1. The Economic Opportunity Principle
To protect total corporate profits across all operating environments, management accountants use the General Optimization Rule to calculate the absolute minimum price a selling division should accept.
 
2. The Opportunity Cost Allocation Equation
Minimum Transfer Price = Incremental Variable Production Cost per Unit + Opportunity Cost to the Total Company
 
3. Analyzing Capacity Variations
Case A: The Supplying Division Has Idle Capacity
If the supplying division has unused machinery and labor, it can produce extra parts for the buying division without losing outside sales. The opportunity cost is $0.
  • Minimum Transfer Price: Equal to the Variable Production Cost alone.

Case B: The Supplying Division Operates at Full Capacity
If the supplying division is running at maximum capacity and can sell every unit to outside customers, transferring a part internally requires turning down an outside client. The opportunity cost is the contribution margin lost from that outside sale.
  Variable Cost = $30 | Outside Market Selling Price = $50
  Lost Outside Contribution = $50 - $30 = $20
  Minimum Transfer Price = $30 (Var Cost) + $20 (Lost Contribution) = $50 (Market Price)

If the supplying division operates at full capacity, the minimum transfer price must equal the full market price to prevent corporate sub-optimization.
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