Question

Best Practices, Inc., is a management consulting firm. Its Corporate Division advises private firms on the adoption and use of cost management systems. Government Division consults with state and local governments. Government Division has a client that is interested in implementing an activity-based costing system in its public works department. The division’s head approached the head of Corporate Division about using one of its associates. Corporate Division charges clients $640 per hour for associate services, the same rate other consulting companies charge. The Government Division head complained that it could hire its own associate at an estimated variable cost of $240 per hour, which is what Corporate pays its associates.

Required:

a. What is the minimum transfer price that Corporate Division should obtain for its services, assuming that it is operating at capacity?

b. What is the maximum price that Government Division should pay?

c-1. Is there any change in minimum transfer price as referred in part (a), if Corporate Division had idle capacity?

c-2. Is there any change in maximum transfer price as referred in part (b), if Corporate Division had idle capacity?

Answer 1

a)If corporate division is operating at full capacity ,then it must charge to Government division as follows:

Estimated variable cost	$ 240
Loss of contribution from regular clients if associates is provided to government division since operated at capacity [640-240]	400
Minimum transfer price	$ 640 per hour

b)Maximum price that government division will pay is equals to price at which it can acquire associates in the market = $ 240 per hour

c)1)If there is an idle capacity :

Estimated variable cost	$ 240
Loss of contribution from regular clients if associates is provided to government division since operated at capacity	0
Minimum transfer price	$ 240 per hour

c-2)

No,Since maximum transfer price is the price which government division is ready to pay and availability of excess capacity with corporate division has no relevance to it