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Transfer Pricing Concepts

Kringly Corporation

Two divisions of a Kringly Corporation 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.

Recently, outside suppliers have lowered their prices, but C Division is not lowering its prices. 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 then need from external parties to lower cost and increase profitability.

The current pattern is that Division A purchases 3,000 units of product part 101 from Division C (the supplying division) and another 1,000 units from an external supplier. The market price for part 101 is $900 per unit. Division B purchases 1,000 units of part 201 from Division C and another 1,000 units from an external supplier.

The mangers 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 found for these products in the short term given that supply is greater than demand in the market.

Division C will manufacture 2,000 units of part 101 for the Division A and 500 units of part 201 for the Division B.

Division A will buy 2,000 units of part 101 from Division C and 2,000 units from an external supplier at $900 per unit.

Division B will buy 500 units of part 201 from Division C and 1,500 units from an external supplier at $1,900 per unit.

Division C Data 2011 Based on the Current Agreement:

Part 101 201

Direct Materials $200 $300
Direct Labour $200 $300
Variable Overhead $300 $600
Transfer Price $1000 $2000
Annual Volume $3000 units $1000 units

Required:

Calculate the increase or decrease in profits for the three divisions and the company if the agreement is enforced. Comment on the situation and make a suggestion.

Evaluate and discuss the implications of the following transfer pricing policies:
Transfer price = cost plus a mark-up for the selling division
Transfer price = standard cost plus a mark-up for the selling division.
Transfer price = incremental cost
Transfer price = price negotiated by the managers

Solution Preview

Transfer Pricing
Kringly Corporation

Two divisions of a Kringly Corporation 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.

Recently, outside suppliers have lowered their prices, but C Division is not lowering its prices. 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 then need from external parties to lower cost and increase profitability.

The current pattern is that Division A purchases 3,000 units of product part 101 from Division C (the supplying division) and another 1,000 units from an external supplier. The market price for part 101 is $900 per unit. Division B purchases 1,000 units of part 201 from Division C and another 1,000 units from an external supplier.

The mangers for Divisions A and B are ...

$2.19