Question

The trailer division of Baxter Bicycles makes bike trailers that attach to bicycles and can carry children or cargo. The trailers have a retail price of $99 each. Each trailer incurs $30 of variable manufacturing costs. The trailer division has capacity for 22,000 trailers per year and incurs fixed costs of $500,000 per year.
   
Required:
1. Assume the assembly division of Baxter Bicycles wants to buy 5,700 trailers per year from the trailer division. If the trailer division can sell all of the trailers it manufactures to outside customers, what price should be used on transfers between Baxter Bicycles's divisions?
2. Assume the trailer division currently only sells 10,100 trailers to outside customers, and the assembly division wants to buy 5,700 trailers per year from the trailer division. What is the range of acceptable prices that could be used on transfers between Baxter Bicycles's divisions?

Answer 1

• All working forms part of the answer
• The transfer price should be based on the relevant cost.
• Relevant cost include variable cost of production + Contribution margin lost (if any) + Avoidable Fixed Cost
• Requirement 1

If out of 22000 trailers, 5700 are transferred, the sale of 5700 trailers will be lost.

A	Sale price per unit for outside customer	$                   99.00
B	Variable cost per unit	$                   30.00
C = A - B	Contribution margin per unit sold to outside customer	$                   69.00
D	No. of units NOT SOLD to outside customer due to internal transfer	5700
E = C x D	Total contribution margin lost from outside market	$         393,300.00
F = 5700 units x B	Total Variable cost of producing the units to be transferred	$         171,000.00
G = E+F	Total relevant cost for Transfer Pricing	$         564,300.00
H = D	No. of units to be transferred	5700
I - G/H	The transfer price should be	$                   99.00

Hence, the transfer price = Variable cost of production + Contribution margin lost (if any) + Avoidable Fixed Cost

= $ 30 + $ 69 + $ 0

= $ 99 per unit

• Requirement 2

If outside sale is 10100 trailers only, and 5700 trailers are to be transferred, these 5700 trailers can be transferred without affecting any outside sale and hence no contribution margin will be lost.

Hence, the transfer price = Variable cost of production + Contribution margin lost (if any) + Avoidable Fixed Cost

= $ 30 + $ 0 + $ 0

= $ 30 per unit