Transfer Pricing:

ChatGPT:
Got it ✅ I’ll make this exam-focused, concise, and conceptual for ACCA PM (F5).

Rules for Transfer Pricing (TP)

A good TP should:
1. Preserve goal congruence → Encourage decisions in the interest of the group.
2. Promote divisional autonomy → Allow fair performance measurement.
3. Provide a fair performance measure → Profit reflects effort and efficiency.
Transfer Price Determination
1. If no external market exists → TP = Marginal cost (MC) + Opportunity cost (OC).
o Opportunity cost = Contribution lost from not selling externally.
2. If perfectly competitive external market exists → TP = Market price.
3. If spare capacity exists and no external demand sacrificed → TP = Marginal cost.
4. If limited external capacity → TP = Market price for units sacrificed + MC for surplus.
5. Negotiated pricing → Acceptable range = [MC, Market Price].
6. Dual pricing (if required) → Supplying division records at market price, receiving division at
MC.

Question Set
Q1 – No External Market, Spare Capacity
Division A produces a component at MC = $10/unit. Division B requires 5,000 units.
No external market exists. Fixed cost per unit = $4.
Required: Determine the transfer price.
Answer Q1:
No external market + spare capacity → TP = MC = $10.

Q2 – External Market, Full Capacity

Division A produces 10,000 units at MC = $12. Market price = $20.
External demand = 10,000 units. Division B requires 2,000 units.
Required: Minimum TP?
Answer Q2:
Opportunity cost = Contribution lost = $20 – $12 = $8.
TP = MC + OC = $12 + $8 = $20.

Q3 – Partial Capacity, Mixed Case

Division A produces 12,000 units at MC = $15. Capacity = 15,000.
External demand = 14,000 units at market price = $25.
Division B needs 3,000 units.
Required: Minimum TP per unit.
Answer Q3:
 First 2,000 units supplied to B would reduce external sales (since 14,000 ext demand vs 12,000
produced).
Opportunity cost = $25 – $15 = $10. TP = $15 + $10 = $25.
 Remaining 1,000 units can be produced using spare capacity (up to 15,000). TP = MC = $15.
So, TP = $25 for 2,000 units + $15 for 1,000 units.

🔥 Q4: Spare Capacity – Variable Cost Basis

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Division A produces a part at a variable cost of $10 per unit. Fixed costs are $2 per unit. Division B
requires 1,000 units. Division A has sufficient idle capacity. The external market price is $18.
Required: Determine the transfer price range and recommend.
Solution:
 Min TP = VC = $10
 Max TP = Market = $18
 Any TP between $10–$18 acceptable.
 Goal congruence: $10 works since no opportunity cost.

Q5: No Spare Capacity – Opportunity Cost

Division A can sell 10,000 units externally at $20 each (VC = $12). Fixed cost is $5 per unit. Division B
requests 2,000 units. If A supplies B, external sales will fall by 2,000 units.
Required: Minimum transfer price per unit.
Solution:
 Lost contribution = $20 – $12 = $8 per unit.
 Min TP = VC + Opportunity cost = $12 + $8 = $20.
 So TP must be ≥ $20 (equal to market price).

Q6: Negotiated / Dual Pricing Scenario

Division A makes a component (VC $15, selling price $25). B needs 5,000 units. A has spare capacity for
3,000 units but must sacrifice external sales for the remaining 2,000.
Required: Suggest a suitable transfer pricing arrangement.
Solution:
 For 3,000 units (spare capacity): Min TP = $15.
 For 2,000 units (capacity constrained): Min TP = $15 + ($25 – $15) = $25.
 Mixed approach: 3,000 @ $15 + 2,000 @ $25.
 Or dual pricing: A credited at market ($25), B charged at VC ($15). HQ bears the difference.

Transfer Pricing Decision Checklist

1. Is there an external market for the product?
o ❌ No → TP = Marginal Cost (MC).
o ✅ Yes → go to step 2.
2. Does the supplying division have spare capacity?
o ✅ Yes →
 Units supplied from spare capacity → TP = MC.
 Units that reduce external sales → TP = Market Price.
o ❌ No (full capacity) → TP = Market Price.
3. Is negotiation allowed?
o Yes → Range = [MC, Market Price].
o If dual pricing is used → Supplying division at Market Price, Receiving at MC.

Exam-Style Formula
TP=MC+Opportunity Cost (Contribution Lost)TP = MC + \text{Opportunity Cost (Contribution Lost)}

✅ With this flow, in an exam:

 Step 1 → check external market.
 Step 2 → check spare/full capacity.
 Step 3 → apply MC, Market, or mix.

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Rule of Thumb for Exam:
 If spare capacity exists → Minimum transfer price = VC per unit.
 If no spare capacity → Minimum transfer price = VC per unit + opportunity cost
(contribution lost per unit from external sales).

Transfer Pricing Exercise with Savings

Scenario:
 Division A manufactures a component.
 Variable cost = $12 per unit.
 External selling price = $20 per unit.
 Division B currently buys the component from outside suppliers at $22 per unit.
 If Division A transfers internally, transport and selling expenses of $3 per unit (incurred only on
external sales) are saved.
 Demand from B = 5,000 units. Division A has sufficient spare capacity.
Required:
(i) Minimum transfer price.
(ii) Maximum transfer price.
(iii) Total company saving if B buys internally instead of externally.

✅ Solution
(i) Minimum TP = Variable cost + any opportunity cost – savings
= $12 + 0 – $3 (selling cost saved)
= $9
(ii) Maximum TP = Cost to B if buying outside = $22
→ Transfer price acceptable range = $9 – $22
(iii) Saving to company if B purchases from A:
 External purchase cost avoided = $22 × 5,000 = $110,000
 Internal variable cost = $12 × 5,000 = $60,000
 No selling expense (saved $3 × 5,000 = $15,000)
Net internal cost = $60,000
Net saving = $110,000 – $60,000 = $50,000

Great 😎 let’s do the hybrid tricky case — this one forces you to apply both savings and opportunity
cost in one question. Perfect exam practice.

📌 Hybrid Transfer Pricing Exercise

Scenario:
 Division A makes a component.
 Variable cost = $14 per unit.
 External selling price = $24 per unit.
 External sales incur selling expenses of $2 per unit (not incurred if transferring internally).
 Division B currently buys the component externally at $26 per unit.
 B requires 6,000 units.
 A has spare capacity for 4,000 units only. To meet the remaining 2,000 units, A would have to
reduce external sales.
Required:
(i) Minimum transfer price for units from spare capacity.
(ii) Minimum transfer price for units requiring sacrifice of external sales.
(iii) Total saving to the company if B sources all 6,000 units internally.

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✅ Solution
(i) Spare capacity units (4,000):
 Min TP = Variable cost – selling cost saved
= $14 – $2 = $12 per unit
(ii) Capacity constrained units (2,000):
 Lost contribution (opportunity cost) = $24 – $14 – $2 = $8 per unit
 Min TP = VC + Opp. cost = $14 + $8 = $22 per unit
(iii) Company saving:
🔹 If B buys externally:
= 6,000 × $26 = $156,000
🔹 If B buys internally:
 Cost of 4,000 units (spare capacity) = 4,000 × $14 = $56,000
 Cost of 2,000 units (lost sales) = 2,000 × $14 = $28,000
 Contribution lost on 2,000 external sales = 2,000 × $8 = $16,000
Total = $56,000 + $28,000 + $16,000 = $100,000
Saving = $156,000 – $100,000 = $56,000

✅ This covers all angles in one exercise:

 Spare capacity → TP = VC – selling costs saved.
 No spare capacity → TP = VC + contribution lost.
 Net saving to company.

📌 ACCA PM Transfer Pricing – Exam Cheat Sheet

🎯 Core Objectives
A transfer price should:
 Encourage goal congruence
 Allow fair performance measurement
 Maintain divisional autonomy
 Motivate efficiency
 Be simple to apply

📌 Transfer Pricing Rules

1. If Spare Capacity Exists
Minimum TP=Variable Cost−Any selling costs saved\text{Minimum TP} = \text{Variable Cost} - \
text{Any selling costs saved}
o No opportunity cost.
o Range: VC → Market Price.

2. If No Spare Capacity (External Sales Lost)

Minimum TP=Variable Cost+Opportunity Cost\text{Minimum TP} = \text{Variable Cost} + \
text{Opportunity Cost} Opportunity Cost=Contribution lost per unit from external sales\text{Opportunity
Cost} = \text{Contribution lost per unit from external sales}

3. Hybrid Case (Partial Spare + Partial Lost Sales)

 For spare capacity portion → TP = VC – selling costs saved.
 For constrained portion → TP = VC + lost contribution.

4. Maximum Transfer Price (for receiving division)

Max TP=External purchase price\text{Max TP} = \text{External purchase price}

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📌 Company Saving Formula
Saving=External purchase cost avoided−[Internal VC+Lost contribution]\text{Saving} = \text{External
purchase cost avoided} - [\text{Internal VC} + \text{Lost contribution}]

📌 Quick Scenarios
🔹 Spare capacity: Min TP = VC (– selling costs saved).
🔹 No spare capacity: Min TP = VC + contribution lost.
🔹 Hybrid: Split between spare capacity and lost sales.
🔹 Dual pricing: Supplying division credited at market price, receiving charged at VC (HQ absorbs
difference).

✅ With this you can handle:

 Straight spare capacity Qs
 No spare capacity Qs
 Hybrid/mixed capacity Qs
 Savings calculation

📌 Transfer Pricing Rapid-Fire Practice

Q1. Spare Capacity
Division A’s VC = $12, selling price = $20, selling expenses $2 per unit. Division B needs 1,000 units. A
has spare capacity.
👉 Minimum TP = ?
A) $10
B) $12
C) $14
D) $20

Q2. No Spare Capacity

Division A’s VC = $15, external price = $25. B wants 500 units, but A must reduce external sales.
👉 Minimum TP = ?
A) $15
B) $25
C) $40
D) $10

Q3. Hybrid Case

Division A has VC = $10, external price = $18, selling expense = $2. B needs 5,000 units. A has 3,000
spare capacity, but 2,000 would displace external sales.
👉 TP per unit for each group?
A) $10 for 3,000, $18 for 2,000
B) $8 for 3,000, $18 for 2,000
C) $10 for all 5,000
D) $18 for all 5,000

Q4. Saving by Internal Transfer

B buys externally at $30/unit. If bought internally: VC = $20, no selling costs (saving $4/unit). A has
spare capacity. Demand = 2,000 units.
👉 Company saving if transfer occurs = ?

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A) $6,000
B) $12,000
C) $20,000
D) $24,000

Q5. Dual Pricing

Supplying division wants recognition of market price = $25. Receiving division wants cost basis = $15.
👉 Best compromise method?
A) Negotiated price
B) Dual pricing
C) Market-based price only
D) Head office fixed price

✅ Answers
1. A ($10) → VC $12 – $2 saved = $10.
2. B ($25) → VC $15 + contribution lost ($25 – $15) = $25.
3. A → Spare = VC – $2 saved = $10; Constrained = VC + opp. cost ($10 + $8) = $18.
4. B ($12,000) → Saving = (30 – 20 – 4) × 2,000 = $12,000.
5. B (Dual pricing) → HQ absorbs difference, both divisions happy.

📌 ACCA PM Exam-Style Question (20 Marks)

Scenario:
Division A produces a specialist component with:
 Variable cost = $16 per unit
 Fixed cost allocation = $4 per unit
 External selling price = $28 per unit
 Selling expense = $3 per unit (avoided if transferred internally)
Division B requires 8,000 units of the component.
 Division A has 6,000 units of spare capacity.
 Any further internal transfers must reduce external sales.
 Division B currently buys the component from outside suppliers at $30 per unit.
Head office wants to maximize group profit while ensuring divisional managers remain motivated and
fairly assessed.

Required
(a) Calculate the minimum transfer price for:
 Units from spare capacity
 Units that reduce external sales
(6 marks)
(b) Calculate the total company saving if B purchases all 8,000 units internally rather than externally.
(6 marks)
(c) Discuss two advantages and two disadvantages of using dual pricing in this situation.
(8 marks)

✅ Suggested Solution
(a) Minimum Transfer Price
 For spare capacity units (6,000):
Min TP=VC–Sellingcostssaved=16–3=13\text{Min TP} = VC – Selling costs saved = 16 – 3 = \
mathbf{13}

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  For constrained units (2,000):
Contribution lost per unit = ($28 – $16 – $3) = $9
Min TP=16+9=25\text{Min TP} = 16 + 9 = \mathbf{25}

(b) Total Company Saving

🔹 If B buys externally:
8,000×30=240,0008,000 × 30 = 240,000
🔹 If B buys internally:
 Cost of 6,000 spare = 6,000 × 16 = 96,000
 Cost of 2,000 constrained = 2,000 × 16 = 32,000
 Lost contribution on 2,000 external sales = 2,000 × 9 = 18,000
Total=96,000+32,000+18,000=146,000\text{Total} = 96,000 + 32,000 + 18,000 = 146,000
Saving = 240,000 – 146,000 = \mathbf{94,000}

(c) Dual Pricing – Evaluation

✅ Advantages
1. Encourages goal congruence: Supplying division credited at market ($28), receiving charged at
cost ($16). Both managers see fairness.
2. Improves performance measurement: Supplying manager judged as if selling externally;
receiving judged on realistic purchase cost.
❌ Disadvantages
1. Creates complexity: Head office must reconcile two sets of prices and adjust group accounts.
2. Can distort motivation: If divisions see HQ always intervening, autonomy is reduced.

Marking guide (20 marks)

 Part (a): 6 marks (3 + 3)
 Part (b): 6 marks (method 3, calculation 3)
 Part (c): 8 marks (2 adv = 2+2, 2 disadv = 2+2)

📌 Transfer Pricing Exam Hack Checklist

Step 1 – Check Capacity
 Does the supplying division have spare capacity?
o Yes → No opportunity cost.
o No → There is opportunity cost (lost external sales).
o Partial spare → Hybrid case (split).

Step 2 – Minimum Transfer Price (TPmin)

TPmin=VC per unit+Opportunity cost per unit−Selling costs saved (if any)\text{TPmin} = \text{VC per
unit} + \text{Opportunity cost per unit} - \text{Selling costs saved (if any)}
 Spare capacity only → TPmin = VC – selling cost saved.
 No spare capacity → TPmin = VC + (Market price – VC – selling cost).
 Hybrid → Mix of both.

Step 3 – Maximum Transfer Price (TPmax)

TPmax=External purchase price for receiving division\text{TPmax} = \text{External purchase price for
receiving division}

Step 4 – Calculate Group Saving

Saving=External purchase cost avoided−[Internal VC + Lost contribution]\text{Saving} = \text{External
purchase cost avoided} - [\text{Internal VC + Lost contribution}]

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Step 5 – Comment on Goal Congruence
 Does the TP ensure both divisions act in group’s best interest?
 If not, suggest: Negotiated price / Dual pricing / HQ intervention.

Step 6 – Evaluation Points (for discussion parts)

✅ Advantages of internal transfer:
 Group profit ↑
 Avoids external purchase costs
 Savings in selling/distribution costs
❌ Disadvantages:
 Possible demotivation if divisions feel unfairly treated
 Autonomy reduced
 Complexity if dual pricing used

⚡ Memory Shortcut
👉 “C–M–S–G–G–E” (like a mantra):
1. Capacity check
2. Min TP
3. Max TP
4. Saving
5. Goal congruence
6. Evaluation

📌 ACCA PM – Transfer Pricing Mock (10-minute practice)

Scenario:

 Division A produces a part.

 VC = $18 per unit
 Fixed cost per unit = $5
 External selling price = $32
 Selling expenses = $4 per unit (avoided on internal transfer)

Division B needs 10,000 units.

 Division A has 7,000 units of spare capacity.

 Any additional supply must reduce external sales.
 Division B’s external purchase price = $34 per unit.

Required (Total 20 marks)

(a) Calculate the minimum transfer price for:

 Spare capacity units (7,000)

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  Constrained units (3,000)
(6 marks)

(b) Calculate the total group saving if B purchases all 10,000 units internally.
(6 marks)

(c) Recommend a suitable transfer pricing approach (other than simple cost-based) to ensure fairness
and motivation, and briefly justify.
(8 marks)

✅ Suggested Answer

(a) Minimum Transfer Prices

 Spare capacity (7,000):

TPmin=VC–selling cost saved=18–4=14

Constrained units (3,000):
Lost contribution = $32 – $18 – $4 = $10
TPmin = VC + Opp. cost = 18 + 10 = 28

(b) Total group saving if B buys all 10,000 internally

Group saving (per unit) = B’s external purchase price ($34) − minimum
transfer price charged by A.

⇒ Saving = 7,000 × 16 = $112,000.

 For the 7,000 spare units: saving per unit = $34 − $18 = $16.

⇒ Saving = 3,000 × 6 = $18,000.

 For the 3,000 constrained units: saving per unit = $34 − $28 = $6.

Total group saving = $112,000 + $18,000 = $130,000.

(c) Suitable Approach

 Negotiated price: allows autonomy, both divisions can agree between $14–$34.
 Dual pricing: A credited at market ($32), B charged at cost ($18). HQ bears the difference,
ensuring both managers are motivated and fairly measured.

Justification:

 Avoids conflict between divisions.

 Encourages goal congruence.
 Ensures performance evaluation reflects real contribution.

✅ This mock applies every step of the C–M–S–G–G–E checklist.

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 Transfer pricing from various resources:
Practical Transfer Pricing
Transfer prices are set using the following techniques:
1. Market prices
2. Production Cost (of Division A) – this can be based on variable or full cost including a mark-up
3. Negotiation

Maximum: Market price - Cost savings

✓ Minimum:
◼ Spare capacity: minimum transfer price = marginal cost
◼ No spare capacity: minimum transfer price = marginal cost + opportunity cost
Minimum and Maximum Transfer Prices
1. Minimum
Division A will want its variable costs covered at least (when it has spare capacity)
Division A will want its variable costs plus any contribution lost by not selling elsewhere (if it is at full
capacity)
2. Maximum
The maximum Division B will pay is the market price

MC Question 1
Perrin Co has two divisions, A and B.
Division A has limited skilled labour and is operating at full capacity making product Y. It has been asked
to supply a different product, X, to division B. Division B currently sources this product externally for
$700 per unit.
The same grade of materials and labour is used in both products. The cost cards for each product are
shown below:
Y X
Product
($)/unit ($)/unit

Selling price 600 -

Direct materials ($50 per kg) 200 150

Direct labour ($20 per hour) 80 120

Apportioned fixed overheads ($15 per hour) 60 90

Using an opportunity cost approach to transfer pricing, what is the minimum transfer price?
A. $270
B. $750
C. $590
D. $840
Answer: B

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MC Question 14
Ox Co has two divisions, A and B. Division A makes a component for air conditioning units which it can
only sell to Division B. It has no other outlet for sales.
Current information relating to Division A is as follows:
Marginal cost per unit $100
Transfer price of the component $165
Total production and sales of the component each year 2,200 units
Specific fixed costs of Division A per year $10,000
Cold Co has offered to sell the component to Division B for $140 per unit. If Division B accepts this
offer, Division A will be closed.
If Division B accepts Cold Co’s offer, what will be the impact on profits per year for the group as a
whole?
A Increase of $65,000
B Decrease of $78,000
C Decrease of $88,000
D. Increase of $55,000
Answer: B
Increase in variable costs per unit from buying in ($140 – $100) =$40
Therefore total increase in variable costs (2,200 units x $40) = $88,000
Less the specific fixed costs saved if A is shut down = ($10,000)
Decrease in profit = $78,000

Question 4a
A manufacturing company, Man Co, has two divisions: Division L and Division M. Both divisions make a
single standardised product. Division L makes component L, which is supplied to both Division M and
external customers.
Division M makes product M using one unit of component L and other materials. It then sells the
completed product M to external customers. To date, Division M has always bought component L from
Division L.
The following information is available:
Component L Product M
$ $
Selling price 40 96
Direct materials:
Component L (40)
Other (12) (17)
Direct labour (6) (9)
Variable overheads (2) (3)
Selling and distribution costs (4) (1)

Contribution per unit before fixed costs 16 26

Annual fixed costs $500,000 $200,000

Annual external demand (units) 160,000 120,000
Capacity of plant 300,000 130,000

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Division L charges the same price for component L to both Division M and external customers. However,
it does not incur the selling and distribution costs when transferring internally.
Division M has just been approached by a new supplier who has offered to supply it with component L
for $37 per unit. Prior to this offer, the cheapest price which Division M could have bought component L
for from outside the group was $42 per unit.
It is head office policy to let the divisions operate autonomously without interference at all.
Required:
(a) Calculate the incremental profit/(loss) per component for the group if Division M accepts the
new supplier’s offer and recommend how many components Division L should sell to Division M if
group profits are to be maximised. (3 marks)

Answer:
Maximising group profit
Division L has enough capacity to supply both Division M and its external customers with component L.
Therefore, incremental cost of Division M buying externally is as follows:
Cost per unit of component L when bought from external supplier: $37
Cost per unit for Division L of making component L: $20.
Therefore incremental cost to group of each unit of component L being bought in by Division M rather
than transferred internally: $17 ($37 – 20).
From the group’s point of view, the most profitable course of action is therefore that all 120,000 units of
component L should be transferred internally.

Question 4b
A manufacturing company, Man Co, has two divisions: Division L and Division M. Both divisions make a
single standardised product. Division L makes component L, which is supplied to both Division M and
external customers.
Division M makes product M using one unit of component L and other materials. It then sells the
completed product M to external customers. To date, Division M has always bought component L from
Division L.
The following information is available:
Component L Product M
$ $
Selling price 40 96
Direct materials:
Component L (40)
Other (12) (17)
Direct labour (6) (9)
Variable overheads (2) (3)
Selling and distribution costs (4) (1)

Contribution per unit before fixed costs 16 26

Annual fixed costs $500,000 $200,000

Annual external demand (units) 160,000 120,000
Capacity of plant 300,000 130,000
Division L charges the same price for component L to both Division M and external customers. However,
it does not incur the selling and distribution costs when transferring internally.

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Division M has just been approached by a new supplier who has offered to supply it with component L
for $37 per unit. Prior to this offer, the cheapest price which Division M could have bought component L
for from outside the group was $42 per unit.
It is head office policy to let the divisions operate autonomously without interference at all.
Required:
(b) Using the quantities calculated in (a) and the current transfer price, calculate the total annual
profits of each division and the group as a whole. (6 marks)
Answer:
Calculating total group profit
Total group profits will be as follows:
Division L:
Contribution earned per transferred component = $40 – $20 = $20
Profit earned per component sold externally = $40 – $24 = $16
$
120,000 x $20 2,400,000
2,560,000
160,000 x $16
4,960,000
Less fixed costs (500,000)

Profit 4,460,000

Division M:
Profit earned per component sold externally = $27 – $1 = $26
$
120,000 x $26 3,120,000
(200,000)
Less fixed costs
2,920,000
Profit
7,380,000
Total profit

Question 4c
A manufacturing company, Man Co, has two divisions: Division L and Division M. Both divisions make a
single standardised product. Division L makes component L, which is supplied to both Division M and
external customers.
Division M makes product M using one unit of component L and other materials. It then sells the
completed product M to external customers. To date, Division M has always bought component L from
Division L.
The following information is available:
Component L Product M
$ $
Selling price 40 96
Direct materials:
Component L (40)
Other (12) (17)
Direct labour (6) (9)

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Variable overheads (2) (3)
Selling and distribution costs (4) (1)

Contribution per unit before fixed costs 16 26

Annual fixed costs $500,000 $200,000

Annual external demand (units) 160,000 120,000
Capacity of plant 300,000 130,000
Division L charges the same price for component L to both Division M and external customers. However,
it does not incur the selling and distribution costs when transferring internally.
Division M has just been approached by a new supplier who has offered to supply it with component L
for $37 per unit. Prior to this offer, the cheapest price which Division M could have bought component L
for from outside the group was $42 per unit.
It is head office policy to let the divisions operate autonomously without interference at all.
Required:
(c) Discuss the problems which will arise if the transfer price remains unchanged and advise the
divisions on a suitable alternative transfer price for component L. (6 marks)
Problems with current transfer price and suggested alternative

Answer:
The problem is that the current transfer price of $40 per unit is now too high. Whilst this has not been a
problem before since external suppliers were charging $42 per unit, it is a problem now that Division M
has been offered component L for $37 per unit.
If Division M now acts in its own interests rather than the interests of the group as a whole, it will buy
component L from the external supplier rather than from Division L.
This will mean that the profits of the group will fall substantially and Division L will have significant
unused capacity.
Consequently, Division L needs to reduce its price. The current price does not reflect the fact that there
are no selling and distribution costs associated with transferring internally, i.e. the cost of selling
internally is $4 less for Division L than selling externally.
So, it could reduce the price to $36 and still make the same profit on these sales as on its external sales.
This would therefore be the suggested transfer price so that Division M is still saving $1 per unit
compared to the external price.
A transfer price of $37 would also presumably be acceptable to Division M since this is the same as the
external supplier is offering.

Question 2
Mobe Co manufactures electronic mobility scooters. The company is split into two divisions: the scooter
division (Division S) and the motor division (Division M). Division M supplies electronic motors to both
Division S and to external customers. The two divisions run as autonomously as possible, subject to the
group’s current policy that Division M must make internal sales first before selling outside the group; and
that Division S must always buy its motors from Division M. However, this company policy, together
with the transfer price which Division M charges Division S, is currently under review.
Details of the two divisions are given below.
Division S
Division S’s budget for the coming year shows that 35,000 electronic motors will be needed. An external
supplier could supply these to Division S for $800 each.

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Division M
Division M has the capacity to produce a total of 60,000 electronic motors per year. Details of Division
M’s budget, which has just been prepared for the forthcoming year, are as follows:
Budgeted sales volume (units) 60,000
Selling price per unit for external sales of motors $850
Variable costs per unit for external sales of motors $770
The variable cost per unit for motors sold to Division S is $30 per unit lower due to cost savings on
distribution and packaging.
Maximum external demand for the motors is 30,000 units per year.
Required:
Assuming that the group’s current policy could be changed, advise, using suitable calculations, the
number of motors which Division M should supply to Division S in order to maximise group profits.
Recommend the transfer price or prices at which these internal sales should take place.
Note: All relevant workings must be shown.
Answer:
Mobe Co
From the group’s perspective
For every motor sold externally, Division M generates a profit of $80 ($850 – $770) for the group as a
whole. For every motor which Division S has to buy from outside of the group, there is an incremental
cost of $60 per unit ($800 – [$770 – $30]).
Therefore, from a group perspective, as many external sales should be made as possible before any
internal sales are made.
Consequently, the group’s current policy will need to be changed. This does, however, assume that the
quality of the motors bought from outside the group is the same as the quality of the motors made by
Division M.
Division M’s total capacity is 60,000 units. Given that it can make external sales of 30,000 units, it can
only supply 30,000 of Division S’s demand for 35,000 motors.
These 30,000 units should be bought from Division M since, from a group perspective, the cost of
supplying these internally is $60 per unit cheaper than buying externally. The remaining 5,000 motors
required by Division S should then be bought in from the external supplier at $800 per unit.
In order to work out the transfer price which should be set for the internal sales of 30,000 motors, the
perspective of both divisions must be considered.
From Division M’s perspective
Division M’s only buyer for these 30,000 motors is Division S, so the lowest price it would be prepared to
charge is the marginal cost of making these units, which is $740 per unit.
However, it would ideally want to make some profit on these motors too and would consequently expect a
significantly higher price than this.
From Division S’s perspective
Division S knows that it can buy as many external motors as it needs from outside the group at a price of
$800 per unit. Therefore, this will be the maximum price which it is prepared to pay.
Overall
Therefore, the transfer price should be set somewhere between $740 and $800. From the perspective of
the group, the total group profit will be the same irrespective of where in this range the transfer price is
set.
However, it is important that divisional managers and staff remain motivated. Given the external sales
price which Division M can achieve and the fact that Division S would have to pay $800 for each motor
bought from outside the group, the transfer price should probably be at the higher end of the range.

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MC Question 8
Oxco has two divisions, A and B. Division A makes a component for air conditioning units which it can
only sell to Division B. It has no other outlet for sales.
Current information relating to Division A is as follows:
Marginal cost per unit $100
Transfer price of the component $165
Total production and sales of the component each year 2,200 units
Specific fixed costs of Division A per year $10,000
Cold Co has offered to sell the component to Division B for $140 per unit. If Division B accepts this
offer, Division A will be shut.
If Division B accepts Cold Co’s offer, what will be the impact on profits per year for the group as a
whole?
A. Increase of $65,000
B. Decrease of $78,000
C. Decrease of $88,000
D. Increase of $55,000

Answer:
B
Increase in variable costs from buying in (2,200 units x $40 ($140 – $100)) = $88,000
Less the specific fixed costs saved if A is shut down = ($10,000)
Decrease in profit = $78,000

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