Question

RHODE ISLAND CORPORATION

…… has two divisions, A and B, which manufacture bicycles. Division A produces the bicycle frame, and Division B assembles the rest of the bicycle. There is a market for both the bicycle frame produced by Division A, and the final product. Each division is treated as a profit center and have complete autonomy in setting transfer prices and in deciding how much, if any, units to produce.

The transfer price for the bicycle frame has been set by company headquarters at the current market price of $200. This is the same price that Division B would have to pay on the open market, if it wished to obtain the frames elsewhere, versus getting them from Division A.

The following data is available for normal production of both frames and completed bicycles:

Selling price for the bicycle                   $300

Selling price for bicycle frame               200

Variable cost per unit in Division A        120

Fixed cost per unit in Division A            150

Variable cost per unit in Division B        150

Fixed cost per unit in Division B            130

The manager of Division B has made the following calculation for his division:

Selling price for bicycle                                     $300

Transferred-in cost per unit (market price)         $200

Variable cost per unit in Division B                    150    350

Profit (loss) on bicycle                                                   ($50)

Required:

Assume that no idle capacity exists in Division A for parts 3 through 6

3. As manager of Division B, who has complete autonomy in transfer price situations, would you accept the bicycle from Division A at the market price transfer price? Why or why not?

4. Would the company as a whole want Division B to accept the bicycle from Division A? Why or why not?

5. Would the manager of Division A want the bicycle frame to be transferred to Division B? Why or why not?

6. What would be the minimum price that Division A would accept in order to make this transfer? What is the largest amount that Division B is willing to pay?

NOW, for parts 7 – 11, ASSUME that Division A has idle capacity.

7. As a manager of Division B, would you accept the bicycle frame from Division A at the market price? Why or why not?

8. Would the company as a whole want Division B to accept the bicycle from Division A? Why or why not?

9. Would the manager of Division A want the bicycle frame to be transferred to Division B at the market price? Why or why not?

10. What happens if the transfer price is set at $150 per unit? Is there now a balance between goal congruence and autonomy? (That is, can the divisions act as they wish and STILL meet the goals of the company overall?)

11. Assuming your answer to number 10 above is “no”, is there a negotiated transfer price solution so that there will be goal congruence and autonomy? (That is, is there a price that can be negotiated between the two divisions that will meet the individual goals of the divisions AND the goals of the company?)

12. How might income taxes play a role in determining the transfer price of goods and services between divisions?

Answer 1

3). As a manager of division B, it is not acceptable to receive cycle frames from Division A at market price because if we receive at cost of $200 it will result in loss of $50 per unit. Hence not acceptable.

4). Company as a whole may or may not require the Divisioin B to accept bycycles from Division A because it does not impact the profitability of the company. Here A makes profit of $80 per unit and B makes loss of $50 per unit which total results in profit of $30 per unit and it remains same in both the conditions. However quality related matter can be considered for the internal transfers.

5). For the manager of Division A , the decision is indifference because in both the cases it is making contribution of $80 per unit.

6). The minimum transfer price which is acceptable to division A is the market price i.e $200 which includes, variable cost and the opportunity lost.

7). As a manager of Division B, when there is idle capacity in division A, transfer price at market price is not acceptable because there is some portion which is vacant and division A is unable to sell that portion in the market. So units from the vacant capacity is not acceptable at the market price.

8). Yes, the company as a whole require division B to accept the bicycle from A, for the portion of vacant capacity. which in turn benefit the company as a whole, because in division A there is profit factor which will setoff the loss factor in division B and results in profit.

9).Manager of Division A will definitely want the bicycles to transfer to B at market price because it will increase the profit in its division and will utilize the vacant capacity.

10). If transfer price is fixed at $150 it will give a decent amount of contribution to division A and also will not result in negative contribution of division B, and internal transfers are aleady beneficial for the company in idle capacity.