Cost Management: A Strategic Emphasis 5th Edition by David Stout, Edward Blocher, Gary Cokins

Exercise 52

General Transfer-Pricing Rule; Goal Congruence American Motors, Inc., is divided, for performance-evaluation purposes, into several investment centers. The Automobile Division of American Motors purchases most of its transmission systems from another unit of the company. The Transmission Division’s incremental cost for manufacturing a standard transmission is approximately $900 per unit. This division is currently working at 75 percent of capacity. The current market price for a standard transmission is approximately $1,250.

Required

1. Using the general guideline equation presented in the chapter, what is the minimum price at which the Transmission Division would sell its output to the Automobile Division?

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2. Suppose now that American Motors requires that whenever divisions with excess capacity sell their output internally to other divisions of the company, they must do so at the incremental cost of the supplying (producing) division. Evaluate this transfer-pricing rule vis-à-vis each of the following objectives: autonomy, goal congruency, performance evaluation of the divisions, and motivation/incentive effects.

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3. If the two divisions of American Motors were to negotiate a transfer price, what is the likely range of possible prices? Evaluate the use of a negotiated transfer price using the same objectives listed above in (2).

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4. Which, in your opinion, is the preferable transfer-pricing method—(2) or (3) above? Why?

Step 1 of 5

Transfer pricing is the price calculation approach where the good is been sold from one unit to another unit of same firm. There are different methods to calculate transfer pricing like variable cost method, full cost method, market price method, etc.