Question

Decision on transfer pricing

Materials used by the Instrument Division of XPort Industries are currently purchased from outside suppliers at a cost of $387 per unit. However, the same materials are available from the Components Division. The Components Division has unused capacity and can produce the materials needed by the Instrument Division at a variable cost of $321 per unit.

Assume that a transfer price of $368 has been established and that 43,100 units of materials are transferred, with no reduction in the Components Division’s current sales.

a. How much would XPort Industries’ total income from operations increase?
$______

b. How much would the Instrument Division’s income from operations increase?
$______

c. How much would the Components Division’s income from operations increase?
$_____

d. Any transfer price will cause the total income of the company to _______ (Increase or decrease) , as long as the supplier division capacity is ______(Used or not used) toward making materials for products that are ultimately sold to the outside.

Answer 1

Part 1 - Calculation of increment in total income of Xport Industries

Particulars	Amount
Increment in income of Instrument division Buying cost = $387 Per unit Internal transfer price = $368 Per unit Net increment in income ($387 - $368) = $19 Per unit	$818900 ($19*43100)
Increment in income of component division Variable cost = $321 Transfer price = $368 Net Increment in revenue = ($368 - $321) = $47	$2025700 ($47*43100)
Net Increment in revenue ($2025700+$818900)	$2844600

Part 2 - Increment in revenue of instrument Division

Buying cost = $387

Transfer price = $368

Net Increment in income = ($387 - $368) = $19

= $19*43100 = $818900

Part 3 - Increment in revenue of component division

Variable cost = $321

Transfer Price = $368

Net Increment in revenue = ($368 - $321) = $47

= ($47*43100) = $2025700

Part 4 - Any Transfer will cause the total income of the company to Increase as long as the supplier division capacity is Used towards making materials for products that are ultimately sold to the outside.

This is because the transfer price should be set between variable cost and market price. If transfet price is lower than variable cost then supplier division would incur loss and if transfer price is more than market price than purchasing divison will be at loss.