Transfer Pricing in Decentralized Organizations

What factors determine the transfer price between divisions in a decentralized organization?

How does the presence of excess capacity affect the range of acceptable prices on transfers between divisions in this scenario?

Factors Affecting Transfer Price

The transfer price between divisions of a decentralized organization ranges from the variable cost to the market price, depending on the capacity utilization.

Impact of Excess Capacity

In the first scenario when there is no excess capacity, the transfer price should be $200, the market price. However, in the presence of excess capacity, the transfer price should range from $80 to $200.

Transfer pricing in decentralized organizations is crucial for effective cost allocation and performance evaluation. The transfer price refers to the price at which goods or services are transferred between different divisions of the same company.

When determining the transfer price, several factors come into play. These factors include the variable cost of production, market price, and capacity utilization of the producing division. In the case of Baxter Bicycles, the Trailer Division has a market price of $200 per trailer and incurs variable manufacturing costs of $80 per trailer.

When the Trailer Division has no excess capacity and can sell all its trailers to external customers, the transfer price should be set at the market price of $200. This ensures that the company maximizes revenue by not selling internally at a lower price.

On the other hand, when the Trailer Division has excess capacity and only sells a portion of its trailers to outside customers, the transfer price should cover at least the variable cost of production, which is $80. The maximum transfer price would still be the market price of $200, as the Assembly Division would not pay more than the market price for the trailers.

It is important for companies to consider the balance between cost minimization and revenue maximization when setting transfer prices between divisions. Effective transfer pricing helps in allocating costs accurately, evaluating divisional performance, and making informed decisions about production and sales strategies.

Understanding the impact of factors such as variable cost, market price, and capacity utilization is essential in determining the range of acceptable prices on transfers between divisions in a decentralized organization like Baxter Bicycles.