Two Divisions Of A Company Are In A Dispute Division

Two Divisions Of A Company Are Involved In A Dispute Division A Purc

Two divisions of a company are involved in a dispute. Division A purchases part 101 and Division B purchases part 201 from a third division, C. All divisions need the parts for their products, and the current intercompany transaction pattern has remained unchanged for several years. Due to external suppliers' lowered prices, the divisions are considering purchasing externally to lower costs and enhance profitability. The challenge involves analyzing the financial implications of changing current transfer pricing policies and procurement strategies.

Paper For Above Instruction

In the contemporary business environment, effective transfer pricing strategies are vital for optimizing interdepartmental transactions, especially when divisions are autonomous profit centers. This essay examines the scenario involving Divisions A, B, and C within a hypothetical company, evaluates the financial impact of current and proposed transaction patterns, and discusses key transfer pricing policies and their managerial implications.

The scenario presents three key divisions: Division A and Division B, which purchase parts 101 and 201, respectively, from Division C, the internal supplier. Both divisions also purchase from external suppliers. Currently, Division A sources 3,000 units of part 101 internally and 1,000 units externally, with the market price at $900 per unit. Similarly, Division B sources 1,000 units of part 201 internally and 1,000 units externally. Both divisions aim to reduce costs by increasing external procurement in response to lower supplier prices.

Analyzing Current and Proposed Procurement Patterns

The current profit impact of these arrangements can be assessed by calculating the profit contributions of each division considering the transfer prices and external costs. Under the existing pattern, Division A's internal transfer price for part 101 is $1,000 per unit, with external suppliers offering the same part at $900. For Division B, the internal transfer price for part 201 is $2,000 per unit, whereas external suppliers sell at $1,900. The profit implications for each division depend on the transfer prices and costs incurred.

When considering the proposed scenario, Division C plans to supply 2,000 units of part 101 to Division A at the current transfer price, and the remaining units might be purchased externally. Similarly, Division B would purchase 500 units internally at $2,000 and the rest externally at $1,900. If the internal transfer prices are set equal to the variable costs ($200 for direct materials, $200 for labor, and $300 for variable overhead, totaling $700 per unit), the divisions could realize increased profits by purchasing externally at lower prices.

Profit Calculations and Implications

Calculating the profit change involves assessing the transfer pricing mechanism. Under the current transfer prices ($1,000 and $2,000), Division C gains a markup over its costs, while Divisions A and B incur additional costs compared to the external market prices. If the divisions switch to external purchases, the overall company profit could increase due to lower procurement costs. However, this could erode the internal transfer revenue of Division C, possibly impacting its profitability.

Assuming variable costs and external prices, the profit changes can be summarized as follows:

• Division A: Savings of $100 per unit on 1,000 units purchased externally instead of internally, totaling $100,000 in savings.
• Division B: Savings of $100 per unit on 500 units (from $2,000 to $1,900), totaling $50,000.
• Division C and the company: Likely reduction in transfer revenue but overall cost savings in procurement.

The total impact depends on whether internal transfer prices are adjusted to reflect market prices or cost-based methods, influencing each division's profit margins. Furthermore, transfer pricing policies directly affect behavioral incentives, resource allocation, and overall profitability.

Discussion of Transfer Pricing Policies

Three common transfer pricing policies are analyzed:

1. Cost plus a markup: This approach ensures that the supplying division covers its costs plus a profit margin. It encourages the supplying division to be efficient but may lead to overpricing if the markup isn’t aligned with market conditions.
2. Fair market value: Setting transfer prices equal to external market prices promotes arm’s length transactions and aligns internal prices with market conditions. It encourages divisions to consider external costs and facilitates profit measurement.
3. Negotiated prices: Managers negotiate transfer prices, potentially leading to optimal outcomes tailored to divisional strategies. Negotiation can reflect bargaining power but may also induce conflicts if not regulated properly.

The choice of policy impacts divisional motivation, performance measurement, and overall corporate profitability. Cost-based approaches may incentivize cost control, market-based prices foster market efficiency, and negotiated prices offer flexibility but could introduce subjectivity.

Significance of Transfer Pricing from Financial and Managerial Perspectives

Transfer pricing remains a crucial issue because it affects income distribution, tax obligations, performance evaluation, and resource allocation. From a financial standpoint, nested transfer prices influence divisional profits and thus managerial incentives. Properly aligned transfer prices facilitate accurate performance measurement and decision-making.

From a managerial perspective, transfer pricing determines divisional autonomy, motivation, and strategic behavior. An inappropriate transfer price might lead to internal conflicts, suboptimal resource allocation, or tax inefficiencies. Thus, establishing transparent, fair, and strategically aligned transfer pricing policies is essential for sustaining overall corporate health and managerial harmony.

Conclusion

In conclusion, developing an optimal transfer pricing strategy requires balancing internal profit motives with external competitive realities. Adapting transfer prices to reflect market conditions enhances transparency and efficiency, fostering collaborative decisions that benefit the overall organization. The scenario underscores the importance of strategic transfer pricing policies in managing interdivisional relationships and maximizing corporate profitability.

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