Icecream is a recently added product line of the a2 milk

Question

Transfer Pricing

Icecream is a recently added product line of The a2 Milk Company. As part of the production of of icecream, the icecream mixture is transferred from the mixing department to the freezing department for further processing. The following table summarises hypothetical data relating to the cost to the mixing department to produce each litre of icecream mixture. The unprocessed icream mixture can be sold by the mixing department to external parties for $2.00 per litre.

	Icecream mixing department (cost per litre)	Freezing department (cost per litre)
Direct Materials	$0.50	$0.10 (does not include cost of transferred icreacream mixture)
Direct Labour	$0.20	$0.10
Variable Overhead	$0.40	$0.60
Fixed Overhead	$0.20	$0.50

Required:

1. If negotiated transfer pricing was used, what is the minimum transfer price that the icecream mixing department manager would likely accept and why? What is the maximum transfer price that the freezing department manager will likely be willing to pay and why? Would cost-plus pricing be appropriate for transfer prices in this situation? If so, what cost base should be used?
2. Calculate the transfer price for sales between the mixing and the freezing if cost-plus pricing, based on absorption cost with a 40% markup, is used. Determine the contribution margin per unit for the icecream department if this transfer price is used.
3. Calculate the transfer price for sales between the mixing and the freezing departments if cost-plus pricing, based on variable cost with a 50% markup, is used. Determine the contribution margin per unit for the icecream department if this transfer price is used.
4. Discuss whether the transfer prices determined above in requirements 2 and 3 is likely to be acceptable to the icecream mixing department.
5. Discuss how the application of the general transfer price could be used in this situation. Provide examples which illustrate how the existence of spare capacity within the icecream mixing department would be relevant.

Ensure that your answers for the above are discussed and supported by relevant calculations/workings.