Deck 19: Transfer Pricing

Question 1

The transfer price should be chosen so that each division manager, when striving to maximize his or her own division's profits, makes the decision that maximizes the company's profit.

Answer 1

True

Question 2

A transfer price represents the amount charged when one division sells goods or services to another division of the same company.

Answer 2

True

Question 3

In a decentralized organization, the managers of profit centers and investment centers have little autonomy in deciding whether to accept or reject orders and whether to buy from inside the organization or from outside.

Answer 3

False

Question 4

The transfer price charged when one division of an organization sells goods or services to another division affects the total profit of the overall organization, assuming a transfer is made.

Question 5

The transfer pricing policy of a company can affect the incentives of autonomous division managers as they decide whether to make the transfer.

Question 6

The goal in setting transfer prices is to establish incentives for autonomous division managers to make decisions that support the goals of the division.

Question 7

Under imperfect competition, where the external market price depends on the production decisions of the producer, the opportunity cost incurred buy the company as a result of internal transfers depends on the quantity sold internally.

Question 8

A general rule that will ensure goal congruence is to set the transfer price equal to the sum of the additional outlay cost per unit incurred because goods are transferred and the opportunity cost per unit to the organization because of the transfer.

Question 9

When there is excess production capacity, there is no opportunity cost to the company and the transfer price under the general rule is only the outlay cost.

Question 10

Every unit transferred to another company division results in one less unit sold in the external market when there is no excess production capacity.

Question 11

Full-cost-based transfer prices lead the buying division to view costs that are non-unit-level costs for the company as a whole as unit-level costs to the buying division which can lead to faulty decision making.

Question 12

Basing transfer prices on artificially low distress market prices could lead the producing division to sell or close the productive resources devoted to producing the product for transfer.

Question 13

Transfer prices based upon variable costs are very useful for performance evaluations because such prices will always result in profit for the selling division.

Question 14

A common approach is to set the transfer price equal to the price in the external market and when there is no excess production capacity and perfect competition prevails, the general transfer pricing rule and the external price yield the same transfer price.

Question 15

Use of negotiation to arrive at a transfer price can lead to divisiveness and competition between participating division managers.

Question 16

In situations when the producing division has excess capacity or the external market is imperfectly competitive, the general rule and the external market price will yield the same transfer price.

Question 17

Some US presidential candidates believe that the US could collect billions per year in additional taxes if transfer pricing was calculated according to US tax laws.

Question 18

Because tax rates vary among countries, companies have incentives to set transfer prices that will increase revenues (and profits) in low-tax countries and increase costs (thereby reducing profits) in high-tax countries.

Question 19

ABC Company has two divisions in different foreign countries, X and Y. If X imposes an import duty on goods transferred in from Y, the company has an incentive to set a relatively low transfer price on the transferred goods which will minimize the duty to be paid and maximize overall company profit.

Question 20

External segment reporting accepts the use of negotiated transfer prices.

Question 21

In general, a product cost will be the highest price used as a transfer price, and the market price will be the lowest price used as a transfer price

Question 22

In an international environment, setting a transfer price below product cost may result in accusations of "dumping"
product

Question 23

Goal Congruence is a critical factor in setting transfer prices

Question 24

The market price may be an inappropriate transfer price if

A) Competitors are practicing predatory pricing to eliminate competition
B) No intermediate markets exist
C) The market for the product is distressed
D) All of the above

Question 25

Kim Bauer, a division of Waterfun Inc, produces swim suits from material it purchases from the Fabric Division. An appropriate transfer price for the material may be

A) The variable cost of selling the product
B) The full absorption price of producing the material
C) The direct labor cost of the product
D) All of the above

Question 26

When setting transfer prices, company officials need to consider

A) What will motivate managers to control costs
B) What will motivate managers to maintain the highest and best level of effort
C) What will minimize taxes, customs charges and duties
D) All of the above

Question 27

What is not an adjustment to market price that might be made during internal transfer price negotiation?

A) Adjust for production cost savings that only occur on the internal transfers
B) Commissions might not have to be paid on internally transferred products
C) No external market exists for the transferred product
D) Both A and C are adjustments

Question 28

Which of the following are drawbacks related to negotiated transfer prices?

A) Negotiations can lead to divisiveness and competition between participating division managers
B) Negotiating skill should not be the sole or dominant factor in evaluating a division manager
C) Both are drawbacks
D) Neither are drawbacks

Question 29

Which of the following is not a cost-based transfer price?

A) Standard unit-level cost
B) Actual cost
C) Standard unit-level cost plus a markup
D) Full cost (the product's unit-level cost plus an assigned portion of the higher-level costs)

Question 30

Transfer pricing is appropriate when

A) The company cannot compute residual income
B) The company only has cost centers
C) The company has profit and/or investment centers
D) The company is highly centralized

Question 31

___is one that would leave the purchasing division no worse off if there were an internal transaction.

A) A minimum transfer price
B) A cost-based transfer price
C) A maximum transfer price
D) None of the above

Question 32

___is the most appropriate method of transfer pricing when there is a perfectly competitive outside market for the product being considered for an internal transfer.

A) Variable cost pricing
B) Market price
C) Absorption cost pricing
D) Dual pricing

Question 33

What is the transfer price per unit for the component based on standard variable cost?
Ponderosa Inc. has two divisions, X and Y. Division X sells a component to Division Y. There is no external market for Division X's component. X's standard costs are as follows:

A) $23
B) $18
C) $15
D) None of the above

Question 34

Use the following to answer questions:
Simmons Company's records show the following costs for Division X's output:

The units typically are transferred from Division X to Division Y, although they may be sold externally at $98 per unit.. Beginning and ending inventories are equal to zero.

-What would be the transfer price if variable cost is used?

A) $98
B) $ 88
C) $ 75
D) $ 60

Question 35

Use the following to answer questions:
Simmons Company's records show the following costs for Division X's output:

The units typically are transferred from Division X to Division Y, although they may be sold externally at $98 per unit.. Beginning and ending inventories are equal to zero.

-What would be the transfer price if absorption cost is used?

A) $98
B) $ 88
C) $ 75
D) $ 60

Question 36

What are the problems related to market-based transfer prices for external segment reporting?

A) The segments frequently are interdependent so market prices may not really reflect the same risk in an intercompany sale as they do in third-party sales
B) Frequently market prices are either not readily available or may exist for only some products
C) Both a and b are problems
D) Neither a nor b are problems

Question 37

Use the following to answer questions:
Vallarta Inc. has two divisions, P and Q, with the following information:

The variable cost of Division Q will be incurred regardless of where it purchases the components, internally or externally.

-If Division P wants to transfer the component to Division Q at a $45 transfer price, the manager of Division Q would

A) Buy from Division P because it would be in the best interests of the company as a whole
B) Ask the manager of Division P to split the difference between the transfer price and market price, equally
C) Not want to buy from Division P since the component could be purchased in the market for $38
D) Buy from Division P as long as Division Q could supply enough quantity to make it profitable for Division Q

Question 38

Use the following to answer questions:
Vallarta Inc. has two divisions, P and Q, with the following information:

The variable cost of Division Q will be incurred regardless of where it purchases the components, internally or externally.

-Division Q would be willing to pay Division P as high as ____ for the component?

A) $25
B) $30
C) $38
D) $70

Question 39

Use the following to answer questions:
Vallarta Inc. has two divisions, P and Q, with the following information:

The variable cost of Division Q will be incurred regardless of where it purchases the components, internally or externally.

-If Division P has no excess capacity; the best transfer price under the general rule would be

A) $25
B) $30
C) $38
D) $70

Question 40

Use the following to answer questions:
Vallarta Inc. has two divisions, P and Q, with the following information:

The variable cost of Division Q will be incurred regardless of where it purchases the components, internally or externally.

-If Division P has no excess capacity; the lowest transfer price Division P would be willing to accept would be

A) $25
B) $30
C) $38
D) $670

Question 41

Use the following to answer questions:
Vallarta Inc. has two divisions, P and Q, with the following information:

The variable cost of Division Q will be incurred regardless of where it purchases the components, internally or externally.

-If Division P has excess capacity, ____ is the lowest transfer price it would be willing to accept from Division Q.

A) $25
B) $30
C) $38
D) $70

Question 42

Use the following to answer questions:
Madison Co. has two divisions: Chocolate and Mocha. The Chocolate Division produces the chocolate to be used in Mocha Instant produced by the Mocha Division. Mocha Instant sells for $2.00 a cup. Chocolate Division's costs are $1.50 per cup. Mocha Instant requires ¼ cup of Chocolate powder and additional $1.20 per cup for additional materials, labor and variable overhead.

-What is Chocolate Division's operating income per cup assuming a transfer price of $2.25 per pound?

A) $2.25
B) $1.75
C) $0.75
D) $0.50

Question 43

Use the following to answer questions:
Madison Co. has two divisions: Chocolate and Mocha. The Chocolate Division produces the chocolate to be used in Mocha Instant produced by the Mocha Division. Mocha Instant sells for $2.00 a cup. Chocolate Division's costs are $1.50 per cup. Mocha Instant requires ¼ cup of Chocolate powder and additional $1.20 per cup for additional materials, labor and variable overhead.

-What is the Mocha Division's operating income for 4 cups of Mocha Instant, assuming the transfer price of the ingredient is set at $2.25 per cup.

A) $2.25
B) $1.35
C) $1.10
D) $0.95

Question 44

Which of the following is an environmental factor affecting performance evaluation (and business) in a multinational firm?

A) Sociological factors
B) Political factors
C) Economic factors
D) All are factors

Question 45

Use the following to answer questions:
Fjord Inc. has several plants located around the world. The plant in Norway manufacturers a component that is used in a product manufactured by one of the U.S. plants. The Norway plant has excess capacity. The current tax rate in Norway is 40%, while the U.S. corporate tax rate is 30%.

-What is the minimum transfer price the Norway plant would accept?

A) $ 150.00
B) $ 59.00
C) $ 94.00
D) $102.00

Question 46

Use the following to answer questions:
Fjord Inc. has several plants located around the world. The plant in Norway manufacturers a component that is used in a product manufactured by one of the U.S. plants. The Norway plant has excess capacity. The current tax rate in Norway is 40%, while the U.S. corporate tax rate is 30%.

-What is the maximum transfer price the U.S. plant would pay?

A) $ 150.00
B) $ 59.00
C) $ 94.00
D) $102.00

Question 47

Use the following to answer questions:
Fjord Inc. has several plants located around the world. The plant in Norway manufacturers a component that is used in a product manufactured by one of the U.S. plants. The Norway plant has excess capacity. The current tax rate in Norway is 40%, while the U.S. corporate tax rate is 30%.

-What is the transfer price that would be the best for Fjord Inc.

A) $ 150.00
B) $ 59.00
C) $ 94.00
D) $102.00

Question 48

A transfer price set as 135 percent of absorption costs is an example of a

A) Market pricing agreement
B) Cost-plus approach
C) Dual pricing approach
D) Replacement cost approach

Question 49

A company with divisions both domestic and international would not consider which of the following when determining transfer prices?

A) International and U.S. taxation
B) Tariffs or import duties
C) Income or dividend payment restrictions
D) International or national holidays

Question 50

Mason Company wants to maximize the cash it recovers from its division in Norway. The country places restrictions on the amount of funds that can be transferred outside its borders. Several plans have been considered but which one, if implemented, will achieve Mason's goal?

A) Maximize the transfer price of goods transferred into Norway
B) Minimize the transfer price of goods transferred into Norway
C) Minimize the transfer price of goods shipped out of Norway
D) Maximize the transfer price of goods shipped out of Norway

Question 51

Dual transfer prices are useful because

A) They are a means of creating profit for the selling division
B) They allow the purchasing division to earn a profit
C) They do not require an intermediate market
D) All of the above

Question 52

Use the following to answer questions:
The Furniture Express has two divisions: cutting and assembly and finishing. The company makes quality furniture. The costs for its completed tables are:

While the tables usually are transferred to assembly and finishing, there is a market for the unassembled-unfinished tables where they sell for $130 for a complete set of parts for a table. The company expects a 25 percent markup as its minimum profit level.

-If the company uses negotiated pricing to set a transfer price, it should be a

A) Maximum of $130
B) Minimum of $103
C) Maximum of $100
D) Minimum of $95

Question 53

Use the following to answer questions:
The Furniture Express has two divisions: cutting and assembly and finishing. The company makes quality furniture. The costs for its completed tables are:

While the tables usually are transferred to assembly and finishing, there is a market for the unassembled-unfinished tables where they sell for $130 for a complete set of parts for a table. The company expects a 25 percent markup as its minimum profit level.

-What would be the transfer price is Furniture Express uses absorption costing and the markup?

A) $130.00
B) $118.75
C) $106.75
D) $ 95.00

Question 54

Use the following to answer questions:
The Furniture Express has two divisions: cutting and assembly and finishing. The company makes quality furniture. The costs for its completed tables are:

While the tables usually are transferred to assembly and finishing, there is a market for the unassembled-unfinished tables where they sell for $130 for a complete set of parts for a table. The company expects a 25 percent markup as its minimum profit level.

-What is the transfer price for Furniture Express using variable cost without a markup?

A) $ 95
B) $ 90
C) $ 85
D) $130

Question 55

Which of the following statements about transfer pricing is true?

A) The transfer price charged when one division of an organization sells goods or services to another division does not affect the total profit of the overall organization, assuming the transfer is made
B)The transfer price affects the profit measurement for both the selling and buying divisions of the organization because the divisions are buying and selling from and to each other
C) The transfer pricing policy can affect the incentives of autonomous managers as they decide whether to make the transfer
D) All are true statements

Question 56

Which of the following statements about transfer pricing is false?

A) The goal in setting transfer prices is to establish incentives for autonomous division managers to make decisions that support the overall goals of the organization
B) The transfer price should be chosen so that each division manager, when striving to maximize his or her own division's profit, makes the decision that maximizes the company's profit
C) The goal in setting the transfer price is to provide incentives for each division manager to act in his or her best interests
D) All are true statements

Question 57

The general rule for transfer pricing is stated as:

A) Transfer price = additional outlay cost per unit incurred because goods are transferred
B) Transfer price = opportunity cost per unit to that organization because of the transfer
C) (A - B), above
D) (A + B), above

Question 58

When there is excess capacity in the selling division, which of the following statements is false?

A) There is no opportunity cost because the selling division can still meet external demand
B) The general rule would show a transfer price equal to outlay cost
C) The demand for the selling division's product from all sources is less than the plant's production capacity
D) All are true statements

Question 59

What causes difficulties in measuring opportunity cost when implementing the general rule?

A) Uniqueness of the transferred goods or services
B) Imperfect competition
C) No outside market for the product being considered for transfer
D) All are potential difficulties

Question 60

Which is not a way to set a transfer price?

A) External market price
B) Negotiation
C) Replacement cost
D) Standard unit-level cost

Question 61

Division A is operating at 60 percent of its 400,000 unit capacity. Required:
1) What is the minimum transfer price Division A should charge for internal transfers?
2) What is the maximum price Division B would be willing to pay?
3) Why should Division A reduce its price to Division B?
Division A of Friedman Inc. transfers its product to Division B. Division B can either buy the item internally or externally (cost = $73 each). Division A has just completed its annual cost update as follows:

Question 62

The output of Division M, which sells for $10/unit externally, is used by Division N. Required: Compute the transfer price for a unit of Division M's output using:
1) market price
2) variable production cost plus 30 percent
3) absorption cost plus 25 percent
4) variable cost
5) total cost plus 10 percent
The following costs exist for Division M of Clark Corp.

Question 63

Grupe Inc. has a division located in Spain and another in the U.S. the Spanish division produces a part needed for the product made by the U.S. division. There is substantial excess capacity in the Spanish division. The tax rate of the Spanish division is 35% and U.S. division tax rate is 30%. The part sells externally for $75 and the Spanish division's manufacturing costs are:

Required:
1) What would be the lowest acceptable transfer price for the Spanish division?
2) What would be the highest acceptable transfer price for the U.S. division?
3) What would be the transfer price that would be the best for Grupe Inc and why?

Question 64

Explain how the presence or absence of excess capacity affects transfer pricing policy?

Question 65

Briefly describe the differences between a market-price and a negotiated-price transfer price.

Question 66

Discuss briefly the issues of goal and behavioral congruence that impact a transfer pricing policy.

Question 67

Division A has no excess production capacity. Required:
1) In order to ensure the best use of the productive capacity of A, what transfer price should be set by Division A and what effect does this transfer price have on the overall margin for the company? Is the answer goal congruent under the general rule?
2) Should Division B accept a special order for its product if the selling price is reduced to $70. Use your answer from 1 and explain.
3) Would your answer to 2 change if Division A had excess capacity? Explain.
The following information is available for the two divisions of CPAECON Co.:

Question 68

Litwak Inc. has two divisions: production and marketing, which it treats as profit centers. Because the production division has no marketing capabilities, it does not have a traditional market price to consider and the company does not want to use negotiation.
Required: Discuss the following cost-based transfer prices along with problems that might exist for each.
1) Standard unit-level cost
2) Absorption (full) cost
3) Actual cost

Question 69

During the current year Ruby Company's foreign division A incurred production costs of $4 million for units that are transferred to its other foreign division, B. Costs in Division B, outside of the costs of production of the final product are $8 million. These are third-party costs. Sales revenue for the final product for Division B is $30 million. Other companies in the same country import a similar type of part as Division B at a cost of $7 million. Ruby has set its transfer price at $14 million, justifying this price because of the special controls it has on the operations in Division A as well as its special manufacturing method. The tax rate in the country where Division A is located is 40% while the tax rate for Division B's country is 70%.
Required:
1) What would Ruby's total tax liability for both divisions be if it used the $7 million transfer price?
2) What would the liability be if it used the $14 million transfer price?

Question 70

Mr. Dessler, the Production V.P. is looking at two of the Divisions that report to him. These divisions are viewed as profit centers by the company. He has called in the head of Division A which provides a part used by Division M because he has noticed that Division M is going to an external supplier for the part. Mr. Araz, the head of Division A, tells him that he has set the transfer price at $38 per part even though the external price is $33 per part. The standard unit-level cost is $22. "I have set the $38 price because I am operating with no excess capacity and do not want to have the internal transfer to Division M. I have some good external customers and do not want to lose them by selling internally. If I had excess capacity, I would willing sell to Division M at a lower price."
Mr. Dessler says that he has to think about this situation because something doesn't seem right to him. After Mr. Araz leaves the office, he calls his friend in the controller's department for some help. Required: You are that friend. Explain to Mr. Dessler the differences in transfer pricing when there is no excess capacity and when there is excess capacity and what Mr. Araz is doing wrong.

Question 71

Ms. Marwan, one of the marketing managers, has come to the meeting with a number of reports about one of her products. The Marketing V.P. sees her agitation and asks her what the problem is. "Well, the product made by the East Coast Division is losing sales even after the price had been lowered drastically. The manager of the division is threatening to close because of the reduced demand."
The Marketing V.P. asks why the lowered prices are a problem and Ms. Marwan says that, according to the manager, the price used to transfer the goods to Southern Division are based on market price and, with the lowered market price, the unit-level costs are no longer being covered and he is losing money on every transfer as well as every third-party sale.
Required: Explain further to the Marketing V.P. the issues involved in transfer pricing when there are distressed market prices.

Question 72

Whey Inc. has just purchased a foreign subsidiary that makes a component used by one of the domestic divisions. Ms. Bierko, the controller, has been asked about issues that should be considered in establishing a transfer price for the new subsidiary. Since this is Wheys' first foray into the multinational arena, there is little to no expertise in international issues in the company. Ms. Bierko has told her boss that she will get back to him with a report as to the issues to be considered. She then calls a friend of hers at a branch of one of the big-4 CPA firms that deals with international issues for some help.
Required: What is the basic information that Ms. Bierko will be given by her friend?

Question 73

Mr. Cummings, the controller, and Ms. Trevino, the CPA, are going over the final versions of the financial statements before the audit is completed. The last part of the work being discussed is the segment reporting section. Mr. Clark is questioning the comments made by Ms. Trevino regarding the use of negotiated transfer prices by the firm for the major segments being shown.
Required: Explain to Mr. Cummings the issue according to the FASB (SFAS 14).

Question 74

Washington Farms Inc. is in the process of decentralizing. However, they have discovered that one of the divisions that they want to set up as a profit center does not have an external market for its product. Mr. Raines, the manager of the division, has come to Ms. Almeida, the controller, asking what he should use as a transfer price because of the lack of a market price. The division would be transferring its product internally to another division that uses the part as input to its product.
Required: Explain, as Ms. Almeida, the options available other than market price.

Question 75

Dalin Inc. has two divisions: the Liquid Division that manufactures chocolate and sells the liquid both internally and externally; and the Bar Division that manufactures candy bars. The Bar Division currently purchases liquid chocolate from the Liquid Division for $6 a gallon. They recently received a bid from the Sly Company to provide liquid chocolate at a price of $4.50 a gallon. The Liquid Division does not want to meet the price, saying it will cost them money because their costs are $5 per gallon.

Required:
1) What is the Liquid Division Income: a) Currently
b) If it accepts the $4.50 price
c) If it does not accept the $4.50 price
2) What other issues need to be considered

Question 76

Jonah, Inc has two operating divisions in a decentralized structure. Division X is located in the US and produces the Teeth X, which is an input to Division Y's WhaleY. Division Y is located in the South of France. Division X uses idle capacity to produce Teeth X. Teeth X has a US domestic market price of $60. Its variable costs are $25 per unit. Jonah's US tax rate is 40% of income.
In addition to the transfer price for each Teeth X "purchased"
from DivisionX, Division Y also pays a shipping fee of $15 per unit. The WhaleY requires an additional $10 to produce and sells in France for an equivalent of $115 U.S. dollars. The company's French tax rate is 70% of income. Assume French tax laws permit transferring at either variable cost or market price.
1) What income will Jonah, Inc receive if the variable cost is used for the transfer price?
2) What income will Jonah, Inc receive if the market price is used for the transfer price?
3) What transfer Price is economically optimal for Jonah, Inc.