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 $615 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 $215 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? Complete this question by entering your answers in the tabs below. Req A Req B Req C1 Req c2 What is the minimum transfer price that Corporate Division should obtain for its services, assuming that it is operating at capacity? Minimum transfer price per hour ReqA ReqB >

Answer 1

A. There are different ways to find the minimum acceptable transfer price. Some companies simply set the minimum as equal to variable costs. Others add variable costs with a calculated opportunity cost it available. The general economic transfer price rule is that the minimum must be greater than or equal to the marginal cost of the selling division.

so in this case where corporate division is operating at capacity then the Transfer Price would be Marginal Variable cost plus Loss of opportunity cost (Contribution) i.e. $215+ Loss of contribution i.e. $400 = $615.

Working Note: Contribution lost = sales price Less Variable cost = $615-$215 = $400 is the amount which can be earned by the corporate division by providing the services outside.

B. The maximum price that the Government division will want to pay is the market price of the associates that can be hired by the Government Division i.e. $215. Government Division will not be ready to pay anything over and above $215.

C-1. if Corporate Division has the Idle Capacity ; then the minimum transfer price would be the marginal cost. If there is spare capacity, then, for any sales that are made by using that spare capacity, the opportunity cost is zero. This is because workers and machines are not fully utilised. So, where a selling division has spare capacity the minimum transfer price is effectively just marginal cost. In this case the Minimum Transfer Price would be $215.

C-2 Since the Government Division can hire the same associates at the price of marginal cost of $215 it will anyways not be ready to pay any amount over and above $215 so whether or not Corporate division has Capacity ; the maximum transfer price for Government Division would be $215. so there is no change in the maximum transfer price.