Question

Katsen Coffee has two divisions, Roasting and Brewing. The Roasting division can sell its products to an external market for $15 per unit. The division's variable manufacturing costs are $4.5 per pound and fixed manufacturing costs are $0.90 per pound.

1. Using the economic rule of transfer pricing, what internal price should be set to transfer a pound of coffee from the Roasting division to the Brewing division? Assume there is sufficient capacity to support the internal transfer.
2. Now assume the Roasting division is currently at maximum capacity, selling all the beans they can roast to their external customers. What internal price should be set to transfer a pound of coffee from the Roasting division to the Brewing division?

Answer 1

Answer (a):

The roasting division has sufficient capacity to support the internal transfer. As such roasting division will not loose any of its current external sales.

Minimum transfer price will be = Its variable cost per pound = $4.50  

Minimum transfer price will be = $4.50  

Answer (b):

The Roasting division is currently at maximum capacity, selling all the beans they can roast to their external customers.As such roasting division will loose its current external sales if it has sell internally.

The transfer price per pound will be = Price it can sell its products to external market = $15

Any price lesser than $15 will reduce its contribution margin and hence profit.

Internal price that should be set to transfer a pound of coffee from the Roasting division to the Brewing division = $15