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• Topic 7: Transfer Pricing

As part of the production of Ned Whisky, the oak barrel department prepares barrels for use by whisky bottling and storage department. These barrels can be bought and sold on the external market for $800 per barrel.

The costs incurred by the oak barrel department to produce each barrel are provided below:

Direct materials	$350
Direct labour	$80
Variable overhead	$40
Fixed overheard	$60

In addition to the above, staff from the oak barrel department earn a commission of 5% on the selling price for any sales to external customers. For any barrel sales to external customers, the oak barrel department incurs $40 in shipping costs per barrel. These costs are not incurred for internal transfers of barrels to the whisky bottling and storage department.

The managers from the oak barrel and whisky bottling and storage departments both have significant experience working within the firm. Both managers are entitled to an annual bonus based on their respective departments' contribution margin.

Required:

1. If the transfer price for internal transfers of barrels was set through negotiation, discuss what the likely range of transfer prices might be. Suggest and discuss a reasonable transfer price that would balance the preferences of both departments and illustrate how this could be achieved through cost-plus pricing based on absorption costing (10 marks).
2. Provide and discuss examples (include financial figures and workings) which illustrate how transfer prices for barrels could be set using the general transfer price rule under the following scenarios:

Scenario	Oak barrel department capacity	Whisky bottling and storage department demand	External market demand
1	300 units	300 units	500 units
2	600 units	500 units	150 units
3	900 units	850 units	0

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