GROCERY STOREHOUSE- AN EXAMPLE

If West Coast Plantations has sufficient idle capacity (3000 crates) to satisfy
Grocery Mart’s demands (1000 crates), without sacrificing sales to other
customers, then the lowest and highest possible transfer prices are computed
as follows:

Selling division’s lowest possible transfer price:

Buying Divisions highest possible transfer price:

Therefore, the range of acceptable transfer price is $10 - $20

If West Coast Plantations has no idle capacity (0 crates) and must sacrifice
other customer orders (1000 crates) to satisfy Grocery Mart’s demands (1000
crates), then the lowest and highest possible transfer prices are computed as
follows:

Selling division’s lowest possible transfer price:

Buying Divisions highest possible transfer price:

Therefore, there is no range of acceptable transfer prices

If West Coast Plantations has some idle capacity (500 crates) and must
sacrifice other customer orders (500 crates) to satisfy Grocery Mart’s demands
(1000 crates), then the lowest and highest possible transfer prices are
computed as follows:

Selling division’s lowest possible transfer price:

Buying Divisions highest possible transfer price:

Therefore, the range of acceptable transfer prices is $17.50 - $20.00

QUICK CHECK:
Bronx Corporation’s Gauge Division manufactures and sells product
no. 24 which is used in refrigerator systems. Per-unit variable
manufacturing and selling costs amount to $20 and $5 respectively.
The Division can sell this item to external domestic customers for
$36 or, alternatively transfer the product to the company’s
Refrigerator Division. Refrigeration is currently purchasing a similar
item from Taiwan for $33. Assume use of the general transfer-pricing
rule.

A. What is the most that the Refrigeration would be willing to pay

the Gauge Division for one unit?
- It would be willing to pay a maximum of $33, its current
outside purchase price
B. If Gauge has excess capacity, what transfer price would the
Division’s Management set?
- The general rule holds that the transfer price be set at
the sum of outlay cost and opportunity cost. Thus ($20 +
$5) + $0 = $25
C. If Gauge had no excess capacity, what transfer price would the
Division’s Management set?
- In this case, the transfer price would amount to $36. ($20
+ $5) + ($36 - $20 - $5)
D. Repeat Part C, assuming that Gauge was able to reduce the
variable cost of internal transfers by $4 per unit.
- The transfer price would be $32. ($20 + $5 - $4) + ($36 -
$20 - $5)
Illustration: Cost-based Transfer Price
● Omni Inc. has a number of divisions, including Alpha Division,
producer of circuit boards and Delta division, a heating and air
conditioning manufacturer
● Alpha Division produces the cb-117 model that can be used by
Delta Division in the production of thermostats that regulate the
heating and air conditioning systems. The market price of the
cb-117 is $14. Cost information for the cb-117 model is:
Variable product cost $2.50
Fixed Cost 6.50
Total product cost $9.00
● Delta needs 30,000 units of model cb-117 per year. Alpha Division
is at full capacity.
REQUIRED:
1. If Omni Inc. has a transfer pricing policy that requires transfer at full
product cost, what would the transfer price be? Do you suppose
that Alpha and Delta divisions would choose to transfer at that
price?
Variable product cost $2.50 Market Price $14
Fixed Cost 6.50
Total product cost $9.00
- The full cost transfer price is $9. Delta Division would be
delighted with that price but Alpha Division would refuse to
transfer since $14 could be earned from the outside market.
2. If Omni Inc. has a transfer pricing policy that requires transfer at full
product cost plus 25%, what would the transfer price be? Do you
suppose that Alpha and Delta divisions would choose to transfer at
that price?
Variable product cost $2.50 Market Price $14
Fixed Cost 6.50
Total product cost $9.00
Multiply by 1 + Mark-up% 2.25
Cost-plus transfer price 11.25
 - Delta Division would be delighted with that price but Alpha
Division would refuse to transfer since $14 could be earned
from the outside market.
3. If Omni Inc. has a transfer pricing policy that requires transfer at
variable product cost plus a fixed fee of $12 per unit, what would
the transfer price be? Do you suppose that Alpha and Delta
divisions would choose to transfer at that price?
Variable product cost $ 2.50 Market Price $14
Plus Fixed Fee 12.00
Transfer Price $14.50
- In this case, Alpha would be delighted but Delta would refuse,
since it can buy all it needs on the outside market for $14.
4. What if Alpha Division plans to produce and sell only 65,000 units of
cb-117 next year? The Omni Inc. policy is that all transfers be at full
cost. Which Division sets the minimum transfer price, and what is
it? Which division sets the maximum transfer price, and what is it?
Do you suppose that Alpha and Delta divisions would choose to
transfer?
Variable product cost $2.50 Market Price $14
Fixed Cost 6.50
Total product cost $9.00
- Minimum Transfer Price= $9 (the full cost of production). This
price is set by Alpha, the selling division. Maximum transfer
price= $14. This is the market price and is set by Delta, the
buying division. Yes both divisions would be willing to accept
the transfer price of $9 per unit.
ACTIVITY 1
SB-44 Company’s Division “S” (selling division) produces a small tool used by other
companies as a key part in their products. Cost and sales data related to the small tool
are given below:
● Selling price per unit P50
● Variable cost per unit P30
● Fixed cost per unit P12
● Based on capacity of 40,000 tools per year
The company’s Division B (buying division) is introducing a new product that will use
the same tool such as the one produced by Division S. An outside supplier has quoted
the Division B a price of P48 per tool

Division B would like to purchase the tools from Division S, only if an acceptable
transfer price can be worked out.
REQUIRED: (WITH SOLUTIONS)
Division S has ample idle capacity to handle all the Division B’s needs:
A. What is the minimum TP for Division S?
- 30 (variable cost)
B. What is the maximum TP for Division B?
- 48 (market price)
Division S is presently selling all the tools it can produce to outside customers:
A. What is the minimum transfer price?
- 50 (Selling price)
B. Shall Division B purchase the tools from Division S or from the outside supplier?
- No, because the Division has a higher purchase price with the amount of
50 while the outside supplier has an amount of 48
Division S is presently selling 36,000 tools per year to outside customers and that
Division B requires 10,000 tools per year and:
A. What is the minimum TP for DIvision S?
- 42 {[10k-4k(the excess) = 6k]} then {[(50-30)*6000/1000 = 12 + 30 = 42]}
B. They will buy from the Division S
ACTIVITY 2
The Gamma Division of Vaughan Corporation produces electric motors, 20% of which
are sold to Vaughan’s Omega Division and 80% to outside customers. Vaughan treats
its divisions as profit centers and allowas division managers to choose whether to sell
or buy from internal divisions. Corporate policy requires that all interdivisional sales and
purchases be transferred at variable cost. Gamma’s Division estimated that all sales
and standard cost data for the year ended December 31, based on a capacity of 60,000
units, are as follows
Omega Outsiders

Unit sales 12,000 48,000

 Sales 660,000 5,760,000

Less: Variable Cost 660,000 2,640,000

Contribution Margin 0 3,120,000

Less:Fixed Cost 175,000 900,000

Operating Income(loss) (175,000) 2,220,000

Gamma has an opportunity to sell the 12,000 units shown above to an outside
customer at 80 per unit. Omega can purchase the units it needs from an outside
supplier for 92 each.
REQUIRED: (WITH SOLUTION)
A. Assuming that Gamma desires to maximize operating income, should it take on
the new customer and discontinue sales to Omega? Why? Answer this using
Gamma’s perspective.
- Selling price outside = 80
- TP if excess = 660k/12k= 55
- If no excess = 55 + CM of 0 = 55
- In Gamma’s POV, it would be more beneficial to sell it to outside
customer for 80 than to transfer it to Omega Division for 55 as they will
have an income of 300k
B. Assume that Vaughn allows division managers to negotiate transfer prices. The
managers agreed on a tentative price of 80 per unit, to be reduced by an equal
sharing of additional Gamma income that results from the sale to Omega of
12,000 motors at 80 per unit. On the basis of this info, compute the company’s
new transfer price
- 80(selling price) - 55(old transfer price) = 25
- 12,000 units x 25 = 300,000
- 300,000/2 = 150,000
- 150,000/12,000 = 12.5
- 80 - 12.5 = 67. 5 is the new transfer price