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# Accounting for Decision Making Essay

Transfer Pricing

1. Calculate the increase or decrease in profits for the three divisions and the company as a whole (four separate computations) if the agreement is enforced. Explain your thought process, comment on the situation, and make a suggestion based on the computations you have made. Given that we have the operating costs of Division C, we can calculate their loss from reduced output. In the case of Division A and Division B, the reduction in cost related to lower outside cost would be considered profit change. The proposal increases profit, but leaves Division C under-utilized. The fixed cost of under utilization would have to be considered before I would suggest the Company go to the new proposal. My suggestion is to go ahead with the new proposal and increase Division C output and sell to outside customers.

2. Evaluate and discuss the implications of the following transfer pricing policies. Transfer pricing policies should include a fixed cost portion of the internal supplier to identify the true cost. Profit taken by the internal supplier is overall company profit. By using a standard costing process, the internal supplier would be expected to keep efficiency at standard. In this case. Division C had profit from part 101 at \$300 per unit and part 201 at \$800 per unit. If the fixed cost of Division C were included in the transfer price, it would not be necessary to identify a profit per part. a. Transfer price = cost plus a mark-up for the selling division This policy provides contribution to the cost of the selling division. The mark up must be appropriate to nulify the cost of the selling department, but not to make the selling department a high proofit center. b. Transfer price = fair market value

This policy will force profit to be declared within the selling division and may or may not provide a means of tracking efficiency. If the fair market value generates a lot of profit for the company this should be used. c. Transfer price = price negotiated by the managers

This is a policy that can create challenging and meaningful relationships between departments. Since the price is negotiated, the result would be benefitial for the company and would encourage competition between divisions. Although the ending price should be less than fair market value.

3. Why is transfer pricing such a significant issue both from a financial and managerial perspective? From a financial perspective, transfer pricing can help improve profits and allows the company more control of quality which would improve profits. It does casue additional financial reporting for the selling division. From a managerial perspective transfer pricing can create a competitive environment within the company resulting in lower cost and higher profit. It can cause problems if one department is making more profit than another, unless it is clearly identified as efficiency variance. In managerial accounting, when different divisions of a multi-entity company are in charge of their own profits, they are also responsible for their own “Return on Invested Capital”. Therefore, when divisions are required to transact with each other, a transfer price is used to determine costs. Transfer prices tend not to differ much from the price in the market because one of the entities in such a transaction will lose out: they will either be buying for more than the prevailing market price or selling below the market price, and this will affect their performance.

Division C data 2012

Proposed

Part
DM
DL
VOH
TP
AnVol
Cost of Unit
Unit Profit
Total Profit
Volume
Profit
Lost Profit
101
\$200
\$200
\$300
\$1,000
3000
\$700
\$300
\$900,000
2000
\$600,000
\$300,000
201
\$300
\$300
\$600
\$2,000
1000
\$1,200
\$800
\$800,000
500
\$400,000
\$400,000

\$1,700,000

\$1,000,000
\$700,000

101
201
Outside
Required
Unit Cost
Outside \$
Profit
Current
A
3000

1000
4000
\$900
\$900,000

B

1000
1000
2000
\$1,900
\$1,900,000

C
3000
1000

4000

Proposed
A
2000

2000
4000

\$1,800,000
\$900,000

B

500
1500
2000

\$2,850,000
\$950,000

C
2000
500

2500

Change in Profit
Follow formula path for further explanation

Division A
\$900,000

Division B
\$950,000

Division C
(\$700,000)

Total Company
\$1,150,000

Source: Investopedia.com

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