Question

erfumes Ltd has two divisions: the Perfume Division and the Bottle Division. The company is decentralised and each division is evaluated as a profit centre. The Bottle Division produces bottles that can be used by the Perfume Division. The Bottle Division's variable manufacturing cost per unit is $3.00 and shipping costs are $0.20 per unit. The Bottle Division's external sales price is $4.00 per unit. No shipping costs are incurred on sales to the Perfume Division. The Perfume Division can purchase similar bottles in the external market for $3.50. The Bottle Division has sufficient capacity to meet all external market demands in addition to meeting the demands of the Perfume Division. Required: a) Using the general rule, determine the minimum transfer price. b) Assume the Bottle Division has no excess capacity and can sell everything produced externally. Would the transfer price change? c) Assume the Bottle Division has no excess capacity and can sell everything produced externally. What is the maximum amount Perfume Division would be willing to pay for the bottles? d) When is it more appropriate to use market-based transfer price rather than cost-based transfer price? (1 mark)

Answer 1

I

Minimum Transfer price for Bottle Division to sell to Perfume division will be the variable manufacturing cost

$3

Shipping cost is not included since there wont be shipping cost if it delivers to Perfume division).

II

Assuming Bottle division having no excess capacity, then Bottle division will sell the bottle to Perfume division

more than the variable manufacturing cost and less than the price incurred for procuring bottles externally by Perfume division.

The range of Transfer price will be in between $ 3.00 to $ 3.50 i.e.

Minimum Transfer price is $ 3.00 & Maximum Transfer Price is $ 3.50

It cant sell beyond $ 3.50 because Perfume division then procures @ $ 3.50 instead from Bottle division.

III

maximum transfer price that Pefume division would be willing to pay is $ 3.50 as Bottle Division cant sell beyond $ 3.50

because Perfume division then procures @ $ 3.50 externally instead from Bottle division.

IV

When company uses cost-based transfer pricing, it will be difficult to evaluate division performance unless the TP (Transfer price) exceed full costs.

Market based transfer pricing establishes Real market supply and demand more clearly than cost based tranfer pricing because,

if supply > demand, generally market prices tend to decrease, here also market-based transfer prices decreases.

Also Company profits included sale through internal divisions also, whereby market based Tranfer pricing contributes to the profits as well.