Question

DC Inc. has two production divisions. Division A produces Component X, which is used by Division B. To Division A, the cost of producing one unit of X consists of unit direct material cost of $100, unit direct labor cost of $130, unit variable overhead of $125, and unit fixed overhead of $48 at the current production volume. The current market price of X is $500 per unit. The company is now trying to determine the transfer price of X.

1. Using the general transfer pricing rule, find the market-based transfer price for each of the following scenarios:

1) Division A is operating at full capacity.

2) Division A is operating at less than full capacity.

(4 points)

2. Describe a situation when a market-based transfer price is not likely to work. Explain in detail using dollar amounts. (8 points)

3. Suggest other approaches that may replace the market-based approach. For each of those alternatives, explain in detail using dollar amounts. (8 points)

Answer 1

1) Division A is operating at full capacity.

It Division A is operating at full capacity the transffer price will be current market price i.e. $ 500 units

2) Division A is operating at less than full capacity

Transfer price

Direct materal

100

Direct labor

130

variable cost

125

Transfer price

355

Describe a situation when a market-based transfer price is not likely to work. Explain in detail using dollar amounts

If the market price fluctuates widely or quickly it may not be suitable.

There is also a possibility that the market price may not be available if the goods are transferred at immediate stage.

Suggest other approaches that may replace the market-based approach. For each of those alternatives, explain in detail using dollar amounts.

There are various approaches like cost based transfer pricing and negotiation based transfer pricing.

To avoid management conflict there is dual rate transfer pricing where both the department record the trasnfer price differently and two part transfer price where transfer price is marginal cost plus a lumpsum charge.