ny could have produced this molten glass for? 65 per ton, this is clearly suboptimal for Cristal Ltd. as a whole. division managers cannot agree on a transfer price, should the company s top management intervene to order the divisions to make the transfer if (as in this case) it is obvious that the transfer would be in the company s best interests? The answer is no. There are two reasons for this:
. For the reasons stated earlier, the preservation of divisional autonomy is an important principle which should not lightly be breached.
. If the division managers are allowed to suffer the consequences of their own intransigence, then they are unlikely to make the same mistake in future. For example both managers will be aware that if they had split the difference and agreed on a transfer price of? 85 per ton, then they could each have earned an incremental profit of? 20 per ton. By failing to agree a price, they have deprived themselves of this profit in the current period. They are likely to remember this lesson in future transfer pricing negotiations. [16, 17]
.2 Further coverage of transfer pricing methods
example, Drury discusses five main methods of transfer pricing in considerable detail. However if students understand the basic principle of transfer pricing set out at the beginning of the previous section (ie, that transfer price should be equal to the marginal cost of producing the transferred product or service plus the opportunity cost of making the transfer) and the four scenarios outlined above, then they already have a basic knowledge of the logic which underlies three of Drury s five methods (market-based transfer prices, marginal cost transfer prices, and negotiated transfer prices). [18] s other two methods are full cost transfer prices and cost-plus-markup transfer prices. The mechanics of these methods are easily illustrated. Returning to the basic data given above in relation to the Molten Glass Division, the full cost per ton can be calculated as follows [16]: full cost method involves using? 83 as the transfer price per ton. The cost-plus-markup method involves using this full cost plus some profit markup. These methods often (but not always) cause suboptimisation. For example, if we consider Scenario 1 in the previous section, it is clear that the full cost transfer price (? 83 per ton) would be too low where no spare capacity exists. However, in Scenario 2 (where spare capacity exists) it is clear that the full cost transfer price of? 83 per ton would lead to optimal decision-making in these circumstances (and, in fact, would split the incremental profit reasonably equitably between the two divisions). issues in transfer pricing: are a couple of other issues which commonly arise in exam questions on transfer pricing:
. Selling costs: Often there are selling costs which arise if goods are sold to an external customer but which are avoided if goods are transferred to another division within the company. should be allowed for in determining the opportunity cost of making the transfer. For example in Scenario 1 above, we calculated the opportunity cost of transferring a ton of molten glass to the Glass Bottles Division (instead of selling it to an external customer) as? 55 per ton. But suppose now that there is a sales commission of? 3 per ton when molten glass is...
