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Hi
In the model answer transfer price for housing now budgeted total production cost 6,902 cost of sales + 1,302 fixed cost – 575 adverse variance marked up by 30%.
Why do you deduct adverse variance (don’t you add because it is an extra cost i.e. underestimated costs)
Thanks
If a division is allowed to transfer at actual production cost (or actual production cost + mark-up) what is the incentive for that division to control its costs? If transfer price = actual cost the division will always break even. If transfer price = actual cost + markup, the higher its costs the higher its profit.
Removing the advese cost variance means that the transfer price is based on standard costs and the cost over-run stays with the transferring (selling) division thus encouraging it to control costs better.
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