Question

Perfumes Ltd has two divisions: the Perfume Division and the Bottle Division. The company is decentralised and each division is evaluated as a profit centre. The Bottle Division produces bottles that can be used by the Perfume Division. The Bottle Division's variable manufacturing cost per unit is $3.00 and shipping costs are $0.20 per unit. The Bottle Division's external sales price is $4.00 per unit. No shipping costs are incurred on sales to the Perfume Division. The Perfume Division can purchase similar bottles in the external market for $3.50. The Bottle Division has sufficient capacity to meet all external market demands in addition to meeting the demands of the Perfume Division. Required: a) Using the general rule, determine the minimum transfer price. b) Assume the Bottle Division has no excess capacity and can sell everything produced externally. Would the transfer price change? c) Assume the Bottle Division has no excess capacity and can sell everything produced externally. What is the maximum amount Perfume Division would be willing to pay for the bottles? d) When is it more appropriate to use market-based transfer price rather than cost-based transfer price? (1 mark)

Answer 1

a) General rule is if a profit centre has excess capacity than it can set the minimum transfer price as the variable cost it incurs. IN the given case variable cost shall be the transfer price as bottle division shall not incur shipping cost while selling to perfume division. So, transfer price shall be $3

b) If Bottle division has no excess capacity, then transfer price shall be the price at which it sells in external market which is $4.

c)But, since perfume division can get bottles from external market at 3.50, it shall be willing to pay a max of 3.50 per unit.

d) It is appropriate to use market based transfer prices if the division has no excess capacity and all that is produced is sold to external market.