Transfer Pricing for Vans: Cost, Market, and External Offers

This assignment solution addresses a transfer pricing problem for Vans, a footwear company. The solution examines how the Rubber Department can use cost-plus pricing to determine transfer prices for rubber transferred to the Assembly Department, providing three examples with different cost bases and markups. It then analyzes the financial implications of using the market price for transfer pricing and compares it to an external supplier's offer. The analysis considers the best financial interests of both departments and the firm as a whole. Finally, it explores the general transfer pricing rule based on variable costs and its impact on the departments' financials, ultimately concluding which scenario maximizes the firm's profit and addresses other non-financial factors such as quality and credibility.

Transfer Pricing
Answer to Part 1:
The three examples as to how the transfer price method based on cost-plus pricing can
be used by the rubber department in fixing their prices are:
1. The rubber department can consider transferring the rubber to assembly
department on cost-plus basis to recover its full cost including both fixed and
variable cost so that the department incurs no loss at all, as all the costs will be
recovered. For Vans, the price under this case should be fixed at $1.40 per kg
based on the cost and profit statement as below:
2. Alternatively, the Rubber department can transfer rubbers to the assembly
based on cost-plus targeted profit to ensure that the transfers result into
profit for the department. Considering the dept. wants a target profit of
$1.00 per kg, the transfer should take place at $2.40 per kg.
3. Lastly, the rubber department can transfer the rubbers at the benchmark
price, which is the price at which it supplies the rubber to the external
customer, which is $2.00 in the given scenario.

Answer to Part 2:
Assuming that the transfer price fixed by the rubber department is the market price of
the rubber which is $2.00 per kg. The cost and margin for both the department can be
computed as below:
Considering, that the assembly department had an external offer for purchasing rubber
at $1.20 per kg, the financial interest for rubber department would be to accept the
offer from external supplier, as there quotation of $1.20 per kg is less than the
department’s variable cost of $1.30 per kg. Further, the revised financials for
assemble department would be as below:
From a financial standpoint the external supplier is in the best interest of the firm as
for rubber department it is less than their variable cost and for assembly
department, their profit increases from $64 to $64.80 per kg.
The other factors that should be considered by the firm in evaluating the proposal are :
Quality of the rubber or the material that is being supplied
Goodwill and credibility of the external suppliers

Credit terms and other T&C extended by the supplier.
Answer to Part 3:
The general transfer price rule states that the transfer’s between departments within
the firms should take place at the variable cost incurred by the department that is
transferring. Thus, the rubber department should transfer the rubber at $1.30 per kg.
Considering this, the financials for the assembly department would be as below:
Thus, we see that the best option for both the department is to accept the offer from
external supplier as for assembly department, their profits will be maximized with
$64.80 per kg and for rubber department it is less than their variable cost.
Answer to Part 4:
The most appropriate setting the transfer price for the rubber in the given situation is
setting the price equal to the offer of the external supplier which is $1.20 per kg as in
that case the profit of the assembly department is the highest and no one wants to
compromise on the profit margin.