# CMA Study Group

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## Part 1, Transfer pricing

• #### 1.  Part 1, Transfer pricing

Posted 23 days ago
I practice on the Wiley's test bank. I am stuck on two questions below.  Why is the first question minus the variable selling price, but the second question is not?

Danhuan
CT, USA

The fabric division of Sweet Petunia's Baby Gear produces fabric designs to be used by the furniture division. The fabric division sells fabric to outside customers for \$800 per bolt. Variable product costs total \$575 per bolt, while variable selling and marketing costs are \$75 per bolt. What is the transfer price if a market-based transfer policy is in effect?

 \$575 per bolt \$650 per bolt \$725 per bolt \$800 per bolt

This answer is correct. Petunia's transfer price policy is based on the market price, which is \$800. However, since an internal transfer to the furniture division should avoid the variable selling and marketing costs of \$75, then the price used to value the transfer should be \$800 − \$75 = \$725.

Dripolator sells premium-roasted coffee beans. In addition to the roasting division, the company has a cupcake division that sells cupcakes and beverages in retail outlets. The roasting division sells coffee beans at an average price of \$5.75 per pound to external customers. Variable product costs for a pound of roasted beans total \$4.45 and variable selling and administrative costs are \$0.80 per pound. Dripolator's transfer price policy is to transfer at a market-based price. Determine the transfer price.

 \$4.95 per pound \$4.45 per pound \$5.75 per pound \$5.25 per pound

When one part of an organization transfers a product or service to another part of the organization, the "price" used to value the transfer is called a transfer price. Since Dripolator's policy is to use market prices as the transfer price, the transfer price will be the market price of \$5.75 per pound.

• #### 2.  RE: Part 1, Transfer pricing

Posted 22 days ago
I guess the variable cost mentioned in the second question is over and above the average sale price of the product (i.e.5.75).

In the first question the variable price is embedded in the final sale price (i.e. 800) of the product and hence needs to be reduced. While in the second question the variable cost is not embedded in the average sale price of the product, I guess that the difference.@

It is purely play of words and one has read carefully before answering!

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Kingsly Samuel
Bangalore
India
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• #### 3.  RE: Part 1, Transfer pricing

Posted 22 days ago
This is the key sentence in the second question: " Dripolator's transfer price policy is to transfer at a market-based price."

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John P. Davis, MBA
Senior Accountant
Columbus, OH
USA
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• #### 4.  RE: Part 1, Transfer pricing

Posted 22 days ago
I take back my previous post. I'm as most as you. The only difference I see is one is listed as variable selling and administrative and the other selling and marketing.

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John P. Davis, MBA
Senior Accountant
Columbus, OH
USA
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• #### 5.  RE: Part 1, Transfer pricing

Posted 22 days ago
Dear,
That's since in first case its marketing costs that would be saved.. If its an internal transfer, no marketing costs would be incurred..

In second case - its the selling admin expenses, which would be incurred in any case, be it internal or to external customer..

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Abdul Naser Parkar
Analyst
Qatar
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• #### 6.  RE: Part 1, Transfer pricing

Posted 4 hours ago
Abdul is pointing to the direction that will identify how one type of transfer price differs from the other.
Rooted in transfer price is the cost of inventory.  Similarly, the cost of goods sold depends on inventory valuation.
For the first example of the furniture company that upholsters its furniture with fabric that is designed and manufactured by the company (within the fabric division), the resulting inventory of furniture will hold both (1) the cost and profit of the fabric and (2) the cost of the furniture assembly process/materials, with overhead included for both divisions in the cost elements.  It benefits the company to put a premium value on its furniture inventory by recognizing the cost of fabric materials including profit associated with the sale of its custom-designed and custom-manufactured fabric on the open market.  This increases the value of its finished goods inventory.  However, the company cannot accumulate the selling costs twice for the same item of goods sold out of inventory.  The fabric is a component material of the finished good, furniture.  Already, in deciding to offer its custom fabric on the open market, the company is opening itself to competition.  It is possible that this strategy might serve as a form of advertising for the company, since its fabric is seen on competitors' furniture offerings.  The company  then develops a strategy that will maximize its net income, given that its furniture may look similar to competitor's offerings.  Already, it is bringing in profit on the fabric from purchases made by competitors.  The profit already is \$150/bolt net of selling and admin costs associated with open market sales of the fabric.  Similarly, when the company uses the fabric in its own furniture assemblies, they recognize a profit of \$150/bolt when the furniture is sold.
What distinguishes the furniture company case is that the fabric division produces material demanded by the furniture division that outputs to a finished goods inventory of furniture that is available for sale.
By contrast, the coffee roasting company puts its roasted coffee into its finished goods inventory.  From the finished goods inventory, the roasted coffee can be purchased by consumers, etc., or it can be purchased by the coffee shops that the company operates.
Maybe when we see this type of question on the test, we might think about finished goods inventory.  Is the transfer item an input material for further processing that results in finished goods inventory?
Also, notice the fabric-furniture problem could have been cast by the company as a joint cost allocation, with the furniture assembly being further processing beyond the split-off point of the custom fabric production.  In the problem given, we see the company chose to recognize the profit associated with the fabric in the open market as part of its furniture finished inventory cost; the company did not choose to use the joint cost allocation method.

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Gayle Vanac
None
Painesville OH
United States
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