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Cost Based Transfer Pricing Essay

965 words - 4 pages

Miliken Inc. is a manufacturer of heart diagnostic equipment. The TA24 machine is manufactured at the company’s plant in
Vancouver and distributed across North America. Miliken sells 3,000 TA24 machines in a typical year. Parts for the machine are either
outsourced or manufactured at the company’s Winnipeg division plant. The pump is one such component. The Winnipeg division
receives input material for the pumps from various sources across Canada.
Winnipeg Division: The Winnipeg division receives inputs at an accumulated cost of $140 per pump. The additional cost of
manufacturing the pump is $70 variable cost and $90 fixed cost per pump. The goods are then shipped to the Vancouver plant ...view middle of the document...

Under conditions of
perfectly competitive markets — when there are homogeneous products where neither buyer nor seller can influence the
pricing structure of the market — interdependence between subunits is minimal, and there are no additional costs or benefits
of using market prices.The objectives of goal congruence, evaluation of management effort, optimal subunit performance,
and subunit autonomy can be achieved using market-based transfer prices.
In Example 6.2-1, the market price was $425 to purchase the pump from the supplier in Toronto. If management wanted to
ensure internal transfers to maintain quality, a transfer price of less than $425 would motivate the Vancouver division to
purchase internally but, if both units had autonomy to do so, the Winnipeg division would be motivated to sell externally to
another company. Setting the price at the market price ensures both divisions act in the best interests of the company as a
whole.
When market prices fluctuate greatly, companies may opt to use long-run average prices, rather than market-based prices.
Cost-based
When market-based prices are not readily available, such as with specialty or unique products, internal cost-based transfer
prices may be an alternative. Companies can choose a variety of cost-based transfer prices including variable cost, fullabsorption
cost, or cost-plus pricing (with a markup over either variable or full-absorption costing), or opt for a dual-pricing
transfer cost strategy.
Full-costing may lead to sub-optimal decisions for the company. In Example 6.2-1, fixed costs are treated as a variable cost.
Assume that the prices for the inputs to the Winnipeg division for the price increased to $190 per pump from the current
$140 per pump. The price per pump using cost-based pricing would be ($190 + $70 + 90) x 125% + $5 (transportation) =
$442.50. The Vancouver division would now reject the Winnipeg pump in favour...

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