Question

1. Transfer Pricing

   Birrell Scientific Inc. manufactures electronic products, with two operating divisions, the GPS Systems and Communication Systems divisions. Condensed divisional income statements, which involve no intracompany transfers and which include a breakdown of expenses into variable and fixed components, are as follows:

   Birrell Scientific Inc. Divisional Income Statements For the Year Ended December 31, 20Y5
   	GPS Systems Division			Communication Systems Division			Total
   Sales:
   85,000 units @ $60 per unit	$5,100,000						$5,100,000
   145,000 units @ $115 per unit				$16,675,000			16,675,000
   	$5,100,000			$16,675,000			$21,775,000
   Expenses:
   Variable:
   85,000 units @ $40 per unit	$(3,400,000)						$(3,400,000)
   145,000 units @ $90 per unit*				$(13,050,000)			(13,050,000)
   Fixed	250,000			(500,000)			(750,000)
   Total expenses	$(3,650,000)			$(13,550,000)			$(17,200,000)
   Operating income	$1,450,000			$3,125,000			$4,575,000

   *$60 of the $90 per unit represents materials costs, and the remaining $30 per unit represents other variable conversion expenses incurred within the Communication Systems Division.

   The GPS Systems Division is presently producing 85,000 units out of a total capacity of 150,000 units. Materials used in producing the Communication Systems Division's product are currently purchased from outside suppliers at a price of $60 per unit. The GPS Systems Division is able to produce the materials used by the Communication Systems Division at a variable cost of $40 per unit. Except for the possible transfer of materials between divisions, no changes are expected in sales and expenses.

   Required:

   1. Would the market price of $60 per unit be an appropriate transfer price for Birrell Scientific Inc.?
   No

   • Yes
   • No

   2. If the Communication Systems Division purchases 25,000 units from the GPS Systems Division, rather than externally, at a negotiated transfer price of $52 per unit, how much would the operating income of each division and the total company operating income increase?

   The GPS Systems Division's operating income would increase by
   $

   The Communication Systems Division's operating income would increase by
   $

   Birrell Scientific Inc.'s total operating income would increase by
   $

   Feedback

   Review how transfer pricing functions.

   2. Multiply the units transferred by the difference between the transfer price (supplying company) or the market price (purchasing company) and the variable cost per unit.

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

   Birrell Scientific, Inc.
   Divisional Income Statements
   For the Year Ended December 31, 20Y5
   	GPS Division	Communication Division	Total
   Sales:
   85,000 units	$		$
   25,000 units
   145,000 units		$
   	$	$	$
   Expenses:
   Variable:
   110,000 units	$		$
   25,000 units		$
   120,000 units
   Fixed
   Total expenses	$	$	$
   Operating income	$	$	$

   Feedback

   3. Keep in mind, 25,000 units are transferred in at $52 per unit plus $38 in other variable conversion expenses incurred within the division.

   4. If a transfer price of $49 per unit is negotiated, how much would the operating income of each division and the total company operating income increase?

   The GPS Systems Division’s operating income would increase by
   $

   The Communication Systems Division's operating income would increase by
   $

   Birrell Scientific Scientific Inc.'s total operating income would increase by
   $

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

   Between $ and $

   5b. Assuming that the managers of the two divisions cannot agree on a transfer price, what transfer price would represent the best compromise? If required, round your answer to the nearest dollar.

   $50

   • 35
   • 40
   • 50
   • 65

Answer 1

Ans: Birrell Scientific Inc.

1) Transferring of Units to Communication Department At $60 per unit

It is not appropriate to charge market price from communication department for the component as the Variable cost is $60 and GPS Department has Idel capacity. So the correct answer is No.

2) Communication Systems Division purchases 25,000 units from the GPS Systems Division

Negotiated transfer price of $52 per unit

Increase in operating Income of GPS Systems Division- 25000*(52-40)

                                                                                    - $300,000

Increase in operating Income of Communication Systems Division - 25000*(60-52)

                                                                                                         - $200,000

Birrell Scientific Inc.'s total operating income would increase by- 25000*(60-40)

                                                                                                   - $500,000

3) Condensed divisional income statements for Birrell Scientific Inc.

Birrell Scientific, Inc.
Divisional Income Statements
For the Year Ended December 31, 20Y5
		GPS Division	Communication Division	Total
Sales:
85,000 units		$5,100,000		$5,100,000
25,000 units	(25,000*52)	$1,300,000		$1,300,000
145,000 units			$16,675,000	$16,675,000
		$6,400,000	$16,675,000	$23,075,000
Expenses:
Variable:
110,000 units		$(3,400,000)		$(3,400,000)
25,000 units	(25000*40)	$(1,000,000)		$(1,000,000)
120,000 units	(120,000*90)+(25,000*(52+30))		$(12,850,000)	$(12,850,000)
Fixed		$(250,000)	$(500,000)	$(750,000)
Total expenses		$(4,650,000)	$(13,350,000)	$(18,000,000)
Operating income		$1,750,000	$3.325,000	$5,075,000

4) If a transfer price of $49 per unit is negotiated

The GPS Systems Division’s operating income would increase by= 25000*(49-40)

                                                                                                        = $225,000

The Communication Systems Division's operating income would increase by= 25000*(60-49)

                                                                                                                         = $275,000

Birrell Scientific Scientific Inc.'s total operating income would increase by= 25000(60-40)

                                                                                                                   = $500,000