Question

Exercise 11A-1 Transfer Pricing Basics [LO11-5]

Sako Company’s Audio Division produces a speaker that is used by manufacturers of various audio products. Sales and cost data on the speaker follow:

Selling price per unit on the intermediate market	$60
Variable costs per unit	$42
Fixed costs per unit (based on capacity)	$8
Capacity in units	25,000

Sako Company has a Hi-Fi Division that could use this speaker in one of its products. The Hi-Fi Division will need 5,000 speakers per year. It has received a quote of $57 per speaker from another manufacturer. Sako Company evaluates division managers on the basis of divisional profits.

Required:
1.	Assume that the Audio Division is now selling only 20,000 speakers per year to outside customers.

a.	From the standpoint of the Audio Division, what is the lowest acceptable transfer price for speakers sold to the Hi-Fi Division?

           

b.	From the standpoint of the Hi-Fi Division, what is the highest acceptable transfer price for speakers acquired from the Audio Division?

          

c.

If left free to negotiate without interference, would you expect the division managers to voluntarily agree to the transfer of 5,000 speakers from the Audio Division to the Hi-Fi Division?

	Yes
	No

d.

From the standpoint of the entire company, should the transfer take place?

	Transfer should take place.
	Transfer should not take place.

2.	Assume that the Audio Division is selling all of the speakers it can produce to outside customers.

a.	From the standpoint of the Audio Division, what is the lowest acceptable transfer price for speakers sold to the Hi-Fi Division?

           

b.	From the standpoint of the Hi-Fi Division, what is the highest acceptable transfer price for speakers acquired from the Audio Division?

          

c.

If left free to negotiate without interference, would you expect the division managers to voluntarily agree to the transfer of 5,000 speakers from the Audio Division to the Hi-Fi Division?

	Yes
	No

d.

From the standpoint of the entire company, should the transfer take place?

	Transfer should take place.
	Transfer should not take place.

Answer 1

Ques 1.
Assumption given - Only 20000 speakers are being sold currently to audio division

Because the audio speakers being sold are only 20,000 as of now, and the left capacity of 5000 is going untilized, which may also increase the fixed cost per unit, IT IS BETTER TO MANUFACTURE THE 5000 SPEAKERS AND SELL THEM TO THE HI-FI DIVISION

A. From the stand-point of audio division, the minimum price that it can bear to sell the speakers to the Hi-Fi division should be 50, so that it can atleast recover its total cost per unit

B. From the standpoint of Hi-Fi division, as it is getting an other manufacturer for the price of $57, the max transfer cost should be $57, because it will always be better to take the product of own company rather than outside manufacture

C. Yes, the divisional managers should freely give the transfer of 5000 speakers to the Hi-Fi division because-

1. It will reduce the per unit fixed cost

2. As per unit fixed cost is reduced, the profits for audio division speakers would be high

3. Selling speakers anywhere between $50 and $57 would get them the deal and bring in high profits

D. From the stand-point of entire company, the transfer should take place because-T

1. Both divisions get products from company's manufacture which is better

2. Manufacturing capacity is well utilized and

Ques 2. Assumption that audio division uses entire 25000 speakers

a. Because the audio division is getting Profit of $10 from each unit it produces by selling it at $60, it would not want to lose out on any profit and hence charge $60 for speakers sold to the Hi-Fi division as well

b. From the standpoint of Hi-Fi division, it would not want to get speakers more than $57 because it is getting them at cheaper rates from other manufacturers

c. NO, the divisional managers would not want to freely give away the speakers to the Hi-Fi division at a cost anywhere less than $60 because it would cause them loss of profits and revenues

d. From the standpoint of company, the transfer SHOULD NOT OCCUR, because it Hi-Fi division pays anywhere more than $57, it would lead to increasded OPERATIONAL RAW MATERIAL COSTS, and if audio speakers are sold under $60, the audio division would lose on the profits