Fifth edition Alnoor Bhimani Charles T. Horngren Srikant M. Datar Madhav V. Rajan Farah Ahamed

Correcting student misconceptions

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Cost-based transfer prices Points to stress
Teaching tips

Correcting student misconceptions
Clarify the conflict caused by distress prices. If the seller receives very low (distress price) sales revenue, the seller may decide to produce other products, which may not be in the company’s long-term interest. Alternatively, if the TP is based on the long-term average market price, the buyer would prefer to buy externally. If management forces them to buy internally (at the long- term market price, autonomy will be violated.
Cost-based transfer prices
Points to stress
If TP are based on actual costs, sellers can pass along costs of inefficiency to the buyers. Setting
TP, based on budgeted rather than actual costs, can help motivate the seller to produce efficiently. However, even if sellers use budgeted-cost-based TP, if there is information asymmetry, sellers may still be able to pass on costs of inefficiency by budgeting high costs. Another rationale for using TP based on full cost is the following. If the selling subunit’s full cost exceeds the market price, the buying unit will prefer to outsource. While this maybe suboptimal in the short run, it appears more reasonable in the long run. If the seller cannot produce at a competitive cost, management should consider reallocating resources elsewhere.
Teaching tips
Students without negotiating experience usually do not recognise the incentives against sharing information. Because TP allocates profits across subunits, subunit managers often view each other as competitors and this limits their willingness to share information. Students can experience such incentives

Bhimani, Horngren, Datar and Rajan, Management and Cost Accounting, 5
th
Edition, Instructor’s Manual
© Pearson Education Limited 2012 for secrecy (with plenty of opportunity for number crunching) through an innovative TP role play based on the cases in the book.
Example
Companies may use different TP methods for different items market-based TP for big ticket items, variable cost-plus for low-value items and periodic negotiations for midrange items. Companies may also allocate more purchasing, receiving and inspection costs to externally sourced items, if internal sourcing requires less of such activities (e.g. buying internally may require less negotiation and an internal source maybe more reliable in delivering high-quality items in the right quantity at the right time. Recognising any extra costs from sourcing externally renders internal sourcing relatively more attractive.

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