Analyzing Transfer Pricing and Division Performance at Speed Racer

This case study analyzes the transfer pricing strategies of Speed Racer, a company with decentralized operations. The assignment explores whether the frames division should accept an order, considering direct materials, labor, variable and fixed costs. It determines the optimal range of transfer prices for division managers acting independently and calculates transfer prices under different arrangements, including full cost allocation. The analysis examines the impact of income taxes on transfer pricing, recommending a policy to minimize tax payments and maximize division operating income. The solution recommends a transfer-pricing policy that considers tax regulations and separate evaluation of division performance. The case study concludes with recommendations regarding the sourcing of frames, transfer pricing, and operational strategies to maximize profitability and efficiency.

Running head: TRANSFER PRICING
Transfer Pricing
Name
Institution
1. From the viewpoint of Speed Racer in Victoria as a whole, should the frames division
accept the order for the 2,000 units?
At 2000 units
Direct material; 100 x 2000 = 200,000
Direct Labor; 48 x 2000 = 96,000
Variable cost; 30 x 2000 = 60,000
Fixed cost; 624,000
Total cost = 200,000 +96,000+60,000+ 624,000
= $ 980,000
The cost of sales:
At 2000 units: 2000 x 450 = $ 900,000.
From the calculation, the order for 2000 units should be rejected because the cost of
production ($ 980,000) is higher than the expected total income ($ 900,000).

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2. What range of transfer prices result in achieving the actions determined to be
optimal in question 1 if division managers act in a decentralized manner?
The cost per unit for a different frame;
$
At 2000 units
Direct material 100
Direct Labor 48
Variable cost 30
Fixed cost 312
Total 490
The Cost per unit for the normal frame;
$
At 2000 units
Direct material 150
Direct Labor 60
Variable cost 30
Fixed cost 312
Total 552
Therefore, the transfer prices would range between $ 490 and $ 552.
3. The manager of the assembly division has proposed a transfer price for the frames
equal to the full cost of the frames including an allocation of overhead costs. The
frames division allocates overhead costs to engines on the basis of the total capacity
of the plant used to manufacture the frames.
a. Calculate the transfer price for the frames transferred to the assembly division
under this arrangement.
At 80% Direct material 150 At 100% Direct material 120
At 80% Direct Labor 60 At 100% Direct Labor 48
At 80% Variable cost 30 At 100% Variable cost 24
Fixed cost 312
Total Cost 504
The transfer price would be $504.
b. Do you think that the transfer price calculated in question 3a will result in achieving
the actions determined to be optimal in question 1, if division managers act in a
decentralized manner?
The transfer price won’t allow the division managers to achieve the required optimal
results. The cost of production will be higher than the income revenue.

TRANSFER PRICING 3
c. Comment in general on one advantage and one disadvantage of using full costs of the
producing division as the basis for setting transfer prices.
Managers have an advantage when a full cost method is applied. When the selling price
is lower, more units would be sold. Therefore the managers would earn an increased
commission. On the other hand, the production cost is higher than the selling price.
Therefore, the company will incur losses (Bhimani, Horngren, Datar, & Raja, 2015).
4. Now consider the effect of income taxes.
a. A transfer price that would ensure minimum tax payment
The Speed Racer would earn a profit by selling the bicycles, after being assembled by
assembling division, at a transfer price of at least $504 per unit. Selling the products at the
assembling division would incur a 10% tax payment. On the other hand, selling the product at
the frame division won’t attract the 10% tax payment. Therefore, the company should move
the finished products back to the frame division and sell them there to avoid the 10% taxation
(Feinschreiber & Kent, 2012).
b. Each division manager maximizes division operating income using the transfer price
calculated in 4a.
At a transfer price of $504, the division managers would earn a revenue totaling to
$1,008,000. With the cost of production amounting to $ 980,000, each division will maximize
their operating income (Taschner & Charifzadeh, 2016).
5. What transfer-pricing policy would you recommend Speed Racer use and why?
Would you continue to evaluate division performance on the basis of division
operating incomes?
Irrespective of decentralized operations between the two divisions, The Speed Racer
realizes its profitability from a combined performance of the two units. Also, the two
divisions operating in two different countries with different taxation systems. The company
should adopt the Tax Regulations and Transfer Price policy (Paisey & Li, 2012). The policy
would allow the company to maximize its operating income in the countries with low tax

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rates and minimize its operations in countries with high tax rates. The two divisions have
been categorized on the basis of the activities carried out. The company should continue
evaluating the performance of the two divisions separately. Separate evaluation allows the
company to establish the performance of each division (CPA Australia, 2012).
6. Provide a recommendation given the case facts and your analysis.
First, the Assembly obtains the frame units from the Frame division at a transfer price
of $ 450. The same product can be obtained from outside the market at a price of $ 480 per
unit. Therefore, the Assembly division should continue buying the frame units from the
Frame division (Bhimani, Horngren, Datar, & Raja, 2015). Second, the company should
choose a transfer price that would maximize its profitability level while ensuring its
competitive level in the market. Third, the company should continue operating the two
divisions separately to ensure efficient management. Lastly, the Tax Regulations and
Transfer Price policy should be applied when an organization wants to maximize its profit
level. By taking advantage of taxation plan in different countries, the Speed Racer will
maximize its profit by increasing the sales in countries with lower tax rates and reducing the
operation in the countries with higher tax rates (Paisey & Li, 2012).

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References
Bhimani, A., Horngren, C. T., Datar, S. M., & Raja, M. (2015). Management and Cost
Accounting. New Delhi: Pearson Education Limited.
CPA Australia. (2012). Management Accounting (Second edition ed.). Sydney: BPP Learning
Media Ltd.
Feinschreiber, R., & Kent, M. (2012). Transfer Pricing Handbook: Guidance on the OECD
Regulations. New York: John Wiley & Sons.
Paisey, A., & Li, J. (2012). Transfer Pricing: A Diagrammatic and Case Study Introduction,
with Special Reference to China. California: Universal-Publishers.
Taschner, A., & Charifzadeh, M. (2016). Management and Cost Accounting. New York: John
Wiley & Sons.