is in the best interests of Cristal Ltd. as a whole) and that any other transfer price would be potentially detrimental to the company s best interests. Suppose, for example, that the Molten Glass Division were to match the price (? 105) being offered by the Glass Bottles Division s external supplier. How would the divisions, and Cristal Ltd. as a whole, be affected?
Glass Bottles Division: No change in profit (because it would still be paying the same price as before for molten glass, albeit to the Molten Glass Division rather than to the external supplier).
Molten Glass Division: Reduction in sales revenue, and therefore reduction in profit, of [(? 120 -? 105) * 10,000 tons] =? 150,000.
Cristal Ltd.: Loss of revenue=(? 120 * 10,000 tons =? 1,200,000); Reduction in payments to external suppliers=(? 105 * 10,000 tons =? 1,050,000); Hence reduction in profit=(? 1,200,000 -? 1,050,000 =? 150,000). 2: Spare capacity in the Molten Glass Division now that the Molten Glass Division has the capacity to increase its output above the current level of 40,000 tons per annum, but that there is no demand from external customers for these potential additional tons. This means that it is now possible to produce some extra molten glass for sale to the Glass Bottles Division without any reduction in the quantity sold to external customers. In other words, where spare capacity exists, there is no opportunity cost associated with making the transfer. The minimum transfer price acceptable to the Molten Glass Division for units produced using spare capacity can be calculated as follows:
Marginal cost of producing molten glass =? 65 per ton.
Opportunity cost of making the transfer=Nil.
Hence: Transfer price=[Marginal cost incurred up to the point of transfer] + [Opportunity cost of making the transfer] =? 65 + Nil =? 65 per ton. molten glass produced using spare capacity is transferred to the Glass Bottles Division at any transfer price in excess of? 65 per ton, then the Molten Glass Division s profits will increase by: [(Transfer price -? 65) * Number of tons transferred] . Furthermore, if the Glass Bottles Division pays a transfer price of less than? 105 per ton (ie, the price currently charged by the external supplier), then the Glass Bottles Division s profits will increase by: [(? 105 - Transfer price) * Number of tons transferred]. , So far as units which can be produced using spare capacity are concerned, a transfer price which is greater than? 65 but less than? 105 will result in increased profits for both divisions (compared with the profits which they would earn if they did not trade with each other). In line with the principle of divisional autonomy, it is appropriate to leave it to the two division managers to negotiate the precise transfer price within this range. congruence is also achieved. By using spare capacity, the company is producing molten glass at an incremental cost of? 65 per ton instead of buying it from an external supplier at? 105 per ton. Therefore, Cristal Ltd. s profits are increased by: [(? 105 -? 65 =? 40) * Number of tons produced using spare capacity] .3: LIMITED Spare capacity in the Molten Glass Division is a variation on Scenario 2. Suppose, for example, that the maximum production capacity of the Molten Glass Division is 45,000 tons per annu...
