Exercise 11A-1 Transfer Pricing Basics [LO11-5] Sako Company’s Audio Division pr
ID: 2454392 • Letter: E
Question
Exercise 11A-1 Transfer Pricing Basics [LO11-5]
Sako Company’s Audio Division produces a speaker that is used by manufacturers of various audio products. Sales and cost data on the speaker follow:
Sako Company has a Hi-Fi Division that could use this speaker in one of its products. The Hi-Fi Division will need 12,000 speakers per year. It has received a quote of $37 per speaker from another manufacturer. Sako Company evaluates division managers on the basis of divisional profits.
Assume that the Audio Division is now selling only 55,000 speakers per year to outside customers.
From the standpoint of the Audio Division, what is the lowest acceptable transfer price for speakers sold to the Hi-Fi Division?
From the standpoint of the Hi-Fi Division, what is the highest acceptable transfer price for speakers acquired from the Audio Division?
If left free to negotiate without interference, would you expect the division managers to voluntarily agree to the transfer of 12,000 speakers from the Audio Division to the Hi-Fi Division?
From the standpoint of the entire company, should the transfer take place?
Assume that the Audio Division is selling all of the speakers it can produce to outside customers.
From the standpoint of the Audio Division, what is the lowest acceptable transfer price for speakers sold to the Hi-Fi Division?
From the standpoint of the Hi-Fi Division, what is the highest acceptable transfer price for speakers acquired from the Audio Division?
If left free to negotiate without interference, would you expect the division managers to voluntarily agree to the transfer of 12,000 speakers from the Audio Division to the Hi-Fi Division?
From the standpoint of the entire company, should the transfer take place?
Sako Company’s Audio Division produces a speaker that is used by manufacturers of various audio products. Sales and cost data on the speaker follow:
Explanation / Answer
1.
A)
The relevant cost for Audio Division will be its Variable Cost. Fixed Cost is irrelevant for the decision making as it will remain fixed over a period of time.
STATEMENT OF TRANSFER PRICE
Variable Cost per unit $18
Minimum transfer price $18
B)
From the stand point of Hi Fi Division the highest acceptable transfer price is $37 as it has a supplier providing the quote of $37.
C)
Audio Division is currently selling 55,000 speakers as against its capacity of 67,000 speakers. Thus, it has a spare capacity of 12,000 speakers. If left free to negotiate without interference, the division managers would voluntarily agree to the transfer of 12,000 speakers from the Audio Division to the Hi-Fi Division, as Audio Division can easily meet its relevant cost of $18 in the offer of Hi Fi Division.
D)
Audio Division is working with spare capacity. If it works with full capacity, it can produce 12000 more speakers at a cost of $18, which is much lower than the quotation of outside manufacturer for $37. The transfer should take place.
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