ACCT30002 Chap.4 Internal Transfer Policy
Internal Transfer Policy
Internal transfer policy allocates profit and shapes sourcing decisions between responsibility centres. This chapter derives the seller's minimum from incremental cost and opportunity cost, uses the buyer's outside alternative as a ceiling, and shows how idle capacity changes the range. It compares market, cost, negotiated and dual-pricing methods while keeping divisional incentives distinct from total firm value.
The seller floor equals incremental cost plus contribution forgone from the next best use of scarce capacity. The buyer ceiling equals the relevant cost of an equivalent external alternative. Internal trade is feasible only when the floor does not exceed the ceiling.
Capacity is therefore not a side detail: idle capacity can reduce opportunity cost to zero, full capacity introduces displaced contribution, and partial capacity requires the request to be separated into units that use spare resources and units that displace outside sales. The resulting range identifies economic feasibility but does not decide how joint benefit should be distributed.
Market prices can transmit external opportunity cost, cost-based prices can work where no comparable market exists, negotiated prices use local information but consume bargaining effort, and dual pricing can protect motivation while requiring a central adjustment. Quality, logistics and avoidable coordination effects belong in the relevant comparison when they genuinely change with the choice.
A complete answer reports the seller, buyer and firm perspectives separately, then explains how the chosen policy affects sourcing, reported divisional profit, autonomy and goal congruence.
What this chapter covers
- 01
Transfer policy and decentralised decisions
- 02
Seller minimum and opportunity cost
- 03
Buyer maximum and outside alternatives
- 04
Idle, partial and full capacity
- 05
Market, cost, negotiated and dual prices
- 06
Goal congruence and performance adjustment
Worked example · free
Full-capacity bargaining range
- 1Lost contribution is $65 minus $42, or $23.
- 2Seller floor is $42 plus $23, or $65.
- 1Buyer ceiling is the $68 relevant outside price.
- 1The feasible range is $65 to $68.
Key terms
- Transfer price
- The price recorded for an exchange between organisational units.
- Seller floor
- Incremental cost plus opportunity cost for the supplying division.
- Buyer ceiling
- The relevant cost of the best equivalent outside alternative.
Internal Transfer Policy FAQ
How does idle capacity affect the minimum price?
Idle capacity means an internal transfer may not displace outside contribution, so opportunity cost can be zero and the floor approaches incremental cost. At full capacity, lost contribution raises the floor. Partial capacity requires a schedule or weighted analysis.
Why is full cost not always economically relevant?
Allocated fixed cost may remain unchanged whether or not the transfer occurs. It can be part of an accounting price for evaluation, but it is not automatically incremental. Keep economic cost and reported divisional profit conceptually separate.
When is a market price useful?
A competitive, comparable and accessible market provides an independent benchmark and preserves divisional autonomy. Adjust for quality, logistics and selling costs, and avoid using a quoted price from a market the division cannot actually access.
Why does idle capacity change the transfer-price floor?
When spare capacity can supply an internal request without displacing external sales, opportunity cost can be zero and the seller floor approaches incremental cost. At full capacity, lost external contribution raises the floor. Partial capacity requires separate treatment of units within spare capacity and units that displace sales before choosing any uniform policy price.
Exam move
Draw a number line with the seller floor and buyer ceiling. Change capacity before changing any price. For every answer, state seller, buyer and firm perspectives, then explain how the chosen policy affects evaluation. Start by writing the counterfactual for each division. Ask what contribution the seller loses, what equivalent input the buyer can obtain and which central costs actually change.
Compute idle-capacity and full-capacity cases side by side, remembering that opportunity cost is lost contribution rather than lost revenue. For a partial-capacity request, calculate separate floors before considering whether a uniform policy price is useful. Once the range is established, test four methods: market, variable or full cost, negotiation and dual pricing.
Give one information advantage and one behavioural risk for each method. Rework a case where headquarters mandates a transfer below the seller's economic floor and explain how performance evaluation should be adjusted even if the transaction benefits the firm. Close with a four-part conclusion: feasible range, selected price or method, distribution of divisional profit and total organisational effect.
Add a sensitivity drill in which external price, idle capacity and avoidable freight change one at a time. Redraw the range after each change and state which boundary moved. Test whether an allocated fixed cost changes the firm decision or only the accounting distribution. For policy questions, write the data needed to trust a market benchmark, including specification, delivery and accessible volume.
Practise explaining why a feasible range can still create conflict and how a central adjustment protects controllability without hiding the subsidy. Check every response for the words incremental cost, opportunity cost, external alternative and goal congruence.
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