Question

Two of the decentralized divisions of Gamberi Electronics Corporation are the Plastics Division and the Components Division. The Plastics Division sells molded parts to both the Components Division and to customers outside the corporation.

Assume that the Plastics Division is currently operating with idle capacity. Also assume that the Components Division wants to purchase from Plastics all of the additional parts that could be made with this idle capacity. In order to increase its current level of profitability, the Plastics Division should accept any transfer price on these additional parts that is above the:

Multiple Choice

• variable cost of the additional parts.

• full (absorption) cost of the additional parts.

• variable cost of the additional parts plus the lost contribution margin on all units that could no longer be sold to customers outside the corporation.

• full (absorption) cost of the additional parts plus the lost contribution margin on all units that could no longer be sold to customers outside the corporation.

Answer 1

The correct answer is A. "Variable cost of the additional parts"

The general economic transfer pricing rule when the seller has idle capacity is to set the transfer price at variable cost. As the plant is at idle capacity, fixed cost would have already been absorbed. Also, there will not be any 'lost contribution margin' because the plant is already at idle capacity. Hence, the minimum price above which Plastics Division should accept any transfer price on these additional parts in order to increase it's profitability is "Variable costs of the additional parts"