Assume that Division X has a product that can be sold either to outside customers or to Division Y of the same company for use in its production process in each of the case below. The managers of the divisions are evaluated based on their divisional profits.
Case
A B
Division X:
Capacity in units 200,000 200,000
Number of units being sold to outside customers 200,000 160,000
Selling price per unit to outside customers $90 $75
Variable costs per unit $70 $60
Fixed costs per unit (based in capacity) $13 $8
Division Y:
Number of units needed for production 40,000 40,000
Purchase price per unit now being paid to an outsider supplier$86 $74
Required:
1-a. Refer to the data in case A above. Assume in this case that $3 per unit in variable selling costs can be avoided on intracompany sales. Determine the transfer price of the selling division.
Variable cost per unit 70
Less: Avoidable cost 70
Total contribution margin on lost sales
No. of units transferred 0
Transfer price ≥ 70
2-a. Refer to the data in case B above. In this case, there will be no savings in variable selling costs on intracompany sales. Determine the transfer price of the selling division.
Variable cost per unit 60
Total contribution margin on lost sales
No. of units transferred 0
Transfer price ≥ 0

The selling or transferring division before transferring to another division (receiving division) it must calculate a minimum transfer price. The minimum transfer price is price acceptable to the transferring division

Minimum Transfer Price = Variable Costs - Internal Savings + Opportunity Cost

where,

Opportunity Cost = Short fall / Internal demand x Contribution per unit

For some units that are currently being supplied externally will be taken up by the receiving division

Case A

Here we have an opportunity cost of 40,000 units taken from external supplies

Minimum Transfer Price = $70 - $3 + 40,000 / 40,000 x ($90 - $70)

= $87

Case B

Here there is no opportunity costs no units taken from external supplies

Minimum Transfer Price = $60 - $0 + $0

= $67