9 - Lecture 9 TRANSFER PRICING Transfer Pricing A transfer...

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TRANSFER PRICING Lecture 9
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Transfer Pricing A transfer price is the price charged when one segment (for example, a division) provides goods or services to another segment of the same company. The transfer price creates revenues for the selling segment and purchase costs for the buying segment, affecting each subunit’s operating income.
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Transfer Pricing In setting transfer prices, The buying division will naturally want a low transfer price and selling division will want a high transfer price. From the standpoint of the firm as a whole, transfer prices involve taking money out of one pocket and putting it into the other.
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Transfer Pricing An optimal transfer price is one that leads division managers to make decisions that are in the best interests of the firm as a whole. 1. goal congruence 2. sustained high level of management effort 3. high level of subunit autonomy
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Transfer Pricing Three general approaches are used in practice to set transfer prices: 1. Negotiated price. 2. Cost-based price. a. Variable cost. b. Full (absorption) cost. 1. Market price.
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When division managers work well together and understand their businesses, a negotiated transfer price is an excellent solution to the transfer pricing problem. If a transfer is in the best interests of the entire company, division managers bargaining in good faith should be able to find a transfer price that increases the profits of both the divisions. Negotiated Transfer Price
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The lowest acceptable price from the viewpoint of the selling division: Transfer price ≥ Variable cost per unit + (Total contribution margin on lost sales)/Number of units transferred The highest acceptable price from the viewpoint of the buying division: Transfer price ≤ Cost of buying from outside supplier Negotiated Transfer Price
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Negotiated Transfer Price Example The Battery Division of Barker Co. makes a standard 12- volt battery. Production capacity (no. of batteries) 300,000 Selling price per battery to outsiders $40 Variable costs per battery $18 Fixed costs per battery (based on capacity) $7 Barker Co has a Vehicle Division that could use this battery in its forklift trucks. The Vehicle Division would like to buy 50,000 batteries per year. It is presently buying these batteries from an outside supplier for $39 per battery.
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Negotiated Transfer Price Battery Division Vehicle Division Outside Market for Vehicle Batteries Selling price $40 Purchase price $39 Transfer price ? Forklift Trucks
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Negotiated Transfer Price Situation 1: Selling division with no idle capacity Suppose the Battery Division is operating at capacity. What is the lowest acceptable transfer price from the viewpoint of the selling division? Recall: Transfer price Variable cost per unit + (Total contribution margin on lost sales)/Number of units transferred So, TP $18 + ($40 - $18)x50,000/50,000 = $40
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Negotiated Transfer Price However, the buying division will not pay more than $39, the cost from buying the batteries from the outside. So the two managers will not
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This note was uploaded on 01/16/2010 for the course AF AF 3112 taught by Professor Woo-jonglee during the Spring '08 term at Polytechnic University of Puerto Rico.

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9 - Lecture 9 TRANSFER PRICING Transfer Pricing A transfer...

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