Question

MBS is organized into two divisions—Fabrication and Marketing. Fabrication produces a product that can be sold immediately or transferred to Marketing for customization and then sold. Marketing only buys from Fabrication for quality control reasons.

Fabrication currently sells 20,000 units annually at a price of $200 per unit to outside customers. It sells an additional 10,000 units to Marketing. The unit variable cost in Fabrication is $100 and annual fixed costs are $1.0 million. Fabrication is located in a country with a 30 percent tax rate.

Marketing can sell customized units for $400 each. In addition to what it pays Fabrication, the variable costs in Marketing are $50 per unit. Annual fixed costs in Marketing are $1.2 million. Marketing is located in a country with a 20 percent tax rate.

Required:

a. Suppose Fabrication would have excess capacity even with the demand from Marketing. Ignoring tax implications, what transfer price would you recommend MBS adopt?

b. What would be the total taxes MBS paid under the policy you recommend in requirement (a)? (Enter your answers in dollars and not in millions of dollars.)

c. Suppose Fabrication has no excess capacity. Ignoring tax implications, what transfer price would you recommend MBS adopt?

d. What would be the total taxes MBS paid under the policy you recommend in requirement (c)? (Enter your answers in dollars and not in millions of dollars.)

a.Transfer price (Excess capacity)= ???

b.Total taxes paid (Excess capacity)= ???

c.Transfer price (No excess capacity)= ???

d.Total taxes paid (No excess capacity)= ???

Answer 1

a. MBS should decide to set the transfer price at the cost incr=urred by Fabrication department so that the overall profit of the of the company can increase.

So, Transfer price = Cost incurred

Cost incurred = $100 ( Variable cost)

Transfer price = $100

Fixed cost will be ignored.

b. Division Fabrication

Particulars	Amount
Revenue
Transfer price (10,000 * $100)	1,000,000
selling price   (20,000 * $200)	4,000,000
Total Revenue	5,000,000
Cost
Variable Cost (30,000 * 100)	3,000,000
Fixed Cost	1,000,000
Total Cost	4,000,000
Profit	1,000,000
Tax paid @ 30%	300,000

Division Marketing

Particulars	Amount
Revenue
Transfer price (10,000 * 400)	4,000,000
Total Revenue	4,000,000
Cost
Transfer price (10,000 * 100)	1,000,000
Variable Cost (10,000 * 50)	500,000
Fixed Cost	1,200,000
Total Cost	2,700,000
Profit	1,300,000
Tax paid @ 30%	260,000

Total tax paid by MBS = $300,000 + $260,000 = $560,000

c. If contribution is lost, then

Transfer Price

Particulars	Amount
Cost to be incurred	$100
Contribution lost ($200 - 100)	$100
Transfer price	$200

d.

Division Fabrication

Particulars	Amount
Revenue
Transfer price (10,000 * $200)	2,000,000
selling price   (10,000 * $200)	2,000,000
Total Revenue	4,000,000
Cost
Variable Cost (20,000 * 100)	2,000,000
Fixed Cost	1,000,000
Total Cost	3,000,000
Profit	1,000,000
Tax paid @ 30%	300,000

Division Marketing

Particulars	Amount
Revenue
Transfer price (10,000 * 400)	4,000,000
Total Revenue	4,000,000
Cost
Transfer price (10,000 * 200)	2,000,000
Variable Cost (10,000 * 50)	500,000
Fixed Cost	1,200,000
Total Cost	3,700,000
Profit	300,000
Tax paid @ 30%	90,000

Total tax paid by MBS = $300,000 + $90,000 = $390,000