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Hi Sir,
Question: using an opportunity cost approach what is the minimum transfer price?
Division A has limited skilled labour hrs and is operating at full capacity making product Y. It has been asked to supply a different product X to div B. Division B currently sourced this product externally for $700 per unit.
Product A. B
Sp 600. –
Material. 200. 150
Labour. 80. 120
Apport FC 60. 90A)£270
B)£750
C)£590
D)£840The answer is B £750
I assumed the answer is C £590( 380 + 270) . I thought minimum transfer price would be lost contribution of product A plus v/c of product B as it’s no spare capacity. How do they get £750? Would you please explain where I am going wrong and why would Division B accept a transfer of £750 if they could buy for 700 externally?Thank you so much in advance.
I don’t think you have typed the question correctly because you say there are divisions A and B and then that there are products A and B.
If it is a past exam question or a question in the BPP Revision Kit then say which question and I will be able to see it myself.
I think I can guess how the question was actually worded!
The marginal cost of the second product is $270.
The first product is giving a contribution of $320 per unit. However each unit of the second product is using 1.5 times as much labour as the first product. So the lost contribution of making 1 unit of the second product is 1.5 x $320 = $480.
Therefore the minimum transfer price is 270 + 480 = $750.
(It is the same idea as the last example I work through in my lectures on transfer pricing)
Yes that’s the question. It does cost £80 for labour £20 per labour so you’re right product Y takes 4 hours and X takes 6hrs. I understand now but are they using lost contribution of the labour because the question asks use the opportunity cost approached and labour is limited but was only wondering why is would minimum transfer price be £750? I understand that for division A it would be £750 but for division B it would be £700 as they could purchase it externally for that.
The question doesn’t specify if it’s wants min transfer price for div A or B.?The question says that Division A has been asked to supply to Division B.
It is always the division doing the transferring that fixes the minimum transfer price.
Division B fixes the maximum they are prepared to pay. If they can buy externally for less that $750 then they will not buy from Division A. Division A will not be prepared to transfer for less that $750.
Have you watched my free lectures on transfer pricing?
Hi,
Ohhhh now I understand.
I have watched the lecture twice and even read acca technical article but it was a while ago it was just one of the topics I struggled to understand but thank you so much for explaining.
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