Internal Code - MAS1495
Transfer pricing is used when products or services are transferred between different divisions of the same company.
Explain what a transfer price is. What are the different types of transfer prices that can be used ? Why are these different types of transfer prices used? What are the purposes of using transfer prices?
This question is a practical question requiring answers to the questions at the end of the following information.
The Complete Mining and Manufacturing Company has several divisions and two of these are involved in the transfer of products.The Cleaning and Scraping Division produces raw Cruden and transfers it to the Processing Division where it is processed into an alloy.The Processing Division then sells it on the open market for $160 per unit .Currently the Complete Mining and Manufacturing Company requires all of the Cruden to be transferred from the Cleaning and Scraping Division to the Processing Division . Currently the Cleaning and Scraping Division produces 400,000 units per year and transfers it all to the Processing Division at total actual manufacturing cost plus 10% .
The Cruden can be purchased and sold on the open market for $95 and all that is sent to market can be sold on the market at this price.If the Cleaning and Scraping Division sells the Cruden on the open market it will incur a variable selling cost of $5 per unit .
The following details show the unit costs for the Cleaning and Scraping and Processing Divisions
Cleaning and Scraping Division Processing Division
Transfer price from Cleaning and Scraping $77
Direct material 18 5
Direct labour 12 10
Manufacturing overhead 40 25
Total cost per unit 70 117
Manufacturing overhead in Cleaning and Scraping is 25% fixed,75% variable
Manufacturing overhead in Processing is 60% fixed,40% variable
(a) Explain why transfer prices based on total actual costs are not appropriate as the basis for divisional performance measurement
(b)Using the market price as the transfer price, calculate the contribution margin for both divisions.
(c) If the Complete Mining and Manufacturing 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 Cruden that would be acceptable to both divisions.
(d)Use the general transfer pricing rule to compute the lowest transfer price that would be acceptable to the Cleaning and Scraping Division? Will this transfer price be the one that the manager of the Cleaning and Scraping Division prefers? Provide an explanation for your answer to this question.