1.

Performance report - shows the budgeted and actual amounts and the
variances between these amounts for each responsibility center. It facilitates
management by exception where in executive’s attention are directed to
important differences between actual and budgeted amounts.

Proforma Segmented Income Statement

Sales xx
Less: Variable cost xx
Segment Contribution Margin xx
Less: Controllable fixed cost xx

Segment Controllable Margin xx

Less: Nonconrollable but traceable fixed
cost xx
Segment Margin xx

2. Segmented Income Statement – shows the revenue earned by the segment

being evaluated together with the cost traceable to it. For the purpose of
preparing a segmented income statement, one must familiarize with the following
kinds of costs:
a. Traceable cost – any cost that can be identified or attributed to a certain
segment or division of a company
b. Common Cost – any cost that cannot be identified or attributed to a
certain segment or division of a company. 
c. Controllable cost – any cost subject to a substantial influence of a
particular individual. A cost may be uncontrollable at a certain segment
level but controllable at a higher segment level.
d. Variable Cost – any cost that changes in direct proportion to a change in
an organization activity, also called cost driver
e. Fixed Cost – any cost that does not change in total as activity changes

ROI can be improved by increasing the margin and/or the capital turnover as
illustrated below: 
 TRANSFER PRICING
GENERAL TRANSFER-PRICING RULE

TRANSFER Additional outlay cost per unit Opportunity cost per unit to the
 PRICE = incurred because goods are + organization because of the
transferred transfer
 
The general rule specifies the transfer price as the sum of two cost components.  The
first component is the outlay cost incurred by the division that produces the goods or
services to be transferred.  Outlay costs will include the direct variable costs of the
product or service and any other outlay costs that are incurred only as a result of the
transfer.  The second component is the opportunity cost incurred by the organization as
a whole because of the transfer. 

Scenario 1:  No Excess Capacity

Suppose the Food Processing Division can sell all the bread it can produce to outside
buyers at a market price of P11 per rack.  Since the division can sell all of its
production., it has no excess capacity.  excess capacity exists only when more goods
can be produced than the producer is able to sell, due to low demand for the product.

What transfer price does the general rule yield under this scenario of no excess
capacity?  the transfer price is determined as follows:

Outlay cost:
Standard variable cost of production P 7.00 per rack
Standard variable cost of transportation     0.25 per rack
Total outlay cost P 7.25 per rack
Opportunity cost:
Selling price per unit in external market P11.00 per rack
Less: Variable cost of production and transportation     7.25 per rack
Opportunity cost (Foregone contribution margin) P  3.75 per rack
General Transfer Pricing Rule:
(P7.25 plus P3.75)  = P11

Scenario 2:  Excess Capacity

Now let us change our basic assumption, and suppose the Food Processing Division
has excess capacity.  This means that the total demand for its bread from all sources,
including the Regional and Capital Divisions and the external market, is less than the
bakery’s production capacity.

General Transfer Pricing Rule:

(P7.25 plus P0.00)  = P7.25

PROBLEM EXERCISES

Problem 1 (WHITECOTTON) 112

Avery Company has two divisions, Polk and Bishop. Polk produces an item that
Bishop could use in its production. Bishop currently is purchasing 25,000 units from an
outside supplier for P24 per unit. Polk is currently operating at less than its full capacity
of 600,000 units and has variable costs of P12 per unit. The full cost to manufacture the
unit is P18. Polk currently sells 450,000 units at a selling price of P25.50 per unit.

a. What will be the effect on Avery Company's operating profit if the transfer is made
internally?
Answer: The profit will increase by a difference between variable and manufacture cost:
25,000 x (P24-P12) = P 300,000 profit

b. What is the minimum transfer price from Polk's perspective?

Answer: P12 minimum price for Polk

c. What is the maximum transfer price from Bishop's perspective? 

Answer: P24-market price

Problem 2 (WHITECOTTON)113

Sandy Company has two divisions, Huron and Cortez. Huron produces an item
that Cortez could use in its production. Cortez currently is purchasing 50,000 units from
an outside supplier for P24 per unit. Huron is currently operating at full capacity of
600,000 units and has variable costs of P13.50 per unit. The full cost to manufacture the
unit is P19.50. Huron currently sells 600,000 units at a selling price of P25.50 per unit.

a. What will be the effect on Sandy Company's operating profit if the transfer is made
internally?
Answer: The profit will decrease since there is a difference between market price for
selling division and market price for buying division: 50,000 x(P24-P25.50) = (P 75,000)
less on profit

b. What is the minimum transfer price from Huron's perspective?

Answer: P25.50 market price

c. What is the maximum transfer price from Cortez' perspective? 

Answer: P24 market price

Problem 3 (WHITECOTTON)-119
Washington Company has two divisions, Jefferson and Adams. Jefferson
produces an item that Adams could use in its production. Adams currently is purchasing
100,000 units from an outside supplier for P78.40 per unit. Jefferson is currently
operating at full capacity of 900,000 units and has variable costs of P46.40 per unit. The
full cost to manufacture the unit is P59.20. Jefferson currently sells 900,000 units at a
selling price of P86.40 per unit.

a. What will be the effect on Washington Company's operating profit if the transfer is
made internally?
Answer: The profit will decrease with the difference of market price for selling and
market price for buying division: 100,000 x (P78.40-P86.40) = (P 800,000) less on profit

b. What will be the change in profits for Jefferson if the transfer price is P67.20 per unit?
Answer: 100,000 x (P67.20-P86.40) = (P 1,920,000) less on profit

c. What will be the change in profits for Adams if the transfer price is P67.20 per unit? 
Answer: 100,000 x (P78.40-P67.20) = P 1,120,000 profit

Problem 4 (WHITECOTTON)-115
Sugar Company has two divisions, Lenox and Berkshire. Lenox produces an
item that Berkshire could use in its production. Berkshire currently is purchasing
100,000 units from an outside supplier for P43 per unit. Lenox is currently operating at
full capacity of 750,000 units and has variable costs of P28 per unit. The full cost to
manufacture the unit is P35. Lenox currently sells 750,000 units at a selling price of P44
per unit.

a. What will be the effect on Sugar Company's operating profit if the transfer is made
internally?
Answer: The profit will decrease because of the difference between the market
price of selling division and market price of buying division: 100,000 x (P43-P44) =
(P 100,000) less on profit

b. What will be the change in profits for Lenox if the transfer price is P40 per unit?
Answer: 100,000 x (P40-P44) = (P 400,000) less on profit

c. What will be the change in profits for Berkshire if the transfer price is P40 per unit? 
Answer: 100,000 X (P43-P40) = P 300,000 profit

Problem 5 (AGAMATA)
Lancelot Corporation has two divisions.  Manila Division and Pasig Division.  Manila
Division produces product Cream with the following data:
Unit sales price P120
Production cost per unit:
Materials 10
Direct labor 15
Variable overhead 20
 Fixed overhead (based on normal
capacity of 40,000 units) 10
Marketing and general expenses:
Variable 6
Fixed 4
Maximum capacity 50,000 units
Units sold to outside customers 40,000 units
Pasig Division, a newly established division, needs 5,000 units of Product Cream.  An
outside supplier which produces Cream with comparable quality as that of Manila
Division has quoted Pasig Division to supply the 5,000 units for P70. Pasig Division
would sell product Cream to its customers for P120 after incurring marketing and
packaging costs of P20 per unit.  Manila Division would not incur any variable marketing
expense if the 5,000 units are sold to Pasig Division.

Pasig Division would use P200,000 incremental average assets for the production and
sale of 5,000 units of product Cream.  Manila Division uses an average of P2,000,000 in
assets to produce Cream and generate an income of P1,200,000 from its customers.

Required:
1. For the 5,000 units to be ordered by Pasig Division, determine the ROI for Manila
Division, Pasig Division, and Lancelot Corporation, assuming:
a. An inter-divisional transfer price of P45.
b. An inter-divisional transfer price of P70.
c. Pasig Division buy from an outside supplier of P70.
2. For Lancelot Corporation, how much is the net advantage (disadvantage) if Pasig
Division buys the 5,000 units from Manila Division rather from an outside
supplier?
2. What would be the minimum transfer price between Manila and Pasig Division?
2. What would be the minimum transfer price assuming Manila Division is already
operating at maximum capacity?

Problem 6  Multinational Transfer Pricing. (AGAMATA)

AFB Corporation maintains different related corporations all over the world.  One of its
divisions is located in Indonesia while the other is in the Philippines.

The Indonesian Division is in need of a part, with part code labelled as “X44”, now being
produced by the Philippine Division.  The Indonesian Division is presently purchasing
the said part from a local supplier.  Relevant data are as follows:
PHIL Division IND Division Local IND
Supplier
Unit sales price P40 P120 P55
Other unit variable production cost   21     32 ?
Shipping costs if the part is shipped   15
Tax rate   40%     20%
Required:
Determine the consolidated profit after tax of AFB Corporation based on the following
decision alternatives:
1. The transfer price is at market and the shipping cost is shouldered by the selling
division.
2. The transfer price is at market and the shipping cost is shouldered by the buying
division.
3. The transfer price is at cost and the shipping cost is shouldered by the selling
division.
4. The transfer price is at cost and the shipping cost is shouldered by the buying
division.
5. The Indonesian Division buys from the local supplier and the Philippine Division
sells its produce in the domestic market.

Problem 7 (HILTON)
Clearview Window Company manufactures windows for the home-building industry. The
window frames are produced in the Frame Division. The frames are then transferred to
the Glass Division, where the glass and hardware are installed. The company’s best-
selling product is a 1000 mm x 1250 mm, doublepaned operable window.

The Frame Division also can sell frames directly to custom homebuilders, who install
the glass and hardware. The sales price for a frame is P 80. The Glass Division sells its
finished windows for P 190. The markets for both frames and finished windows exhibit
perfect competition.

The standard variable cost of the window is detailed as follows:

Frame Division Glass Division

Direct material P 15 P 30 *
Direct labor   10 15
Variable   30 30
overhead
Total P 55 P 75

* Not including the transfer price for the frame.

Required:
1. Assume that there is no excess capacity in the Frame Division.
a. Use the general rule to compute the transfer price for window frames.
Answer: 160
b. Calculate the transfer price if it is based on standard variable cost with a 10
percent markup.
Answer: 143
2. Assume that there is excess capacity in the Frame Division:
Answer: 130
a. Use the general rule to compute the transfer price for window frames.
b. Explain why your answers to requirements (1a) and (2a) differ:
 c. Suppose the predetermined fixed-overhead rate in the Frame Division is 125
percent of direct labor cost. Calculate the transfer price if it is based on standard
full cost plus a 10 percent markup.
Answer: 50
d. Assume the transfer price established in requirement (2c) is used. The Glass
Division has been approached by the U.S. Army with a special order for 1,000
windows at P 145. From the perspective of Clearview Window Company as a
whole, should the special order be accepted or rejected? Why?
e. Assume the same facts as in requirement (2d). Will an autonomous Glass
Division manager accept or reject the special order? Why?
f. Comment on any ethical issues you see in the questions raised in requirements
(2d) and (2e).
3. Comment on the use of full cost as the basis for setting transfer prices.

Problem 8 (HILTON)

Cortez Enterprises has two divisions: Birmingham and Manchester. Birmingham

currently sells a diode reducer to manufacturers of aircraft navigation systems for P 775
per unit. Variable costs amount to P 500, and demand for this product currently exceeds
the division’s ability to supply the marketplace.
Despite this situation, Cortez is considering another use for the diode reducer, namely,
integration into a satellite positioning system that would be made by Manchester. The
positioning system has an anticipated selling price of P 1,400 and requires an additional
P 670 of variable manufacturing costs. A transfer price of P 750 has been established
for the diode reducer.
Top management is anxious to introduce the positioning system; however, unless the
transfer is made, an introduction will not be possible because of the difficulty of
obtaining needed diode reducers. Birmingham and Manchester are in the process of
recovering from previous financial problems, and neither division can afford any future
losses. The company uses responsibility accounting and ROI in measuring divisional
performance, and awards bonuses to divisional management.

Required:

1. How would Birmingham’s divisional manager likely react to the decision to

transfer diode reducers to Manchester? Show computations to support your
answer.
2. How would Manchester’s divisional management likely react to the P 750 transfer
price? Show computations to support your answer.
3. Assume that a lower transfer price is desired. Should top management lower the
price or should the price be lowered by other means? Explain.
4. From a contribution margin perspective, does Cortez benefit more if it sells the
diode reducers externally or transfers the reducers to Manchester? By how
much?
Problem 9 (HILTON)

Alpha Communications, Inc., which produces telecommunications equipment in the

United States, has a very strong local market for its circuit board. The variable
production cost is P130, and the company can sell its entire supply domestically for
$170. The U.S. tax rate is 40 percent.
Alternatively, Alpha can ship the circuit board to its division in Germany, to be used in a
product that the German division will distribute throughout Europe. Information about
the German product and the division’s operating environment follows.
Selling Price of final product: P360
Shipping fees to import circuit board: P20
Labor, overhead, and additional material costs of final product: P115
Import duties levied on circuit board (to be paid by the German division): 10% of
transfer price
German tax rate: 60%
Assume that U.S. and German tax authorities allow a transfer price for the circuit board
set at either U.S. variable manufacturing cost or the U.S. market price. Alpha’s
management is in the process of exploring which transfer price is better for the firm as a
whole.
Required:
1. Compute overall company profitability per unit if all are transferred and U.S.
variable manufacturing cost is used as the transfer price. Show separate
calculations for the U.S. operation and the German division.
2. Repeat requirement (1), assuming the se of the U.S. market price as the transfer
price. Which of the two transfer prices is better for the firm?

3. Assume the German division can obtain the circuit board in Germany for P155.
a. If you were the head of the German division, would you rather do business
with your U.S. division or buy the circuit board locally? Why?
b. Rather than proceed with the transfer, is it in the best interest of Alpha to
sell its goods domestically and allow the German division to acquire the
circuit board in Germany? Why? Show computations to support your
answer.
3. Generally speaking, when tax rates differ between countries, what strategy
should a company use in setting its transfer prices?
Problem 10(HILTON)
 
Pretoria Consolidated Resource Company (PCRC) has several divisions. However, only
two divisions transfer products to other divisions. The Mining Division refines toldine,
which is then transferred to the Metals Division. The toldine is processed into an alloy
by the Metals Division, and the alloy is sold to customers at a price of P150 per unit.
The Mining Division is currently required by PCRC to transfer its total yearly output of
500,000 units of toldine to the Metals Division at a total actual manufacturing cost plus
10 pecent. Unlimited quantities of toldine can be purchased and sold on the open
market at P90 per unit. While the Mining Division could sell all the toldine it produces at
P90 per unit in the open market, it would incur a variable selling cost of P5 per unit.
Jacob Ncube, manager of the Mining Division, is unhappy with having to transfer
the entire output of toldine to the Metals Division at 110 percent of cost. In a meeting
with the management of PCRC, he said, “Why should my division be required to sell
toldine to the Metals Division at less than Market Price? For the year ended in May,
Metals’ contribution margin was P24 Million on sales of 500,000 units, while Mining’s
contribution was only P7 Million on the transfer of the same number of units. My division
is subsidizing the profitability of the Metals Division. We should be allowed to charge the
market price for toldine when transferring to the Metals Division.”
The following table shows the detailed unit cost structure for both the Mining and
Metals divisions during the most recent year.
            Mining Metals
            Division        
Division

Transfer Price from Mining Division     --   P 66

Direct material                 P 12
   6
Direct Labor     16       20
Manufacturing overhead     32*       25**

Total cost per unit   P60   P 117

*Manufacturing-overhead cost in the Mining Division is 25 percent fixed and 75 percent

variable.
**Manufacturing-overhead cost in the Metals Division is 60 percent fixed and 40 percent
variable.
Required:
1. Explain why transfer prices based on total actual costs are not appropriate as the
basis for divisional performance measurement.
2. Using the market price as transfer price, determine the contribution margin for
both the Mining Division and the Metals Division
3. If Pretoria Consolidated Resources Company were to institute the use of
negotiated transfer prices and allow divisions to buy and sell on the open market,
determine the price range for toldine that would be acceptable to the both the
Mining Division and the Metals Division. Explain your answer.
4. Use the general transfer-pricing rule to compute the lowest transfer price that
would be acceptable to the Mining Division. Is your answer consistent with your
conclusion in requirement (3)? Explain.
5. Identify which one of the three types of transfer prices (cost-based, market-
based, or negotiated) is most likely to elicit desirable management behavior at
PCRC. Explain your answer.