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

Exercise 35

Two-Part Transfer Prices

Mathes Corporation manufactures paper products. The company operates a landfill, which it uses to dispose of nonhazardous trash. The trash is hauled from the two nearby manufacturing facilities in trucks that can carry up to 5 tons of trash in a load. The landfill operation requires certain preparation activities regardless of the amount of trash in a truck (i.e., for each load). The budget for the landfill for next year follows:

Volume of trash	1,500 tons (300 loads)
Preparation costs (varies by loads)	$ 45,000
Other variable costs (varies by tons)	45,000
Fixed costs	110,000
Total budgeted costs	$200,000

Mathes is considering making the landfill a profit center and charging the manufacturing plants for disposing of the trash. The landfill has sufficient capacity to operate for at least the next 20 years. Other landfills are available in the area (both private and municipal), and each plant would be free to decide which landfill to use.

Required

a. What transfer pricing rule should Mathes implement at the landfill so that its plant managers would independently make decisions regarding landfill use that would be in the company’s best interests?

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b. Illustrate your rule by computing the transfer price that would be applied to a 4-ton load of trash from one of the plants.

Step 1 of 2

Two- Part Transfer Prices:

(A)

Landfill division is helping in disposing off non-hazardous material. In doing so the landfill division is incurring various variable and fixed costs. As long as these cost are met, the managers at the landfill division would be happy. And this price should be the minimum transfer price because manager in the landfill will not accept a price which is lower than the costs incurred in running the landfill. This cost element includes summation of variable costs and fixed costs.

However, managers at landfill shall be cautious of the fact that the managers of plant would not like to pay them a price which is higher than the market price. Hence the prevalent market price become the up side extreme price that can be charged by landfill division. In other words, as long as there is competition in the market, landfill cannot charge a price which is higher than the market price. If it does, then the people at plant would move to a landfill which offers them the lowest cost factor.

On the other hand, manufacturing plants would like to buy the services of landfill at the lowest possible price. It is clearly given in question that there are private as well as municipal landfills are available.