Responsibility Accounting and Transfer Pricing

(B. Transfer Pricing)

B. TRANSFER PRICING B. minimize the transfer price

C. maintain goal congruence between the divisions and the entire firm
THEORIES: D. none of the above
Nature
5. Transfer prices are charges for 2. The objective(s) of transfer pricing are
A. transportation of goods outside units of an organization. A. to motivate managers
B. goods sold by subunits to outside customers. B. to provide an incentive for managers to make decisions consistent with the firm's goals
C. goods exchanged among subunits. (i.e., goal congruence)
D. goods stored within a subunit. C. to provide a basis for fairly rewarding the managers
D. all of the above
23. A transfer price is a price charged
A. to outside customers 4. A transfer pricing system should satisfy which of the following objectives?
B. when one division sells its goods or services to another division A. accurate performance evaluation C. goal congruence
C. by the selling division to the buying division when outside market does not exist B. preservation of divisional autonomy D. all of the above
D. a and b
34. The market price method satisfy a key objective of transfer pricing, namely:
24. Transfer prices are A. objectivity C. consistency
A. necessary to calculate costs in a cost, profit, or investment center B. usability D. reliability
B. preferred by buying divisions are the lowest possible
C. do not make any difference for the company's bottom-line no matter what number is used Irrelevant costs
D. all of the above 29. Which item is usually not relevant to a decision by a divisional manager to reduce a transfer
price to meet a price offered to another division by an outside supplier?
36. Which of the following is a key factor to consider in deciding whether to make internal A. opportunity cost
transfers, and, if so, in setting the transfer price? B. variable manufacturing costs
A. Is there an outside supplier? C. fixed divisional overhead
B. Is the seller's variable cost less than the market price/ D. the price offered by the outside supplier
C. Is the selling unit operating at full capacity?
D. All of the above are key factors. Minimum & Maximum Transfer Price
General rule
32. From the standpoint of the company, the important question in transfer pricing is 9. The general rule in establishing transfer prices consistent with economic decision making is
A. what is fair to the divisions the
B. how to determine the profit of the divisions A. differential cost plus opportunity cost if goods are transferred internally.
C. whether or not the transfer should take place B. actual cost plus opportunity cost if goods are transferred internally.
D. when the transfer should be made C. standard cost plus opportunity cost if goods are transferred internally.
D. all of the above.
Objectives
1. The objective of a transfer pricing system should be to Seller’s standpoint (minimum price)
A. maximize the transfer price 26. The minimum transfer price should be:

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A. opportunity cost for selling division A. cost or cost plus C. negotiation

B. opportunity cost for buying division B. market prices D. all of the above
C. opportunity cost for the company as a whole
D. only variable cost for the selling division 35. Which of the following are transfer pricing models?
A. Variable cost method C. Market cost method
14. A selling division produces components for a buying division that is considering accepting a B. Average price method D. All of the above
special order for the products it produces. The selling division has excess capacity. The
minimum price the selling division would be willing to accept is the Market price
A. selling division’s variable costs 10. If a firm operates at capacity, the transfer price should be the:
B. buying division’s outside purchase price A. external market price. C. actual cost.
C. price that would allow the buying division to cover its incremental cost of the special order B. differential cost. D. standard cost.
D. price that would allow the selling division to maintain its current ROI
12. To avoid waste and maximize efficiency when transferring products among divisions in a
25. The minimum transfer price from the seller's standpoint is competitive economy, a large diversified corporation should base transfer prices on:
A. market price when excess capacity exists A. full cost C. replacement cost
B. market price when excess capacity does not exist B. variable cost D. market price
C. incremental costs when excess capacity exists
D. b and c 13. If an intermediate market exists, the optimal transfer price is the:
A. outlay cost for producing the goods.
Buyer’s standpoint (maximum price) B. opportunity cost of not selling to the outside market.
7. Generally, the outside market price would be C. market price.
A. a floor for internal transfer price. D. variable costs associated with producing the product.
B. a ceiling for internal transfer price.
C. both a and b 16. If there is no excess capacity, the transfer price is often
D. none of the above. A. market price
B. opportunity cost plus incremental cost
Methods of transfer pricing C. variable cost or variable cost plus profit
3. The basic methods used in transfer pricing are D. a or b
A. variable or full costs C. market price or negotiated price
B. dual prices D. all of the above 20. Market pricing approach in transfer pricing
A. helps to preserve unit autonomy
8. An example of a transfer price policy is B. provides incentive for the selling unit to be competitive with outside suppliers
A. market price. C. may be the most practical approach when there is significant conflict
B. actual cost plus markup. D. both a and b
C. standard cost plus markup.
D. all of the above. 28. The best transfer price is usually
A. actual cost plus a percentage markup
27. Transfer prices are set by: B. a reliable market price

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C. budgeted full cost plus a percentage markup D. all of the above

D. budgeted variable cost plus a percentage markup
22. A company may consider using variable costs in transfer pricing when there is
30. Market-based transfer prices are best for the A. excess capacity because variable costs would stay the same
A. company when the selling division is operating below capacity. B. no excess capacity because variable costs would not stay the same
B. company when the selling division is operating at capacity. C. excess capacity because fixed costs would stay the same
C. buying division if it is operating at capacity. D. no excess capacity because fixed costs would stay the same
D. buying division.
Full cost
33. Which transfer price is ideal for the company when the selling division is at capacity? 18. If full cost is used in transfer pricing, it is preferable to use
A. Market price A. standard full cost because the buyer does not wish to be stuck with unknowns
B. Incremental cost B. standard full cost because the seller does not wish to pass along the variations in cost
C. Budgeted full cost C. actual full cost because the buyer is well-advised to deal with the real rather than
D. Actual variable cost plus a percentage profit anticipated costs
D. actual full costs because the seller is well-advised to deal with the real rather than
Actual costs anticipated costs
6. Disadvantages of transfer prices based on actual cost include:
A. reducing the incentive of managers of supplying divisions to control their costs. Negotiated
B. passing on efficiencies or inefficiencies of supplying divisions to receiving divisions. 11. Negotiated transfer prices are appropriate when:
C. both a and b. A. there are cost savings to the selling division.
D. none of the above. B. there is no external market price.
C. the internal market price reflects a bargain price.
15. Which of the following types of transfer prices do not encourage the selling division to be D. all of the above.
efficient?
A. transfer prices based upon market prices 17. A negotiated transfer pricing system is set up where
B. transfer prices based upon actual costs A. the two sides cannot agree on a price and the difference between the two sides is
C. transfer prices based upon standard costs absorbed by the home office
D. transfer prices based upon standard costs plus a markup for profit B. a ready market price is not available and the two sides must come up with an agreeable
price
31. The worst transfer-pricing method is to base the prices on C. the buyer buys at variable cost and the seller only sells at full cost
A. market prices C. budgeted variable costs D. the two sides agree to use a cost basis for transfer pricing
B. budgeted total costs D. actual total costs
Multinational transfer pricing
Variable costing 19. To minimize taxes, some multinational companies set low transfer prices when goods are
21. Variable costing method of transfer pricing is shipped from
A. easy to implement A. low tax countries to other low tax countries
B. intuitive and easily understood B. low tax countries to high tax countries
C. more logical when there is excess capacity C. high tax countries to low tax countries

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D. c or b Capacity in units 200,000

Number of units being sold on the intermediate market 160,000
PROBLEMS: Selling price per unit on the intermediate market P75
Residual income Variables costs per unit 60
i. Marsh Company that had current operating assets of one million and net income of P200,000 Fixed costs per unit (based on capacity) 8
had an opportunity to invest in a project that requires an additional investment of P250,000
and increased net income by P40,000. The company's required rate of return is 12%. After the Division Y:
investment, the company's residual income will amount to Number of units needed for production 40,000
A. 80,000 C. 90,000 Purchase price per unit now being paid to an outside supplier P74
B. 85,000 D. 95,000 The minimum transfer price to be charged by the Division X should be:
A. P60 C. P68
With excess capacity B. P75 D. P74
Bargaining range
ii. An appropriate transfer price between two divisions of the Reno Corporation can be Effect on profit of make decision
determined from the following data: v. Bearing Division of Phantom Corp. sells 80,000 units of Part X to the outside market. Part X
Fabrication Division sells for P10.00 and has a variable cost of P5.50 and a fixed cost per unit of P2.50. Bearing
Market price of subassembly P50 has a capacity to produce 100,000 units per period. Motor Division currently purchases
Variable cost of subassembly P20 10,000 units of Part X from Bearing for P10.00. Motor has been approached by an outside
Excess capacity (in units) 1,000 supplier willing to supply the parts for P9.00. What is the effect on XYZ’s overall profit if
Assembling Division Bearing refuses the outside price and Motor decides to buy outside?
Number of units needed 900 A. no change
What is the natural bargaining range for the two divisions? B. P20,000 decrease in Phantom profits
A. Between P20 and P50 C. Between P50 and P70 C. P35,000 decrease in Phantom profits
B. Any amount less than P50 D. P50 is the only acceptable price D. P10,000 increase in Phantom profits

Minimum transfer price vi. Bearing Division of XYZ Corp. sells 80,000 units of Part X to the outside market. Part X sells
iii. Family Enterprises has two divisions: Davy and Johnny. Davy Division has a capacity to for P10.00 and has a variable cost of P5.50 and a fixed cost per unit of P2.50. Bearing has a
produce 2,000 units and is expecting to sell 1,500 units. Johnny Division wants to purchase capacity to produce 100,000 units per period. Motor Division currently purchases 10,000 units
100 units of a product Davy produces. Davy sells the product at a selling price of P100 per of Part X from Bearing for P10.00. Motor has been approached by an outside supplier willing
unit, the variable cost per unit is P25 and the fixed costs total P30,000. The minimum transfer to supply the parts for P9.00. What is the effect on XYZ’s overall profit if Bearing refuses the
price that Davy will accept is? outside price and Motor decides to buy inside?
A. P100 C. P43.75 A. no change C. P35,000 decrease in XYZ profits
B. P45 D. P25 B. P20,000 decrease in XYZ profits D. P10,000 increase in XYZ profits

iv. Assume that Division X has a product that can be sold either to outside customers on an At capacity
intermediate market or to Division Y of the same company for use in its production process. Minimum transfer price
The managers of the division are evaluated based on their divisional profits. vii. Company Y is highly decentralized. Division X, which is operating at capacity, produces a
Division X: component that it currently sells in a perfectly competitive market for P13 per unit. At the

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current level of production, the fixed cost of producing this component is P4 per unit and the intermediate market or to Fabrication Division of the same company for use in its production
variable cost is P7 per unit. Division Z would like to purchase this component from Division process. The managers of the division are evaluated based on their divisional profits.
X. What would be the price that Division X should charge Division Z? Steel Division:
A. P 7 C. P 11 Capacity in units 200,000
B. P 13 D. P 9 Number of units being sold on the intermediate market 200,000
Selling price per unit on the intermediate market P90
viii. The Black Division of Pluma Company produces a high quality marker. Unit production Variables costs per unit (including P3 of avoidable selling expense) 70
costs (based on capacity production of 100,000 units per year) follow: Fixed costs per unit (based on capacity) 13
Direct materials P 60
Direct labor 25 Fabrication Division:
Overhead (20% variable) 15 Number of units needed for production 40,000
Other information Purchase price per unit now being paid to an outside supplier P86
Sales price 120 The appropriate transfer price should be:
The Black Division is producing and selling at capacity. A. P90 C. P70
What is the minimum selling price that the division would consider as a “transfer price” to the B. P87 D. P86
Red Division on which no variable period costs would be incurred?
A. P120 C. P 88 Partial excess capacity
B. P 91 D. P117 (?) Decision
xi. Chips Division manufacturers electronic circuit boards. The boards can be sold either to
ix. Harem Corporation consists of two divisions, Mining and Builders. The Mining makes black Compo Division of the same company or to outside customers. Last year, the following
steel, a product that can be used in the product that the Builders division makes. Both activity occurred in division A:
divisions are considered profit centers. The following data are available concerning black
steel and the two divisions: Selling price per circuit board P125
Mining Builders Production cost per circuit board 90
Average units produced 150,000 Numbers of circuit boards:
Average units sold 150,000 Produced during the year 20,000
Variable mfg cost per unit P2 Sold to outside customers 16,000
Variable finishing cost per unit P5 Sold to Compo Division 4,000
Fixed divisional costs P75,000 P125,000
The Mining Division can sell all of its output outside the company for P4 per unit. The Sales to Compo Division were at the same price as sales to outside customers. The circuit
Builders Division can buy the black steel from other firms for P4. The Builders Division sells boards purchased by Compo Division were used in an electronic instrument manufactured
its product for P12. by that division (one board per instrument). Compo Division incurred P100 in additional cost
What is the optimal transfer price in this case? per instrument and then sold the instrument for P300 each.
A. P2 per unit C. P7 per unit
B. P4 per unit D. P9 per unit Assume that Chips Division’s manufacturing capacity is 20,000 circuit boards. Next year
Compo Division wants to purchase 5,000 circuits board from Chips Division rather than
x. Assume that Steel Division has a product that can be sold either to outside customers on an 4,000. (Circuit boards of this type are not available from outside sources.)

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Should Chips Division sell 1,000 additional circuit boards to Compo Division or continue to anticipated to be produced. Actual cost, however, amounts to P50 for variable costs. Fixed costs
sell them outside customers? were same as budget. However, actual output was twice as many.
A. No, because the overall profit will decrease by P35,000.
B. Yes, because the overall profit will decrease by P35,000. xiii. Actual cost per unit amounts to
C. No, because there is no change in the overall profit. A. P90 C. P115
D. Yes, because the overall profit will increase by P75,000. B. P92 D. P120

Maximum transfer price xiv. The transfer price based on actual variable costs plus 130% markup amounts to
xii. Chips Division manufacturers electronic circuit boards. The boards can be sold either to A. P90 C. P115
Compo Division of the same company or to outside customers. Last year, the following B. P92 D. P120
activity occurred in division A:
Selling price per circuit board P125 xv. The transfer price based on budgeted full cost plus 30% markup amounts to
Production cost per circuit board 90 A. P117 C. P150
Numbers of circuit boards: B. P140 D. P156
Produced during the year 20,000
Sold to outside customers 16,000
Sold to Compo Division 4,000
i. Answer: C
Sales to Compo Division were at the same price as sales to outside customers. The circuit New Operating Profit (P200,000 + P40,000) P240,000
boards purchased by Compo Division were used in an electronic instrument manufactured Less Required Returns (P1,250,000 x 0.12) 150,000
by that division (one board per instrument). Compo Division incurred P100 in additional cost New Residual Income P 90,000
per instrument and then sold the instrument for P300 each.
ii. Answer: D
Assume that Chips Division’s manufacturing capacity is 20,000 circuit boards. Next year The Fabrication division has excess capacity, therefore the division can transfer the units at
Compo Division wants to purchase 5,000 circuits board from Chips Division rather than a minimum transfer price of P50
4,000. (Circuit boards of this type are not available from outside sources.)
iii. Answer: D
Chips Division proposed that a transfer for additional 1,000 units be produced by requiring The minimum Davy would accept is the opportunity cost to make the product, which would be
its workers to work overtime. Chips Division indicated that the transfer price may be the variable cost of P25.
unreasonably high because of the overtime premium.
iv. Answer: A
What is the maximum transfer that Compo Division will accept for the additional 1,000 units? The minimum transfer price is P60 because the Division X has excess capacity
A. P 90 C. P200
B. P125 D. P300 v. Answer: C
The profit of the company will decrease by P35,000 which is the difference between the
Use the following data to answer questions 11 through 13. variable (relevant) cost and the purchase price.
N & R Company transfers a product from division N to division R. Variable cost of this product is (P9.00 – P5.5) x 10,000 units = P35,000
anticipated to be P40 a unit and total fixed costs amount to P8,000. A total of 100 units are

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xii. Answer: C
vi. Answer: A Final selling price by Compo P300
There is no change in the profit because the Motor Division did not buy from the outside Less additional processing cost 100
supplier Maximum material cost (transfer price) P200
At a transfer price of P200, Compo will not realize any profit on the additional 1,000 units
vii. Answer: B
The division is operating at capacity (zero excess capacity). Any quantity of production to xiii. Answer: A
be transferred to the Division Z must be at P13; Any price below P13, as transfer price, The actual cost is the sum of unit variable cost plus fixed cost divided by actual units
would decrease its profit. produced.
50 + (8000 ÷ 200) = P90
viii. Answer: D
Selling price (market price) P120 xiv. Answer: C
Less avoidable selling expense 15 x 20% 3 Variable cost P 50
Minimum transfer price P117 Markup (P50 x 1.3) 65
Transfer price P115
ix. Answer: B
The optimal transfer price is P4 per unit, which represents the value of using the black steel xv. Answer: D
in the Builders Division because the black steel will cost P2 to manufacture and each unit Budgeted full cost P40 + (P8,000 ÷ 100) P120
used internally is a unit that cannot be sold to external buyers. If an intermediate market Markup (P120 x 0.3) 36
exists, the optimal transfer price is the market price. Transfer price P156

x. Answer: 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 P90
Avoidable selling expense 3
Net Price 87

xi. Answer: D
Selling price charged by Compo Division P300
Selling price charge by Chips Division 125
Additional selling price P175
Less additional processing cost by Compo 100
Additional profit per unit P 75
Additional profit: 1,000 x P75 P75,000

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