In: Accounting
ACC 2234 Hand-In Assignment 3 v3
QUESTION 1
Transfer Pricing Basics
Gerbig Company's Electrical Division produces a high-quality transformer. Sales and cost data on the transformer follow:
Selling price per unit on the outside market $40
Variable costs per unit $21
Fixed costs per unit (based on capacity) $9
Capacity in units 60,000
Gerbig Company has a Motor Division that would like to begin purchasing this transformer from the Electrical Division. The Motor Division is currently purchasing 10,000 transformers each year from another company at a cost of $38 per transformer.
Gerbig Company evaluates its division managers on the basis of divisional profits.
Required:
Assume that the Electrical Division is now selling only 50,000 transformers each year to outside customers.
From the standpoint of the Electrical Division, what is the lowest acceptable transfer price for transformers sold to the Motor Division?
From the standpoint of the Motor Division, what is the highest acceptable transfer price for transformers acquired from the Electrical Division?
If left free to negotiate without interference, would you expect the division managers to voluntarily agree to the transfer of 10,000 transformers from the Electrical Division to the Motor Division? Why or why not?
From the standpoint of the entire company, should a transfer take place? Why or why not?
Assume that the Electrical Division is now selling to outside customers all of the transformers it can produce.
From the standpoint of the Electrical Division, what is the lowest acceptable transfer price for transformers sold to the Motor Division?
From the standpoint of the Motor Division, what is the highest acceptable transfer price for transformers acquired from the Electrical Division?
If left free to negotiate without interference, would you expect the division managers to voluntarily agree to the transfer of 10,000 transformers from the Electrical Division to the Motor Division? Why or why not?
From the standpoint of the entire company, should a transfer take place? Why or why not?
QUESTION 2
Transfer Pricing from the Viewpoint of the Entire Company
Division A manufactures components for plasma TVs. The components can be sold either to Division B of the same company or to outside customers. Last year, the following activity was recorded in Division A:
Selling price per component........................$525
Variable cost per component ......................$390
Number of components:
Produced during the year ........................20,000
Sold to outside customers .......................16,000
Sold to Division B ......................................4,000
Sales to Division B were at the same price as sales to outside customers. The components purchased by Division B were used in a TV set manufactured by that division. Division B incurred $900 in additional variable cost per TV and then sold the TVs for $1,800 each.
Required:
1. Prepare income statements for last year for Division A, Division B, and the company as a whole.
2. Assume that Division A's manufacturing capacity is 20,000 components per year. Next year Division B wants to purchase 5,000 components from Division A, rather than only 4,000 components as it did last year. (Components of this type are not available from outside sources.) From the standpoint of the company as a whole, should Division A sell the 1,000 additional components to Division B, or should it continue to sell them to outside customers? Explain
QUESTION 3
Compute the Return on Investment (ROl)
Tamarind Services Company, a division of a major oil company, provides various services to operators of an oil field in northern Alberta. Data concerning the most recent year are as follow:
Sales ........................................$12,000,000
Operating income .......................$3,600,000
Average operating assets .........$24,000,000
Required:
1. Compute the margin for Tamarind Services Company.
2. Compute the turnover for Tamarind Services Company.
3. Compute the return on investment (ROI) for Tamarind Services Company.
QUESTION 4
Residual Income
British firm Midlands Design Ltd. specializes in providing design services to residential developers. Last year the company had operating income of £600,000 on sales of £2,400,000. The company's average operating assets for the year were £4,400,000 and its minimum required rate of return was 9%.
Required:
Compute the company's residual income for the year.
1). Assuming Electrical division selling only 50000 transformers
to outside.
a). From standpoint of Electrical division ,lowest acceptable
transfer price is variable cost i.e$21 which is relevant
cost.
b).From standpoint of Motor division, highest acceptable transfer
price is $38 per unit.
c). It is expected for managers of both divisions to voluntarily
transfer transformers because motor division can buy transformers
from electrical divisions at lower price.
d). From standpoint of whole company, the trasnfers should take
place as it will benefit both divisions.
Assuming all the transformers are sold to outsiders by
electrical division:
a). From standpoint of Electrical division ,lowest acceptable
transfer price is selling price i.e $40 which is relevant
cost.
b).From standpoint of Motor division, highest acceptable transfer
price is $38 per unit.
c). It is not expected for managers of both divisions to
voluntarily transfer transformers because motor division can buy
transformers from outside at lower price and electrical division
can sell all to ouside at higher price.
d). From standpoint of whole company, the trasnfers should not take
place as it will result in loss to both divisions.
3). Margin = Operating Income / Sales = 3,600,000 / 12,000,000
=0.3 or 30%
ROI = Operating Income / Av. operating Assets = 3,600,000 /
24,000,000 = 0.15 or 15%
4). Residual Income = Operating Income - Desired Income
= 600,000 - (4,400,000 * 9%) = 600,000 - 396,000 = 204,000