CIMA P2 Syllabus C. Managing Performance Of Organisational Units - Transfer pricing - Division A has Spare Capacity - Notes ^{4 / 5}

This happens when:

1. There's no External Market demand left to sell to

2. There's no External Market at all

What Is The Appropriate Transfer Price Then?

• Greater than or equal to the variable cost in Division A

• Less than or equal to the selling price minus variable costs (net marginal revenue) in Division B

Illustration 1

Cow Co has two profit centres, A and B. 

A transfers all its output to B. 

The variable cost of output from A is $7 a unit.

Additional processing costs in B are $5 a unit.

B sells them for $20 a unit.

Required
Determine the transfer price (based on standard full cost plus), in order to motivate the managers to both increase output and reduce costs.

Solution

• The manager of A will increase output if the transfer price exceeds the variable cost of $7 a unit.

• The manager of B will increase output if the transfer price is less than the difference between the fixed selling price ($20) and the variable costs in B itself. 

  This amount of $15 ($20 - $5) is called net marginal revenue.

The range of prices is therefore between $7.01 and $14 .99.

Evaluating Division A when no External Market

There is a strong argument that profit centre accounting Is a waste of time. and better to treat it as a cost centre

Judge performance on the basis of cost variances.

(There is an argument therefore to use standard cost + as a transfer price)