LA CONSOLACION COLLEGE MANILA

8 MENDIOLA ST., MANILA, PHILIPPINES 1005

COLLEGE OF BUSINESS AND ACCOUNTANCY

Transfer Pricing

Presented to the
Faculty of the School of Business and Accountancy of
La Consolacion College Manila

In Partial Fulfillment
Of the Requirement for the Degree of
Bachelor of Science in Accountancy

Dayusan, Jamina
Genanda, Rhoselle Mae
Itable, Joseph
Miguel, Demie
Tejano, Rollyne

May 2020
TABLE OF CONTENTS
TRANSFER PRICING 1

TRUE OR FALSE 6

MULTIPLE CHOICE: THEORIES 7

MULTIPLE CHOICE:PROBLEMS 13

CASE PROBLEMS 23

ANSWER KEY 32

MULTIPLE CHOICE PROBLEM: SOLUTIONS 32

CASE PROBLEM: SOLUTIONS 36

Transfer Pricing
Introduction
Today’s organizational thinking is oriented towards decentralization. One of the
principal challenges in operating a decentralized system is to devise a satisfactory method of
accounting for the transfer of goods and services from one profit center to another in companies
that have a significant amount of these transactions. When two or more profit centers are jointly
responsible for product development, manufacturing, and marketing each should share in the
revenue that is generated when the product is finally sold. The Transfer price is the mechanism
for distributing this revenue. The transfer price is not primarily an accounting tool; rather, it is a
behavioral tool that motivates managers to make the right decisions. Decentralization means the
freedom to make decisions. Decentralization can transform a profit center into an investment
center. Centralization can transform an investment center into a profit center or transform a
profit center into a cost center.

Objectives:
 To understand the concepts of Transfer Pricing
 To understand the need & importance of Transfer Pricing
 To deeply understand various Transfer Pricing Methods & their application
 To be able to successfully prepare a Transfer Pricing Memorandum.

Transfer Price
Transfer prices are a way of promoting divisional autonomy, ideally without
prejudicing the measurement of divisional performance or discouraging overall corporate
profit maximization.

 Transfer prices should be set at a level which ensures that profits for the organization as
a whole are maximized.

Transfer pricingis used when divisions of an organization need to charge other divisions of the
same organization for goods and services they provide to them. For example, subsidiary A
might make a component that is used as part of a product made by subsidiary B of the same
company, but that can also be sold to the external market, including makers of rival products to
subsidiary B's product.

There will therefore be two sources of revenue for A.

(a) External sales revenue from sales made to other organizations.

(b) Internal sales revenue from sales made to other responsibility centers within the same
organization, valued at the transfer price.
 2

The purposes of transfer pricing

 To provide information that motivates divisional managers to make good economic
decisions.
 To provide information that is useful for evaluating the managerial and economic
performance of the divisions.
 To intentionally move profits between divisions or locations.
 To ensure that divisional autonomy is not undermined. The transfer pricing system
operated by a divisional company has the potential to make a significant contribution
towards the achievement of corporate financial objectives. Alternative transfer pricing
methodsMarket-basedMarginal costFull costCost-plus a mark-upNegotiated
transfer prices1

Three Decisions
A transfer pricing situation usually involves three questions or decisions.
1. Should the transfer take place? This is essentially a (Make or Buy) question. Should the
company make the item or outsource, i.e., purchase it on the outside market? This is a relevant
cost problem (also referred to a differential or incremental cost). The key is which costs will be
different under the two alternatives, i.e., make inside and transfer, or buy from outside the
company?

2. If the answer to question one is yes, then what transfer price should be used?

3. Should the central office interfere in establishing the transfer price?

Objectives of Transfer Prices

Management’s objective in setting a transfer price is to encouraged goal congruence among the
division managers involved in the transfer, where the interest of both the division and the
whole company coincide. In a decentralized organization, the managers of profit centers and
investment centers often have considerable autonomy in deciding whether to accept or reject
orders and whether to buy inputs from inside the organization or outside.
The general rule formula in determining transfer price that will ensure goal congruence
is computed as follows:
Additional Opportunity Cost
Transfer Price = Outlay Cost incurred + to the organization
because goods are transferred because of the transfer

The general rule specifies the transfer price as the sum of two cost components. The first
component is the outlay cost incurred by the division that produces the goods or services to be
transferred. Outlay cost will include the direct variable cost of the product or services and any
other outlay cost that are incurred only as a result of the transfer. The second component in
the general transfer-pricing rule is the opportunity cost incurred by the organization as a
 3

whole because of the transfer. Opportunity cost is the benefit foregone as a result of taking a
particular action, such as the contribution margin lost by the selling division from outside
market.

Factors to Consider in Setting the Transfer Price:

 Goal congruence. The transfer price should not only allow a division to achieve its own
goals, but it must also be in the best interest of the entire organization. It should promote the
goals of the company as a whole.
 Performance evaluation. The selling division should not lose income by selling within the
organization. Similarly, the buying division should not incur in very high purchase costs. The
selling and buying divisions could negotiate the transfer price.
 Autonomy. The transfer price should preserve autonomy. The managers of the buying and
selling divisions should have the freedom to operate their divisions as separate entities.
 Capacity and cost structure. The capacity of the selling division to meet the demand of the
buying division should be considered. If there is excess capacity, the cost of producing the
goods to be transferred is relevant. If there is no excess capacity, opportunity costs should be
included in determining the transfer price.
 Other factors such as tax effects and legal consequences should also be considered.

Transfer Pricing Schemes:

In practice, four general approaches are used on setting transfer price.
1. Minimum Transfer Price
2. Market-based Transfer Price
3. Cost-based Transfer Price
a. Variable Cost
b. Full Cost
c. Alternative Cost Measures
4. Negotiated Transfer Price
The transfer price could be based on: (1) market price, (2) cost-based price, or (3) negotiated
price. Market price is applicable if there is an existing market. Cost-based price, either using
variable costing or absorption costing, applies a certain mark-up above production
costs. Negotiated price is a price agreed upon by the seller and buyer and is especially common
when there is no existing active market for the product.
In order to promote the best interest of the selling and buying divisions (and the entire
company), the transfer price is subject to upper and lower limits. The upper limit is the highest
price that the seller can charge. The lower limit is the lowest price that the buyer can negotiate.
The transfer price should be within the upper and lower limit.
Upper limit = Selling price in the outside market (i.e., from an outside seller)
Lower limit = Variable cost per unit plus opportunity cost per unit of the selling division
 4

The opportunity cost refers to the lost contribution margin if the selling division has no excess
capacity. If there is excess capacity, there would be no opportunity costs. Fixed costs are
ignored because the same amount will be incurred regardless of the number of units produced.

Minimum Transfer Price

A general rule for making transfers to maximize a company’s profits in either perfect or
imperfect market uses the formula.

Transfer Price Differential cost Lost contribution margin per unit

on outside sales (or opportunity costs per unit)

The price set by the transfer price formula is equal to the differential cost (generally the
variable costs) of the goods being transferred, plus the contribution margin per unit that is lost
to the selling division as a result of giving up outside sales.
It also represents the lower limit since the selling division must receive at least the amount
shown by the formula in order to be as well of as if it sold only to outside customers. The transfer
price can be more that the amount shown by the formula but for an internal transfer to take
place, the transfer price should not exceed the purchase price from the outside supplier.
If the selling division has sufficient idle capacity to meet the demand of another division
without cutting into the sales of its regular customers, then it does not have any opportunity
costs. Hence, the lowest acceptable transfer price will be equal to differential or variable costs
per unit. From the perspective of a buying division, the maximum acceptable transfer price is
equivalent to the price offered by the outside supplier.

1. Market prices: A market price is considered best if the market is perfectly competitive, i.e., if
a single buyer or seller cannot affect the price. Generally intra-company transfers at market
prices accomplish objectives 1 and 2, but not 3. Unfortunately, several problems occur when
trying to use market prices:
a. Most markets are not perfectly competitive. In other words, the demand curve and  price
structure may shift if the firm buys outside.
b. Market prices may not exist for some products.
c. A market price may not be comparable because of differences in quality, credit terms, or extra
services provided.
d. Price quotations may not be reliable because they are based on temporary distress or
dumping conditions.
e. A market price may not be relevant because the selling division would not have the same
transportation cost, accounting cost for A/R, credit etc. as an outside supplier.
f. Information for the make or buy decision would not be available to the buying division.
 5

2. Full cost: All manufacturing, selling and administrative costs are included. The problems that
occur when full cost is used as a transfer price include:
a. Transfer prices based on full cost do not accomplish any of the objectives stated above. The
selling division could not be evaluated as a profit center or investment center since it is treated
as a cost center.
b. The seller would be motivated to over allocate cost to the product transferred.
c. If actual costs are transferred, the cost of inefficiency will be passed along to the buying
division. Thus, standard costs make better transfer prices although standards may be rigged.
d. The buyer would not have the differential cost information needed for the overall firm make
or buy decision. The irrelevant (mostly common fixed cost) of the seller become relevant cost to
the buyer.
3. Full Cost Plus: All manufacturing, selling and administrative costs plus a markup for profit.
Standard cost plus would be better than actual cost plus to motivate the seller to be an efficient
cost producer. The same problems in 2 are applicable here. Motivation for over allocation is still
present. Transfers at standard could motivate the seller to rig the standard.
4. Variable cost: All variable manufacturing, selling and administrative costs. This may come
close to accomplishing objective 3, since variable cost may approximate differential cost. It
should be noted however, that variable cost and differential cost are not the same since some
fixed cost may also be relevant, i.e., change if the product is purchased outside rather than
produced inside. Objectives 1 and 2 would not be obtained since the other problems listed
under 2 and 3 are applicable here, lack of motivation for profits, potential for cost over
allocation etc.
5. Variable cost plus: This may be a little better than 4, but the plus should be kept separate to
allow for a ball park make or buy decision. Objectives 1 and 2 would not be fully obtained.
6. Negotiated price: Negotiated prices may be best if:
a. An imperfect market exists for the product making it difficult, if not impossible, to determine
the appropriate market price.
b. The seller has excess capacity, thus the transfer becomes a differential cost problem to the
seller. Any transfer price above the seller's differential cost would benefit the seller.
c. There is no external market) for the product, thus no market price.
In these cases the buyer and seller may negotiate a price that allows both parties to share in the
benefits of the transfer. This may accomplish objectives 1 and 2, but not 3. A problem with this
approach is that managers may spend a substantial amount of time and effort negotiating
transfer prices.

TRUE OR FALSE:
1. Transfer prices can be used to promote goal congruence among operating segments of an
organization.
 6

2. In computing a transfer price, the maximum price should be no higher than the lowest
market price at which the buying segment can obtain the good or service externally.
3. In computing a transfer price, the maximum price should be no higher than the highest
market price at which the buying segment can obtain the good or service externally.
4. In computing a transfer price, the minimum price should be no lower than the incremental
costs associated with the goods plus the opportunity cost of the facilities used.
5. One of the main factors to consider when using a cost-based transfer price is whether to use
actual or standard costs.
6. When using a negotiated transfer price, a decision must be made which market price to
use.
7. When using a market-based transfer price, a decision must be made which market price to
use.
8. A particular transfer pricing basis may also be an excellent management tool (1) for
motivating division managers, (2) for establishing and maintaining cost control systems
and for measuring internal performance.
9. When using a negotiated transfer price, a determination must be made if comparable
substitutes are available externally.
10. Market based transfer prices are most effective for common high-cost and high-volume
standardized services.
11. Cost-based transfer prices are most effective for common high-cost and high-volume
standardized services.
12. Negotiated transfer prices are most appropriate customized high-volume and high-cost
services.
13. Market based transfer prices are most appropriate customized high-volume and high-cost
services.
14. Cost based transfer prices are most appropriate for low cost and low volume services.
15. Negotiated transfer prices are most appropriate for low cost and low volume services.
16. An advance pricing agreement can eliminate the possibility of double taxation on
multinational exchanges of goods.
17. The cost-based transfer price approach can reduce a division manager’s control over the
division’s performance.
18. The transfer price approach that conceptual should work the best is the market-based
approach.
19. The market-based approach generally provides the proper economic incentives.
20. The market-based approach produces a higher company contribution margin than the cost-
based approach.
21. The negotiated transfer price approach should be used when no market price is available.
22. The cost-based approach will result in a largest contribution margin to the buying division.
23. Transfer prices are charges for goods stored within a subunit.
24. To the department selling goods and services, the transfer price is its cost.
25. To the department buying the goods and services, the transfer price is its revenue.
26. The general rule in establishing transfer prices consistent with economic decision making is
the differential cost plus opportunity cost if goods are trannsferred internally.
27. The minimum transfer price from the seller’s standpoint should be opportunity cost for
selling division.
 7

28. Generally, the outside market price from the buyer’s standpoint should be the ceiling for
internal transfer price.
29. If a firm operates at capacity, the transfer price should be the external market price.
30. The best transfer price is usually the reliable market price.

MULTIPLE CHOICE: THEORIES:

1. A major benefit of cost-based transfers is that
a. it is easy to agree on a definition of cost.
b. costs can be measured accurately.
c. opportunity costs can be included.
d. they provide incentives to control costs.

2. An internal reconciliation account is not required for internal transfers based on

a. market value.
b. dual prices.
c. negotiated prices.
d. cost.

3. The most valid reason for using something other than a full-cost-based transfer price
between units of a company is because a full-cost price
a. is typically more costly to implement.
b. does not ensure the control of costs of a supplying unit.
c. is not available unless market-based prices are available.
d. does not reflect the excess capacity of the supplying unit.

4. To avoid waste and maximize efficiency when transferring products among divisions in
a competitive economy, a large diversified corporation should base transfer prices on
a. variable cost.
b. market price.
c. full cost.
d. production cost.

5. A transfer pricing system is also known as

a. investment center accounting.
b. a revenue allocation system.
 8

c. responsibility accounting.
d. a charge-back system.

6. The maximum of the transfer price negotiation range is

a. determined by the buying division.
b. set by the selling division.
c. influenced only by internal cost factors.
d. negotiated by the buying and selling division.

7. The presence of idle capacity in the selling division may increase

a. the incremental costs of production in the selling division.
b. the market price for the good.
c. the price that a buying division is willing to pay on an internal transfer.
d. a negotiated transfer price.

8. Which of the following is a consistently desirable characteristic in a transfer pricing

system?
a. system is very complex to be the most fair to the buying and selling units
b. effect on subunit performance measures is not easily determined
c. system should reflect organizational goals
d. transfer price remains constant for a period of at least two years

9. With two autonomous division managers, the price of goods transferred between the
divisions needs to be approved by
a. corporate management.
b. both divisional managers.
c. both divisional managers and corporate management.
d. corporate management and the manager of the buying division.

10. The minimum potential transfer price is determined by

a. incremental costs in the selling division.
b. the lowest outside price for the good.
c. the extent of idle capacity in the buying division.
d. negotiations between the buying and selling division.
 9

11. As the internal transfer price is increased,

a. overall corporate profits increase.
b. profits in the buying division increase.
c. profits in the selling division increase.
d. profits in the selling division and the overall corporation increase.

12. Which of the following is not included in general approaches used on setting transfer
price?
a. Market-based transfer price
b. Minimum transfer price
c. Cost based transfer price
d. Price set based transfer price

13. An internal transfer, the buying division records the transaction by

a. debiting accounts receivable.
b. crediting accounts payable.
c. debiting intracompany CGS.
d. crediting inventory.

14. Top management can preserve the autonomy of division managers and encourage an
optimal level of internal transactions by
a. selecting performance evaluation measures that are consistent with the
achievement of overall corporate goals.
b. selecting division managers who are most concerned about their individual
performance.
c. prescribing transfer prices between segments.
d. setting up all organizational units as revenue centers.

15. To evaluate the performance of individual departments, interdepartmental transfers of a

product should preferably be made at prices
a. equal to the market price of the product.
b. set by the receiving department.
c. equal to fully-allocated costs of the producing department.
d. equal to variable costs to the producing department.
 10

16. External factors considered in setting transfer prices in multinational firms typically do
not include
a. the corporate income tax rates in host countries of foreign subsidiaries.
b. foreign monetary exchange risks.
c. environmental policies of the host countries of foreign subsidiaries.
d. actions of competitors of foreign subsidiaries.

17. The amounts charged for goods and services exchanged between two divisions are known
as:
a. opportunity costs.
b. transfer prices.
c. standard variable costs.
d. residual prices.
e. target prices.

18. If there is no excess capacity, the transfer price is often

a. market price
b. opportunity cost plus incremental cost
c. variable cost or variable cost plus profit
d. a or b

19. A company may consider using variable costs in transfer pricing when there is
a. excess capacity because variable costs would stay the same
b. no excess capacity because variable costs would not stay the same
c. excess capacity because fixed costs would stay the same
d. no excess capacity because fixed costs would stay the same

20. Which of the following describes the goal that should be pursued when setting transfer
prices?
a. Maximize profits of the buying division.
b. Maximize profits of the selling division.
c. Allow top management to become actively involved when calculating the proper dollar
amounts.
d. Establish incentives for autonomous division managers to make decisions that are in the
 11

overall organization's best interests (i.e., goal congruence).

e. Minimize opportunity costs.

21. A general calculation method for transfer prices that achieves goal congruence begins with
the additional outlay cost per unit incurred because goods are transformed and then
a. adds the opportunity cost per unit to the organization because of the transfer.
b. subtracts the opportunity cost per unit to the organization because of the transfer.
c. adds the sunk cost per unit to the organization because of the transfer.
d. subtracts the sunk cost per unit to the organization because of the transfer.
e. adds the sales revenue per unit to the organization because of the transfer.

22. Suddath Corporation has no excess capacity. If the firm desires to implement the general
transfer-pricing rule, opportunity cost would be equal to:
a. zero.
b. the direct expenses incurred in producing the goods.
c. the total difference in the cost of production between two divisions.
d. the contribution margin forgone from the lost external sale.
e. the summation of variable cost plus fixed cost.

23. Tulsa Corporation has excess capacity. If the firm desires to implement the general transfer-
pricing rule, opportunity cost would be equal to:
a. zero.
b. the direct expenses incurred in producing the goods.
c. the total difference in the cost of production between two divisions.
d. the contribution margin forgone from the lost external sale.
e. the summation of variable cost plus fixed cost.

24. Transfer prices can be based on:

a. variable cost.
b. full cost.
c. an external market price.
d. a negotiated settlement between the buying and selling divisions.
e. all of the above.

25. Which of the following transfer-pricing methods can lead to dysfunctional decision-making
behavior by managers?
a.Variable cost.
b.Full cost.
c. External market price.
d. A professionally negotiated, amicable settlement between the buying and selling
divisions.
e.None of the above.
 12

26. Consider the following statements about transfer pricing:

I. Income taxes and import duties are an important consideration when setting a
transfer price for companies that pursue international commerce.
II. Transfer prices cannot be used by organizations in the service industry.
III. Transfer prices are totally cost-based in nature, not market-based.
Which of the above statements is (are) true?
a.I only.
b.II only.
c. I and II.
d. II and III.
e.I, II, and III.

27. Variable costing method of transfer pricing is

a. easy to implement
b. intuitive and easily understood
c. more logical when there is excess capacity
d. all of the above

28. In the formula for the minimum transfer price, opportunity cost is the ____________ of the
goods sold externally.
a. variable cost
b. total cost
c. selling price
d. contribution margin

29. The transfer price approach that conceptually should work the best is the
a. cost-based approach
b. market- based approach
c. negotiated price approach
d. time and material pricing approach

30. The maximum transfer price from the buying division’s standpoint is the
a. total cost + opportunity cost
b. variable cost + opportunity cost
c. external purchase price
d. external purchase price + opportunity cost
 13

MULTIPE CHOICE: PROBLEMS

1. Division J has variable manufacturing costs pf P 45 per unit and fixed costs of P5 per unit.
What is the opportunity cost of an internal transfer when the market price is P55? Assume
that Division J is operating at capacity?
a. 5
b. 10
c. 45
d. 50

2. NeilJam Corporation presented the following information for its three departments for the
past month. Departments A and B are manufacturing departments, whereas C is
distribution.
Production level of A …………………. Significantly below capacity
Sales price to C ………………………….. P50 per unit
A’s variable cost ………………………… P20 per unit
Total fixed cost (A+B) ………………….P120,000
C’s marketing cost……………………….10 percent of SP
C’s selling price…………………………… Market value
Determine the minimum transfer price from A to B.
a. P10
b. P20
c. P30
d. P50

3. Use above information in no.2, determine the minimum unit price that can C sell A’s
product for.
a. P55
b. P40
c. P30
d. P20 + a percentage of fixed cost

4. Division N makes a part that it sells to customers outside of the company. Data concerning
this part appear below:
Selling price to outside customers P50
Variable cost per unit P30
Total fixed costs P400,000
Capacity in units 25,000
Division J of the same company would like to use the pat manufactured by Division N
in one of its products. Division J currently purchases a similar part made by an outside
company for P49 per unit and would substitute the pat made by Division N. Division J
requires 5,000 units of the part each period. Division N can sell all of the units it makes
to outside customers. According to the transfer pricing formula, what is the lower limit
on the transfer price?
a. P50
b. P49
 14

c. P46
d. P30

5. The JD Division sells goods internally to the NV Division of the same company. The
prevailing external price of JD Division’s product is P600 per unit plus transportation. It
costs P200 per unit to transport the goods to NV.
JD incurs the following costs per unit in producing the goods:
Materials P350
Direct labor 85
Storage and handling 70
Total P505
If the market-based transfer pricing method is to be used, the transfer price must be set
at
a. 800
b. 200
c. 600
d. 505

6. Division J of NeilJam Company is currently operating at full capacity of 15,000 units. It sells
all its production in a perfectly competitive market for P350 per unit. Its variable cost is P170
per unit, while its total fixed cost amounts to P400,000
The minimum transfer price that should be charged to Division N of NeilJam Company
for each unit of product transferred by Division J is
a. 330
b. 180
c. 350
d. 450

Assume that SARAH Division has a product that can be sold either to outside customers on an
intermediate market or to DIVINE Division of the same company for use in its production
process. The managers of the division are evaluated based on their divisional profits.

SARAH Division:
Capacity in units 200, 000
Number of units being sold on the intermediate market 200, 000
Selling price per unit on the intermediate market P 90
Variables costs per unit (including P3 of avoidable selling P 70
expense)
Fixed costs per unit (based on capacity) P 13
DIVINE Division:
Number of units needed for production 40, 000
Purchase price per unit now being paid to an outside supplier P 86

7. The appropriate transfer price should be:

 15

a. P 90
b. P 87
c. P 70
d. P 86

The SG Division of MD Intervention Company produces a high quality marker. Unit

production costs (based on capacity production of 100,000 units per year) follow:
Direct materials P 60
Direct labor P 25
Overhead (20% variable) P 15
Other information:
Sales Price P 120

The SG Division is producing and selling at capacity.

8. What is the minimum selling price that the division would consider as a “transfer price” to
MG Division on which no variable period costs would be incurred?
a. P 120
b. P 91
c. P 88
d. P 117

LM Division manufactures electronic circuit boards. The boards can be sold either to GA
Division of the same company or to outside customers. Last year, the following activity
occurred in LM Division:

Selling price per circuit board P 125

Production cost per circuit board P 90
Numbers of circuit boards:
Produced during the year 20, 000
Sold to outside customers 16, 000
Sold to MM Division 4, 000

Sales to GA Division were at the same price as sales to outside customers. The circuit boards
purchased by GA Division were used in an electronic instrument manufactured by that division
(one board per instrument). GA Division incurred P100 in additional cost per instrument and
then sold the instrument for P300 each.
Assume that LM Division’s manufacturing capacity is 20,000 circuit boards. Next year GA
Division wants to purchase 5,000 circuit board from LM Division rather than 4,000. (Circuit
boards of this type are not available from outside sources.)
LM Division proposed that a transfer for additional 1,000 units be produced by requiring its
workers to work overtime. LM Division indicated that the transfer price may be unreasonably
high because of the overtime premium.
 16

9. What is the maximum transfer that GA Division will accept for the additional 1,000 units?
a. P 90
b. P125
c. P200
d. P300

Use the following data to answer the next 3 questions:

SGG Company transfers a product from Division A to Division B. Variable cost of this product
is anticipated to be P40 a unit and total fixed costs amount to P8, 000. A total of 100 units are
anticipated to be produced. Actual cost, however, amounts to P50 for variable costs. Fixed costs
were same as budget. However, actual output was twice as many.
10. Actual cost per unit amounts to
a. P 90
b. P 92
c. P 115
d. P 120
11. The transfer price based on actual variable costs plus 130% mark-up amounts to
a. P 90
b. P 92
c. P 115
d. P 120
12. The transfer price based on budgeted full cost plus 30% mark-up amounts to
a. P 117
b. P 140
c. P 150
d. P 156

DUYAN Company is highly decentralized. Division A, which is operating at capacity, produces

a component that it currently sells in a perfectly competitive market for P13 per unit. At the
current level of production, the fixed cost of producing this component is P4 per unit and the
variable cost is P7 per unit. Division B would like to purchase this component from Division A.
13. What would be the price that Division A should charge Division B?
a. P 7
b. P 13
c. P 11
d. P 9

GREAT UNKNOWN has two divisions: Tala and Kilometro. Tala Division has a capacity to
produce
2,000 units and is expecting to sell 1,500 units. Kilometro Division wants to purchase 100 units
of a product Tala produces. Tala sells the product at a selling price of P100 per unit, the variable
cost per unit is P25 and the fixed costs total P30, 000.
14. The minimum transfer price that Tala will accept is?
a. P 100
 17

b. P 45
c. P 43.75
d. P 25
e.

Use the following data to answer the next 3 questions:

The Motor Division of Lucky Truck Co. uses 5,000 carburetors per month in its production of
automotive engines. It presently buys all of the carburetors it needs from two outside suppliers
at an average cost of P100. The Carburetor Division of Lucky Truck Co. manufactures the exact
type of carburetor that the Motor Division requires. The Carburetor Division is presently
operating at its capacity of 15,000 units per month and sells all of its output to a foreign car
manufacturer at P106 per unit. Its cost structure (on 15,000 units) is:
Variable production costs P70
Variable selling costs 10
All fixed costs 10
Assume that the Carburetor Division would not incur any variable selling costs on units that are
transferred internally.
15. What is the maximum of the transfer price range for a transfer between the two divisions?
a. P106
b. P100
c. P90
d. P70

16. What is the minimum of the transfer price range for a transfer between the two divisions?
a. P96
b. P90
c. P70
d. P106

17. If the two divisions agree to transact with one another, corporate profits will
a. drop by P30,000 per month.
b. rise by P20,000 per month.
c . rise by P50,000 per month.
 18

d. rise or fall by an amount that depends on the level of the transfer price.

Questions for 18 – 22: Refer to Jeb’s Office Inc.

Jeb’s Office Inc. manufactures and sells various high-tech office automation products. Two
divisions of Jeb’s Office Inc. are the Integrated Division and the Computer Division. The
Integrated Division manufactures one product, a “super chip,” that can be used by both the
Computer Division and other external customers. The following information is available on this
month’s operations in the Integrated Division:
Selling price per chip P50
Variable costs per chip P20
Fixed production costs P60,000
Fixed SG&A costs P90,000
Monthly capacity 10,000 chips
External sales 6,000 chips
Internal sales 0 chips
Presently the Computer Division purchases no chips from the Integrated Division, but
instead pays P45 to an external supplier for the 4,000 chips it needs each month.

18. Assume that next month’s costs and levels of operations in the Computer and Integrated
Divisions are similar to this month. What is the minimum of the transfer price range for a
possible transfer of the super chip from one division to the other?
a. P50
b. P45
c. P20
d. P35

19. Assume that next month’s costs and levels of operations in the Computer and Integrated
Divisions are similar to this month. What is the maximum of the transfer price range for a
possible transfer of the chip from one division to the other?
a. P50
b. P45
c. P35
d. P30
 19

20. Two possible transfer prices (for 4,000 units) are under consideration by the two
divisions: P35 and P40. Corporate profits would be ___________ if P35 is selected as the
transfer price rather than P40.
a. P20,000 larger
b. P40,000 larger
c. P20,000 smaller
d. the same

21. If a transfer between the two divisions is arranged next period at a price (on 4,000 units of
super chips) of P40, total profits in the Integrated division will
a. rise by P20,000 compared to the prior period.
b. drop by P40,000 compared to the prior period.
c. drop by P20,000 compared to the prior period.
d. rise by P80,000 compared to the prior period.

22. Assume, for this question only, that the Integrated Division is selling all that it can produce
to external buyers for P50 per unit. How would overall corporate profits be affected if it sells
4,000 units to the Computer Division at P45? (Assume that the Computer Division can purchase
the super chip from an outside supplier for P45.)
a. no effect
b. P20,000 increase
c. P20,000 decrease
d. P90,000 increase

Question for 23-27: Refer to Sulfur Steel Corporation

The Wire Products Division of Sulphur Steel Corporation produces "bales" of steel wire that are
used in various commercial applications. The bales sell for an average of $20 each and The Wire
Products Division has the capacity to produce 10,000 bales per month. The Consumer Products
Division of Sulphur Steel Corporation uses approximately 2,000 bales of steel wire each month
in its production of various appliances. The operating information for the Wire Products
Division at its present level of operations (8,000 bales per month) follows:
 20

Sales (all external) $160,000

Variable costs per bale:
Production $5
Selling 2
G&A 3
Fixed costs per bale (based on a 10,000 unit capacity):

The Production $2
Selling 3
G&A 4

Consumer Products Division currently pays $15 per bale for wire obtained from its external
supplier.
23. Refer to Sulphur Steel Corporation. If 2,000 bales are transferred in one month to the
Consumer Products Division at $10 per bale, what would be the profit/loss of the Wire
Products Division?
a. 10,000 loss
b. 10,000 gain
c. 25,000 loss
d. 25,000 gain

24. Refer to Sulphur Steel Corporation. For the Wire Products Division to operate at break-even
level, what would it need to charge for the production and transfer of 2,000 bales to the
Consumer Products Division? Assume all variable costs indicated will be incurred by the Wire
Products Division.
a. $12
b. $11
c. $15
d. $16

25. Refer to Sulphur Steel Corporation. If Wire Products Division transferred 2,000 wire bales to
the Consumer Products Division at 200 percent of full absorption cost, what would be the
transfer price?
a. $11
b. $12
c. $13
d. $14
 21

26. Refer to Sulphur Steel Corporation. If the Consumer Products Division agrees to pay the
Wire Products Division $16 for 2,000 bales this month, what would be Consumer's change in
total profits?
a. $2,500
b. $2,000
c. $3,400
d. $3,200

27. Refer to Sulphur Steel Corporation. Assuming, for this question only, that the Wire Products
Division would not incur any variable G&A costs on internal sales, what is the minimum price
that it would consider accepting for sales of bales to the Consumer Products Division?
a. $7
b. $21
c. $28
d. &11

Question for 28-30: Refer to Watts Corporation

Watts Corporation produces various products used in the construction industry. The Plumbing
Division produces and sells 100,000 copper fittings each month. Relevant information for last
month follows:

Total sales (all external) $250,000

Expenses (all on a unit base):
Variable manufacturing $0.50
Fixed manufacturing .25
Variable selling .30
Fixed selling .40
Variable G&A .15
Fixed G&A .50
Total $2.10
 22

Top-level managers are trying to determine how a transfer price can be set on a transfer of
10,000 of the copper fittings from the Plumbing Division to the Bathroom Products Division.
28. Refer to Watts Corporation. A transfer price based on variable cost will be set at ___________
per unit.
a. $.50
b. $.80
c. $.60
d. $.95

29. Refer to Watts Corporation. A transfer price based on full production cost would be set at
___________ per unit.
a. $0.75
b. $2.10
c. $1.45
d. $1.60

30. Refer to Watts Corporation. A transfer price based on market price would be set at
___________ per unit.
a. $2.10
b.$2.50
c.$1.60
d.$2.25

CASE PROBLEMS:
Problem 1
NJ Company’s Electrical Division produces a high quality transformer. Sales and cost data on
the transformer follow:
Selling price per unit on the outside market P50
Variable cost per unit P31
Fixed costs per unit P19
Capacity in units 70,000
 23

NJ Company has a Motor Division that would like to begin purchasing this transformer from
the Electrical Division. The Motor Division is currently purchasing 10,000 transformers each
year from another company at a cost of P48 per transformer. NJ Company evaluates its division
managers on the basis of divisional profits.
Required:
1. Assume that the Electrical Division is now selling only 60,000 transformers each year to
outside customers.
a. From the standpoint of the Electrical Division, what is the lowest acceptable transfer
price for transformers sold to the Motor Division?
b. From the standpoint of the Motor Division, what is the highest acceptable transfer
price for transformers acquired from the Electrical Division?
c. If left free to negotiate without interference, would you expect the division managers
to voluntarily agree to the transfer of 10,000 transformers from the Electrical Division
to the Motor Division? Why or why not?
d. From the standpoint of the entire company, should a transfer take place? Why or
why not?
2. Assume that the Electrical Division is now selling all of the transformers it can produce
to outside customers.
a. From the standpoint of the Electrical Division, what is the lowest acceptable transfer
price for transformers sold to the Motor Division?
b. From the standpoint of the Motor Division, what is the highest acceptable transfer
price for transformers acquired from the Electrical Division?
c. If left free to negotiate without interference, would you expect the division managers
to voluntarily agree to the transfer of 10,000 transformers from the Electrical Division
to the Motor Division? Why or why not?
d. From the standpoint of the entire company, should a transfer take place? Why or
why not?

Problem 2
Gridale Company transfers a product from division N to division J. Variable cost of this product
is anticipated to be P40 a unit and total fixed costs amount to P10,000. A total of 100 units are
anticipated to be produced. Actual cost, however, amounts to P50 for variable costs. Fixed costs
expected to continue as budgeted. However, the actual output is twice as the number of
budgeted.
Requirement:
1. Actual cost per unit amounts to
2. The transfer price based on actual variable costs plus 150% markup amounts to
3. The transfer price based on budgeted full cost plus 50% markup amounts to

Problem 3
 24

Division One of Mina Company is currently operating 80% of capacity. It produces a single
product and sells all its production to outside customers for P80 per unit. Variable costs is P40
per unit and fixed costs is P30 per unit at the current production level.
Division Two, which currently buys the same product from an outside supplier for P75 per unit,
would like to buy the product from Division One.
Division One will use one half of its idle capacity if it decides to provide the requirements of
Division Two.
Requirement:
1. What is the minimum price that Division One should charge Division Two for this
product?
2. What is the maximum price that Division Two will be willing to pay for the product if it
will be purchased internally?

Problem 4
The MOMMY DEVINE Company Ltd has two divisions, MATTEO & SARAH. One of the parts
produced by MATTEO is being used by Division SARAH in its manufacturing process. This
part is not unique and there is readily defined market such that MATTEO can sell to outside
firms and SARAH can buy from outside.

The following data is available in respect of division MATTEO:

The following data is available in respect of division MATTEO:
Capacity to produce the part 125, 000 units
External Sales at P 100 per unit 100, 000 units
Transfer to division SARAH 25, 000 units
Costs:
Variable Manufacturing cost per unit P 84
Variable Selling Cost per unit P2
(on external sales only but not incurred on internal transfer)
Fixed Manufacturing Cost (based on 125000 units) P6
Fixed Selling Cost (based on 100000 units) P1
The division Y represents the following data on the assumption of volume of
25000 units:
Variable manufacturing expenses per unit P 100
(excluding internal transfer price/outside purchase)
Variable Selling Expenses per unit P6
Fixed manufacturing cost P 10
Fixed selling expenses P4
Selling price per unit P 240

Required:
 25

1. If division MATTEO could sell 125, 000 units at P 100 each in the open market what
transfer price, the central management would prefer in order to provide proper
motivation to division SARAH?
2. As a management accountant would you advise division SARAH to buy the product at
the transfer price determined in 1 above?
3. Assume transfer price as in 1 above and if selling price for division SARAH’s product
drops to P200 should you buy at that price? Would this be desirable from the point of
the firm, why?

Problem 5
GUIDICELLI, Inc., has a Valve Division that manufactures and sells a standard valve as
follows:
Capacity in units Php 160, 000
Selling price to outside customers on the intermediate market Php 20
Variable costs per unit Php 12
Fixed costs per unit (based on capacity) Php 9

The company has a Pump Division that could use this valve in the manufacture of one of its
pumps. The Pump Division is currently purchasing 16, 000 valves per year from an overseas
supplier at a cost of P19 per valve.

Required:
1. Assume that the Valve Division has ample idle capacity to handle all of the Pump
Division's needs. What is the acceptable range, if any, for the transfer price between the
two divisions?
2. Assume again that the Valve Division is selling all that it can produce to outside
customers on the intermediate market. Also assume that Php 2 in variable expenses can
be avoided on transfers within the company, due to reduced selling costs. What is the
acceptable range, if any, for the transfer price between the two divisions?
3. Assume the Pump Division needs 40,000 special high-pressure valves per year. The
Valve Division's variable costs to manufacture and ship the special valve would be Php
10 per unit. To produce these special valves, the Valve Division would have to reduce its
production and sales of regular valves from 160,000 units per year to 80,000 units per
year. As far as the Valve Division is concerned, what is the lowest acceptable transfer
price? (Round your answer to 2 decimal places.)

Problem 6
 26

LAIDA Products has two divisions—Chocolate and Mint. The Chocolate division typically sells
its chocolate to the Mint division for P 3 per pound, which covers variable costs. The Chocolate
division sells to outside customers for P 5 per pound. Use the general economic transfer pricing
rule to address the following requirements:
Required:
1. Calculate the optimal transfer price assuming the Chocolate division is below
capacity.
2. Calculate the optimal transfer price assuming the Chocolate division is at capacity.

Problem 7
GERONIMO Inc., manufactures sports equipment. The company is comprised of several
divisions, each operating as its own profit unit. Division Teddie has declared to go outside the
company to buy materials, since it was informed that Division Bobbie was increasing its selling
price of the same materials to P 200.

Outside price for materials P 150

Division Teddie’s annual purchases 10, 000 units
Division Bobbie’s variable cost per unit P 140
Division Bobbie’s fixed costs P 1, 250, 000
Division Bobbie’s capacity utilization 100%

Required:
1. Will the company benefit if Division Teddie purchases outside the company?
Assume Division Bobbie cannot sell its materials to outside buyers.
2. Assume Division Bobbie can save P 200, 000 in fixed costs if it does not manufacture
the material for Division Teddie. Should Division Teddie purchase

Problem 8

Floor Covering Division of Queen Home Inc. manufactures a single grade of residential grade
carpeting. The division has the capacity to produce 500,000 sq. yards of carpet each year. Its
current cost and revenues are shown here:
Sales (400,000 square yards) P 2,000,000

Variable cost per square yard:

Production P 2.00
SG&A 1.00
Fixed cost per square yard (based on 500,000 yard capacity)
 27

Production P 0.50
SG&A 1.00

The Building Division currently purchases 40,000 yards of carpeting (of the grade produced by
Floor Covering Division) each year at a cost of P6.50 per square yard from an outside vendor.

Required:
1. If the autonomous Building and Floor Covering Divisions enter negotiations on the
internal transfer of 40,000 square yards of carpeting, what is the maximum price that
will be considered?
2. If the autonomous Building and Floor Covering Divisions enter negotiations on the
internal transfer of 40,000 square yards of carpeting, what is the Floor Covering
Division’s minimum price?
3. If the Building and Floor Covering Divisions agree on the internal transfer of 40,000
square yards of carpet at a price of P4.50per square yard, how will the profits of the
Building Division be affected?
4. If the Building and Floor Covering Division agree on the internal transfer of 40,000
square yards of carpet at a price of P4.00per square yard, how will overall corporate
profits be affected?
5. Assume, for this question only, that the Floor Covering Division is producing and
selling 500,000 square yards of carpet to external buyers at a price of P5 per square yard.
What would be the effect on overall corporate profits if the Floor Covering Division
reduces external sales of carpet by 40,000 square yards and transfers the 40,000 square
yards of carpet to the Building Division?

Problem 9
King’s Company’s Audio Division produces a speaker that is widely used by manufacturers of
various audio products.
Sales and cost data on the speaker follow:
Selling price per unit on the intermediate market P60
Variable cost per unit 42
Fixed costs per unit 8
Capacity in units 25,000

King Company has just organized a Hi-Fi Division that could use this speaker in one of its
products. The Hi-Fi Division will need 5,000 speakers per year. It has received a quote of P57
per speaker from another manufacturer. King Company evaluates divisional managers on the
basis of divisional profits.
 28

Assume that the Audio Division is now selling only 20,000 speakers per year to outside
customers on the intermediate market.
1. From the standpoint of the Audio Division, what is the lowest acceptable transfer price
for speakers sold to the Hi-Fi Division?
2. From the standpoint of the Hi-Fi Division, what is the highest acceptable transfer price
for speakers purchased from the Audio Division?
3. If left free to negotiate without interference,would you expect the division managers to
voluntarily agree to the transfer of 5,000 speakers from the Audio Division to the Hi-Fi
Division? Why or why not?
4. From the standpoint of the entire company, should the transfer take place? Why or why
not?

Problem 10

TND Corporation comprises two divisions: T and D. T currently produces and sells a gear
assembly used by the automotive industry in electric window assemblies. D is currently selling
all of the units it can produce (25,000 per year) to external customers for P25 per unit. At this
level of activity, T’s per unit costs are:

Variable:
Production P7
SG&A 2
Fixed:
Production 6
SG&A 5

D Division wants to purchase 5,000 gear assemblies per year from T Division. D Division
currently purchases these units from an outside vendor at P22 each.
1. What is the minimum price per unit that T Division could accept from D Division for
5,000 units of the gear assembly and be no worse off than currently?
2. What will be the effect on overall corporate profits if the two divisions agree to an
internal transfer of 5,000 units?

Problem 11

GreenMision, Inc., is a nursery products firm. It has three divisions that grow and sell plants:
the Northern Division, the Central Division, and the Southern Division.
 29

Recently, the Central Division of GreenMision acquired a plastics factory that manufactures
green plastic pots. These pots can be sold both externally and internally. Company policy
permits each manager to decide whether to buy or sell internally. Each divisional manager is
evaluated on the basis of return on investment and EVA.
The Northern Division had bought its plastic pots in lots of 100 from a variety of vendors. The
average price paid was P75 per box of 100 pots. However, the acquisition made Gina Linetti,
manager of the Northern Division, wonder whether a more favorable price could be arranged.
She decided to approach Jacob Peralta, manager of the Central Division, to see if he wanted to
offer a better price for an internal transfer. She suggested a transfer of 3,500 boxes at P70 per
box.
Jacob gathered the following information regarding the cost of a box of 100 pots:

Direct materials P35

Direct labor 8
Variable overhead 10
Fixed overhead* 10
Total unit cost P63
Selling price P75
Production capacity 20,000 boxes

Required:
1. Suppose that the plastics factory is producing at capacity and can sell all that it produces
to outside customers. How should Jacob respond to Gina’s request for a lower transfer
price?
2. Now assume that the plastics factory is currently selling 16,000 boxes. What are the
minimum and maximum transfer prices? Should Jacob consider the transfer at P70 per
box?
3. Suppose that Green Mission's policy is that all transfer prices be set at full cost plus 20
percent. Would the transfer take place? Why or why not?

Problem 12
Harem Corporation consists of two divisions, Mining and Builders. The Mining makes black
steel, a product that can be used in the product that the Builders division makes. Both
divisions are considered profit centers. The following data are available concerning black steel
and the two divisions:
Mining Builders
Average units produced 150,000
Average units sold 150,000
 30

Variable mfg cost per unit P2

Variable finishing cost per unit P5
Fixed divisional costs P75,000 P125,000
The Mining Division can sell all of its output outside the company for P4 per unit. The
Builders Division can buy the black steel from other firms for P4. The Builders Division
sells its product for P12.
What is the optimal transfer price in this case?

Problem 13
Amit Industries has two divisions A & B. Division A has a capacity of manufacturing
1,00,000 boxes per year. The selling price is 30 whereas the variable cost is 16 per unit and fixed
cost is 9,00,000 per year. Division B is also using the same box but it is purchasing 10,000 units
per year at a cost of 29 per unit.
Find out the transfer price in following cases:
a.If division A has sufficient idle capacity to handle requirement of division B.
b.If there is no idle capacity in division A, should there be any transfer at this price? c.If there is
no idle capacity in division A, however 3 in variable cost can be avoided on interdivision sales,
due to reduced selling costs.

Problem 14
There are two divisions in a firm, the Valve Division (VD) and a Pump Division (PD). The PD’s
requirement is 20,000 units of a special type of valves which can be supplied by VD. Presently,
the VD is producing 1,00,000 valves of other models at its full capacity (i.e. HAVING NO IDLE
CAPACITY), at variable cost of Rs.16 and selling price of 30 per unit. In order to produce special
type of valve, as required by PD, the VD has to give up 50% of its regular production and need
to incur additional variable cost of Rs.4 per unit. If the VD decides to produce the special type of
valve for PD, what transfer price should it charge to PD?

Problem 15
A company is organized on a decentralized line, with each manufacturing division
operating as a separate profit center. Each division manager has full authority to decide
on the sale of the division’s output to outsiders and to other divisions.Division C has always
purchased its requirement of component from division A. But when informed that division A
was increasing its selling price to 150/-, the manager of division C decided to look at outside
suppliers. Division C can buy the component from an outside supplier for 135/-. But division A
refuses to lower its prices in view of its need to maintain its return on investment.
The top management has following information.
 31

C’s annual purchase of the component 1000 units

A’s variable cost per unit 120
A’s fixed cost per unit 20
Find:
a.) Will the company as a whole benefit, if division C bought the component at 135/- from
an outside buyer. (No)
b.) If A did not produce the material for C, it could use the facilities for other activities
resulting in a cash operating savings of 18000/-. Should C then purchase from outside
sources?(yes)
c.) Suppose there is no alternative use of A’s facilities and the market price per unit for the
component drops by 20, should C buy from outside?(yes)

ANSWER KEY:

TRUE OR FALSE MULTIPLE CHOICE MULTIPLE CHOICE

THEORIES PROBLEMS
1. T 1. C 1. B
2. T 2. D 2. B
3. F 3. B 3. A
4. T 4. B 4. A
5. T 5. D 5. A
6. F 6. A 6. C
7. T 7. A 7. B
8. T 8. C 8. D
9. T 9. B 9. C
10. T 10. A 10. A
11. F 11. C 11. C
12. T 12. D 12. D
13. F 13. B 13. B
14. T 14. A 14. D
15. F 15. A 15. B
16. T 16. C 16. A
 32

17. T 17. B 17. C

18. F 18. D 18. C
19. T 19. C 19. B
20. T 20. D 20. D
21. T 21. A 21. D
22. T 22. D 22. C
23. F 23. A 23. A
24. F 24. E 24. C
25. F 25. B 25. D
26. T 26. A 26. B
27. T 27. D 27. A
28. T 28. D 28. C
29. T 29. C 29. A
30. T 30. C 30. B

MULTIPLE CHOICE PROBLEM: SOLUTIONS

1. B (55-45 = 10)
2. B (20-unit variable cost)
3. A
4. A (lower limit, selling price to OUTSIDE customer)
5. A (600 + 200 = 800 – Market based is to be used ; the sum of the prevailing external price
and transportation cost
6. C (In a perfectly competitive market, the market price is the appropriate transfer price
7. B
The division is operating at capacity, therefore, the minimum transfer price must be the
amount of selling price, less avoidable selling expense.
Selling price P 90
Less: Avoidable selling P3
expense
Net Price P 87
8. D
Selling price (Market Price) P 120
Less: Avoidable selling expense (P 15 x P3
20%)
Net Price P 117
9. C
Final selling price by GA P 300
Less: Additional processing cost P 100
Maximum material cost (transfer price) P 200
Note: At a transfer price of P200, GA will not realize any profit on the additional 1,000
units.
10. A
The actual cost is the sum of unit variable cost plus fixed cost divided by actual units
produced.
 33

50 + (8000 ÷ 200) = P90

11. C
Variable Cost P 50
Add: Mark-up (P 50 x 1.3) P 65
Transfer Price P 115

12. D
Budgeted full cost [P40 + (P8, 000 ÷ 100)] P 120
Add: Mark-up (P 120 x 0.3) P 36
Transfer Price P 156

13. B
The division is operating at capacity (zero excess capacity). Any quantity of production to be
transferred to the Division B must be at P13; any price below P13, as transfer price, would
decrease its profit.
14. D
The minimum Davy would accept is the opportunity cost to make the product, which
would be the variable cost of P25.
15. B
P100 represents the price at which the good could be obtained externally.

16. A
96 represents the external sales price less the selling expenses that will not be incurred
(106-10=96)

17. C
Selling costs of P50,000 (P10/unit) will not be incurred.

18. C
The minimum price acceptable of the transfer price
range for a possible transfer of the super chip from one division to the other is 20.

19. B
The maximum transfer price range for a possible transfer of the chip from one division
to the other is the current purchase price 45.

20. D
Transfer prices are for internal use only; external profits are not affected

21. D
P(40 - 20)/unit * 4,000 units = P80,000
 34

22. C
P5.00/unit * 4,000 units = P20,000 decrease in profit

23. A.
The $10 per unit would equal the Division's variable costs ($5 + 2 + 3 = $10), so the contribution
margin per unit is zero. Thus, only the 8,000 units of external sales would generate a
contribution margin of $80,000 (8,000  $10) to cover fixed costs of $90,000 (10,000  $9). So the
Division would show a $10,000 loss.

24. C
Total fixed costs to Wire are:
Production $2  10,000 = $20,000
Selling $3  10,000 = 30,000
G&A $4  10,000 = 40,000
Total $90,000

Less: Contrib.Margin on Regular Business

[$20 - (5 + 2 + 3)]  8,000 (80,000)
Unrecovered Fixed Costs $10,000

which must be covered by CM of inside sales =

Trans.Price Vol. = SP - [(5 + 2 + 3)  2,000]
SP = $15

25. D
Full absorption cost: Variable Production Cost = $5
Fixed Production Cost = 2
Total full absorption cost $7
Doubled x2
Transfer price $14
 35

26. B
Proposed transfer price per unit $16
Consumer's current market purchase price per unit 15
Increase in cost per unit of wire to Consumer's $1
Times units purchased x 2,000
Decrease in profit due to increased costs $2,000

27. A
Wire Division must cover its out of pocket costs or the relevant variable costs; the fixed costs are
irrelevant since they will be incurred regardless of this extra inside business. Thus, the total cost
to be covered is $7 (production, $5; selling, $2).

28. C
Variable costs = $(0.50 + 0.30 + 0.15) =
$0.95

29. A
Total manufacturing costs = $(0.50 + 0.25) =
$0.75

30. B
Market Price $250,000
External Sales
100,000 units
Price per Unit $2.50/unit

CASE PROBLEM: SOLUTIONS

Problem 1
Requirement 1:
a. The lowest acceptable transfer price from the perspective of the selling division, the
Electrical Division, is given by the following formula:

Total contribution margin

Variable cost on lost sales
Transfer price = +
per unit Number of units transferred
 36

P0
Transfer price = P31 + 10,000 = P31

b. The Motor Division can buy a similar transformer from an outside supplier for P48.
Therefore, the Motor Division would be unwilling to pay more than P48 per transformer.

Transfer price: Cost from buying from outside supplier = P48

c. The acceptable range of transfer prices in this situation is:

P31 : Transfer price : P48

Assuming that the managers understand their own businesses and that they are
cooperative, they should be able to agree on a transfer price within this range and the
transfer should take place.

d. From the standpoint of the entire company, the transfer should take place. The cost of
the transformers transferred is only P31 and the company saves the P48 cost of the
transformers purchased from the outside supplier.

Requirement 2:
a. This can also be computed using the formula for the lowest acceptable transfer price as
follows:
(P50 – P31) x 10,000
Transfer price = P31 +
10,000

= P31 + (P50 – P31)

= P50
b. As before, the Motor Division would be unwilling to pay more than P48 per transformer.

c. The selling division must have a price of at least P50 whereas the buying division will
not pay more than P48. An agreement to transfer the transformers is extremely unlikely.

d. From the standpoint of the entire company, the transfer should not take place. By
transferring a transformer internally, the company gives up revenue of P50 and saves
P48, for a loss of P2.

Problem 2
1. The actual is the sum of unit variable cost plus fixed cost divided by actual units
produced. 50 + (10,000 / 200) =P100
2. Variable cost P50
 37

Markup (P50 x 1.5) 75

Transfer price: P125

3. Budgeted full cost P40 + (P10,000 / 100) P140

Mark up (P120 x 0.5) 60
Transfer price: P200

Problem 3
1. Since idle capacity exists, opportunity cost is equal to zero. The minimum price that
must be charged for the product is equal to its variable cost per unit of P40.
2. Considering the point of view of the buying segment, the maximum transfer price
acceptable is equal to the purchase price of the goods if acquired from outside suppliers.
Answer: 75

Problem 4
1. MATTEO selling the product to outsiders at P 100.
Selling Price P 100
Less: Variable Cost (Production) P 84
Variable Cost (Selling) P2
Contribution P 14
Less: Fixed Cost (Production) P6
Fixed Cost (Selling) P1
Profit P7

Minimum Transfer Price:

= Variable Cost Of production +Contribution Lost
= P 84 + P 14
= P 98

(Justification)
For transferring the product MATTEO must get its VC of P 84
Production
It must get its FC of Production +P6
It must get its FC of selling +P1
MATTEO must earn the profit +P7
MATTEO must charge a transfer price of P 98
 38

2. As a management accountant of Division SARAH would you advise the purchase at TP of

98
SARAH SARAH
Purchases from Purchases
MATTEO at TP from outside
of 98 at P 100
Selling Price P 240 P 240
Less: Variable Cost (Production) P 100 P 100
Variable Cost (Bought out P 98 P 100
item)
Variable Cost (Selling) P6 P6
Contribution P 36 P 34

Since the option to purchase the item from MATTEO at TP of 98 gives better contribution,
division SARAH should go for this transaction.
3. If sales price of division SARAH’s product drops to P 200, whether the TP of 98 will be
acceptable
Co. uses product of Co. opts to sell the
MATTEO in division Product of MATTEO in
SARAH Open market at 100
Selling Price P 200 P 100
Less: Variable Cost (Production) P 100 P 84
Variable Cost (Bought out P 84
item)
Variable Cost (Selling) P6 P2
Contribution P 10 P 14

Since from company’s point of view selling the product of division MATTEO to outside
buyer gives better contribution than transferring it to division SARAH.

Problem 5
1. Minimum transfer price for the Valve division = Variable cost per unit
Minimum transfer price for the Pump division = Purchase cost
The acceptable range for the transfer price between the two divisions, when there is idle
capacity is between the variable cost and the purchase cost.
Acceptable range = 12 - 19.

2. Minimum transfer price in case of no excess capacity to valve division should be more than
the selling price to outside customers which is 20
As the Pump division can purchase from the outside supplier at 19 per valve, Pump
division would get benefited by purchasing from an outside supplier.
 39

Acceptable range = none.

3. The Valve Division's variable costs to manufacture and ship the special valve = 10 per unit

Contribution margin from the lost sales

= Reduction in units * (selling price - variable costs)
= 80,000 * (20 - 12)
= 640,000

Relevant costs
= Variable costs + Contribution margin from the lost sales
= (40,000 * 10) + 640,000 = 1,040,000

Lowest acceptable transfer price for the valve division

= Relevant costs / No of units
= 1,040,000 / 40,000
= 26 per unit.

Problem 6
1. Because the Chocolate division is below capacity, no outside customer sales are forgone as a
result of selling internally. Thus the opportunity cost of selling internally is zero. The optimal
transfer price is P 3, calculated as follows:

Transfer price
= Differential cost to selling division + Opportunity cost of selling internally
= P 3*+ P 0**
=P3
*This is the variable cost per pound.
**Opportunity cost is zero since no outside sales are forgone as a result of selling internally.
2. Since the Chocolate division is at capacity, outside customer sales are forgone as a result of
selling internally. Thus there is an opportunity cost of selling internally. The optimal transfer
price is P 5, calculated as follows:
Transfer price
= Differential cost to selling division + Opportunity cost of selling internally
= P 3*+ P 2**
=P5
*This is the variable cost per pound.
**Opportunity cost is the revenue forgone of P 2 by selling internally
 40

(= P 5 market price – P 3 variable cost).

Problem 7
1. Division Teddie’s purchase decision from the overall firm perspective:
Purchase costs from outside (10,000 x P150) P 1, 500, 000
Less: Savings of Divisions Bobbie’s variable costs (10,000 x P 1, 400, 000
P140)
Net Cost (Benefit) for Teddie to buy outside P 100, 000

Assuming Division Bobbie has no outside sales, Division Teddie should buy inside from
Division Bobbie for the benefit of the entire firm.

2. As above, but in addition, if Division Teddie buys outside, Division Bobbie saves an
additional P200,000.
Purchase costs from outside (10,000 x P150) P 1, 500, 000
Less: Savings in variable costs (10,000 x P140) P 1, 400, 000
Less: Savings of Bobbie material assignment P 200, 000
Net Cost (Benefit) for Teddie to buy outside P (100, 000)

The additional savings in Division Bobie means that now Division Teddie should buy outside.

Problem 8
1. The maximum price or ceiling is the current purchase price of P6.50 per yard.
2. The minimum price acceptable to Floor Covering is its incremental cost of P3 (P2 + P1)
per square yard.
3. Current external purchase price P6.50
Less: Proposed transfer price (4.50)
Total: Reduction in purchase price per yard P2.00
Times yards acquired ×40,000
Total Increase in profitsP80,000
4. Current outside purchase price per square yard P6.50
Less: Carpet’s variable cost per square yard (3.00)
Total: Savings per square yard to Building Division & corporate P3.50
Times number square yards bought × 40,000
Total Savings to corporate and increase in profits P140,000
5. Since the Floor Covering Division is operating at full capacity, it would lose the
contribution margin on the 40,000 square yards. However, the Building Division would
not have to buy externally. Thus,
 41

Lost CM (P2 × 40,000 yd) = P(80,000 )

Gained CM (P3.50 × 40,000 yd) = 140,000
Net increase in corporate profits P 60,000

Problem 9
1. The lowest acceptable transfer price for speakers sold to the Hi-Fi Division is 42.
2. The highest acceptable transfer price for speakers purchased from the Audio Division is
57.
3. Yes; they will agree on the price.
4. Yes; the profit will increase by P75,000
Purchase Price P57
Less: Variable cost per unit 42
Total 15
X 5000
Total Increase in profit 75000

Problem 10
1. T Division is operating and selling outside at full capacity so minimum price is equal to
the variable cost to make and sell plus the lost contribution margin from outside sales:
VC: Production $7
SGA 2 $9
Contribution margin 16
Selling price $25

2. Corporate profits will decrease by forcing the transfer.

CM per units earned by T is from external sales $25 – [$7 + $2] $16
Times units to be sold × 5,000
Decrease in CM to T and TND Corp. $ 80,000
Net savings to buy internally
rather than externally [$22 – $9] $13
Times units to be purchased × 5,000
Savings by buying internally $ 65,000
Net effect on TND Corp. profits $(15,000)
 42

Problem 11
1. If Jacob can sell all the product to the outside customers (market), he shouldn't accept
Gina's request to reduce the price. Because Jacob can tell all the products at price P75, he
will get the optimum profit. But, if he accepts Gina's request, he only can sell the product
at price P70.
2. As we know that to produce 1 unit plastic pot, the firm needs variable cost:
Direct materials P35
Direct labor 8
Variable overhead 10
Total Variable Cost 53
So, the minimum price is P53 The maximum price as much as the market price is P75.
Yes, Jacob should consider to accept the Gina's request because the income will
increase by:
[3.500(70-53)]=59,500

3. If the price is set at full cost plus 20%, the cost would be:
= 63 + (20% X 63)
= P75,6
No, transfer price will not occur. Because the price is higher than the market price. So,
Gina better buy the product to the market.

Problem 12
The optimal transfer price is P4 per unit, which represents the value of using the black steel in
the Builders Division because the black steel will cost P2 to manufacture and each unit used
internally is a unit that cannot be sold to external buyers. If an intermediate market exists, the
optimal transfer price is the market price.

Problem 13
a.Option I-
Division A has idle capacity i.e. it can produce more but can not sell the additional produce. In
this situation whatever it can sell to division B over above the variable cost is acceptable to it.
Division A’s opportunity cost is Zero i.e. it is not loosing any contribution on account of
transfer. Contribution Lost per unit = ZERO
Therefore Minimum TP=VC per unit + Contribution Lost per unit
= 16 + 0
= 16
 43

But to provide motivate division A, by carrying negotiations, TP may be set any where between
16 to 29. (as division B is in a position to get the said product from open market at 29)

b. Option I – Division A has NO IDLE capacity i.e. whatever it can produce it can sell.
Therefore
in this situation division A need not reduce its transfer price below the market price. And any
such transfer required to be made must compensate for the total contribution lost by A on
account of such transfer.
Contribution Lost per unit = Rs14 {30-16}
Therefore Minimum TP= VC per unit + Contribution Lost per unit
= 16 + 14
= 30
However note that division B is also able to get its requirement at 29, therefore no transfer is
possible between the divisions.
c. Division A has no idle capacity, but it can save variable cost of 3 on internal transfer to
division B on account of reduced selling cost. Therefore in this situation Varibale Cost of Div. A
= 16-3 = 13
Minimum TP= VC per unit + Contribution Lost per unit
= 13 + 14
= 27

Problem 14
In order to produce 20,000 units of special type of valves, the VD need to cut its regular
production by half i.e. by 50,000 units. And in this case the contribution lost would be

Contribution Lost per unit = 50,000 (30 – 16)

= 7,00,000
And it needs to recover this loss from the production of special type of valve. It is
required to produce 20,000 special type of valves. Therefore the lost contribution per
special valve comes out to be 35( 7,00,000 / 20,000)
And based on this lost contribution per unit transfer price be set as under

Minimum TP= VC per unit + Contribution Lost per unit

 44

= 20 + 35
= 55

Thus VD should charge minimum transfer price of Rs.55 to PD so as to compensate the

switchover in production.

Problem 15
a.) Div C Buys from outside parties at 135
SP per unit 135
VC per unit 120
Contribution per unit 15
Here if the division C buys the product at 135 from the outside parties instead of
division A, the company as whole will be loosing the contribution otherwise would have
been earned of 15, because it can produce the said item at variable cost of 120 only.
Therefore division should not buy the product from outside at 135

b.) C’s annual requirement is 1000 components

If A produce this requirement and transfer it to C it is incurring the additional cost of 18000,
in other words it save on this cost if it does not produce the C required stock.
i.e. per unit of this produce leads to cost of18000/1000 i.e. 18 per unit
So instead of producing and earing 15 as contribution it can save 18 per unit by choosing not
to produce.
Therefore in this situation division C should go for purchase of the component fron
outside parties at 135
Purchase cost 1000*135 135000
Less Saving on VC 1000*120 120000
Less Saving of A if its 18000
capacity used for other activities
----------
Net Cost (benefit) to the company (3000)
iii) If the selling price for A’s product drops by 20, the new selling price will be 115 per unit.
Price drops from 135 to 115
 45

SP per unit 115

VC per unit 120
Contribution per unit (5)

In this situation the revised prices reduces the division A’s contribution and it becomes -5 per
unit, it will better if division C goes for outside purchase because to produce the component
division A has to incur variable cost of 120/ but the said component is available at less than that
so from A’s as well as from company’s point of view it is advisable for C to go for outside
purchase.