Green Auto's Northern Division is currently purchasing a part from an outside supplier.The company's Southern Division,which has no excess capacity,makes and sells this part for external customers at a variable cost of $19 and a selling price of $31.If Southern begins sales to Northern,it (1)will use the general transfer-pricing rule and (2)will be able to reduce variable cost on internal transfers by $3.On the basis of this information,Southern would establish a transfer price of:

Question

Quizplus · Accepted Answer

Southern Division can sell the part to the Northern Division at a transfer price of $28, which is the sum of the variable cost of $19 plus the opportunity cost of lost external sales of $9 ($31 external selling price - $22 variable cost after a $3 cost reduction on internal transfers). This price ensures that the company as a whole does not lose any potential profits from external sales and Southern still makes a profit from internal sales. Choosing a transfer price lower than $28 would result in a loss of potential profits from external sales while choosing a transfer price higher than $28 would make the Northern Division better off, but the company as a whole would lose potential external sales.

Green Auto's Northern Division Is Currently Purchasing a Part from an Outside