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Sir, I have a few doubts in the following question:
In a company with a divisionalised structure, Division A transfers its output to Division B. Division A, produces just one item, Component X. Division B makes and sells and end product that requires one unit of component X.
MC of production in Division A $8
Fixed overhead cost of production $3
Cost of selling in the external market $1
Market price in the external market $16
Division B contribution from further processing $25
component X, before deducting the transfer costDivision A is working at full capacity.
I understand that division A has limited production and so the minimum transfer price will be calculated as Marginal Cost + any lost contribution.
The problem I am facing with this question is that I cannot understand what they mean by:
1) Cost of selling in the external market
2) Market price in the external market
3) Division B contribution from further processing component X, before deducting the transfer cost.
I tried looking at the explanation in the answers section of the BPP learning kit, but they have simply solved i
I tried looking at the explanation in the answers section of the BPP learning kit, but they have simply solved it and given the end result.
I cannot seem to understand the statements and why they did what they did.
Could you please help me understand the statements, thank you.
Please do not type out full questions here – they are copyright of BPP and so we are not allowed to publish them here as well. I have the BPP Revision Kit and so all you need to is give the number of the question.
Division A can sell ‘outside’ to the external market for $16. If they do, then they will have to pay costs of selling ‘outside’ of $1, and since the marginal cost of producing is $8, then if they sell externally they will make a contribution of 16 – 1 – 8 = $7 per unit.
If instead they transfer to the other division, they will have the marginal cost of $8 and they will lose contribution that they could have made by selling externally of $7. Therefore the minimum transfer price is 8 + 7 = $15 per unit.
I suggest that you watch my free lectures on this. The lectures are a complete free course for Paper PM and cover everything needed to be able to pass the exam well.
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