TRANSFER PRICING AND RESPONSIBILITY CENTERS
Coffee Maker’s Incorporated (CMI)
Three divisions of a CMI are involved in a dispute. Division A purchases Part 101 and Division B purchases Part 201 from a third division, C. Both divisions need the parts for products that they assemble. The intercompany transactions have remained constant for several years.
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Recently, outside suppliers have lowered their prices, but Division C refuses to do so. In addition, all division managers are feeling the pressure to increase profit. Managers of divisions A and B would like the flexibility to purchase the parts they need from external parties at a lower cost and increase profitability.
The current pattern is that
- Division A purchases 2,700 units of product part 101 from Division C (the supplying division) and another 1,300 units from an external supplier.
- Division B purchases 1,100 units of Part 201 from Division C and another 700 units from an external supplier.
- Note that both divisions A and B purchase the needed supplies from both the internal source and an external source at the same time.
The managers for divisions A and B are preparing a new proposal for consideration.
- Division C will continue to produce Parts 101 and 201. All of its production will be sold to Divisions A and B. No other customers are likely to be found for these products in the short term, given that supply is greater than demand in the market.
- Division A will buy 2,000 units of Part 101 from Division C at the existing transfer price; and
- 2,000 units from an external supplier at the market price of $900 per unit.
- Division B will buy 900 units of Part 201 from Division C at the existing transfer price; and
- 900 units from an external supplier at $1,800 per unit.
Division C Data Based on the Current Agreement
|Annual volume (units)||2,700||1,100|
The fixed overhead for Division C is $1,200,000.
Computations (use Excel)
- Set up a table similar the one below to compute the difference between the current situation and the proposal for Divisions A and B.
|No. of Units||Purchase Price||Total Purchases||No. of Units||Purchase Price||Total Purchases|
|Total cost for Part 101||$||$|
|Savings to Div. A||$|
- Compute the operating income for Division C under the current agreement and the proposed agreement.
- Is the revised agreement a good idea? Support your answer with computations.
Memo (use Word)
Write a 4- or 5-paragraph memo to the division manager explaining the analysis performed. Start with an introduction and end with a recommendation. Each of the four or five paragraphs should have a heading.
Short Essay (use Word)
Start with an introduction and end with a summary or conclusion. Use headings.
Evaluate and discuss the implications of the following transfer pricing policies:
- Transfer price = cost plus a mark-up for the selling division
- Transfer price = fair market value
- Transfer price = price negotiated by the managers
Why is transfer pricing such a significant issue both from a financial and managerial perspective?
Each submission should include two files: (1) An Excel file and (2) a Word document. The Word document shows the memo first and short essay last. Assume a knowledgeable business audience and use required format and length. Individuals in business are busy and want information presented in an organized and concise manner.