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Module 3 – Case

Transfer Pricing and Responsibility Centers

ASSIGNMENT OVERVIEW

Coffee Maker’s Incorporated (CMI)

Three divisions of a CMI are involved in a dispute. Division A purchases Part 101 and Division B purchases Part 201 from a third division, C. Both divisions need the parts for products that they assemble. The intercompany transactions have remained constant for several years.

Recently, outside suppliers have lowered their prices, but Division C refuses to do so. In addition, all division managers are feeling the pressure to increase profit. Managers of divisions A and B would like the flexibility to purchase the parts they need from external parties at a lower cost and increase profitability.

The current pattern is that

• Division A purchases 2,700 units of product part 101 from Division C (the supplying division) and another 1,300 units from an external supplier.
• Division B purchases 1,100 units of Part 201 from Division C and another 700 units from an external supplier.
• Note that both divisions A and B purchase the needed supplies from both the internal source and an external source at the same time.

The managers for divisions A and B are preparing a new proposal for consideration.

• Division C will continue to produce Parts 101 and 201. All of its production will be sold to Divisions A and B. No other customers are likely to be found for these products in the short term, given that supply is greater than demand in the market.
• Division A will buy 2,000 units of Part 101 from Division C at the existing transfer price; and
• 2,000 units from an external supplier at the market price of $900 per unit.
• Division B will buy 900 units of Part 201 from Division C at the existing transfer price; and
• 900 units from an external supplier at $1,800 per unit.

Division C Data Based on the Current Agreement

Part	101	201
Annual volume (units)	2,700	1,100
Transfer price/unit	$1,000	$2,000
Variable expenses/unit	$700	$1,200

The fixed overhead for Division C is $1,200,000.

CASE ASSIGNMENT

Required:

Computations (use Excel)

• Set up a table similar the one below to compute the difference between the current situation and the proposal for Divisions A and B.

Division A
	Current Situation			Proposal
	No. of Units	Purchase Price	Total Purchases	No. of Units	Purchase Price	Total Purchases
Internal purchases	2,700		$	2,000		$
External purchases	1,300			2,000
Total cost for Part 101			$			$
Savings to Div. A						$

• Compute the operating income for Division C under the current agreement and the proposed agreement.
• Is the revised agreement a good idea? Support your answer with computations.

Memo (use Word)

Write a 4- or 5-paragraph memo to the division manager explaining the analysis performed. Start with an introduction and end with a recommendation. Each of the four or five paragraphs should have a heading.

Short Essay (use Word)

Start with an introduction and end with a summary or conclusion. Use headings.

Evaluate and discuss the implications of the following transfer pricing policies:

• Transfer price = cost plus a mark-up for the selling division
• Transfer price = fair market value
• Transfer price = price negotiated by the managers

Why is transfer pricing such a significant issue both from a financial and managerial perspective?

ASSIGNMENT EXPECTATIONS

Each submission should include two files: (1) An Excel file and (2) a Word document. The Word document shows the memo first and short essay last. Assume a knowledgeable business audience and use required format and length. Individuals in business are busy and want information presented in an organized and concise manner.

Module 3 – SLP

Transfer Pricing and Responsibility Centers

Third part of the presentation. See background information for the Module 1 SLP.

Required:

Include the following items in your presentation.

• The organization is currently centralized, but is reviewing options to put a decentralized structure in place.
• You are asked to comment on responsibility centers and their functions.
• Cost centers can be a drain on an organization. Could internal charge backs be implemented? Present specific ideas.
• Comment on the role of business analytics in a growing decentralized organization.

SLP ASSIGNMENT EXPECTATIONS

Submit a PowerPoint presentation or a Word Document. A PowerPoint presentation should have no more than six slides and a Word document cannot exceed two pages. Use words, tables, and graphs to make a succinct presentation. Document all sources and provide links at the end. It is acceptable to add another slide or page to list the sources.

Combine the submissions from prior module(s) into one file before uploading to the SLP 3 Dropbox.

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Module 3 – Background

Transfer Pricing and Responsibility Centers

MODULAR LEARNING OBJECTIVES

Keep the following objectives in mind as you work through the material in this module:

• Define the role of responsibility accounting.
• Differentiate between controllable and uncontrollable costs.
• Analyze structure of a decentralized organization.
• Define profit centers, cost centers, and investment centers.
• Compute transfer prices.
• Identify three main transfer pricing approaches.

REQUIRED READING

This module covers the role of responsibility accounting and responsibility centers. Explore these topics further while keeping the above six objectives in mind. Click on the three arrows to explore each topic in more detail:

CHECK YOUR UNDERSTANDING

Check your understanding to make sure that you have a good grasp of the background material. If you are not comfortable with the concepts, review some of the material again or go to the optional resource for more examples.

Click on the quiz icon for an ungraded, 20-question true-or-false self-study quiz to check your progress. If you are not satisfied with the score, review some of the material again. For more in-depth information, review materials listed under optional reading at the bottom of this page.

Final Thoughts A responsibility center is a part or subunit of a company for which a manager has authority and responsibility. The company’s detailed organization chart is a logical source for determining responsibility centers. The most common responsibility centers are the departments within a company. When the manager of a responsibility center can control only costs, the responsibility center is referred to as a cost center. If a manager can control both costs and revenues, the responsibility center is known as a profit center. If a manager has authority and responsibility for costs, revenues, and investments the responsibility center is referred to as an investment center. The existence of responsibility centers necessitates the setting of an internal price for the transfer of parts, goods, and services among units and responsibility centers. Transfer prices are contentious because management intervenes by creating policies which have an effect on the income of a responsibility center or unit. Transfers among international jurisdictions involve additional considerations. Not only accounting rules, but income taxation and duties affect pricing strategies. Most countries have regulations to help prevent the use of this pricing method as a means of evading taxes or similar unethical and illegal activities.

OPTIONAL READING

For further detail refer to Dr. Walther’s accounting text and videos.

Walther, L. (2017). Chapter 23: Reporting to Support Managerial Decisions.

LICENSES AND ATTRIBUTIONS