Assume that Selling Division and Buying Division are both owned by Overall Corporation. Selling Division sells a product that is used by Buying Division and outside customers. Selling Division has 27,000 units of excess capacity. Selling Division currently sells the product for $90 per unit and Buying Division currently buys 27,000 units of the product from an outside source for $90 per unit. Variable costs of the product are $18, of which $4.5 is the cost of selling the product to an outside customer.
1. Using Selling price less avoidable costs as the minimum price, fill in the following formula for the desired transfer price: $__________ < transfer price < $_________.
2. Using Variable costs as the minimum price, fill in the following formula for the desired transfer price: $___________ < transfer price < $____________.
Assume there are no avoidable costs with an internal sale (variable costs equal $18) and that Buying Division buys 27,000 units from Selling Division. Complete the table for each transfer price:
3.
|
Transfer Price |
Transfer Price |
|
|
$85 |
$25 |
|
|
Increase in net income of Selling Division |
$ |
$ |
|
Increase in net income of Buying Division |
$ |
$ |
|
Increase in net income of Overall Corporation |
$ |
$ |
One reason for companies to set transfer pricing policy is to move profits from one division to another. This may be done for competitive reasons, when the goal is to challenge division management to act as a standalone company in order to compare a division with its competitors. Another reason to move profits is for tax purposes or other cost savings for the company as a whole.
Selling Division sells 33,000 units to Buying Division. Selling Division’s tax rate is 15%, and Buying Division’s tax rate is 20%. Market price is $68.80 per unit, and it costs Selling Division $27.00 to produce each unit.
Overall Corporation abides by tax authority guidelines and can support the use of market-based transfer pricing and cost plus 20% transfer pricing.
