User Able Computer, Inc., with headquarters in San Francisco, manufactures and sells desktop computers. User Able has three divisions, each of which is located in a different country:
a. China division— manufactures memory devices and keyboards
b. South Korea division— assembles desktop computers using locally manufactured parts, along with memory devices and keyboards from the China division
c. U. S. division— packages and distributes desktop computers
Each division is run as a profit center. The costs for the work done in each division for a single desktop computer are as follows:
China division: Variable cost .....= 875 yuan
Fixed cost ...........= 1,575 yuan
South Korea division: Variable cost.= 375,000 won
Fixed cost...........= 525,000 won
U. S. division: Variable cost.... = $ 75
Fixed cost........... = $ 175
• Chinese income- tax rate on the China division’s operating income: 32%
• South Korean income- tax rate on the South Korea division’s operating income: 24%
• U. S. income- tax rate on the U. S. division’s operating income: 40%
Each desktop computer is sold to retail outlets in the United States for $ 3,400. Assume that the current foreign exchange rates are:
7 yuan = $ 1 U. S.
1,500 won = $ 1 U. S.
Both the China and the South Korea divisions sell part of their production under a private label. The China division sells the comparable memory/ keyboard package used in each User Able desktop computer to a Chinese manufacturer for 2,800 yuan. The South Korea division sells the comparable desktop computer to a South Korean distributor for 1,725,000 won.
1. Calculate the after- tax operating income per unit ( in dollars) earned by each division under the following transfer- pricing methods:
(a) Market price,
(b) 200% of full cost, and
(c) 300% of variable cost. (Costs transferred in from prior divisions are included in the computation of the cost- based transfer prices but income taxes are excluded.)
2. Which transfer- pricing method(s) will maximize the after- tax operating income per unit of User Able Computer?