Question

3. Katsen Coffee has two divisions, Roasting and Brewing. The Roasting division can sell its products to an external market for $15 per unit. The division's variable manufacturing costs are $4.5 per pound and fixed manufacturing costs are $0.90 per pound.
   1. Using the economic rule of transfer pricing, what internal price should be set to transfer a pound of coffee from the Roasting division to the Brewing division? Assume there is sufficient capacity to support the internal transfer.

2. Now assume the Roasting division is currently at maximum capacity, selling all the beans they can roast to their external customers. What internal price should be set to transfer a pound of coffee from the Roasting division to the Brewing division?

Answer 1

a. Using the economic rule of transfer pricing, what internal price should be set to transfer a pound of coffee from the Roasting division to the Brewing division? Assume there is sufficient capacity to support the internal transfer.

Solution: Given that there is a sufficient capacity for internal transfer. In this case, there will not be any loss of contribution form the sale to external parties. So the main objective is to cover its variable expense of the Roasting division. Therefore, minimum transfer price will be its Variable costs i.e., $ 4.5 per pound.

b. Now assume the Roasting division is currently at maximum capacity, selling all the beans they can roast to their external customers. What internal price should be set to transfer a pound of coffee from the Roasting division to the Brewing division?

Solution: Given that Roasting division is already operating at full capacity. In order to transfer some materials internally, Roasting division should forgo some sales from the external parties which causes Loss of contribution. Therefore, minimum transfer price will be Loss of contribution + Variable cost i.e, $ 10.5 + $ 4.5 = $15.

Calculation of loss of contribution:

Particulars	$
Selling price per pound	15
Less: Variable cost	4.5
Contribution	10.5