Optimal Transfer Price Calculations for ACCA PM

Understand Optimal Transfer Price Calculations

Key rules to remember

Minimum transfer price

Minimum = marginal cost of the seller + opportunity cost to the group

Opportunity cost is the contribution lost on other uses of the resource, such as outside sales.

Minimum price with spare capacity

Minimum = marginal cost per unit

No outside sales are lost, so opportunity cost is nil. Fixed costs are not relevant.

Minimum price at full capacity with an external market

Minimum = marginal cost + contribution lost per unit on external sale = external market price (less any saved selling costs)

Where the item is sold externally at the same cost, this reduces to the market price net of costs saved on internal sales.

Minimum price with a limited key resource

Minimum = marginal cost + (contribution per unit of scarce resource forgone × scarce resource used per unit)

Use when production of other products is given up to make the transferred item.

Maximum transfer price

Maximum = lower of (net marginal revenue of the buyer) and (external purchase price of an equivalent item)

Net marginal revenue = final selling price less the buyer's further marginal costs.

Acceptable range

Transfer is worthwhile for the group if minimum ≤ maximum

Any price within the range is acceptable to both divisions in theory. Negotiation decides the point within it.

How to solve Optimal Transfer Price Calculations questions

1. 1Identify the seller and the buyer, and the quantity the buyer wants to transfer.
2. 2Find the seller's marginal cost per unit. Use variable cost only. Ignore fixed overhead unless it is clearly incremental.
3. 3Check the seller's capacity. If there is spare capacity for the whole transfer, opportunity cost is zero.
4. 4If capacity is limited, work out what the seller gives up per unit transferred. This is usually the contribution on lost external sales, or on another product if a scarce resource is shared.
5. 5Add marginal cost and opportunity cost to get the minimum transfer price per unit.
6. 6Find the buyer's maximum: net marginal revenue (selling price less the buyer's own further costs) and the external purchase price. Take the lower.
7. 7Compare the two figures. State the range, say whether transfer benefits the group, and comment on any behavioural issue such as a division refusing to trade.

Quickest way: Three-line check for the range

Common mistakes in Optimal Transfer Price Calculations

• Including fixed costs in the minimum transfer price when there is spare capacity.

  Students use full cost because it is the figure given first in the data.

  Fix: Fixed costs are not incremental. With spare capacity use variable cost only, unless the question says fixed costs will rise.

• Forgetting opportunity cost when the seller is at full capacity.

  Students stop after calculating marginal cost.

  Fix: Always ask the capacity question first. At full capacity, add the contribution lost on external sales.

• Double counting by adding the lost selling price and the marginal cost.

  Opportunity cost is confused with lost revenue.

  Fix: Opportunity cost is lost contribution (selling price less variable cost). Marginal cost plus lost contribution equals the lost selling price, net of any costs saved.

• Using the buyer's final selling price as the maximum price.

  Students forget that the buyer has further processing costs.

  Fix: Deduct the buyer's further marginal costs to reach net marginal revenue.

• Ignoring the external purchase price when finding the maximum.

  The question gives the net marginal revenue first and it looks complete.

  Fix: Check whether the buyer could buy the item outside. The maximum is the lower of the two figures.

• Treating partial spare capacity as all or nothing.

  Students apply one rule to all units.

  Fix: Work out the units that use spare capacity and the units that displace other sales. Calculate a price for each, or the total relevant cost for the transfer.

Worked examples