Ch23 | Control & Transfer Pricing – Test Bank

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Horngren's Cost Accounting: A Managerial Emphasis, 17e, Global Edition by Datar/Rajan

Chapter 23 Management Control Systems, Transfer Pricing, and Multinational Considerations

Objective 23.1

1) Which of the following is a characteristic of a management control system?

A) It gathers key information that aids in the process of making decisions.

B) It encourages short-term profit planning.

C) Helps managers to act rapidly and with autonomy.

D) It deals with coordinating planning across the organization and is not concerned with behavioral aspects of managing.

Diff: 2

Objective: 1

AACSB: Analytical thinking

2) Which of the following is a part of the formal management control system?

A) mutual commitments among the members of the organization

B) the accounting information system provides metrics about costs, revenues, and contribution margins

C) shared values and loyalties among the members of the organization

D) general understanding about acceptable behavior for managers

Diff: 2

Objective: 1

AACSB: Analytical thinking

3) Which of the following is a part of the informal management control system?

A) explicit rules and procedures

B) mutual commitments among members of the company

C) performance measures and methods

D) incentive plans that guide behavior of employees

Diff: 2

Objective: 1

AACSB: Analytical thinking

4) Which of the following is true of goal congruence?

A) It exists when the management's strategy is in line with the shareholders' requirements.

B) It exists when individuals and groups work toward achieving the organization's goals.

C) It exists when both internal and external stakeholders of an organization have similar goals.

D) It exists when an organization's goals are in line with the social acceptability of organizational goals.

Diff: 3

Objective: 1

AACSB: Analytical thinking

5) A well-designed management control system uses information from:

A) internal sources only as they are the most reliable sources of information

B) external sources only as they are more dynamic and future oriented

C) both internal and external sources as a wide range of information is required

D) external sources only as they are the most reliable sources of information

Diff: 2

Objective: 1

AACSB: Analytical thinking

6) Which of the following would be considered an example of an element of an informal control system?

A) procedures developed by first level managers to help guide staff in their daily work

B) a policy that requires all employees to take at least two weeks of vacation each year

C) shared values within an organization's culture

D) the master budget

Diff: 2

Objective: 1

AACSB: Analytical thinking

7) If a computer manufacturer used its common stock price as a Balanced Scorecard control measure, it would be utilizing which of the following?

A) an external measure

B) customer related measure

C) internal business process measure

D) learning and growth measure

Diff: 2

Objective: 1

AACSB: Analytical thinking

8) Line managers supervising individual refineries are concerned with:

A) obtaining information about the firm's opportunity costs

B) obtaining information about the firm's sunk costs

C) obtaining information about the firm's equipment downtime and product quality

D) obtaining information about customer satisfaction and market share

Diff: 2

Objective: 1

AACSB: Analytical thinking

9) In a management control system, which of the following is described as the extent to which managers strive or endeavor in order to achieve a goal?

A) efficiency

B) effectiveness

C) effort

D) variance

Diff: 2

Objective: 1

AACSB: Analytical thinking

10) ________ is the extent to which managers strive to achieve goals.

A) Effort

B) Congruence

C) Motivation

D) Procedure

Diff: 2

Objective: 1

AACSB: Analytical thinking

11) The formal management control system includes the shared values, loyalties, and mutual commitments among members of the organization.

Diff: 2

Objective: 1

AACSB: Analytical thinking

12) Management control systems is designed only for top level managers and is not applicable to line managers.

Diff: 3

Objective: 1

AACSB: Analytical thinking

13) Management control systems utilize information gathered within a company and from external sources so as to aid management with their planning and control decision making.

Diff: 1

Objective: 1

AACSB: Analytical thinking

14) The human resources systems is a part of the formal management control systems of an organization.

Diff: 2

Objective: 1

AACSB: Analytical thinking

15) The management accounting system is an informal management control system which provide information about the firm's costs, revenues, and income.

Diff: 2

Objective: 1

AACSB: Analytical thinking

16) The formal management control system includes shared values, loyalties, and mutual commitments among members of the company, company culture, and norms about acceptable behavior for managers and other employees.

Diff: 2

Objective: 1

AACSB: Analytical thinking

17) Effort refers to physical exertion, such as a worker producing at a faster rate, but excludes non-physical aspects like acumen and diligence of a worker.

Diff: 2

Objective: 1

AACSB: Analytical thinking

18) An organization should design its management control system independently of its strategies, so that the system is not affected by change of strategies in future.

Diff: 2

Objective: 1

AACSB: Analytical thinking

19) Goal congruence exists when individuals work toward achieving one goal, and groups work toward achieving a different goal.

Diff: 2

Objective: 1

AACSB: Analytical thinking

20) Management control systems should be designed to support the organizational responsibilities of individual managers.

Diff: 2

Objective: 1

AACSB: Analytical thinking

21) Effort in terms of management control systems is defined in terms of physical exertion such as a worker producing at a faster rate.

Diff: 2

Objective: 1

AACSB: Analytical thinking

22) Effective management control systems should also motivate managers and other employees.

Diff: 2

Objective: 1

AACSB: Analytical thinking

23) For each of the following Balanced Scorecard measures, identify which of the four perspectives (Financial, Customer, Internal Business Process, or Learning and Growth) the measure best represents.

________ a. On-time delivery of gasoline from refineries to retail stations

________ b. Customer satisfaction

________ c. Common stock price

________ d. Return on investment

________ e. Market share

________ f. Number of days lost to accidents

________ g. Employee satisfaction

________ h. Friendliness of employees

________ i. Repeat purchases

________ j. Cash flow from operations

a. Internal business process

b. Customer

c. Financial

d. Financial

e. Customer

f. Internal business process

g. Learning and growth

h. Internal business process

i. Customer

j. Financial

Diff: 3

Objective: 1

AACSB: Analytical thinking

24) What is goal congruence?

goals—that is, managers working in their own best interest take actions that align with the overall goals of top management.

Diff: 2

Objective: 1

AACSB: Analytical thinking

25) "Management control systems consist of formal and informal control systems." Briefly explain the formal and informal management systems and enlist their components.

1) The management accounting systems, which provide information about the firm's

costs, revenues, and income.

2) The human resources systems, which provide information about the recruiting and

training of employees, absenteeism, and accidents.

3) The quality system, which provides information about yields, defective products, and

late deliveries to customers.

The informal management control system includes the shared values, loyalties, and mutual commitments among members of the organization, the company's culture, and the unwritten norms about acceptable behavior for managers and other employees.

Diff: 2

Objective: 1

AACSB: Analytical thinking

Objective 23.2

1) Which of the following is NOT a benefit of decentralization?

A) Duplication of effort among subunit managers.

B) Sharpens the focus of subunit managers.

C) Assists in development and learning.

D) Creates greater responsiveness to the needs of customers and suppliers.

Diff: 2

Objective: 2

AACSB: Analytical thinking

2) Which of the following is an advantage of decentralization?

A) leads to gains from rapid decision making by subunit managers

B) focuses manager's attention on the organization as a whole

C) does not result in a duplication of activities

D) reduces the cost of gathering information

Diff: 1

Objective: 2

AACSB: Analytical thinking

3) Which of the following is an advantage of decentralization?

A) It assists management development and learning.

B) It focuses managers' attention on the organization as a whole.

C) It does not result in a duplication of activities.

D) It encourages suboptimal decision making.

Diff: 1

Objective: 2

AACSB: Analytical thinking

4) Which of the following is a benefit of decentralization?

A) It creates greater responsiveness to local needs.

B) It helps in raising capital at a local level.

C) It relieves top managers of accountability.

D) It sharpens the focus of subunits and broadens the reach of top management.

Diff: 2

Objective: 2

AACSB: Analytical thinking

5) ________ occurs when a decision's benefits for one subunit is more than offset by the costs to the organization as a whole.

A) Suboptimal decision making

B) Independent decision making

C) Congruent decision making

D) Departmental decision making

Diff: 2

Objective: 2

AACSB: Analytical thinking

6) Which of the following statements is true of decentralization?

A) A decentralized structure does not empower employees to handle customer complaints directly.

B) A decentralized structure forces top management to lose some control over the organization.

C) Decentralization slows responsiveness to local needs for decision making.

D) A decentralized structure only delegates recurring and structured decisions to lower levels.

Diff: 2

Objective: 2

AACSB: Analytical thinking

7) In decentralized organizations, a manager might look to further the success of their subunit to the detriment of other subunits. Such behavior would be from which of the following results of decentralization?

A) duplication of output

B) gains from raid decision making

C) unhealthy competition

D) broadening the reach of top management

Diff: 2

Objective: 2

AACSB: Analytical thinking

8) Which of the following is a drawback of decentralizing a multinational company?

A) It may lead to increased exchange rate risk.

B) It may result in lack of control and results in increasing risk.

C) It creates less responsiveness to the needs of a subunit's customers, suppliers, and employees.

D) It may lead to an increase in bureaucracy.

Diff: 2

Objective: 2

AACSB: Analytical thinking

9) Which of the following is a responsibility center to measure the revenues and costs of subunits in centralized or decentralized companies?

A) investment center

B) environmental center

C) exchange policy center

D) taxation rebate center

Diff: 2

Objective: 2

AACSB: Analytical thinking

10) Decentralization in multinational companies may lead to lack of control.

Diff: 2

Objective: 2

AACSB: Analytical thinking

11) An investment center is always a decentralized subunit.

Diff: 2

Objective: 2

AACSB: Analytical thinking

12) In a profit center, the manager is accountable for investments, revenues, and costs.

Diff: 2

Objective: 2

AACSB: Analytical thinking

13) Decisions regarding sources of long-term financing are best made at subunit level as the subunit has local knowledge and can leverage it in negotiations.

Diff: 2

Objective: 2

AACSB: Analytical thinking

14) Surveys indicate that decisions made most frequently at the corporate level are related to sources of supplies and products to manufacture.

Diff: 2

Objective: 2

AACSB: Analytical thinking

15) The labels profit center and cost center are dependent on the degree of centralization or decentralization in a company.

Diff: 1

Objective: 2

AACSB: Analytical thinking

16) Incongruent decision making occurs when individuals and groups work toward achieving the organization's goals even if departmental performance is adversely affected.

Diff: 2

Objective: 2

AACSB: Analytical thinking

17) Executing decentralization in multinational companies presents less challenges than decentralization of domestic based operations.

Diff: 2

Objective: 2

AACSB: Analytical thinking

18) For each of the following activities, characteristics, and applications, identify whether they can be found in a centralized organization, a decentralized organization, or both types of organizations.

________ a. Freedom for managers at lower organizational levels to make decisions

________ b. Gathering information may be very expensive

________ c. Greater responsiveness to user needs

________ d. Have few interdependencies among divisions

________ e. Maximum constraints and minimum freedom for managers at lowest levels

________ f. Maximization of benefits over costs

________ g. Minimization of duplicate functions

________ h. Minimum of suboptimization

________ i. Multiple responsibility centers with various reporting units

________ j. Profit centers

a. Decentralization

b. Decentralization

c. Decentralization

d. Decentralization

e. Centralization

f. Both

g. Centralization

h. Centralization

i. Both

j. Both

Diff: 2

Objective: 2

AACSB: Analytical thinking

19) The president of Silicon Company has just returned from a week of professional development courses and is very excited that she will not have to change the organization from a centralized structure to a decentralized structure just to have responsibility centers. However, she is somewhat confused about how responsibility centers relate to centralized organizations where a few managers have most of the authority.

Required:

Explain how a centralized organization might allow for responsibility centers.

Diff: 2

Objective: 2

AACSB: Analytical thinking

20) What is decentralization and what are its benefits?

Benefits of decentralization:

1. It creates greater responsiveness to the needs of a subunit's customers, suppliers, and employees. Good decisions cannot be made without good information. Compared with top managers, subunit managers are better informed about their competitors, suppliers, and employees, as well as about local factors that affect performance, such as ways to decrease costs, improve quality, and better respond to customers.

2. It leads to gains from faster decision making by subunit managers. Decentralization speeds decision making, creating a competitive advantage over centralized organizations. Centralization slows down decision making because the decisions must be pushed upward through layer after layer of management before they are finalized.

3. It assists management development and learning. Subunit managers are more motivated

and committed when they can exercise initiative.

4. It sharpens the focus of subunit managers and broadens the reach of top management. In a decentralized setting, the manager of a subunit has a concentrated focus.

Diff: 3

Objective: 2

AACSB: Analytical thinking

21) Why is decentralization costly?

1. Leads to suboptimal decision making. If the subunit managers do not have the necessary

expertise or talent to make major decisions, the company, as a whole, is worse

off because its top managers have relinquished their responsibility for doing so. Even

if subunit managers are sufficiently skilled, suboptimal decision making—also called

incongruent decision making or dysfunctional decision making—occurs when a decision's

benefit to one subunit is more than offset by the costs to the organization as

a whole.

2. Leads to unhealthy competition. In a decentralized setting, subunit managers may regard

themselves as competing with managers of other subunits in the same company

as if they were external rivals.

3. Results in duplication of output. If subunits provide similar products or services,

their internal competition could lead to failure in the external markets. The reason is

that divisions may find it easier to steal market share from one another, by mimicking

each other's successful products, rather than those of competing firms. Eventually,

this leads to confusion in the minds of customers and the loss of each division's distinctive

strengths.

4. Results in duplication of activities. Even if the subunits operate in distinct markets,

several individual subunits of the company may undertake the same activity separately.

Diff: 3

Objective: 2

AACSB: Analytical thinking

Objective 23.3

1) A product may be passed from one subunit to another subunit in the same organization. The product is known as a(n):

A) interdepartmental product

B) intermediate product

C) subunit product

D) transfer product

Diff: 1

Objective: 3

AACSB: Analytical thinking

2) Which of the following best describes a transfer price?

A) It is the price charged by an organization when it transfer goods to another organization in lieu of services provided by it.

B) It is the price that is to be used while calculating revenue from sales to customers for tax purposes.

C) It is the price that is charged by a department of an organization when it sells its goods to its competitors.

D) It is the price one subunit charges for a product or service supplied to another subunit of the same organization.

Diff: 2

Objective: 3

AACSB: Analytical thinking

3) A transfer-pricing method leads to goal congruence when:

A) there is a price difference in different markets due to market inefficiencies

B) managers do no act for their own best interest and work for the long-term best interest of the manager's subunit

C) managers act in their own best interest and the decision is in the long-term best interest of the company

D) there is a low degree of centralization

Diff: 3

Objective: 3

AACSB: Analytical thinking

4) Which of the following is true of transfer pricing?

A) It creates costs for the selling subunit.

B) It creates revenues for the buying subunit.

C) It helps top managers evaluate the performance of individual subunits.

D) It makes managers' information-processing and decision-making tasks difficult.

Diff: 2

Objective: 3

AACSB: Analytical thinking

5) Transfer-pricing systems enable managers to focus on maximizing the performance of their subunits.

Diff: 1

Objective: 3

AACSB: Analytical thinking

6) The product or service transferred between subunits of an organization is called an intermediate product.

Diff: 1

Objective: 3

AACSB: Analytical thinking

7) The transfer price creates revenues for the selling subunit and costs for the buying subunit affecting each subunit's operating income.

Diff: 1

Objective: 3

AACSB: Analytical thinking

8) What are transfer prices and what are its criteria?

1. Promote goal congruence, so that division managers acting in their own interest will take actions that are aligned with the objectives of top management.

2. Induce managers to exert a high level of effort. Subunits selling a product or service should be motivated to hold down their costs; subunits buying the product or service should be motivated to acquire and use inputs efficiently.

3. Help top managers evaluate the performance of individual subunits.

4. Preserve autonomy of subunits if top managers favor a high degree of decentralization.

Diff: 3

Objective: 3

AACSB: Analytical thinking

Objective 23.4

1) Negotiated transfer prices are often employed when:

A) market prices are stable

B) market prices are volatile

C) market prices change by a regular percentage each year

D) goal congruence is not a major objective

Diff: 2

Objective: 4

AACSB: Analytical thinking

2) The costs used in cost-based transfer prices:

A) are actual costs

B) are budgeted costs

C) can either be actual or budgeted costs

D) are lower than the market-based transfer prices

Diff: 2

Objective: 4

AACSB: Analytical thinking

3) Which of the following is true of hybrid transfer prices?

A) The cost used in hybrid transfer prices is always the actual cost.

B) The cost used in hybrid transfer prices is always the budgeted cost.

C) They take into account both cost and market information.

D) They are less popular in manufacturing industry.

Diff: 2

Objective: 4

AACSB: Analytical thinking

4) To reduce the excessive focus of subunit managers on their own subunits, many companies compensate subunit managers on the basis of:

A) both the operating income earned by their respective subunits and the company as a whole

B) both the investing income earned by their respective subunits and the company as a whole

C) only the investing income earned by their respective subunits

D) both the net income and earned by their respective subunits and the company as a whole

Diff: 2

Objective: 4

AACSB: Analytical thinking

5) Axelia Corporation has two divisions, Refining and Extraction. The company's primary product is Luboil Oil. Each division's costs are provided below:

Extraction: Variable costs per barrel of oil $10

Fixed costs per barrel of oil $7

Refining: Variable costs per barrel of oil $26

Fixed costs per barrel of oil $37

The Refining Division has been operating at a capacity of 40,000 barrels a day and usually purchases 26,000 barrels of oil from the Extraction Division and 15,300 barrels from other suppliers at $63 per barrel.

What is the transfer price per barrel from the Extraction Division to the Refining Division, assuming the method used to place a value on each barrel of oil is 175% of variable costs?

A) $17.50

B) $29.75

C) $80.00

D) $140.00

Diff: 2

Objective: 4

AACSB: Application of knowledge

6) Axelia Corporation has two divisions, Refining and Extraction. The company's primary product is Luboil Oil. Each division's costs are provided below:

Extraction: Variable costs per barrel of oil $13

Fixed costs per barrel of oil $6

Refining: Variable costs per barrel of oil $26

Fixed costs per barrel of oil $36

The Refining Division has been operating at a capacity of 40,800 barrels a day and usually purchases 25,600 barrels of oil from the Extraction Division and 15,100 barrels from other suppliers at $62 per barrel.

What is the transfer price per barrel from the Extraction Division to the Refining Division, assuming the method used to place a value on each barrel of oil is 110% of full costs?

A) $19.00

B) $20.90

C) $55.00

D) $99.00

Diff: 2

Objective: 4

AACSB: Application of knowledge

7) Axelia Corporation has two divisions, Refining and Extraction. The company's primary product is Luboil Oil. Each division's costs are provided below:

Extraction: Variable costs per barrel of oil $15

Fixed costs per barrel of oil $12

Refining: Variable costs per barrel of oil $26

Fixed costs per barrel of oil $40

The Refining Division has been operating at a capacity of 40,900 barrels a day and usually purchases 25,300 barrels of oil from the Extraction Division and 15,300 barrels from other suppliers at $66 per barrel.

Assume 300 barrels are transferred from the Extraction Division to the Refining Division for a transfer price of $18 per barrel. The Refining Division sells the 300 barrels at a price of $180 each to customers. What is the operating income of both divisions together?

A) $10,800

B) $26,100

C) $20,100

D) $48,600

Diff: 3

Objective: 4

AACSB: Application of knowledge

8) Timekeeper Corporation has two divisions, Distribution and Manufacturing. The company's primary product is high-end watches. Each division's costs are provided below:

Manufacturing: Variable costs per unit $1.95

Fixed costs per unit $8.17

Distribution: Variable costs per unit $1.10

Fixed costs per unit $1.00

The Distribution Division has been operating at a capacity of 4,007,000 units a week and usually purchases 2,003,500 units from the Manufacturing Division and 2,003,500 units from other suppliers at $16.00 per unit.

What is the transfer price per watch from the Manufacturing Division to the Distribution Division, assuming the method used to place a value on each watch is 160% of variable costs? (Round the answer to the nearest cent.)

A) $1.95

B) $3.12

C) $3.89

D) $14.05

Diff: 2

Objective: 4

AACSB: Application of knowledge

9) Timekeeper Corporation has two divisions, Distribution and Manufacturing. The company's primary product is high-end watches. Each division's costs are provided below:

Manufacturing: Variable costs per unit $3.81

Fixed costs per unit $10.45

Distribution: Variable costs per unit $0.70

Fixed costs per unit $1.20

The Distribution Division has been operating at a capacity of 4,008,000 units a week and usually purchases 2,004,000 units from the Manufacturing Division and 2,004,000 units from other suppliers at $13.50 per unit.

What is the transfer price per watch from the Manufacturing Division to the Distribution Division, assuming the method used to place a value on each transfer is 120% of full costs? (Round the answer to the nearest cent.)

A) $14.26

B) $17.11

C) $13.50

D) $19.21

Diff: 2

Objective: 4

AACSB: Application of knowledge

10) Timekeeper Corporation has two divisions, Distribution and Manufacturing. The company's primary product is high-end watches. Each division's costs are provided below:

Manufacturing: Variable costs per unit $1.81

Fixed costs per unit $9.52

Distribution: Variable costs per unit $1.20

Fixed costs per unit $1.00

The Distribution Division has been operating at a capacity of 4,003,000 units a week and usually purchases 2,001,500 units from the Manufacturing Division and 2,001,500 units from other suppliers at $13.50 per unit.

Assume 100,000 units are transferred from the Manufacturing Division to the Distribution Division for a transfer price of $10.00 per unit. The Distribution Division sells the 100,000 units at a price of $17 each to customers. What is the operating income of both divisions together?

A) $401,000

B) $566,500

C) $347,000

D) $952,000

Diff: 3

Objective: 4

AACSB: Application of knowledge

11) Branded Shoe Company manufactures only one type of shoe and has two divisions, the Stitching Division and the Polishing Division. The Stitching Division manufactures shoes for the Polishing Division, which completes the shoes and sells them to retailers. The Stitching Division "sells" shoes to the Polishing Division. The market price for the Polishing Division to purchase a pair of shoes is $50. (Ignore changes in inventory.) The fixed costs for the Stitching Division are assumed to be the same over the range of 40,000-103,000 units. The fixed costs for the Polishing Division are assumed to be $24 per pair at 103,000 units.

Stitching's costs per pair of shoes are:

Direct materials $11

Direct labor $9

Variable overhead $7

Division fixed costs $5

Polishing's costs per completed pair of shoes are:

Direct materials $15

Direct labor $8

Variable overhead $10

Division fixed costs $22

What is the market-based transfer price per pair of shoes from the Stitching Division to the Polishing Division?

A) $23

B) $40

C) $50

D) $61

Diff: 2

Objective: 4

AACSB: Application of knowledge

12) Branded Shoe Company manufactures only one type of shoe and has two divisions, the Stitching Division and the Polishing Division. The Stitching Division manufactures shoes for the Polishing Division, which completes the shoes and sells them to retailers. The Stitching Division "sells" shoes to the Polishing Division. The market price for the Polishing Division to purchase a pair of shoes is $44. (Ignore changes in inventory.) The fixed costs for the Stitching Division are assumed to be the same over the range of 40,000-103,000 units. The fixed costs for the Polishing Division are assumed to be $22 per pair at 103,000 units.

Stitching's costs per pair of shoes are:

Direct materials $20

Direct labor $18

Variable overhead $16

Division fixed costs $14

Polishing's costs per completed pair of shoes are:

Direct materials $15

Direct labor $11

Variable overhead $5

Division fixed costs $19

What is the transfer price per pair of shoes from the Stitching Division to the Polishing Division if the method used to place a value on each pair of shoes is 175% of variable costs?

A) $36.75

B) $66.50

C) $94.50

D) $3.50

Diff: 2

Objective: 4

AACSB: Application of knowledge

13) Branded Shoe Company manufactures only one type of shoe and has two divisions, the Stitching Division and the Polishing Division. The Stitching Division manufactures shoes for the Polishing Division, which completes the shoes and sells them to retailers. The Stitching Division "sells" shoes to the Polishing Division. The market price for the Polishing Division to purchase a pair of shoes is $52. (Ignore changes in inventory.) The fixed costs for the Stitching Division are assumed to be the same over the range of 40,000-101,000 units. The fixed costs for the Polishing Division are assumed to be $22 per pair at 101,000 units.

Stitching's costs per pair of shoes are:

Direct materials $18

Direct labor $16

Variable overhead $14

Division fixed costs $12

Polishing's costs per completed pair of shoes are:

Direct materials $14

Direct labor $7

Variable overhead $8

Division fixed costs $16

What is the transfer price per pair of shoes from the Stitching Division to the Polishing Division if the transfer price per pair of shoes is 120% of full costs?

A) $21.60

B) $40.80

C) $57.60

D) $72.00

Diff: 2

Objective: 4

AACSB: Application of knowledge

14) Branded Shoe Company manufactures only one type of shoe and has two divisions, the Stitching Division and the Polishing Division. The Stitching Division manufactures shoes for the Polishing Division, which completes the shoes and sells them to retailers. The Stitching Division "sells" shoes to the Polishing Division. The market price for the Polishing Division to purchase a pair of shoes is $43. (Ignore changes in inventory.) The fixed costs for the Stitching Division are assumed to be the same over the range of 40,000-102,000 units. The fixed costs for the Polishing Division are assumed to be $23 per pair at 102,000 units.

Stitching's costs per pair of shoes are:

Direct materials $17

Direct labor $15

Variable overhead $13

Division fixed costs $11

Polishing's costs per completed pair of shoes are:

Direct materials $20

Direct labor $7

Variable overhead $7

Division fixed costs $17

Calculate and compare the difference in overall corporate net income of Branded Shoe Company between Scenario A and Scenario B if the Assembly Division sells 102,000 pairs of shoes for $122 per pair to customers.

Scenario A: Negotiated transfer price of $37 per pair of shoes

Scenario B: Market-based transfer price

A) $612,000 more net income under Scenario A

B) $612,000 less net income using Scenario B

C) $2,142,000 less net income using Scenario A.

D) The net income would be the same under both scenarios.

Diff: 3

Objective: 4

AACSB: Application of knowledge

15) Branded Shoe Company manufactures only one type of shoe and has two divisions, the Stitching Division and the Polishing Division. The Stitching Division manufactures shoes for the Polishing Division, which completes the shoes and sells them to retailers. The Stitching Division "sells" shoes to the Polishing Division. The market price for the Polishing Division to purchase a pair of shoes is $52. (Ignore changes in inventory.) The fixed costs for the Stitching Division are assumed to be the same over the range of 40,000-110,000 units. The fixed costs for the Polishing Division are assumed to be $23 per pair at 110,000 units.

Stitching's costs per pair of shoes are:

Direct materials $10

Direct labor $8

Variable overhead $6

Division fixed costs $4

Polishing's costs per completed pair of shoes are:

Direct materials $15

Direct labor $11

Variable overhead $8

Division fixed costs $19

Assume the transfer price for a pair of shoes is 185% of total costs of the Stitching Division and 40,000 of shoes are produced and transferred to the Polishing Division. The Stitching Division's operating income is:

A) $952,000

B) $720,000

C) $800,000

D) $1,240,000

Diff: 3

Objective: 4

AACSB: Analytical thinking

16) Branded Shoe Company manufactures only one type of shoe and has two divisions, the Stitching Division and the Polishing Division. The Stitching Division manufactures shoes for the Polishing Division, which completes the shoes and sells them to retailers. The Stitching Division "sells" shoes to the Polishing Division. The market price for the Polishing Division to purchase a pair of shoes is $42. (Ignore changes in inventory.) The fixed costs for the Stitching Division are assumed to be the same over the range of 40,000-110,000 units. The fixed costs for the Polishing Division are assumed to be $22 per pair at 110,000 units.

Stitching's costs per pair of shoes are:

Direct materials $14

Direct labor $12

Variable overhead $10

Division fixed costs $8

Polishing's costs per completed pair of shoes are:

Direct materials $18

Direct labor $7

Variable overhead $7

Division fixed costs $16

If the Polishing Division sells 110,000 pairs of shoes at a price of $135 a pair to customers, what is the operating income of both divisions together?

A) $9,570,000

B) $9,240,000

C) $7,920,000

D) $4,730,000

Diff: 3

Objective: 4

AACSB: Analytical thinking

17) Plish Company manufactures only one type of washing machine and has two divisions, the Compressor Division, and the Fabrication Division. The Compressor Division manufactures compressors for the Fabrication Division, which completes the washing machine and sells it to retailers. The Compressor Division "sells" compressors to the Fabrication Division. The market price for the Fabrication Division to purchase a compressor is $40.00. (Ignore changes in inventory.) The fixed costs for the Compressor Division are assumed to be the same over the range of 8,000-13,000 units. The fixed costs for the Fabrication Division are assumed to be $8.00 per unit at 13,000 units.

Compressor's costs per compressor are:

Direct materials $24

Direct labor $14.00

Variable overhead $5.00

Division fixed costs $11.50

Fabrication's costs per completed air conditioner are:

Direct materials $154.00

Direct labor $65.50

Variable overhead $20.00

Division fixed costs $11.50

What is the market-based transfer price per compressor from the Compressor Division to the Fabrication Division?

A) $15.00

B) $34.00

C) $42.00

D) $40.00

Diff: 2

Objective: 4

AACSB: Application of knowledge

18) Plish Company manufactures only one type of washing machine and has two divisions, the Compressor Division, and the Fabrication Division. The Compressor Division manufactures compressors for the Fabrication Division, which completes the washing machine and sells it to retailers. The Compressor Division "sells" compressors to the Fabrication Division. The market price for the Fabrication Division to purchase a compressor is $40.00. (Ignore changes in inventory.) The fixed costs for the Compressor Division are assumed to be the same over the range of 9,000-14,000 units. The fixed costs for the Fabrication Division are assumed to be $7.50 per unit at 14,000 units.

Compressor's costs per compressor are:

Direct materials $21

Direct labor $19.00

Variable overhead $8.00

Division fixed costs $11.50

Fabrication's costs per completed air conditioner are:

Direct materials $162.00

Direct labor $65.00

Variable overhead $29.00

Division fixed costs $11.50

What is the transfer price per compressor from the Compressor Division to the Fabrication Division if the method used to place a value on each compressor is 115% of variable costs?

A) $28.50

B) $55.20

C) $54.35

D) $52.00

Diff: 2

Objective: 4

AACSB: Application of knowledge

19) Plish Company manufactures only one type of washing machine and has two divisions, the Compressor Division, and the Fabrication Division. The Compressor Division manufactures compressors for the Fabrication Division, which completes the washing machine and sells it to retailers. The Compressor Division "sells" compressors to the Fabrication Division. The market price for the Fabrication Division to purchase a compressor is $54.00. (Ignore changes in inventory.) The fixed costs for the Compressor Division are assumed to be the same over the range of 9,000-14,000 units. The fixed costs for the Fabrication Division are assumed to be $12.50 per unit at 14,000 units.

Compressor's costs per compressor are:

Direct materials $15

Direct labor $14.50

Variable overhead $4.00

Division fixed costs $10.00

Fabrication's costs per completed air conditioner are:

Direct materials $158.00

Direct labor $67.00

Variable overhead $25.00

Division fixed costs $10.00

What is the transfer price per compressor from the Compressor Division to the Fabrication Division if the transfer price per compressor is 120% of full costs?

A) $18.00

B) $33.00

C) $49.20

D) $52.20

Diff: 2

Objective: 4

AACSB: Application of knowledge

20) Plish Company manufactures only one type of washing machine and has two divisions, the Compressor Division, and the Fabrication Division. The Compressor Division manufactures compressors for the Fabrication Division, which completes the washing machine and sells it to retailers. The Compressor Division "sells" compressors to the Fabrication Division. The market price for the Fabrication Division to purchase a compressor is $42.00. (Ignore changes in inventory.) The fixed costs for the Compressor Division are assumed to be the same over the range of 8,000-13,000 units. The fixed costs for the Fabrication Division are assumed to be $9.50 per unit at 13,000 units.

Compressor's costs per compressor are:

Direct materials $17

Direct labor $22.50

Variable overhead $6.00

Division fixed costs $10.50

Fabrication's costs per completed air conditioner are:

Direct materials $170.00

Direct labor $67.00

Variable overhead $22.00

Division fixed costs $10.50

Assume the transfer price for a compressor is 150% of total costs of the Compressor Division and 1,600 of the compressors are produced and transferred to the Fabrication Division. The Compressor Division's operating income is:

A) $134,400

B) $44,800

C) $47,600

D) $38,000

Diff: 3

Objective: 4

AACSB: Application of knowledge

21) Plish Company manufactures only one type of washing machine and has two divisions, the Compressor Division, and the Fabrication Division. The Compressor Division manufactures compressors for the Fabrication Division, which completes the washing machine and sells it to retailers. The Compressor Division "sells" compressors to the Fabrication Division. The market price for the Fabrication Division to purchase a compressor is $56.00. (Ignore changes in inventory.) The fixed costs for the Compressor Division are assumed to be the same over the range of 6,000-11,000 units. The fixed costs for the Fabrication Division are assumed to be $7.50 per unit at 11,000 units.

Compressor's costs per compressor are:

Direct materials $21

Direct labor $19.00

Variable overhead $7.00

Division fixed costs $8.00

Fabrication's costs per completed air conditioner are:

Direct materials $154.00

Direct labor $64.50

Variable overhead $22.00

Division fixed costs $8.00

If the Fabrication Division sells 1,900 air conditioners at a price of $415.00 per washing machine to customers, what is the operating income of both divisions together?

A) $224,200

B) $211,850

C) $176,700

D) $171,950

Diff: 3

Objective: 4

AACSB: Application of knowledge

22) Division A sells ground veal internally to Division B, which in turn, produces veal burgers that sell for $15 per pound. Division A incurs costs of $3.75 per pound while Division B incurs additional costs of $7.00 per pound.

What is Division A's operating income per burger, assuming the transfer price of the ground veal is set at $5.50 per burger?

A) $1.75

B) $0.75

C) $6.50

D) $1.50

Diff: 2

Objective: 4

AACSB: Analytical thinking

23) Division A sells ground veal internally to Division B, which in turn, produces veal burgers that sell for $20 per pound. Division A incurs costs of $7.25 per pound while Division B incurs additional costs of $6.00 per pound.

Which of the following formulas correctly reflects the company's operating income per pound?

A) $20 - ($7.25 + $6.00) = $6.75

B) $20 - ($3.00 + $6.00) = $11.00

C) $20 - ($7.25 + $9) = $3.75

D) $20 - ($1.50 + $3.00 + $3.00) = $3.50

Diff: 2

Objective: 4

AACSB: Analytical thinking

24) The choice of a transfer-pricing method has minimal effect on the allocation of company-wide operating income among divisions.

Diff: 2

Objective: 4

AACSB: Analytical thinking

25) Transfer prices do not affect managers whose compensation is directly dependent on an organization's operating income because transfer prices affect only divisional profits and not the organization's profit.

Diff: 3

Objective: 4

AACSB: Analytical thinking

26) Hybrid transfer prices take into account both cost and market information.

Diff: 2

Objective: 4

AACSB: Analytical thinking

27) Hybrid transfer prices can be arrived at through negotiations.

Diff: 2

Objective: 4

AACSB: Analytical thinking

28) Negotiated transfer prices are often employed when market prices are stable.

Diff: 2

Objective: 4

AACSB: Analytical thinking

29) The cost used in cost-based transfer prices can be actual cost or budgeted cost.

Diff: 2

Objective: 4

AACSB: Analytical thinking

30) For each of the following, identify whether it BEST relates to market-based, cost-based, negotiated, or all types of transfer pricing.

________ a. Bargaining between selling and buying units

________ b. Budgeted costs

________ c. 145% of full costs

________ d. Internal product transfers are required if goods are available internally

________ e. Manufacturing costs plus marketing costs plus distribution costs

plus customer service costs

________ f. Prices listed in a trade journal

________ g. Selling price less normal sales commissions

________ h. Variable manufacturing cost plus a markup

a. Negotiated

b. Cost-based

c. Cost-based

d. Any method

e. Cost-based

f. Market-based

g. Market-based

h. Cost-based

Diff: 2

Objective: 4

AACSB: Analytical thinking

31) For each of the following statements regarding the satisfaction of transfer pricing criteria, identify whether you would expect the transfer pricing method to meet the criteria. Provide a yes, no, or sometimes for each situation.

________ a. Market-Based transfer pricing achieves goal congruence.

________ b. Cost-Based transfer pricing achieves goal congruence.

________ c. Negotiated transfer pricing achieves goal congruence.

________ d. Market-Based transfer pricing motivates management effort.

________ e. Cost-Based transfer pricing motivates management effort.

________ f. Negotiated transfer pricing motivates management effort.

________ g. Market-Based transfer pricing is useful for evaluating subunit performance.

________ h. Cost-Based transfer pricing is useful for evaluating subunit performance.

________ i. Negotiated transfer pricing is useful for evaluating subunit performance.

________ j. Market-Based transfer pricing preserves subunit autonomy.

________ k. Cost-Based transfer pricing preserves subunit autonomy.

________ l. Negotiated transfer pricing preserves subunit autonomy.

a. Yes

b. Sometimes

c. Yes

d. Yes

e. Yes

f. Yes

g. Yes

h. Sometimes

i. Yes

j. Yes

k. No

l. Yes

Diff: 2

Objective: 4

AACSB: Analytical thinking

32) The River Falls Company has two divisions. The Cutting Division prepares timber at its sawmills. The Coating Division prepares the cut lumber into finished wood for the furniture industry. No inventories exist in either division at the beginning of 20X5. During the year, the Cutting Division prepared 60,000 cords of wood at a cost of $720,000. All the lumber was transferred to the Coating Division, where additional operating costs of $5 per cord were incurred. The 600,000 boardfeet of finished wood were sold for $2,500,000.

Required:

a. Determine the operating income for each division if the transfer price from Cutting to Coating is at cost - $12 a cord.

b. Determine the operating income for each division if the transfer price is $9 per cord.

c. Since the Cutting Division sells all of its wood internally to the Coating Division, does the manager care what price is selected? Why? Should the Cutting Division be a cost center or a profit center under the circumstances?

a.

* 60,000 cords × $12 = $720,000

b.

* 60,000 cords × $9 = $540,000

c. The manager of Cutting cares about the transfer price if the division is a profit center but not if it is a cost center. Under the circumstances, the division probably should be a cost center and not worry about the profit it pretends to make by selling to another division.

Diff: 2

Objective: 4

AACSB: Application of knowledge

33) Sandra's Sheet Metal Company has two divisions. The Raw Material Division prepares sheet metal at its warehouse facility. The Finishing Division prepares the cut sheet metal into finished products for the air conditioning industry. No inventories exist in either division at the beginning of 20X8. During the year, the Raw Material Division prepared 450,000 square feet of sheet metal at a cost of $1,800,000. All the sheet metal was transferred to the Finishing Division, where additional operating costs of $1.50 per square foot were incurred. The 450,000 square feet of finished fabricated sheet metal products were sold for $3,875,000.

Required:

a. Determine the operating income for each division if the transfer price from Raw Material to Finishing is at a cost of $4 per square foot.

b. Determine the operating income for each division if the transfer price is $6 per square foot.

c. Since the Raw Materials Division sells all of its sheet metal internally to the Finishing Division, does the Raw Materials manager care what price is selected? Why? Should the Raw Materials Division be a cost center or a profit center under the circumstances?

a.

* 450,000 square feet × $4 = $1,800,000

b.

* 450,000 square feet × $6 = $2,700,000

c. The manager of Raw materials cares about the transfer price if the division is a profit center but not if it is a cost center. Under the circumstances, the division probably should be a cost center and should not worry about the profit it pretends to make by selling to another division.

Diff: 2

Objective: 4

AACSB: Application of knowledge

34) Bedtime Bedding Company manufactures pillows. The Cover Division makes covers and the Assembly Division makes the finished products. The covers can be sold separately for $5.00. The pillows sell for $6.00. The information related to manufacturing for the most recent year is as follows:

Required:

Compute the operating income for each division and the company as a whole. Use market value as the transfer price. Are all managers happy with this concept? Explain.

The Assembly manager is probably not happy because the division is showing a loss. The manager would probably argue for a transfer price at something less than market price. However, since the market is open and competitive, the market price can be justified. The division needs to either increase its price or reduce its costs if it expects to show a profit.

Diff: 3

Objective: 4

AACSB: Analytical thinking

35) DesMoines Valley Company has two divisions, Computer Services and Consultancy Services. In addition to their external customers, each division performs work for the other division. The external fees earned by each division in 20X5 were $200,000 for Computer Services and $350,000 for Consultancy Services. Computer Services worked 3,000 hours for Consultancy Services, who, in turn, worked 1,200 hours for Computer Services. The total costs of external services performed by Computer Services were $110,000 and $240,000 by Consultancy Services.

Required:

a. Determine the operating income for each division and for the company as a whole if the transfer price from Computer Services to Consultancy Services is $15 per hour and the transfer price from Consultancy Services to Computer Services is $12.50 per hour.

b. Determine the operating income for each division and for the company as a whole if the transfer price between divisions is $17 per hour.

c. What are the operating income results for each division and for the company as a whole if the two divisions net the hours worked for each other and charge $12.50 per hour for the one with the excess? Which division manager prefers this arrangement?

a.

* Computer Services = 3,000 hours × $15 = $45,000

Consultancy Services = 1,200 hours × $12.50 = $15,000

Revenue for one is an expense of the other.

b.

* Computer Services = 3,000 hours × $17 = $51,000

Consultancy Services = 1,200 hours × $17 = $20,400

Revenue for one is an expense of the other.

c.

* Computer Services net = (3,000 - 1,200) × $12.50 = $22,500

Revenue for one is an expense of the other.

The manager of Computer Services favors this procedure for the current year. If the hours are always in favor of Computer Services, the manager of Computer Services will favor this procedure.

Diff: 2

Objective: 4

AACSB: Application of knowledge

36) Olive Branch Company recently acquired an olive oil processing company that has an annual capacity of 2,000,000 liters and that processed and sold 1,400,000 liters last year at a market price of $4 per liter. The purpose of the acquisition was to furnish oil for the Cooking Division. The Cooking Division needs 800,000 liters of oil per year. It has been purchasing oil from suppliers at the market price. Production costs at capacity of the olive oil company, now a division, are as follows:

Management is trying to decide what transfer price to use for sales from the newly acquired company to the Cooking Division. The manager of the Olive Oil Division argues that $4, the market price, is appropriate. The manager of the Cooking Division argues that the cost of $2.14 should be used, or perhaps a lower price, since fixed overhead cost should be recomputed with the larger volume. Any output of the Olive Oil Division not sold to the Cooking Division can be sold to outsiders for $4 per liter.

Required:

a. Compute the operating income for the Olive Oil Division using a transfer price of $4.

b. Compute the operating income for the Olive Oil Division using a transfer price of $2.20.

c. What transfer price(s) do you recommend? Compute the operating income for the Olive Oil Division using your recommendation.

a.

b.

c. Due to current demand in excess of the capacity, the Olive Oil Division should not be penalized by having to sell inside. All sales equivalent to the current external demand of 1,400,000 liters should be at the market price.

Diff: 3

Objective: 4

AACSB: Application of knowledge

37) Briefly explain each of the three methods used to determine a transfer price.

Diff: 2

Objective: 4

AACSB: Analytical thinking

38) How does cost-based transfer price method help managers to determine transfer prices?

Diff: 2

Objective: 4

AACSB: Analytical thinking

Objective 23.5

1) Transferring products internally at a market price leads to optimal decisions when all of the following conditions are prevalent except:

A) the market for the transferred product (intermediate product) is perfectly competitive

B) there are no additional costs to the company from buying in the external market instead of transacting internally

C) the interdependence of subunits is minimal

D) there are additional benefits to the company by selling in the external markets instead of transferring internally

Diff: 2

Objective: 5

AACSB: Analytical thinking

2) A perfectly competitive market exists when which of the following conditions are present?

A) individual buyers or sellers can affect prices by their own actions

B) market prices reach well above their historical averages due to demand outstripping supply

C) market prices drop well below their historical averages due to supply outstripping demand

D) there is a homogeneous product with buying prices equal to selling prices

Diff: 2

Objective: 5

AACSB: Analytical thinking

3) A benefit of using a market-based transfer price is that the:

A) profits of the transferring division are sacrificed for the overall good of the corporation

B) profits of the division receiving the products are sacrificed for the overall good of the corporation

C) economic viability and profitability of each division can be evaluated individually

D) transferring division can be assured of recovering its full costs in all scenarios

Diff: 2

Objective: 5

AACSB: Analytical thinking

4) When an industry has excess capacity, market prices may drop well below their historical average. If this drop is temporary, it is called:

A) distress prices

B) dropped prices

C) low-average prices

D) substitute prices

Diff: 1

Objective: 5

AACSB: Analytical thinking

5) Market-based transfer prices are helpful when:

A) the product is specialized

B) the internal product is different from the products available externally in terms of its quality

C) the interdependencies of subunits are minimal

D) the markets are not perfectly competitive

Diff: 2

Objective: 5

AACSB: Analytical thinking

6) If the distress price is used as the transfer price:

A) the selling division will show a loss because the distress price will not exceed the full cost of the division

B) the buying division will show a loss because the distress price will not exceed the full cost of the division

C) the selling division will show a loss because the distress price will exceed the full cost of the division

D) the buying division will show a loss because the distress price will exceed the full cost of the division

Diff: 3

Objective: 5

AACSB: Analytical thinking

7) Briefly describe the conditions that should be met for market-based transfer pricing to lead to optimal decision making among subunits of a large organization.

In a perfectly competitive market, the market-based transfer prices promote goal congruence, motivate the management to take the same actions as if they were transacting externally, evaluate subunit performance, and preserve subunit autonomy.

Diff: 2

Objective: 5

AACSB: Analytical thinking

8) What are distress prices and which transfer prices should be used for judging performance if distress prices prevail?

If the drop in prices is expected to be temporary, these low market prices are called "distress

prices." Some companies use the distress prices themselves, but others use long-run average prices, or "normal" market prices.

Diff: 2

Objective: 5

AACSB: Analytical thinking

Objective 23.6

1) When companies do not want to use market prices or find it too costly, they typically use ________ prices, even though suboptimal decisions may occur.

A) average-cost

B) full-cost

C) long-run cost

D) short-run average cost

Diff: 2

Objective: 6

AACSB: Analytical thinking

2) Aerated Water Company makes internal transfers at 175% of full cost. The Soda Refining Division purchases 30,000 containers of carbonated water per day, on average, from a local supplier, who delivers the water for $33 per container via an external shipper. To reduce costs, the company located an independent supplier in Missouri who is willing to sell 30,000 containers at $29 each, delivered to Aerated Water Company's Shipping Division in Missouri. The company's Shipping Division in Missouri has excess capacity and can ship the 30,000 containers at a variable cost of $6.00 per container. What is the total cost to Aerated Water Company if the carbonated water is purchased from the local supplier?

A) $990,000

B) $982,500

C) $2,295,000

D) $1,732,500

Diff: 2

Objective: 6

AACSB: Application of knowledge

3) Crush Company makes internal transfers at 155% of full cost. The Soda Refining Division purchases 40,300 containers of carbonated water per day, on average, from a local supplier, who delivers the water for $58 per container via an external shipper. To reduce costs, the company located an independent supplier in Illinois who is willing to sell 40,300 containers at $50 each, delivered to Crush Company's Shipping Division in Missouri. The company's Shipping Division in Missouri has excess capacity and can ship the 40,300 containers at a variable cost of $5.00 per container. What is the total cost of purchasing the water from the Illinois supplier and shipping it to the Soda Division?

A) $2,015,000

B) $2,216,500

C) $2,337,400

D) $201,500

Diff: 2

Objective: 6

AACSB: Application of knowledge

4) An advantage of using budgeted costs for transfer pricing among divisions is that:

A) overall corporate profitability is usually higher

B) it usually provides a basis for optimal decision making

C) the divisions know the transfer price in advance

D) it promotes subunit autonomy

Diff: 2

Objective: 6

AACSB: Analytical thinking

5) A company should use cost-based transfer prices:

A) when a company's product is specialized

B) the market for the intermediate product is perfectly competitive

C) the interdependencies of subunits are minimal

D) there is no benefit from market-based transfer price

Diff: 2

Objective: 6

AACSB: Analytical thinking

6) A transfer price based on the full cost plus a markup may lead to suboptimal decisions because:

A) it leads the buying division to regard the fixed costs and the markup of the selling division as a variable cost

B) it leads the buying division to regard the variable costs and the markup of the selling division as a fixed cost

C) it leads the buying division to regard the fixed costs and the markup of the selling division as total costs

D) it leads the buying division to regard the variable costs and the markup of the selling division as total costs

Diff: 2

Objective: 6

AACSB: Analytical thinking

7) Cost-based transfer prices are often used when markets for the product are not competitive or when the quality of the internal product is different from the externally available products.

Diff: 2

Objective: 6

AACSB: Analytical thinking

8) A major advantage of using actual costs for transfer prices is that often inefficiencies are NOT passed along to the receiving division.

Diff: 2

Objective: 6

AACSB: Analytical thinking

9) The full cost plus a markup transfer-pricing method can sometimes lead to goal incongruence.

Diff: 2

Objective: 6

AACSB: Analytical thinking

10) Cost-based transfer prices are helpful when markets are not perfectly competitive.

Diff: 2

Objective: 6

AACSB: Analytical thinking

11) When using transfer prices based on costs rather than market prices, management can better determine profitability of the investment made in the intermediate producing division.

Diff: 2

Objective: 6

AACSB: Analytical thinking

12) Super Shoes Company manufactures sneakers. The Athletic Division sells its socks for $18 a pair to outsiders. Sneakers have manufacturing costs of $6.00 each for variable and $6.00 for fixed. The division's total fixed manufacturing costs are $315,000 at the normal volume of 70,000 units.

The European Division has offered to buy 15,000 Sneakers at the full cost of $12. The Athletic Division has excess capacity and the 15,000 units can be produced without interfering with the current outside sales of 70,000. The 85,000 volume is within the division's relevant operating range.

Explain whether the Athletic Division should accept the offer.

The proposal should be accepted because it makes a contribution to fixed costs and profits of $6.00 per unit. This would increase the division's operating income by $90,000 = ($6.00 × 15,000 units).

Diff: 2

Objective: 6

AACSB: Analytical thinking

13) Nig Car Company manufactures automobiles. The Fastback Car Division sells its cars for $50,000 each to the general public. The fastback cars have manufacturing costs of $30,000 each for variable and $15,000 each for fixed costs. The division's total fixed manufacturing costs are $75,000,000 at the normal volume of 5,000 units.

The Coupe Car Division has been unable to meet the demand for its cars this year. It has offered to buy 1,000 cars from the Fastback Car Division at the full cost of $40,000. The Fastback Car Division has excess capacity and the 1,000 units can be produced without interfering with the current outside sales of 5,000. The 6,000 volume is within the division's relevant operating range.

Explain whether the Fastback Car Division should accept the offer.

The proposal should be accepted because it makes a contribution to fixed costs and profits of $10,000 per unit. This would increase the division's operating income by $10,000,000 = ($10,000 × 1,000 units).

Diff: 2

Objective: 6

AACSB: Analytical thinking

14) Cornerstone Company has two divisions. The Bottle Division produces products that have variable costs of $3 per unit. Its 20X5 sales were 140,000 to outsiders at $5 per unit and 40,000 units to the Mixing Division at 140% of variable costs. Under a dual transfer-pricing system, the Mixing Division pays only the variable cost per unit. The fixed costs of the Bottle Division are $125,000 per year.

Mixing sells its finished products to outside customers for $11.50 per unit. Mixing has variable costs of $2.50 per unit in addition to the costs from the Bottle Division. The annual fixed costs of Mixing were $85,000. There were no beginning or ending inventories during the year.

Required:

What are the operating incomes of the two divisions and the company as a whole for the year? Explain why the company's operating income is less than the sum of the two divisions' total income.

* 40,000 × $3 × 1.40 = $168,000

The internal sales are not included in the company's statement because the company cannot sell to itself. Therefore, it has to exclude $48,000 of dual pricing.

Diff: 2

Objective: 6

AACSB: Analytical thinking

15) When cost-based transfer pricing is used between subunits of a large organization, describe how to avoid making suboptimal decisions.

A more appropriate method would be to use a variable cost or incremental cost for the units being transferred between subunits within an organization.

In the event that the supplying organization is a profit center and has other external customers for its products, then there may be some accommodation made for prorating the difference between variable cost and full cost. This method would be superior to allowing a full cost (or full cost plus markup) method to be used. The objective is to have the organization as a whole act in a manner that will approximate competitive marketplace conditions as much as possible to promote cost efficiency in the long run.

Diff: 2

Objective: 6

AACSB: Analytical thinking

Objective 23.7

1) An advantage of a negotiated transfer price of a product to be transferred between divisions is the:

A) close relationship between the negotiated price and the market price

B) negotiated transfer price preserves divisional autonomy

C) negotiations usually do not require much time and energy

D) simplicity of its computations and close approximation to market price

Diff: 2

Objective: 7

AACSB: Analytical thinking

2) The range over which two divisions will negotiate a transfer price is:

A) between the supplying division's variable cost and the market price of the product

B) between the supplying division's variable cost and its full cost of the product

C) it could be anywhere above the supplying division's full cost of the product

D) between the supplying division's full cost and 180% above its full cost

Diff: 2

Objective: 7

AACSB: Analytical thinking

3) The transfer-pricing method that reduces the goal-congruence problems associated with a pure cost-plus-based transfer-pricing method is the:

A) dual pricing

B) market pricing

C) single pricing

D) distress pricing

Diff: 2

Objective: 7

AACSB: Analytical thinking

4) Which of the following is a disadvantage of using negotiated transfer price?

A) It requires each division manager to put forth effort to increase division operating income.

B) Negotiated transfer prices take away the divisional autonomy as prices depend on bargaining strength.

C) Negotiations usually require much time and energy thereby consuming precious managerial time.

D) It may lead to divisional enmity because negotiation process may cause frictions among departments.

Diff: 2

Objective: 7

AACSB: Analytical thinking

5) Which of the following is true about transfer pricing?

A) The maximum price that the buying division is willing to pay is the higher of the eventual contribution generated from an internal transaction and the price of purchasing from an external party.

B) The selling division must always set a transfer price above the market price of the product to make the transaction economically feasible for the buying division.

C) There is generally a minimum transfer price the selling division will not go below based on its own cost structure.

D) The transfer-price range lies between the its fixed cost per unit and the higher of its contribution or price at which the product is available from external suppliers.

Diff: 2

Objective: 7

AACSB: Analytical thinking

6) Which of the following is a disadvantage of dual pricing?

A) It strongly preserves the autonomy of divisions, and the division managers are motivated to put forth effort to increase the operating income of their respective divisions, causing inefficiencies.

B) The price arrived by using dual pricing has no specific relationship to either costs or the market price.

C) It insulates managers from the realities of the marketplace because costs, not market prices, affect the revenues of the supplying division.

D) It assumes that the minimum transfer price equals the incremental cost per unit incurred up to the point of transfer minus the opportunity cost per unit to the selling division.

Diff: 2

Objective: 7

AACSB: Analytical thinking

7) One advantage of prorating the difference between a maximum and minimum transfer price of a product to be moved between divisions is that it saves the cost of objective audits of transfer pricing.

Diff: 2

Objective: 7

AACSB: Analytical thinking

8) Dual pricing uses two separate transfer-pricing methods to price each transfer from one subunit to another.

Diff: 2

Objective: 7

AACSB: Analytical thinking

9) One concern with dual pricing is that it leads to disputes about which price should be used when computing the taxable income of subunits located in different tax jurisdictions.

Diff: 2

Objective: 7

AACSB: Analytical thinking

10) Dual pricing insulates managers from the realities of the marketplace because costs, not market prices, affect the revenues of the supplying division.

Diff: 2

Objective: 7

AACSB: Analytical thinking

11) TrueValue Company makes all types of office desks. The General Desk Division is currently producing 10,000 desks per year with a capacity of 15,000. The variable costs assigned to each desk are $300 and annual fixed costs of the division are $900,000. The General desk sells for $400.

The Executive Division wants to buy 5,000 desks at $250 for its custom office design business. The General Desk manager refused the order because the price is below variable cost. The executive manager argues that the order should be accepted because it will lower the fixed cost per desk from $90 to $60 and will take the division to its capacity, thereby causing operations to be at their most efficient level.

Required:

a. Should the order from the Executive Division be accepted by the General Desk Division? Why?

b. From the perspective of the General Desk Division and the company, should the order be accepted if the Executive Division plans on selling the desks in the outside market for $420 after incurring additional costs of $100 per desk?

c. What action should the company president take?

a.

The manager should not accept the order because it is below variable costs. It will generate a loss of $250,000 [5,000 units × $(50)]. This is a losing proposition in both the short run and long run.

b. What the Executive Division does with the desks after receiving them is of no consequence to the General Desk Division. However, the division will still object to the transfer price of $250. The company, on the other hand, will encourage the offer because it increases total company operating income by $100,000 = 5,000 × [$420 - ($300 + $100)].

c. If the company president wants the Executive Division to have the new business, it should arrange a dual-pricing system or else have negotiated prices between divisions. Dual pricing would allow the selling division to get a market value for the transfer and the buying division to get some type of cost-plus transfer price. The negotiated price would allow the buying and selling divisions to feel like they had a part in the final pricing decision.

Diff: 3

Objective: 7

AACSB: Application of knowledge

12) The Microchip Division of Silicon Computers produces computer chips that are sold to the Personal Computer Division and to outsiders. Operating data for the Microchip Division for 20X5 are as follows:

The Personal Computer Division has just received an offer from an outside supplier to furnish chips at $8.90 each. The manager of Microchip Division is not willing to meet the $8.90 price. She argues that it costs her $9.00 to produce and sell each chip. Sales to outside customers are at a maximum of 200,000 chips.

Required:

a. Verify the Microchip Division's $9.00 unit cost figure.

b. Should the Microchip Division meet the outside price of $8.90? Explain.

c. Could the $8.60 price be met and still show a profit for the Microchip Division sales to the Personal Computer Division? Show computations.

a.

b. Yes, because the contribution margin is positive ($8.90 - $4.00 = $4.90). If it loses the internal business, the other sales would have to absorb the fixed costs, which would force even higher external prices. The Microchip Division manager does not have much bargaining power since the external sales are already at a maximum.

c.

Internal sales will not show a profit. This assumes the fixed costs are still allocated at $5.00 per unit.

Diff: 2

Objective: 7

AACSB: Application of knowledge

13) Dual pricing is not widely used. Explain its disadvantages.

Diff: 2

Objective: 7

AACSB: Analytical thinking

Objective 23.8

1) Which of the following transfer-pricing methods always achieves goal congruence?

A) a market-based transfer price

B) a cost-based transfer price

C) a negotiated transfer price

D) full-cost plus a standard profit margin

Diff: 2

Objective: 8

AACSB: Analytical thinking

2) In comparing the three basic approaches to transfer pricing, which of the following statements would be true?

A) A cost-based approach preserves subunit autonomy while negotiated transfer prices do not.

B) Market-based transfer pricing motivates managers but negotiated prices do not.

C) Cost-based transfer pricing systems are more difficult to implement and often make more time to implement than negotiated transfer pricing.

D) Market-based transfer pricing achieves goal congruence when markets are competitive while cost-based can achieve goal congruence, but not always.

Diff: 2

Objective: 8

AACSB: Analytical thinking

3) Which of the following denotes minimum transfer price?

A) Minimum transfer price = Incremental cost per unit incurred up to the point of transfer + Opportunity cost per unit to the selling subunit

B) Minimum transfer price = Total cost per unit incurred up to the point of transfer + Sunk cost per unit to the selling subunit

C) Minimum transfer price = Current cost per unit incurred up to the point of transfer + Historical cost per unit to the selling subunit

D) Minimum transfer price = Variable cost per unit incurred up to the point of transfer + Fixed cost per unit to the selling subunit

Diff: 2

Objective: 8

AACSB: Analytical thinking

4) The minimum transfer price equals:

A) opportunity costs less the additional outlay costs

B) opportunity costs times 125% plus the additional outlay costs

C) opportunity costs divided by the additional outlay costs

D) incremental costs plus opportunity costs

Diff: 1

Objective: 8

AACSB: Analytical thinking

5) The seller of Product A has no idle capacity and can sell all it can produce at $53 per unit. Outlay cost is $18. What is the opportunity cost, assuming the seller sells internally?

A) $18

B) $35

C) $53

D) $71

Diff: 2

Objective: 8

AACSB: Application of knowledge

6) The seller of a product has no idle capacity and can sell all it can produce at $39 per unit. Outlay cost is $12. What is the opportunity cost, assuming the seller sells internally?

A) $12

B) $27

C) $39

D) $51

Diff: 2

Objective: 8

AACSB: Application of knowledge

7) In markets that are not perfectly competitive:

A) the selling division will not have any unused capacity

B) companies can increase their capacity utilization only by decreasing their prices

C) minimum transfer price will equal the incremental cost per unit incurred up to the point of transfer

D) the opportunity cost will equal the minimum contribution margin

Diff: 2

Objective: 8

AACSB: Application of knowledge

8) In analyzing transfer prices, the:

A) buyer will not willingly purchase a product for less than the incremental costs incurred to manufacture the product internally

B) seller will not willingly sell a product for less than the incremental costs incurred to make the product

C) buyer will willingly pay more than the ceiling transfer price

D) buyer will not pay less than the ceiling transfer price

Diff: 3

Objective: 8

AACSB: Analytical thinking

9) Minimum transfer price can be arrived at by adding incremental cost per unit incurred up to the point of transfer with the markup required.

Diff: 2

Objective: 8

AACSB: Analytical thinking

10) Both the market-based transfer pricing approach and cost-based methods are useful for evaluating subunit performance.

Diff: 2

Objective: 8

AACSB: Analytical thinking

11) The additional cost of producing and transferring the product or service is called variable manufacturing cost.

Diff: 2

Objective: 8

AACSB: Analytical thinking

12) If the selling subunit is operating at capacity, the opportunity cost of transferring a unit internally rather than selling it externally is equal to the market price minus the variable cost.

Diff: 2

Objective: 8

AACSB: Analytical thinking

13) The Fabrication Division of American Car Company has offered to purchase 90,000 batteries from the Electrical Division for $104 per unit. At a normal volume of 250,000 batteries per year, production costs per battery are as follows:

The Electrical Division has been selling 250,000 batteries per year to outside buyers at $136 each; capacity is 350,000 batteries per year. The Fabrication Division has been buying batteries from outside sources for $130 each.

Required:

a. Should the Electrical Division manager accept the offer? Explain.

b. From the company's perspective, will the internal sales be of any benefit? Explain.

a. Variable cost per battery = $40 + $30 + $12 = $82

Because the Electrical Division is not at capacity, it should sell to the Fabrication Division up to 100,000 units at $104. This will add $1,980,000 (90,000 × $22) at the current level to its operating income without reducing its outside sales.

b. The internal sales would be beneficial to the company because the internal variable manufacturing costs of $82 per battery are less than the external price of $130 currently being paid by the Fabrication Division. The company would be saving $4,320,000 [90,000 × ($130 - $82)] per year.

Diff: 3

Objective: 8

AACSB: Application of knowledge

14) Soft Cushion Company is highly decentralized. Each division is empowered to make its own sales decisions. The Assembly Division can purchase stuffing, a key component, from the Production Division or from external suppliers. The Production Division has been the major supplier of stuffing in recent years. The Assembly Division has announced that two external suppliers will be used to purchase the stuffing at $36 per pound for the next year. The Production Division recently increased its unit price to $52. The manager of the Production Division presented the following information — variable cost $34 and fixed cost $22 —to top management in order to attempt to force the Assembly Division to purchase the stuffing internally. The Assembly Division purchases 20,600 pounds of stuffing per month.

What would be the monthly operating advantage (disadvantage) of purchasing the goods internally, assuming the external supplier increased its price to $80 per pound and the Production Division is able to utilize the facilities for other operations, resulting in a monthly cash-operating savings of $32 per pound?

A) $1,648,000

B) $947,600

C) $(288,400)

D) $(82,400)

Diff: 2

Objective: 8

AACSB: Analytical thinking

Objective 23.9

1) One of the problems in using one set of accounting records for tax reporting and another set of records for internal management reporting is that:

A) it is illegal as well as unethical to do so

B) the tax authorities may suspect manipulation of records

C) it is almost impossible to keep the records straight and hard to reconcile the books

D) the shareholders do not approve of such methods and the market prices will decline

Diff: 1

Objective: 9

AACSB: Analytical thinking

2) Which of the following helps in avoiding costly transfer-pricing disputes between taxpayers and tax authorities?

A) transfer price redressal panel

B) grievance redressal forum

C) transfer price agreements

D) advanced pricing agreements

Diff: 1

Objective: 9

AACSB: Analytical thinking

3) Which of the following taxes does transfer pricing affect?

A) customs duties

B) taxes on dividends received

C) corporate income taxes

D) foreign property taxes

Diff: 2

Objective: 9

AACSB: Application of knowledge

4) Which of the following best describes an Advanced Pricing Agreement (APA)?

A) An agreement between a corporation and a foreign subsidiary as to what method, cost or market-based, will be used to set a transfer price for products.

B) A binding agreement between a foreign government's taxing authority, the IRS and a U.S. based corporation to help avoid disputes related to transfer pricing.

C) An agreement under IRS code Section 482 that requires a company to utilize market based transfer prices and to document them for tax return purposes.

D) A binding agreement between the IRS and a corporation to help avoid disputes related to transfer pricing.

Diff: 2

Objective: 9

AACSB: Analytical thinking

5) Global Giant, a multinational corporation, has a producing subsidiary in a low tax rate country and a marketing subsidiary in a high tax country. If Global Giant wants to minimize its worldwide tax liability, we would expect Global Giant to:

A) stop producing in the low tax rate country

B) stop marketing in the high tax rate country

C) establish a low transfer price when the producing unit sells to the marketing unit

D) establish a high transfer price when the producing unit sells to the marketing unit

Diff: 2

Objective: 9

AACSB: Application of knowledge

6) The tariffs and customs duties governments levy on imports of products into a country also affect the transfer pricing practices of multinationals.

Diff: 2

Objective: 9

AACSB: Analytical thinking

7) A company may choose to keep one set of accounting records for tax reporting and a second set for internal management reporting.

Diff: 2

Objective: 9

AACSB: Analytical thinking

8) Companies have an incentive to lower the transfer prices of products they are exporting into a country to reduce the tariffs and customs duties charged on those products.

Diff: 2

Objective: 9

AACSB: Analytical thinking

9) A company has a plant in a high tax jurisdiction that produces products for a facility in a low tax jurisdiction. Suggest a strategy, including transfer prices, which will result in the lowest tax for the overall corporation.

Diff: 2

Objective: 9

AACSB: Analytical thinking

10) What is the role of unused capacity within the selling division in the determination of a negotiated transfer price to another division?

Diff: 2

Objective: 9

AACSB: Analytical thinking

11) What does Section 482 of the U.S. Internal Revenue Code govern?

Diff: 3

Objective: 9

AACSB: Analytical thinking