Question

Transfer Pricing

Vans produces a range of lifestyle footwear styles. The following question presents hypothetical data concerning the transfer of rubber from Vans' Rubber Department to the firm's Assembly Department.

Beyond supplying other internal departments, the Rubber Department can also sell rubber to external customers for $2.00/kg.

Relevant cost data for each department is supplied below.

	Rubber Department (price per kg of Rubber)	Assembly Department (price per unit)
Market price	$2.00	$130.00
Direct Materials	$1.00	$35.00*
Direct Labour	$0.20	$20.00
Variable Overhead	$0.10	$5.00
Fixed Overhead	$0.10	$4.00

*Does not include the cost of rubber.

1. Provide and discuss examples which illustrate how the general transfer price rule could be used for rubber transfers. Which of the options provided would be preferred by each department?
2. Identify and discuss the most appropriate method of setting a transfer price for rubber in this situation

Answer 1

Generally, transfer price includes only the relevant costs which are in nature of Variable Costs and fixed costs are not considered because they will incur even there is change in production or not.

There is no difference whether the Rubber Department sell to Assembly Department or External Customers because the cost per Kg of rubber is same ($2 per Kg) whether to assembly department or to external customers, hence, for the Rubber Department, the profit remains same whether to sell internally or externally.

When it is compared whole Firm as one then it is suggested for Assembly Department to purchase the rubber from external suppliers at $1.20 per kg instead purchasing the same rubber from Rubber Department at $2 per Kg so that Assembly Department can save $0.80 per Kg ($2 - $1.20).

For Rubber Department, it can sell the rubber to external customers at the same price of $2 per Kg so even Rubber Department will not incur any loss by selling to external customers so, in the best interests of the firm as a whole, it is suggested to Assembly Department to purchase the rubber from external suppliers and Rubber Department to sell to external customers so the whole firm can save a cost of $0.80 per Kg which increases the whole firm's profit by $0.80 compare with current situation.

There are no other factors to be considered based on the given information so to improve overall profitability of the Firm, it is suggested for Assembly Department to purchase rubber from external supplies and for Rubber Department, to sell the rubber to external customers and it is the best method.