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

Exercise 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?

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b. Which price would Seattle Transit prefer? Why?

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

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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)?

Step 1 of 5

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.