Fundamentals of Cost Accounting 3rd Edition by William N. Lanen, Shannon W. Anderson, Michael Maher

Exercise 19

Evaluate Transfer Pricing System

Division A offers its product to outside markets for $30. It incurs variable costs of $11 per unit and fixed costs of $75,000 per month based on monthly production of 4,000 units. Division B can acquire the product from an alternate supplier for $31 per unit or from Division A for $30 plus $2 per unit in transportation costs in addition to the transfer price charged by Division A.

Required

a. What are the costs and benefits of the alternatives available to Division A and Division B with respect to the transfer of Division A’s product? Assume that Division A can market all that it can produce.

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b. How would your answer change if Division A had idle capacity sufficient to cover all of Division B’s needs?

Step 1 of 4

Evaluate Transfer Pricing System;

A.

Before attempting the question, let us just make two assumptions:

1. First assumption that A offers its products at the factory gate at the price of $ 30. This implies that A is not bearing any costs of transportation.

2. Second assumption is that B also receives its input material at the factory gate, if it buys it from the open market. In other words, this follows that the effective cost per unit for B will be $ 31.