QUESTION 1 Transfer Pricing Basics Gerbig Companys Electrica

QUESTION 1 Transfer Pricing Basics Gerbig Company\'s Electrical Division produces a high-quality transformer. Sales and cost data on the transformer follow Selling price per unit on the outside market Variable costs per unit Fixed costs per unit (based on capacity) Capacity in units $40 $21 $9 60,000 Gerbig Company has a Motor Division that would like to begin purchasing this transformer from the Electrical Division. The Motor Division is currently purchasing 10,000 transformers each year from another company at a cost of $38 per transformer Gerbig Company evaluates its division managers on the basis of divisional profits. Required Assume that the Electrical Division is now selling only 50,000 transformers each year to outside customers. 1. From the standpoint of the Electrical Division, what is the lowest acceptable transfer price for transformers sold to the Motor Division? From the standpoint of the Motor Division, what is the highest acceptable transfer price for transformers acquired from the Electrical Division? If left free to negotiate without interference, would you expect the division managers to voluntarily agree to the transfer of 10,000 transformers from the Electrical Division to the Motor Division? Why or why not? From the standpoint of the entire company, should a transfer take place? Why or why not? a. b. c. d. 2. Assume that the Electrical Division is now selling to outside customers all of the transformers it can produce. a. From the standpoint of the Electrical Division, what is the lowest b. From the standpoint of the Motor Division, what is the highest acceptable c. If left free to negotiate without interference, would you expect the division acceptable transfer price for transformers sold to the Motor Division? transfer price for transformers acquired from the Electrical Division? managers to voluntarily agree to the transfer of 10,000 transformers from the Electrical Division to the Motor Division? Why or why not? From the standpoint of the entire company, should a transfer take place? Why or why hot? d.

Solution

1 a Lowest acceptable transfer price from viewpoint of Electrical division Should be its Variable cost + any contribution margin on lost sales per unit Since there is idle capacity of 10,000 Units, so only variable cost is lowest possible transfer price. $21 b The Motor Division can buy a similar transformer from an outside supplier for $38. Therefore, the Motor Division would be unwilling to pay more than $38 per transformer. c If we combine the requirement of both the divisions, then transfer price should range between $21 and $38 d From the viewpoint of entire company, transfer is beneficial since it will save $17 ($38-$21) per Unit. 2 a Since there is no idle capacity so minimum transfer price from the view point of Motor division should be $21 + ($19*10000)/10000 = $40 per unit b As before, the Motor Division would be unwilling to pay more than $38 per transformer. c The requirements of both the division is not compatible, so transfer there is very unlikely that a transfer would take place. d From the standpoint of the entire company, the transfer should not take place. By transferring a transformer internally, the company gives up revenue of $40 and saves $38, for a loss of $2.