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

Exercise 27

Transfer Pricing with Imperfect Markets: RI Evaluation, Normal Costing.

Refer to the data in Problem 15-26. Division managers are evaluated using residual income using a 15 percent cost of capital.

Required

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

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b. What is Spartan’s residual income 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 residual income with the transfer as it would accept by selling its 450,000 units to the outside market?

Step 1 of 3

Transfer Pricing with Imperfect Markets: RI Evaluation, Normal Costing

A. Residual Income without transfer to T

Before attempting to solve this question, students should understand the concept of residual income. Residual income is a part of income which remains after making appropriations of interest on capital and other items. Here , as the instructions given in the question is to charge cost of capital @ 15% to the income statement.

Hence the cost of capital is calculated @ 15%, of the capital employed. The capital employed as given in the question is $ 8400,000

ROI of Spartan Division
SR.NO	Details	Amount
1	Sales	$ 126,00,000
2	Variable Costs	$ 3600,0000
3	Contribution	$ 90,00,0000
4	Fixed Costs	$ 70,00,000
5	Cost of Capital @ 15 at Investment of $ 84,00,000	$ 12,60,000
6	Net Operating Profit	$ 7,40,000

Return on investment is 8.81%.