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TRANSFER PRICING
Question 1: Godrej Ltd is a manufacturing company of which division ABC
manufactures a single standardized product. Some of the output is sold extremely
whilst the remainder is transferred to division XYZ where it is a subassembly in the
manufacture of that divisions product. ABC has the capacity (annual) to produce
30,000 units of the product. The unit costs of division ABCs product are as under:
Direct material 40
Direct labour 20
Direct expenses 20
Variable manufacturing overheads 20
Fixed manufacturing overheads 40
Sells and packaging expenses-variable 10
150
Annually 20,000 units of the product are sold externally at the standardprice of 300 per unit.
In additional to the external sales, 10,000 units are transferred annually
to division XYZ at an internal transfer price of 290 per unit. This transfer
price is obtained by deducting variable selling and packing expenses from
the external price since those expenses are not incurred for interna
transfers.
Division XYZ incorporates the transferred in goods into a moreadvanced product. The unit costs of this product are as follows:-
Transferred in-term (from division ABC) 290
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Direct material and components 230
Direct labour 30
Variable overheads 120
Fixed overheads 120
Selling and packing expenses variable 10
800
Division XYZs manager disagrees with the basis used to set the transfer
price. He argues that the transfers should be made at variable cost plus an
agreed ( minimal) mark up because his division is taking output that division
ABC would be unable to sell at the price of 300.
Partly because of this disagreement, a study of the relationship between
selling price and demand has recently been carried out for each division by
the companys sales director. The study has brought out the following
demand schedule:
DIVISION ABC
Selling price () 200 300 400
Demand (units) 30,000 20,000 10,000
DIVISION XYZ
Selling price () 800 900 1000
Demand (units) 14,400 10,000 5,600
The manager of the division XYZ claims that this study supported his case.
He suggest that a transfer price of 120 would give division ABC a
reasonable contribution to its fixed overheads while allowing division XYZ to
earn a reasonable profit. He also believes that it would lead to an increase
of output and an improvement in the overall level of company profits.REQUIRED:-
(1) Calculate the effect of the transfer price of 290 per unit on
companys operating profit. Calculate the optimal product mix.
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(2) Advise the company on whether the transfer price should be revised
to 120 per unit. (ICAI ADOPTED, Nov2012, ICWA FINAL)
-----------------------------------------------------------------------------------------------------
Question 2:AB Ltd. makes component C and billing machines. Division A
makes component C that is used in the final assembly of the machine in
Division B. (one unit of Component C is used per machine). Component C
has a outside market also. A and B operate as profit centres and h can take
its own decisions. The following data is given in the existing scenario for
Division A and B, under which Division A has enough special and externa
demand to use its capacity and hence is offering B rates of 800 /unit for
quantity up to 750 units and 900 /unit for more than 750 units, so that its
outside contribution is not affected by transfers to B. A and B can sell any
quantity up to the maximum indicated under units sold without affecting their
future demands.
Division A Division BEternal market
( normal sales)
(Special
sales)
External market
(normal sales)
Selling Price(`/u) 1,000 800 4000
Variable manuf. cost(/u) 600 600 1,500* (*excluding
Component C)
Variable selling cost(.u) 100** - 200** (** Not incurred oninter division
transfers)
Total variable cost (/unit) 700 600 1700* (*excluding
component C)
Contribution (/unit) 300 200
Units sold 1250 750 900
Production capacity 2000 units 900 units
For the next period, A requires for its own use in its selling outlets, 50 units
of billing machines produced by B. Bs manager proposes as follows:
Option I-B will supply 50 machines to A on its variable manufacturing cost
basis provided A supplies to B, 500 units of Components C at As variable
manufacturing cost basis.
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Option II- Both A and B resort to total variable cost per unit basis
applicable to normal external sale,, through neither A nor B incurs any
selling cost on inter division transfers. A will be given 50 machines for its
use. A will have to supply B all the 900 units that B requires.
Option III- Both A and B use the external market selling price (i.e. 1,000
and 4,000 /unit for 900 units of Components C and 50 machinesrespectively).
From a financial perspective advise Division As manger what he should
choose. Support your advice with relevant figures.
What is the change in the rate of discount per unit given by B to A (based on
unit transfer price to market price ratio) from option I to Option II?
(note: Students need not work out the total cost statements. Steps showing
relevant figures for evaluation are sufficient). (ICAI ADOPTED)SOLUTION:-
A has the following options
Option No. 1
Benefit on receiving 50 machines 95,000
{4000 ( 600 + 1500)}X 50
Loss for A on 500 units of C transfer to department B
500(unit) X 200i.e. Contribution to be lost for special sale 1,00,000
A:- (5000)
OPTION NO.2
As benefit on 50 Machines 80,000
(4000 ( 700 + 1700) X 50
Loss on 900(unit) transfer to B
Rev. 900 X 700Cost 900 X 600
Benefit on transfer 900 X 100
Benefit would have been on 750 X 200 =150000
External sale 150 X 300 = 45000 (1,05,000)
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(195000 90,000) 1,95,000 (25,000)
Working Note-1
The relevant cost for department A would be 600 & 1500 which otherwise to
be purchased from outside market for 4000. Hence benefit would be 1900
on 50 machines.
OPTION NO. 3Benefit on 50 Machine Cost
(4000 4000) 50 = Nil
Benefit on 900(unit) transfer to B
Extra revenue : Extra benefit
750 X ( 1000 800) 1,50,000
150 X 100 15,000
1,65,000Its better to select 3rdoption due to higher benefit.
The difference of Transfer Price between option 1 & 2 (From department B
to department A)
Transfer Price as per 1stoption = 2100
Transfer Price as per 2ndoption = 2400
= 300
Discount as % of Market Price = 300/4000 X 100 = 7.5%.-----------------------------------------------------------------------------------------------------
Question 3: Bajaj Ltd. consists of the X Division and the Y Division. X
Division produce two different components, the new high performance ALFA
and an older product called BETA. These two products have the following
cost characteristics:
ALFA BETA
Material Parts 20Labour 2 hours 140 280
Parts 10 hours 140 70
Annual overhead in X Division is 10,00,000 all fixed. The X Division
capacity is set at 50,000 hours per year.
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To date, only one customer has developed a product utilising ALFA, and
this customer orders a maximum of 15,000 ALFA per year at a price of 600
per unit. If Bajaj Ltd. cannot meet his entire demand, the customer curtails
his own production. The rest of the Xs capacity is devoted to BETA, for
which there is unlimited demand at 120 per unit.
The Y Division produces only one product, a GAMA, which requires a
complex circuit board imported at a price of 600. The GAMA costs are:
GAMA
Material
Labour
Circuit board
Other parts
5 hours @ 100
600
80
500
The Y Division is composed of only a small assembly plant and all overhead
is fixed at a total of 20,00,000 per year. The current market price for the
GAMA is 2000 per unit.
The Production manger discovered that with minor modifications, a single
ALFA could be substituted for the circuit board, currently used by Y division,
the modification would require an extra one hour of labour by Ys staff for a
total of 6 hours per unit of GAMA. Y has, therefore asked X Division to
declare a transfer price at which X Division would sell ALFA a internally.Required
1.Y expects to sell 6,000 of GAMA this year. From the overall point of view
Bajaj Ltd., how many X should be transferred to Y Division to replace circuit
boards?
2:- What should be the transfer Price for such 6000 units.
3.if demand for the GAMA rises to 12,000 units at a price of 2000 per unit
how many of 12,000 units should be built ALFA? (All other data
unchanged).
SOLUTION:- Hours Ranking
Alpha 15000 X 2 30,000 I
BAJAJ
X
Beta 40,000 X 1/2 20,000 II
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Y Board Total 50,000
X Division has no spare capacity, hence in order to produce extra unit of
Alpha for transfer, X division will have to sacrifice the required labour hours
from the product having least Contribution/hour.
STATEMENT OF RANKING
ALPHA BETASelling Price 600 120
Variable Cost 300 80
Contribution per unit 300 40
Hours per unit 2 1/2
Contribution per hour 150 80
Ranking I II
STATEMENT OF OPTIMUM PRODUCT MIXUnit Hour per unit Hours
ALPHA 15000 2 30,000
BETA 40,000 1/2 20,000 (B/F)
50,000
The requirement of Y division is 6000 (u) of ALPHA to replace circuit board
which can be produced by division X by releasing labour hour from BETA
subject to the interest of Company.STATEMENT OF COMPARATIVE COST ( 6000(unit))
Manufacture Per unit Purchase Per Unit
ALPHA
V.C 300 Purchase cost of
Board
600
+ Contribution to be lost 2 hour X
40/
160
460
+ Extra Cost to be incurred by Y 100
Total Relevant Cost 560 Purchase Cost 600
X division can produce extra units of Alpha as 6000(unit) for Y division but
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maximum unit would be 20,000/2 = 10,000 (unit).
(ii) Transfer Price would be 460 for each unit of ALPHA up to 6000 (unit)
TRNASFER PRICE = 460 to 500.
(iii) If the requirement of Y dept. increase to 12,000(unit) than X dept can
produce of transfer 10,000(unit) of ALPHA by reducing its product BETA.
However in order to produce & transfer over and above 10,000(unit) X dept.will have to reduce existing demand of ALPHA which should be reduces
subject to the interest of Co.
STATEMENT OF COMPARITION COST
Manufacture Purchase Cost
V.C. 300
+ Contribution lost 300 Purchase Cost 600600
+ Extra Cost 100
700 600
X dept. should not produce & transfer over and above 10,000(units) of
ALPHA.
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Question 4: A manufacturing Company has two Division X and Y. Theoutput of X can be transfer to Division Y.
Division Y has always purchased its requirements of component from
Division X. But when informed that Division X was increasing its transfer
price to 170, the manager of Division Y decided to look at outside
suppliers.
Division Y buys the component from an outside supplier for 140. But
Division X refuses to lower its Price.The management has the following information:
Ys annual purchase of the component 2,000 units
Xs variable costs per unit 110
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Xs fixed cost 20000
Required
(i)Calculate Transfer Price in each of the following cases.
(ii) Suppose there are no other alternative use of Xs facilities, Will the
company as a whole benefit, if Division Y bought the component at 140
from an outside supplier ?
(iii)If X did not produce the material for Y, it could use the facilities for other
activities resulting in a cash operating savings of 70,000. Should Y then
purchase from outside sources?
(iv) Suppose there are no other alternative use of Xs facilities and the
market price per unit for the component drops by 35. Should Y now buy
from outside? (ICAI & ICWA Final Adopted)
SOLUTION:-
(ii) STATEMENT OF COMPARITIVE COST
Per unit
Manufacture Purchase
Variable
Cost
110 Purchase
cost
140
110 140
Decision:- Its better to manufacture in house.
In other words we can say the Company will not be in benefit position if
division y would like to purchase the component from outside market
because purchase cost is more than its variable cost.
STATEMENT OF TRANSFER PRICE
Cost to be incurred 110+ benefit to be lost -
Minimum Transfer price 110
(iii) STATEMENT OF COMPARITIVE COST
Per unit
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Manufacture Purchase
Variable
Cost
110 Purchase
cost
140
110 140
STATEMENT OF COST BENEFIT
Loss on purchase 60,000
Benefit from release capacity 70,000
Net Benefit 10,000
Decision:- Its better ot purchase component from outside market. Release
capacity of supply division should be utilized for other activities thereby
Company can achieve incremental benefit of 10,000. In other words we can
say Y should be purchased from outside market.
STATEMENT OF TRANSFER PRICE
Cost to be incurred due to transfer 110
+ benefit to be lost due to transfer 70,000/2000 35
Transfer price (Minimum) 145(IV) STATEMENT OF COMPARITIVE COST
Per unit
Manufacture Purchase
Variable
Cost
110 Purchase cost 105
110 105
Decision:- Its better to purchase the component from outside marketbecause Purchase cost is less than the variable cost.
STATEMENT OF TRANSFER PRICE
Cost to be incurred 110
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+ benefit lost -
Minimum T.P. 110
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Question 5:A company has a division A producing three products called
X,Y,Z. Each products can be sold in open market in the following manner
The maximum external sale are X 800 units, Y 500 units, Z 300 units.X Y Z
Selling price per unit
Variable cost of production in Division A
Labour hours required per unit in Division A
96
33
6
92
24
8
80
28
4
Product Y can be transferred to Division B, but the maximum quantity that
might be required for transfer is 300 units of Y.
Division B could buy similar product in the open market at a price of 45 perunit. What should the transfer price be for each unit for 300 units of Y, if the
total labour hours available in Division A are: (a) 13000 hours (b) 8000
hours (c) 12000 hours. (C.A. Final & ICWA Final 2011)
SOLUTION:-
STATEMENT OF LABOUR HOURS 13000 Hrs.
External Sale Qty Hours Per Unit Hours
X 800 6 4800Y 500 8 4000
Z 300 4 1200
Requirement 10000
Availability 13000
Spare 3000
Division A can produce 300 units of product Y & transfer to Division B at its
relevant cost by utilizing, its spare capacity.STATEMENT OF TRANSFER PRICING
Per Unit
Cost to be incurred 24
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+ benefit to be lost -
Minimum T.P. 24
Transfer Price - 24 to 45.
Ii:- If we have 8000 Labour hours than it means such labour hours are the
limiting factors which means we are utilizing in optimum manner.
STATEMENT OF RANKING
X Y Z
Contribution/unit ( 63 68 52
Labour Hours/ unit 6 8 4
Contribution/Hour () 10.5 8.5 13
Ranking II III I
STATEMENT OF OPTIMUM PRODUCT MIX(Present)Unit Hour per unit Hours
X 800 6 4800
Y 250 8 2000 (B/F)
Z 300 4 1200
8000 Hours
In order to produce 300 units of Y, for the purpose of transfer, the company
requires 300 X 8 = 2400 labour hours which should be managed by not
producing product of Y ( 2000 Hours) and X ( 400 Hours)
STATEMENT OF TRANSFER PRICING Per unit
Cost to be incurred 24
+ cont. to be lost
A:- 2000 Hours X 8.5 17,000
B:- 400 Hrs. X 10.5 p.u. 4200
21,200/300 70.66Transfer price 94.66
III:- 12000 Hours
If we have 12000 Labour hour than after utilizing in external demand the co
will have surplus labour hour 12000- 10,000 2000 labour hour which can
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be utilized for producing 2000 = 250 (u) of Y for transfer price in order to
produce and transfer price next 50 units, the co. will have to reduce 50 X 8
= 400 labour hour from external demand of Y.
STATEMENT OF TRANSFER PRICE
Cost to be incurred 24 X 300
+ Contribution to be lost400 hrs X 8.5 3400
Transfer value 10,600
/ Quantity 300
Min. Transfer Price 35.00
Transfer Price 35.33 to 45.
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Question 6: Reliance is a group having of four different companies.Reliance Power . Reliance Petro, Reliance Chemical and Reliance Refinary.
Reliance Refinary proposes to place a contract for a component to be used
in one of its new products and in accordance with Reliance policy has to
obtain quotations from any suitable company within the group and at least
one outside company.
Within the group Reliance Power is approached as the most suitable
company and submits a quotation of 3000. In order to do the job, howeverReliance Power will need to sub-contract some of the work to Reliance
Petro and some to Reliance Chemical.
Arrangements between the companies for this sub-contract are as follows:
Reliance Power will buy from Reliance Petro a parts at a price of 300.
Reliance Power will buy from Reliance Chemical components at a price of
1,500.
Reliance Power total costs (including purchases from Reliance Petro and
Reliance Chemical) for the Reliance Refinary contract are 2,400.
The following information is also given:
1: The variable costs of each group company relating to the work for which it
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Power Petro Chemica
Variable Cost
(60% of 600)
360 Variable
Cost
240 Variable cost 1000
+Fixed Cost 240 Fixed Cost 250
Own cost 600 Fixed Cost 60 Own Cost 1250
+ Purchase Cost 1500 + Profit Purchase Cost -Petro Transfer Cost 1250
Chemical 300 Purchase
cost
Nil Profit 250
Transfer Cost 2400 1500
+ Profit 600
Transfer Price 3,000 300
Note:- All Calculations are in reverse order.STATEMENT OF COMPARATIVE COST
Manufacture Purchase
Cost to be incurred Purchase Cost 2000
Reliance Power 360 (outside)
Petro 240
Chemical 1000
1600 2000Decision:- Its better to produce the component in house & transfer
because relevant cost is less than its Purchase cost. Further we can say
fixed cost are sunk for Reliance Power, Petro & chemical & profit unrealized
due to internal transfer (spare capacity)
(ii) WHAT would ne your decision in above situation if reliance chemical is a
profit centre.
STATEMENT OF COMPARATIVE COSTCost to be incurred
Reliance Power 360
Petro 240 Purchase Cost 2000
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Chemical 1000
+ Contribution to be lost
Reliance Chemical 500
2100 2000
In this situation its better to purchase the component from XYZ Co.
because Purchase Cost is less than Relevant Cost.-----------------------------------------------------------------------------------------------------
Question 7:A company has two divisions. Division A produces a Product
which is used by division B in making a final product.
Division A has a capacity to produce 3,000 units and the whole quantity can
be transferred to Division B. The transfer price for such component would
be 250 per unit which division A would like to charge from division B.
Division B however, can purchase from the outside market at 220 each
The selling price of final product is 500.
The variable costs Division A is 180 and fixed costs 10000 . The variable
costs of Division B in manufacturing the final product by using the
component is 180 (excluding the component cost). Present statements
indicating the position of each Division and the company as a whole taking
each of the following situations separately:
(i) What transfer price would you fix for the component in each of the
following three circumstances?
(iI)If there are no alternative uses for the production facilities of A, will the
company benefit if division B buys from outside suppliers at 220 per
component?
(iii) If internal facilities of A are not otherwise idle and the alternative use of
the facilities will give an annual cash operating saving of 50,000 to DivisionA, should Division B purchase the component from outside suppliers?
(iv)If there are no alternative uses for the production facilities of Division A
and the selling price for the component in the outside market drops by 50
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should Division B purchase from outside suppliers?
SOLUTION:-
(ii) STATEMENT OF TRNASFER PRICE
per unit
Cost to be incurred 180
+ benefit to be lost -
Minimum Transfer Price 180
Transfer Price = 180 per unit to 220 per unit.
STATEMENT OF PROFIT (WITH TRNASFER)
Deptt. A Deptt. B Co.
Transfer(Revenue)
180 X 3000 Sale 3000 X 500 Total Project
Less: Cost 180 X 3000 Own
Cost
180 X 3000 A -
Profit Transfer Cost 180 X 3000 B 4,20,000
PROFIT 4,20,000 Total 4,20,000
STATEMENT OF PROFIT (WITHOUT TRANSFER)
B Co.
500 X 30003000 X 220 A -
180 X 3000 B 3,00,000
3,00,000 Total 3,00,000
On the basis of above analysis we can say its better for the Co. if
department B receives 3000(unit) from department A.
(iii) STATEMENT OF TRANSFER PRICE
per unit
Cost to be incurred 180
+ benefit to be lost due to transfer 50
(1,50,000/3,000) Minimum Transfer Price 230
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STATEMENT OF RPOFIT (WITHOUT TRANSFER)
A Deptt A B Deptt B Co.
Cash saving 1,50,000 Rev. 15,00,000 A 1,50,000
- cost - - Purchase cost 3000 X 220 B 3,00,000
- Own Cost 3000 X 180
Net Benefit 1,50,000 3,00,000 Total 4,50,000
STATEMENT OF PROFIT (WITH TRANSFER)
Deptt. A B Co.
3000 X 230 Revenue 15,00,000
3000 80 Less Transfer Cost 3000 X 230 A 1,50,000
Purchase Cost 3000 X 180 B 2,70,000
1,50,000 Benefit 2,70,000 Total 4,20,000Its better to purchase the entire requirement of B from outside market due
to higher benefit.
(iii) STATEMENT OF TRANSFER PRICE
Cost to be incurred 180
Minimum Transfer price 180
STATEMENT OF PROFIT (WITHOUT TRNASFER)
AB
Co.
Revenue 15,00,000
Less Purchase Cost 3000 X 170 A -
Own Cost 3000 X 180 B - 4,50,000
4,50,000 4,50,000
STATEMENT OF PROFIT (WITH TRANSFER)
A B Co.
Revenue 3000X 180 Revenue 15,00,000
Cost 3000 X 180 (-) Transfer 3000 X 180 A -
(-)Own Cost 3000 X 180 B 4,20,000
--- 4,20,000 Total 4,20,000
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(ii) In view of the companys overall interest, calculate the customer wise
units to be produced by A in 2010.
(iii) Assuming that A follows its best strategy between what values of
transfer price will B be able to negotiate with A, so that As best strategy is
unchanged in 2011. (ICAI Adopted)
SOLUTION:-For Department A
If transfer unit & order unit become less than 10,000 unit better to incur
variable cost 5 per unit.
Transfer unit/Order units are more than 10,000 (units) better to incur Fixed
Cost 50,000.
Indifference Point = 50,000/5 = 10,000(unit)
STATEMENT OF RANKINGOption External Sale
Up to 30,000 unit
Special order
15000 units
Transfer to B
< 45,000 unit
Transfer to B
45000 unit
Selling Price ( 65 55 55 60
-Variable Cost ( 35 35 35 35
_ Selling &
distribution (
10 - - -
Cont/unit( 20 20 20 25
Selling & distribution Cost would be 50,000 instead of variable element because in
option no. 2 & or Option No. III, Quantity exceeds 10,000 (unit)
The best strategy for Dept.A would be as under
i:- Transfer to B : 45000 unit
ii:- External Sale : 5000 unit
STATEMENT OF PROFIT (A)
Contribution transfer to B 45000 X 25 12,25,000
External Sale 5000 X 20 10,00,000
Less: Fixed Cost
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30,000 unit 4,30,000
10,000 unit 1,00,000
10,000 unit 1,00,000 6,30,000
Less: Selling & Distribution 50,000
Profit 5,45,000In 2010 Best strategy for A
STATEMENT OF RANKING
Options External Sale up to
25000 unit
Special order
10,000 unit
Transfer to B