Strategic Cost Management · Transfer Pricing (Cost Management)

Transfer Pricing Decisions: Minimum and Maximum Transfer Price

Updated 11 October 2026 · Fact-checked

The minimum transfer price is the least the selling division can accept: its variable cost per unit plus the contribution lost per unit by selling internally. With spare capacity, nothing is lost, so it equals variable cost. The maximum price is the lower of the buyer's outside purchase price and its net realisable value per unit.

Understand Transfer Pricing Decisions and Minimum/Maximum Price

A transfer price is the price at which one division of a company sells goods to another division of the same company. For the company as a whole, the price is only an internal transfer of money. But it decides how profit is split between divisions, and it can push managers into decisions that hurt the company.

The seller will not agree to a price below what it gives up. So the minimum transfer price is the seller's relevant cost per unit. It has two parts: the incremental (usually variable) cost of making the unit, and the opportunity cost of selling internally.

The opportunity cost depends on capacity. With spare capacity, the seller loses no other sale by supplying the buyer, so opportunity cost is zero. At full capacity, each unit sent inside means a unit not sold outside, so the seller loses the contribution it would have earned elsewhere. Then the minimum price equals the outside market price (less any selling cost saved on internal sales).

The maximum transfer price is the buyer's side. The buyer will not pay more than it would pay for the same item outside, and not more than the item is worth to it. If the buyer converts the item into a final product, its worth is the net realisable value: the final selling price less the buyer's further processing cost and other costs.

A deal is good for the company when the buyer's maximum is at least the seller's minimum. Any price between the two makes both divisions better off. If the maximum is below the minimum, the transfer should not happen.

Key rules to remember

Minimum transfer price (general): Minimum price = Incremental cost per unit + Opportunity cost per unit; Incremental cost is normally variable cost. Add any extra fixed cost that the transfer really causes.
Minimum price with spare capacity: Minimum price = Variable cost per unit; Opportunity cost is nil because no outside sale is lost.
Minimum price at full capacity (outside sale lost): Minimum price = Variable cost per unit + (Outside price − Variable cost per unit) = Outside price; Reduce the outside price by any selling or delivery cost saved on the internal sale.
Partial spare capacity: Opportunity cost per unit transferred = Contribution per outside unit × Outside units lost ÷ Units transferred. Minimum price = Variable cost per unit + (Contribution per outside unit × Outside units lost ÷ Units transferred); Only the units that displace outside sales carry opportunity cost. Compute the total, then spread over all units transferred. The opportunity cost alone is not the minimum price; always add variable cost.
Maximum transfer price (buyer): Maximum price = Lower of (Outside purchase price, Net realisable value per unit to the buyer); Net realisable value = Final selling price − Buyer's further processing and other costs, before the transfer price.
Transfer decision rule: Transfer if Maximum price ≥ Minimum price; The range between them is the negotiating range. Company gain per unit = Maximum − Minimum.

How to solve Transfer Pricing Decisions and Minimum/Maximum Price questions

Use this order for any question on minimum and maximum transfer price, make-or-buy within a group, or internal transfer versus outside sale.

1Identify the seller and the buyer. Note the units the buyer needs and the seller's capacity.
2List the seller's variable cost per unit. Remove costs that will not be incurred on internal sales, such as packing or commission.
3Check capacity. If the seller can make the internal units without losing outside sales, opportunity cost is nil. If not, find the contribution on each outside sale lost.
4Calculate the seller's minimum price = incremental cost + opportunity cost per unit.
5Find the buyer's maximum price: compare the outside purchase price with the net realisable value after its own further costs. Take the lower.
6Compare the two. If maximum is below minimum, do not transfer. If not, state the negotiating range.
7Give a clear recommendation for the company as a whole, with the total gain or loss in rupees. Mention fixed costs only if they change.

Quickest way: Capacity test, then compare two numbers

When to use it: Use when time is short and the question asks for a price range or whether to accept an internal transfer.

Write the seller's variable cost and the outside price in two lines.
Ask: does supplying inside cost me an outside sale? If no, minimum = variable cost. If yes, minimum = outside price (net of saved costs).
For partial capacity, find lost outside units, multiply by outside contribution, add to variable cost of all internal units, then divide by units transferred.
Write buyer's maximum = lower of outside buy price and NRV.
Compare. Say transfer or not, and give the rupee gain = (maximum − minimum) × units.

Common mistakes in Transfer Pricing Decisions and Minimum/Maximum Price

Using full cost instead of variable cost as the minimum price under spare capacity.
Students are used to cost-plus transfer prices, where fixed cost is absorbed.
Fix: Fixed costs that stay the same whether or not the transfer happens are not relevant. Use variable cost, and add only fixed cost that actually increases.
Ignoring opportunity cost at full capacity.
Students stop after variable cost, because the question gives no separate figure for opportunity cost.
Fix: Always ask what the seller gives up. At full capacity, that is the contribution on the outside sale, so the minimum becomes the outside price.
Not adjusting the outside price for saved costs.
The outside price is copied directly as the minimum.
Fix: If internal sales avoid commission, packing or delivery, deduct these from the outside price to get the true minimum.
Using the buyer's final selling price as the maximum price.
Students forget that the buyer has its own processing cost.
Fix: Maximum = final selling price − buyer's further costs (NRV). Then compare with the outside purchase price and take the lower.
Treating partial spare capacity as all-or-nothing.
Students apply the spare-capacity rule or the full-capacity rule to the whole quantity.
Fix: Split the internal units: those from spare capacity carry no opportunity cost, those that displace outside sales carry lost contribution. Then find the total relevant cost and decide.
Recommending based on one division's profit rather than the company's.
The question names divisions, so the answer stays at division level.
Fix: End with the effect on the whole company. Compare the company's cash flows with and without the transfer.

Worked examples

Example 1

Division A makes component X. Variable cost is ₹120 per unit and the outside price is ₹180. Division B needs 2,000 units and can buy the same component outside at ₹175 per unit. A has spare capacity of 5,000 units. (a) Find the minimum and maximum transfer price. (b) Should the transfer take place? State the gain to the company if B buys from A instead of outside.

Show the solution

A has spare capacity, so supplying B costs A no outside sale. Opportunity cost = ₹0.
Minimum price = variable cost ₹120 + ₹0 = ₹120.
B's maximum price is what it pays outside = ₹175 (no NRV figure is given).
Maximum ₹175 ≥ minimum ₹120, so the transfer is worthwhile.
The company saves the outside purchase cost and incurs only A's variable cost: ₹175 − ₹120 = ₹55 per unit.
Total gain = ₹55 × 2,000 = ₹1,10,000.

Answer: Minimum ₹120, maximum ₹175. Transfer should take place. Any price from ₹120 to ₹175 works, and the company gains ₹1,10,000.

Example 2

Division P makes a part with variable cost of ₹80 per unit. It sells outside at ₹130 per unit, with ₹10 per unit of packing and delivery cost that is not incurred on internal sales. P is working at full capacity. Division Q can use the part to make a product that sells for ₹200 per unit, with Q's further processing cost of ₹50 per unit. Q can also buy a similar part outside at ₹135. (a) Find P's minimum transfer price. (b) Find Q's maximum transfer price. (c) Should the transfer take place?

Show the solution

P is at full capacity, so each internal unit displaces an outside sale.
Outside contribution = ₹130 − ₹80 − ₹10 = ₹40 per unit.
Minimum price = variable cost on internal sale ₹80 + lost contribution ₹40 = ₹120. (Same as outside price ₹130 less saved ₹10.)
Q's NRV = ₹200 − ₹50 = ₹150 per unit.
Q's outside purchase price is ₹135. Maximum = lower of ₹135 and ₹150 = ₹135.
Maximum ₹135 ≥ minimum ₹120, so a range exists from ₹120 to ₹135.
Company gain per unit: if Q buys outside, P still sells outside and the company pays ₹135 for Q's part. If Q buys from P, P forgoes an outside net revenue of ₹120 (₹130 − ₹10), which is the same as its variable cost ₹80 plus lost contribution ₹40. Saving = ₹135 − ₹120 = ₹15 per unit.

Answer: Minimum ₹120, maximum ₹135. The transfer is worthwhile, with a company gain of ₹15 per unit. A price between ₹120 and ₹135 benefits both divisions.

Exam tips

Write the capacity position first. Markers look for the words spare capacity, full capacity, and opportunity cost in your working.
Show minimum price as two lines: incremental cost and opportunity cost. Even if the total is wrong, you earn method marks.
Read the question for costs avoided on internal sales, such as commission, packing or freight. These are often hidden in the data.
In MCQs, check whether the buyer's maximum is the outside price or NRV. The answer is the lower of the two.
Finish with a recommendation and a rupee figure for the company. Fourteen-mark questions expect a decision, not only a price.

Practice questions from Transfer Pricing (Cost Management)

Transfer Pricing Decisions and Minimum/Maximum Price: frequently asked questions

What is the minimum transfer price formula under spare capacity and full capacity?

Minimum price = incremental cost per unit + opportunity cost per unit. With spare capacity, opportunity cost is nil, so the minimum is variable cost. At full capacity, the opportunity cost is the contribution lost on outside sales, so the minimum equals the outside price, less any cost saved on internal sales.

What is the difference between minimum and maximum transfer price?

The minimum is set by the seller: the lowest price it can accept without becoming worse off. The maximum is set by the buyer: the highest price it will pay, limited by its outside purchase price or by the net realisable value of the item. A transfer makes sense only when the maximum is at least the minimum.

Should a division accept an internal transfer or sell outside?

Compare the seller's contribution from each option. If it has spare capacity, internal sales add to profit at any price above variable cost. If it is at full capacity, it should accept the internal order only when the transfer price at least equals the outside price net of saved costs.

How do you calculate opportunity cost in transfer pricing?

Opportunity cost is the contribution the seller gives up on the best alternative use of the capacity, usually outside sales. Calculate contribution per outside unit, multiply by the units lost, and divide by the units transferred to get a per-unit figure.