Transfer Pricing

1. A company has two profit centers, Division A and Division B. Division A supplies Division B with a part-finished product. Division B completes the production and sells the finished units in the market at $35 per unit. There is no external market for Division A's part-finished product.

Budgeted data for the year:

Division A Division B

Number of units transferred/sold 10,000 10,000

Material cost per unit $8 $2

Other variable cost per unit $2 $3

Annual fixed costs $60,000 $30,000

Required

Calculate the budgeted annual profit for each division and for the company as a whole of the transfer price for the components supplied by Division A to Division B is:

(a) Full cost plus 10%

(b) Marginal cost plus 10%

(c) Evaluate both transfer prices from the perspective of each individual division and from the perspective of the company as a whole.

2. A company operates two divisions of Able and Baker. Able manufactures two products, X and Y. Product X is sold to external customers for $42 per unit. The only outlet for product Y is Baker.

Baker supplies an external market and can obtain its semi-finished supplies (product Y) from either Able or an external source. Baker currently has the opportunity to purchase product Y from an external supplier for $38 per unit. The capacity of division Able is measured in units of output, irrespective of whether product X, Y or a combination of both being manufactured.

The associated product costs are as follows:

X y

Variable cost per unit $32 $35

Fixed overheads per unit $5 $5

Total unit costs $37 $40

Required:

Using the above information, advise on the determination of an appropriate transfer price for the sale of product Y from division Able to division Baker under the following conditions:

(a) When division Able has spare capacity and limited external demand for product X

(b) When division Able is operating at full capacity with unsatisfied external demand for product