Question

if one division has excess capacity, wouldn't it make sense for that division to produce and sell their products to other divisions within the company at any price that was higher than the variable cost incurred to produce the product? If not, why not?

Answer 1

If one division has excess capacity it makes sense for the division to produce and transfer to other division within company at any price above variable cost. The reason being it will be lead to capacity utilisation and increase the contribution margin for the division. Also since capacity is excess there is no loss of sales of external customers. Hence the minimum price to be charged should be equal to variable cost of the production so that there is no loss incurred on account of internal transfer. The transfer price to be charged can depend on the policy of the division like return on investment , pricing policy, etc but overall the price charged has to be lower than the external market price so that the other department also benefits from the same and at overall company level there is profit.

Overall summary

1. Minimum pricing should be equal to variable cost
2. Transfer price should be less than external market price
3. Internal pricing policy should set the guidelines for transfer pricing