Question

The Engine Division provides engines for the Tractor Division of a company. The standard unit costs for Engine Division are: Direct materials $ 600 Direct labor 1,200 Variable overhead 300 Fixed overhead 150 Market price per unit 2,730 The engine department has excess capacity. What is the best transfer price to avoid transfer price problems? a. $300 b. $900 c. $2,100 d. $1,350

Answer 1

The transfer price should be such that none of the department (supplying and receiving) suffers loss.

The minimum transfer price should be equal or greater than the cost of production.cost of production includes Direct material labor variable and fixed overheads.if there is excess capacity available fixed overhead becomes irrelevant. as the total fixed costs are constant and does not increase with increase in production.

Maximum transfer price should be equal or lower to the market price of unit.

Here, engine department has excess capacity. so the transfer price should be:

Direct material	$600
Direct Labor	$1,200
Variable overhead	$300
Total overhead [600+1200+300]	$2,100

This are the costs that varies with the production. so to produce one unit of engine the engine division will incur $2,100 cost.

so to avoid loss the best transfer price is $2,100