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

Exercise 18

Evaluate Transfer Pricing System

A company permits its decentralized units to “lease” space to one another. Uptown Division has leased some of its idle warehouse space to Downtown Division for $60 per square foot per month. Recently, Uptown obtained a new five-year contract, which will increase its production sufficiently so that the warehouse space is more valuable to it. Uptown has notified Downtown that the rental price will increase to $210 per square foot per month. Downtown can lease space at $120 per square foot in another warehouse from an outside company but prefers to stay in the shared facilities. Downtown’s manager states that she would prefer not to move. If Downtown Division continues to use the space, Uptown will have to rent other space for $180 per square foot per month. (The difference in rental prices occurs because Uptown Division requires a more substantial warehouse building than Downtown Division does.)

Required

Recommend a transfer price and explain your reasons for choosing that price.

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.