Question

Transfer Pricing

Exoplex Industries Inc. is a diversified aerospace company, including two operating divisions, Semiconductors and Navigational Systems. Condensed divisional income statements, which involve no intracompany transfers and include a breakdown of expenses into variable and fixed components, are as follows:

Exoplex Industries Inc.
Divisional Income Statements
For the Year Ended December 31, 20Y8 Semiconductors 
DivisionNavigational 
Systems 
DivisionTotalSales:        2,240 units × $396 per unit $887,040   $887,040        3,675 units × $590 per unit   $2,168,250 2,168,250            Total sales $887,040 $2,168,250 $3,055,290Expenses:    Variable:        2,240 units × $232 per unit $519,680   $519,680        3,675 units × $472* per unit   $1,734,600 1,734,600    Fixed 220,000 325,000 545,000        Total expenses $739,680 $2,059,600 $2,799,280Income from operations $147,360 $108,650 $256,010

*$432 of the $472 per unit represents materials costs, and the remaining $40 per unit represents other variable conversion expenses incurred within the Navigational Systems Division.

The Semiconductors Division is presently producing 2,240 units out of a total capacity of 2,820 units. Materials used in producing the Navigational Systems Division's product are currently purchased from outside suppliers at a price of $432 per unit. The Semiconductors Division is able to produce the components used by the Navigational Systems Division. Except for the possible transfer of materials between divisions, no changes are expected in sales and expenses.

Required:

1.  Would the market price of $432 per unit be an appropriate transfer price for Exoplex Industries Inc.?
No 

2.  If the Navigational Systems Division purchases 580 units from the Semiconductors Division, rather than externally, at a negotiated transfer price of $310 per unit, how much would the income from operations of each division and total company income from operations increase?

The Semiconductors Division's income from operations would increase by
$

The Navigational Systems Division's income from operations would increase by
$

Exoplex Industries Inc.'s total income from operations would increase by
$

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3.  Prepare condensed divisional income statements for Exoplex Industries Inc. based on the data in part (2).

Exoplex Industries Inc.Divisional Income StatementsFor the Year Ended December 31, 20Y8SemiconductorsNavigational SystemsTotalSales:2,240 units$$580 units3,675 units$Total sales$$$Expenses:Variable:2,820 units$$580 units$3,095 unitsFixedTotal expenses$$$Income from operations$$$

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4.  If a transfer price of $340 per unit is negotiated, how much would the income from operations of each division and total company income from operations increase?

The Semiconductors Division's income from operations would increase by
$

The Navigational Systems Division's income from operations would increase by
$

Exoplex Industries Inc.'s total income from operations would increase by
$

5a.  What is the range of possible negotiated transfer prices that would be acceptable for Exoplex Industries Inc.?

Any transfer price greater  than the Semiconductors Division’s variable expenses per unit but less  than the market price would be acceptable.

5b.  Assuming that the managers of the two divisions cannot agree on a transfer price, what price would you suggest as the transfer price?
$

Answer 1

Part 1)

No, the market price of $432 per unit wouldn't be an appropriate transfer price for Exoplex Industries Inc. It is because of the unused capacity available within the supplying (semi-conductors) division. Because of this excess capacity, the market price of $432 will not result in a scenario where the total income of the company will get maximized.

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Part 2)

The Semiconductors Division's income from operations would increase by the following amount:

Increase in Semiconductors Division's Income from Operations = Number of Units*(Transfer Price - Current Variable Cost) = 580*(310 - 232) = $45,240

_____

The Navigational Systems Division's income from operations would increase by amount calculated as below:

Increase in Navigational Division's Income from Operations = Number of Units*(Market Price - Transfer Price) = 580*(432 - 310) = $70,760

_____

Exoplex Industries Inc.'s total income from operations would increase by amount determined below:

Increase in Exoplex Industries Inc.'s Total Income from Operations = Increase in Semiconductors Division's Income from Operations + Increase in Navigational Systems Division's Income from Operations = 45,240 + 70,760 = $116,000

_____

Part 3)

The condensed divisional income statement is given as below:

EXOPLEX INDUSTRIES INC.
Divisional Income Statements
	Semiconductors	Navigational Systems	Total
Sales
2240 Units*$396 Per Unit	887,040		887,040
580 Units*$310 Per Unit	179,800		179,800
3675 Units*590		2,168,250	2,168,250
Total Sales	1,066,840	2,168,250	3,235,090
Expenses:
Variable
2820 Units*232 Per Unit	654,240		654,240
580 Units*350 Per Unit		203,000	203,000
3095 Units*$472 Per Unit		1,460,840	1,460,840
Fixed	220,000	325,000	545,000
Total Expenses	874,240	1,988,840	2,863,080
Income from Operations	$192,600	$179,410	$372,010

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Part 4)

The Semiconductors Division's income from operations would increase by the following amount:

Increase in Semiconductors Division's Income from Operations = Number of Units*(Transfer Price - Current Variable Cost) = 580*(340 - 232) = $62,640

_____

The Navigational Systems Division's income from operations would increase by amount calculated as below:

Increase in Navigational Division's Income from Operations = Number of Units*(Market Price - Transfer Price) = 580*(432 - 340) = $53,360

_____

Exoplex Industries Inc.'s total income from operations would increase by amount determined below:

Increase in Exoplex Industries Inc.'s Total Income from Operations = Increase in Semiconductors Division's Income from Operations + Increase in Navigational Systems Division's Income from Operations = 62,640 + 53,360 = $116,000

_____

Part 5a)

Any transfer price greater than the Semiconductors Division’s variable expenses per unit ($232) but less than the market price ($432) would be acceptable.

_____

Part 5b)

In case, the managers of the two divisions cannot agree on a transfer price, the price at which the income from operations of both the divisions will increase by the same amount can be taken as the transfer price. Therefore, a transfer price of $332 would be appropriate. At a transfer price of $332, the income from operations of both the divisions would increase by $58,000 calculated as below:

Increase in Semiconductors Division's Income from Operations at a Transfer Price of $332 = Number of Units*(Transfer Price - Current Variable Cost) = 580*(332 - 232) = $58,000

_____

The Navigational Systems Division's income from operations would increase by amount calculated as below:

Increase in Navigational Division's Income from Operations at a Transfer Price of $332 = Number of Units*(Market Price - Transfer Price) = 580*(432 - 332) = $58,000

_____

Notes:

The transfer price for Part 5b) is arrived as below:

Semiconductor Division = Variable Cost Per Unit + 100 = 232 + 100 = $332

Navigational Systems Division = Market Price Per Unit - 100 = 432 - 100 = $332