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Transfer Pricing
Methods of Setting the Transfer Methods of Setting the Transfer Price Price
Pricing alternatives:
Market price Cost-based price Negotiated price Arbitrary price Dual Pricing
S UAT IT ION
Transfer Price at Variable Cost
E R E N(E VE GR E )
A/R - Division MB Intracom pany Sales Intracom pany CGS Finished Goods A/R - Division MB Intracom pany Sales Intracom pany CGS Finished Goods A/R - Division MB Intracom pany Sales Intracom pany CGS Finished Goods 400 400 450 450 450 450 450 450 720 720 450 450
450 450
720 720
Transfer Price at Dual Price Market Price for selling division & Full Prod Cost for buying division
A/R - Division MB 450 Intracom pany Sales in excess of Assigned Cost 270 Intracom pany Sales Intracom pany CGS 450 Finished Goods
450 450
NOTE: Entries for negotiated transfer prices would be similar to those at full production cost, except that the negotiated transfer price would be shown for first entry for the selling division and the purchase entry for the buyingdivision.
Sales: External (4,000 x 0.72) Internal (1,000 x 0.45) Costs (5,000 x 0.52) Income before tax
Suppose the Marine Biochemical Division of Scott Company can purchase evergreen units externally from United Company for P0.44 and that the externally purchased units are of the same quality and specifications as those produced internally. Thus, although the buying segment manager appears to save P0.01 per unit, the company would be better off by P4,000 if the units were purchased internally rather than externally: Unit cost to Marine Biochemical Division to purchase externally P0.44 Unit cost to produce in Evergreen Division (out-of-pocket costs) 0.40 Net advantage of company to produce per unit P0.04 Multiplied by number of units transferred 1,000 Total savings to produce internally P4,000
*These facts assume that the Evergreen Division does not have an opportunity cost of more than P0.04 per evergreen unit. Under the above circumstances, the general transfer pricing rules also would have yielded the decision not to make the internal transfer. The sum of the P0.40 incremental cost to produce and the P0.32 opportunity cost of additional contribution on external sales is P0.72, which exceeds the upper limit of the P0.44 market price. Scott Company should not make the transfer as long as the Marine Biochemical Division can purchase the units externally for a price less than P0.72.