Detailed Answer
(d) The goal of transfer pricing is to encourage managers
to make transfer decisions which maximize profits of the
company as a whole. Some transfers may not be profitable to a
particular division, but would effect a cost savings to the company
by avoiding costs of purchasing externally. For example,
when a division is already operating at full capacity and uses variable
cost transfer prices, additional production for internal
transfer would result in a loss for the transferring division because
no contribution margin is earned to cover the differential fixed
costs incurred. Conversely, internal production may be cheaper
to the corporate entity than purchasing the product, in which
case the division should accept the order. However, the division
manager is likely to engage in suboptimization by rejecting the
order to enhance the division’s performance, while adversely
affecting overall company performance.