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There are several methods for setting a Transfer Price is as follows:
1) Cost-plus transfer pricing
It is where the transfer price is determined by setting a reasonable cost and adding an appropriate required profit.
2) Sensible Transfer Pricing
It is where the transfer price is determined by a rule of minimum and maximum transfer price which helps achieve goal congruence.
Goal Congruence means that both the managers of division A and division B should take goal congruent decisions to make their division profitable.
3) Transfer Pricing at Market Price
4) Transfer Pricing at Opportunity cost
Do we also test on Market Price and Opportunity cost in the exam? I could not find that in the lecture.
Goal congruence means that both divisions make decisions that are to the benefit of the company as a whole.
Transfer pricing at market price is covered in the lectures. It is the fact that the minimum transfer price is the marginal cost plus any lost contribution (which in most cases is the external market selling price).
Opportunity costs are only relevant for one-off contracts and are dealt with in the lectures on relevant costing.
This is an MCQ that asked about several methods of transfer pricing.
Which TWO of the following bases for setting a transfer price are most likely to
result in goal congruent behaviour by BOTH the selling and receiving
A. Opportunity cost
B. Market price
C. Actual cost
D. Standard full cost plus
Is it correct that both market price and opportunity cost are part of a sensible transfer pricing which is used to achieve goal congruence and managers are motivated in this approach because both the divisions will be profitable using sensible transfer pricing?
Yes it is true.
(And I should have added to my previous reply that opportunity costs are also relevant in the sense of lost contributions when there is a loss of external sales)