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 $440. 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 $635. 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

Solution 2) The Minimum Transfer Price to be charged by Fabrication Department assuming that Fabrication Department is working to capacity will be equal to the Selling price in the external market i.e $635. As Fabrication Department will make a loss if it sells at a price lower that $635 as there is demand for the product in the external market.

Solution 3) If the Fabrication Department has an excess capacity, the Minimum Transfer Price should be equal to the variable manufacturing cost per unit i.e. $440. As there is no demand for additional units in the external market, the Fabrication Department should atleast cover the variable manufacturing cost per unit from Assembly Department. No Fixed Overheads should be considered while deciding the minimum transfer price as overheads cost will be incurred irrespective of whether the transfer takes place between Fabrication and Assembly Departments.