Division A produces a product with a variable cost of $5 per unit and an allocated fixed cost of S3 per unit The market price of the product is S15 plus 20 percent selling cost. Division B currently purchases this product from an external supplier but is going to purchase it from division A for S18 Which of the following methods of transfer pricing is being used?

Question breakdown

Tests

Identify transfer pricing methods from given data

Difficulty

Easy

Key idea: A transfer price equal to the external market price, including normal selling cost, is a market-price transfer.

How to reach the answer

1. Compute the market price: $15 plus 20% equals $18.
2. Compare it to the $18 transfer price; they match.
3. Check the cost-based alternatives: full cost is $8 and variable cost is $5, and neither matches.
4. Nothing in the question indicates bargaining, so negotiation is ruled out.

Each option

• ACorrect. The $18 transfer price equals $15 plus the 20% selling cost, which is the market price.
• BIncorrect. The question describes no bargaining, and the price exactly matches market, so it is not negotiated.
• CIncorrect. Full absorption cost would be $5 + $3 = $8, not $18.
• DIncorrect. Variable cost would be $5, far below the $18 transfer price.

Common trap: Seeing a price other than the $15 headline figure may suggest a negotiated price, unless you add the 20% selling cost.

In practice: Auditors review intercompany pricing for fairness to divisional performance measurement and for tax and regulatory compliance.

Remember: When the transfer price equals the external price (including normal selling costs), it is market-based.

Reviewed by Alexandra Stone.