Two divisions of a Kringly Corporation 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 C Division is not lowering its prices. 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 to lower cost and increase profitability.

The current pattern is that Division A purchases 3,000 units of product part 101 from Division C (the supplying division) and another 1,000 units from an external supplier. The market price for part 101 is $900 per unit. Division B purchases 1,000 units of part 201 from Division C and another 1,000 units from an external supplier.

The mangers 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 found for these products in the short term given that supply is greater than demand in the market.

Division C will manufacture 2,000 units of part 101 for the Division A and 500 units of part 201 for the Division B.

Division A will buy 2,000 units of part 101 from Division C and 2,000 units from an external supplier at $900 per unit.

Division B will buy 500 units of part 201 from Division C and 1,500 units from an external supplier at $1,900 per unit.

Division C Data 2012 Based on the Current Agreement
Direct materials
Direct labor
Variable overhead
Transfer price
Annual Volume

Part 101

• $200
• $200
• $300
• $1,000
• 3,000 units

Part 201

• $300
• $300
• $600
• $2,000
• 1,000 units

Required:

1. Calculate the increase or decrease in profits for the three divisions and the company if the agreement is enforced. Comment on the situation and make a suggestion.
2. Evaluate and discuss the implications of the following transfer pricing policies:
3. Transfer price = cost plus a mark-up for the selling division
4. Transfer price = standard cost plus a mark-up for the selling division.
5. Transfer price = incremental cost
6. Transfer price = price negotiated by the managers