Transfer Pricing
Medium Practice Test
Medium Practice Test
Click the “Check Your Answer” box below each question to reveal the correct answer and explanation.
1. A valid reason for not using a full cost-based transfer price is
a. a full cost is difficult to estimate
b. the full cost does not give the selling division incentive to control costs
c. the full cost does not allow for excess capacity of the selling unit
d. the full cost can not be determined without considering the external selling price
Answer
2. Idle capacity in the purchasing division will
a. lead to a higher transfer price
b. lead to a lower transfer price
c. increase the external selling price
d. have no impact on the transfer price
Answer
The presence of idle capacity at the selling division should reduce the possible minimum transfer price.
.
3. Multi-national companies do not consider which of the following when determining transfer prices?
a. corporate tax rates in each country
b. the availability of labor at each manufacturing plant
c. foreign exchange risks
d. profits at each division
Answer
B. The availability of labor is not considered when determining the price. It may be considered in determining whether or not to produce the product at a particular division. All of the other choices are considered when determining the transfer price.
4. A company that evaluates management based on profitability at each division should set transfer prices based on
a. full cost
b. absorption cost
c. incremental costs
d. external selling prices
Answer
D. The external selling price will be the most representative of a third-party transaction.
Cost based methods are often subjective as to which costs are included and do not give an objective profit to the selling division.
5. The division that is producing at full capacity should set transfer prices that consider
a. only incremental variable costs
b. the normal contribution margin from selling externally
c. only added fixed costs to produce to demand
d. none of the above
Answer
B. A division producing at capacity must consider that sales to external customers at a higher price will be lost and should consider the lost contribution margin when setting the transfer price.
6. A disadvantage of setting transfer prices based on cost is
a. the selling division increases profits at the expense of the buyer
b. the selling division gets no credit for profit on the sale
c. the purchasing division normally pays a higher price for the goods
d. none of the above
Answer
B. When the transfer price is equal to costs there is no profit on the sale. The purchasing division normally pays a lower price than market. External suppliers will have to charge cost plus profit which will most likely be higher than the selling division’s costs.
7. A division that sells at a transfer price based on full cost will
a. report a lower profit than if the internal sale had not occurred
b. report a higher profit than if the internal sale had not occurred
c. report the same profit than if the internal sale had not occurred
d. have a lower transfer price than a transfer price based on incremental costs only
Answer
B. Profits will be higher because the selling division gets to charge for fixed costs that would have been incurred if the internal sale had not occurred. The selling division charges for costs they would have incurred regardless of the internal sale. A full cost price will be higher than a price based on incremental costs.
8. A division that sales all it can produce and sets transfer prices based on external market prices will
a. report a lower profit than if the internal sale had not occurred
b. report a higher profit than if the internal sale had not occurred
c. report the same profit than if the internal sale had not occurred
d. have a lower transfer price than a transfer price based on incremental costs only
Answer
C. The selling division will report the same profit if it sells to external or internal customers when they sell all produced at the external sales price.
9. Setting the transfer price at the minimum price should encourage
a. the purchasing division to buy from the selling division
b. the selling division to sell to the purchasing division
c. the selling division to increase currently required fixed costs
d. all of the above
Answer
A. The minimum transfer price is equal to incremental costs incurred to manufacture the product. This should be less than any external price that will include costs plus profits of the supplier. The lower price should encourage the purchasing division to purchase the units internally. The selling division will earn no profit on the sale and would prefer to sell outside the company.
10. When determining a transfer price, the lack of idle capacity will always
a. increase the transfer price
b. ensure the transfer price is lower than the external selling price by the selling division
c. ensure the transfer price is higher than the external selling price by the selling division
d. discourage the purchasing division from purchasing internally
Answer
A. No idle capacity means the selling division will have to cease selling to external customers to supply the inter-company division. In order to keep profits the same, the selling division will have to sell to the purchasing division at approximately the external selling price. The external selling price is the maximum transfer price which is a higher transfer price than the minimum transfer price based on incremental costs.
11. A company has two divisions, electronics and appliances. The electronics division manufactures an electronic computer chip that can be sold externally and is also used by the appliance division. The electronics division would have to pay $125,000 for special equipment in order to manufacture to the appliance division’s requirements. The following information is available for the computer chip:
List Selling Price: $25.60 10% higher than competitors
Variable Production Costs: $14.00
Fixed Overhead Costs
$300,000 allocated on the basis of units produced
Variable Selling Costs $3;
includes $1 per unit in advertising costs
Fixed Selling Costs $400,000 Total Units Produced Annually: 200,000 Internal Requirements: 50,000 Units Sold Externally: 150,000
A. Determine the minimum transfer price using the incremental cost method
B. Determine the maximum transfer price:
Answer
A. The minimum transfer price should be the total of incremental costs. Incremental costs are all incremental variable costs plus any fixed costs that must be added to service the division.
Variable production costs $14 Variable selling costs $ 2 Added fixed costs $ 2.50 Total incremental costs $18.50
Minimum transfer price is $18.50
Current fixed costs are ignored.
Added fixed costs = $125,000 / 50,000 units = $2.50
Advertising costs do not have to be incurred for internal sales
Capacity is available to produce to sell to the appliance division.
B. The maximum transfer price should be the lowest price the division can purchase from an external supplier.
The electronics division currently sell at $25.60 which is 10% higher than competitors which means that other suppliers sell at a price of $23.04
($25.60 x 90% = $23.04)
The maximum transfer price should be $23.04
12. A company makes disposable cameras and the Camera Division can purchase film from either the company’s Film Division or from an outside supplier. The Camera division currently buys 25,000 rolls of film monthly from an outside supplier for $3 each.
Below is monthly information for the Film Division Selling price per roll to external customers $3.50 Variable costs per roll $1.60 Fixed costs per month $150,000 Capacity 100,000 rolls Outside sales 80,000 rolls Current Inside sales 0
A. What is the minimum price per roll that Film Division would have to charge the Camera Division in order maintain current profits and provide Camera Division with all 25,000 rolls per month? Film Division cannot expand capacity.
B. If the Film Division matched the outside supplier price of $3 per roll and sold Camera 25,000 rolls, what would be the effect on the monthly income of the total Company?
Answer
A. The minimum transfer should be computed as follows:
Incremental cost per unit – variable costs $1.60 x units before capacity reached 20,000 = Total incremental cost before capacity is reached $32,000
At capacity, minimum cost is current sale price to external customers:
Units over capacity 5,000 x current sales price $3.50 Total cost for units over capacity $17,500 Cost to Camera division for units before capacity $32,000 Cost to Camera division for units after capacity $17,500 Total cost to camera division $49,500
The minimum price that the camera division can charge and not impact division profits negatively:
$49,000 / 25,000 = $1.98 per unit
B. Matching the outside supplier price increases the total company profits by the external purchase price less incremental costs to produce. The costs to the camera division remain the same and the film division earns profit for the sales price less incremental costs for the units below capacity. For units above capacity, the film division loses the difference in the current outside customer sales price and the price sold to the camera division.
Additional profit earned by the film division:
Sales price $3 - Incremental costs $1.60 Added contribution margin $1.40 x Units x 25,000 Added profit for Division A $35,000
Lost contribution margin on sales no longer sold to external customers:
External sales price $3.50 - Variable Costs $1.60 Lost CM $1.90 x Units 5,000 = Lost Total CM $9,500
Division B profits will not change because they will continue to purchase at $3.
Total company profits will increase $35,000 – $9,500 = $25,500
13. A Pharmacy manufactures and sells pain medication. The Paper Division manufactures packaging and the Drug Division manufactures the pain tablet, packages the product and sells the product. The Drugs Division would like to purchase packaging from the Paper Division, given the price is competitive. The normal market purchase price for the packaging is $10 per 100 count. Costs per 100 count for the Paper Division is as follows:
Direct Material $4 Direct Labor $1 Variable O/H $.75 Fixed O/H $1 Sales commission $1.25 Sales price to outside customers: $11.25
Fixed cost is for 1,000,000 units
“Drugs” has offers from outside manufacturers to sell the packaging to them for prices between $11 and $12.
A. Determine the minimum and maximum transfer price given excess capacity.
B. Determine the minimum and maximum transfer price given no excess capacity.
Answer
A. The minimum transfer price is the total incremental costs to manufacture:
Sales commission will not be paid on inside sales
Direct Material $4 Direct Labor $1 Variable O/H $0.75 Total Incremental costs $5.75 Minimum transfer price = $5.75
Maximum transfer price is equal to the lowest purchase price of outside suppliers:
$11.
B. The minimum transfer price should be the price currently sold to external customers when there is excess capacity: $11.25
The maximum price should be price currently sold to external customers when
there is no excess capacity. $11.25