Transfer Pricing of a Coffee Maker's Incorporated - Assignment Example

?Transfer Pricing of a Coffee Maker's Incorporated (CMI). Paper: Introduction Transfer Price is the price at which two or moredivisions within a company transact. These transactions may be in terms of supplies or work force between related departments. Transfer prices are used when individual entities of a larger multi-entity firm are treated and measured as separately run entities. In management accounts, the various divisions of a bigger company are responsible for generating of their own profits and return on Invested Capital. (Drury, 2004) These divisions are obligated to transact amongst themselves, the costs are decided by using a transfer. Even though the transfer prices may not differ much from the market prices, one of the divisions or the company as a whole in such a transaction go at a loss The buying divisions may buy for more than the principal market price or the selling division can sell below the market price, hence affecting their performance. This can either result into a loss or gain in any or all of the divisions. The company can also make a profit or a loss (Tully, 2012) Table1 of Supply Division C Quantity Manufactured Quantity supplied Current supply Price per unit Total Cost Proposed supply Price per unit Total Cost Supplier C part 101 2,000 3,000 $900 $2,700,000 2,000 $900 $1,800,000 Supplier C part 201 500 1,000 $900 $900,000 500 $1,900 $950,000 From the table 1: Division C will experience a loss, since it, supply of Part 101 reduces from a volume of $2,700,000 to $1,800,000. The transfer price is $2,000 while the market price for this part 101 is $900. Even though the total volume of supply of part 201 to Division B indicates a slight drop from the transfer price. The overall transaction for this division is a loss. Table2 for Buying Division A Quantity Bought Current purchase Price per unit Total Cost Proposed Purchases Price per unit Total Cost Supplier C part 101 3,000 $900 $2,700,000 2,000 $900 $1,800,000 External Supplier part 101 1,000 $900 $900,000 2,000 $900 $1,800,000 The buying division A will be in profit, because the price for the part A is $900. This price is less than the transfer price of $1,000. Even though the quantity supplied by Division C has reduced, they have increased their purchase volume from the external supply from 1,000 units to 2,000 units Table three for buying division B Quantity Bought Current Purchases Price per unit Total Cost Proposed Purchase Price per unit Total Cost Supplier C part 201 1,000 $900 $900,000 2,000 $900 $1,800,000 External Supplier part 201 1,000 $900 $900,000 1,500 $1,900 $2,850,000 Division B is a buying division will be in profit if the proposal is implemented. This is driven by two factors: they will have to buy more units both from division C and Externally at a price less than the transfer price. The transfer price is put at $2,000 while the market price for part 201 is $1,900. Profit will be $4,650,000-$1,800,000 =$3,250,000 Table 4 External Supplier Current supply Price per unit Total Cost Proposed supply Price per unit Total Cost Supplier part 101 to A 3,000 $900 $2,700,000 2,000 $900 $1,800,000 Supplier part 201 to B 1,000 $900 $900,000 1,500 $1,900 $2,850,000 From the above data, the company will make a loss since the overall increase in the external supply of both parts. The internal supplier namely the division C is disadvantaged in the new proposal. The total supply by this division will be a total 2,500 units, while external supplier will bring in 3,500 units. Division A: Buying division or downstream Part 101 Transfer cost = $1,000 Current Operation Units bought currently = (3,000 units from supplier C + 1,000 units from External supplier) = 4,000 units Unit cost = $ 900 Total cost = $ 900 X 4,000 = $36,000 Proposed Operation Product cost = $1,200 Transfer cost = $2,000 Units bought Proposed = (2,000 units from supplier C + 2,000 units from External supplier) = 4,000 units Unit cost = $ 900 Total Proposed Buying cost = $ 900 X 4,000 = $36,000 Units bought currently = (3,000 units from supplier C + 1,000 units from External supplier) = 4,000 units Division B Buying division or downstream Part 201 Current Operation Units bought currently = (1,000 units from supplier C + 1,000 units from External supplier) = 2,000 units Unit cost = $ 900 Total cost = $ 900 X 2,000 = $18,000 Proposed Operation Product cost = $1,200 Transfer cost = $2,000 Units bought Proposed = (500 units from supplier C + 1,500 units from External supplier) =2,000 units Unit cost = $1,900 Total Proposed Buying cost = $1, 900 X 2,000 = $38,000 Division C: Selling division upstream Proposed selling Price Manufacture of part 101 total units = (2,000 for Division A of Part) = 2,000 units Product cost = $700 Total units sold = ($ 700 X 2,000) = $ 1,400 Manufacture of part 201 total units = (500 for Division B of Part 201) = 500 units Product cost = $1,200 Total units sold = ($ 1,200 X 500) = $ 6,000 Transfer pricing policies In principle, the selling divisions for example division C is referred to as the upstream division the Division A and division B that buys the part 101 and part 201 respectively from division C are known as downstream divisions. Three general policies govern the determination of transfer prices. The first one is market-based transfer price. This is where in the existence of competitive and steady external markets for the products, which are transferred internally; the external market price or fair market price will then be used as the transfer price. Secondly, there is cost-based transfer price. This is when the transfer price is taken as the cost of production of goods by the upstream division (Anuschka Bakker, Marc M. Levey, 2011). However, before price determination, the following criteria must be specified: Standard cost or actual cost, Variable cost and the amount of mark-up price, if any, this would enable the upstream division to realize a profit on the product traded. Thirdly, the negotiated transfer price, which is done by the divisional managers other than by the senior management who will leave it open. Divisional managers would negotiate and come into agreement on a particular price. Cost plus is where products supplied to unrelated parties are regularly priced at actual cost plus a fixed mark-up price. (Drury, 2004) Conclusion Downstream division (division A and Division B) may opt to out- source the product for a lesser cost from external suppliers. This can be necessitated by the need to maximize on their profit margins. Failure by the downstream division to make a reasonable profit after selling the final product, will force it to pay the upstream division’s full cost of production for the product. (Drury, 2004) References Anuschka Bakker, Marc M. Levey. (2011). Transfer Pricing and Dispute Resolution. In M. M. Anuschka Bakker, Transfer Pricing and Dispute Resolution. SBN:978-90-8722-100-3. Drury, C. (2004). Management and cost accounting 6th Edition. In C. Drury, Management and cost accounting 6th edition. Thomson. Tully, B. (2012, August). Transfer Pricing Strategies and the Impact on Organizations. 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