# Coffee Makers Incorporated’s Transfer Pricing

## The Increase in Profits for Division A

The agreement that existed previously allowed the three divisions within the company to trade with each other with little or no restrictions. Such an agreement made sure that most of the parts purchased were done so within the organization. The table below shows the calculations for Division A’s business (Feinschreiber & Kent, 2012).

 Division A Price in \$ Amounts Product Units Price Per Unit Total Price Purchase From C 101 3,000 1,000 3,000,000 External Purchase 101 1,500 900 1,350,000 Totals Purchases 4,350,000

The agreement allowed Division A to obtain 3,000 units of Parts 101 from Division C at \$1,000. Therefore, the purchase price was \$3,000,000. The table above indicates that the 1,500 units that Division A also bought from the external suppliers amounted to \$1,350,000. Therefore, the total cost of purchase came to \$4,350,000. C benefited the most since majority of the purchases came from Division A. In the new proposal, Division A had to change its buying criteria.

If the management had to agree to the new terms, then Division A would have to buy 2,000 units of Parts 101 from Division C at \$1,000. The results in the table below are indicative of the same. It would also have to buy another 2,000 units from external suppliers as one can see from the table below.

 Division A Price in \$ Amounts Product Units Price Per Unit Total Price Purchase from C 101 2,000 1,000 2,000,000 External Purchase 101 2,000 900 1,800,000 Totals Purchases 3,800,000

The total purchase price would come to \$3,800,000. The profit would increase. The change would ensure that Division A buys an extra 1,000 units from external suppliers who are cheaper by \$100 per unit. Division A would, therefore, save \$ 100,000. It would also save \$100on each of the 500 units added for external purchase, culminating to \$ 50,000. And hence the total amount collected would be \$150,000. From the calculations above, Division A can change the course and become more profitable than before.

## Division B

The initial agreement indicated that B was supposed to continue trading with its suppliers. Its highest units would come from internal sources so that the company would continue to earn income. It would cost Division B a total \$ 2,950,000. In the new proposal, Division B was to reduce the Parts it buys internally. It would lead to an increase in the number of units bought from outside sources. The Division would realize savings from purchases leading to profit increase.

 Division B Initial Agreement Price in \$ Amounts Product Units Price Per Unit Total Price Purchase From Division C 201 1,000 2,000 2,000,000 External Purchase 201 500 1,900 950,000 Totals Purchases 2,950,000

### The Increase in Profits for Division B

In the new proposal, Division B would have to reduce the units it used to obtain from Division C by 500 units and increase the units it would buy from the external sources by 1,000 units. It would mean that B saves \$100 on each of the 500 units which would come to \$50,000. It would also save \$100 on each of the 1,000 units added to external sources. It would add up to \$100,000. B would, therefore, save \$ 150,000. The savings would enable the department to reinvest more for the next purchases.

 Division B Price in \$ Amounts Product Units Price Per Unit Total Price From Division C 201 500 2,000 1,000,000 From External Suppliers 201 1,500 1,900 2,850,000 Totals Purchases 3,850,000

## Division C

Its sales would decrease since it would not be allowed to sell more units than the ones in the previous agreement. It would also not be permitted to sell to outside buyers. It would lose about \$ 2,000,000 in sales.

 Division C Division C The Current Pattern The New Proposal Amount in \$ Amount in \$ Amount in \$ Amount in \$ Sales from 101 (Division A) 3,000,000 Sales from 101 (Division A) 2,000,000 Sales from 201 (Division B) 2,000,000 Sales from 201 (Division B) 1,000,000 Totals Sales 5,000,000 Totals Sales 3,000,000 Expenses Expenses Direct Materials 200 Direct Materials 200 Direct Labor 200 Direct Labor 200 Variable Overhead 300 Variable Overhead 300 Total Expenses 700 Total Expenses 700 Profit 4,999,300 Profit 2,999,300

According to the calculations above, the new proposal would make the company lose sales of 1,000 units of Parts 101 and 500 units of Parts 201. When the sales from Division C go down, it means that its profit goes down by that much. It is correct to state that it would also save the production cost for extra products (Feinschreiber & Kent, 2012).

The entire company would make a considerable increase in profit. The total numbers of units that both divisions buy externally are more affordable than the ones they acquire internally. When the expense goes down, the profit margin goes up.

The company should continue increasing its external purchase so that each division can continue making profits. It should also allow Division C to sell to external market. The inter-trading within the company enables health coordination. It also helps the company to make a profit within the business. The transactions between departments also allow the finished products within the enterprise to have an arm’s length market.

## Transfer Pricing Policies

When the transfer price is equal to the cost plus a markup for the selling division, it means that the department must sell at a price that is beneficial to the company. The company can come up with a calculation of how much profit they expect from its products (Davis & Davis, 2012).

When the transfer price is equal to the fair market value, it means that the divisions must follow what the market outside is doing. Whether it is profitable or not, they have to adhere to the market prices. It becomes unpredictable because the company has no control over the price (Davis & Davis, 2012).

If the transfer price is the price that the managers can discuss and agree on, it becomes advantageous to the company (Feinschreiber & Kent, 2012). It promotes internal trading and enhances quality purchase. The managers have to set a price that is profitable to each division and hence have control over the profits they would make.

Transfer pricing is very significant both from a financial and managerial perspective because it determines the company’s profitability. The management would want to ensure that each division can benefit from each other rather than waiting for the external market decisions. From the financial perspective, the company can set a price that is supposed to promote its income prospects (Feinschreiber & Kent, 2012). It can set and be sure of an accurate profit.

## References

Davis, C., & Davis, E. (2012). Managerial accounting. Hoboken, N.J.: John Wiley & Sons.

Feinschreiber, R., & Kent, M. (2012). Asia-Pacific transfer pricing handbook. Singapore: John Wiley & Sons.

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