Question

PROBLEM 22.8A Transfer Pricing Decisions LO22-1, LO22-6

Sparta and Associates produces trophies and has two divisions—the green division and the white division. The green division produces the trophy base, which it can sell to outside markets for $150. A trophy base has variable costs per unit of $65 and fixed costs of $100,000, based on monthly production of 2,000 bases. Each trophy base could be sold to outside customers by the green division, as bases are in high demand. The green division has no idle capacity.

The white division uses the base in the production of championship trophies. The market price of a championship trophy is $300. The white division can acquire trophy bases from outside suppliers for $160. The manager of the white division is interested in purchasing 1,500 trophy bases from the green division, but she wants to negotiate for a lower transfer price of $135. The current transfer price for a trophy base is the full market price of $150. The fixed costs in producing championship trophies are $57,500, and the variable cost of producing a championship trophy is $75, excluding the cost of the trophy base.

Instructions

1. What is the operating profit before tax for each division using the market transfer price of $150?
2. What is the operating profit before tax for each division using the transfer price of $135, as suggested by the manager of the white division?
3. How is the company's net income affected under the two transfer pricing scenarios?
4. Would it be more beneficial to the company if the green division sold trophy bases externally and the white division purchased trophy bases from an outside supplier? Show your calculations.

Answer 1

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