Question

(Transfer Pricing Question) Managerial Accounting

Ampro Inc. has two division. Division A makes and sells student desks. Division B manufactures and sells reading lamps. Each desk has a reading lamp as one its components. Division A needs 10,000 lamps for the coming year and can purchase reading lamps at a cost of $10 from an outside vendor. Division B has the capacity to manufacture 50,000 lamps annually. Sales to outside customers are estimated at 40,000 lamps for the next year. It sells reading lamps for $12 each. Variable costs are $8 per lamp and include $1 of variable sales costs that are not incurred if division B sells lamps internally to division A. The total amount of fixed costs for division B is $80,000.

Consider the following independent situations:

a) What should be the minimum transfer price division B accepts for the 10,000 lamps and the maximum transfer price division A pays? Justify your answer.

b) Suppose division B could use the excess capacity to produce and sell externally 20,000 units of a new product at a price of $8 per unit. The variable cost for this new product is $6 per unit. What should be minimum transfer price division B accepts for the 10,000 lamps and the maximum transfer price division A pays? Justify your answer.

c) If division A needs 15,000 lamps instead of 10,000 during the next year, what should be the minimum transfer price division B accepts and the maximum transfer price division A pays? Justify your answer.

Answer 1

(a) Minimum transfer price that division B accepts for the transfer of 10,000 lamps will be the RELEVANT COST.

Here, the relevant cost will be the variable costs upto tge point of internal transfers. (Variable sales cost shall not be included as they arenot incurred in case of internal transfers. )

Therefore,

Minimum transfer price acceptable to division B = $7 per lamp

(b) Since division B (transferor) is working at full capacity, the minimum transfer price acceptable shall be:

Variable costs + opportunity costs

Selling price of new product	$8
(-) variable costs of new product	$6
Opportunity cost per unit	$2

So, the minimum transfer price = $(7 + 2) = $9 per unit.

(c) In this case, 10000 lamps can be transferred from extra production but 5000 units that could be sold in the market will also have to be transferred. So, the minimum transfer price acceptable to division B will be the MINIMUM AVERAGE TRANSFER PRICE.

Variable cost	$7
Loss of contribution [5000units × $(12-8)/15000units]	$1.33
Minimum average transfer price	$8.33

In all the above cases the maximum transfer price division A pays shall be the cost of purchase from outside vendor i.e. $10 per unit.

However, if selling price of division B would have been lower than the purchase price from outside vendor, such selling price would be maximum price payable by division A.