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CHAPTER 22 MANAGEMENT CONTROL SYSTEMS, TRANSFER PRICING, AND MULTINATIONAL CONSIDERATIONS. 100% Correct

Questions 22-1 What is a management control system? 22-2 Describe three criteria you would use to evaluate whether a management control system is effective. 22-3 What is the relationship among motivation, goal congruence, and effort? 798 CHAPTER 22 MANAGEMENT CONTROL SYSTEMS, TRANSFER PRICING, AND MULTINATIONAL CONSIDERATIONS 22-4 Name three benefits and two costs of decentralization. 22-5 “Organizations typically adopt a consistent decentralization or centralization philosophy across all their business functions.” Do you agree? Explain. 22-6 “Transfer pricing is confined to profit centers.” Do you agree? Explain. 22-7 What are the three methods for determining transfer prices? 22-8 What properties should transfer-pricing systems have? 22-9 “All transfer-pricing methods give the same division operating income.” Do you agree? Explain. 22-10 Under what conditions is a market-based transfer price optimal? 22-11 What is one potential limitation of full-cost-based transfer prices? 22-12 Give two reasons why the dual-pricing system of transfer pricing is not widely used. 22-13 “Cost and price information play no role in negotiated transfer prices.” Do you agree? Explain. 22-14 “Under the general guideline for transfer pricing, the minimum transfer price will vary depending on whether the supplying division has unused capacity or not.” Do you agree? Explain. 22-15 How should managers consider income tax issues when choosing a transfer-pricing method? Exercises 22-16 Evaluating management control systems, balanced scorecard. Adventure Parks Inc. (API) operates ten theme parks throughout the United States. The company’s slogan is “Name Your Adventure,” and its mission is to offer an exciting theme park experience to visitors of all ages. API’s corporate strategy supports this mission by stressing the importance of sparkling clean surroundings, efficient crowd management and, above all, cheerful employees. Of course, improved shareholder value drives this strategy. Required 1. Assuming that API uses a balanced scorecard approach (see Chapter 13) to formulating its manage ment control system. List three measures that API might use to evaluate each of the four balanced scorecard perspectives: financial perspective, customer perspective, internal-business-process perspective, and learning-and-growth perspective. 2. How would the management controls related to financial and customer perspectives at API differ between the following three managers: a souvenir shop manager, a park general manager, and the corporation’s CEO? 22-17 Cost centers, profit centers, decentralization, transfer prices. Fenster Corporation manufactures windows with wood and metal frames. Fenster has three departments: glass, wood, and metal. The glass department makes the window glass and sends it to either the wood or metal department where the glass is framed. The window is then sold. Upper management sets the production schedules for the three departments and evaluates them on output quantity, cost variances, and product quality. Required 1. Are the three departments cost centers, revenue centers, or profit centers? 2. Are the three departments centralized or decentralized? 3. Can a centralized department be a profit center? Why or why not? 4. Suppose the upper management of Fenster Corporation decides to let the three departments set their own production schedules, buy and sell products in the external market, and have the wood and metal departments negotiate with the glass department for the glass panes using a transfer price. a. Will this change your answers to requirements 1 and 2? b. How would you recommend upper management evaluate the three departments if this change is made? 22-18 Benefits and costs of decentralization. Jackson Markets, a chain of traditional supermarkets, is interested in gaining access to the organic and health food retail market by acquiring a regional company in that sector. Jackson intends to operate the newly-acquired stores independently from its supermarkets. One of the prospects is Health Source, a chain of twenty stores in the mid-Atlantic. Buying for all twenty stores is done by the company’s central office. Store managers must follow strict guidelines for all aspects of store management in an attempt to maintain consistency among stores. Store managers are evaluated on the basis of achieving profit goals developed by the central office. The other prospect is Harvest Moon, a chain of thirty stores in the Northeast. Harvest Moon managers are given significant flexibility in product offerings, allowing them to negotiate purchases with local organic farmers. Store managers are rewarded for exceeding self-developed return on investment goals with company stock options. Some managers have become significant shareholders in the company, and have even decided on their own to open additional store locations to improve market penetration. However, the increased autonomy has led to competition and price cutting among Harvest Moon stores within the same geographic market, resulting in lower margins. Required 1. Would you describe Health Source as having a centralized or a decentralized structure? Explain. 2. Would you describe Harvest Moon as having a centralized or a decentralized structure? Discuss some of the benefits and costs of that type of structure. ASSIGNMENT MATERIAL 799 3. Would stores in each chain be considered cost centers, revenue centers, profit centers, or investment centers? How does that tie into the evaluation of store managers? 4. Assume that Jackson chooses to acquire Harvest Moon. What steps can Jackson take to improve goal congruence between store managers and the larger company? 22-19 Multinational transfer pricing, effect of alternative transfer-pricing methods, global income tax minimization. Tech Friendly Computer, Inc., with headquarters in San Francisco, manufactures and sells a desktop computer. Tech Friendly has three divisions, each of which is located in a different country: a. China division—manufactures memory devices and keyboards b. South Korea division—assembles desktop computers using locally manufactured parts, along with memory devices and keyboards from the China division c. U.S. division—packages and distributes desktop computers Each division is run as a profit center. The costs for the work done in each division for a single desktop computer are as follows: Chinese income tax rate on the China division’s operating income: 40% South Korean income tax rate on the South Korea division’s operating income: 20% U.S. income tax rate on the U.S. division’s operating income: 30% Each desktop computer is sold to retail outlets in the United States for $3,800. Assume that the current foreign exchange rates are as follows: Both the China and the South Korea divisions sell part of their production under a private label. The China division sells the comparable memory/keyboard package used in each Tech Friendly desktop computer to a Chinese manufacturer for 4,500 yuan. The South Korea division sells the comparable desktop computer to a South Korean distributor for 1,340,000 won. 1,000 won = $1 U.S. 9 yuan = $1 U.S. Fixed cost = $325 U.S. division: Variable cost = $125 Fixed cost = 470,000 won South Korea division: Variable cost = 350,000 won Fixed cost = 1,980 yuan China division: Variable cost = 900 yuan 1. Calculate the after-tax operating income per unit earned by each division under the following transfer- Required pricing methods: (a) market price, (b) 200% of full cost, and (c) 350% of variable cost. (Income taxes are not included in the computation of the cost-based transfer prices.) 2. Which transfer-pricing method(s) will maximize the after-tax operating income per unit of Tech Friendly Computer? 22-20 Transfer-pricing methods, goal congruence. British Columbia Lumber has a raw lumber division and a finished lumber division. The variable costs are as follows: Raw lumber division: $100 per 100 board-feet of raw lumber Finished lumber division: $125 per 100 board-feet of finished lumber Assume that there is no board-feet loss in processing raw lumber into finished lumber. Raw lumber can be sold at $200 per 100 board-feet. Finished lumber can be sold at $275 per 100 board-feet. 1. Should British Columbia Lumber process raw lumber into its finished form? Show your calculations. Required 2. Assume that internal transfers are made at 110% of variable cost. Will each division maximize its division operating-income contribution by adopting the action that is in the best interest of British Columbia Lumber as a whole? Explain. 3. Assume that internal transfers are made at market prices. Will each division maximize its division operating-income contribution by adopting the action that is in the best interest of British Columbia Lumber as a whole? Explain. 22-21 Effect of alternative transfer-pricing methods on division operating income. (CMA, adapted) Ajax Corporation has two divisions. The mining division makes toldine, which is then transferred to the metals division. The toldine is further processed by the metals division and is sold to customers at a price of $150 per unit. The mining division is currently required by Ajax to transfer its total yearly output of 800 CHAPTER 22 MANAGEMENT CONTROL SYSTEMS, TRANSFER PRICING, AND MULTINATIONAL CONSIDERATIONS 200,000 units of toldine to the metals division at 110% of full manufacturing cost. Unlimited quantities of toldine can be purchased and sold on the outside market at $90 per unit. The following table gives the manufacturing cost per unit in the mining and metals divisions for 2012: Mining Division Metals Division Direct material cost Direct manufacturing labor cost Manufacturing overhead cost Total manufacturing cost per unit $12 16 ƒ32a $60 $ 6 20 ƒ25b $51 aManufacturing overhead costs in the mining division are 25% fixed and 75% variable. bManufacturing overhead costs in the metals division are 60% fixed and 40% variable. U.S. income tax rate on the U.S. division’s operating income Austrian income tax rate on the Austrian division’s operating income Austrian import duty Variable manufacturing cost per unit of Product 4A36 Full manufacturing cost per unit of Product 4A36 Selling price (net of marketing and distribution costs) in Austria 35% 40% 15% $ 550 $ 800 $1,150 Required 1. Calculate the operating incomes for the mining and metals divisions for the 200,000 units of toldine trans ferred under the following transfer-pricing methods: (a) market price and (b) 110% of full manufacturing cost. 2. Suppose Ajax rewards each division manager with a bonus, calculated as 1% of division operating income (if positive). What is the amount of bonus that will be paid to each division manager under the transfer-pricing methods in requirement 1? Which transfer-pricing method will each division manager prefer to use? 3. What arguments would Brian Jones, manager of the mining division, make to support the transferpricing method that he prefers? 22-22 Transfer pricing, general guideline, goal congruence. (CMA, adapted). Quest Motors, Inc., operates as a decentralized multidivision company. The Vivo division of Quest Motors purchases most of its airbags from the airbag division. The airbag division’s incremental cost for manufacturing the airbags is $90 per unit. The airbag division is currently working at 80% of capacity. The current market price of the airbags is $125 per unit. Required 1. Using the general guideline presented in the chapter, what is the minimum price at which the airbag division would sell airbags to the Vivo division? 2. Suppose that Quest Motors requires that whenever divisions with unused capacity sell products internally, they must do so at the incremental cost. Evaluate this transfer-pricing policy using the criteria of goal congruence, evaluating division performance, motivating management effort, and preserving division autonomy. 3. If the two divisions were to negotiate a transfer price, what is the range of possible transfer prices? Evaluate this negotiated transfer-pricing policy using the criteria of goal congruence, evaluating division performance, motivating management effort, and preserving division autonomy. 4. Instead of allowing negotiation, suppose that Quest specifies a hybrid transfer price that “splits the difference” between the minimum and maximum prices from the divisions’ standpoint. What would be the resulting transfer price for airbags? 22-23 Multinational transfer pricing, global tax minimization. The Mornay Company manufactures telecommunications equipment at its plant in Toledo, Ohio. The company has marketing divisions throughout the world. A Mornay marketing division in Vienna, Austria, imports 10,000 units of Product 4A36 from the United States. The following information is available: Suppose the United States and Austrian tax authorities only allow transfer prices that are between the full manufacturing cost per unit of $800 and a market price of $950, based on comparable imports into Austria. The Austrian import duty is charged on the price at which the product is transferred into Austria. Any import duty paid to the Austrian authorities is a deductible expense for calculating Austrian income taxes due. Required 1. Calculate the after-tax operating income earned by the United States and Austrian divisions from transferring 10,000 units of Product 4A36 (a) at full manufacturing cost per unit and (b) at market price of comparable imports. (Income taxes are not included in the computation of the cost-based transfer prices.) 2. Which transfer price should the Mornay Company select to minimize the total of company import duties and income taxes? Remember that the transfer price must be between the full manufacturing cost per 22-24 Multinational transfer pricing, goal congruence (continuation of 22-23). Suppose that the U.S. division could sell as many units of Product 4A36 as it makes at $900 per unit in the U.S. market, net of all marketing and distribution costs. 1. From the viewpoint of the Mornay Company as a whole, would after-tax operating income be maximized Required if it sold the 10,000 units of Product 4A36 in the United States or in Austria? Show your computations. 2. Suppose division managers act autonomously to maximize their division’s after-tax operating income. Will the transfer price calculated in requirement 2 of Exercise 22-23 result in the U.S. division manager taking the actions determined to be optimal in requirement 1 of this exercise? Explain. 3. What is the minimum transfer price that the U.S. division manager would agree to? Does this transfer price result in the Mornay Company as a whole paying more import duty and taxes than the answer to requirement 2 of Exercise 22-23? If so, by how much? 22-25 Transfer-pricing dispute. The Allison-Chambers Corporation, manufacturer of tractors and other heavy farm equipment, is organized along decentralized product lines, with each manufacturing division operating as a separate profit center. Each division manager has been delegated full authority on all decisions involving the sale of that division’s output both to outsiders and to other divisions of Allison-Chambers. Division C has in the past always purchased its requirement of a particular tractor-engine component from division A. However, when informed that division A is increasing its selling price to $150, division C’s manager decides to purchase the engine component from external suppliers. Division C can purchase the component for $135 per unit in the open market. Division A insists that, because of the recent installation of some highly specialized equipment and the resulting high depreciation charges, it will not be able to earn an adequate return on its investment unless it raises its price. Division A’s manager appeals to top management of Allison-Chambers for support in the dispute with division C and supplies the following operating data: C’s annual purchases of the tractor-engine component 1,000 units A’s variable cost per unit of the tractor-engine component $120 A’s fixed cost per unit of the tractor-engine component $ 20 1. Assume that there are no alternative uses for internal facilities of division A. Determine whether the com- Required pany as a whole will benefit if division C purchases the component from external suppliers for $135 per unit. What should the transfer price for the component be set at so that division managers acting in their own divisions’ best interests take actions that are also in the best interest of the company as a whole? 2. Assume that internal facilities of division A would not otherwise be idle. By not producing the 1,000 units for division C, division A’s equipment and other facilities would be used for other production operations that would result in annual cash-operating savings of $18,000. Should division C purchase from external suppliers? Show your computations. 3. Assume that there are no alternative uses for division A’s internal facilities and that the price from outsiders drops $20. Should division C purchase from external suppliers? What should the transfer price for the component be set at so that division managers acting in their own divisions’ best interests take actions that are also in the best interest of the company as a whole? 22-26 Transfer-pricing problem (continuation of 22-25). Refer to Exercise 22-25. Assume that division A can sell the 1,000 units to other customers at $155 per unit, with variable marketing cost of $5 per unit. Determine whether Allison-Chambers will benefit if division C purchases the 1,000 units from external sup- Required pliers at $135 per unit. Show your computations. Problems 22-27 General guideline, transfer pricing. The Slate Company manufactures and sells television sets. Its assembly division (AD) buys television screens from the screen division (SD) and assembles the TV sets. The SD, which is operating at capacity, incurs an incremental manufacturing cost of $65 per screen. The SD can sell all its output to the outside market at a price of $100 per screen, after incurring a variable marketing and distribution cost of $8 per screen. If the AD purchases screens from outside suppliers at a price of $100 per screen, it will incur a variable purchasing cost of $7 per screen. Slate’s division managers can act autonomously to maximize their own division’s operating income. 1. What is the minimum transfer price at which the SD manager would be willing to sell screens to the AD? Required 2. What is the maximum transfer price at which the AD manager would be willing to purchase screens from the SD? 3. Now suppose that the SD can sell only 70% of its output capacity of 20,000 screens per month on the open market. Capacity cannot be reduced in the short run. The AD can assemble and sell more than 20,000 TV sets per month. a. What is the minimum transfer price at which the SD manager would be willing to sell screens to the AD? 802 CHAPTER 22 MANAGEMENT CONTROL SYSTEMS, TRANSFER PRICING, AND MULTINATIONAL CONSIDERATIONS b. From the point of view of Slate’s management, how much of the SD output should be transferred to the AD? c. If Slate mandates the SD and AD managers to “split the difference” on the minimum and maximum transfer prices they would be willing to negotiate over, what would be the resulting transfer price? Does this price achieve the outcome desired in requirement 3b? 22-28 Pertinent transfer price. Europa, Inc., has two divisions, A and B, that manufacture expensive bicycles. Division A produces the bicycle frame, and division B assembles the rest of the bicycle onto the frame. There is a market for both the subassembly and the final product. Each division has been designated as a profit center. The transfer price for the subassembly has been set at the long-run average market price. The following data are available for each division: Selling price for final product $300 Long-run average selling price for intermediate product 200 Incremental cost per unit for completion in division B 150 Incremental cost per unit in division A 120 Selling price for final product Transferred-in cost per unit (market) Incremental cost per unit for completion Contribution (loss) on product $300 ƒ350 $ƒ(50) $200 ƒ150 The manager of division B has made the following calculation: Should transfers be made to division B if there is no unused capacity in division A? Is the market price the correct transfer price? Show your computations. 2. Assume that division A’s maximum capacity for this product is 1,000 units per month and sales to the intermediate market are now 800 units. Should 200 units be transferred to division B? At what transfer price? Assume that for a variety of reasons, division A will maintain the $200 selling price indefinitely. That is, division A is not considering lowering the price to outsiders even if idle capacity exists. 3. Suppose division A quoted a transfer price of $150 for up to 200 units. What would be the contribution to the company as a whole if a transfer were made? As manager of division B, would you be inclined to buy at $150? Explain. 22-29 Pricing in imperfect markets (continuation of 22-28). Refer to Problem 22-28. Required 1. Suppose the manager of division A has the option of (a) cutting the external price to $195, with the certainty that sales will rise to 1,000 units or (b) maintaining the external price of $200 for the 800 units and transferring the 200 units to division B at a price that would produce the same operating income for division A. What transfer price would produce the same operating income for division A? Is that price consistent with that recommended by the general guideline in the chapter so that the resulting decision would be desirable for the company as a whole? 2. Suppose that if the selling price for the intermediate product were dropped to $195, sales to external parties could be increased to 900 units. Division B wants to acquire as many as 200 units if the transfer price is acceptable. For simplicity, assume that there is no external market for the final 100 units of division A’s capacity. a. Using the general guideline, what is (are) the minimum transfer price(s) that should lead to the correct economic decision? Ignore performance-evaluation considerations. b. Compare the total contributions under the alternatives to show why the transfer price(s) recommended lead(s) to the optimal economic decision. 22-30 Effect of alternative transfer-pricing methods on division operating income. Crango Products is a cranberry cooperative that operates two divisions, a harvesting division and a processing division. Currently, all of harvesting’s output is converted into cranberry juice by the processing division, and the juice is sold to large beverage companies that produce cranberry juice blends. The processing division has a yield of 500 gallons of juice per 1,000 pounds of cranberries. Cost and market price data for the two divisions are as follows: Harvesting Division Processing Division Variable cost per pound of cranberries $0.10 Variable processing cost per gallon of juice produced $0.20 Fixed cost per pound of cranberries $0.25 Fixed cost per gallon of juice produced $0.40 Selling price per pound of cranberries in outside market $0.60 Selling price per gallon of juice $2.10 D E ASSIGNMENT MATERIAL 803 1. Compute Crango’s operating income from harvesting 400,000 pounds of cranberries during June 2012 Required and processing them into juice. 2. Crango rewards its division managers with a bonus equal to 5% of operating income. Compute the bonus earned by each division manager in June 2012 for each of the following transfer pricing methods: a. 200% of full cost b. Market price 3. Which transfer-pricing method will each division manager prefer? How might Crango resolve any conflicts that may arise on the issue of transfer pricing? 22-31 Goal-congruence problems with cost-plus transfer-pricing methods, dual-pricing system (continuation of 22-30). Assume that Pat Borges, CEO of Crango, had mandated a transfer price equal to 200% of full cost. Now he decides to decentralize some management decisions and sends around a memo that states the following: “Effective immediately, each division of Crango is free to make its own decisions regarding the purchase of direct materials and the sale of finished products.” 1. Give an example of a goal-congruence problem that will arise if Crango continues to use a transfer Required price of 200% of full cost and Borges’s decentralization policy is adopted. 2. Borges feels that a dual transfer-pricing policy will improve goal congruence. He suggests that transfers out of the harvesting division be made at 200% of full cost and transfers into the processing division be made at market price. Compute the operating income of each division under this dual transfer pricing method when 400,000 pounds of cranberries are harvested during June 2012 and processed into juice. 3. Why is the sum of the division operating incomes computed in requirement 2 different from Crango’s operating income from harvesting and processing 400,000 pounds of cranberries? 4. Suggest two problems that may arise if Crango implements the dual transfer prices described in requirement 2. 22-32 Multinational transfer pricing, global tax minimization. Industrial Diamonds, Inc., based in Los Angeles, has two divisions: South African mining division, which mines a rich diamond vein in South Africa U.S. processing division, which polishes raw diamonds for use in industrial cutting tools The processing division’s yield is 50%: It takes 2 pounds of raw diamonds to produce 1 pound of top-quality polished industrial diamonds. Although all of the mining division’s output of 8,000 pounds of raw diamonds is sent for processing in the United States, there is also an active market for raw diamonds in South Africa. The foreign exchange rate is 6 ZAR (South African Rand) = $1 U.S. The following information is known about the two divisions: 1 South African Mining Division 2 Variable cost per pound of raw diamonds 600 ZAR 3 Fixed cost per pound of raw diamonds 1,200 ZAR 4 Market price per pound of raw diamonds 3,600 ZAR A B C D F G 5 Tax rate 25% 6 7 U.S. Processing Division 8 Variable cost per pound of polished diamonds 220 U.S. dollars 9 Fixed cost per pound of polished diamonds 850 U.S. dollars Market price per pound of polished diamonds 10 3,500 U.S. dollars 11 Tax rate 40% 1. Compute the annual pretax operating income, in U.S. dollars, of each division under the following Required transfer-pricing methods: (a) 250% of full cost and (b) market price. 2. Compute the after-tax operating income, in U.S. dollars, for each division under the transfer-pricing methods in requirement 1. (Income taxes are not included in the computation of cost-based transfer price, and Industrial Diamonds does not pay U.S. income tax on income already taxed in South Africa.) 3. If the two division managers are compensated based on after-tax division operating income, which transfer-pricing method will each prefer? Which transfer-pricing method will maximize the total aftertax operating income of Industrial Diamonds? 4. In addition to tax minimization, what other factors might Industrial Diamonds consider in choosing a transfer-pricing method? 804 CHAPTER 22 MANAGEMENT CONTROL SYSTEMS, TRANSFER PRICING, AND MULTINATIONAL CONSIDERATIONS 22-33 International transfer pricing, taxes, goal congruence. Argone division of Gemini Corporation is located in the United States. Its effective income tax rate is 30%. Another division of Gemini, Calcia, is located in Canada, where the income tax rate is 42%. Calcia manufactures, among other things, an intermediate product for Argone called IP-2007. Calcia operates at capacity and makes 15,000 units of IP-2007 for Argone each period, at a variable cost of $60 per unit. Assume that there are no outside customers for IP-2007. Because the IP-2007 must be shipped from Canada to the United States, it costs Calcia an additional $4 per unit to ship the IP-2007 to Argone. There are no direct fixed costs for IP-2007. Calcia also manufactures other products. A product similar to IP-2007 that Argone could use as a substitute is available in the United States for $75 per unit. Required 1. What is the minimum and maximum transfer price that would be acceptable to Argone and Calcia for IP-2007, and why? 2. What transfer price would minimize income taxes for Gemini Corporation as a whole? Would Calcia and Argone want to be evaluated on operating income using this transfer price? 3. Suppose Gemini uses the transfer price from requirement 2, and each division is evaluated on its own after-tax division operating income. Now suppose Calcia has an opportunity to sell 8,000 units of IP-2007 to an outside customer for $68 each. Calcia will not incur shipping costs because the customer is nearby and offers to pay for shipping. Assume that if Calcia accepts the special order, Argone will have to buy 8,000 units of the substitute product in the United States at $75 per unit. a. Will accepting the special order maximize after-tax operating income for Gemini Corporation as a whole? b. Will Argone want Calcia to accept this special order? Why or why not? c. Will Calcia want to accept this special order? Explain. d. Suppose Gemini Corporation wants to operate in a decentralized manner. What transfer price should Gemini set for IP-2007 so that each division acting in its own best interest takes actions with respect to the special order that are in the best interests of Gemini Corporation as a whole? 22-34 Transfer pricing, goal congruence. The Bosh Corporation makes and sells 20,000 multisystem music players each year. Its assembly division purchases components from other divisions of Bosh or from external suppliers and assembles the multisystem music players. In particular, the assembly division can purchase the CD player from the compact disc division of Bosh or from Hawei Corporation. Hawei agrees to meet all of Bosh’s quality requirements and is currently negotiating with the assembly division to supply 20,000 CD players at a price between $44 and $52 per CD player. A critical component of the CD player is the head mechanism that reads the disc. To ensure the quality of its multisystem music players, Bosh requires that if Hawei wins the contract to supply CD players, it must purchase the head mechanism from Bosh’s compact disc division for $24 each. The compact disc division can manufacture at most 22,000 CD players annually. It also manufactures as many additional head mechanisms as can be sold. The incremental cost of manufacturing the head mechanism is $18 per unit. The incremental cost of manufacturing a CD player (including the cost of the head mechanism) is $30 per unit, and any number of CD players can be sold for $45 each in the external market. Required 1. What are the incremental costs minus revenues from sale to external buyers for the company as a whole if the compact disc division transfers 20,000 CD players to the assembly division and sells the remaining 2,000 CD players on the external market? 2. What are the incremental costs minus revenues from sales to external buyers for the company as a whole if the compact disc division sells 22,000 CD players on the external market and the assembly division accepts Hawei’s offer at (a) $44 per CD player or (b) $52 per CD player? 3. What is the minimum transfer price per CD player at which the compact disc division would be willing to transfer 20,000 CD players to the assembly division? 4. Suppose that the transfer price is set to the minimum computed in requirement 3 plus $2, and the division managers at Bosh are free to make their own profit-maximizing sourcing and selling decisions. Now, Hawei offers 20,000 CD players for $52 each. a. What decisions will the managers of the compact disc division and assembly division make? b. Are these decisions optimal for Bosh as a whole? c. Based on this exercise, at what price would you recommend the transfer price be set? 22-35 Transfer pricing, goal congruence, ethics. Jeremiah Industries manufactures high-grade aluminum luggage made from recycled metal. The company operates two divisions: metal recycling and luggage fabrication. Each division operates as a decentralized entity. The metal recycling division is free to sell sheet aluminum to outside buyers, and the luggage fabrication division is free to purchase recycled sheet aluminum from other sources. Currently, however, the recycling division sells all of its output to the fabrication division, and the fabrication division does not purchase materials from any outside suppliers. Aluminum is transferred from the recycling division to the fabrication division at 110% of full cost. The recycling division purchases recyclable aluminum for $0.50 per pound. The division’s other variable costs equal $2.80 per pound, and fixed costs at a monthly production level of 50,000 pounds are $1.50 per pound. ASSIGNMENT MATERIAL 805 During the most recent month, 50,000 pounds of aluminum were transferred between the two divisions. The recycling division’s capacity is 70,000 pounds. Due to increased demand, the fabrication division expects to use 60,000 pounds of aluminum next month. Metalife Corporation has offered to sell 10,000 pounds of recycled aluminum next month to the fabrication division for $5.00 per pound. Due to the high skill level necessary for the craftsmen, the semiconductor division’s capacity is set at 45,000 hours per year. Maximum demand for the Super-chip is 15,000 units annually, at a price of $80 per chip. There is unlimited demand for the Okay-chip at $26 per chip. The process-control division produces only one product, a process-control unit, with the following cost structure: Direct materials (circuit board): $70 Direct manufacturing labor (3 hours $15): $45 The current market price for the control unit is $132 per unit. A joint research project has just revealed that a single Super-chip could be substituted for the circuit board currently used to make the process-control unit. Direct labor cost of the process-control unit would be unchanged. The improved process-control unit could be sold for $145. * 1. Calculate the transfer price per pound of recycled aluminum. Assuming that each division is consid- Required ered a profit center, would the fabrication manager choose to purchase 10,000 pounds next month from Metalife? 2. Is the purchase in the best interest of Jeremiah Industries? Show your calculations. What is the cause of this goal incongruence? 3. The fabrication division manager suggests that $5.00 is now the market price for recycled sheet aluminum, and that this should be the new transfer price. Jeremiah’s corporate management tends to agree. The metal recycling manager is suspicious. Metalife’s prices have always been considerably higher than $5.00 per pound. Why the sudden price cut? After further investigation by the recycling division manager, it is revealed that the $5.00 per pound price was a one-time-only offer made to the fabrication division due to excess inventory at Metalife. Future orders would be priced at $5.50 per pound. Comment on the validity of the $5.00 per pound market price and the ethics of the fabrication manager. Would changing the transfer price to $5.00 matter to Jeremiah Industries? Collaborative Learning Problem 22-36 Transfer pricing, utilization of capacity. (J. Patell, adapted) The California Instrument Company (CIC) consists of the semiconductor division and the process-control division, each of which operates as an independent profit center. The semiconductor division employs craftsmen who produce two different electronic components: the new high-performance Super-chip and an older product called Okay-chip. These two products have the following cost characteristics: Super-chip Okay-chip Direct materials $ 5 $ 2 Direct manufacturing labor, 3 hours $20; 1 hour $20 * * 60 20 1. Calculate the contribution margin per direct-labor hour of selling Super-chip and Okay-chip. If no Required transfers of Super-chip are made to the process-control division, how many Super-chips and Okay-chips should the semiconductor division manufacture and sell? What would be the division’s annual contribution margin? Show your computations. 2. The process-control division expects to sell 5,000 process-control units this year. From the viewpoint of California Instruments as a whole, should 5,000 Super-chips be transferred to the process-control division to replace circuit boards? Show your computations. 3. What transfer price, or range of prices, would ensure goal congruence among the division managers? Show your calculations. 4. If labor capacity in the semiconductor division were 60,000 hours instead of 45,000, would your answer to requirement 3 differ? Show your calculations.

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