Setting Transfer Prices$-$Market Price versus Full Cost

Objective $5-$ Explain the role of transfer pricing in a decentralized firm., $6$ Discuss the methods of setting transfer prices.

Ardmore, Inc., manufactures heating and air conditioning units in its six divisions. One division, the Components Division, produces electronic components that can be used by the other five. All the components produced by this division can be sold to outside customers; however, from the beginning, about $70$ percent of its output has been used internally. The current policy requires that all internal transfers of components be transferred at full cost.

Recently, Cynthia Busby, the new chief executive officer of Ardmore, decided to investigate the transfer pricing policy. She was concerned that the current method of pricing internal transfers might force decisions by divisional managers that would be suboptimal for the firm. As part of her inquiry, she gathered some information concerning Part $4CM,$ used by the Small $AC$ Division in its production of a window air conditioner, Model $7$AC$.$

The Small AC Division sells $10,000$ units of Model $7$AC each year at a unit price of $$58.$ Given current market conditions, this is the maximum price that the division can charge for Model $7$AC$.$ The cost of manufacturing the air conditioner is computed as follows:

$\backslash$table$[[,],[$Part $4$CM$,],[$Direct materials,$6\mathrm{.}45],[$Direct labor,$23\mathrm{.}00],[$Variable overhead,$15\mathrm{.}00],[$Fixed overhead,$3\mathrm{.}50],[,$ Total unit cost,${6\mathrm{.}50}_{?}$