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

Question No. 1(1) :

If Division is Operating at Full Capacity, the Transfer Price shall be equal to the Market Price i.e $ 500

Question No. 1(2) :

If Division is Operating at less than Full Capacity, then the transfer Price shall be equal to the Marginal cost i.e Variable Cost = $ 100+ $130+$125 = $355

Question No. 2:

market-Based transfer Price is not likely to work if the purchase price of the receiving department is less than the Market Price of the Product

Example: The Market Price of Commodity X is $500. Division B purchases the product from the outside market for $ 450. In this case, Market based transfer price is not likely to Work.

Question No. 3:

Cost Plus Method

Under this method, the transfer Price is equal to the cost of Product plus fixed Mark up

Example: The Cost per Component of X for Division A is $ 403 and the markup is fixed at 20% of the cost, then the divisional transfer price is equal to 403 + (403*20%) = $ 483.60

Transactional Profit Split Method

The Profit on the Sale of Product is shared between the divisions in the agreed ratio.

Example: The Cost per Component of X for Division A is $ 403 and the additional processing cost of Division B is $ 47 and the sale price of processed COmponent is $ 600. Total Profit = 600-403-47 = $150

Then the divisional Transfer prive is equal to = 403 + 150/2 = $ 478