Transfer Pricing
Practice As You Learn
You will be asked to determine the appropriate transfer price.
You must memorize the guidelines for the minimum and maximum transfer price.
Minimum – total of incremental costs:
All variable costs + added fixed costs
If at capacity – current sales price to external customers
Maximum – the lowest market purchase price outside the company
If at capacity – the current sales price to external customers
To determine the minimum transfer price:
1st – identify incremental variable and fixed costs.
Include variable costs because they are always incremental
Include fixed costs only if they are incurred to service the internal customer only
2nd – determine if the selling unit is at capacity
If at capacity – sales price to external customers is the minimum
To determine the maximum transfer price:
Determine the lowest price the purchasing segment can pay outside the company.
A company has a copy center that is available to make copies of documents for other departments. The cost unit charges a transfer price for services provided. Costs related to the copy center cost unit are as follows:
| Cost of Paper | $0.01 per page |
| Cost of Toner | $0.02 per page |
| Wages and Salaries for those who make copies | $60,000 |
| Cost of Copy Machines | $50,000 |
| Cost of Facilities used for the copy area | $22,000 |
| Total number of copies made during the year | 1,200,000 |
| The copy center annual capacity in pages | 1,500,000 |
The copy center has provided service to other companies for a price of $0.15 per page.
Other departments can get similar service for a price of $0.14 at Kinko’s copy centers and $0.17 at a custom copy shop a mile from corporate headquarters.
A. Determine the minimum transfer price per page.
B. Determine the maximum transfer price per page
Answer
A. The minimum transfer price should be equal to all variable costs + fixed costs used specifically for the purpose of providing the service internally (incremental).
1st – identify the fixed and variable costs and determine the cost per for fixed:
Variable costs:
Paper $0.01
Toner $0.02
Fixed costs:
Wages/salaries $0.05
Machines $0.04
Facilities $0.02
Divided total fixed costs for each by copies made to get a cost per unit at the current level of service
($ / 1,200,000 = fixed cost per unit)
2nd – list the variable cost and the incremental fixed costs:
Facilities costs will be incurred regardless and are not incremental
Wages & copy machine costs will be not be incurred if the service is not performed and are incremental costs
Variable costs:
Paper $0.01
Toner $0.02
Fixed costs:
Wages/salaries $0.05
Machines $0.04
Total Incremental Costs $0.12
The minimum transfer price is the total incremental costs: $0.12
B. $0.14
The maximum transfer price that should be charged is the minimum price the service can be obtained for outside the company
Transfer Pricing – Practice Problem 2
One division of the company uses a component in products it manufactures for customers. The component can be purchased from outside suppliers for $8.00 or it can be purchased from another manufacturing division of the company. Information related to the division of the company that internally manufactures the component are as follows:
| Variable production costs | $5.25 |
| Variable selling costs | $0.50 |
| Fixed production costs | $100,000 |
| Fixed Selling costs | $40,000 |
| Sales price to outside customers | $8.50 |
| Units sold to outside customers | 10,000 |
| Production capacity | 15,000 |
Variable selling costs are sales commissions that will not be earned on an internal sale.
A. Determine the minimum and maximum transfer price for an internal sale of 3,000 units.
B. Determine the minimum and maximum transfer price for an internal sale of 8,000 units
Answer
A. Minimum and Maximum – sale of 3,000 units
The company has the excess capacity to produce 3,000 units: (15,000 produced less 10,000 currently sold = 5,000 additional units that can be produced to sell)
1st – Determine the incremental variable and fixed costs of manufacturing:
| Variable production | $5.25 | |
| Variable selling | $ 0 | this will not be incurred for an internal sale |
| Fixed production | $ 0 | not incremental, will be incurred regardless |
| Fixed Selling | $ 0 | not incremental, will be incurred regardless |
2nd – the total of all incremental costs will be the minimum transfer price: $5.25
3rd – Maximum: Determine the lowest price the component can be purchased outside the company.
$8 is the maximum transfer price.
Ignore the current price to customers when there is capacity.
The other segment should not pay the higher current price to customers when they can purchase it elsewhere for less. This would reduce total company profits as total company costs will be higher.
B. Minimum and Maximum – sale of 8,000 units
For the part that the company has capacity to produce – use the minimum determined in part A.
3,000 units can be sold at a minimum price of $5.25
For this division to sell the other 5,000 internally, contribution margin on these units from outside customers would be lost.
| Sales price | $8.50 |
| Less VC – production | $5.25 |
| Less VC – selling | $0.50 |
| Total contribution margin outside customers | $2.75 |
Assume fixed costs will not be incremental unless told otherwise
The minimum transfer price when there is no excess capacity is:
| Incremental costs | $5.25 |
| + Lost contribution margin | $2.75 |
| = Minimum transfer price | $8.00 |
5,000 units should be sold at a minimum transfer price of $8.00
The minimum price when at capacity will be the current price to external customers.
Final Answer:
Minimum:
1st 3,000 at $5.25
2nd 5,000 at $8.00
Maximum: $8.00
The lowest external market price