Requirements: This Is An Assignment Consisting Of Two Parts

Requirementsthis Is An Assignment Consisting Of Two Parts Part A And

This is an assignment consisting of two parts, Part A and Part B. Part A: Report format is to be used for this part Transfer pricing is used when products or services are transferred between different divisions of the same company. Explain what a Transfer Price is. What are the different types of transfer prices that can be used? Why are these different types of transfer prices used? What are the purposes of using transfer prices? Part B: This question is a practical question requiring answers to the questions at the end of the following information. The Complete Mining and Manufacturing Company has several divisions and two of these are involved in the transfer of products. The Cleaning and Scraping Division produces raw Cruden and transfers it to the Processing Division where it is processed into an alloy. The Processing Division then sells it on the open market for $160 per unit. Currently the Complete Mining and Manufacturing Company requires all of the Cruden to be transferred from the Cleaning and Scraping Division to the Processing Division. Currently the Cleaning and Scraping Division produces 400,000 units per year and transfers it all to the Processing Division at total actual manufacturing cost plus 10%. The Cruden can be purchased and sold on the open market for $95 and all that is sent to market can be sold on the market at this price. If the Cleaning and Scraping Division sells the Cruden on the open market it will incur a variable selling cost of $5 per unit. The following details show the unit costs for the Cleaning and Scraping and Processing Divisions Cleaning and Scraping Division Processing Division Transfer price from Cleaning and Scraping $77 Direct material 18 5 Direct labour 12 10 Manufacturing overhead Total cost per unit Manufacturing overhead in Cleaning and Scraping is 25% fixed, 75% variable Manufacturing overhead in Processing is 60% fixed, 40% variable Required: (a) Explain why transfer prices based on total actual costs are not appropriate as the basis for divisional performance measurement (b) Using the market price as the transfer price, calculate the contribution margin for both divisions. (c) If the Complete Mining and Manufacturing Company were to institute the use of negotiated transfer prices and allow divisions to buy and sell on the open market determine the price range for Cruden that would be acceptable to both divisions. (d)Use the general transfer pricing rule to compute the lowest transfer price that would be acceptable to the Cleaning and Scraping Division? Will this transfer price be the one that the manager of the Cleaning and Scraping Division prefers? Provide an explanation for your answer to this question.

Paper For Above instruction

Transfer pricing is a critical concept in managerial accounting, especially within large multinational corporations with multiple divisions or subsidiaries. It refers to the price at which goods, services, or intangible assets are transferred between different units of the same organization. Properly setting transfer prices is essential for performance evaluation, resource allocation, and strategic decision-making. This paper explains what transfer pricing entails, the various types of transfer prices, and their purposes. It also discusses the practical application of transfer pricing using a case from the Complete Mining and Manufacturing Company, addressing the limitations of cost-based transfer prices, the advantages of market-based transfer prices, and the implications of negotiated transfer prices.

Understanding Transfer Pricing

Transfer pricing involves setting the price at which goods, services, or intangible assets are exchanged between divisions or subsidiaries within a single organization. Its primary purpose is to allocate revenues and costs appropriately, evaluate divisional performance, and facilitate internal decision-making. Transfer prices also influence the behavior of managers, encourage or discourage internal transactions, and affect tax liabilities across different jurisdictions.

Different types of transfer prices include:

• Market-based transfer prices: These are set equal to the external market price for the product or service, assuming market conditions are competitive and free of distortions.
• Cost-based transfer prices: These are derived from the production costs incurred by the supplying division, often including markup percentages or costing approaches such as variable cost, full cost, or actual cost.
• Negotiated transfer prices: These are mutually agreed upon between divisions, considering the costs, market prices, and strategic considerations, often resulting in a price within an acceptable range for both parties.

The choice of transfer pricing method depends on strategic, tax, and performance evaluation considerations.

Purposes of Using Transfer Prices

Organizations employ transfer prices for several reasons:

• Performance evaluation: Accurate transfer prices help evaluate the profitability of individual divisions, influencing managerial incentives and accountability.
• Resource allocation: Proper transfer prices ensure that resources are allocated efficiently within the organization.
• Tax compliance and planning: Transfer prices impact taxable income across jurisdictions, making strategic pricing essential for tax optimization and compliance.
• Strategic decision making: Transfer prices influence decisions related to product lines, production levels, and internal versus external sales.

Case Analysis: Complete Mining and Manufacturing Company

The case involves divisions producing and transferring Cruden, with specific cost structures and market conditions. Analyzing the transfer prices in this context reveals the implications for divisional performance, profitability, and strategic decisions.

Limitations of Cost-Based Transfer Prices

Using total actual costs as transfer prices poses issues for performance measurement. Actual costs include both fixed and variable components, which can distort divisional performance. Fixed costs, in particular, are sunk costs from the perspective of the transfer and do not vary with the transfer quantity; thus, basing transfer prices solely on actual costs can lead to misjudgment of divisional efficiency and profitability.

Market Price as a Transfer Price

Adopting the market price ($95 per unit for Cruden) as the transfer price aligns internal decisions with external market conditions. It provides an incentive for divisions to operate efficiently, as the transfer price reflects the true opportunity cost for the selling division. Calculating contribution margins under this scenario allows analysis of profitability and simplicity in financial assessment.

Negotiated Transfer Prices

Negotiated transfer prices enable divisions to determine mutually beneficial prices within a range acceptable to both sides. These prices consider external market prices, costs, and strategic considerations. For Cruden, the acceptable range can be calculated based on the minimum price the selling division is willing to accept (covering variable costs and opportunity costs) and the maximum the buying division is willing to pay (up to the external market price minus additional costs).

Using the General Transfer Pricing Rule

The general rule for the lowest acceptable transfer price is the variable cost of the selling division plus opportunity costs. For the Cleaning and Scraping Division, this includes variable costs per unit and the opportunity cost of not selling externally at market price. Considering the detailed costs, the lowest transfer price calculation ensures that the selling division does not incur losses and makes sales internally more attractive than external sales under certain conditions.

Conclusion

Transfer pricing plays a vital role in internal financial management, fostering efficiency and aligning divisional incentives. While cost-based transfer prices are straightforward, they might distort performance measurement. Market-based prices serve as a fair and strategic benchmark, and negotiated prices offer flexibility and mutual agreement. Managers must carefully choose the appropriate transfer pricing method to balance performance evaluation, tax considerations, and strategic goals.

References

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