It is often claimed that a two-part transfer pricing system offers a number of advantages to organizations which use it. Which of the following…

A two-part transfer pricing system uses a variable charge per unit (typically standard marginal cost) and a periodic fixed lump-sum charge. The fixed fee is designed to cover the supplying division's fixed costs and provide a reasonable profit margin on the internal transfer. This ensures the supplying division is not penalized for transferring internally and remains a viable profit center. The statement that the fee simply compensates for fixed costs is incorrect because it omits the crucial profit element, which is necessary to motivate the supplying division and ensure its performance is measured fairly.

A. This is a core advantage. Using marginal cost encourages optimal output decisions for the company as a whole, while the fixed fee allows the supplying division to recover fixed costs and earn a profit.

B. This is an advantage. The system makes the receiving division aware of the full cost structure (variable and fixed) of the intermediate product, leading to better long-term planning and cost consciousness.

C. This is an advantage. The negotiation of the fixed lump-sum fee requires divisional managers to communicate and coordinate regarding capacity usage, production plans, and cost allocation.

1. Drury

C. (2018). Management and Cost Accounting (10th ed.). Cengage Learning. In Chapter 21

Section 21.8

it is explained that the two-part tariff method involves a transfer price consisting of the standard variable cost plus a periodic fixed charge. The text clarifies

"The purpose of the fixed charge is to reimburse the supplying division for its fixed costs and provide it with a profit allowance." (p. 636).

2. Horngren

C. T.

Datar

S. M.

& Rajan

M. V. (2017). Cost Accounting: A Managerial Emphasis (16th ed.). Pearson Education. Chapter 23

"Management Control Systems

Transfer Pricing

and Multinational Considerations

" describes this method. It states that the lump-sum charge is for a share of the supplying division's fixed costs and a return on capital

explicitly including a profit component. This ensures the supplying division earns a profit on its assets employed in internal transfers.

3. CIMA (2017). CIMA Official Terminology. The Chartered Institute of Management Accountants. The definition of a 'two-part tariff' transfer price explains it as "A transfer price with two parts: a charge for each unit transferred (the marginal cost per unit) and a fixed charge for the period." The rationale behind the fixed charge

as detailed in CIMA study materials

is to cover fixed costs and contribute to the supplying division's profit.