Question

Transfer Pricing

Aulman Inc. has a number of divisions, including a Furniture Division and a Motel Division. The Motel Division owns and operates a line of budget motels located along major highways. Each year, the Motel Division purchases furniture for the motel rooms. Currently, it purchases a basic dresser from an outside supplier for $40. The manager of the Furniture Division has approached the manager of the Motel Division about selling dressers to the Motel Division. The full product cost of a dresser is $29. The Furniture Division can sell all of the dressers it makes to outside companies for $40. The Motel Division needs 10,000 dressers per year; the Furniture Division can make up to 50,000 dressers per year.

Refer to the information for Aulman Inc. above. Also, although the Furniture Division has been operating at capacity (50,000 dressers per year), it expects to produce and sell only 40,000 dressers for $40 each next year. The Furniture Division incurs variable costs of $14 per dresser. The company policy is that all transfer prices are negotiated by the divisions involved.

Required:

1. What is the maximum transfer price? Which division sets it?

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2. What is the minimum transfer price? Which division sets it?

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3. Suppose that the two divisions agree on a transfer price of $35. What is the benefit for the Furniture Division? For the Motel Division? For Aulman Inc. as a whole?

Answer 1

A transfer price is the price charged for a component by selling division to the buying division of the same company. The price charged for the transferred good affects both

• The cost of the buying division

• The revenues of the selling division

1. Aulman Inc. has a number of divisions including the Furniture division, and motel division. Each year the motel division purchases furniture for the motel rooms. The manager of the furniture division has approached about selling dressers to the motel division.

Given:

The furniture division can make upto 40,000 dressers per year.

The maximum transfer price is $40. This price is equal to the market price which is set by Motel division, the buying division.

2. The minimum transfer price is $14 which is set by the furniture division, the selling division. In this case, only variable costs of $14 per dresser are relevant because the furniture division has excess capacity.

3.

Operating income for the furniture division
Revenue	$350,000
Less: variable cost	$140,000
Benefit	$210,000
Operating income for the motel division
Outside supplier	$400,000
Transfer price	$350,000
Benefit	$50,000

The benefit for Aulman Inc. is

The change in operating profit for furniture division is $210,000.

The change in operating income for motel division is $50,000.

The change in operating income for the company is $260,000.