Question

Perrin Co has 2 divisions, A and B. Division A has limited skilled labour and is operating at full capacity making product Y. It has been asked to supply a different product, X to Division B. Division B currently sources this product externally for $700 per unit. The same grade of materials and labour is used in both products. The cost card is below :
Product Y.X
Selling price $600. -
materials ($50 per kg) - $200.$150
Labour ($20 per hr) - $80.$120
Fixed overhead ($15 per hr) - $60.$90

Using opportunity cost approach to transfer pricing, what is the minimum transfer price?

Please explain your answer with workings and the reasoning behind it.
Thanks.

Answer 1

Answer :

Note :As per opportunity cost approach when Division is operating at full capacity making a product,

the minimum transfer price = Variable cost for manufacturing Product X + Opportunity cost  

Computation of Minimum transfer price

Materials	$150
Labor	$120
Opportunity cost [Working Note]	$480
Minimum transfer price	$750

Working Note :

• Labor hrs required for Product Y = $80 / $20 per hour = 4 hours
• Labor hrs required for Product X = $120 / $20 per hour = 6 hours
• Contribution per unit of Product Y = Selling price - materials - labor = $600 - $200 - $80 = $320
• Contribution per labor hour for Product Y = Contribution per unit of Product Y / Labor hrs required for Product Y = $320 / 4 hours = $80

Since Division A has limited skilled labor & labor hrs required for Product X is 6 hours ,

Thus opportunity cost for Product X = Contribution per labor hour for Product Y * Labor hrs required for Product X

= $80 * 6 hours = $480