Three divisions of a CMI are involved in a dispute. Division A purchases Part 101 and
Division B purchases Part 201 from a third division, C. Both divisions need the parts for
products that they assemble. The intercompany transactions have remained constant
for several years.
Recently, outside suppliers have lowered their prices, but Division C refuses to do so. In
addition, all division managers are feeling the pressure to increase profit. Managers of
divisions A and B would like the flexibility to purchase the parts they need from external
parties at a lower cost and increase profitability.
The current pattern is that
Division A purchases 2,700 units of product part 101 from Division C (the supplying
division) and another 1,300 units from an external supplier.
Division B purchases 1,100 units of Part 201 from Division C and another 700 units
from an external supplier.
Note that both divisions A and B purchase the needed supplies from both the
internal source and an external source at the same time.
The managers for divisions A and B are preparing a new proposal for consideration.
Division C will continue to produce Parts 101 and 201. All of its production will be
sold to Divisions A and B. No other customers are likely to be found for these
products in the short term, given that supply is greater than demand in the market.
Division A will buy 2,000 units of Part 101 from Division C at the existing transfer
price; and
2,000 units from an external supplier at the market price of $900 per unit.
Division B will buy 900 units of Part 201 from Division C at the existing transfer
price; and
900 units from an external supplier at $1,800 per unit.
Listen
Division C Data Based on the Current Agreement
Part 101 201
Annual volume (units) 2,700 1,100
Transfer price/unit $1,000 $2,000
Variable expenses/unit $700 $1,200
The fixed overhead for Division C is $1,200,000.
Case Assignment
Required:
Computations (use Excel)
Set up a table similar the one below to compute the difference between the current
situation and the proposal for Divisions A and B.
Division A
Current Situation Proposal
No. of
Units
Purchase
Price
Total
Purchases
No. of
Units
Purchase
Price
Total
Purchases
Internal
purchases
2,700 $ 2,000 $
External
purchases
1,300 2,000
Total cost for
Part 101
$ $
Savings to Div. A $
Compute the operating income for Division C under the current agreement and the
proposed agreement.
Is the revised agreement a good idea? Support your answer with computations.
Memo (use Word)
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Write a 4- or 5-paragraph memo to the division manager explaining the analysis
performed. Start with an introduction and end with a recommendation. Each of the four
or five paragraphs should have a heading.
Short Essay (use Word)
Start with an introduction and end with a summary or conclusion. Use headings.
Evaluate and discuss the implications of the following transfer pricing policies:
Transfer price = cost plus a mark-up for the selling division
Transfer price = fair market value
Transfer price = price negotiated by the managers
Why is transfer pricing such a significant issue both from a financial and managerial
perspective?