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Lecture 13

MGAB03H3 Lecture Notes - Lecture 13: Icq, Transfer Pricing, Fixed Cost

Financial Accounting
Course Code
G.Quan Fun

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Chapter 13

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ICQ #1
E13-27 Transfer Prices
ED Electronics operates as a decentralized company. The bit division manufactures
an electronic device and purchases a component, part X22, from the part division
of the same company. The division managers have full authority on decisions
involving transactions with internal or external customers and suppliers. Currently,
the part division is operating at full capacity and the bit division is operating below
its capacity of 5,000 units. Part X22 can be sold externally for $75. The costs of
producing the electronic device, excluding the cost of part X22, are as follows:
Direct materials $120
Direct labour 30
Variable overhead 125
Fixed overhead 100
Total $375
The manager of the bit division has received an offer from a national distributor
willing to buy 500 electronic devices at a price of $425 per unit.
A. Indicate the minimum transfer price that the manager of the part division would
agree to. Justify your answer.
B. Indicate the maximum transfer price that the manager of the bit division would
be willing to pay for part X22. Justify your answer.
C. Assume the full cost of part X22 is $50. Explain whether the firm as a whole
would benefit if part X22 is transferred from the part division to the bit division
at full cost. Justify your answer.
D. Explain whether your answer to Part C would be different if the part division is
not operating at full capacity.

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ICQ #2
E13-28 Transfer Prices
Wood Inc. manufactures wood poles. It has two divisions, Harvesting and Sawing,
which are both evaluated as profit centres. The Harvesting Division is responsible
for all the harvesting operations and transfers logs to the Sawing Division, which
transforms the logs into poles for external customers. Sawing can produce 10,000
poles per year. The Sawing Division is currently producing at full capacity, after
management decided a year ago to manufacture a higher-demand wood pole, Pole-
S, that can be sold readily. The manager of the Sawing Division suggests that the
maximum price the division can pay for logs transferred from Harvesting is $61.50
per log. The following information supports this suggestion:
Price that external customers are willing to pay for one unit of Pole-S $122.0.0
Costs per unit:
Direct labour $35.00
Variable overhead 4.50
Fixed overhead 8.50
Direct materials (other than logs) 2.50  
Total cost per unit 50.50
Target profit margin 10.00
Total cost and margin $60.50
Maximum transfer price for one log $61.50
The manager of the Harvesting Division disagrees with the proposed transfer price
of $61.50. The division is operating at full capacity and can sell all the logs it
produces to external customers for $75. Moreover, the director says: “For each unit
of Pole-S my direct labour cost is $40.50, variable overhead is $9.50, and fixed
overhead is $15. I cannot spend $65 to cut trees and sell them for $61.50.”
A. Determine whether it would be beneficial for the company as a whole if logs
were transferred to the Sawing Division at the suggested price of $61.50 per
log. Show all your calculations.
B. Explain the impact of transferring the logs to the Sawing Division at $61.50 on
the performance of each division and specifically on each manager.
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