Question

Koppenhaver Products, Inc., has a Relay Division that manufactures and sells a number of products, including a standard relay that could be used by another division in the company, the Electronics Division, in one of its products. Data concerning that relay appear below:

Capacity in units		86,000
Selling price to outside customers	$	63
Variable cost per unit	$	41
Fixed cost per unit (based on capacity)	$	10

The Electronics Division is currently purchasing 15,000 of these relays per year from an overseas supplier at a cost of $57 per relay.

Assume that the Valve Division is selling all of the valves it can produce to outside customers. Also assume that $10 in variable expenses can be avoided on transfers within the company due to reduced shipping and selling costs. What should be the minimum acceptable transfer price for the valves from the standpoint of the Valve Division?

Answer 1

Valve Division
Capacity in Units	86000 Units
Selling Price to Outside	63$
Variable Manufacturing	41$

Electronics Division
15000 Relays	$57

If Goods Sold Outside by Valve Division Cost Incurred = 41$ + 22$ ( Contribution per unit)

Contribution per unit = 63$ - 41$ = 22 $.

For Goods sold Outside = 86000 - 15000 = 71000 Units i.e. Contribution per unit is 22$ ( Sale Price is = 63$)

For Goods not solde outside = Contribution Lost 22 $ + Variable cost of manufacturing 41$ - Saving in Variable cost $ 10$ = 22$+41$ - 10$ = 53$

Here fixed Cost is not taken into account, while determining Transfer pricing, as itis chargeable on entity as  whole whether same is transfered to outside or not.

Secondly, 53$ is charged because saved on cost of shipping 10$ hence same is deducted from the units transfered to Electronic department, Normal cost 31$ is the cost incurred and contribution lost 22$ shall be charged to the electronic division as it covers our manufacturing cost and the contribution lost. Same is the Only acceptable price from the point of view of Valve division.