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Perrin Co has two divisions, A and B.
Division A has limited skilled labour and is operating at full capacity making product Y. It has been asked to supply a different product, X, to division B. Division B currently sources this product externally for $700 per unit.
The same grade of materials and labour is used in both products. The cost cards for each product are shown below.
Product Y($)/unit X($)/unit
Selling price 600 –
Direct materials ($50 per kg) 200 150
Direct labour ($20 per hour) 80 120
Apportioned fixed overheads ($15 per hour) 60 90Using an opportunity cost approach to transfer pricing, what is the minimum transfer price?
hello sir please solve the question stated above, according to my calculation the lost contribution per hour is 80, but the answer shows the lost contrbution as 480? please clarify, thanks
Please find below the clear question details.
SELLNG PRICE
Y= 600
X= –Direct materials ($50 per kg)
Y = 200
X = 150Direct labour ($20 per hour)
Y = 80
X = 120Apportioned fixed overheads ($15 per hour)
Y= 60
X= 90The lost contribution per hour is indeed 80.
However product X takes 6 hours to produce (120/120) and so the lost contribution for every unit made of X is 6 x 80 = $480.
Hi Sir,
1)In the above question( relating to perrin Co) we have excluded fixed cost and determined the transfer price).
2) below is a question from kaplan .q 178 JB ltd that includes fixed cost as a marginal cost and has arrived at the transfer price of 10.5.
JB Ltd has divisions A and B. Division A makes a single product, which it sells on the external market at a price of $12 per unit. The variable cost of the product is $8 per unit and the fixed cost is $3 per
unit. Market demand for the product considerably exceeds Division A’s maximum
production capacity of 10,000 units per month.
Division B would like to obtain 500 units of the product from Division A. If Division A
does transfer some of its production internally rather than sell externally, then the saving
in packaging costs would be $1.50 per unit. What transfer price per unit ?My question is
1) when do we include fixed cost as part of transfer price .2) For JB ltd my calculation of transfer price is
*opportunity cost of $1 (ie SP 12-Cost 11) + marginal cost of 8 – savings 1.5= 7.5.Is this calculations correct?
Kindly help me out
Fixed costs are only relevant if total fixed costs change.
The fixed costs may have been absorbed as $3 per unit, but the total fixed costs (by definition) will not change with the number of units produced.For (2), you surely have an answer in your Kaplan book and so I am puzzled as to why you are asking if your answer is correct!
The lost contribution is 12 – 8 = $4 (fixed costs do not affect contribution!).
Therefore the minimum transfer price is 8 + 4 – 1.50 = $10.50 per unit.I suggest that you watch my free lectures on transfer pricing. The lectures are a complete free course for Paper PM and cover everything needed to be able to pass the exam well.
Thank you Sir.i did watch your lecture notes and i dnt remember it mentioning anything about fixed costs.Hence that doubt on fixed cost.
i do know the text books give answers and i do check them out. please understand that sometimes text book doesnt explain things clearly thats why i raise the questions on this platform.
The answer behind the text says “Therefore, the correct transfer price from
a decision-making point of view is $12 (the market price) – $1.50 (the saving in packaging cost) = $10.50.” So it makes you think that fixed cost is included .Hence the doubt.I asked if my answer was correct to know if i understood it correctly.i realise that my answer went wrong because of the concept of fixed cost.
thank you so much for your immediate answers Sir and clearing my understanding.Highly appreciated. Keep up the great work. 🙂
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