Transcript CHAPTER 22

Transfer Pricing
Managerial Accounting
David Fender
Possible pricing strategies
1. Cost plus …
2. Willingness to pay…
Objectives for pricing policy
1. Identifying and adhering to both short-run and
2.
3.
4.
5.
6.
long-run pricing strategies
Maximizing profits
Maintaining or gaining market share
Setting socially responsible prices
Maintaining a minimum rate of return on
investment
Being customer focused
Economic Pricing Concepts
 Economic approach to pricing
 Based on microeconomic theory
Marginal Cost = Marginal Return
Profit will be maximized when the difference between total
revenue and total costs is the greatest
Example of economic pricing concept
Organization and flow of goods
within a company
One consequence of having different
organizational units of a large company is the need
to have transfer prices for goods
Transfer Pricing
 Transfer Price – the price one subunit (department or
division) charges for a product or service supplied to
another subunit of the same organization
 Transfer prices are used to coordinate the actions of
subunits and to evaluate their performance
© 2009 Pearson Prentice Hall. All rights reserved.
Why are transfer prices a hot issue?
 They effect profits of divisions
EARNINGS!!!
 Power
 Compensation
 Pride – prestige
 Quality of employees
 They effect the decision what a company
manufactures PROFITABILITY!!!
 TAXES!!!

The optimal transfer price allows
each division manager to make
decisions that maximize the
company’s profit, while
attempting to maximize his/her
own division’s profit.
What rule should a
company apply?
Drum roll …
© 2009 Pearson Prentice Hall. All rights reserved.
Scenario I: No Excess Capacity
General Rule
When the selling division is operating
at capacity, the transfer price should be
set at the market price.
Scenario II: Excess Capacity
General Rule
When the selling division is operating
below capacity, the minimum transfer
price is the variable cost per unit.
So, the transfer price will be no lower
than variable cost, and no higher than (outside)
market price.
Example
Scenario I: No Excess Capacity
 The Battery Division makes a standard 12-volt
battery.
Production capacity
Selling price per battery
Variable costs per battery
Fixed costs per battery
300,000 units
$40 (to outsiders)
$18
$7 (at 300,000 units)
 The Battery division is currently selling 300,000
batteries to outsiders at $40. The Auto Division can
use 100,000 of these batteries in its X-7 model.
What is the appropriate transfer
price?
Scenario I: No Excess Capacity
Transfer
price
=
Additional outlay
cost per unit
incurred because
goods are
transferred
Transfer
price
=
$18 variable
cost per battery
Transfer
price
=
$40 per battery
+
Opportunity cost
per unit to the
organization
because of
the transfer
+
$22 Contribution
lost if outside
sales given up
Scenario I: No Excess Capacity
Auto division can
purchase 100,000
batteries from an
outside supplier
for less than $40.
Auto division can
purchase 100,000
batteries from an
outside supplier
for more than $40.
Transfer
will not
occur.
Transfer
will
occur.
$40
transfer
price
Scenario II: Excess Capacity
 The Battery Division makes a standard 12-volt battery.
Production capacity
Selling price per battery
Variable costs per battery
Fixed costs per battery $7
300,000 units
$40 (to outsiders)
$18
(at 300,000 units)
 The Battery division is currently selling 150,000
batteries to outsiders at $40. The Auto Division can use
100,000 of these batteries in its X-7 model. It can
purchase them for $38 from an outside supplier.
What is the appropriate transfer
price?
Scenario II: Excess Capacity
=
Additional outlay
cost per unit
incurred because
goods are
transferred
+
Transfer
price
=
$18 variable
cost per battery
+
Transfer
price
=
$18 per battery
Transfer
price
Opportunity cost
per unit to the
organization
because of
the transfer
$0
Scenario II: Excess Capacity
General Rule
When the selling division is
operating below capacity, the
minimum transfer price is the
variable cost per unit.
So, the transfer price will be no lower
than $18, and no higher than $38.
Scenario II: Excess Capacity
Transfer
will not
occur.
Transfer
will
occur.
$18
transfer
price
Transfer
will not
occur.
$38
transfer
price