California State University, Sacramento



ACCY 121 Optional Extra Credit Assignment Instructions

1. After reading and studying Chapter 15 (Transfer Pricing) of the Lanen 3e text, answer the following assigned Review Questions, Exercises, and Problems:

a. Review Questions 15:1-9.

b. Exercises 15:16, 20, 22, 24

c. Problems 15:32, 35

2. The criteria used to allocate points to this assignment are:

a. Completion

b. Neatness, clear labeling, and demonstration of effort

3. Based on my strict discretion:

a. 20 points will be earned if both criteria are fully met.

b. 10 points will be earned if the criteria are substantially (but not fully) met.

c. 0 points will be earned if the criteria are not substantially met.

4. Points earned will be added only to the numerator (not the denominator) of your total point percentage in the course. Mathematically, this is to your advantage (as opposed to also adding the 20 points possible to your denominator).

5. This assignment is due and should be submitted in hard copy to my office (TAH 2098) before the deadline of your final exam.

6. There is no penalty for not doing this assignment. It is completely optional. All answers must originate from the individual student. No copying, collaboration, answer borrowing, or consulting with others is allowed.

(Note: Answers must be in “complete” sentences).

Review Questions

15-1. What is the purpose of a transfer price?

15-2. Do transfer prices exist in centralized firms? Why?

15-3. Many firms prefer to use market prices for transfer prices. Why would they have this preference?

15-4. What are the limitations of market-based transfer prices? What are the limitations of cost-based transfer prices?

15-5. When would you advise a firm to use direct intervention to set transfer prices? What are the disadvantages of such a practice?

15-6. When would you advise a firm to use prices other than market prices for interdivisional transfers?

15-7. What is the basis for choosing between actual and standard costs for cost-based transfer pricing?

15-8. What are the advantages and disadvantages of a negotiated transfer price system?

15-9. What is the general transfer pricing rule? What is the transfer price that results from this rule when:

a. There is a perfect market for the product?

b. The selling division is operating below capacity?

15-16. Apply Transfer Pricing Rules

Best Practices, Inc., is a management consulting firm. Its Corporate Division advises private firms on the adoption and use of cost management systems. Government Division consults with state and local governments. Government Division has a client that is interested in implementing an activity-based costing system in its public works department. The division's head approached the head of Corporate Division about using one of its associates. Corporate Division charges clients $450 per hour for associate services, the same rate other consulting companies charge.

The Government Division head complained that it could hire its own associate at an estimated variable cost of $150 per hour, which is what Corporate pays its associates.

Required

a. What is the minimum transfer price that Corporate Division should obtain for its services, assuming that it is operating at capacity?

b. What is the maximum price that Government Division should pay?

c. Would your answers in (a) or (b) change if Corporate Division had idle capacity? If so, which answer would change, and what would the new amount be?

15-20. Evaluate Transfer Pricing System

Seattle Transit Ltd. operates a local mass transit system. The transit authority is a state governmental agency. It has an agreement with the state government to provide rides to senior citizens for 50 cents per trip. The government will reimburse Seattle Transit for the “cost” of each trip taken by a senior citizen.

The regular fare is $2 per trip. After analyzing its costs, Seattle Transit figured that with its operating deficit, the full cost of each ride on the transit system is $4. Routes, capacity, and operating costs are unaffected by the number of senior citizens on any route.

Required

a. What alternative prices could be used to determine the governmental reimbursement to Seattle Transit?

b. Which price would Seattle Transit prefer? Why?

c. Which price would the state government prefer? Why?

d. If Seattle Transit provides an average of 150,000 trips for senior citizens in a given month, what is the monthly value of the difference between the prices in (b) and (c)?

15-22. International Transfer Prices: Ethical Issues

Trans Atlantic Metals has two operating divisions. Its forging operation in Finland forges raw metal, cuts it, and then ships it to the United States where the company's Gear Division uses the metal to produce finished gears. Operating expenses amount to $10 million in Finland and $30 million in the United States exclusive of the costs of any goods transferred from Finland. Revenues in the United States are $75 million.

If the metal were purchased from one of the company's U.S. forging divisions, the costs would be $15 million. However, if it had been purchased from an independent Finnish supplier, the cost would be $20 million. The marginal income tax rate is 60 percent in Finland and 40 percent in the United States.

Required

a. What is the company's total tax liability to both jurisdictions for each of the two alternative transfer pricing scenarios ($15 million and $20 million)?

b. Is it ethical to choose the transfer price based on the impact on taxes?

15-24. Segment Reporting

Leapin' Larry's Pre-Owned Cars has two divisions, Operations and Financing. Operations is responsible for selling Larry's inventory as quickly as possible and purchasing cars for future sale. Financing Division takes loan applications and packages loans into pools and sells them in the financial markets. It also services the loans. Both divisions meet the requirements for segment disclosures under accounting rules.

p. 572

Operations Division had $51 million in sales last year. Costs, other than those charged by Financing Division, totaled $39 million. Financing Division earned revenues of $12 million from servicing loans and incurred outside costs of $10 million. In addition, Financing charged Operations $6 million for loan-related fees. Operations's manager complained to Larry that Financing was charging twice the commercial rate for loan-related fees and that Operations would be better off sending its buyers to an outside lender.

Financing's manager replied that although commercial rates could be lower, servicing Larry's loans is more difficult, thereby justifying the higher fees.

Required

a. What are the reported segment operating profits for each division, ignoring income taxes and using the $6 million transfer price for the loan-related fees?

b. What are the reported segment operating profits for each division, ignoring income taxes and using a $3 million commercial rate as the transfer price for the loan-related fees?

15-32. Evaluate Transfer Price System

Western States Supply, Inc. (WSS), consists of three divisions—California, Northwest, and Southwest—that operate as if they were independent companies. Each division has its own sales force and production facilities. Each division manager is responsible for sales, cost of operations, acquisition and financing of divisional assets, and working capital management. WSS corporate management evaluates the performance of each division and its managers on the basis of ROI.

Southwest has just been awarded a contract for a product that uses a component manufactured by outside suppliers as well as by Northwest, which is operating well below capacity. Southwest used a cost figure of $37 for the component in preparing its bid for the new product. Northwest supplied this cost figure in response to Southwest's request for the average variable cost of the component; it represents the standard variable manufacturing cost and variable marketing costs.

Northwest's regular selling price for the component that Southwest needs is $65. Northwest's management indicated that it could supply Southwest the required quantities of the component at the regular selling price less variable selling and distribution expenses. Southwest management responded by offering to pay standard variable manufacturing cost plus 25 percent.

The two divisions have been unable to agree on a transfer price. Corporate management has never established a transfer price policy. The corporate controller suggested a price equal to the standard full manufacturing cost (that is, no selling and distribution expenses) plus a 20 percent markup. The two division managers rejected this price because each considered it grossly unfair.

The unit cost structure for the Northwest component and the suggested prices follow.

[pic]

Required

a. Discuss the effect that each of the proposed prices could have on the attitude of Northwest's management toward intracompany business.

b. Is the negotiation of a price between Northwest and Southwest a satisfactory method to solve the transfer price problem? Explain your answer.

c. Should WSS's corporate management become involved in this transfer price controversy? Explain your answer.

(CMA adapted)

15-35. Two-Part Transfer Prices

Mathes Corporation manufactures paper products. The company operates a landfill, which it uses to dispose of nonhazardous trash. The trash is hauled from the two nearby manufacturing facilities in trucks that can carry up to 5 tons of trash in a load. The landfill operation requires certain preparation activities regardless of the amount of trash in a truck (i.e., for each load). The budget for the landfill for next year follows:

[pic]

Mathes is considering making the landfill a profit center and charging the manufacturing plants for disposing of the trash. The landfill has sufficient capacity to operate for at least the next 20 years. Other landfills are available in the area (both private and municipal), and each plant would be free to decide which landfill to use.

Required

a. What transfer pricing rule should Mathes implement at the landfill so that its plant managers would independently make decisions regarding landfill use that would be in the company's best interests?

b. Illustrate your rule by computing the transfer price that would be applied to a 4-ton load of trash from one of the plants.

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