Question

Setting Transfer Prices-Market Price versus Full Cost Ardmore, Inc., manufactures heating and air conditioning units in its six divisions. One division, the Components Division, produces electronic components that can be used by the other five. All the components produced by this division can be sold to outside customers; however, from the beginning, about 70 percent of its output has been used internally. The current policy requires that all internal transfers of components be transferred at full cost. Recently, Cynthia Busby, the new chief executive officer of Ardmore, decided to investigate the transfer pricing policy. She was concerned that the current method of pricing internal transfers might force decisions by divisional managers that would be suboptimal for the firm. As part of her inquiry, she gathered some information concerning Part 4CM, used by the Small AC Division in its production of a window air conditioner, Model 7AC. ا ت The Small AC Division sells 10,000 units of Model 7AC each year at a unit price of $58. Given current market conditions, this is the maximum price that the division can charge for Model ZAC. The cost of manufacturing the ait conditioner is computed as follows: Part 4CM Direct materials Direct labor Variable overhead Fixed overhead Total unit cost العة اليان The window unit is produced efficiently, further reduction in manufacturing costs is possible. The manager of the Components Div ivision indicated that he could sell 10,000 units (the division's capacity for this

Answer 1

1)	Computation of Contribution Margin
	Contribution margin = Sales price of a product minus its variable costs
Sr No	Particulars	Components Division	Small AC Division	Company	TM
		Part 4CM	Model 7AC
	No of Units proposed	10,000	10,000	10,000
a	Sales price	12.00	58.00	58.00
b	Part 4CM		6.45	4.65	*
c	Direct Material	2.75	23.00	23.00
d	Direct Labour	0.80	15.00	15.00
e	Variable Overhead	1.10	3.50	3.50
f = (b +c+d+e)	Total Cost	4.65	47.95	46.15
e = a-f	Contribution Margin per Unit	7.35	10.05	11.85
	Contribution Margin %	61.25%	17.33%	20.43%
	* Variable cost Firmwide or Company level shall not include the fixed costs associated with the Components division as well
2)	Minimum and Maximum transfer price
	The minimum transfer price equals the incremental cost to create one product. The incremental price includes direct labor, direct material and direct overhead costs
	This shall not include the fixed price associated to the same.
	Minimum Price
	Particulars	Components Division (Rs)
	Direct Material	2.75
	Direct Labour	0.80
	Variable Overhead	1.10
	Total	4.65
	Maximum Transfer price
	The maximum price that the buying division will want to pay is the market price for the product – ie whatever they would have to pay an external supplier for it.
	In this specific case Maximum price is Rs. 12 per Unit for which Small AC Division could buy from external buyers.