Management Accounting · Transfer Pricing

Transfer Pricing Numerical Problems with Spare and Full Capacity

Updated 10 October 2026 · Fact-checked

Transfer pricing numericals ask for the price range at which goods move between divisions. The minimum is the selling division's variable cost plus any contribution lost by not selling outside. The maximum is the lower of the buying division's net marginal revenue and the outside purchase price. Transfer internally if the minimum does not exceed the maximum.

Understand Transfer Pricing Numerical Problems

A transfer price is the price at which one division of a company supplies goods to another division. The company earns the same total profit whatever the price. The price only decides how that profit is split between the two divisions.

The selling division will not accept a price below its minimum transfer price. The buying division will not pay more than its maximum transfer price. If the minimum is higher than the maximum, internal transfer does not help the company and the buyer should go outside. If the minimum is at or below the maximum, any price in that range works for both divisions.

The minimum depends on capacity. With spare capacity, the selling division loses no outside sales by supplying internally, so it only needs to recover its variable cost. At full capacity, every unit sent inside is a unit not sold outside, so it must also recover the contribution it gives up. That lost contribution is the opportunity cost.

The maximum depends on what the buyer gains. It cannot exceed the price at which the buyer can buy the same item outside. It also cannot exceed the buyer's own net marginal revenue, which is its selling price less its further processing cost. The lower of the two is the ceiling.

For the company, think in relevant costs only. Compare the extra cost of making the item internally, including any outside contribution lost, with the cost of buying it outside. Fixed costs that do not change are ignored.

Key rules to remember

Minimum transfer price (general): Minimum price per unit = Variable cost per unit + Opportunity cost per unit; Variable cost here means the cost the seller actually incurs on the transferred unit. Opportunity cost is the contribution lost elsewhere.
Minimum price with spare capacity: Minimum price = Variable cost per unit (opportunity cost = 0); Applies only to units that can be made without cutting outside sales.
Minimum price at full capacity: Minimum price = Variable cost + (Outside price − Variable cost − Selling costs saved) = Outside price − Selling costs saved on internal sale; Selling costs such as commission or delivery are saved only if the internal sale does not incur them. If there are none, the minimum is simply the outside price.
Minimum price with partial spare capacity: Total minimum = (Units from spare capacity × Variable cost) + (Units displacing outside sales × Outside net price). Divide by total units for the average per unit.; Use when the buyer wants more units than the spare capacity.
Maximum transfer price: Maximum price = Lower of (Net marginal revenue of buyer; Outside purchase price of the same item); Net marginal revenue = Final selling price − Further variable processing cost of the buyer.
Transfer decision rule: Transfer internally if Minimum price ≤ Maximum price; If the minimum is higher, the company is better off with the buyer purchasing outside.
Company gain from internal transfer: Gain = Outside purchase price × Total units − [Variable cost × Total units + Lost contribution per displaced unit × Displaced units]; Lost contribution is per displaced unit, net of selling costs saved, and applies only to units that displace outside sales. It is zero under spare capacity. Do not apply it to all units unless every unit displaces an outside sale. A negative result means do not transfer.

How to solve Transfer Pricing Numerical Problems questions

Use the same order for every transfer pricing question. It keeps the working clean and earns step marks.

1Read the question and mark the seller's capacity, outside demand, the units the buyer wants, and any selling costs saved on internal sales.
2Find the seller's spare capacity: capacity less outside sales. Compare it with the units the buyer needs.
3Calculate the minimum transfer price: variable cost plus opportunity cost. Use zero opportunity cost for spare units and lost contribution for units that displace outside sales.
4Calculate the maximum transfer price: the lower of the buyer's net marginal revenue and the outside purchase price.
5State the range and decide. If minimum is at or below maximum, transfer; otherwise the buyer should purchase outside.
6Work out the effect on each division's profit at the given transfer price and on company profit. Check that the two divisional changes add up to the company change.
7Write a one-line conclusion with the recommendation and the rupee gain or loss to the company.

Quickest way: Opportunity cost shortcut for exam time

When to use it: Use when the question asks for the minimum price, maximum price or whether to buy outside, and you have limited time.

Ask one question first: does supplying internally reduce outside sales? If no, minimum = variable cost. If yes, minimum = outside price less any selling cost saved.
Set the maximum as the lower of outside buying price and (final selling price − buyer's further cost).
Compare the two numbers. Minimum above maximum means no transfer.
For the company gain, compare only two things: the outside buying price for all units against the seller's variable cost for all units plus the lost outside contribution on displaced units only.
Write the total gain as the final answer.

Common mistakes in Transfer Pricing Numerical Problems

Using full cost (including fixed overheads) as the minimum price under spare capacity.
Students link transfer price with cost-plus pricing from other chapters.
Fix: With spare capacity, fixed costs are not affected by the transfer, so they are not relevant. Use variable cost only.
Ignoring opportunity cost when the seller is at full capacity.
The question gives variable cost clearly, so students stop there.
Fix: Always ask whether outside sales will be given up. If yes, add the lost contribution, which makes the minimum equal to the outside net price.
Forgetting to deduct selling costs saved on internal sales.
The outside price is read as the opportunity cost directly.
Fix: Opportunity cost is outside price less variable cost less selling costs not incurred internally. Check the data for commission, packing or delivery.
Taking the maximum price as only the outside purchase price.
Students forget the buyer's own profitability limit.
Fix: Calculate net marginal revenue as well and take the lower of the two figures.
Applying the opportunity cost to all units when only some displace outside sales.
Students treat the buyer's order as one block.
Fix: Split the units. Spare capacity units carry variable cost only. Only the extra units carry the lost contribution. Then find the average if asked.
Showing divisional profits but not checking the company effect.
The transfer price seems to create profit by itself.
Fix: Remember the transfer price is a transfer between divisions. Company profit changes only through real costs and real outside sales. Always add the two divisional changes to confirm.

Worked examples

Example 1

Division A makes a component with a variable cost of ₹60 per unit. Its capacity is 10,000 units a year and it can sell 8,000 units outside at ₹100 each. Division B wants 4,000 units and can buy the same component outside at ₹90. (a) Find the minimum and maximum transfer price per unit for the 4,000 units, ignoring B's own selling price. (b) Should B buy internally? What is the gain to the company? (c) Show the effect on each division at a transfer price of ₹85.

Show the solution

Spare capacity of A = 10,000 − 8,000 = 2,000 units. B needs 4,000 units, so 2,000 units can come from spare capacity and 2,000 units will displace outside sales.
Minimum for the 2,000 spare units = variable cost = ₹60 each = ₹1,20,000.
Minimum for the 2,000 displacing units = variable cost ₹60 + lost contribution (₹100 − ₹60 = ₹40) = ₹100 each = ₹2,00,000.
Total minimum = ₹1,20,000 + ₹2,00,000 = ₹3,20,000. Average minimum per unit = ₹3,20,000 ÷ 4,000 = ₹80.
Maximum = outside purchase price = ₹90 per unit. (B's selling price is not given, so no net marginal revenue limit applies.)
Range is ₹80 to ₹90. Minimum is below maximum, so internal transfer is worthwhile.
Company gain = Outside purchase price × Total units − [Variable cost × Total units + Lost contribution per displaced unit × Displaced units] = ₹90 × 4,000 − [₹60 × 4,000 + ₹40 × 2,000] = ₹3,60,000 − [₹2,40,000 + ₹80,000] = ₹3,60,000 − ₹3,20,000 = ₹40,000. This equals (₹90 − ₹80) × 4,000.
At ₹85: A's revenue = 4,000 × ₹85 = ₹3,40,000. Less variable cost ₹2,40,000 and lost outside contribution ₹80,000. A's profit gain = ₹20,000.
B's saving = (₹90 − ₹85) × 4,000 = ₹20,000.
Total = ₹20,000 + ₹20,000 = ₹40,000, which matches the company gain.

Answer: Minimum transfer price is ₹80 per unit on average and maximum is ₹90. B should buy internally. Company profit rises by ₹40,000. At ₹85, A gains ₹20,000 and B gains ₹20,000.

Example 2

Division P makes a part with a variable cost of ₹90 per unit (excluding selling cost). It sells all 5,000 units of its capacity outside at ₹150 per unit and incurs selling cost of ₹10 per unit on outside sales, which is not incurred on internal sales. Division Q needs 1,000 units. Q can buy the part outside at ₹120. After using the part, Q incurs further variable cost of ₹40 per unit and sells the final product at ₹170. Find the minimum and maximum transfer prices and advise whether Q should buy from P. State the effect on company profit.

Show the solution

P is at full capacity, so each unit sent to Q displaces an outside sale.
Contribution per outside unit = ₹150 − ₹90 − ₹10 = ₹50. This is the opportunity cost.
Minimum transfer price = variable cost ₹90 + opportunity cost ₹50 = ₹140. Check: outside price ₹150 less selling cost saved ₹10 = ₹140.
Net marginal revenue of Q = ₹170 − ₹40 = ₹130.
Outside purchase price = ₹120. Maximum = lower of ₹130 and ₹120 = ₹120.
Minimum ₹140 is above maximum ₹120, so internal transfer should not take place.
Company effect per unit. If Q buys outside: P still earns ₹50 outside contribution, and Q earns ₹170 − ₹40 − ₹120 = ₹10. Total = ₹60.
If transferred internally: P earns no outside contribution on that unit, and Q earns ₹170 − ₹40 − ₹90 = ₹40. Total = ₹40.
Using the gain formula: ₹120 × 1,000 − [₹90 × 1,000 + ₹50 × 1,000] = ₹1,20,000 − ₹1,40,000 = −₹20,000.
Loss from internal transfer = ₹60 − ₹40 = ₹20 per unit, which equals ₹140 − ₹120. For 1,000 units the loss is ₹20,000.

Answer: Minimum transfer price is ₹140 and maximum is ₹120. Q should buy outside. Internal transfer would reduce company profit by ₹20,000.

Exam tips

Start every answer with the capacity position. Write spare capacity in units in the first line, because the examiner looks for it.
Show the minimum and maximum price as two separate labelled calculations, then state the range. Step marks are given for each.
When the question gives the buyer's selling price and further cost, always compute net marginal revenue. It is often the lower limit on the maximum price.
In the MCQ section, read for words such as full capacity, spare capacity and selling cost saved. Most wrong options come from missing one of these.
End the written answer with a recommendation and the rupee effect on company profit. Do not stop at the price range.

Practice questions from Transfer Pricing

Transfer Pricing Numerical Problems in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Transfer Pricing Numerical Problems: frequently asked questions

How do I calculate minimum transfer price with opportunity cost?

Add the seller's variable cost per unit to the contribution lost per unit from giving up outside sales. At full capacity this equals the outside price less any selling costs saved. With spare capacity the opportunity cost is zero.

What is the transfer price when there is spare capacity?

The minimum is the variable cost of the seller. Any price from variable cost up to the buyer's maximum is acceptable to the company. The final price within that range decides how profit is shared between divisions.

How do I decide whether to buy externally or transfer internally?

Compare the seller's minimum price with the buyer's maximum price. If the minimum is higher than the maximum, buy outside. If not, transfer internally. The company gain is the outside price for all units less the seller's variable cost for all units and the lost outside contribution on displaced units.

What if the buyer needs more units than the spare capacity?

Split the order. Units made from spare capacity are priced at variable cost. Extra units that displace outside sales are priced at variable cost plus lost contribution. Add both amounts and divide by total units for the average minimum price.