of the company. Data concerning this part
appear below:

products. Division Y currently purchases a similar part made by an outside company for $49 per unit
and would substitute the part made by Division X. Division Y requires 5,000 units of the part each
period. Division X can sell all of the units it makes to outside customers. What is the lowest acceptable
transfer price from the standpoint of the selling division?

A. $50.
B. $49.
C. $46.
D. $30.
From the perspective of the selling division, profits would increase as a result of the transfer if, and only
if:
Transfer price > Variable cost + Opportunity cost
The opportunity cost is the contribution margin on the lost sales, divided by the number of units
transferred:
Opportunity cost = [($50 - $30) × 5,000] ÷ 5,000 = $20
Therefore, Transfer price > $30 + $20 = $50.

Blooms: Apply

15-98
52. Division X of Operandi Corporation makes and sells a single product which is used by manufacturers of
fork lift trucks. Presently it sells 12,000 units per year to outside customers at $24 per unit. The annual
capacity is 20,000 units and the variable cost to make each unit is $16. Division Y of Operandi
Corporation would like to buy 10,000 units a year from Division X to use in its products. There would
be no cost savings from transferring the units within the company rather than selling them on the
outside market. What should be the lowest acceptable transfer price from the perspective of Division X?
A. $24.00.
B. $21.40.
C. $17.60.
D. $16.00.
From the perspective of the selling division, profits would increase as a result of the transfer if, and
only if:
transferred:
Opportunity cost = [($24 - $16) × 2,000*] ÷ 10,000 = $1.60
*10,000 - (20,000 - 12,000) = 2,000
Therefore, Transfer price > $16 + $1.60 = $17.60.

Blooms: Apply
Difficulty: 3 Hard

15-99
53. Division A of Chappelle Company has the capacity for making 3,000 motors per month and regularly
sells 1,950 motors each month to outside customers at a contribution margin of $62 per motor. The
variable cost per motor is $35.70. Division B of Chappelle Company would like to obtain 1,400 motors
each month from Division A. What should be the lowest acceptable transfer price from the perspective
of Division A?

A. $26.57.
B. $51.20.
C. $35.70.
D. $62.00.
From the perspective of the selling division, profits would increase as a result of the transfer if, and
only if:
Transfer price > Variable cost per unit + Opportunity cost
transferred:
Opportunity cost = [$62 × 350*] ÷ 1,400 = $15.50
*1,400 - (3,000 - 1,950) = 350
Therefore, Transfer price > $35.70 + $15.50 = $51.20.

Blooms: Apply
Difficulty: 3 Hard

15-100
54. Which of the following statements is(are) true?
(A) If a transfer has no effect on divisional profit, managers will be indifferent between making the
transfer or not.
(B) If an intermediate market exists but divisions are prohibited from buying or selling from the
outside, the intermediate market can be ignored in determining the optimal transfer price.

A. Only A is true.

B. Only B is true.
C. Both A and B are true.
D. Neither A nor B is true.
Both are true statements.

Blooms: Remember

55. In general, if a potential transfer has no effect on divisional profits:

A. no transfer will take place between the divisions.

B. managers will be indifferent between making the transfer or not.
C. the organization should not intervene to force a transfer.
D. the optimal transfer price is the opportunity cost for the buying division.
Managers are motivated by the profits of their division. If there is no effect, managers will be
indifferent.

Blooms: Remember

15-101
56. An intermediate market is perfect when:

A. there are no quality differences between inside and outside suppliers.
B. there are quality differences between inside and outside customers.
C. buyers and sellers can sell any quantity without affecting the market price.
D. buyers and sellers are motivated to make decisions that are consistent with those of the organization.
This is the definition of a perfect market.

Blooms: Remember
Difficulty: 1 Easy

57. When there is no intermediate market:

A. there is no optimal transfer price.

B. the selling division cannot transfer its goods internally.
C. the buying division cannot purchase its goods externally.
D. there is no reason for top management to intervene in transfer pricing disputes.
The intermediate market is an external market for the goods.

Blooms: Remember

58. The general principle on setting transfer prices that are in the organization's best interests is:

A. outlay cost plus opportunity cost of the resource at the point of transfer.
B. variable costs plus opportunity cost of the resource at the point of transfer.
C. lost contribution margin less the allocated fixed costs for the selling division.
D. gross margin for the buying division plus the gross margin for the selling division.
Incremental fixed costs may also occur and would be included in outlay costs.

Blooms: Remember
15-102
Difficulty: 1 Easy

59. If the selling division has excess capacity, the transfer price should be set at its:

A. differential outlay costs.

B. differential outlay costs plus the foregone contribution to the organization of making the transfer
internally.
C. selling price less the variable costs.
D. selling price less the variable costs plus the foregone contribution to the organization of making the
transfer internally.
The opportunity cost would be zero.

Blooms: Remember

60. Given a competitive outside market for identical intermediate goods, what is the best transfer price,
assuming all relevant information is readily available?

A. Standard production cost per unit.

B. Market price of the intermediate goods.
C. Actual full cost per unit plus a normal markup.
D. Market price of the final goods less any opportunity costs.
The best price is the market price if it exists.

Blooms: Remember
Difficulty: 1 Easy

15-103
61. The optimal transfer price when there are intermediate markets is:

A. full cost.

B. outlay costs.
C. variable cost.
D. market prices.
If markets exist the market price is the optimal transfer price.

Blooms: Remember
Difficulty: 1 Easy

variable marketing costs are $6 per unit. What is the opportunity cost of transferring internally,

A. $15.
B. $19.
C. $21.
D. $25.
($40 - $15 - $6) = $19

Blooms: Analyze
Difficulty: 1 Easy

63. Division A has variable manufacturing costs of $25 per unit and fixed costs of $5 per unit. Division A is
operating at capacity, what is the opportunity cost of an internal transfer when the market price is $35?

A. $5.
B. $10.
C. $25.
D. $30.
$35 - $25 = $10

15-104
Blooms: Analyze
Difficulty: 1 Easy

64. Lock Division of Morgantown Corp. sells 80,000 units of part Z-25 to the outside market. Part Z-25
sells for $40, has a variable cost of $22, and a fixed cost per unit of $10. The Lock Division has a
capacity to produce 100,000 units per period. The Cabinet Division currently purchases 10,000 units of
part Z-25 from the Lock Division for $40. The Cabinet Division has been approached by an outside
supplier willing to supply the parts for $36. What is the effect on Morgantown's overall profit if the
Lock Division refuses the outside price and the Cabinet Division decides to buy outside?


($36 - $22) × 10,000 = $140,000 decrease in profits

Blooms: Analyze
Difficulty: 1 Easy

65. The Lock Division of Morgantown Corp. sells 80,000 units of part Z-25 to the outside market. Part Z-25
sells for $40, has a variable cost of $22, and a fixed cost per unit of $10. The Lock Division has a
capacity to produce 100,000 units per period. The Cabinet Division currently purchases 10,000 units of
part Z-25 from the Lock Division for $40. The Cabinet Division has been approached by an outside
supplier willing to supply the parts for $36. What is the effect on Morgantown's overall profit if the
Lock Division accepts the outside price and the Cabinet Division continues to buy inside?


No change since costs have not changed for the Lock Division.

Blooms: Analyze
Difficulty: 1 Easy
15-105

66. Concrete Corporation has two producing centers, Contractor and Retailer. The Contractor Division has a
variable cost of $12 for its products and a total fixed cost of $120,000. The Contractor Division also has
idle capacity for up to 50,000 units per month. The Retailer Division would like to purchase 20,000
units of the Contractor Division's products per month, but is unable to convince the Contractor Division
to transfer units to the Retailer Division at $16 per unit. The Contractor Division has consistently argued
that the market price of $20 is nonnegotiable. What is The Contractor Division's opportunity cost of
not transferring units to the Retailer Division?

A. $20.
B. $12.
C. $8.
D. $4.
$16 - $12 = $4

Blooms: Analyze
Difficulty: 1 Easy

15-106
67. You have been provided with the following information for the Wool Division of a decentralized
company:

Selling price $45
The Blanket Division would like to purchase all of its units internally. The Blanket Division needs
6,000 units each period and currently pays $42 per unit to an outside firm. What is the lowest price that
Wool Division could accept from the Blanket Division? Assuming that the Blanket Division wants to
use a sole supplier and will not purchase less than 6,000 from a supplier, what is the lowest price that
Wool Division could accept from the Blanket Division?

A. $45.
B. $42.
C. $40.
D. $38.
[$33(2,500) + $45(3,500)]/6,000 = $40

Blooms: Analyze
Difficulty: 3 Hard

15-107
68. Given the following data for Keyboard Division:

The Computer Division would like to purchase 15,000 units each period from the Keyboard Division.
The Keyboard Division has ample excess capacity to handle all of the Computer Division's needs. The
Computer Division now purchases from an outside supplier at a price of $20. If the Keyboard Division
refuses to accept an $18 price internally, the company, as a whole, will be worse off by:

A. $30,000.
B. $75,000.
C. $90,000.
D. $120,000.
($20 - 12) × 15,000 = $120,000

Blooms: Analyze
Difficulty: 1 Easy

15-108
69. Given the following data for Electrical Cord Division:

Assume that Electrical Cord Division is selling all it can produce to outside customers. If it sells to the
Appliance Division, $1 can be avoided in variable cost per unit. The Appliance Division is presently
purchasing from an outside supplier at $38 per unit. From the point of view of the company as a whole,
any sales to the Appliance Division should be priced at:

A. $40.
B. $39.
C. $38.
D. The company would not want the transfer to take place.
The company as a whole would lose if the transfer was made. It is better off to buy from outside at $38
and to sell outside at $40. The $1 savings is not enough to make up this differential.

Blooms: Analyze
Difficulty: 3 Hard

15-109
70. Given the following data for Handle Division:

Fixed cost per unit (based on capacity) 30
Cabinet Division would like to purchase 10,000 units from the Handle Division at a price of $125 per
unit. Handle Division has no excess capacity to handle the Cabinet Division's requirements. The
Cabinet Division currently purchases from an outside supplier at a price of $140. If the Handle Division
accepts a $125 price internally, the company, as a whole, will be better or worse off by:

A. $600,000
B. $(100,000)
C. $115,000
D. $250,000
($150 - 140) × 10,000 = $(100,000)

Blooms: Analyze

15-110
71. Altoona Corporation has two divisions, Hinges and Doors, which are both organized as profit centers;
the Hinge Division produces and sells hinges to the Door Division and to outside customers. The Hinge
The Door Division has received an offer from an outsider vendor to supply all the hinges it needs
(20,000 hinges) at a cost of $45. The manager of the Door Division is considering the offer but wants to
approach the Hinge Division first.
What would be the profit impact to Altoona Corporation as a whole if the Door Division purchased the
20,000 hinges it needs from the outside vendor for $45?

A. No change in profit to Altoona.

B. $100,000 increase in profits.
C. $100,000 decrease in profits.
D. $500,000 decrease in profits.
Outside price $45 - Selling division's variable costs $20 = $25 higher costs × 20,000 units = $500,000
increase in costs which leads to a $500,000 decrease in profits

Blooms: Analyze
Difficulty: 1 Easy

What is the minimum transfer price from the Hinge Division to the Door Division?

A. $20.
B. $35.
C. $45.
D. $50.
Selling division's variable costs = $20

15-111
Blooms: Analyze
Difficulty: 1 Easy

What is the maximum transfer price from the Hinge Division to the Door Division?

A. $20.
B. $35.
C. $45.
D. $50.
Maximum price would be the market price the buyer would pay: $45

Blooms: Analyze

15-112
Clearwater, Florida. The repair division works on classic motorcycles, as well as other classic
automobiles.
backlog of work for automobile restoration. They charge $48.00 per hour for labor, which is standard
for this type of work. The Management division complained that it could hire its own repair workers for
$30.00 per hour, including leasing an adequate work area.
What is the minimum transfer price per hour that the Repair division should obtain for its services,

A. $28.50.
B. $30.00.
C. $39.00.
D. $48.00.
When at capacity, the market price of $48 is the appropriate transfer price.

Blooms: Analyze
Difficulty: 1 Easy

15-113
automobiles.
What is the maximum transfer price per hour that the Management division should pay?

A. $28.50.
B. $30.00.
C. $39.00.
D. $46.50.
$30, what the management division can purchase from outside.

Blooms: Analyze
Difficulty: 1 Easy

15-114
automobiles.
If the Repair division had idle capacity, what is the minimum transfer price that the Repair division
should obtain?

A. $28.50.
B. $30.00.
C. $39.00.
D. $46.50.
The selling division's variable cost of $28.50 is the appropriate transfer price.

Blooms: Analyze
Difficulty: 1 Easy

investment base of $750,000 and produces (and sells) 100,000 units of Collars at a market price of
$10.00 per unit. Variable costs total $3.50 per unit, and fixed charges are $4.00 per unit (based on a
capacity of 120,000 units). The Night Wear Division wants to purchase 25,000 units of Collars from
The Day Wear Division. However, the Night Wear Division is only willing to pay $6.75 per unit.
What is the contribution margin for the Day Wear Division without the transfer to the Night Wear
Division?

A. $250,000.
B. $650,000.
C. $675,000.
D. $1,000,000.
100,000 units × ($10 - $3.50) = $650,000

15-115
Blooms: Analyze

What is the contribution margin for the Day Wear Division if it transfers 25,000 units to the Night
Wear Division at $6.75 per unit?

A. $250,000.
B. $650,000.
C. $675,000.
D. $698,750.
(95,000 × $6.50) + [25,000 × ($6.75 - $3.50)] = $698,750

Blooms: Analyze

What is the minimum transfer price for the 25,000 unit order that the Day Wear Division would accept
if it wishes to maintain its pre-order contribution?

A. $3.50.
B. $4.00.
C. $4.80.
D. $6.00.
Opportunity cost = 5,000 × $6.50 = $32,500; transfer price: $3.50 + (32,500/25,000) = $4.80

15-116
Blooms: Analyze

80. A company is highly centralized. The Cutting Division, which is operating at capacity, produces a
component that it currently sells in a perfectly competitive market for $13 per unit. At the current level
of production, the fixed cost of producing this component is $4 per unit and the variable cost is $7 per
unit. Grinding Division would like to purchase this component from the Cutting Division. The price that
the Cutting Division should charge the Grinding Division per unit for this component is:

A. $7.
B. $11.
C. $13.
D. $15.
Since The Cutting Division is at full capacity, the appropriate transfer price is its market price.

Blooms: Analyze
Difficulty: 1 Easy

15-117
81. A company has two divisions, Softwoods and Hardwoods, each operating as a profit center. The
Softwood Division charges the Hardwood Division $35 per unit (for each unit transferred to the
Hardwood Division). Other data for the Softwood Division are as follows:

Variable Cost per unit $30
Fixed Costs $10,000
Annual Sales to the Hardwood Division 5,000 units
Annual Sales to Outsiders 50,000 units
The Softwood Division is planning to raise its transfer price to $50 per unit. The Hardwood Division
can purchase units at $40 per unit from outsiders, but doing so would idle the Softwood Division's
facilities (now committed to producing units for the Hardwood Division). The Softwood Division
cannot increase its sales to outsiders. From the perspective of the company as a whole, from who
should the Hardwood Division acquire the units, assuming the Hardwood Division's market is
unaffected?

A. Outside vendors.

B. The Softwood Division, but only at the variable cost per unit.
C. The Softwood Division, but only until fixed costs are covered, then should purchase from outside
vendors.
D. The Softwood Division, in spite of the increased transfer price.
The company as a whole only pays the $30 variable cost which is less than the $40 outside price. The
overall company would like an internal transfer.

Blooms: Analyze
Difficulty: 1 Easy

15-118
82. Given the following information for Camping Division:

The Lantern Division would like to purchase internally from the Camping Division. The Lantern
Division now purchases 5,000 units each period from outside suppliers at $49 per unit. The Camping
Division has ample excess capacity to handle all of the Lantern Division's needs. What is the lowest
price that Camping Division could accept?

A. $50.00.
B. $49.00.
C. $46.00.
D. $30.00.
The minimum transfer price is the variable costs of the selling division when the selling division has
excess capacity.

Blooms: Analyze
Difficulty: 1 Easy

83. Accutron, a large manufacturing company, has several autonomous divisions that sell their products in
perfectly competitive external markets as well as internally to the other divisions of the company. Top
management expects each of its divisional managers to take actions that will maximize the
organization's goal as well as their own goals. Top management also promotes a sustained level of
management effort of all of its divisional managers. Under these circumstances, for products exchanged
between divisions, the transfer price that will generally lead to optimal decisions for Accutron would be
a transfer price equal to the: (CIA adapted)

A. full cost of the product.

B. full cost of the product plus a markup.
C. variable cost of the product plus a markup.
D. market price of the product.
Since the market is perfect, market price is the best.

Blooms: Apply
15-119


Direct labor .40
Fixed overhead .20
Polishing Division purchases 20,000 handles from the Extruding Division and completes the hand
tools. An outside supplier, Venture Steel, has offered to supply 20,000 units of the handle to Polishing
Division for $1.25 per unit. The Extruding Division currently has idle capacity that cannot be used.
What is the cost impact to Martin as a whole of purchasing from Venture Steel? (CMA adapted)

A. increase the handle unit cost by $0.05.

B. increase the handle unit cost by $0.15.
C. decrease the handle unit cost by $0.15.
D. decrease the handle unit cost by $0.25.
Make: $0.60 + 0.40 + 0.10 = $1.10; Buy: $1.25; Differential: Buy $1.25 - Make $1.10 = $0.15 more
cost if buying outside

Blooms: Analyze
Difficulty: 1 Easy

15-120

Direct labor .40
Fixed overhead .20
If Martin would like to develop a range of transfer prices, what would be the maximum transfer price
that Polishing would be willing to pay?

A. $1.00.
B. $1.10.
C. $1.25.
D. $1.30.
Maximum price would be the market price = $1.25

Blooms: Analyze
Difficulty: 1 Easy

15-121

Direct labor .40
Fixed overhead .20
If Martin would like to develop a range of transfer prices, what would be the minimum transfer price
that Extruding would be willing to accept?

A. $1.00.
B. $1.10.
C. $1.25.
D. $1.30.
The minimum price would be variable costs plus any opportunity costs: $1.10

Blooms: Analyze
Difficulty: 1 Easy

15-122
87. The Alpha Division of a company, which is operating at capacity, produces and sells 1,000 units of a
certain electronic component in a perfectly competitive market. Revenue and cost data are as follows:
(CIA adapted)

Sales $50,000
Fixed costs 12,000
The minimum transfer price that should be charged to the Beta Division of the same company for each
component is:

A. $12.
B. $34.
C. $46.
D. $50.
Since it is a perfect market at full capacity, transfer price is the market price: $50,000/1,000 = $50

Blooms: Analyze

88. The Hinges Division of Altoona Corp. sells 80,000 units of part Z-25 to the outside market. Part Z-25
sells for $40, has a variable cost of $22, and a fixed cost per unit of $10. The Hinges Division has a
capacity to produce 100,000 units per period. The Door Division currently purchases 10,000 units of
part Z-25 from the Hinges Division for $40. The Door Division has been approached by an outside
supplier willing to supply the parts for $36. If Altoona uses a negotiated transfer pricing system, what is
the maximum transfer price that should be charged for this transaction?

A. $40.
B. $36.
C. $32.
D. $22.
Maximum price is the outside market price for the buying division: $36

Blooms: Analyze
15-123

89. The Hinges Division of Altoona Corp. sells 80,000 units of part Z-25 to the outside market. Part Z-25
sells for $40, has a variable cost of $22, and a fixed cost per unit of $10. The Hinges Division has a
capacity to produce 100,000 units per period. The Door Division currently purchases 10,000 units of
part Z-25 from the Hinges Division for $40. The Door Division has been approached by an outside
supplier willing to supply the parts for $36. If Altoona uses a negotiated transfer pricing system, what is
the minimum transfer price that should be charged for this transaction?

A. $40.
B. $36.
C. $32.
D. $22.
Minimum price is the outlay cost plus any opportunity costs: $22

Blooms: Analyze

90. The Eastern Division sells goods internally to the Western Division at Tennessee Company. The quoted
external price in industry publications from a supplier near Eastern is $200 per ton plus transportation. It
costs $20 per ton to transport the goods to Western. Eastern's actual market cost per ton to buy the direct
materials to make the transferred product is $100. Actual per-ton direct labor is $50. Other actual costs
of storage and handling are $40. Tennessee Company's president selects a $220 transfer price. This is an
example of: (CIA adapted)

A. market-based transfer pricing.

B. cost-based transfer pricing.
C. negotiated transfer pricing.
D. cost plus 20% transfer pricing.
Since the market is perfect, market price is the best.

Blooms: Apply
Difficulty: 1 Easy

15-124
91. Which of the following is the most significant disadvantage of a cost-based transfer price? (CIA
adapted)

A. Requires internally developed information.

B. Imposes market effects on company operations.
C. Requires externally developed information.
D. May not promote long-term efficiencies.
Cost-based transfer prices pass on inefficiencies from the selling division so there is no incentive for
improvement.

Blooms: Apply
Difficulty: 1 Easy

92. An appropriate transfer price between two divisions of The Fathom Company can be determined from
the following data: (CIA adapted)

Fabricating Division
Market price of
$50
subassembly
Variable cost of
$20
subassembly
Excess capacity (in units) 1,000
Assembling Division
Number of units needed 900
What is the natural bargaining range for the two divisions?

A. Between $20 and $50.

B. Between $50 and $70.
C. Any amount less than $50.
D. $50 is the only acceptable transfer price.
The minimum is the variable cost, while the maximum is the market price.

Blooms: Analyze
Difficulty: 3 Hard
15-125

93. A limitation of transfer prices based on actual cost is that they: (CIA adapted)

A. charge inefficiencies to the department that is transferring the goods.

B. charge inefficiencies to the department that is receiving the goods.
C. must be adjusted by some markup.
D. lack clarity and administrative convenience.
There is no motivation for the supplier to work on efficiency since all costs are passed on.

Blooms: Remember
Difficulty: 1 Easy

94. Which of the following is not an appropriate use of transfer pricing?

A. Product costing.

B. Decision making.
C. Establishing standards.
D. Evaluating performance.
Transfer prices do not affect standard costs.

Blooms: Remember
Difficulty: 1 Easy

15-126
95. An internal transfer between two divisions is in the best economic interest of the entire organization
when:

A. the variable costs plus the opportunity cost of the selling division is greater than the external price
for the buying division.
B. the variable costs plus the opportunity cost of the selling division is less than the external price for
C. there is excess capacity in the buying division with no alternative use.
D. there is no established market prices for the buying division.
If the variable cost plus opportunity cost is less than the external price, the company will show a higher
profit.

Blooms: Remember
Difficulty: 1 Easy

96. Top management intervention in settling transfer pricing disputes between two divisions should be
avoided unless

A. there is no intermediate markets.

B. the intermediate market is imperfect.
C. there is an extraordinarily large order.
D. there is no opportunity costs.
Intervention removes authority from the decentralized units.

Blooms: Remember
Difficulty: 1 Easy
Topic: Top-Management Intervention in Transfer Pricing

15-127
97. The transfer price that should be used by top management in evaluating whether a division should buy
within the company or from an outside supplier is:

A. negotiated transfer price.

B. transfer price based on full cost.
C. transfer price based on variable cost.
D. transfer price based on an open market price.
If there is an open market, that price should be used.

Blooms: Remember
Difficulty: 1 Easy
Topic: Top-Management Intervention in Transfer Pricing

98. Some managers prefer to use cost rather than market price in controlling transfers between divisions. If
cost is to be used, then it should be:

A. full cost.

B. direct cost.
C. variable cost.
D. standard cost.
A standard cost will not pass along inefficiencies.

Blooms: Remember
Difficulty: 1 Easy

15-128
99. Cost-based transfer prices that include a normal markup to the costs act as a surrogate for:

A. negotiated market prices.

B. opportunity costs.
C. differential costs.
D. market prices.
The goal is to approximate market prices.

Blooms: Remember
Difficulty: 1 Easy

100. Multinational firms often face conflicting pressures when developing transfer pricing policies. Tax
avoidance results when:

A. inflated transfer prices are used to reduce the profits of divisions in high tax-rate countries.
B. inflated transfer prices are used to reduce the profits of divisions in low tax-rate countries.
C. cost-based transfer prices are used instead of market transfer prices in high tax-rate countries.
D. cost-based transfer prices are used instead of negotiated market transfer prices in low tax-rate
countries.
Taxes are avoided when profits are reduced in a high tax country (and by extension profits would be
higher in a low tax country).

Blooms: Remember

15-129
101. Which of the following transfer pricing methods must be used in segment reporting by the oil and gas
industry?

A. Absorption cost.

B. Differential cost.
C. Negotiated market price.
D. Market price.
This is a GAAP requirement.

Blooms: Remember
Difficulty: 1 Easy

Essay Questions

15-130
102. Galena Corp. manufactures RD34 in its City Division. This output is sold to the Urban Division as raw
material in Urban's product. City also further processes the RD34 into RD35, and then sells it to other
companies.
The City Division's variable costs for the basic ingredient are $15 per unit. The Urban Division's
variable costs are $5 per unit in addition to what it pays the City Division. The Urban Division has a
capacity of 400,000 units and it can sell everything it produces. The market price for the finished
additive is $40 per unit. If the City Division converts the RD34 into RD35, it can receive $25 per unit
on the open market, but it incurs an additional $4 per unit for this processing.
Required:
a. What is the lowest price the City Division should be willing to transfer RD34 to the Urban Division,
assuming the City Division is not at full capacity?
b. What is the lowest price the City Division should be willing to transfer RD34 to the Urban Division,
assuming the City Division is at full capacity?
c. Ignore parts (a) and (b). Assume that the City Division has a capacity of 500,000 units, but can only
sell 300,000 on the open market. How many units should the City Division sell externally and how
many units should it sell to Urban Division at a transfer price of $20?

a. Since City is operating at less than full capacity, the lowest price is the variable cost of $15.
b. Opportunity cost: $25 for RD35 - $15 - $4 = $6. Optimal transfer price = outlay cost $15 +
opportunity cost $6 = $21.
c. Contribution margin is higher for outside sales ($25 - $15 - $4 = $6) than it is for internal ($20 - $15
= $5). Therefore, sell as much outside as possible. Open market 300,000 × $6 = $1,800,000; internal
(500,000 - 300,000) = 200,000 × ($20 - $15) = $1,000,000.

Blooms: Analyze
Difficulty: 3 Hard

15-131
103. Shipping Industries is a decentralized company that evaluates its divisions based on ROI. The North
Division has the capacity to produce 2,000 units of a component. The North Division's variable costs are
$85 per unit; fixed costs are $70 per unit.
The South Division can use the product as a component in one of its products. The South Division
Required:
a. Assume the North Division can sell all that it produces for $185 each. The South Division needs 100
units. What is the appropriate transfer price?
b. Assume the North Division can sell 1,800 units at $265. Any excess capacity will be unused unless
the units are purchased by the South Division (which can use up to 100 units). What are the minimum
and maximum transfer prices?

a. North is at full capacity: market price = $185

b. North is at less than full capacity. Minimum price = variable cost of North = $85; Maximum price =
incoming market price to South, but this is unknown. The most South will pay is the selling price of the
final product $310 less incremental variable costs of $65 = $245.

Blooms: Analyze

15-132
104. Trevor Company operates several investment centers. The manager of the Genesis Division expects the
following results for the coming year.

Sales (50,000 units at $20) $1,000,000
Fixed costs 250,000
Profit $150,000
Genesis Division has just found that she can buy the component from the Solar Division, another
division of Trevor Company. The Solar Division sells 300,000 units of the component to outsiders at $8
and its variable cost is $4 per unit. The Solar Division offers to sell the component to Genesis at a price
of $6. Solar is operating well below capacity.
Required:
a. If Genesis accepts the offer, what will happen to the income of the Solar Division?
b. If Genesis accepts the offer, what will happen to the income of the Genesis Division?
c. If Genesis accepts the offer, what will happen to the income of the Trevor Company?

a. 50,000 units × ($6 transfer price - $4 variable cost) = 50,000 × $2 = $100,000 increase in profit.
b. 50,000 units × ($7 old price - $6 new price) = 50,000 × $1 savings = $50,000 increase in profit.
c. 50,000 units × ($7 outside price - $4 variable cost) = 50,000 × $3 savings = $150,000 increase.

Blooms: Analyze

15-133
105. The Trevor Company operates several investment centers. The manager of the Genesis Division expects
the following results for the coming year.

Sales (50,000 units at $20) $1,000,000
Fixed costs 250,000
Profit $150,000
Genesis Division has just found that she can buy the component from the Solar Division, another
division of Trevor Company. The Solar Division sells 300,000 units of the component to outsiders at $8
and its variable cost is $4 per unit. Solar offers to sell the component to Genesis at a price of $6.
Solar has a capacity of 330,000 units. Assume that Genesis wants to buy all of its needs from one
source, so that Solar must supply all or none of the Genesis Division's need for 50,000 units.
Required:
a. Determine the change in income of the Solar Division of supplying the component to Genesis at $6
as opposed to not supplying Genesis.
b. Determine the change in income of Trevor Company if Solar supplies Genesis at $6.

a. Lost sales [300,000 - (330,000 - 50,000)] × ($8 - $4) = $80,000 opportunity cost; 50,000 units × [$6 -
$4] - $80,000 opportunity cost = $20,000 increase in profit.
b. 50,000 units × ($7 outside price - $4 variable cost) = 50,000 × $3 savings = $150,000 - $80,000
opportunity cost = $70,000 increase.

Blooms: Analyze

15-134
106. The Barrel Division of Chemco Inc. has a capacity of 200,000 units and expects the following results.
Sales (160,000 units at $4) $640,000

Variable costs, at $2 320,000
Fixed costs 260,000
Income $60,000
Tank Division of Chemco Inc. currently purchases 50,000 units of a part for one of its products from an
outside supplier for $4 per unit. The Tank Division's manager believes he could use a minor variation of
the Barrel Division's product instead, and offers to buy the units from the Barrel Division at $3.50.
Making the variation desired by the Tank Division would cost the Barrel Division an additional $0.50
per unit and would increase the Barrel Division's annual cash fixed costs by $20,000. Barrel's manager
agrees to the deal offered by Tank's manager.
Required:
a. What is the effect of the deal on the Tank Division's income?

b. What is the effect of the deal on the Barrel Division's income?
c. What is the effect of the deal on the income of Chemco Inc. as a whole?

a. 50,000 units × ($4 current price - $3.50 new price) = 50,000 × $0.50 = $25,000 increase in profit.
b. Lost sales [(160,000 + 50,000) -200,000] × ($4 - $2) = $20,000 opportunity cost; 50,000 units ×
[$3.50 - ($2.00 + $0.50)] - $20,000 increase in fixed - $20,000 opportunity cost = $10,000 increase in
profit.
c. $25,000 + $10,000 = $35,000 increase.

Blooms: Analyze

15-135
To To

Sales (5,000 × $60) $300,000
(25,000 × $72) $1,800,000
relative units
Profit $60,000 $600,000
Required:
a. Division A refuses to meet the $45 price, sales to outsiders cannot be increased, and Division B buys
from the outside supplier. Compute the effect on the income of Spangler.
b. Division A cannot increase its sales to outsiders, does meet the $45 price, and Division B continues
to buy from A. Compute the effect on the income of Spangler.

a. 5,000 units × ($45 outside price - $36 variable cost) = $45,000 decrease.
b. No change. Division A will show less profit, but B will show an equal amount of increased profit.

Blooms: Analyze

15-136
108. Veritron Division of Argos Inc. has a capacity of 100,000 units and expects the following results for the
year.

Sales (90,000 units at $30) $2,700,000
Variable costs, at $20 1,800,000
Fixed costs 700,000
Income $200,000
Magnatron Division of Argos Inc. currently purchases 20,000 units of a part for one of its products from
an outside supplier at $32 per unit. Magnatron's manager believes she could use a minor variation of
Veritron's product instead, and offers to buy the units from Veritron at $26. Making the variation
desired by Magnatron would cost Veritron an additional $5 per unit and would increase Veritron's
annual cash fixed costs by $80,000. Veritron's manager agrees to the deal offered by Magnatron's
manager.
Required:
a. Find the effect of the deal on Magnatron's income.

b. Find the effect of the deal on Veritron's income.
c. Find the effect of the deal on the income of Argos Inc. as a whole.

a. 20,000 units × (old price $32 - new price $26) = $120,000 increase.
b. Lost sales by Veritron: 10,000 units × ($30 - $20) = $100,000 opportunity cost; 20,000 units × [$26 -
($20 + $5)] - added fixed of $80,000 - opportunity cost $100,000 = $160,000 decrease.
c. Argos = Magnatron + Veritron = $120,000 - $160,000 = $40,000 decrease.

Blooms: Analyze

15-137
To To

Sales (5,000 × $60) $300,000
(25,000 × $60) $1,500,000
relative units
Profit $60,000 $300,000
Assume that Division A cannot increase sales to outsiders.
Required:
a. What would be the optimal transfer price?

b. Assume that Spangler allows the divisional managers to negotiate transfer prices. What would the
maximum transfer price be?
c. Assume that Spangler allows the divisional managers to negotiate transfer prices. What would the
minimum transfer price be?

a. Division A operating at less than capacity, optimal transfer price = variable cost $36.
b. Maximum price is the outside vendor price of $45.
c. The minimum price would be the outlay cost to Division A: variable costs = $36.

Blooms: Analyze

15-138
110. Winton Industries evaluates its divisions based on residual income. The Springfield Division has the
capacity to produce 20,000 units of a component. The Springfield Division's variable costs are $150 per
unit; fixed costs are $110 per unit.
The Monnett Division can use the product as a component in one of its products. The Monnett Division
Required:
a. Assume the Springfield Division can sell all that it produces for $285 each. The Monnett Division
needs 1,000 units. What is the appropriate transfer price?
b. Assume the Springfield Division can sell 18,000 units at $285. Any excess capacity will be unused
unless the units are purchased by the Monnett Division (which can use up to 1,000 units). What are the
minimum and maximum transfer prices?

a. Springfield is at full capacity: market price = $285.

b. Springfield is at less than full capacity. Minimum price = variable cost of Springfield = $150;
Maximum price = incoming market price to Monnett, but this is unknown. The most Monnett will pay
is the selling price of the final product $300 less incremental variable costs of $75 = $225.

Blooms: Analyze

15-139
111. Table Lake Cruises Inc., operates two divisions: (1) a recreational division that owns and manages
charter boats on the lake and (2) a repair division that operates a division at Rogers. The repair division
works on small gasoline crafts, as well medium size diesel engine boats. The repair division has an
estimated variable cost of $45 per labor-hour. The repair division has a backlog of work for diesel
engines. They charge $125 per hour for labor & overhead, which is standard for this type of work. The
recreational division complained that it could hire its own repair workers for $85 per hour, including
leasing an adequate work area.
Required:
a. What is the minimum transfer price per hour that the repair division should obtain for its services,
b. What is the maximum transfer price per hour that the recreational division should pay?
c. If the repair division had idle capacity, what is the minimum transfer price that the repair division
should obtain?

a. Repair is operating at capacity, transfer price = market price = $125/hr.

b. The maximum that recreational will pay is the "incoming" price of $85/hr. It is in the best interest of
the company profits for the recreational division to buy outside and repair to continue with its high rates
selling to outsiders.
c. If repair has excess capacity, the minimum transfer price is the variable cost of $45.

Blooms: Analyze

112. The Counter Division can sell externally for $60 per unit. Its variable manufacturing costs are $35 per
unit, and its fixed costs are $12 per unit.
Required:
a. What is the optimal transfer price for transferring internally, assuming the division is operating at
capacity?
b. What is the optimal transfer price for transferring internally, assuming the division is operating at
well below capacity?

a. Operating at capacity: transfer price = market price = $60.

b. Below capacity: optimal price = outlay cost = $35. Fixed costs are not outlay costs.

Blooms: Analyze
15-140

113. Salamander Company expects the following results:
Sales A: (10,000 × $160) $1,600,000
B: (25,000 × $72) $1,800,000
Fixed costs 160,000 360,000
Profit $80,000 $540,000
Included in Division A's costs are 10,000 units of a subcomponent purchased from an outside supplier
for $45. The managers have recently initiated negotiations for Division B to supply the components to
Required:
a. Would the Salamander Company prefer the subcomponent used by A to be purchased internally from
B or from the outside vendor?

a. Division B variable cost = $900,000/25,000 = $36. Internal purchase: inside cost 10,000 units ×
variable cost $36 = $360,000; outside: 10,000 × $45 = $450,000.
b. Minimum = variable cost $36; maximum incoming market $45.

Blooms: Analyze

15-141
15-142
114. The Salamander Company expects the following results:

Sales A: (10,000 × $160) $1,600,000
B: (25,000 × $72) $1,800,000
Fixed costs 160,000 360,000
Profit $80,000 $540,000
Included in Division A's costs are 10,000 units of a subcomponent purchased from an outside supplier
for $45. The managers have recently initiated negotiations for Division B to supply the components to
Required:
a. Prepare a new segment reporting statement for the Salamander Company, assuming an internal
transfer at the maximum transfer price.
b. Prepare a new segment reporting statement for the Salamander Company, assuming an internal
transfer at the minimum transfer price.

a. Division A Division B
Sales A: (10,000 × $160) $1,600,000
B: (25,000 × $72) $1,800,000
B transfer (10,000 ×
450,000
$45)
Variable costs 1,360,000 1,260,000
Fixed costs 160,000 360,000
Profit $80,000 $630,000

b. Division A Division B
Sales A: (10,000 × $160) $1,600,000
B: (25,000 × $72) $1,800,000
B transfer (10,000 ×
360,000
$36)
Variable costs 1,270,000 1,260,000
Fixed costs 160,000 360,000
Profit $170,000 $540,000
15-143
a. Maximum price = $45; new variable costs for B: ($900,000/25,000) × 35,000 = $1,260,000; no
change in variable cost to A.
b. Minimum price = variable cost = $36; new variable costs for A: $1,360,000 - old cost (10,000 × $45)
+ new cost (10,000 × $36) = $1,360,000 - $90,000 = $1,270,000.

Blooms: Analyze

115. Thai Company has two divisions organized as profit centers: Redmon and Tomlin. Thai expects the
following results:

Redmon Tomlin
Sales
Redmon: (10,000 × $16) $1,600,000
Tomlin: (250,000 × $7.20) $1,800,000
Variable costs 1,360,000 1,000,000
Fixed costs 160,000 460,000
Profit $80,000 $340,000
Included in Redmon's costs are 100,000 units of a subcomponent purchased from an outside supplier
for $4.50. The managers have recently initiated negotiations for Tomlin to supply the components to
Redmon. Tomlin has a total capacity of 400,000 units.
Required:
a. Would Thai Company prefer the subcomponent used by Redmon to be purchased internally from
Tomlin or from the outside vendor? What would be the profit impact?

a. Internal cost = variable cost = $1,000,000/250,000 units = $4; external price = $4.50; prefer internal:
100,000 units × ($4.50 - $4) = $50,000 more profit.
b. Maximum = outside price $4.50; minimum = variable cost = $4.

Blooms: Analyze

15-144
116. Macon Motor Works has just acquired a new Battery Division. The Battery Division produces a
standard 12-volt battery that it sells to retail outlets at a competitive price of $20. The retail outlets
purchase about 800,000 batteries a year. Since the Battery Division has a capacity of 1,000,000 batteries
a year, top management is thinking that it might be wise for the company's Automotive Division to start
purchasing batteries from the newly acquired Battery Division.
The Automotive Division now purchases 300,000 batteries a year from an outside supplier, at a price of
$18 per battery. The discount from the competitive $20 price is a result of the large quantity purchased.
The Battery Division's cost per battery is shown below:

Direct materials $8
Direct labor 4
Variable overhead 2
Fixed overhead 2
Total cost $16
Fixed costs are based on 1,000,000 batteries.

Both divisions are to be treated as investment centers, and their performance is to be evaluated by the
ROI formula.
Required:
a. What transfer price would you recommend and why?

b. What transfer price would you recommend if the Battery Division is now selling 1,000,000 batteries
a year to retail outlets?
c. Suppose the manager of the Battery Division can increase its capacity to 1,500,000 units for
$1,200,000. She then has the option of (a) cutting the retail price to $17.50 with the certainty that sales
will increase to 1,500,000 batteries, or (b) maintaining the outside price of $20.00 for the 800,000
batteries and transferring the 300,000 batteries to the Automotive Division at some price that would
produce the same income for the Battery Division as option (a). What is the minimum transfer price you
would recommend in this situation?

a. Any price between the selling division's variable cost ($14 per unit) and the buying division's external
market price ($18).
b. There is no price that's acceptable in this case since the selling division's external market price ($20)
is greater than the buying division's external market price ($18).
c. [($17.50 - $14) × 1,500,000] = [($20 - $14) × 800,000] + [($X - $14) × 300,000]; X = $15.50 (Note:
The increased fixed costs of $1,200,000 are irrelevant to this decision.)

Blooms: Analyze
Difficulty: 3 Hard

15-145
117. Chattanooga Inc., has two divisions for its metal fabrication business. The Stamp Division stamps the
objects and then transfers them to the Finish Division, which finishes and sells them. Last year, the
Stamp Division had administrative expenses of $40,000. The Finish Division incurred additional
production costs of $120,000 (exclusive of amounts paid to the Stamp Division for the stamped steel) to
process 120,000 units. The Finish Division sold the finished goods for $500,000 and incurred $80,000
in variable selling and administrative expenses.
Required:
a. Prepare income statements for each division. Use a transfer price of the Stamp Division's total cost
plus 5%. Assume Cost of Goods Sold for the Finish Division is $351,000.
b. Repeat (a), using a transfer price of $2.00 per unit; this is also the market price.
c. Repeat (a), using a negotiated transfer price of $1.90 per unit.
d. Which transfer price results in higher income to Chattanooga Inc.?

a. Cost Plus Stamp Division Finish Division

Sales $231,000 $500,000
Cost of Goods Sold 180,000 351,000
Other Costs 40,000 80,000
Operating Profit $11,000 $69,000
b. Transfer = $2 Stamp Division Finish Division
Sales $240,000 $500,000
c. Transfer = $1.90 Stamp Division Finish Division
Sales $228,000 $500,000
d. In terms of total company income, transfer prices have no impact; i.e., the total profit is $80,000
regardless of how it is allocated between the two divisions. However, different pricing systems can
provide managers with different incentives, which may have an impact on profits.
a. The Stamp Division = The Finish Division COGS $351,000 - $120,000 added costs = $231,000;
$231,000 = 105% of the Stamp Division costs; The Stamp Division cost = $231,000/105% = $220,000;
$220,000 - $40,000 other costs = $180,000 Stamp Division COGS.

Blooms: Analyze
Difficulty: 3 Hard
15-146

118. Division S sells its product to unrelated parties at a price of $20 per unit. It incurs variable costs of $7
per unit and has fixed costs of $50,000 per month. Monthly production is generally 10,000 units.
Division B uses Division S's product in its operations. It can purchase the units from Division S at $20
per unit, but must pay a $1.50 per unit in shipping costs. Alternatively, Division B can buy from
Division S's competition at a delivered price of $21 per unit.
Required:
a. From the company's perspective, should Division B purchase the units internally or externally?
Assume Division S has ample capacity to handle all of Division B's needs.
b. Would your answer change if Division S can sell everything it produces to outside customers?

a. External $21, internal $7 variable cost + $1.50 shipping = $8.50; savings = $21 - $8.50 = $12.50 ×
10,000 units = $125,000 (internal transfer since Division A has ample capacity).
b. Purchase internal: $20 + $1.50 = $21.50 versus $21 external (better to have external supply).

Blooms: Analyze
Difficulty: 3 Hard

15-147
119. Calvin Machinery Company manufactures heavy-duty equipment used in foundries, mining operations,
and similar operations. The company is very decentralized, with various division managers having
control over capital investments and most production decisions. The Cylinder Division fabricates a
component which is used by the Press Division in its production of metal presses. The Cylinder
Division has been selling to the Press Division at a price of $3,000 per unit. Because of a cost increase,
the Cylinder Division wants to increase its price to $3,200, even though the Press Division can still
purchase an equivalent component externally for $3,000. The following information has been gathered
regarding this issue:

Press Division’s annual purchases 100 units
Cylinder Division’s variable costs $2,400 per unit
Cylinder Division’s fixed costs $600 per unit
Required:
a. If the Press Division buys its units externally, the Cylinder Division will have idle capacity for which
there are no alternative uses. Will the company as whole benefit if the Press Division purchases its units
externally for $3,000 per unit?
b. If the Press Division buys its units externally, the Cylinder Division will have idle capacity which
can be used to generate a positive cash flow of $40,000. Will the company as whole benefit if the Press
Division purchases its units externally for $3,000 per unit?
c. Refer to (b). Will your answer change if the price at which the Press Division can buy externally
decreases to $2,700 per unit? Support your answer.

a. External purchase: 100 × $3,000 = $300,000; internal purchase: 100 × $2,400 variable cost =
$240,000; differential in profit = $60,000 decrease. No, the company as a whole will earn $60,000 in
less profit if there is an external transfer.
b. External purchases $300,000 - $40,000 usage of capacity = $260,000; internal = $240,000;
differential = $20,000 decrease. No, the company will still earn $20,000 less profit with an external
transfer.
c. External purchase: 100 × $2,700 = $270,000 - $40,000 = $230,000 versus $240,000 internal;
differential $10,000 increase in profit. The company would prefer an external purchase as profits will
increase by $10,000.

Blooms: Analyze
Difficulty: 3 Hard

15-148
15-149
120. The GrowPro Manufacturing Company has a division (Division P) that produces an essential ingredient
used by the Lawn Division in making lawn fertilizer. Historically, 75% of Division P's output has been
purchased by Division L and 25% has been sold to other fertilizer companies. The transfer price
between Division P and Division L has been based on the outside sales price less selling and
administrative expenses directly applicable to the outside sales. Last year, the transfer price was $35 per
ton; Division P would like the same transfer price this year. However, the general manager of Division
L has found an outside supplier who will sell the ingredient for $30 per ton. She would like to continue
buying from Division P, but Division P's manager does not want to match the $30 price because he
thinks that the margin is too small. Top management does not get involved in transfer pricing disputes,
but rather, allows division managers to make their own decisions concerning internal or external
purchases and sales.
The following information has been gathered regarding Division P's operations last year:

Sales to L External
Sales $4,200,000 $2,000,000
Variable costs 3,000,000 1,000,000
Fixed costs 360,000 120,000
The information presented above is based on selling 120,000 tons internally and 40,000 tons externally.
Required:
a. If Division L buys externally, Division P can increase its current external sales by only 20,000 tons.
What arguments can the general manager of Division L make to help Division P to match the $30 price?
b. Division L wants to use only one supplier, so Division P will either sell 120,000 tons to Division L
or nothing. If Division L's capacity is 160,000 tons, how many units does Division P need to sell to
outsiders at $50 per ton before it is better off selling to outsiders? Ignore any additional marketing costs
which would be incurred to increase sales.

a. Drop price internally, overall profit = $1,120,000; lose inside sales, increase outside, overall profit =
$1,020,000.
b. 64,000 tons.

a. internal price
Sales to L External Total
= $30
Sales $3,600,000 $2,000,000
Variable costs 3,000,000 1,000,000
Contribution
$600,000 $1,000,000 $1,600,000
margin
Fixed costs 360,000 120,000 480,000
Operating profit $240,000 $880,000 $1,120,000
No internal sales, external increases by 20,000.

15-150
External Total
Sales $3,000,000
Variable costs 1,500,000
Contribution
$1,500,000 $1,500,000
margin
Fixed costs 480,000 480,000
Operating profit $1,020,000 $1,020,000
b. There needs to be $1,600,000 in contribution margin. The contribution margin per ton is $50 - $25 =
$25. Volume needed is $1,600,000/$25 = 64,000 tons.

Blooms: Analyze
Difficulty: 3 Hard

15-151
121. The Measurement Division of Flow Co. produces pumps which it sells for $20 each to outside
customers. The Measurement Division's cost per pump, based on normal volume of 500,000 units per
period, is shown below:

Variable costs $12
Fixed overhead 3
Total $15
Flow has recently purchased a small company which makes sprinkler systems. This new company is
presently purchasing 100,000 pumps each year from another manufacturer. Since the Measurement
Division has a capacity of 600,000 pumps per year and is now selling only 500,000 pumps to outside
customers, management would like the new Sprinkler Division to begin purchasing its pumps internally.
The Sprinkler Division is now paying $20 per pump, less a 10% quantity discount. The Measurement
Division could avoid $1 per unit in variable costs on any sales to the Sprinkler Division.
Required:
a. Treating each division as an independent profit center, within what price range should the internal
sales price fall?
b. Now assume that the Measurement Division is selling 600,000 pumps per year on the outside.
Determine the appropriate transfer price. Show all computations.

a. Current price being paid by the Sprinkler Division:
$20 - (10% × $20) = $18
Using the transfer pricing formula, the minimum transfer price is:
Transfer Price > Variable Costs + Lost Contribution Margin > $11 + $0 = $11.
Therefore, the transfer price would be between $11 and $18 per unit.
b. In this case, there is no idle capacity. Therefore, the appropriate transfer price would be:
Transfer Price > Variable Costs + Lost Contribution Margin > $11 + ($20 - $12) = $11 + $8 = $19.

Blooms: Analyze

15-152
122. Finnish Corporation has a Supply Division that does work for other Divisions in the company as well as
for outside customers. The company's Custodial Products Division has asked the Supply Division to
provide it with 10,000 special items each year. The special items would require $15.00 per unit in
variable production costs.
The Custodial Products Division has a bid from an outside supplier for the special items at $29.00 per
unit. In order to have time and space to produce the special items, the Supply Division would have to
cut back production of another product - the H56 that it presently is producing. The H56 sells for $32.00
per unit, and requires $19.00 per unit in variable production costs. Packaging and shipping costs of the
H56 are $3.00 per unit. Packaging and shipping costs for the new special part would be only $1.00 per
unit. The Supply Division is now producing and selling 40,000 units of the H56 each year. Production
and sales of the H56 would drop by 20% if the new special item is produced for the Custodial Products
Division.
Required:
a. What is the range of transfer prices within which both the Divisions' profits would increase as a
result of agreeing to the transfer of 10,000 special parts per year from the Supply Division to the
Custodial Products Division?
b. Is it in the best interests of Finnish Corporation for this transfer to take place? Explain. (Note: Due to
limitations in fonts and word processing software, > and < signs must be used in this solution rather
than "greater than or equal to" and "less than or equal to" signs.)

a. From the perspective of the Supply Division, profits would increase as a result of the transfer if, and
only if:
transferred:
Opportunity cost = [($32.00 - $19.00 - $3.00) × 8,000*]/10,000 = $8.00
*20% × 40,000 = 8,000
Therefore, Transfer price > ($15.00 + $1.00) + $8.00 = $24.00. From the viewpoint of the Custodial
Products Division, the transfer price must be less than the cost of buying the units from the outside
supplier. Therefore, Transfer price < $29.00.
Combining the two requirements, we get the following range of transfer prices: $24.00 < Transfer price
< $29.00.
b. Yes, the transfer should take place. From the viewpoint of the entire company, the cost of
transferring the units within the company is $24.00, but the cost of purchasing the special parts from the
outside supplier is $29.00. Therefore, the company's profits increase on average by $5.00 for each of the
special items that is transferred within the company, even though this would cut into production and
sales of another product.

Blooms: Analyze
Difficulty: 3 Hard
15-153

15-154
123. Division N has asked Division M of the same company to supply it with 10,000 units of part P782 this
year to use in one of its products. Division N has received a bid from an outside supplier for the parts at
a price of $25.00 per unit. Division M has the capacity to produce 50,000 units of part P782 per year.
Division M expects to sell 46,000 units of part P782 to outside customers this year at a price of $26.00
per unit. To fill the order from Division N, Division M would have to cut back its sales to outside
customers. Division M produces part P782 at a variable cost of $17.00 per unit. The cost of packing and
shipping the parts for outside customers is $1.00 per unit. These packing and shipping costs would not
have to be incurred on sales of the parts to Division N.
Required:
result of agreeing to the transfer of 10,000 parts this year from Division N to Division M?
b. Is it in the best interests of the overall company for this transfer to take place? Explain. (Note: Due to
limitations in fonts and word processing software, > and < signs must be used in this solution rather
than "greater than or equal to" and "less than or equal to" signs.)

a. From the perspective of Division N, profits would increase as a result of the transfer if, and only if:
transferred:
Opportunity cost = [($26.00 - $17.00 - $1.00) × 6,000*]/10,000 = $4.80

*
Demand from outside customers 46,000
Units required by Division N 10,000
Total requirements 56,000
Capacity 50,000
Required reduction in sales to outside
6,000
customers
Therefore, Transfer price > $17.00 + $4.80 = $21.80.
From the viewpoint of Division M, the transfer price must be less than the cost of buying the units from
the outside supplier. Therefore,
Transfer price < $25.00. Combining the two requirements, we get the following range of transfer
prices:
$21.80 < Transfer price < $25.00.
transferring the units within the company is $21.80, but the cost of purchasing them from the outside
supplier is $25.00. Therefore, the company's profits increase on average by $3.20 for each of the special
parts that is transferred within the company.

15-155
Blooms: Analyze

15-156
15-157
124. Farris Yard Equipment Corporation manufactures lawn mowers and snow blowers. It also manufactures
engines that are used by the Lawn Mower Assembly Division (LMAD). The Engine Division (ED) also
sells about 40% of its output to the outside market (these are multipurpose engines). Its annual capacity
is 150,000 units and annual output 135,000 units. All engines sold internally to the LMAD are priced at
cost plus 20% markup.
In January 2016, the Snow Blower Assembly Division (SBAD) approached the ED to 'buy' 20,000
engines. Diane Rogers, the controller of ED, computed the costs of manufacturing these engines as
follows:

Total Per unit
Materials $300,000 $15.00
Labor 400,000 20.00
Special equipment 36,000 1.80
Quality inspection 24,000 1.20
Other manufacturing costs 350,000 17.50
Total costs $1,110,000 $55.50
Rogers quoted a price of $66.60 for each engine transferred to the SBAD. Jackson White, the manager
of SBAD, was furious to note that the ED was "trying to make money off a sister division." He argued
that the price must include only the cost of materials, as all other costs will be incurred irrespective of
whether or not SBAD places the order for 20,000 engines. Morton Downey, the production manager of
ED, pointed out that the special equipment will be purchased only for fulfilling this internal order.
Moreover, he argued that inspection must also be done just like on all other engines; therefore, the
inspection costs must also be included. Labor is paid a flat monthly salary. Other manufacturing costs
include both variable and fixed components (in roughly equal proportion).
Required:
(a) Given that excess capacity exists, what is the minimum price that the ED must charge to the SBAD?
(b) What are the pros and cons of internal sourcing?

(a) The costs that are explicitly associated with the manufacture of engines required by the SBAD are as
follows:

Materials: $300,000
Special equipment: 36,000
Inspection: 24,000
Other manufacturing costs: 175,000
Total $535,000 $26.75 per unit
Therefore, the minimum price at which the ED can 'sell' to the SBAD would be $32.10 ($26.75 × 1.20).
It is important to note that excess capacity exists; therefore, the ED does not have any opportunity costs
associated with the SBAD's order.
15-158
(b) The pros of internal sourcing are as follows:
• Productive use of excess capacity.

• Potential cost savings.
• Protection of proprietary knowledge.
The cons of internal sourcing are as follows:
• Setting internal pricing policies and refereeing disputes.

• Supporting inefficient operations with artificially high internal prices.
It is important to note that any policy stated as "cost plus 20 percent" is asking for trouble, because
"cost" is undefined. If market prices are available, the company probably should use these for internal
sales, with a policy of sourcing internally at the market price. Using cost-based internal prices may be
necessary, but creates complications of creating the price that motivates managers to benefit themselves
and the company as a whole.

Blooms: Analyze
Difficulty: 3 Hard

15-159
125. Allentown Division of Sparks Inc. transfers its product to the Youngstown Division. The Youngstown
Division can either buy the item internally or externally (cost = $73 each). The Allentown Division has
just completed its annual cost update as follows:

Direct material $25.00
Direct labor 18.00
Variable manufacturing
6.00
overhead
Fixed manufacturing
3.50
overhead
Variable selling expenses 4.00
Fixed selling and
8.50
administrative expenses
Total costs $65.00
Desired return 14.00
Sales price $79.00
The Allentown Division is operating at 60 percent of its 400,000 unit capacity.
Required:
1) What is the minimum transfer price the Allentown Division should charge for internal transfers?
2) What is the maximum price the Youngstown Division would be willing to pay?
3) Why should the Allentown Division reduce its price to the Youngstown Division?

1) The minimum transfer price should be total variable cost = $25 + $18 + $6 + $4 = $53.
2) The maximum transfer price = market price = $73.
3) The Allentown Division should reduce its price because it has excess capacity. Under the general
rule, even though it doesn't work well with excess capacity, only costs incurred because of production
necessitated by the internal transfer should be considered—therefore, only variable costs should make
up the transfer price. The price also does not reflect that actual fixed cost per unit will decrease as more
units are produced and, with an internal sale, variable selling expense might be eliminated or, at least,
reduced.

Blooms: Analyze

15-160
126. The following costs exist for Wiring Division of Corriander Corp.

Direct material $67,500
Direct labor 45,000
Manufacturing overhead (25% variable) 45,000
Operating expenses (30% variable) 75,000
Output 30,000 Units
The output of the Wiring Division, which sells for $10/unit externally, is used by the Electrical Harness
Division.
Required:
Compute the transfer price for a unit of the Wiring Division's output using:
1) market price
2) variable production cost plus 30 percent
3) absorption cost plus 25 percent
4) variable cost
5) total cost plus 10 percent

1) $10 per unit.

2) 1.3($67,500 + $45,000 + .25($45,000))/30,000 = 1.3($123,750)/30,000 = $160,875/30,000 =
$5.3625.
3) 1.25($67,500 + $45,000 + $45,000)/30,000 = 1.25($157,500)/30,000 = $196,875/30,000 = $6.5625.
4) ($67,500 + $45,000 + .25($45,000) + .3($75,000))/30,000 = ($67,500 + $45,000 + $11,250 +
$22,500)/30,000 = $146,250/30,000 = 4.875.
5) 1.1($67,500 + $45,000 + $45,000 + $75,000)/30,000 = 1.1($232,500)/30,000 = $255,750/30,000 =
$8.525.

Blooms: Analyze

15-161
127. SEMO Inc. has a division located in Spain and another in the U.S. The Spanish division produces a part
needed for the product made by the U.S. division. There is substantial excess capacity in the Spanish
division. The tax rate of the Spanish division is 35% and U.S. division tax rate is 30%.
The part sells externally for $75 and the Spanish division's manufacturing costs are:

Direct material $32
Direct labor 12
Variable overhead 6
Fixed overhead 19
Required:
1) What would be the lowest acceptable transfer price for the Spanish division?
2) What would be the highest acceptable transfer price for the U.S. division?
3) What would be the transfer price that would be the best for SEMO Inc. and why?

1) Minimum transfer price = $32 + $12 + $6 = $50 variable production cost.

2) Maximum transfer price = $75 market.
3) A transfer price of $50 would be the best for SEMO, Inc. It would minimize U.S. income tax overall
since less would be taxed at the 35% level and, while there would be more profit for the U.S. division,
the U.S. tax rate is lower.

Blooms: Analyze

15-162
15-163
128. The following information is available for the two divisions of MAC Co.:

Division A
Selling price to outside market $55
Standard unit-level costs 35
Division B
Selling price of finished product $95
Standard unit-level costs for Division B 25
Division A has no excess production capacity.
Required:
1) In order to ensure the best use of the productive capacity of A, what transfer price should be set by
Division A and what effect does this transfer price have on the overall margin for the company? Is the
answer goal congruent under the general rule?
2) Should Division B accept a special order for its product if the selling price is reduced to $70. Use
your answer from #1 and explain.
3) Would your answer to #2 change if Division A had excess capacity? Explain.

1)
Company (after transfer to

Division A
Division B)
Selling price $55 Retail selling price $95
Standard unit-level Standard unit-level
35
cost costs
Contribution
$20 Division A $35
Margin
Division B 25 60
Contribution Margin $35
The appropriate transfer price should be $55 which fits in with the transfer price from the general rule
so it is goal congruent. This would be in the best interest of the company and would still encourage
Division B to purchase internally. B's contribution margin would be $15 ($95 - $55 - $25).
2)

Company-after
Division B
transfer
Selling price-special
$70 $70
order
Standard unit-level

costs
Division A $55 $35
15-164
Division B 25 80 25 60
Contribution Margin ($10) $10
No. Division B would lose $10 per unit if the special order were accepted. The company will make
more if Division A would sell directly to the external market with a $20 contribution. A decision to sell
the part externally is still goal congruent under the general rule.
(3) Under the general rule the transfer price when there is excess capacity would be $35. The overall
contribution would be $10 per unit and Division B's contribution would also be $10. It would be in the
best interests of the company to accept the special order and under the general rule goal congruent
behavior still continues.

Blooms: Analyze

15-165
129. Division X has asked Division K of the Easton Company to supply it with 5,000 units of part L433 this
year to use in one of its products. Division X has received a bid from an outside supplier for the parts at
a price of $26.00 per unit. Division K has the capacity to produce 30,000 units of part L433 per year.
Division K expects to sell 26,000 units of part L433 to outside customers this year at a price of $30.00
per unit. To fill the order from Division X, Division K would have to cut back its sales to outside
customers. Division K produces part L433 at a variable cost of $21.00 per unit. The cost of packing and
shipping the parts for outside customers is $2.00 per unit. These packing and shipping costs would not
have to be incurred on sales of the parts to Division X.
Required:
result of agreeing to the transfer of 5,000 parts this year from Division X to Division K?
b. Is it in the best interests of the overall Easton Company for this transfer to take place? Explain.

solution rather than "greater than or equal to" and "less than or equal to" signs).
a. From the perspective of Division X, profits would increase as a result of the transfer if, and only if:
Transfer price > Variable cost + Opportunity cost.
transferred:
Opportunity cost = [($30.00 per unit - $21.00 per unit - $2.00 per unit) × 1,000 units*]/5,000 units =
$1.40 per unit.

* Demand from outside customers 26,000

Units required by Division X 5,000
Total requirements 31,000
Capacity 30,000
Required reduction in sales to outside
1,000
customers
Therefore, Transfer price > $21.00 per unit + $1.40 per unit = $22.40 per unit.
From the viewpoint of Division K, the transfer price must be less than the cost of buying the units from
the outside supplier. Therefore,
Transfer price < $26.00.
Combining the two requirements, we get the following range of transfer prices:
$22.40 < Transfer price < $26.00.
b. Yes, the transfer should take place. From the viewpoint of the Easton Company, the cost of
transferring the units within the company is $22.40, but the cost of purchasing them from the outside
supplier is $26.00. Therefore, the company's profits increase on average by $3.60 for each of the special
parts that is transferred within the Easton Company.

15-166
Blooms: Apply

15-167
130. Pomme Corporation has a Motor Division that does work for other Divisions in the company as well as
for outside customers. The company's Equipment Division has asked the Motor Division to provide it
with 2,000 special motors each year. The special motors would require $17.00 per unit in variable
production costs. The Equipment Division has a bid from an outside supplier for the special motors at
$28.00 per unit. In order to have time and space to produce the special motor, the Motor Division would
have to cut back production of another motor - the J789 that it presently is producing. The J789 sells for
$34.00 per unit, and requires $22.00 per unit in variable production costs. Packaging and shipping costs
of the J789 are $4.00 per unit. Packaging and shipping costs for the new special motor would be only
$0.50 per unit. The Motor Division is now producing and selling 10,000 units of the J789 each year.
Production and sales of the J789 would drop by 10% if the new special motor is produced for the
Equipment Division.
Required:
a. What is the range of transfer prices within which both the Divisions' profits would increase as a result
of agreeing to the transfer of 2,000 special motors per year from the Motor Division to the Equipment
Division?
b. Is it in the best interests of Pomme Corporation for this transfer to take place? Explain.

a. From the perspective of the Motors Division, profits would increase as a result of the transfer if, and
only if:
Transfer price > Variable cost + Opportunity cost.
transferred:
Opportunity cost = [($34.00 per unit - $22.00 per unit - $4.00 per unit) × 1,000 units*]/2,000 units =
$4.00 per unit.
*10% × 10,000 units = 1,000 units.
Therefore, Transfer price > ($17.00 per unit + $0.50 per unit) + $4.00 per unit = $21.50 per unit.
From the viewpoint of the Equipment Division, the transfer price must be less than the cost of buying
the units from the outside supplier. Therefore, Transfer price < $28.00.
Combining the two requirements, we get the following range of transfer prices: $21.50 < Transfer price
< $28.00.
transferring the units within the company is $21.50, but the cost of purchasing the special parts from the
outside supplier is $28.00. Therefore, the company's profits increase on average by $6.50 for each of the
special motors that is transferred within the company, even though this would cut into production and
sales of another product.

Blooms: Apply
Difficulty: 3 Hard
15-168

15-169
15-170
131. Randolph Company has two divisions organized as profit centers: Redmon and Tomlin. Randolph
expects the following results:

Redmon Tomlin
Sales
Redmon: (10,000 × $16) $1,600,000
Tomlin: (250,000 × $7.20) $1,800,000
Variable costs 1,360,000 1,000,000
Fixed costs 160,000 460,000
Profit $80,000 $340,000
Included in Redmon's costs are 100,000 units of a subcomponent purchased from an outside supplier
for $4.50. The managers have recently initiated negotiations for Tomlin to supply the components to
Redmon. Tomlin has a total capacity of 400,000 units.
Required:
a. Prepare a new segment reporting statement for Randolph, assuming an internal transfer at the
maximum transfer price.
b. Prepare a new segment reporting statement for Randolph, assuming an internal transfer at the
minimum transfer price.

a. Redmon Tomlin
Sales
Redmon: (10,000 × $16) $1,600,000
Tomlin: (250,000 × $7.20) $1,800,000
Transfer (100,000 × $4.50) 450,000
Variable costs 1,360,000 1,400,000
Fixed costs 160,000 460,000
Profit $80,000 $340,000

b. Redmon Tomlin
Sales
Redmon: (10,000 × $16) $1,600,000
Tomlin: (250,000 × $7.20) $1,800,000
Transfer (100,000 × $4) 400,000
Variable costs 1,310,000 1,400,000
Fixed costs 160,000 460,000
15-171
Profit $130,000 $340,000
a. Maximum price = $4.50; new variable costs for B: ($1,000,000/250,000) × 350,000 = $1,400,000; no
change in variable cost to A.
b. Minimum price = variable cost = $4.00; new variable costs for A: $1,360,000 - old cost (100,000 ×
$4.50) + new cost (100,000 × $4) = $1,360,000 - $50,000 = $1,310,000.

Blooms: Analyze

132. Why is transfer pricing only a concern for profit or investment centers and not for cost or revenue
centers?

A cost center is not concerned with making a profit, only with controlling costs. Similarly, a revenue
center is also not concerned with profits, only with revenues. Transfer prices consider the profit impact
of making a decision as to the source of a product.

Blooms: Remember

133. Explain the general principle for determining the optimal transfer price.

The general principle for an optimal transfer price is to set the price equal to the outlay cost for the
supplier up to the point of transfer and opportunity cost of the resources of the supplier. This principle
should result in a transfer price that leads managers to make decisions in the firm's best interests.

Blooms: Remember

15-172
134. What is meant by a dual transfer pricing system? What are some advantages and disadvantages of it?

A dual transfer pricing system is one where the selling division is awarded a price that includes profits
while the buying division is charged only for costs. The advantage is this type of system encourages
transfers. Disadvantages include the transfer price will not serve as a signal as to the value of the good
to the firm. Performance evaluation is also more difficult under this system.

Blooms: Remember

135. What are the limitations of market-based transfer prices?

A perfect intermediate market may not exist, there may be differences between the internal products and
those available on the market with respect to distribution costs, quality, or product characteristics.

Blooms: Remember

136. What are the advantages and disadvantages of using a negotiated transfer price?

The major advantage of a negotiated transfer price is that it preserves the autonomy of the divisional
managers. The disadvantages include 1) a great deal of management time may be consumed by the
negotiating process and 2) the final price and its implications for performance measurement could
depend more on the manager's ability to negotiate than on what is best for the company.

Blooms: Remember

15-173
137. Why is transfer pricing important in tax accounting?

Transfer pricing is important in tax accounting, because transfers of goods or services often occurs
across different tax jurisdictions (countries, for example). The transfer price affects the revenue
(income) and cost (income) that are reported in the different jurisdictions. If the different jurisdictions
have different income tax rates, the total tax liability across all jurisdictions will depend on the transfer
price.

Blooms: Remember

138. What are the principal items that must be disclosed about each segment and how does this differ if a
company has significant foreign operations?

The following are the principal items that must be disclosed about each segment:
• Segment revenue, from both internal and external customers.

• Interest revenue and expense.
• Segment operating profit or loss.
• Identifiable segment assets.
• Depreciation and amortization.
• Capital expenditures.
• Certain specialized items.
In addition, if a company has significant foreign operations, it must disclose revenues, operating profits
or losses, and identifiable assets by geographical region.

Blooms: Remember

15-174
139. Hartland Company has used market price as its transfer price for the Sterling Division for many years
with no problems. This year, because of changes in the economy, the demand for its final product has
dropped along with the price.
Required:
Explain the problems of basing the transfer prices on distress market prices and possible solutions to the
problems.

Under such extreme situations, basing transfer prices on market prices can lead to decisions that are not
in the best interests of the overall company. Basing transfer prices on artificially low "distress" prices
can lead the producing division to sell or close the productive resources devoted to producing the
product for transfer to switch to a more profitable product. This might provide a short-run improvement
in divisional profit but might not be in the best interests of the company overall. The company might be
better off if no productive resources are sold off and it rides out the period of market distress. To
encourage managers to act in this more appropriate way of transfer pricing, some companies set the
transfer prices equal to a long-run average external market price rather than the current market price.

Blooms: Understand
Difficulty: 3 Hard

15-175
140. Midland Inc. has two divisions: production and marketing, which it treats as profit centers. Because the
production division has no marketing capabilities, it does not have a traditional market price to consider
and the company does not want to use negotiation.
Required:
Discuss the following cost-based transfer prices along with problems that might exist for each.
1) Standard unit-level cost.

2) Absorption (full) cost.
3) Actual cost.

1) Standard unit-level cost: the selling division's contribution margin would be zero which would give
no incentive to make the transfer. This problem can be avoided by using standard unit-level cots plus a
markup to give the selling division a positive contribution margin.
2) Absorption (full) cost: unit-level cost plus an assigned portion of higher-level costs. This can lead to
dysfunctional decision making behavior. Full cost-based transfer prices leads the buying division to
view costs that are non-unit-level costs for the company as a whole as unit-level costs to the buying
division which can cause problems with decision making.
3) Actual cost: actual cost-based transfer prices allow an inefficient producing division to pass the
excess production costs on to the buying division via the transfer price. Also, the selling division has no
incentives to control costs since the cost of inefficiency are passed on. Standard-based transfer prices
avoid these problems.

Blooms: Understand

15-176
141. Mr. Massee, the Vice President of Production is looking at two of the Divisions that report to him.
These divisions are viewed as profit centers by the company. He has called in the head of Brake
Division A, which provides a part used by Wheel Division, because he has noticed that Wheel Division
is going to an external supplier for the part. Mr. Omsby, the head of the Brake Division, tells him that he
has set the transfer price at $38 per part even though the external price is $33 per part. The standard
unit-level cost is $22. "I have set the $38 price because I am operating with no excess capacity and do
not want to have the internal transfer to the Wheel Division. I have some good external customers and
do not want to lose them by selling internally. If I had excess capacity, I would be willing sell to the
Wheel Division at a lower price."
Mr. Massee says that he has to think about this situation because something doesn't seem right to him.
After Mr. Omsby leaves the office, he calls his friend in the controller's department for some help.
Required:
You are that friend. Explain to Mr. Massee the differences in transfer pricing when there is no excess
capacity and when there is excess capacity and what Mr. Omsby is doing wrong.

When there is no excess capacity, sales to third parties are given up in order to make the internal
transfers so a transfer price equal to outlay costs plus opportunity cost is appropriate. This usually is
market price or very close to market price. The market-based transfer price allows both divisions to be
no worse off with the transfer inasmuch as the same dollar figures are involved as if they each went to
outside parties. Mr. Omsby, in charging as a transfer price $38 instead of $33 is not operating in a goal
congruent manner. It is in the company's best interests to have the internal transfer. The most he should
be charging the Wheel Department is $33. Where there is excess capacity, the transfer price usually is
set around variable cost. If one can use the results of the general rule in this situation, the opportunity
cost would be equal to zero because no sales to third-parties would be given up and only the variable
costs increase as more units are produced.

Blooms: Understand

15-177
142. Ms. Clarke, one of the marketing managers, has come to the meeting with a number of reports about one
of her products. The Vice President of Marketing sees her agitation and asks her what the problem is.
"Well, the product made by the East Coast Division is losing sales even after the price had been lowered
drastically. The manager of the division is threatening to close because of the reduced demand."
The Vice President of Marketing asks why the lowered prices are a problem and Ms. Clarke says that,
according to the manager, the price used to transfer the goods to Southern Division are based on market
price and, with the lowered market price, the unit-level costs are no longer being covered and he is
losing money on every transfer as well as every third-party sale.
Required:
Explain further to the Vice President of Marketing the issues involved in transfer pricing when there are
distressed market prices.

Under such extreme situations, basing transfer prices on market prices can lead to decisions that are not
in the best interests of the overall company. Basing transfer prices on artificially low "distress" prices
can lead the producing division to sell or close the productive resources devoted to producing the
product for transfer or to switch to a more profitable product. This might provide a short-run
improvement in divisional profit but might not be in the best interests of the company overall. The
company might be better off if no productive resources are sold off and it rides out the period of market
distress. To encourage managers to act in this more appropriate way of transfer pricing, some companies
set the transfer price equal to a long-run average external market price rather than the current market
price.

Blooms: Understand
Difficulty: 3 Hard

15-178
143. Briefly discuss some of the general issues of multinational transfer pricing.

In international transactions, transfer prices may affect tax liabilities, royalties, and other payments
because of different laws in different countries (or states). Because tax rates vary among countries,
companies have incentives to set transfer prices that will increase revenues (and profits) in low-tax
countries and increase costs (thereby reducing profits) in high-tax countries. There is a feeling by some
that the tax avoidance caused by foreign companies selling goods to their U.S. subsidiaries at inflated
transfer prices artificially reduces the profits of the U.S. subsidiaries and reduces the taxes collected in
the U.S. International taxing authorities look closely at transfer prices for companies engaged in related-
party transactions that cross national boundaries and frequently companies have to support the transfer
price they have chosen.

Blooms: Understand

15-179
144. During the current year Tuesday Company's foreign Division A incurred production costs of $4 million
for units that are transferred to its other foreign Division, B. Costs in Division B, outside of the costs of
production of the final product are $8 million. These are third-party costs. Sales revenue for the final
product for Division B is $30 million. Other companies in the same country import a similar type of part
as Division B at a cost of $7 million. Tuesday has set its transfer price at $14 million, justifying this
price because of the special controls it has on the operations in Division A as well as its special
manufacturing method. The tax rate in the country where Division A is located is 40% while the tax rate
for Division B's country is 70%.
Required:
1) What would Tuesday's total tax liability for both divisions be if it used the $7 million transfer price?
2) What would the liability be if it used the $14 million transfer price?

1)
Revenue $7,000,000 $30,000,000
Third-party costs (4,000,000) (8,000,000)
Transferred goods costs (7,000,000)
Taxable income $3,000,000 $15,000,000
Tax Rate × 40% × 70%
Tax Liability $1,200,000 $10,500,000
Total Tax liability $11,700,000
2)

Revenue $14,000,000 $30,000,000
Third-party costs (4,000,000) (8,000,000)
Transferred goods costs (14,000,000)
Taxable income $10,000,000 $8,000,000
Tax Rate × 40% × 70%
Tax Liability $4,000,000 $5,600,000
Total Tax liability $9,600,000

Blooms: Apply

15-180
145. How do import duties affect transfer pricing?

Import duties, or tariffs, are fees charged to an importer, generally on the basis of reported value of the
goods being imported. If a company has divisions in two countries and Country A imposes an import
duty on goods transferred in from Country B, the company has an incentive to set a relatively low
transfer price on the transferred goods. This will minimize the duty to be paid and maximize the overall
profit for the company as a whole. Countries sometimes pass laws to limit a multinational ability in
setting transfer prices for the purpose of maximizing import duties.

Blooms: Understand

15-181
146. Space Inc. has just purchased a foreign subsidiary that makes a component used by one of the domestic
divisions. Ms. Jenner, the controller, has been asked about issues that should be considered in
establishing a transfer price for the new subsidiary. Since this is Space's first foray into the multinational
arena, there is little to no expertise in international issues in the company. Ms. Jenner has told her boss
that she will get back to him with a report as to the issues to be considered. She then calls a friend of
hers at a branch of one of the big-4 CPA firms that deals with international issues for some help.
Required:
What is the basic information that Ms. Jenner will be given by her friend?

In international transactions, transfer prices may affect tax liabilities, royalties, and other payments
because of different laws in different countries (or states). Because tax rates vary among countries,
companies have incentives to set transfer prices that will increase revenues (and profits) in low-tax
countries and increase costs (thereby reducing profits) in high-tax countries. There is a feeling by some
that the tax avoidance caused by foreign companies selling goods to their U.S. subsidiaries at inflated
transfer prices artificially reduces the profits of the U.S. subsidiaries and reduces the taxes collected in
the U.S. International taxing authorities look closely at transfer prices for companies engaged in related-
party transactions that cross national boundaries and frequently companies have to support the transfer
price they have chosen.
Import duties, or tariffs, are fees charged to an importer, generally on the basis of reported value of the
goods being imported. If a company has divisions in two countries and Country A imposes an import
duty on goods transferred in from Country B, the company has an incentive to set a relatively low
transfer price on the transferred goods. This will minimize the duty to be paid and maximize the overall
profit for the company as a whole. Countries sometimes pass laws to limit a multinational firm's ability
in setting transfer prices for the purpose of maximizing import duties.

Blooms: Understand

15-182
147. Briefly discuss transfer prices in relation to external segment reporting under GAAP.

The FASB requires companies engaged in different lines of business to report certain information about
segments that meet the FASB's technical requirements. This reporting requirement is intended to
provide a measure of the performance of those segments of a business that are significant to the
company as a whole. Among the principal items that must be reported are segment revenue and segment
operating profits or loss.
Negotiated transfer prices are not generally acceptable for external segment reporting. In general, the
accounting profession has indicated a preference for market-based transfer prices because the purpose of
the segment disclosure is to enable an investor to evaluate a company's divisional sales as though they
were free-standing enterprises. While this is sound conceptually, in reality it may not work because the
segments are interdependent and market prices may not really reflect the same risk in an intracompany
sale that they do in third-party sales.

AICPA: FN Reporting
Blooms: Understand
Difficulty: 3 Hard

15-183

Transfer Pricing: True / False Questions

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Transfer Pricing: True / False Questions

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Chapter 15

True / False Questions

Multiple Choice Questions

21. Which of the following statements is(are) false?

Selling price $90

A. the variable cost of producing a unit of product.

Selling price to outside customers $75

Selling price to outside

A. $0.40 per pound.

A. $0.40 per pound.

A. worse off by $70,000 each period.

A. better off by $10,000 each period.

Capacity in units 300,000 pillars

A. no transfer will take place between the divisions.

A. there are no quality differences between inside and outside suppliers.

A. there is no optimal transfer price.

A. differential outlay costs.

A. Standard production cost per unit.

A. No change in Morgantown's profits.

A. No change in Morgantown's profits.

Selling price to outside customers $25

A. No change in profit to Altoona.

Selling price to outside customers $50

A. full cost of the product.

A. increase the handle unit cost by $0.05.

A. market-based transfer pricing.

A. Requires internally developed information.

What is the natural bargaining range for the two divisions?

A. Between $20 and $50.

A. charge inefficiencies to the department that is transferring the goods.

A. there is no intermediate markets.

A. negotiated transfer price.

A. negotiated market prices.

(consider each question independent of each other):

Sales (160,000 units at $4) $640,000

a. What is the effect of the deal on the Tank Division's income?

(consider each question independent of each other):

a. Find the effect of the deal on Magnatron's income.

a. What would be the optimal transfer price?

(consider each question independent of each other):

Fixed costs are based on 1,000,000 batteries.

a. What transfer price would you recommend and why?

The Allentown Division is operating at 60 percent of its 400,000 unit capacity.

Division A has no excess production capacity.

1) Standard unit-level cost.

True / False Questions

This is the definition of transfer pricing.

Since there is no effect on profit, there is no risk.

Since the divisions are prohibited, the outside price is irrelevant.

In a perfect market, the market price is optimal.

Conflicts may be reduced, but will not be eliminated.

The market determines the price, not the division.

The profit would be the same in either case.

There is no profit for the selling division.

Numerous surveys have shown this to be true.

This is a requirement of GAAP.

Multiple Choice Questions

A. Only A is false.

A. Cost center.

Transfer prices affect only profit or investment centers.

A. production centers.

($60 - $35 - $12) = $13

Operating at capacity: market price = $60