Transfer pricing

Hi,
Thanks for your question.

Ok – so Division A can sell the part-finished units by selling externally at $20 each. Because Division A has limited capacity they will not sell their part to division B at anything less than $20.

For Division B to sell the finished product they firstly need to do $10 per unit extra work on the part finished units received from A.
Therefore if the market price for Division B’s finished product was $35 per unit ….then the sensible transfer price range would be from between $20 (Div A’s minimum) to $25 ($35-10 which is market price less cost of conversion).

However, if the external market price for Division B is reduced to $28 per unit – then Division B would be looking to pay at most $18 (28 – 10).
As you know Division A will not accept less than $20 so this is a conflict.

If Division B can not source the product for cheaper elsewhere and can not reduce its $10 conversion costs – then it is best for the company as a whole for Division B to withdraw the product from its range and leave A to sell its part finished goods at $20. (see below from whole company perspective)

A & B Company (Division A & B)
Sales = $28 p.u
Less costs for A =$15 p.u
less costs for B = $10 p.u
Profit per unit = $3

Whereas if Division A sells externally and Division B withdraws:
A & B Company profit will be:
Sales $20 per unit
less cost for A = $15
Profit per unit is $5

Hope that explains ok 🙂
Cath

You’re welcome 🙂