Alpha Communications, Inc., which produces telecommunications equipment in the United States, has a very strong local market for its circuit board. The variable production cost is $130, and the company can sell its entire supply domestically for $170. The U.S. lax rate is 40 percent.
Alternatively, Alpha can ship the circuit board to its division in Germany, to be used in a product that the German division will distribute throughout Europe. Information about the German product and the division’s operating environment follows.
Selling price of final product: $360
Shipping fees to import circuit board: $20
Labor, overhead, and additional material costs of final product: $115
Import duties levied on circuit board (to be paid by the German division): 10% of transfer price German tax rate: 60%
Assume that U.S. and German tax authorities allow a transfer price for the circuit board set at either U.S. variable
Required:
- 1. Compute overall company profitability per unit if all units are transferred and U.S. variable manufacturing cost is used as the transfer price. Show separate calculations for the U.S. operation and the German division.
- 2. Repeat requirement (1), assuming the use of the U.S. market price as the transfer price. Which of the two transfer prices is better for the firm?
- 3. Assume that the German division can obtain the circuit board in Germany for $155.
- a. If you were the head of the German division, would you rather do business with your U.S. division or buy the circuit board locally? Why?
- b. Rather than proceed with the transfer, is it in the best interest of Alpha to sell its goods domestically and allow the German division to acquire the circuit board in Germany? Why? Show computations to support your answer.
- 4. Generally speaking, when tax rates differ between countries, what strategy should a company use in setting its transfer prices?
- 5. Build a spreadsheet: Construct an Excel spreadsheet to solve requirements (1) and (2) above. Show how the solution will change if the following information changes: the U.S. tax rate is 35 percent, the German tax rate is 55 percent, and the import duties are 8 percent of the transfer price.
1.
Calculate the overall profitability per unit of company A and show separate calculation for U.S. operation and German operation.
Explanation of Solution
Return on investment (ROI): Return on investment evaluates how efficiently the assets are used in earning income from operations. So, ROI is a tool used to measure and compare the performance of a units or divisions or a companies.
Calculate the overall profitability per unit of company A and show separate calculation for U.S. operation and German operation as follows:
Profitability per unit of U. S. Operation:
Particulars | $ per unit |
Sales revenue | $130.00 |
Less: Variable cost | $130.00 |
Contribution margin | $0 |
Table (1)
Profitability per unit of German Operation:
Particulars | $ per unit | $ per unit |
Sales revenue | $360.00 | |
Less: Transfer price | $130.00 | |
Shipping fees | $20.00 | |
Additional processing costs | $115.00 | |
Import duties | $13.00 | $278.00 |
Income before tax | $82.00 | |
Less: Income tax expense | $49.20 | |
Income after tax | $32.80 |
Table (2)
Overall profitability per unit of company A:
2.
Calculate the overall profitability per unit of company A and show separate calculation for U.S. operation and German operation if company uses the U.S market price as the transfer price. Indicate the transfer price which is best for the firm.
Explanation of Solution
Calculate the overall profitability per unit of company A and show separate calculation for U.S. operation and German operation if company uses the U.S market price as the transfer price as follows:
Profitability per unit of U. S. Operation:
Particulars | $ per unit |
Sales revenue | $170.00 |
Less: Variable cost | $130.00 |
Income before tax | $40.00 |
Less: Income tax expense | $16.00 |
Income after tax | $24.00 |
Table (3)
Profitability per unit of German Operation:
Particulars | $ per unit | $ per unit |
Sales revenue | $360.00 | |
Less: Transfer price | $170.00 | |
Shipping fees | $20.00 | |
Additional processing costs | $115.00 | |
Import duties | $13.00 | $322.00 |
Income before tax | $38.00 | |
Less: Income tax expense | $22.80 | |
Income after tax | $15.20 |
Table (4)
Overall profitability per unit of company A:
In this case, U.S. market price is better for the firm because it provides higher profitability ($39.20) than the U.S. variable manufacturing cost ($32.80).
3. a.
Explain whether the company can do business with U.S. division or buy the circuit board locally if the German division can obtain the circuit board for $155.
Explanation of Solution
When the circuit board can be obtained locally for $155, it is difficult to get excited to do business, because the cost of local circuit board ($155) is less than the cost of German division circuit board
3. b.
Explain whether company A can make circuit board or not if company does not have any transfer price and show necessary calculations.
Explanation of Solution
Explain whether company A can make circuit board or not if company does not have any transfer price and show necessary calculations as follows:
Profitability per unit of U. S. Operation:
Particulars | $ per unit |
Sales revenue | $170.00 |
Less: Variable cost | $130.00 |
Income before tax | $40.00 |
Less: Income tax expense | $16.00 |
Income after tax | $24.00 |
Table (5)
Profitability per unit of German Operation:
Particulars | $ per unit | $ per unit |
Sales revenue | $360.00 | |
Less: Transfer price | $155.00 | |
Additional processing costs | $115.00 | $270.00 |
Income before tax | $90.00 | |
Less: Income tax expense | $54.00 | |
Income after tax | $36.00 |
Table (6)
Overall profitability per unit of company A:
Yes, Company A will make circuit board and sold in U.S. when the company does not have any transfer price, because the overall profitability without transfer price ($60 per unit) is more than the overall profitability with transfer price ($39.20 per unit).
4.
Explain the strategy that should a company use in setting the transfer prices when the tax rates differ between countries.
Explanation of Solution
In this case, the company should try to generate less income in high tax rate countries and high income in low tax rate countries when the tax rates differ. It is a best strategy to avoid more taxes in setting the transfer prices.
5.
Prepare a spreadsheet and solve the requirement (1) and (2) if the U.S. tax rate is 35% and German tax rate is 55%.
Explanation of Solution
Prepare a spreadsheet and solve the requirement (1) and (2) if the U.S. tax rate is 35% and German tax rate is 55% as follows:
Figure (1)
Excel workings:
Figure (2)
Want to see more full solutions like this?
Chapter 13 Solutions
MANAGERIAL ACCOUNTING-ACCESS
- Due to rising labor costs in Malaysia, Domain Computer, based in Singapore, is considering shorting part of its production facilities from Malaysia to an emerging market, Vietnam, to better integrate its supply chain in the South east Asia region. John Lawson, the CFO of the company, estimates that Domain Computer needs to invest USD735,000 to acquire an existing factory in Vietnam and another USD285,000 in renovations and installation of new machineries. The cost of training new workers is estimated to be USD310,000. Andrew believes that the new factory will lead to an estimated USD928,000 savings in labor costs and another USD417,000 savings in logistics expenses. Required: Use cost-benefit analysis to recommend whether Domain Computer should shift parts of its production facilities from Malaysia to Vietnam. Explain your answer.arrow_forwardConner Manufacturing has one plant located in Italy and another plant located in the United States. The Italian plant manufactures a component used in a finished product manufactured at the U.S. plant. Currently, the Italian plant is operating at 75 per cent capacity. In Italy, the income tax rate is 32 per cent; in the United States, the corporate income tax rate is 35 per cent. The market price of the component is £240 and the Italian plant's costs to manufacture the component are as follows: Direct materials £60Direct labour 40Variable overhead 20Fixed overhead 30 Which transfer price would be in the best interest of the overall company? Group of answer choices £240 £100 £150 £120arrow_forwardThe Burton Company manufactures chainsaws at its plant in Sandusky, Ohio. The company has marketing divisions throughout the world. A Burton marketing division in Lille, France, imports 200,000 chainsaws annually from the United States. The following information is available: U.S. income tax rate on the U.S. division’s operating income 40% French income tax rate on the French division’s operating income 45% French import duty 20% Variable manufacturing cost per chainsaw $100 Full manufacturing cost per chainsaw $175 Selling price (net of marketing and distribution costs) in France $300 Suppose the United States and French tax authorities only allow transfer prices that are between the full manufacturing cost per unit of $175 and a market price of $250, based on comparable imports into France. The French import duty is charged on the price at which the product is transferred into France. Any import duty paid to the French authorities is a deductible expense for calculating French income…arrow_forward
- Billabong Fashion is based in Melbourne, Australia. Billabong Fashion has a subsidiary in Shanghai that generates RMB85 million in annual sales. Any earnings generated by the subsidiary are reinvested to support its operations. Belle Fashion is the close competitor of Billabong Fashion. Belle Fashion is a local Australian company located in Japan with annual export sale to Malaysia of about MYR 45 million. Based on the information provided, which firm is subject to a higher degree of translation exposure? Justify your answer with thorough explanation on both companies.arrow_forwardThe Burton Company manufactures chainsaws at its plant in Sandusky, Ohio. The company has marketing divisions throughout the world. A Burton marketing division in Lille, France, imports 200,000 chainsaws annually from the United States. The following information is available: U.S. income tax rate on the U.S. division’s operating income 40% French income tax rate on the French division’s operating income 45% French import duty 20% Variable manufacturing cost per chainsaw $100 Full manufacturing cost per chainsaw $175 Selling price (net of marketing and distribution costs) in France $300 Suppose the United States and French tax authorities only allow transfer prices that are between the full manufacturing cost per unit of $175 and a market price of $250, based on comparable imports into France. The French import duty is charged on the price at which the product is transferred into France. Any import duty paid to the French authorities is a deductible expense for calculating French income…arrow_forwardLobby Company produces and sells its only product XT-300. The company has been approached by a new customer from the USA with an offer to purchase 15,000 units of XT-300 for $11.50 each. Selling to the US will not affect the company’s other customers, and existing sales would not be affected. Lobby normally produces 110,000 units per year but only plans to produce and sell 90,000 in the coming year. Exporting the product to the USA will require a further packaging cost of $0.30 per unit. The normal sales price is $16 per unit. Unit cost information for the normal level of activity is as follows: Direct materials $4.50 Direct labour 4.20 Variable overhead 1.65 Fixed overhead 2.00 Total $12.35 Required: A). What are the relevant costs and benefits of this special order? B). Will operating income increase or decrease if the order from this new customer is accepted – if so, by how much? C). Suppose the new customer wants to buy 25,000 units, should…arrow_forward
- Lobby Company produces and sells its only product XT-300. The company has been approached by a new customer from the USA with an offer to purchase 15,000 units of XT-300 for $11.50 each. Selling to the US will not affect the company’s other customers, and existing sales would not be affected. Lobby normally produces 110,000 units per year but only plans to produce and sell 90,000 in the coming year. Exporting the product to the USA will require a further packaging cost of $0.30 per unit. The normal sales price is $16 per unit. Unit cost information for the normal level of activity is as follows: Direct materials $4.50 Direct labour 4.20 Variable overhead 1.65 Fixed overhead 2.00 Total $12.35 Required: A). What are the relevant costs and benefits of this special order? B). Will operating income increase or decrease if the order from this new customer is accepted – if so, by how much?arrow_forwardDue to rising labor costs in Malaysia, Domain Computer, based in Singapore, is considering shifting part of its production facilities from Malaysia to an emerging market, Vietnam, to better integrate its supply chain in the South east Asia region. John Lawson, the CFO of the company, estimates that Domain Computer needs to invest USD735,000 to acquire an existing factory in Vietnam and another USD285,000 in renovations and installation of new machineries. The cost of training new workers is estimated to be USD310,000. He believes that the new factory will lead to an estimated USD928,000 savings in labor costs and another USD417,000 savings in logistics expenses. Required: Use cost-benefit analysis to recommend whether Domain Computer should shift parts of its production facilities from Malaysia to Vietnam. Explain your answer. You are required to write 500 to 800 words. ( Currently I have completed my Cost-benefit analysis; but I am confused as to how to use PESTLE's analysis with…arrow_forwardMossfort, Inc., has a division in Canada that makes long-lasting exterior wood stain. Mossfort has another U.S. division, the Retail Division, that operates a chain of home improvement stores. The Retail Division would like to buy the unique, long-lasting wood stain from the Canadian division, since this type of stain is not currently available. The Exterior Stain Division incurs manufacturing costs of 13.45 for one gallon of stain. If the Retail Division purchases the stain from the Canadian division, the shipping costs will be 1.40 per gallon, but sales commissions of 0.75 per gallon will be avoided with an internal transfer. The Retail Division plans to sell the stain for 32.80 per gallon. Normally, the Retail Division earns a gross margin of 35 percent above cost of goods sold. Required: 1. Which Section 482 method should be used to calculate the allowable transfer price? 2. Calculate the appropriate transfer price per gallon. (Round to the nearest cent.)arrow_forward
- Khan Ltd. has two divisions, Europe and Asia. Europe produces a ball bearing that Asia uses in its production. Europe's variable cost is $2 per unit and the fixed cost per unit is $1.50. Ball bearings sell on the open market for $6 each. If Europe has excess capacity, what would be the minimum transfer price if Asia currently is purchasing 100,000 units on the open market?arrow_forwardMama Mia Inc and Wonderful Inc are European-based companies with subsidiaries located in Kuala Lumpur. Both companies distribute chemical supplies (produced in Europe) to customers throughout Asia. Both subsidiaries purchase the products at cost and sell the products at 90 percent markup. The other operating costs of the subsidiaries are very low. Mama Mia Inc has a research and development centre in Europe that focuses on improving its medical technology. Wonderful Inc. has a similar centre based in Kuala Lumpur. The parent of each firm subsidizes its respective research and development centre on an annual basis. Which company is subject to a higher degree of economic exposure? Justify your answer with thorough explanation on both companies.arrow_forwardLTE Chem Co. is a small-size U.S. chemical company. Two divisions at the company, K1 and K2, are involved in an internal transfer of a chemical ingredient, KXB. Currently, K1 sells 10,000Kgs of KXB to K2 at a price of $ 14.50/kg. The manager at K1 claims that the cost of producing KXB has recently increased, proposing a new price of $ 16.00/Kg, which is the one he can realize by selling the ingredient to the market. K2 has recently approached an external supplier who can supply the 10,000Kgs at a cost of $ 15.10. The cost figures for producing a Kg of KXB at K1 are: Direct Materials. Direct Labor.. Variable Overhead Fixed Overhead $5.15 4.35 0.50 1.60 Required: a. Based on the figures above, what is the current acceptable range of prices for the 10,000Kgs? What would be the net loss or saving for the company as a whole if, on the other hand, K1 expects to forgo 5,000Kgs that could be sold at $ 16.00/Kg to external customers? b. Now assume that, to push external sales of KXB by K1,…arrow_forward
- Cornerstones of Cost Management (Cornerstones Ser...AccountingISBN:9781305970663Author:Don R. Hansen, Maryanne M. MowenPublisher:Cengage Learning