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You explained working through the last example on transfer pricing in the lecture notes on Transfer Pricing with limiting factor (in chapter 18 example 8) where there is only one division making two products but due to production limitations, we have a limiting factor.
We will be asked this kind of question in section A or B either but not in section C (long questions).
It could be in section A or B or part of a full section C question.
You will find examples of transfer pricing questions from all three sections in your Revision Kit.
ALL the questions on transfer pricing in section C (long questions) are always without capacity limitations.
I couldn’t find a single question with capacity limitations in section C in the revision kit. It always appears in an MCQ only. This is the reason I asked you.
Thank you although 🙂
I do not know which Revision Kit you are using, but there have certainly been Section C exam questions with capacity limitations and the BPP Revision Kit has at least one of them (Man Co.)
I have a little question about transfer price capacity limitations – example 8.
Product X has a contribution of $4 per hour and Product Y has a contribution of $3 per hour. We need to supply product Y to division B so we will make product Y instead of product X but we would lose the contribution of $4.
BUT how do you calculate the opportunity cost – I cannot understand. I check your lecture but didn’t really understand the logic. Could you please help me with this?
If they were not transferring anything to the other division then they would prefer to make product X because it generates the highest contribution per hour (as per normal key factor analysis).
The other division wants product Y. We can produce Y but every hour that is used to produce product Y is taking one hour that they would otherwise have used to produce product X and is therefore losing them $4 per hour. So the transfer price for product Y must be such as it is giving them $4 per hour otherwise it would not be worth their while to produce Y.
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