Transfer Pricing

Transfer price is the price on subunit (department or division) charges for product or service
supplied to another subunit of the same organization

Calculate transfer prices using three different methods.

1-Market-based transfer prices.
Top management chooses to use the price of similar product or service that is publicly available.
2- Cost-based transfer prices.
Top management chooses a transfer price based on the costs of producing the product in question.
Examples include:
Variable Production Costs
Variable and Fixed Production Costs
Full Costs of the production
3- Hybrid (Negotiated) transfer prices

Example page 803-804:

Horizon petroleum has two division, transportation division purchase crude oil in Matamoros, Mexico
and transports it from Matamoros, Mexico.

The refining division processes crude oil into gasoline, the transportation division transports the oil to
Houston and then (sells) it to the refining division.

The pipeline from Matamoros to Huston has the capacity to carry 40,000 barrels of crude oil per day

The refining division has been operating at capacity (30,000 barrels of crude oil a day.

The refining division sell the gasoline it produced to outside parties at $190 per barrel.

1
Market-based transfer price $85 per barrel

Cost-based transfer price at 105% of full cost =cost of crude oil purchased in Matamoros+
transportation division VC and FC ($72+$1+$3)*105%=$79.80

Hybrid (negotiated) price $82Between market based and cost based transfer price

2
Example 2:
Lomas & Co. has two divisions: Transportation and Refining.
Transportation purchases crude oil in Alaska and sends it to Seattle.
Refining processes crude oil into gasoline

External market price for supplying crude oil per barrel: $13

Transportation Division:

Variable cost per barrel of crude oil $ 2

Fixed cost per barrel of crude oil $3

Total $ 5

The pipeline can carry 35,000 barrels per day.

External purchase price for crude oil per barrel: $23

Refining Division:

Variable cost per barrel of gasoline $8

Fixed cost per barrel of gasoline $4

Total $ 12

The division is buying 20,000 barrels per day

The external market price to outside parties is $60 per barrel.

The Refining Division is operating at 30,000 barrels capacity per day.

Required: What is the market-based transfer price from transportation to refining?

$23 per barrel

What is the cost-based transfer price at 112% of full cost?

1-

Purchase price of crude oil per barrel: $13

Variable cost per barrel of crude oil $ 2

Fixed cost per barrel of crude oil $3

Total $ 18

2- $18 *112%= $20.16

3
What is Hybrid (negotiated) price?

Between $20.16 and $23 per barrel

ASSUME that the refining Davison buys 1,000 barrels of crude oil from the transportation Davison.
The refining division convert these 1,000 barrels of crude oil into 500 gallons of gasoline and sell
them.

1-What is the transportation Davison operating income using Market-based price?

2-What is the refining division operating income using Market-based price?

3- What is operating income of both division together (Market-based price)?

4- What is the transportation and refining Davison operating income using the 112% of full cost price?

5- What is operating income of both division together (112% of full cost price)?

1-

Transportation Division:
Revenues: ($23 1,000) $23,000

Deduct costs: ($18 1,000) 18,000

Operating income $ 5,000

2-

Refining Division:

Revenues: ($60 500) $30,000

Deduct costs:

Transferred-in ($23 1,000) 23,000

Division variable ($8 500) 4,000

Division fixed ($4 500) 2,000

Operating income $ 1,000

3-

Transportation Division +Refining Division= $5,000 +$1,000 =$6,000

4
4- using the 112% of full cost price

Transportation Division:

Revenues: ($20.16 1,000) $20,160

Deduct costs: ($18.00 1,000) 18,000

Operating income $ 2,160

Refining Division:

Revenues ($60 500) $30,000

Deduct costs:

Transferred-in ($20.16 1,000) 20,160

Division variable ($8.00 500) 4,000

Division fixed ($4.00 500) 2,000

Operating income $ 3,840

5-

Transportation Division +Refining Division = $2,160+ $3,840 = $6,000