Exercise 12A2 Transfer Pricing from the Viewpoint of the Ent

Exercise 12A-2 Transfer Pricing from the Viewpoint of the Entire Company [LO12-5] Division A manufactures electronic circuit boards. The boards can be sold either to Division B of the same company or to outside customers. Last year, the following activity occurred in Division A: Selling price per circuit board Variable cost per circuit board $125 90 Number of circuit boards Produced during the year Sold to outside customers 20,000 16,000 4,000 Sold to Division B Sales to Division B were at the same price as sales to outside customers. The circuit boards purchased by Division B were used in an electronic instrument manufactured by that division (one board per instrument). Division B incurred $100 in additional variable cost per instrument and then sold the instruments for $300 each Required 1. Prepare income statements for Division A, Division B, and the company as a whole Division A Division B Total Company Sales Expenses Added by the division Transfer price paid Total expenses 0 Net operating income

Solution

Answer

Division A

Division B

Total Company

Sales

$ 25,00,000.00

$          12,00,000.00

$          37,00,000.00

Expenses:

Added by the division

$ 18,00,000.00

$            4,00,000.00

$          22,00,000.00

Transfer Price paid

$                       -  

$            5,00,000.00

$             5,00,000.00

Total expenses

$ 18,00,000.00

$            9,00,000.00

$          27,00,000.00

Net Operating income

$    7,00,000.00

$            3,00,000.00

$          10,00,000.00

Working with calculation:

Division A

Division B

Total Company

Sales

=20000*125

=4000*300

=2500000+1200000

Expenses:

Added by the devision

=20000*90

=4000*100

=1800000+400000

Transfer Price paid

0

=4000*125

500000

Total expenses

=1800000+0

=400000+500000

=2200000+500000

Net Operating income

=2500000-1800000

=1200000-900000

=3700000-2700000

The correct answer is Option 2: Sell the 1,000 additional circuit boards to division B. This is because:

---Division A’s revenue will not be affected whether it sells units to outside market or to division B because the sales price and transfer price to division B are same ($125)

---These circuit boards are not available to be purchased from outside sources, and if Division A does not transfer these, Division B will not be able to sell its final product. This will lead to fall in Division B’s sales and for a company as a whole resulting in Lower Net Incomes.

	Division A	Division B	Total Company
Sales	$ 25,00,000.00	$          12,00,000.00	$          37,00,000.00
Expenses:
Added by the division	$ 18,00,000.00	$            4,00,000.00	$          22,00,000.00
Transfer Price paid	$                       -	$            5,00,000.00	$             5,00,000.00
Total expenses	$ 18,00,000.00	$            9,00,000.00	$          27,00,000.00
Net Operating income	$    7,00,000.00	$            3,00,000.00	$          10,00,000.00