22-22 Multinational transfer pricing, global tax minimization.
The Burton Company
manufactures chainsaws at its plant in Sandusky, Ohio. The company has marketing divisions
throughout the world. A Burton marketing division in Lille, France, imports 200,000 chainsaws
annually from the United States. The following information is available:
U.S. income tax rate on the U.S. division’s operating income 40%
French income tax rate on the French division’s operating income 45%
French import duty 20%
Variable manufacturing cost per chainsaw $100
Full manufacturing cost per chainsaw $175
Selling price (net of marketing and distribution costs) in France $300
Required:
Suppose the United States and French tax authorities only allow transfer prices that are
between the full manufacturing cost per unit of $175 and a market price of $250, based on
comparable imports into France. The French import duty is charged on the price at which
the product is transferred into France. Any import duty paid to the French authorities is a
deductible expense for calculating French income taxes.
1. Calculate the after-tax operating income earned by the United States and French divisions
from transferring 200,000 chainsaws (a) at full manufacturing cost per unit and (b) at
market price of comparable imports. (Income taxes are not included in the computation of
the cost-based transfer prices.)
2. Which transfer price should the Burton Company select to minimize the total of company
import duties and income taxes? Remember that the transfer price must be between the
full manufacturing cost per unit of $175 and the market price of $250 of comparable
imports into France. Explain your reasoning.
22-24 Transfer-pricing dispute. The Kelly-Elias Corporation, manufacturer of tractors and
other heavy farm equipment, is organized along decentralized product lines, with each
manufacturing division operating as a separate profit center. Each division manager has been
delegated full authority on all decisions involving the sale of that division’s output both to
outsiders and to other divisions of Kelly-Elias. Division C has in the past always purchased its
requirement of a particular tractor-engine component from division A. However, when informed
that division A is increasing its selling price to $135, division C’s manager decides to purchase
the engine component from external suppliers.
Division C can purchase the component for $115 per unit in the open market. Division A
insists that, because of the recent installation of some highly specialized equipment and the
resulting high depreciation charges, it will not be able to earn an adequate return on its
investment unless it raises its price. Division A’s manager appeals to top management of Kelly-
Elias for support in the dispute with division C and supplies the following operating data:
C’s annual purchases of the tractor-engine component 1,900 units
A’s variable cost per unit of the tractor-engine component $ 105
A’s fixed cost per unit of the tractor-engine component $ 25
Required:
1. Assume that there are no alternative uses for internal facilities of division A. Determine
whether the company as a whole will benefit if division C purchases the component from
external suppliers for $115 per unit. What should the transfer price for the component be set
at so that division managers acting in their own divisions’ best interests take actions that are
also in the best interest of the company as a whole?
2. Assume that internal facilities of division A would not otherwise be idle. By not producing
the 1,900 units for division C, division A’s equipment and other facilities would be used for
other production operations that would result in annual cash-operating savings of $22,800.
Should division C purchase from external suppliers? Show your computations.
3. Assume that there are no alternative uses for division A’s internal facilities and that the price
from outsiders drops $15. Should division C purchase from external suppliers? What should
the transfer price for the component be set at so that division managers acting in their own
divisions’ best interests take actions that are also in the best interest of the company as a
whole?
22-26 General guideline, transfer pricing. The Slate Company manufactures and sells
television sets. Its assembly division (AD) buys television screens from the screen division (SD)
and assembles the TV sets. The SD, which is operating at capacity, incurs an incremental
manufacturing cost of $65 per screen. The SD can sell all its output to the outside market at a
price of $100 per screen, after incurring a variable marketing and distribution cost of $8 per
screen. If the AD purchases screens from outside suppliers at a price of $100 per screen, it will
incur a variable purchasing cost of $7 per screen. Slate’s division managers can act
autonomously to maximize their own division’s operating income.
Required:
1. What is the minimum transfer price at which the SD manager would be willing to sell
screens to the AD?
2. What is the maximum transfer price at which the AD manager would be willing to purchase
screens from the SD?
3. Now suppose that the SD can sell only 70% of its output capacity of 20,000 screens per
month on the open market. Capacity cannot be reduced in the short run. The AD can
assemble and sell more than 20,000 TV sets per month.
a. What is the minimum transfer price at which the SD manager would be willing to sell
screens to the AD?
b. From the point of view of Slate’s management, how much of the SD output should be
transferred to the AD?
c. If Slate mandates the SD and AD managers to “split the difference” on the minimum and
maximum transfer prices they would be willing to negotiate over, what would be the
resulting transfer price? Does this price achieve the outcome desired in requirement 3b?
22-27 Pertinent transfer price, perfect and imperfect markets. Mountaineer, Inc., has
two divisions, A and B, that manufacture expensive bicycles. Division A produces the
bicycle frame, and division B assembles the rest of the bicycle onto the frame. There is a
market for both the subassembly and the final product. Each division has been designated as
a profit center. The transfer price for the subassembly has been set at the long-run average
market price. The following data are available for each division:
Selling price for final product $280
Long-run average selling price for intermediate product 160
Incremental cost per unit for completion in division B 170
Incremental cost per unit in division A 100
The manager of division B has made the following calculation:
Selling price for final product $280
Transferred-in cost per unit (market) $160
Incremental cost per unit for completion 170 330
Contribution (loss) on product $ (50)
Required:
1. Should transfers be made to division B if there is no unused capacity in division A? Is the
market price the correct transfer price? Show your computations.
2. Assume that division A’s maximum capacity for this product is 2,000 units per month and
sales to the intermediate market are now 1,200 units. Assume that for a variety of reasons,
division A will maintain the $160 selling price indefinitely. That is, division A is not
considering lowering the price to outsiders even if idle capacity exists. Should 800 units be
transferred to division B? At what transfer price?
