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Webly Corporation Transfer Pricing.

Webly Corporation
Two divisions of a Webly 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 they 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.
â?¢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.
â?¢Division C will manufacture 2,000 units of part 101 for the Division A and 500 units of part 201 for the Division B.
â?¢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.
â?¢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 2012 Based on the Current Agreement
Part 101
Direct materials $200
Direct labor $200
Variable overhead $300
Transfer price $1,000
Annual Volume 3,000 units

Division C Data 2012 Based on the Current Agreement
Part 201
Direct materials $300
Direct labor $300
Variable overhead $600
Transfer price $2,000
Annual Volume 1,000 units

Required:

â?¢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.

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

Solution Preview

If the company insists on enforcing the current transfer policy, that is, the current agreement of having Division A buy 3,000 units from Division C and Division B buying 1,000 units from Division C, the revenues are higher than market in Division C and the costs are higher than market in Divisions A and B. So, this distorts the operating performance in all three divisions but is offset in the consolidated firm (see Excel spreadsheet attached). In a decentralized firm, this makes it difficult to evaluation managers. In a centralized firm, where individual division performance is not an issue, this is less troublesome.

However, there is more to the picture. If Division A and B were free to obtain their supplies from the lower-priced market sources, would Division C be able to produce and sell to replace this lost volume? If so, then it would benefit the consolidated firm to have Division A and B obtain the lower prices and divert Division C to the making of other sellable products. However, if Division C would be otherwise idle without selling part 101 and 201 to the divisions, and therefore lose the unavoidable fixed costs that continue even if activity ceases, then it isn't quite so easy. In ...

Solution Summary

Your tutorial is 813 words and discusses the four mentioned policies (pros and cons). Two suggestions are made for this firm.

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