Question

Should companies use marginal costs to imitate short-term variable costs or full costs to imitate long-term costs when calculating transfer prices? What are the positives and negatives of the different approaches?

Answer 1

Yes.

Companies uses Marginal Costs to imitate Short term variable costs OR full costs to imitate long term costs while determining the Transfer prices.

Positives & negatives of marginal Cost Approach:

• By using marginal costs approach, all variable costs incurred will be incurred
• useful for making decisions
• Fixed costs can't be recovered by using this approach
• Full- costs are not assumed in this approach
• This approach is only useful for short term, not useful for long term
• By following this approach, the transfering division may get losses
• Receiving division will get benifited.

Positives & negatives of Full Cost Approach:

• By using Full costs Approach, All costs including Fixed costs will be considered
• Fixed costs are also recovered by using this approach
• This Approach is useful for long term as well as for short term
• By following this approach, the transfering division will be benifited.
• Excess burden of costs for receiving division.