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

Exercise 26

Transfer Pricing with Imperfect Markets: ROI Evaluation, Normal Costing

Athena Company has two divisions. Spartan Division, which has an investment base of $8,400,000, produces and sells 450,000 units of a product at a market price of $28 per unit. Its variable costs total $8 per unit. The division also charges each unit $14 of fixed costs based on a capacity of 500,000 units.

Trojan Division wants to purchase 100,000 units from Spartan. However, it is willing to pay only $16 per unit because it has an opportunity to accept a special order at a reduced price. The order is economically justifiable only if Trojan can acquire Spartan’s output at a reduced price.

Required

a. What is the ROI for Spartan without the transfer to Trojan?

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b. What is Spartan’s ROI if it transfers 100,000 units to Trojan at $16 each?

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c. What is the minimum transfer price for the 100,000-unit order that Spartan would accept if it were willing to maintain the same ROI with the transfer as it would accept by selling its 450,000 units to the outside market?

Step 1 of 4

Transfer pricing:

Transfer pricing is used for evaluating the profit segment in many industries where there is a significant transfer of goods between the divisions. The transfer price affects the divisional managers to engage in the transactions. The profit of both the selling division and buying division may affect the sales. Therefore, the selling division should not lose its profit because of inter division sales. Therefore the transfer price should be set such way that it does not affect the selling division.