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Divisional performance appraisal and transfer pricing

Scenario 2: The selling division has surplus capacity

Transfer price
negotiated between

Minimum price selling division Maximum price buying
will accept is marginal cost * division will pay, lower of

Net marginal revenue i.e. selling price
External purchase price final product less marginal cost of
of product
buying division’s final product

* Note:

 This is the minimum price. The selling division may also want to cover some/all
of the fixed costs and recognise a % profit.

 The standard cost should be used rather than the actual cost to aid planning
and prevent inefficiencies being passed on to the buying division.

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