Case 6-1

Transfer Pricing Problems

Problem 1: Calculate the transfer price for Product X and Y and the standard cost for
Product Z.
a. For Product X:
Standard cost = Material Purchased Outside + Direct labor + Variable overhead + Fixed
overhead per unit
= $2.00 + $1.00 + $1.00 + $3.00
= $7.00
10% return on inventories and fixed assets = 0.1 [(30,000+70,000)/10,000] = $1.00
Transfer price = standard cost + 10% return on inventories and fixed assets
= $7.00 + $1.00
= $8.00
b. For Product Y:
Standard cost = Material Purchased Outside + Direct labor + Variable overhead + Fixed
overhead per unit + transfer price of X
= $3.00 + $1.00 + $1.00 + $4.00 + $8.00 = $17.00
10% return on inventories and fixed assets = 0.1 [(15,000+45,000/10,000]= $0.6
Transfer price = standard cost + 10% return on inventories and fixed assets
= $17.00 + $0.6
= $17.6
c. For Product Z:
Standard cost = Material Purchased Outside + Direct labor + Variable overhead + Fixed
overhead per unit + Transfer price of Y
= $1.00 + $2.00 + $2.00 + $1.00 + $17.6
= $23.6

Problem 2: Calculate the transfer price for Product X and Y and the standard cost for
Product Z (with additional information)
a. For Product X:
Standard variable cost = Material Purchased Outside + Direct labor + Variable overhead

= $2.00 + $1.00 + $1.00 = $4.00

Monthly charge = fixed costs +10% return on inventories and fixed assets
= $3.00 + 0.1 [(30,000+70,000)/10,000]
= $4.00
Transfer price = standard variable cost + monthly charge
= $4.00 + $4.00
= $8.00
b. For Product Y:
Standard variable cost = Material Purchased Outside + Direct labor + Variable overhead +
Transfer price of X
= $3.00 + $1.00 + $1.00 + $8.00
= $13.00
Monthly charge = fixed costs + 10% return on inventories and fixed assets
= $4.00 + 0.1 [(15,000+45,000)/10,000]
= $4.60
Transfer price = standard variable cost + monthly charge
= $13.00 + $4.60
= $17.60
Unit standard cost = Variable cost + Fixed cost = $13.00 + $4.00 = $17.00
c. For Product Z:
Standard variable cost = Material Purchased Outside + Direct labor + Variable overhead +
Transfer price of Y
= $1.00 + $2.00 + $2.00 + $1.00 + $17.6
= $23.60
Problem 3 Lambda Company (with additional information)
Questions and Answer:
a. With transfer price calculated in Problem 1, is Division C better advised to maintain its
price at $28.00 or follow competition in each of the instances above?
Under possible competitive price $27.00
If company maintain the price at $28.00, the profit = (28-23.6) 9,000 = $39,600
If company follow the possible competitive price at $27.00, the profit = (27-23.6)
10,000 = $34,000
Under possible competitive price $26.00

If company maintain the price at $28.00, the profit = (28-23.6) 7,000 = $30,800
If company follow the possible competitive price at $26.00, the profit = (26-23.6)
10,000 = $24,000
Under possible competitive price $25.00
If company maintain the price at $28.00, the profit = (28-23.6) 5,000 = $22,000
If company follow the possible competitive price at $25.00, the profit = (25-23.6)
10,000 = $14,000
Under possible competitive price $23.00
If company maintain the price at $28.00, the profit = (28-23.6) 2,000 = $8,800
If company follow the possible competitive price at $23.00, the profit = (23-23.6)
10,000 = ($6,000)
Under possible competitive price $22.00
If company maintain the price at $28.00, the profit = (28-23.6) 0 = $0
If company follow the possible competitive price at $22.00, the profit = (22-23.6)
10,000 = ($16,000)
So, no matter how much is the possible competitive price, when the company maintain its
price at $28.00, it can get more profit than follow the possible competitive price.
b. With the transfer prices calculated in Problem 2, is Division C better advised to
maintain its present price at $28.00 or to follow competition in each of the instances
above?
Because the answer to the Problem 2 is the same as the answer to the Problem 1, so the
answer to this question is the same as the question 3 (a).
Maintaining the price at $28.00, the company can get more profit.
c. Which decisions are to the best economic interests of the company, other things being
equal?
From the question 3 (a) and 3 (b), no matter which method the company use to calculate the
cost, when the company maintains the price at $28.00, the company can maximum the profit.
d. Using the transfer prices calculated in Problem 1, is the manager of Division C making
a decision contrary loss to the company in each of the competitive pricing actions
described above?
No. The goal to the company is maximum its profit, and as our calculated, when the company
maintains its price at $28.00, it can get the most profit, so the manager has acted in the best
interest of the company.
If the company follows the competitive price, the opportunity losses are shown as followed:
1. The possible competitive price is $27.00, opportunity loss = 39,600-34,000 = $5,600

2.
3.
4.
5.

The possible competitive price is $26.00, opportunity loss = 30,800-24,000 = $6,800

The possible competitive price is $25.00, opportunity loss = 22,000-14,000 = $8,000
The possible competitive price is $23.00, opportunity loss = 8,800-(-6,000) = $14,800
The possible competitive price is $22.00, opportunity loss = 0-(-16,000) = $16,000