Business

Company adopts actual full (absorption) manufacturing cost as internal dealing price which the price is equal to the sum of production variable and fixed cost (Hilton 2011). Hilton (2011) discussed that manager dysfunctional decision making behavior will occur if the company uses the full cost transfer method.

First, the supplying division loses their incentive in controlling their manufacturing cost since all the costs are reimbursed and transferred to the buying division. (Ken Garrett 2009). Hence, the probability of exaggerated cost, waste operation and inefficient manufacturing might significantly increase. Besides this, since there are no significant profit in the division, manager has no control on the investment and price negotiation, therefore managers of supplying division is demotivated to regulate the manufacture process intensively.

In contrast, if the transfer price limits or decreases the overall performance of purchasing division then the division might also be demotivated as well. Since the internal transfer price is fixed and the division is entailed with all incremental cost, they would source externally if they are not happy with the internal dealing price. However, the price that lowers than transfer price offered from external market might benefit buying division but not performing the best interest for the company. Furthermore, they might have faculty decision making in accepting or rejecting special order as the viewpoint to cost is different between company and division (Hilton 2012).

For illustration, Table one showed that purchasing division has a transfer price at $ 9.75. Thus, manager would tend to reject to accept the order priced at $9.60 to protect the division from making $ 0.15 profit. However, Table two showed that company will be benefited if the order is accepted as the price is higher than actual variable cost of production, which provides a contribution margin of $ 2.35 to the company. In this circumstance, division...