Fundamentals of Cost Accounting 3rd Edition by William N. Lanen, Shannon W. Anderson, Michael Maher

Exercise 17

Evaluate Transfer Pricing System

Mississippi Company has two decentralized divisions, Illinois and Iowa. Illinois always has purchased certain units from Iowa at $60 per unit. Because Iowa plans to raise the price to $80 per unit, Illinois is considering buying these units from outside suppliers for $60 per unit. Iowa’s costs follow:

Variable costs per unit	$56
Annual fixed costs	$100,000
Annual production of these units	5,000 units

Required

If Illinois buys from an outside supplier, the facilities that Iowa uses to manufacture these units will remain idle. What will be the result if Mississippi enforces a transfer price of $80 per unit between Illinois and Iowa?

Step 1 of 2

Transfer pricing

Transfer pricing is the amount charged by one business unit of a company to another business unit for the products supplied. Each business unit is considered as separate responsibility centers and sale from one business unit to another business unit is consider as sale to an outsider. The sales based on transfer pricing are recorded in the accounting books of a firm and transfer prices are used for decision making, merchandise costing and performance assessment.