Transfer pricing of Tivo and Airbag division

Tivo division
Air bag
Incremental cost $90 per unit
Current Market
price $125
Capacity 80%

Required
1. Using the guideline, what is the minimum price at which the airbag division would sell airbags
to the Tivo Division?
2. Suppose the company requires that whatever division with unused capacity sells products
internally, they must do so at the incremental cost. Evaluate this transfer policy
3. If the two divisions were to negotiate a transfer price, what is the range of possible transfer
price? Evaluate the negotiated transfer pricing policy using the criteria of goal congruence,
evaluating division performance / motivating effort and preserving division autonomy.
Transfer pricing of Tivo and Airbag division

Solution
1. Since there is an unused capacity, there is no opportunity cost foregone. Therefore the
minimum price would be
Minimum price = Incremental cost + opportunity cost foregone

Minimum price 90

2. Suppose the company requires the division to sell unused capacity at the incremental cost
then the price would be

Price
Incremental cost up to the point of transfer + opportunity cost foregone

Incremental cost 90

Opportunity cost 35
_____

125
_____

This transfer price provides incentive to the air bag division to cover the fixed cost but it do not
make any difference for the Tino divisions as the market price is $125

3. Two divisions would accept the transfer price between $*90 and $125. Air bag division
would not accept the price below $90 as it incurs the incremental costs of $90. Similarly, Tive
division would not accept the price above $125 because the units are available at $125 in the
outside market.Therefore, the transfer price range between 90 and $125 would be the optimum
price range for both the divisions.
Transfer pricing of Pillercat

Required
1. Compute advantage or disadvantage to Pillercat as a whole if the tractor division buys
crankshafts internally from Machining division under each of the following three cases:
a) Machining division has no alternatives for the facilities used to manufacture crankshafts
b) Machining division can use the facilities for the other production operations, which will
result in monthly cash operating savings of $29,000
c) Machining division has no alternative use of the facilities, and the external supplier
drops its price to $185 per crankshaft
2. As the president of pillercat, how would you respond to Juan Gomez's request to order
the tractor division to purchase all of its crankshafts from the machining division? Would your
response differ according to the scenarios described in (a), (b) and © of requirement 1? why?
 Transfer pricing of Pillercat

Solution
1. Advantage or disadvantage to Pillercat as a whole if the tractor division buys crankshafts
internally from Machining division under each of the following three cases

Operating statement of Pillercat as a whole

(A) (B) (C)

Total purchase cost if buying
From the external suppliers
2000 crank shaft
(a) 200

(b) 200

(c) 185

Total purchase cost if buying from

the external suppliers (a) 400,000.00 400,000.00 370,000.00

Total outlay costs if purchased internally

2000 crank shaft @190 380,000.00 380,000.00 380,000.00

Opportunity cost 0 29,000.00 0

Total relevant costs if purchased ---------------------------------------------------------------------
internally (b) 380,000.00 409,000.00 380,000.00
--------------------------------------------------------------------

Monthly advantage /(disadvantage)to

Pillercat operating income if purchased
from Machining division (a-b) 20,000.00 (9,000.00) (10,000.00)

Transfer pricing of Pillercat

2. The organization being a decentralized. No forced transfers were made. The company would
buy from external customers under case (b) and © and under case (a), the company can buy
from internally.
Suppose the machining department refuse to meet the requirement of $200 and force to transfer
@220, the top management cannot interfere as it will undercut the principle of decentralized
organization but if the organization go in line with the machining department, it will not create
the incentive for tractor division.Therfore it can set the general guideline for the transfer price
highlighted in requirement (1)

(A) (B) (C )
(a) Additional outlay costs to the
Point of transfer 190 190 190
Alternative use of the facilities 0 14.5 0
Transfer price 190 204.5 190
External market price 200 200 185

Therefore it is better to buy internally under (a) and to buy externally under ((b) and © to
maximize the operating income

Transfer pricing of Mining and Metal division

Mining Metal
Direct Material cost 12 6
Direct Manufacturing labour 16 20
Manuf overheads 32 25
Total cost 60 51
Market price 90 150

Required
1. Calculate the op. income for the mining division & metal division for the 400,000 units under
the following conditions (a) MP and (b) 110% of full cost.
2. Suppose the company rewards bonus @ 1% of division operating income. What is the amount
of bonus that will be paid to each divisional manager?
3. What arguments that Brian would support, the transfer method that he prefers?
 Transfer pricing of Mining and Metal division
Solution

1(a). Operating income of Mining and Metal if the units transferred @ MP

Particulars Mining Metal

Sp per unit (a) 90 150

Less : Costs
Fixed and variable cost per unit 60 51
Transfer cost 90
..………………………………
Total cost per unit (b) 60 141
…...…………………….........
Operating income per unit (a-b) 30 9
--------------------------------------
Units 400,000 400,000

Operating income 12,000,000.00 3,600,000.00

(b)Operating income of Mining and Metal if the units transferred @110 % of full cost
basis

Particulars Mining Metal

Sp per unit (a) 66 150

Less : Costs
Fixed and variable cost per unit 60 51
Transfer cost 66
………………………………………
Total cost per unit (b) 60 117
………………………………………
Operating income per unit (a-b) 6 33
 ---------------------------------------------
Units 400,000 400,000

Operating income 2,400,000.00 13,200,000.00

Transfer pricing of Mining and Metal division

2. Calculation of 1% of operating income as bonus under MP

Particulars Mining Metal

Operating income 12,000,000.00 3,600,000.00
Bonus 120,000.00 36,000.00

Calculation of 1% of operating income as bonus under 110% of full cost basis

Particulars Mining Metal

Operating income 2,400,000.00 13,200,000.00
Bonus 24,000.00 132,000.00

As a manger of mining division, he would like to transfer the units at the rate of market price to
maximize the profit by $9,600,000
As a manger of metal division, he would like to transfer the units at the rate of full cost basis to
maximize the profit by $9,600,000