Question

Elite Inc. has many divisions that are evaluated on the basis of return on investment (ROI). One division, Beta, makes boxes. A second division, Lambda, makes chocolates and needs 90,000 boxes per year. Beta incurs the following costs for one box: Direct materials $0.40 Direct labor 0.70 Variable overhead 0.50 Fixed overhead 0.16 Total $1.76 Beta has the capacity to make 720,000 boxes per year. Lambda currently buys its boxes from an outside supplier for $2.00 each (the same price that Beta receives). Assume that Elite Inc. mandates that any transfers take place at full manufacturing cost. What would be the transfer price if Beta transferred boxes to Lambda? Question 29 options: $1.35 $1.76 $1.00 The transfer price cannot be determined from the information given. $0.90

Answer 1

A Transfer price is that notional value at which goods and services are Transferred between divisions in a organization.

Transfer prices are normally set for intermediate products which are goods and services are supplied by selling division to buying division.

There are different methods of calculating transfer pricing

1) Pricing based at cost

2) Market price as a transfer price

3) Negotiated price

4) Pricing based on oppurtunity cost

If we use pricing based on cost : Under this method actual cost of production is taken as transfer price for divisional transfer.

Such actual costs may consists of Variable costs including fixed costs.

or If we take market price as transfer price :

The transfer price will be determined according to the market price.It act as a good incentive for efficient production to the sellng division and any efficiency in production and abnormal costs will not be borne by buying division.The logic used in this method is that if the buying division would have purchased the goods from the open market they would have paid the market price, hence same price should be paid to selling division.

One of the variation in this method is that, Selling and distribution OH should be deducted and thus price should be charged as a transfer price because there are no selling efforts by selling division to sell the goods to buying division.

If we follow 1st method

Transfer price would be = 0.4+0.7+0.5+0.16 = $ 1.76

If we follow 2nd method,

Transfer price would be = $ 2

(Assume Selling and distribution OH = 0)

From the options we can pick $ 1.76 as answer to the question.