The Parts Division of Nydron Corporation makes Part Y6P, which it sells to outside companies for $17.00 per unit. According to the cost accounting system, the costs of making one unit of Part Y6P consist of $7.00 for direct materials, $3.00 for direct labor, $4.50 for variable manufacturing overhead, and $1.20 for fixed manufacturing overhead. The Parts Division has enough idle capacity to make 1,000 units of Part Y6P each month. The Assembly Division of Nydron Corporation can use Part Y6P in one of its products. At present, the Assembly Division is purchasing an equivalent part from an outside supplier for $16.85 per unit. The Assembly Division needs 2,000 units of the part each month. It has been suggested that the Assembly Division buy Part Y6P from the Parts Division instead of buying the equivalent part from the outside supplier. The transfer price for this transaction would lie within what limits?

The Parts Division of Nydron Corporation

The Transfer Price for this transaction would lie between $16.85 and $17.00.

Relevant costs of making Part Y6P per unit is computed as the variable or marginal costs:

Sales Price to outside companies = $17

Buying Price from outside supplier = $16.85

Marginal Costs:

Direct Materials $7

Direct Labor $3

Var. Mfg O/H $4.50

Total Variable = $14.50

Fixed Costs = $1.20

Total costs = $15.20

Explanation:

This is a Transfer Price decision, in a buy or make situation.  In making such decision, management of Nydron Corporation should concentrate on the relevant costs and the lowest and higher transfer prices.  The costs that are relevant in this decision are those that can be avoided, called avoidable costs.  They make the difference in making choices.

Since the relevant costs equal $14.50 (without the fixed cost of $1.20, which must be incurred irrespective of the decision taken) and the part can be sold for $17.00 to outside buyers, the transfer price would lie within the relevant manufacturing cost and the outside selling price.  However, since the part can be bought from outside at $16.85, this becomes the lowest transfer price and $17.00 the highest transfer price.

Transfer price is the price that a division can sell its products or services to another division of the company and between subsidiaries and parent companies.  Transfer pricing is an accounting and taxation practice that enables prices to be set for transactions done internally within businesses and between subsidiaries that operate under common control or ownership. The transfer pricing practice extends to cross-border transactions as well as domestic ones, and have taxation implications.

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