Transfer Pricing Project (10 points) Name__________________________________________

Adapted from Hansen, Mowen and Guan Cost Management: Accounting and Control, 6^th ed.

Chapin, Inc. owns a number of food service companies. Two divisions are the Coffee Division and the Donut Shop Division. The Coffee Division purchases and roasts coffee beans for sale to supermarkets and specialty shops. The Donut Shop Division operates a chain of donut shops where the donuts are made on the premises. Coffee is an important item for sale along with the donuts and, to date, has been purchased from the Coffee Division. Company policy permits each manager the freedom to decide whether or not to buy or sell internally. Each divisional manager is evaluated on the basis of return on investment.

Recently, an outside supplier has offered to sell coffee beans, roasted and ground, to the Donut Shop Division for $4.00 per pound. Since the current price paid to the Coffee Division is $4.50 per pound, Brandi Alzer, the manager of the Donut Shop Division, was interested in the offer. However, before making the decision to switch to the outside supplier, she decided to approach Raymond Jasson, manager of the Coffee Division, to see if he wanted to offer an even better price. If not, then Brandi would buy from the outside supplier.

Upon receiving the information from Brandi about the outside offer, Raymond gathered the following information about the coffee:

Direct materials	$ 0.90
Direct labor	0.40
Variable overhead	0.70
Fixed overhead*	1.50
Total unit cost	$3.50

*Fixed overhead is based on $1,500,000/1,000,000 pounds

Selling price per pound	$4.50
Production capacity	1,000,000 pounds
Internal sales (to Donut)	100,000 pounds

Required: Place your answers in the spaces provided. Show your computations on a separate sheet(s) for credit. Assume Chapins divisions use variable costing for internal decisions and performance evaluation.

Suppose that the Coffee Division is producing at capacity and can sell all that it produces to outside customers.Compute:

CM/Unit (coffee division) $__________/unit Minimum transfer price $__________/unit

Maximum transfer price $__________/unit

Will a transfer be made? _____________

Should a transfer be made? _____________

If no internal transfer is made, all sales are to outside customers, compute: (circle one)

Total effect on Coffee Division contribution margin $_____________ increase or decrease?

Total effect on Donut Division contribution margin $_____________ increase or decrease?

Total effect on Chapin Company contribution margin $_____________ increase or decrease?

Now, assume that the Coffee Division is currently selling 950,000 pounds, including 100,000 to Donut division.If no units are sold internally (to Donut division), total coffee sales will drop to 850,000 pounds.Compute:

Minimum transfer price $______________/unit

Maximum transfer price $______________/unit

Should a transfer be made? _____________

If Raymond refuses to lower the price below $4.50 Compute:(circle one)

Total effect on Coffee Division contribution margin $_____________ increase or decrease?

Total effect on Donut Division contribution margin $_____________ increase or decrease?

Total effect on Chapin Company contribution margin $_____________ increase or decrease?

Ignoring part 2a, suppose the transfer price is set at the maximum price less $1.Compute the effect on the firms contribution margin and on each divisions contribution margin.

Minimum transfer price $______________ Transfer price $_____________/unit

Maximum transfer price $______________

(circle one)

Total effect on Coffee Division contribution margin $_____________ increase or decrease?

Total effect on Donut Division contribution margin $_____________ increase or decrease?

Total effect on Chapin Company contribution margin $_____________ increase or decrease?

Ignoring parts 2a and 2b, compute the net operating income for Coffee if it sells 950,000 units (including 100,000 to Donut).Now, refer to Requirement 2b.What will Coffees divisional NOI be if the transfer price of the maximum price less $1 is implemented?

Original (part 2 - 950,000 units) NOI New (part b 950,000 units) NOI

Sales $__________________ Sales $_________________

Variable costs __________________ Variable costs __________________

Contribution Margin __________________ Contribution Margin __________________

Fixed Costs __________________ Fixed Costs __________________

Net Operating Income__________________ Net Operating Income__________________

For discussion, think about the following:

How will the change in ROI affect Raymond?

What information has he gained as a result of the transfer pricing negotiations?