Transfer Pricing Case Study

Management Accounting

Coffee Makers Incorporated Transfer Prices Case Study

The Current Position

Department B

Proposed Changes

Department B

Coffee Makers Incorporated has two divisions which purchase parts internally form a third department. Two parts; 101 and 201 are produced internally. The current transfer price for those parts is $1,000 and $2,000 respectively. The departments which are buying the parts; dept. A is buying part 101 and dep. B is buying part 201, want to change the purchase pattern, as external suppliers can supply the parts at a price less than the transfer price (dept. C) is charging.

Currently Dept A buys 3000 of the 101 parts from department C. topped up with 1,000 parts from external suppliers, department B. purchases 1,000 parts from dept. C and 1,000 parts from external suppliers. Both departments want to make a change to reduce their own costs, moving more purchases to the external supplier. It is likely that they are assuming the lower cost to the department will benefit the firm. However, the transfer price is not a price at cost; it is a price in which there is a surplus of revenues after the variable costs have been deducted. To assess if the plan to purchase more parts from external suppliers would be beneficial to the firm it is necessary to look a both the savings that will be made by the purchasing departments and the level of contribution that would be lost by department C (Atkinson et al., 2011)

The Current Position

The first stage of the calculation is to assess the current position. The contribution level of the internal parts needs to be determined; this is calculated by taking the internal transfer price and deducted all of the variable costs; this is shown in table 1.

Table 1; Contribution level for Parts 101 and 201

Transfer price

1,000

2,000

Direct material

Direct labor

Variable overhead

Total variable costs

Contribution per unit

Department A

The next stage is to calculate the costs of the departments purchasing the goods.Department A purchases 3,000 units at $1,000 from dept C, and 1,000 units from external suppliers at $900, these costs are sown in table 2

Table 2; Purchase costs to dept A

Purchase source

Units purchased

Cost per unit

Total costs

Dept C

3,000

1,000

3,000,000

External supplier

1,000

900,000

Total

4,000

3,900,000

The price includes the contribution which is created, so this needs to be assessed, and is shown in table 3.

Table 3; Current contribution generated on sales to dept. A

No of units purchased

Contribution per unit generated

Total contribution

3,000

900,000

The net cost to the firm is the cost paid out by dept A., less the contributions received by dept C, shown in table 4.

Table 4; Current net cost to the firm for dept. A

Costs for department A

3,900,000

Less contribution from dept c

900,000

Net cost to firm

3,000,000

Department B

The same process may be used to calculate the current net cost. Table 5 shows the costs that are incurred by dept. B under the current purchase arrangements

Table 5; Current costs to dept. B

Purchase source

Units purchased

Cost per unit

Total costs

Dept C

1,000

2,000

2,000,000

External supplier

1,000

1,900

1,900,000

Total

2,000

3,900,000

The next stage is to assess the contribution that is created for dept C. As a result of the transaction. This is shown in table 6.

Table 6; Current contribution generated on sales to dept. B

No of units purchased

Contribution per unit generated

Total contribution

1,000

800,000

With the impact on both departments calculated, they can be brought together in order to assess the net cost of the purchases to the firm, this is shown in table 7.

Table 7; Current net cost to the firm for dept. B

Costs for department.....