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

Exercise 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?

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

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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?

Step 1 of 3

a.

In this case corporate division is operating at its capacity and so there is no additional capacity available in which case the division should set the transfer price equivalent to the market price which in this case is $450 per hour.

Thus, corporate division should set minimum transfer price of .