Assignment Material

Questions

  1. 23-1. What is a management control system?
  2. 23-2. Describe three criteria you would use to evaluate whether a management control system is effective.
  3. 23-3. What is the relationship among motivation, goal congruence, and effort?
  4. 23-4. Name three benefits and two costs of decentralization.
  5. 23-5. “Organizations typically adopt a consistent decentralization or centralization philosophy across all their business functions.” Do you agree? Explain.
  6. 23-6. “Transfer pricing is confined to profit centers.” Do you agree? Explain.
  7. 23-7. What are the three methods for determining transfer prices?
  8. 23-8. What properties should transfer-pricing systems have?
  9. 23-9. “All transfer-pricing methods give the same division operating income.” Do you agree? Explain.
  10. 23-10. Under what conditions is a market-based transfer price optimal?
  11. 23-11. What is one potential limitation of full-cost-based transfer prices?
  12. 23-12. Give two reasons why the dual-pricing system of transfer pricing is not widely used.
  13. 23-13. “Cost and price information play no role in negotiated transfer prices.” Do you agree? Explain.
  14. 23-14. “Under the general guideline for transfer pricing, the minimum transfer price will vary depending on whether the supplying division has unused capacity.” Do you agree? Explain.
  15. 23-15. How should managers consider income tax issues when choosing a transfer-pricing method?

Exercises

  1. 23-16. COST CENTERS, PROFIT CENTERS, DECENTRALIZATION, TRANSFER PRICES. Fenster Corporation manufactures windows with wood and metal frames. Fenster has three departments: glass, wood, and metal. The glass department makes the window glass and sends it to either the wood or metal department where the glass is framed. The window is then sold. Upper management sets the production schedules for the three departments and evaluates them on output quantity, cost variances, and product quality.
    1. Required
    2. 1. Are the three departments cost centers, revenue centers, or profit centers?
    3. 2. Are the three departments centralized or decentralized?
    4. 3. Can a centralized department be a profit center? Why or why not?
    5. 4. Suppose the upper management of Fenster Corporation decides to let the three departments set their own production schedules, buy and sell products in the external market, and have the wood and metal departments negotiate with the glass department for the glass panes using a transfer price.
      1. a. Will this decision change your answers to requirements 1 and 2?
      2. b. How would you recommend upper management evaluate the three departments if this change is made?
  2. 23-17  TRANSFER-PRICING METHODS, GOAL CONGRUENCE. Vancouver Lumber has a raw lumber division and a finished lumber division. The variable costs are as follows:
    1. • Raw lumber division: $120 per 100 board-feet of raw lumber
    2. • Finished lumber division: $145 per 100 board-feet of finished lumber
  3. Assume that there is no board-feet loss in processing raw lumber into finished lumber. Raw lumber can be sold at $170 per 100 board-feet. Finished lumber can be sold at $370 per 100 board-feet.
    1. Required
    2. 1. Should Vancouver Lumber process raw lumber into its finished form? Show your calculations.
    3. 2. Assume that internal transfers are made at 130% of variable cost. Will each division maximize its division operating-income contribution by adopting the action that is in the best interest of Vancouver Lumber as a whole? Explain.
    4. 3. Assume that internal transfers are made at market prices. Will each division maximize its division ­operating-income contribution by adopting the action that is in the best interest of Vancouver Lumber as a whole? Explain.
  4. 23-18 TRANSFER PRICE, PRORATION. Chocfix produces hot cocoa mix. The company has two divisions, each operating as a profit center. The transportation division purchases raw cocoa in the Ivory Coast and transports it to the mixing division in Atlanta, Georgia. The mixing division processes the raw cocoa into the cocoa mix. It takes two pounds of raw cocoa to yield one pound of cocoa mix. Variable and fixed costs per pound of raw cocoa in the transportation division and variable and fixed costs per pound of cocoa mix in the mixing division area as follows:
<p>A table shows variable and fixed costs per pound of raw cocoa in the transportation division</p>

The table depicts variable and fixed costs per pound of raw cocoa in the transportation division. The details of the table are as follows:

1. Price per pound of raw cocoa supplied in the Ivory Coast: 10 dollars

2. Variable transportation costs per pound of raw cocoa: 1 dollar

3. Fixed transportation costs per pound of raw cocoa: 1 dollar

<p>A table shows variable and fixed costs per pound of cocoa mix in the mixing division</p>

The table depicts variable and fixed costs per pound of cocoa mix in the mixing division. The details of the table are as follows:

1. Variable mixing costs per pound of cocoa mix: 4 dollars

2. Fixed mixing costs per pound of cocoa mix: 4 dollars

  1. The market price for a pound of raw cocoa supplied to the mixing division in Atlanta is $14. Chocfix can sell each pound of hot cocoa mix for $42.
    1. Required
    2. 1. What are the minimum and maximum transfer prices per pound of raw cocoa transported to the mixing division at which both divisions are willing to transact with each other? Assume the transportation division has unused capacity to transport raw cocoa to the mixing division.
    3. 2. Refer to your answer in requirement 1. The management of Chocfix is trying to decide on the specific transfer price within the bounds identified in requirement 1. James Ladell, Chocfix’s CEO, is suggesting to split the difference between the maximum and the minimum transfer price evenly. What is the transfer price under this scenario? What is the contribution margin per pound of raw cocoa for the transportation division? What is the contribution margin per pound of cocoa mix for the mixing division?
    4. 3. Leila Brown, Chocfix’s CFO, disagrees with James Ladell’s suggestion to split the difference evenly. She argues that the difference between the maximum and minimum transfer price should be prorated based on the value of the work contributed by each of the divisions to the final product.
      1. a. What is the value of the work contributed by each of the divisions towards a pound of cocoa mix? Ignore fixed costs.
      2. b. What is the transfer price if the difference between the maximum and the minimum transfer price (identified in requirement 1) is prorated based on the relative value of the work contributed by each of the divisions (identified in requirement 3a)? What is the contribution margin per pound of raw cocoa for the transportation division? What is the contribution margin per pound of cocoa mix for the mixing division?
      3. c. Which transfer price, the one identified in requirement 2 or the one identified in requirement 3b, do you think Chocfix should use?
  2. 23-19. TRANSFER PRICING, DUAL PRICING. Jose Martinez is the CEO of ShakeIt, a producer of premium ice cream. ShakeIt has two divisions, the supplying division and the processing division. The supplying division supplies milk, the main ingredient, to the processing division. Jose is an ambitious entrepreneur, and he is hoping to soon sell ShakeIt, which is a private company, to one of the larger competitors. The supplying division buys milk from local farmers for $5 per 10 gallons, and incurs $1 of variable costs per 10 gallons transported to the processing division (the supplying division doesn’t incur any material fixed costs). The processing division could buy milk of the same high quality for $8 per 10 gallons on the outside market. Jose is trying to “whip his company into shape” by implementing a transfer pricing system that he views as providing very strong incentives for the two divisions to work hard: The supplying division will get reimbursed for its incremental costs of supplying the milk to the processing division; the processing division is charged the price that it would have to pay on the open market.
    1. Required
    2. 1. What is the profit for the supplying division of supplying 10 gallons of milk to the processing division under Jose’s transfer pricing system? Do you think that the transfer pricing system incentivizes the managers of the supplying division to work hard, as Jose intends?
    3. 2. In the back of Jose’s mind is that one of the larger competitors may be interested in buying only one of the divisions, and not his entire company. He is patting himself on the back for choosing the transfer pricing system since, in his view, it makes the profitability of each of the two divisions look very good. Do you agree with Jose?
  3. 23-20. MULTINATIONAL TRANSFER PRICING, EFFECT OF ALTERNATIVE TRANSFER-PRICING METHODS, GLOBAL INCOME TAX MINIMIZATION. People Able Computer, Inc., with headquarters in San Francisco, manufactures and sells a desktop computer. People Able has three divisions, each of which is located in a different country:
    1. a. China division—manufactures memory devices and keyboards
    2. b. South Korea division—assembles desktop computers using locally manufactured parts, along with memory devices and keyboards from the China division
    3. c. U.S. division—packages and distributes desktop computers
  4. Each division is run as a profit center. The costs for the work done in each division for a single desktop computer are as follows:
China division: Variable cost = 1,000 yuan
       Fixed cost = 1,800 yuan
South Korea division: Variable cost = 360,000 won
      Fixed cost = 480,000 won
U.S. division:Variable cost = $100
      Fixed cost = $200
  1. • Chinese income tax rate on the China division’s operating income: 40%
  2. • South Korean income tax rate on the South Korea division’s operating income: 20%
  3. • U.S. income tax rate on the U.S. division’s operating income: 28%
  4. Each desktop computer is sold to retail outlets in the United States for $3,200. Assume that the current foreign exchange rates are as follows:

8 yuan=$1 U.S.1,200 won=$1 U.S.  

  1. Both the China and the South Korea divisions sell part of their production under a private label. The China division sells the comparable memory/keyboard package used in each People Able desktop computer to a Chinese manufacturer for 3,600 yuan. The South Korea division sells the comparable desktop computer to a South Korean distributor for 1,560,000 won.
    1. Required
    2. 1. Calculate the after-tax operating income per unit earned by each division under the following transfer-pricing methods: (a) market price, (b) 200% of full cost, and (c) 300% of variable cost. (Income taxes are not included in the computation of the cost-based transfer prices.)
    3. 2. Which transfer-pricing method(s) will maximize the after-tax operating income per unit of People Able Computer?
  2. 23-21. TRANSFER PRICING, GENERAL GUIDELINE, GOAL CONGRUENCE. (CMA, adapted). Watson Motors, Inc., operates as a decentralized multidivision company. The Vadner division of Watson Motors purchases most of its airbags from the airbag division. The airbag division’s incremental cost for manufacturing the airbags is $160 per unit. The airbag division is currently working at 80% of capacity. The current market price of the airbags is $200 per unit.
    1. Required
    2. 1. Using the general guideline presented in the chapter, what is the minimum price at which the airbag division would sell airbags to the Vadner division?
    3. 2. Suppose that Watson Motors requires that whenever divisions with unused capacity sell products internally, they must do so at the incremental cost. Evaluate this transfer-pricing policy using the criteria of goal congruence, evaluating division performance, motivating management effort, and preserving division autonomy.
    4. 3. If the two divisions were to negotiate a transfer price, what is the range of possible transfer prices? Evaluate this negotiated transfer-pricing policy using the criteria of goal congruence, evaluating division performance, motivating management effort, and preserving division autonomy.
    5. 4. Instead of allowing negotiation, suppose that Watson specifies a hybrid transfer price that “splits the difference” between the minimum and maximum prices from the divisions’ standpoint. What would be the resulting transfer price for airbags?
  3. 23-22. MULTINATIONAL TRANSFER PRICING, GLOBAL TAX MINIMIZATION. The Burton Company manufactures chainsaws at its plant in Sandusky, Ohio. The company has marketing divisions throughout the world. A Burton marketing division in Lille, France, imports 200,000 chainsaws annually from the United States. The following information is available:
<p>A table shows information from The Burton Company, which manufactures chainsaws</p>

The table depicts information from The Burton Company, which manufactures chainsaws. The details of the table are as follows:

1. U.S. income tax rate on the U.S. division&rsquo;s operating income: 40 percent

2. French income tax rate on the French division&rsquo;s operating income: 45 percent

3. French import duty: 20 percent

4. Variable manufacturing cost per chainsaw: 100 dollars

5. Full manufacturing cost per chainsaw: 175 dollars

6. Selling price (net of marketing and distribution costs) in France: 300 dollars

  1. Suppose the United States and French tax authorities only allow transfer prices that are between the full manufacturing cost per unit of $175 and a market price of $250, based on comparable imports into France. The French import duty is charged on the price at which the product is transferred into France. Any import duty paid to the French authorities is a deductible expense for calculating French income taxes.
    1. Required
    2. 1. Calculate the after-tax operating income earned by the United States and French divisions from transferring 200,000 chainsaws (a) at full manufacturing cost per unit and (b) at market price of comparable imports. (Income taxes are not included in the computation of the cost-based transfer prices.)
    3. 2. Which transfer price should the Burton Company select to minimize the total of company import duties and income taxes? Remember that the transfer price must be between the full manufacturing cost per unit of $175 and the market price of $250 of comparable imports into France. Explain your reasoning.
  2. 23-23. MULTINATIONAL TRANSFER PRICING, GOAL CONGRUENCE (CONTINUATION OF 23-22). Suppose that the U.S. division could sell as many chainsaws as it makes at $225 per unit in the U.S. market, net of all marketing and distribution costs.
    1. Required
    2. 1. From the viewpoint of the Burton Company as a whole, would after-tax operating income be maximized if it sold the 200,000 chainsaws in the United States or in France? Show your computations.
    3. 2. Suppose division managers act autonomously to maximize their division’s after-tax operating income. Will the transfer price calculated in requirement 2 of Exercise 23-22 result in the U.S. division manager taking the actions determined to be optimal in requirement 1 of this exercise? Explain.
    4. 3. What is the minimum transfer price that the U.S. division manager would agree to? Does this transfer price result in the Burton Company as a whole paying more import duty and taxes than under the answer to requirement 2 of Exercise 23-22? If so, by how much?
  3. 23-24. TRANSFER-PRICING DISPUTE. The Jill-Farley Corporation, manufacturer of tractors and other heavy farm equipment, is organized along decentralized product lines, with each manufacturing division operating as a separate profit center. Each division manager has been delegated full authority on all decisions involving the sale of that division’s output both to outsiders and to other divisions of Jill-Farley. Division C has in the past always purchased its requirement of a particular tractor-engine component from division A. However, when informed that division A is increasing its selling price to $145, division C’s manager decides to purchase the engine component from external suppliers.
  4. Division C can purchase the component for $120 per unit in the open market. Division A insists that, because of the recent installation of some highly specialized equipment and the resulting high depreciation charges, it will not be able to earn an adequate return on its investment unless it raises its price. Division A’s manager appeals to top management of Jill-Farley for support in the dispute with division C and supplies the following operating data:
<p>A table shows operating data from The Jill-Farley Corporation</p>

The table depicts operating data from The Jill-Farley Corporation. The details of the table are as follows:

1. C’s annual purchases of the tractor-engine component: 1,800 units

2. A’s variable cost per unit of the tractor-engine component: 110 dollars

3. A’s fixed cost per unit of the tractor-engine component: 20 dollars

  1. Required

1. Assume that there are no alternative uses for internal facilities of division A. Determine whether the company as a whole will benefit if division C purchases the component from external suppliers for $120 per unit. What should the transfer price for the component be set at so that division managers acting in their own divisions’ best interests take actions that are also in the best interest of the company as a whole?

2. Assume that internal facilities of division A would not otherwise be idle. By not producing the 1,800 units for division C, division A’s equipment and other facilities would be used for other production operations that would result in annual cash-operating savings of $21,000. Should division C purchase from external suppliers? Show your computations.

3. Assume that there are no alternative uses for division A’s internal facilities and that the price from outsiders drops by $20. Should division C purchase from external suppliers? What should the transfer price for the component be set at so that division managers acting in their own divisions’ best interests take actions that are also in the best interest of the company as a whole?

  1. 23-25. TRANSFER-PRICING PROBLEM (CONTINUATION OF 23-24). Refer to Exercise 23-24. Assume that division A can sell the 1,800 units to other customers at $153 per unit, with variable marketing costs of $8 per unit.
  2. Required
  3. Determine whether Jill-Farley will benefit if division C purchases the 1,800 units from external suppliers at $120 per unit. Show your computations.

Problems

  1. 23-26. GENERAL GUIDELINE, TRANSFER PRICING. The Aqua Company manufactures and sells television sets. Its assembly division (AD) buys television screens from the screen division (SD) and assembles the TV sets. The SD, which is operating at capacity, incurs an incremental manufacturing cost of $60 per screen. The SD can sell all its output to the outside market at a price of $110 per screen, after incurring a variable marketing and distribution cost of $10 per screen. If the AD purchases screens from outside suppliers at a price of $110 per screen, it will incur a variable purchasing cost of $8 per screen. Aqua’s division managers can act autonomously to maximize their own division’s operating income.
    1. Required
    2. 1. What is the minimum transfer price at which the SD manager would be willing to sell screens to the AD?
    3. 2. What is the maximum transfer price at which the AD manager would be willing to purchase screens from the SD?
    4. 3. Now suppose that the SD can sell only 80% of its output capacity of 10,000 screens per month on the open market. Capacity cannot be reduced in the short run. The AD can assemble and sell more than 10,000 TV sets per month.
      1. a. What is the minimum transfer price at which the SD manager would be willing to sell screens to the AD?
      2. b. From the point of view of Aqua’s management, how much of the SD output should be transferred to the AD?
      3. c. If Aqua mandates the SD and AD managers to “split the difference” on the minimum and maximum transfer prices they would be willing to negotiate over, what would be the resulting transfer price? Does this price achieve the outcome desired in requirement 3b?
  2. 23-27. PERTINENT TRANSFER PRICE, PERFECT AND IMPERFECT MARKETS. Chicago, Inc., has two divisions, A and B, that manufacture expensive bicycles. Division A produces the bicycle frame, and division B assembles the rest of the bicycle onto the frame. There is a market for both the subassembly and the final product. Each division has been designated as a profit center. The transfer price for the subassembly has been set at the long-run average market price. The following data are available for each division:
Selling price for final product$360
Long-run average selling price for intermediate product275
Incremental cost per unit for completion in division B120
Incremental cost per unit in division A150
  1. The manager of division B has made the following calculation:
<p>A table shows calculations for division B of Chicago, Inc.</p>

The table depicts calculations for division B of Chicago, Inc. The details of the table are as follows:

1. Selling price for final product: 360 dollars

2. Transferred-in cost per unit (market): 275 dollars

3. Incremental cost per unit for completion: 120 dollars

4. Total costs: 395 dollars

4. Contribution (loss) on product: 35 dollars loss

  1. Required

1. Should transfers be made to division B if there is no unused capacity in division A? Is the market price the correct transfer price? Show your computations.

2. Assume that division A’s maximum capacity for this product is 1,200 units per month and sales to the intermediate market are now 900 units. Assume that for a variety of reasons, division A will maintain the $275 selling price indefinitely. That is, division A is not considering lowering the price to outsiders even if idle capacity exists. Should 300 units be transferred to division B? At what transfer price?

3. Suppose division A quoted a transfer price of $240 for up to 300 units. What would be the contribution to the company as a whole if a transfer were made? As manager of division B, would you be inclined to buy at $240? Explain.

4. Suppose the manager of division A has the option of (a) cutting the external price to $270, with the certainty that sales will rise to 1,200 units, or (b) maintaining the external price of $275 for the 900 units and transferring the 300 units to division B at a price that would produce the same operating income for division A. What transfer price would produce the same operating income for division A? Is that price consistent with that recommended by the general guideline in the chapter so that the resulting decision would be desirable for the company as a whole?

  1. 23-28. EFFECT OF ALTERNATIVE TRANSFER-PRICING METHODS ON DIVISION OPERATING INCOME. Cranfuel Products is a cranberry cooperative that operates two divisions, a harvesting division and a processing division. Currently, all of harvesting’s output is converted into cranberry juice by the processing division, and the juice is sold to large beverage companies that produce cranberry juice blends. The processing division has a yield of 500 gallons of juice per 1,000 pounds of cranberries. Cost and market price data for the two divisions are as follows:
Spreadsheet screenshot shows cost and market price data for the two divisions.

The details are as follows:

Harvesting Division

Processing Division

  1. Required

1. Compute Cranfuel’s operating income from harvesting 520,000 pounds of cranberries during June 2020 and processing them into juice.

2. Cranfuel rewards its division managers with a bonus equal to 4% of operating income. Compute the bonus earned by each division manager in June 2020 for each of the following transfer-pricing methods:

a. 175% of full cost

b. Market price

3. Which transfer-pricing method will each division manager prefer? How might Cranfuel resolve any conflicts that may arise on the issue of transfer pricing?

  1. 23-29. [Required] GOAL-CONGRUENCE PROBLEMS WITH COST-PLUS TRANSFER-PRICING METHODS, DUAL-PRICING SYSTEM (CONTINUATION OF 23-28). Refer to Problem 23-28. Assume that Pat Borges, CEO of Cranfuel, had mandated a transfer price equal to 175% of full cost. Now he decides to decentralize some management decisions and sends around a memo that states: “Effective immediately, each division of Cranfuel is free to make its own decisions regarding the purchase of direct materials and the sale of finished products.”
    1. Required
    2. 1. Give an example of a goal-congruence problem that will arise if Cranfuel continues to use a transfer price of 175% of full cost and Borges’s decentralization policy is adopted.
    3. 2. Borges feels that a dual transfer-pricing policy will improve goal congruence. He suggests that transfers out of the harvesting division be made at 175% of full cost and transfers into the processing division be made at market price. Compute the operating income of each division under this dual transfer-pricing method when 520,000 pounds of cranberries are harvested during June 2020 and processed into juice.
    4. 3. Why is the sum of the division operating incomes computed in requirement 2 different from Cranfuel’s operating income from harvesting and processing 520,000 pounds of cranberries in requirement 1 of Problem 23-38?
    5. 4. Determine two problems that may arise if Cranfuel implements the dual transfer prices described in requirement 2.
  2. 23-30. MULTINATIONAL TRANSFER PRICING, GLOBAL TAX MINIMIZATION. Rapid Grow Inc., based in Des Moines, Iowa, sells high-end fertilizers. Rapid Grow has two divisions:
    1. • North Italy mining division, which mines potash in northern Italy
    2. • U.S. processing division, which uses potash in manufacturing top-grade fertilizer 
  3. The processing division’s yield is 50%: It takes 2 tons of raw potash to produce 1 ton of top-grade fertilizer. Although all of the mining division’s output of 15,000 tons of potash is sent for processing in the United States, there is also an active market for potash in Italy. The foreign exchange rate is 0.80 Euro=1 U.S.  The following information is known about the two divisions:
Spreadsheet screenshot shows information about the North Italy Mining Division and U.S. Processing Division.

Details as follows:

North Italy Mining Division

U.S. Processing Division

  1. Required

1. Compute the annual pretax operating income, in U.S. dollars, of each division under the following transfer-pricing methods: (a) 150% of full cost and (b) market price.

2. Compute the after-tax operating income, in U.S. dollars, for each division under the transfer-pricing methods in requirement 1. (Income taxes are not included in the computation of cost-based transfer price, and Rapid Grow does not pay U.S. income tax on income already taxed in Italy.)

3. If the two division managers are compensated based on after-tax division operating income, which transfer-pricing method will each prefer? Which transfer-pricing method will maximize the total after-tax operating income of Rapid Grow?

4. In addition to tax minimization, what other factors might Rapid Grow consider in choosing a transfer-pricing method?

  1. 23-31. TRANSFER PRICING, EXTERNAL MARKET, GOAL CONGRUENCE. Ballantine Corp. produces and sells lead crystal glassware. The firm consists of two divisions, commercial and specialty. The commercial division manufactures 300,000 glasses per year. It incurs variable manufacturing costs of $8 per unit and annual fixed manufacturing costs of $900,000. The commercial division sells 100,000 units externally at a price of $12 each, mostly to department stores. It transfers the remaining 200,000 units internally to the specialty division, which modifies the units, adds an etched design, and sells them directly to consumers online.
  2. Ballantine Corp. has adopted a market-based transfer-pricing policy. For each glass it receives from the commercial division, the specialty division pays the weighted-average external price the commercial division charges its customers outside the company. The current transfer price is accordingly set at $12.
  3. Eileen McCarthy, the manager of the commercial division, receives an offer from Home Décor, a chain of upscale home furnishings stores. Home Décor offers to buy 20,000 glasses at a price of $9 each, knowing that the entire lead crystal industry (including Ballantine Corp.) has excess capacity at this time. The variable manufacturing cost to the commercial division for the units Home Décor is requesting is $8, and there are no additional costs associated with this offer. Accepting Home Décor’s offer would not affect the current price of $12 charged to existing external customers.
    1. Required
    2. 1. Calculate the commercial division’s current annual level of profit (without the new order).
    3. 2. Compute the change in the commercial division’s profit if it accepts Home Décor’s offer. Will Eileen McCarthy accept this offer if her aim is to maximize the commercial division’s profit?
    4. 3. Would the top management of Ballantine Corp. want the commercial division to accept the offer? Compute the change in firm-wide profit associated with Home Décor’s offer.
  4. 23-32. INTERNATIONAL TRANSFER PRICING, TAXES, GOAL CONGRUENCE. Beacon, a division of Libra Corporation, is located in the United States. Its effective income tax rate is 30%. Another division of Libra, Falcon, is located in Canada, where the income tax rate is 40%. Falcon manufactures, among other things, an intermediate product for Beacon called XPS-2022. Falcon operates at capacity and makes 15,000 units of XPS-2022 for Beacon each period, at a variable cost of $28 per unit. Assume that there are no outside customers for XPS-2022. Because the XPS-2022 must be shipped from Canada to the United States, it costs Falcon an additional $4 per unit to ship the XPS-2022 to Beacon. There are no direct fixed costs for XPS-2022. Falcon also manufactures other products.
  5. A product similar to XPS-2022 that Beacon could use as a substitute is available in the United States for $38.50 per unit.
    1. Required
    2. 1. What are the minimum and maximum transfer prices that would be acceptable to Beacon and Falcon for XPS-2022, and why?
    3. 2. What transfer price would minimize income taxes for Libra Corporation as a whole? Would Beacon and Falcon want to be evaluated on operating income using this transfer price?
    4. 3. Suppose Libra uses the transfer price from requirement 2 and each division is evaluated on its own after-tax division operating income. Now suppose Falcon has an opportunity to sell 8,000 units of XPS-2022 to an outside customer for $31 each. Falcon will not incur shipping costs because the customer is nearby and offers to pay for shipping. Assume that if Falcon accepts the special order, Beacon will have to buy 8,000 units of the substitute product in the United States at $38.50 per unit.
      1. a. Will accepting the special order maximize after-tax operating income for Libra Corporation as a whole?
      2. b. Will Beacon want Falcon to accept this special order? Why or why not?
      3. c. Will Falcon want to accept this special order? Explain.
      4. d. Suppose Libra Corporation wants to operate in a decentralized manner. What transfer price should Libra set for XPS-2022 so that each division acting in its own best interest takes actions with respect to the special order that are in the best interest of Libra Corporation as a whole?
  6. 23-33. TRANSFER PRICING, GOAL CONGRUENCE, ETHICS. Jeremiah Industries manufactures high-grade aluminum luggage made from recycled metal. The company operates two divisions: metal recycling and luggage fabrication. Each division operates as a decentralized entity. The metal recycling division is free to sell sheet aluminum to outside buyers, and the luggage fabrication division is free to purchase recycled sheet aluminum from other sources. Currently, however, the recycling division sells all of its output to the fabrication division, and the fabrication division does not purchase materials from any outside suppliers.
  7. Aluminum is transferred from the recycling division to the fabrication division at 110% of full cost. The recycling division purchases recyclable aluminum for $0.50 per pound. The division’s other variable costs equal $2.80 per pound, and fixed costs at a monthly production level of 50,000 pounds are $1.50 per pound. During the most recent month, 50,000 pounds of aluminum were transferred between the two divisions. The recycling division’s capacity is 70,000 pounds.
  8. Due to increased demand, the fabrication division expects to use 60,000 pounds of aluminum next month. Metalife Corporation has offered to sell 10,000 pounds of recycled aluminum next month to the fabrication division for $5.00 per pound.
    1. Required
    2. 1. Calculate the transfer price during the most recent month per pound of recycled aluminum. Assuming that each division is considered a profit center, would the fabrication manager choose to purchase 10,000 pounds next month from Metalife?
    3. 2. Is the purchase in the best interest of Jeremiah Industries? Show your calculations. What is the cause of this goal incongruence?
    4. 3. The fabrication division manager suggests that $5.00 is now the market price for recycled sheet aluminum, and that this should be the new transfer price. Jeremiah Industries’ corporate management tends to agree. The metal recycling manager is suspicious. Metalife’s prices have always been considerably higher than $5.00 per pound. Why the sudden price cut? After further investigation by the recycling division manager, it is revealed that the $5.00 per pound price was a one-time-only offer made to the fabrication division due to excess inventory at Metalife. Future orders would be priced at $5.50 per pound. Comment on the validity of the $5.00 per pound market price and the ethics of the fabrication manager. Would changing the transfer price to $5.00 matter to Jeremiah Industries?
  9. 23-34.TRANSFER PRICING, GOAL CONGRUENCE. The Croydon division of CC Industries supplies the Hauser division with 100,000 units per month of an infrared LED that Hauser uses in a remote control device it sells. The transfer price of the LED is $8, which is the market price. However, Croydon does not operate at or near capacity. The variable cost to Croydon of the LED is $4.80, while Hauser incurs variable costs (excluding the transfer price) of $12 for each remote control. Hauser’s selling price is $32.
  10. Hauser’s manager is considering a promotional campaign. The market research department of Hauser has developed the following estimates of additional monthly volume associated with additional monthly promotional expenses.
Additional Monthly Promotional Expenses:$80,000$120,000$160,000
Additional Monthly Volume (Units)10,00015,00018,000
  1. Required

1. What level of additional promotional expenses would the Hauser division manager choose?

2. As the manager of the Croydon division, what level of additional promotional expenses would you like to see the Hauser division manager select?

3. As the president of CC Industries, what level of spending would you like the Hauser division manager to select?

4. What is the maximum transfer price that would induce the Hauser division to spend the optimal additional promotional expense from the standpoint of the firm as a whole?

  1. 23-35. TRANSFER PRICING, PERFECT AND IMPERFECT MARKETS. Letang Company has three divisions (R, S, and T), organized as decentralized profit centers. Division R produces the basic chemical Ranbax, in multiples of 1,000 pounds, and transfers it to divisions S and T. Division S processes Ranbax into the final product Syntex, and division T processes Ranbax into the final product Termix. No material is lost during processing.
  2. Division R has no fixed costs. The variable cost per pound of Ranbax is $0.18. Division R has a capacity limit of 10,000 pounds. Divisions S and T have capacity limits of 4,000 and 6,000 pounds, respectively. Divisions S and T sell their final product in separate markets. The company keeps no inventories of any kind.
  3. The cumulative net revenues (i.e., total&nbsp;revenues&nbsp;−&nbsp;total&nbsp;processing&nbsp;costs) for divisions S and T at various output levels are summarized below.
<p>A table shows cumulative net revenues for divisions S and T at various output levels</p>

The table depicts. The details of the table are as follows:

1. Division S, first output level

2. Division S, second output level

3. Division S, third output level

4. Division S, fourth output level

5. Division T, first output level

6. Division T, second output level

7. Division T, third output level

8. Division T, fourth output level

9. Division T, fifth output level

8. Division T, sixth output level

  1. Required

1. Suppose there is no external market for Ranbax. What quantity of Ranbax should the Letang Company produce to maximize overall income? How should this quantity be allocated between the two processing divisions?

2. What range of transfer prices will motivate divisions S and T to demand the quantities that maximize overall income (as determined in requirement 1), as well as motivate division R to produce the sum of those quantities?

3. Suppose that division R can sell any quantity of Ranbax in a perfectly competitive market for $0.33 a pound. To maximize Letang’s income, how many pounds of Ranbax should division R transfer to divisions S and T, and how much should it sell in the external market?

4. What range of transfer prices will result in divisions R, S, and T taking the actions determined as optimal in requirement 3? Explain your answer.

  1. 23-36. TRANSFER PRICING, FULL COST AND MARKET-BASED TRANSFER PRICES. Compost Systems, Inc. (CSI) operates a composting service business and produces organic fertilizer that it sells to farmers in the Midwest. CSI operates with two divisions, collection and composting. The collection division contracts with universities, hospitals, and other large institutions to provide compostable waste collection bins in their dining service areas, and hauls the waste away daily. The waste providers pay the collection division a monthly fee for this service, and the collection division in turn charges the composting division for the compostable materials at a full-cost transfer price of $200 per ton. Monthly, CSI collects and transfers 1,000 tons of waste.
  2. The composting division processes the waste, places it in bins, adds microbes to break down the organic material, and ultimately delivers the fertilizer it produces to farmers for use in their fields. After the removal of water, 1,000 tons of waste produces 500 tons of fertilizer. Demand for the fertilizer has risen steeply as consumer demand for organic produce has increased in recent years.
  3. Below are key data related to CSI’s monthly operations:
<p>A table shows key data related to CSI’s monthly operations</p>

The table depicts key data related to CSI’s monthly operations. The details of the table are as follows:

1. Collection division, Revenues

2. Collection division, Costs

3. Divisional operating income: 50,000 dollars

4. Composting division, Revenues

5. Composting division, Costs

6. Divisional operating income: 50,000 dollars

7. Operating income of both divisions together: 80,000 dollars

  1. The composting division has demand for an additional 200 tons of fertilizer per month. To provide the 400 tons of compostable waste necessary to meet the increased demand, the collection division will have to invest in additional marketing and equipment that will increase monthly fixed costs by $28,000. Estimated additional monthly revenue to the collection division from waste providers is $10,000.
    1. Required
    2. 1. Compute the new full-cost transfer price if it is applied to all waste transferred to the composting division.
    3. 2. Compute the new full-cost transfer price if it is applied to just the additional 400 tons.
    4. 3. What difficulties do you see in using a full-cost transfer-pricing system in the future?
    5. 4. The composting division has identified a source of additional compostable waste at a price of $205 per ton. What would be the impact on the company as a whole if the 400 tons of material is purchased from the outside supplier? As a decentralized unit, what decision would the composting division make regarding the additional material?
    6. 5. Would a market-based transfer price be agreeable to both divisional managers?
  2. 23-37. TRANSFER PRICING, UTILIZATION OF CAPACITY. (J. Patell, adapted) Sierra Inc. consists of a semiconductor division and a process-control division, each of which operates as an independent profit center. The semiconductor division employs craftsmen who produce two different electronic components: the new high-performance Xcel-chip and an older product called the Dcel-chip. These products have the following cost characteristics:
<p>A table shows cost characteristics for Xcel-chip and Dcel-chip from Sierra Inc.</p>

The table depicts direct materials and direct manufacturing labor for Xcel-chip and Dcel-chip. The details of the table are as follows:

1. Direct materials

2. Direct manufacturing labor

  1. Due to the high skill level necessary for the craftsmen, the semiconductor division’s capacity is set at 55,000 hours per year.
  2. Maximum demand for the Xcel-chip is 13,750 units annually, at a price of $130 per chip. There is unlimited demand for the Dcel-chip at $65 per chip.
  3. The process-control division produces only one product, a process-control unit, with the following cost structure:
    1. • Direct materials (circuit board): $80
    2. • Direct manufacturing labor (3.5 hours×$10) : $35 
  4. The current market price for the control unit is $125 per unit.
  5. A joint research project has just revealed that a single Xcel-chip could be substituted for the circuit board currently used to make the process-control unit. The direct manufacturing labor cost of the process-control unit would be unchanged. The improved process-control unit could be sold for $185.
    1. Required
    2. 1. Calculate the contribution margin per direct labor-hour of selling Xcel-chip and Dcel-chip. If no transfers of Xcel-chip are made to the process-control division, how many Xcel-chips and Dcel-chips should the semiconductor division manufacture and sell? What would be the division’s annual contribution margin? Show your computations.
    3. 2. The process-control division expects to sell 1,250 process-control units this year. From the viewpoint of Sierra Inc. as a whole, should 1,250 Xcel-chips be transferred to the process-control division to replace circuit boards? Show your computations.
    4. 3. What transfer price, or range of prices, would ensure goal congruence among the division managers? Show your calculations.
    5. 4. If labor capacity in the semiconductor division were 60,000 hours instead of 55,000, would your answer to requirement 3 differ? Show your calculations.