Cost Accounting

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Transfer Pricing Q

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Des Moines Valley Company

Des Moines Valley Company has two divisions, Computer Services and Management Advisory Services. In addition to their external customers, each division performs work for the other division. The external fees earned by each division in 19x1 were $200,000 for Computer Services and $350,000 for Management Advisory Services. Computer Services worked 3,000 hours for Management Advisory Services, who, in turn, worked 1,200 hours for Computer Services. The total costs of external services performed by Computer Services were $110,000, and $240,000 by Management Advisory Services. Required:

a Determine the operating income for each division and for the company as a whole if the transfer price from Computer Services to Management Advisory Services is $15 per hour, and the transfer price from Management Advisory Services to Computer Services is $12.50 per hour. b Determine the operating income for each division and for the company as a whole if the transfer price from each to the other is $15 per hour. c What are the operating income results for each division and for the company as a whole if the two divisions net their hours worked for each other and charge $12.50 per hour for the one with the excess? Which division manager prefers this arrangement?

Transfer Pricing Q
Des Moines Valley Company

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Answer

Revenue: External Internal* Total Cost of services: Incurred Transferred-in Total Operating income

Computer $200,000 $45,000 $245,000 $110,000 $15,000 $125,000 $120,000

Management $350,000 $15,000 $365,000 $240,000 $45,000 $285,000 $80,000

Company $550,000 $0 $550,000 $350,000 $0 $350,000 $200,000

* Computer Services = 3,000 hours x $15 = $45,000 Management Advisory Services = 1,200 hours x $12.50 = $15,000 Revenue for one is an expense of the other. b. Revenue: External Internal* Total Cost of services: Incurred Transferred-in Total Operating income Computer Management Company

$ 200,000 $ 45,000 $ 245,000 $ 110,000 $ 18,000 $ 128,000 $ 117,000

$ $ $ $ $ $ $

350,000 18,000 368,000 240,000 45,000 285,000 83,000

$ 550,000 $ $ 550,000 $ $ $ $ 350,000 350,000 200,000

* Computer Services = 3,000 hours x $15 = $45,000 Management Advisory Services = 1,200 hours x $15 = $18,000 Revenue for one is an expense of the other. c. Revenue: External Internal* Total Cost of services: Incurred Transferred-in Total Operating income Computer $200,000 $22,500 $222,500 $110,000 $0 $110,000 $112,500 Management $350,000 $0 $350,000 $240,000 $22,500 $262,500 $87,500

* Computer Services net = (3,000 - 1,200) x $12.50 = $22,500 Revenue for one is an expense of the other. The manager of Computer Services favors this procedure for the year, but unless the hours are always in favor of Computer Services, neither manager is favored all the time.

Transfer Pricing Q

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Better Food Company

Better Food Company recently acquired an olive oil processing company that has an annual capacity of 2,000,000 liters, and that processed and sold 1,400,000 liters last year at a price of $4 per liter. The purpose of the acquisition was to furnish oil for the Cooking Division. The Cooking Division needs 800,000 liters of oil per year. It has been purchasing oil from supplies at the market price. Production costs at capacity of the olive oil company, now a division, are as follows: Direct materials per liter Direct processing labor Variable processing overhead Fixed processing overhead Total $ $ $ $ $ 1.00 0.50 0.24 0.40 2.14

Management is trying to decide what transfer price to use for sales from the newly acquired company to the Cooking Division. The manager of the Olive Oil Division argues that $4, the market price, is appropriate. The manager of the Cooking Division argues that the cost of $2.14 should be used, or perhaps a lower price, since fixed overhead cost should be recomputed with the larger volume. Any output of the Olive Oil Division not sold...
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