Analyzing Transfer Pricing Strategies in Management Accounting

This document offers a detailed solution to a management accounting assignment, specifically addressing the concept of transfer pricing. It begins by defining transfer pricing and its significance in encouraging managers to maximize company profits and achieve goal congruence. The assignment explores various methods for determining transfer prices, including variable cost pricing when there is spare capacity, variable cost plus opportunity cost when at capacity, and negotiated pricing. The solution also highlights the importance of considering opportunity costs and the irrelevance of fixed costs in these calculations. Furthermore, it discusses alternative methods like negotiated prices and dual pricing, providing a comprehensive overview of transfer pricing strategies. The references include various academic sources which are cited to support the arguments.

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MANAGEMENT
ACCOUNTING

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Answer 1:
Part a:
The transfer price is determined as the price at which the goods and the services are
transferred from one company to another or from one division to another. There are
many approaches that could be followed for the purposes of establishment of the
transfer between the divisions. The main aim of the transfer price is to encourage the
managers to do what best they can to achieve profit for the company. This is done for
the purposes of ensuring goal congruence for the company. This is also required to
be done in the best interest of the manager of the division.
The following are the method the following of which could help in the determination of
the transfer price:
 When the company has some spare capacity, then it is always recommended
for the company to transfer its goods at the variable cost at which the goods
are being manufactured. In such of the case, the opportunity cost shall be 0
since there is no outside market available to sell the goods of the company
(Saylordotorg, 2019).
 When the company is at capacity, then it is recommended for the company to
transfer its goods at the variable cost plus the opportunity cost at which the
goods are being manufactured and are being sold. In such of the case, the
opportunity cost shall be the profit earned by the company since there is an
outside market available to sell the goods of the company.
 When the company has no spare capacity, then it is recommended for the
company to transfer its goods at the variable cost plus the opportunity cost at
which the goods are being manufactured and are being sold. In such of the

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case, the opportunity cost shall be the profit earned by the company since
there is an outside market available to sell the goods of the company (The
Fuqua School of Business, 2019).
In the given case, Cleveland is correct since, assuming that the company is
manufacturing its goods at capacity with no spare capacity, the division could transfer
its goods to another division at variable cost plus the opportunity cost. The main
reason behind the same is the fact that the company always look for the ways
through which the profit could be maximised without hurting the sentiments of the
customers. But wherein, transfer of the goods between the divisions takes place, it is
wise that the company does transfer its goods at variable cost, if there is a spare
capacity for its products and no external market exists for them. This in light of the
fact that if the division is able to get more price for its products from outside, then it is
logical that it would go to sell its products outside the company. Also, the fixed costs
are not considered in this since these costs are sunk costs, the obligation of which
has already been decided and hence, these costs would be incurred even if the
production of the company is 0.
Part b:
The following are the other ways of determining the transfer prices:
 The company could go for the negotiated prices. This is the middle price which
exists between the market and the cost based prices. Under this method, the
managers of the companies function as the owners of the companies and
decide the price with their mutual understanding. These strategies are similar
with the ones that are employed when there is a trading outside the company.

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If both of the parties agree, then the negotiated price shall be somewhat close
to the market price only.
 Then there is another method, dual prices method under which the managers
could decide amongst themselves to choose either the market or the
negotiated price or cost plus profit margin price (ACCA Global, 2019).

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References
https://www.accaglobal.com, A. (2019). Transfer pricing | F5 Performance
Management | ACCA Qualification | Students | ACCA Global. [online]
Accaglobal.com. Available at: https://www.accaglobal.com/in/en/student/exam-
support-resources/fundamentals-exams-study-resources/f5/technical-articles/
transfer-pricing.html [Accessed 15 May 2019].
Personal.psu.edu. (2019). Transfer Pricing. [online] Available at:
http://www.personal.psu.edu/sjh11/BA521/NEW/Class08/TransferPricing.pdf
[Accessed 15 May 2019].
Saylordotorg.github.io. (2019). Appendix: Transfer Prices between Divisions. [online]
Available at: https://saylordotorg.github.io/text_managerial-accounting/s15-08-
appendix-transfer-prices-betwe.html [Accessed 15 May 2019].