Four basic methods of transfer price setting are in common use: variable cost, full cost, market price, and negotiated price. With respect to each of the following independent scenario, identify the best method to set transfer prices between Selling division and buying division:

Choose between: Variable cost, Full Absorption cost, Market price, Negotiated price

1.(ans) Selling division is producing at full capacity and can sell all of its output at the market price.

2. (ans) Selling division has excess of capacity to produce more. Due to high market saturation, supplying division can not find outside buyer for any additional output.

3.(ans) Transfer price need not be based directly on particular market or cost information. Rather, the organizational subunits are free to determine the prices at which they buy and sell internally. Hence, a transfer price may simply reflect the best bargain that the parties can strike between themselves.

4. (ans) Selling division wants to set a transfer price that ensures the division will not incur a loss. The drawback of the transfer price setting is that there is no motivation for the seller to control production costs since all costs can be passed along to the buying division.