Responsibility Accounting and Transfer Pricing

(B. Transfer Pricing)

B. TRANSFER PRICING A. maximize the transfer price

B. minimize the transfer price
THEORIES: C. maintain goal congruence between the divisions and the entire firm
Nature D. none of the above
5. Transfer prices are charges for
A. transportation of goods outside units of an organization. 2. The objective(s) of transfer pricing are
B. goods sold by subunits to outside customers. A. to motivate managers
C. goods exchanged among subunits. B. to provide an incentive for managers to make decisions consistent with the firm's goals
D. goods stored within a subunit. (i.e., goal congruence)
C. to provide a basis for fairly rewarding the managers
23. A transfer price is a price charged D. all of the above
A. to outside customers
B. when one division sells its goods or services to another division 4. A transfer pricing system should satisfy which of the following objectives?
C. by the selling division to the buying division when outside market does not exist A. accurate performance evaluation C. goal congruence
D. a and b B. preservation of divisional autonomy D. all of the above

24. Transfer prices are 34. The market price method satisfy a key objective of transfer pricing, namely:
A. necessary to calculate costs in a cost, profit, or investment center A. objectivity C. consistency
B. preferred by buying divisions are the lowest possible B. usability D. reliability
C. do not make any difference for the company's bottom-line no matter what number is used
D. all of the above Irrelevant costs
29. Which item is usually not relevant to a decision by a divisional manager to reduce a transfer
36. Which of the following is a key factor to consider in deciding whether to make internal price to meet a price offered to another division by an outside supplier?
transfers, and, if so, in setting the transfer price? A. opportunity cost
A. Is there an outside supplier? B. variable manufacturing costs
B. Is the seller's variable cost less than the market price/ C. fixed divisional overhead
C. Is the selling unit operating at full capacity? D. the price offered by the outside supplier
D. All of the above are key factors.
Minimum & Maximum Transfer Price
32. From the standpoint of the company, the important question in transfer pricing is General rule
A. what is fair to the divisions 9. The general rule in establishing transfer prices consistent with economic decision making is
B. how to determine the profit of the divisions the
C. whether or not the transfer should take place A. differential cost plus opportunity cost if goods are transferred internally.
D. when the transfer should be made B. actual cost plus opportunity cost if goods are transferred internally.
C. standard cost plus opportunity cost if goods are transferred internally.
Objectives D. all of the above.
1. The objective of a transfer pricing system should be to

393
 Responsibility Accounting and Transfer Pricing
(B. Transfer Pricing)

Seller’s standpoint (minimum price) D. all of the above.

26. The minimum transfer price should be:
A. opportunity cost for selling division 27. Transfer prices are set by:
B. opportunity cost for buying division A. cost or cost plus C. negotiation
C. opportunity cost for the company as a whole B. market prices D. all of the above
D. only variable cost for the selling division
35. Which of the following are transfer pricing models?
14. A selling division produces components for a buying division that is considering accepting a A. Variable cost method C. Market cost method
special order for the products it produces. The selling division has excess capacity. The B. Average price method D. All of the above
minimum price the selling division would be willing to accept is the
A. selling division’s variable costs Market price
B. buying division’s outside purchase price 10. If a firm operates at capacity, the transfer price should be the:
C. price that would allow the buying division to cover its incremental cost of the special order A. external market price. C. actual cost.
D. price that would allow the selling division to maintain its current ROI B. differential cost. D. standard cost.

25. The minimum transfer price from the seller's standpoint is 12. To avoid waste and maximize efficiency when transferring products among divisions in a
A. market price when excess capacity exists competitive economy, a large diversified corporation should base transfer prices on:
B. market price when excess capacity does not exist A. full cost C. replacement cost
C. incremental costs when excess capacity exists B. variable cost D. market price
D. b and c
13. If an intermediate market exists, the optimal transfer price is the:
Buyer’s standpoint (maximum price) A. outlay cost for producing the goods.
7. Generally, the outside market price would be B. opportunity cost of not selling to the outside market.
A. a floor for internal transfer price. C. market price.
B. a ceiling for internal transfer price. D. variable costs associated with producing the product.
C. both a and b
D. none of the above. 16. If there is no excess capacity, the transfer price is often
A. market price
Methods of transfer pricing B. opportunity cost plus incremental cost
3. The basic methods used in transfer pricing are C. variable cost or variable cost plus profit
A. variable or full costs C. market price or negotiated price D. a or b
B. dual prices D. all of the above
20. Market pricing approach in transfer pricing
8. An example of a transfer price policy is A. helps to preserve unit autonomy
A. market price. B. provides incentive for the selling unit to be competitive with outside suppliers
B. actual cost plus markup. C. may be the most practical approach when there is significant conflict
C. standard cost plus markup. D. both a and b

394
 Responsibility Accounting and Transfer Pricing
(B. Transfer Pricing)

Variable costing
28. The best transfer price is usually 21. Variable costing method of transfer pricing is
A. actual cost plus a percentage markup A. easy to implement
B. a reliable market price B. intuitive and easily understood
C. budgeted full cost plus a percentage markup C. more logical when there is excess capacity
D. budgeted variable cost plus a percentage markup D. all of the above

30. Market-based transfer prices are best for the 22. A company may consider using variable costs in transfer pricing when there is
A. company when the selling division is operating below capacity. A. excess capacity because variable costs would stay the same
B. company when the selling division is operating at capacity. B. no excess capacity because variable costs would not stay the same
C. buying division if it is operating at capacity. C. excess capacity because fixed costs would stay the same
D. buying division. D. no excess capacity because fixed costs would stay the same

33. Which transfer price is ideal for the company when the selling division is at capacity? Full cost
A. Market price 18. If full cost is used in transfer pricing, it is preferable to use
B. Incremental cost A. standard full cost because the buyer does not wish to be stuck with unknowns
C. Budgeted full cost B. standard full cost because the seller does not wish to pass along the variations in cost
D. Actual variable cost plus a percentage profit C. actual full cost because the buyer is well-advised to deal with the real rather than
anticipated costs
Actual costs D. actual full costs because the seller is well-advised to deal with the real rather than
6. Disadvantages of transfer prices based on actual cost include: anticipated costs
A. reducing the incentive of managers of supplying divisions to control their costs.
B. passing on efficiencies or inefficiencies of supplying divisions to receiving divisions. Negotiated
C. both a and b. 11. Negotiated transfer prices are appropriate when:
D. none of the above. A. there are cost savings to the selling division.
B. there is no external market price.
15. Which of the following types of transfer prices do not encourage the selling division to be C. the internal market price reflects a bargain price.
efficient? D. all of the above.
A. transfer prices based upon market prices
B. transfer prices based upon actual costs 17. A negotiated transfer pricing system is set up where
C. transfer prices based upon standard costs A. the two sides cannot agree on a price and the difference between the two sides is
D. transfer prices based upon standard costs plus a markup for profit absorbed by the home office
B. a ready market price is not available and the two sides must come up with an agreeable
31. The worst transfer-pricing method is to base the prices on price
A. market prices C. budgeted variable costs C. the buyer buys at variable cost and the seller only sells at full cost
B. budgeted total costs D. actual total costs D. the two sides agree to use a cost basis for transfer pricing

395
 Responsibility Accounting and Transfer Pricing
(B. Transfer Pricing)

Multinational transfer pricing What is the natural bargaining range for the two divisions?
19. To minimize taxes, some multinational companies set low transfer prices when goods are A. Between P20 and P50 C. Between P50 and P70
shipped from B. Any amount less than P50 D. P50 is the only acceptable price
A. low tax countries to other low tax countries
B. low tax countries to high tax countries Minimum transfer price
3
C. high tax countries to low tax countries . Family Enterprises has two divisions: Davy and Johnny. Davy Division has a capacity to
D. c or b produce 2,000 units and is expecting to sell 1,500 units. Johnny Division wants to purchase
100 units of a product Davy produces. Davy sells the product at a selling price of P100 per
PROBLEMS: unit, the variable cost per unit is P25 and the fixed costs total P30,000. The minimum transfer
Residual income price that Davy will accept is?
1
. Marsh Company that had current operating assets of one million and net income of P200,000 A. P100 C. P43.75
had an opportunity to invest in a project that requires an additional investment of P250,000 B. P45 D. P25
and increased net income by P40,000. The company's required rate of return is 12%. After the
4
investment, the company's residual income will amount to . Assume that Division X has a product that can be sold either to outside customers on an
A. 80,000 C. 90,000 intermediate market or to Division Y of the same company for use in its production process.
B. 85,000 D. 95,000 The managers of the division are evaluated based on their divisional profits.
Division X:
With excess capacity Capacity in units 200,000
Bargaining range Number of units being sold on the intermediate market 160,000
2
. An appropriate transfer price between two divisions of the Reno Corporation can be Selling price per unit on the intermediate market P75
determined from the following data: Variables costs per unit 60
Fabrication Division Fixed costs per unit (based on capacity) 8
Market price of subassembly P50
Variable cost of subassembly P20 Division Y:
Excess capacity (in units) 1,000 Number of units needed for production 40,000
Assembling Division Purchase price per unit now being paid to an outside supplier P74
Number of units needed 900 The minimum transfer price to be charged by the Division X should be:
A. P60 C. P68
B. P75 D. P74
1 .Answer: C
New Operating Profit (P200,000 + P40,000) P240,000
Less Required Returns (P1,250,000 x 0.12) 150,000 3 .Answer: D
New Residual Income P 90,000 The minimum Davy would accept is the opportunity cost to make the product, which would be
the variable cost of P25.
2 .Answer: D
The Fabrication division has excess capacity, therefore the division can transfer the units at a 4 .Answer: A
minimum transfer price of P50 The minimum transfer price is P60 because the Division X has excess capacity

396
 Responsibility Accounting and Transfer Pricing
(B. Transfer Pricing)

current level of production, the fixed cost of producing this component is P4 per unit and the
Effect on profit of make decision variable cost is P7 per unit. Division Z would like to purchase this component from Division X.
5
. Bearing Division of Phantom Corp. sells 80,000 units of Part X to the outside market. Part X What would be the price that Division X should charge Division Z?
sells for P10.00 and has a variable cost of P5.50 and a fixed cost per unit of P2.50. Bearing A. P 7 C. P 11
has a capacity to produce 100,000 units per period. Motor Division currently purchases B. P 13 D. P 9
10,000 units of Part X from Bearing for P10.00. Motor has been approached by an outside
8
supplier willing to supply the parts for P9.00. What is the effect on XYZ’s overall profit if . The Black Division of Pluma Company produces a high quality marker. Unit production costs
Bearing refuses the outside price and Motor decides to buy outside? (based on capacity production of 100,000 units per year) follow:
A. no change Direct materials P 60
B. P20,000 decrease in Phantom profits Direct labor 25
C. P35,000 decrease in Phantom profits Overhead (20% variable) 15
D. P10,000 increase in Phantom profits Other information
Sales price 120
6
. Bearing Division of XYZ Corp. sells 80,000 units of Part X to the outside market. Part X sells The Black Division is producing and selling at capacity.
for P10.00 and has a variable cost of P5.50 and a fixed cost per unit of P2.50. Bearing has a What is the minimum selling price that the division would consider as a “transfer price” to the
capacity to produce 100,000 units per period. Motor Division currently purchases 10,000 units Red Division on which no variable period costs would be incurred?
of Part X from Bearing for P10.00. Motor has been approached by an outside supplier willing A. P120 C. P 88
to supply the parts for P9.00. What is the effect on XYZ’s overall profit if Bearing refuses the B. P 91 D. P117 (?)
outside price and Motor decides to buy inside?
9
A. no change C. P35,000 decrease in XYZ profits . Harem Corporation consists of two divisions, Mining and Builders. The Mining makes black
B. P20,000 decrease in XYZ profits D. P10,000 increase in XYZ profits steel, a product that can be used in the product that the Builders division makes. Both

At capacity The division is operating at capacity (zero excess capacity). Any quantity of production to be
Minimum transfer price transferred to the Division Z must be at P13; Any price below P13, as transfer price, would
7
. Company Y is highly decentralized. Division X, which is operating at capacity, produces a decrease its profit.
component that it currently sells in a perfectly competitive market for P13 per unit. At the
8 .Answer: D
5 .Answer: C Selling price (market price) P120
The profit of the company will decrease by P35,000 which is the difference between the Less avoidable selling expense 15 x 20% 3
variable (relevant) cost and the purchase price. Minimum transfer price P117
(P9.00 – P5.5) x 10,000 units = P35,000
9 .Answer: B
6 .Answer: A The optimal transfer price is P4 per unit, which represents the value of using the black steel in
There is no change in the profit because the Motor Division did not buy from the outside the Builders Division because the black steel will cost P2 to manufacture and each unit used
supplier internally is a unit that cannot be sold to external buyers. If an intermediate market exists, the
optimal transfer price is the market price.
7 .Answer: B

397
 Responsibility Accounting and Transfer Pricing
(B. Transfer Pricing)

divisions are considered profit centers. The following data are available concerning black steel A. P90 C. P70
and the two divisions: B. P87 D. P86
Mining Builders
Average units produced 150,000 Partial excess capacity
Average units sold 150,000 Decision
11
Variable mfg cost per unit P2 . Chips Division manufacturers electronic circuit boards. The boards can be sold either to
Variable finishing cost per unit P5 Compo Division of the same company or to outside customers. Last year, the following activity
Fixed divisional costs P75,000 P125,000 occurred in division A:
The Mining Division can sell all of its output outside the company for P4 per unit. The Builders
Division can buy the black steel from other firms for P4. The Builders Division sells its product Selling price per circuit board P125
for P12. Production cost per circuit board 90
What is the optimal transfer price in this case? Numbers of circuit boards:
A. P2 per unit C. P7 per unit Produced during the year 20,000
B. P4 per unit D. P9 per unit Sold to outside customers 16,000
Sold to Compo Division 4,000
10
. Assume that Steel Division has a product that can be sold either to outside customers on an
intermediate market or to Fabrication Division of the same company for use in its production Sales to Compo Division were at the same price as sales to outside customers. The circuit
process. The managers of the division are evaluated based on their divisional profits. boards purchased by Compo Division were used in an electronic instrument manufactured by
Steel Division: that division (one board per instrument). Compo Division incurred P100 in additional cost per
Capacity in units 200,000 instrument and then sold the instrument for P300 each.
Number of units being sold on the intermediate market 200,000
Selling price per unit on the intermediate market P90 Assume that Chips Division’s manufacturing capacity is 20,000 circuit boards. Next year
Variables costs per unit (including P3 of avoidable selling expense) 70 Compo Division wants to purchase 5,000 circuits board from Chips Division rather than 4,000.
Fixed costs per unit (based on capacity) 13 (Circuit boards of this type are not available from outside sources.)

Fabrication Division: Should Chips Division sell 1,000 additional circuit boards to Compo Division or continue to sell
Number of units needed for production 40,000 them outside customers?
Purchase price per unit now being paid to an outside supplier P86 A. No, because the overall profit will decrease by P35,000.
The appropriate transfer price should be: B. Yes, because the overall profit will decrease by P35,000.
11 .Answer: D
10 .Answer: B Selling price charged by Compo Division P300
The division is operating at capacity, therefore, the minimum transfer price must be the Selling price charge by Chips Division 125
amount of selling price, less avoidable selling expense. Additional selling price P175
Selling price P90 Less additional processing cost by Compo 100
Avoidable selling expense 3 Additional profit per unit P 75
Net Price 87 Additional profit: 1,000 x P75 P75,000

398
 Responsibility Accounting and Transfer Pricing
(B. Transfer Pricing)

C. No, because there is no change in the overall profit. Use the following data to answer questions 11 through 13.
D. Yes, because the overall profit will increase by P75,000. N & R Company transfers a product from division N to division R. Variable cost of this product is
anticipated to be P40 a unit and total fixed costs amount to P8,000. A total of 100 units are
Maximum transfer price anticipated to be produced. Actual cost, however, amounts to P50 for variable costs. Fixed costs
12
. Chips Division manufacturers electronic circuit boards. The boards can be sold either to were same as budget. However, actual output was twice as many.
Compo Division of the same company or to outside customers. Last year, the following activity
13
occurred in division A: . Actual cost per unit amounts to
Selling price per circuit board P125 A. P90 C. P115
Production cost per circuit board 90 B. P92 D. P120
Numbers of circuit boards:
14
Produced during the year 20,000 . The transfer price based on actual variable costs plus 130% markup amounts to
Sold to outside customers 16,000 A. P90 C. P115
Sold to Compo Division 4,000 B. P92 D. P120
15
Sales to Compo Division were at the same price as sales to outside customers. The circuit . The transfer price based on budgeted full cost plus 30% markup amounts to
boards purchased by Compo Division were used in an electronic instrument manufactured by A. P117 C. P150
that division (one board per instrument). Compo Division incurred P100 in additional cost per B. P140 D. P156
instrument and then sold the instrument for P300 each.

Assume that Chips Division’s manufacturing capacity is 20,000 circuit boards. Next year
Compo Division wants to purchase 5,000 circuits board from Chips Division rather than 4,000.
(Circuit boards of this type are not available from outside sources.)
13 .Answer: A
Chips Division proposed that a transfer for additional 1,000 units be produced by requiring its The actual cost is the sum of unit variable cost plus fixed cost divided by actual units
workers to work overtime. Chips Division indicated that the transfer price may be produced.
unreasonably high because of the overtime premium. 50 + (8000 ÷ 200) = P90
What is the maximum transfer that Compo Division will accept for the additional 1,000 units?
A. P 90 C. P200
14 .Answer: C
Variable cost P 50
B. P125 D. P300
Markup (P50 x 1.3) 65
Transfer price P115
12 .Answer: C
Final selling price by Compo P300 15 .Answer: D
Less additional processing cost 100 Budgeted full cost P40 + (P8,000 ÷ 100) P120
Maximum material cost (transfer price) P200 Markup (P120 x 0.3) 36
At a transfer price of P200, Compo will not realize any profit on the additional 1,000 units Transfer price P156

399