Question

Gatco Industries is a decentralized firm. It has two production centres: Vancouver and Kamloops. Each one is evaluated based on its return on investment. Vancouver has the capacity to manufacture 100,000 units of component TR222. Vancouver's variable costs are $150 per unit. Kamloops uses component TR222 in one of its products. Kamloops adds $90 of variable costs to the component and sells the final product for $450. Requirements Consider the following independent situations: (a) Vancouver can sell all 100,000 units of TR222 on the open market at a price of $250 per unit. Kamloops is willing to buy 10,000 of those units. What should the transfer price be? Explain your decision. (b) Of the 100,000 units of component TR222 it can produce, Vancouver can sell 70,000 units on the open market at a price of $250 per unit. Kamloops is willing to buy an additional 10,000 units. What should the transfer price be? Explain your decision. (c) Of the 100,000 units of component TR222 it can produce, Vancouver can sell 80,000 units on the open market at a price of $250 per unit. Kamloops is willing to buy an additional 30,000 units. What should the transfer price be? Explain your decision. (d) The head office of West-Coast has asked the two centres to negotiate a transfer price. List the advantages and disadvantages of negotiated transfer prices. (adapted from CGA-Canada, now CPA Canada)

Answer 1

Requirement a
	Transfer price should be $250 per unit.
	This is so because it will not make any difference to company as whole as same
	contribution will be earned by Gatco Industires and Vancouver Division would not
	like to negotiate the price as its all production units can be sold in the open market
	at this price
Requirement b
	The transfer price is anything above or equal to $150 per unit but less than $250 per unit,
	as Vancouver Division has excess capacity of 30000 unit which will remain unutilisied
	if they don't sell the required units of 10000 to Kamloops division.
Requirement c
	The transfer price should be as follow
	For 10000 units, it should be 250$ and for 20000 units it should be between $150 per unit
	and $250 per unit
	The reason for above pricing is Vancouver Division has excess capacity to the extent of
	20000 units which should not remain unutilised. Hence anything fatched between the above
	price for 20000 units will increase the profitability of the company as whole. However, as for
	10000 units, the Vancouver division will not like to negotiate the price as they are already
	fatching $250 per unit from open market.
Requirement d
	Advantages of Negotiated transfer price.
	1	Negotiated prices leads to business-like attitude amongst the divisions of the company.
		The purchasing division may buy their requiement from outside sources, if the prices in
		the open market are lower than internal divisional transfer price.
	2	As the manager have the complete freedom, it can promote the sub-unit autonomy. It
		also motivates the managers.
	3	If negotiation done properly, it can satisfy the requirements of the division and it can be in the
		best inerest of the company as whole.
	Disadvatnages of Negotiated transfer price.
	1	The agreed price may be depend on the bargaining power and negotiating skills of the
		managers involved. The result may not be always optimal.
	2	It may leads to conflict between the division and may require the attention of the top
		management
	3	The transfer prices which depends on manager's bargaining skills will leads to defeat the
		purpose of performance evaluation
	4	It can be time consuming.