Which of the following is the ideal basis to use for a transfer price when there is a perfect external market?

When a perfect external market exists for an intermediate product, the ideal transfer price is the market price. This is because the market price represents the opportunity cost for the supplying division (the revenue it forgoes by not selling externally) and the cost the receiving division would incur if it purchased from an external supplier. Setting the transfer price at the market price ensures that divisional performance is measured accurately and that decisions made by divisional managers to maximize their own profit also maximize the profit for the company as a whole, thus achieving goal congruence.

A. Actual variable cost: This ignores the opportunity cost of the external sale for the supplying division, potentially leading it to refuse an internal transfer that is beneficial for the company.

C. Standard variable cost: Like actual variable cost, this method fails to account for the opportunity cost (lost contribution margin from external sales) for the supplying division.

D. Full cost plus: This method can result in a transfer price higher than the market price, leading the receiving division to buy externally, which is a suboptimal decision for the company.

1. Drury

C. (2018). Management and Cost Accounting (10th ed.). Cengage Learning. In Chapter 18

Section 18.5

it is stated: "Where a perfectly competitive market exists for the intermediate product

the optimal transfer price is the market price... Using the market price as the transfer price will induce managers to make correct decisions." (p. 518).

2. Horngren

C. T.

Datar

S. M.

& Rajan

M. V. (2017). Cost Accounting: A Managerial Emphasis (16th ed.). Pearson. Chapter 22

"Pricing Decisions and Cost Management

" explains that in a perfectly competitive market for the intermediate product

the market price is the optimal transfer price. The chapter notes

"A market-based transfer price promotes goal congruence in decisions..." (p. 841).

3. CIMA (Chartered Institute of Management Accountants). (2017). CIMA Official Terminology. "Market-based transfer price: A transfer price that is based on the price that would be charged if the product were to be sold to an external customer or purchased from an external supplier." This definition supports its use when an external market exists. (p. 68).