Question

Scottsdale Manufacturing is organized into two divisions: Fabrication and Assembly. Components transferred between the two divisions are recorded at a predetermined transfer price. Standard variable manufacturing cost per unit in the Fabrication Division is $410. At the present time, this division is working to capacity. Fabrication estimates that the units it produces could be sold on the external market for $580. The product under consideration is viewed as a commodity-type product, with no differentiating features or characteristics.

Required:

2. Based on the general transfer pricing rule presented in the chapter, what is the minimum transfer price between units when the Fabrication Division is working to capacity?

3. What if the Fabrication Division had excess capacity? How would this change the minimum transfer price as determined by the application of the general transfer pricing rule?

Answer 1

2. Based on the general transfer pricing rule, the minimum transfer price between the units should be the actual manufacturing cost that the transferring division incurs add any opportunity cost that is lost by the transferring division.

Therefore, the minimum transfer price under present situation is $410.

3. If the fabrication division has excess capacity, then the per unit cost of manufacturing 1 unit will get reduced as long as the capacity is increasing. Therefore the minimum transfer price as determined above will reduce further if the fabrication division has excess capacity.

It shall also be noted that if there is an opportunity cost for the transferring division, then as per general rule we should consider the opportunity cost while arriving at the transfer price, but if there exists any excess capacity, then opportunity cost won't intervene.