Transfer Pricing – Lecture Notes

Kagawad Products, Inc. has a Valve Division that manufactures and sells a standard valve as follows:

Plant Capacity 100,000

Selling price to outside customers on P 30.00

the intermediate market
Variable costs per unit 16.00
Fixed costs per unit (based on capacity) 9.00
Total Profit per unit P 5.00

The company has a Pump Division that could use this valve in the manufacturer of one its pumps. The Pump
Division is currently purchasing 10,000 valves per year from an overseas supplier at cost of P29 per valve.

Assumption 1. That the Valve Division has ample idle capacity to handle all of the Pump Division’s needs.
Answer the following questions:

1. Is the fixed cost relevant in deciding for this problem?

a) Yes, since it is part of product cost under absorption costing.
b) Yes, since it will become P8.18 per unit resulting to lower cost of P24.18.
c) No, since fixed cost will be never relevant costs.
d) No, since fixed do not usually change with the increase in production capacity as long as there
is the idle capacity, and all other factors remaining constant.

2. What should be the minimum transfer price between constant?

a. P24.18
b. P16.00
c. P21.00
d. P30.00
e. P29.00

Assumption 2. That the Valve Division is selling all that it can produce to outside customers on the
intermediate market.

1. How much is the relevant unit cost?

a. P16.00
b. P17.00
c. P25.18
d. 30.00

2. What should be the transfer price between the two divisions?

a. Within the range of P17 - P29
b. Within the range of P16 – P30
c. P17, at the least
d. P30, at the least

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Transfer Pricing – Lecture Notes
3. At this price, will any transfer be made?
a. Yes, for an incremental revenue of P290,000
b. No, for a net incremental costs of P170,000
c. No, for a net savings of P10,000
d. Yes, for an incremental profit of P290,000

Assumption 3. That the Valve Division is selling all that it can produce to outside customer on the
intermediate market. Also assume that P3 in variable expenses can be avoided on intra-company sales, due
to reduced selling costs.

1. How much is the relevant cost per unit?

a. P13.00
b. P17.00
c. P22.18
d. P27.00
e. P30.00

2. What should be the transfer price between the two divisions?

a. P27 – P29
b. P27 – P30
c. P30 at the least
d. P29 at the least

3. If pump Division orders from the Valve Division P28.00, what will be the effect to the whole
organization’s income?
a. P 10,000 Net Decrease
b. Net cash outlay of P270,000
c. Net savings of P 10,000
d. Net cash outlay P280,000

Assumption 4. That the Pump Division needs 20,000 special valves per year that is to be supplied by the
Valve Division. The Valve division’s variables costs to manufacturer and the ship the special valve would be
P20 per unit. To produce these valves, the Valve division would have to give up one half of its production of
the regular valves (that is, slash its production of the regular from 100,000 units per year to 50,000 units per
year). You can assume that the Valve Division is selling all of the regular valves that it can produce to outside
customer on the intermediate market.

If the Valve Division decides to produce the special valves for the Pump Division, what transfer price should it
charge per valve?

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