ExpertMedium2 marksMultiple Choice
ACCA · Question 15 · Transfer Pricing
Section A
AutoParts Ltd has two divisions: Engine and Assembly. Engine division produces a component with a variable cost of $40. It sells this component externally for $70. Engine division currently has spare capacity and can meet all external demand as well as the internal demand from Assembly division.
What is the minimum transfer price the Engine division should accept from the Assembly division?
Section A
AutoParts Ltd has two divisions: Engine and Assembly. Engine division produces a component with a variable cost of $40. It sells this component externally for $70. Engine division currently has spare capacity and can meet all external demand as well as the internal demand from Assembly division.
What is the minimum transfer price the Engine division should accept from the Assembly division?
Answer options:
A.
$0
B.
$40
C.
$70
D.
$110
How to approach this question
Apply the general rule for transfer pricing: Minimum TP = Marginal Cost + Opportunity Cost. Since there is spare capacity, opportunity cost is zero.
Full Answer
B.$40✓ Correct
The minimum transfer price from the supplying division's perspective is Marginal Cost + Opportunity Cost. Because the Engine division has spare capacity, it does not have to give up any external sales to supply the Assembly division. Therefore, the opportunity cost is $0. The minimum transfer price is simply the variable cost of $40.
Common mistakes
Selecting $70, forgetting that opportunity cost only applies when capacity is fully utilized.
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