TRANSFER PRICING

(Amended as per current pattern of ICAI Examination Including selected question of ICMA &ICWA exams)

CA. Sanjay Aggarwal FCA, FICWA

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 Direct labour Direct expenses Variable manufacturing overheads Fixed manufacturing overheads Sells and packaging expenses-variable 40 20 20 20 40 10 150

Annually 20,000 units of the product are sold externally at the standard price 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 internal transfers. Division XYZ incorporates the transferred in goods into a more advanced product. The unit costs of this product are as follows:-

`
Transferred in-term (from division ABC) 290
2

Direct material and components Direct labour Variable overheads Fixed overheads Selling and packing expenses variable

230 30 120 120 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 200 300 400 Selling price (`) Demand (units) DIVISION XYZ Selling price (`) 30,000 800 20,000 900 10,000 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.
3

(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 external 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 B
Eternal market ( normal sales)
Selling Price(`/u) Variable manuf. cost(`/u) Variable selling cost(`.u) 1,000 600 100**

(Special sales)
800 600 -

External market (normal sales)

4000 1,500* 200** (*excluding Component C) (** Not incurred on inter division transfers) (*excluding component C)

Total variable cost (`/unit) Contribution (`/unit) Units sold Production capacity

700 300 1250

600 200 750 2000 units

1700*

900 900 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 machines respectively). 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 200 i.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 700 Cost 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. 3 Benefit 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 1,65,000 rd Its better to select 3 option due to higher benefit. The difference of Transfer Price between option 1 & 2 (From department B to department A) = 2100 Transfer Price as per 1st option nd Transfer Price as per 2 option = 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 Labour 2 hours ` 140 ` 20 280 Parts hours ` 140 ` 10 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 Circuit board ` 600 Labour Other parts 80 5 hours @ ` 100 500 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 X BAJAJ 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 BETA Selling 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 MIX Unit 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

Manufacture ALPHA V.C Per unit 300 Purchase

( 6000(unit))
Per Unit

Purchase cost of 600 Board

+ Contribution to be lost 2 hour X 160 40/ 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

300 300 Purchase Cost 600 600 + Extra Cost 100 700 600 X dept. should not produce & transfer over and above 10,000(units) of ALPHA. ----------------------------------------------------------------------------------------------------Question 4: A manufacturing Company has two Division X and Y. The output 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
9

Manufacture V.C. + Contribution lost

Purchase Cost

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 Variable Cost 110 Purchase cost Purchase 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 + benefit to be lost Minimum Transfer price 110 110 Per unit
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(iii)

STATEMENT OF COMPARITIVE COST

Manufacture Variable Cost

`
110 110 Purchase cost

Purchase

`
140 140

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 + benefit to be lost due to transfer Transfer price (Minimum) 110 70,000/2000 35 145 Per unit Manufacture Variable Cost 110 Purchase cost Purchase 105

(IV) STATEMENT OF COMPARITIVE COST

110 105 Decision:- Its better to purchase the component from outside market because Purchase cost is less than the variable cost.

STATEMENT OF TRANSFER PRICE

Cost to be incurred 110
11

+ benefit lost Minimum T.P. 110 ----------------------------------------------------------------------------------------------------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 ` 96 ` 92 ` 80 Variable cost of production in Division A ` 33 ` 24 ` 28 Labour hours required per unit in Division A 6 8 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 per unit. 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 4800 Y 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 Cost to be incurred Per Unit ` 24
12

+ 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 63 68 52 Contribution/unit (`) Labour Hours/ unit Contribution/Hour (`) 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 70.66 Transfer 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
13

6 10.5

8 8.5

4 13

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 lost 400 hrs X 8.5 3400 Transfer value 10,600 / Quantity 300 Min. Transfer Price 35.00 Transfer Price 35.33 to 45. ----------------------------------------------------------------------------------------------------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, however Reliance 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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has quoted are: As a proportion of the total cost of the work it does itself (i.e. excluding parts or components bought from other group companies): Reliance Power 60% Reliance Chemical 80% As a proportion of selling price Reliance Petro 80% 2: Reliance Chemical prices included a 20 % profit margin on total cost (including where appropriate, any special parts purchased). From companies outside the group, Reliance Refinary obtain the following quotations: XYZ Co. quotes ` 2000. Advice whether from the Reliance group point of view it is more advantageous for the contract to be placed with Reliance Power, or XYZ Co. What would be your decision if Reliance Metro is selling their product in (ICMA LONDON, ICWA) competitive market.

SOLUTION:Company

Reliance Reliance Reliance Reliance Power Petro Chemical Refining Power = 60% of own cost = Variable Cost, & balance is Fixed Cost Chem. = 80% of own cost = Variable Cost, balance is Fixed Cost Petro = 80% of Selling Price = Variable Cost Variable Cost + Fixed Cost + Profit = Selling Price In the absence of instruction the nature of department/Co. under the same management would be cost centre.

STATEMENT OF COST
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Variable Cost (60% of 600) +Fixed Cost Own cost + Purchase Cost Petro Chemical

Power 360 Variable Cost 240 600 Fixed Cost 1500 + Profit 300 Purchase cost

Petro 240 Variable cost Fixed Cost Own Cost Purchase Cost Transfer Cost Profit

Chemical 1000 250 1250 1250 250 1500

60

Nil

Transfer Cost 2400 + Profit 600 Transfer Price 3,000 300 Note:- All Calculations are in reverse order. STATEMENT OF COMPARATIVE COST

Manufacture
Cost to be incurred Reliance Power Petro Chemical

Purchase
Purchase Cost (outside)

`
2000

360 240 1000 1600 2000 Decision:- 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 COST Cost to be incurred ` `

Reliance Power Petro 360 240 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 Division A, 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,
17

should Division B purchase from outside suppliers? SOLUTION:(ii) STATEMENT OF TRNASFER PRICE

` per unit
Cost to be incurred + benefit to be lost 180 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) Less: Cost Profit 180 X 3000 Sale 3000 X 500 Total Project A B Total ` 4,20,000 4,20,000

180 X 3000 Own 180 X 3000 Cost Transfer Cost 180 X 3000 PROFIT 4,20,000

STATEMENT OF PROFIT (WITHOUT TRANSFER) B Co. 500 X 3000 3000 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 + benefit to be lost due to transfer (1,50,000/3,000) Minimum Transfer Price 180 50 230
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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 Co. B ` 3000 X 230 3000 80 Revenue 15,00,000 -

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 4,20,000 Its 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) A Co. B ` Revenue Less Purchase Cost Own Cost 15,00,000 -

`
4,50,000 4,50,000

A
Cost

3000 X 170 A 3000 X 180 B 4,50,000 STATEMENT OF PROFIT (WITH TRANSFER) B Co.
Revenue 15,00,000 A B Total 3000 X 180 --(-) Transfer 3000 X 180 (-)Own Cost 3000 X 180 4,20,000

Revenue 3000X 180

`
4,20,000 4,20,000
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Its better to purchase the component from outside market because Purchase Cost is less than the variable cost which will increase the profit of Co. by 30,000. (C.A. Final Nov., ICWA final adopted) ----------------------------------------------------------------------------------------------------Question 8: Dabur Ltd has two divisions A and B, making products A and B respectively. One unit of A is an input for each unit of B. B has production capacity of 45,000 units and ready market for 45,000 units in both the years 2010 and 2011. Other information available:
Year Division A
Capacity (production units) Maximum demand in usual external market(units)

2010
50,000 25,000

2011
50,000 30,000

Special order(units) (to be fully accepted or fully rejected) Fixed cost `/annum upto 30,000 units (Beyond 30,000 units, fixed cost increases by `1,00,000 for every additional 10,000 units for each year). Variable manufacturing cost `/unit Variable selling cost `/unit (only for usual external sales) Variable selling cost `/unit (only for special order and transfer to B) Selling price (usual external market) `/unit

10,000 4,30,000

15,000 4,30,000

35 10 5 65 55

35 10 5 65 55

` B buys input A from outside at a slightly incomplete stage at ` 30 per unit

and incurs sub- contract charges at ` 20 per unit to complete it to a stage to match the output of Division A. In 2011, subcontract charges will increase to ` 30 per unit. B is willing to pay A, the price if incurs viz ` 50 and ` 60 per unit in 2010 and 2011 respectively, provided A supplies Bs full requirement. For any lesser quantity, (B will accept any quantity), B is willing to pay A only ` 45 and ` 55 per unit in 2010 and 2011 respectively. Assume no changes in inventory levels in 2011. A may choose to avoid the variable selling overhead of ` 5 per unit on transfer to B or special order, by incurring a fixed overhead of ` 50,000 p.a. instead. (i) What will be the maximum profits of A under its best strategy in 2011?
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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 RANKING
Option Selling Price (`) External Sale Up to 30,000 unit 65 Special order Transfer to B Transfer to B 15000 units < 45,000 unit 45000 unit 55 55 60 35 20 35 20 35 25

-Variable Cost (`) 35 _ Selling & 10 distribution (`) 20 Cont/unit(`)

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 External Sale Less: Fixed Cost 45000 X 25 5000 X 20 12,25,000 10,00,000
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30,000 unit 10,000 unit 10,000 unit Less: Selling & Distribution In 2010
Options

` 4,30,000 ` 1,00,000 ` 1,00,000

Profit Best strategy for A 6,30,000 50,000 5,45,000

STATEMENT OF RANKING
External Sale up to 25000 unit Selling Price 65 Variable cost 35 Selling & 10 Distribution Cont./ unit 20 Ranking I Special order 10,000 unit 55 35 20 II Transfer to B < Transfer to B 45000 unit 45000 unit 45 50 35 35 10 III 15

The best strategy for A would be as under i:- External sale = 25000 ii:- Special order = 10,000 iii:- Transfer to B = 15,000 (iii) B dept would like to pay maximum amount ` 60 to A = Purchase Cost & this would be the upper limit of negotiated range. For any transfer price less than ` 60 will increase the profit of B, correspondingly decrease the profit of A but overall profit remain unchanged but lower limit to be decided by dept. A on the basis of its relevant cost I.e. cost to be incurred due to transfer. Minimum Transfer Price = 35 + 50,000/45,000 + Contribution to be lost is 20 = 56.11. ----------------------------------------------------------------------------------------------------Question 9: A Manufacter fixes the inter-divisional transfer prices for its products on the basis of Total cost plus markup on its investment in its divisions. The relevant portion of the budget for the division for the year
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201112 is given below: Desired markup on investment 30% Fixed Assets 10,00,000 Fixed cost 10,00,000 P.A. Current assets 5,00,000 Variable cost per unit of product 20 Budgeted output (Units) 1,00,000 Required:- To determine the transfer price for the division X. (ICAI Adopted)

SOLUTION:-

STATEMENT OF TRNASFER PRICE

Per unit (`) 20 10 30 4.5 34.50

Variable Cost + Fixed Cost 10,00,000 /1,00,000 Total Cost + Mark Up 30% (15,00,000)/1,00,000 Transfer Price

Investment = FA+ CA CL = ` 10,00,000 + 5,00,000. ----------------------------------------------------------------------------------------------------Question 11: Maruti Ltd. which has a system of assessment of Divisional performance on the basis of Residual Income has two divisions: ALFA and BETA. ALFA has annual capacity to manufacture 15 lakhs nos. of a special component which it sells to outside customers; but has idle capacity. The budgeted residual income of BETA is ` 200 lakhs while that of ALFA is ` 100 lakhs. Other relevant details extracted from the Budget of ALFA for the year are: Sale (to outside customers) 12 Lakhs units @ ` 180 per unit. Variable Cost per unit `160 Divisional fixed cost Capital employed ` 80 Lakhs ` 750 Lakhs
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Cost of Capital 12% BETA has just received a special order for which it requires components similar to the ones made by ALFA. Fully aware of ALFAs un utilised capacity. BETA has asked ALFA to quote for manufacture and supply of 3,00,000 numbers of the components with a slight modification during final processing. ALFA and BETA agree that this will involve an extra variable cost of ` 8 per unit. (i) Calculate the transfer price which ALFA should quote to BETA to achieve its budgeted residual income. (ii) Indicate the circumstances in which the proposed transfer price may result in a sub- optimal decision for the group as a whole.

SOLUTION:Residual Income Actual Profit Normal Profit

STATEMENT OF PRESENT RESAIDUAL INCOME ` Lakh

Sale - Cost Variable Cost 180 X 1200,000 160 X 1200,000 Contribution 2160

1920 240 - Fixed Cost 80 Business Profit 160 - Normal Profit 750,00,000 X 12% 90 Residual Income 70 Target 100 Deficit 30 STATEMENT OF TRANSFER PRICE

` Per unit
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Cost to be incurred 160 + Modification Cost 8 Relevant Cost 168 +Deficit to be recovered 30,00,000 / 3,00,000 10 Transfer Price 178 As suggested by Mgt. (ii) If purchase cost of the component false below its variable cost i.e. 168 then its better to purchase from outside market. Its means in that case
proposed transfer price( I.e.178)have no meaning in result in suboptimal decision.

----------------------------------------------------------------------------------------------------Question 12: Ponds Limited producing a range of minerals is divided into two trading groups: one handles wholesale business and the other to retailers. One of its products is a molding clay. The wholesale group extracts the clay and sells it to external wholesale customers and transfer to the retail group. The Production capacity is 2,000 tonnes per month but at present sales are limited to 1,000 tonnes to wholesale customers and 600 tonnes to retail. The transfer price was agreed at ` 200 per tonne in line with the external wholesale trade price at the 1 April which was the beginning of the budget year. As from 1 December, however competitive pressure has forced the wholesale trade price down to `180 per tonne. The member of the retail group contend that the transfer price to them should be the same as for outside customers. The wholesale group refuses the argument on the basis that the original budget established the price for the whole budget year. The retail group produces 100 bags of refined clay from each tonne of molding clay which sells at ` 5 a bag. It would sell a further 40,000 bags if the retail price were reduced to ` 3 a bag. The other data relevant to the operation are:

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Variable cost per tonne Fixed cost per month

Wholesale group ` 70 10,000

Retail group ` 60 20,000

(a) Prepare estimated profit statement for the month of December for each group and for Ponds limited as a whole based on transfer prices of ` 200 per tonne and of ` 180 per tonne when producing at: (1) 80 % capacity and (2) 100% capacity utilising the extra sales to supply retail trade: ----------------------------------------------------------------------------------------------------Question 13: ATLAS Cycles has two divisions A and B which manufacture expensive bicycles. Division A produces the bicycle frame, and Division B assembles the rest of the bicycle onto the frame. There is a market for both the sub-assembly and the final product. The following data are available for each division: Selling price for final product ` 3,000 Ong run average selling price for intermediate product 2,000 Incremental costs for completion in Division B 1,500 Incremental costs in Division A 1,200 The manager of Division B has made the following calculation Selling price for final product ` 3,000 Transferred in costs (market) ` 2,000 Incremental costs for completion Contribution (loss) on product. 1,500 3,500 ` (500)

Required 1. Should transfers be made to division B if there is no unused capacity in Division A? Is the market price the correct transfer price ? 2. Assume that Division As maximum capacity for this product is 1,000 units per month, and sales to the intermediate market are now 800 units. Should
26

200 units be transferred to Division B? At what transfer price? Assume that for a variety of reasons, Division A will maintain the ` 2,000 selling price indefinitely. That is, Division A is not considering about lowering the price to outsiders even if idle capacity exists. 3. Suppose Division quoted a transfer price of ` 1,500 for up to 200 units. What would be the contribution to the company as a whole if a transfer were made? As a manager of Division B, would you be inclined to buy at ` 1,500 ? Explain. 4. Suppose the manager of Division A has the option of (a) cutting the external price to ` 1,950 with the certainty that sales will rise to 1,000 units, or (b) maintaining the outside price of ` 2,000 for the 800 units and transferring the 200 units of Division B at a price that would produce the same operating income for Division A. What transfer price would produce the same operating income for Division A? 5. Suppose that if the selling price for the intermediate product is dropped to `1,950, outside sales can be increased to 900 units. Division B wants to acquire as many as 200 units if the transfer price is acceptable. For simplicity assume that there is no outside market for the final 100 units of Division As capacity. The minimum transfer prices that should lead to the correct economic decision?

SOLUTION:A: Deptt.
Revenue Costs

B: Deptt.

Co.
800 (500) 300 Co.
27

2000 Revision 3000 1200 Transfer Cost (2000) A Own Cost (1500) B Benefit 800 Profit (500) Total STATEMENT OF PROFIT (WITH TRANSFER) A B Revenue 2000 Revenue 3000

-Cost

1200

1500 B (500) 800 (500) 300 STATEMENT OF PROFIT (IF A does not transfer to B) A B Co. External Sale 2000 X A 800 Less Cost 1200 X B Benefit 800 X 800 Its better to produce bicycle frame in deptt. A & sold in external market instead of transfer to Division B. (ii) A department has spare capacity 200 units & these 200 units can be produced and transfer to department B at minimum price (1200) it is variable Cost.

Transfer Cost Bs Cost

2000

800

STATEMENT OF TRANSFER PRICE

(200 units) Relevant Cost (` )

Cost to be incurred 1200 + Contribution to be lost Minimum Transfer Price 1200 Maximum Transfer Price would be equal to incremental profit for B. 3000 1500 = 1500 Selling Price Own Cost Transfer Price for 200 units Transfer price 0 -200 Unit

` 1200 ` 1500 per unit. (iii) STATEMENT OF CONTRIBUTION Co. A ` B `

200X 3000 A 200X 1500 B 200X 1500 7,00,000 28

External sale 800 X 2000 Sale Transfer price 200 X 1500 Less Cost Cost 1000 X 1200 Transfer Own Cost

Contribution 7,00,000 --7,00,000 Overall contribution to the Co. would be 7,00,000 due to transfer Management of division B would not be interested to receive 200 (units) at ` 1500 . (iv) Selling Price (`) Quantity 2000 Per unit 800 1950 per unit 1000 Quantity Price Sale 800 2000 200 ? Let X be the transfer price for 200 units. Operating income from A1 = Operating income from A2. 1950 X 1000- 1200X 1000 = 800 X 2000 + 200 X x-1000X 1200 X = 1750 per unit Minimum Transfer Price would be ` 1750 per unit. (v) Qty Selling price Variable Cost 800 1200 2000 ` per unit 900 1950 ` per unit 1200

Contribution 800 X 800 750 X 900

3500 A department has spare capacity 100 units in any case. Hence Transfer price for these 100 units would be variable cost i.e. `1200 per unit. For next 100 units Transfer Price would be variable cost + Contribution to be lost.

`
Cont. (Without transfer) 900 X (1950 -1200) 6,75,000 Cont. (With transfer) 800 X (2000 -1200) 6,40,000 Contribution to be lost 35,000
29

STATEMENT OF TRANSFER PRICE For next 100 units

` Per unit
Cost to be incurred + Contribution to be lost (35000/100) Level 100 units Next 100 units Transfer price 1200 350 1550

` 1200 1500 per unit ` 1550 per unit

----------------------------------------------------------------------------------------------------------------Question 14: MRF Ltd. has three divisions X, Y and Z, with make products X, Y, and Z respectively. For division Y, the only direct material is product X and for Z the only direct material is product Y. Division X purchases all its raw material from outside. Division Y additionally incurs `10 per unit and ` 8 per unit on units delivered to external customers and Z respectively, also ` 6 per unit picked up from X whereas external supply at Ys factory at the stated price of ` 85 per unit. Additional information is given below:
Figures `/unit X Y 20,000 30,000 14,000 26,000 Z 40,000 unit 42,000 unit

Production capacity ( unit ) Demand ( Unit) Direct materials (external supplier rate) Direct labour Selling price in external market

` 40 ` 30 ` 95

` 85 ` 50 ` 155

` 135 ` 45 ` 230

Required To discuss the range of negotiation for Managers X, Y and Z, for the number of unit and the transfers price for internal transfers from company overall point of view. (ICAI Adopted). SOLUTION:30

Negotiated Range between X & Y,

Option no. 1
X dept has spare capacity 6000 units hence Transfer price would be at its variable cost only i.e. 40+30 = ` 70 which is acceptable by Y. Option No. 2

` per unit
X deptt. can reduce its market demand and transfer at its variable cost = 70

+ Contribution to be lost

= 25 Transfer price 95

Not acceptable by Y. Option no. I is acceptable but Y can offer maximum price to X. i.e. 85 6 = 79 Transfer price = Level (unit) Negotiable Range 0 - 6000

` 70 to 79 per unit .

Negotiate Range between Y and Z Deptt. Y dept has following option. OPTION NO.1 By reducing its market sale in 26000 (unit) Transfer Price = Selling Price = 155 10 + 8 = 153 Not acceptable by Z . OPTION No. 2 By utilizing spare capacity upto 4000 at its Variable Cost Variable Cost = 85 + 50 + 8 = 143 ` per unit Also Not acceptable by Z. OPTION No.3 Y can transfer 4000(unit) to Z out of 6000 received from X at 79 Transfer Price = 79 + 6 + 50 + 8 = 143
31

Also Not acceptable by Z (because Z can purchase at 135 from outside market). OPTION NO. 4 Y can transfer 4000(u) to Z out of 6000 received from X. Transfer price = 70 + 6 + 50 + 8 = 134 Which is acceptance subject to the interest of Co. STATEMENT OF PROFIT (if y does not transfer 4000 out of 6000) Y Z Ex.Sale 26,000 X 155 Sale 40,000 X 230 Cost Transfer Cost 6,000 X 70 Purchase Cost 40,000 X 135 Transportation 6,000 X 6 Labour Cost 40,000 X 45 Cost Purchase Cost 20,000 X 85 Labour Cost 26,000 X 50 Delivery 26,000 X 10 Profit 3,14,000 20,00,000 Total Profit = 3,14,000 + 20,00,000 = 23,14,000 STATEMENT OF PROFIT (if Y transfer 4000 out of 6000) Y Z Ex.Sale 26,000 X 155 Sale 40,000 X 230 Cost 4000 X 134 Transfer Cost 4,000 X 134 Transfer Cost 6,000 X 70 Purchase Cost 36,000 X 135 Transportation Cost 6,000 X 6 Labour Cost 40,000 X 45 Purchase Cost 24,000 X 85 Labour Cost 30,000 X 50 4000 X 8 Delivery 26,000 X 10 Profit 2,78,000 20,04,000 Total Profit = 22,82,000 Decision:- Y dept should not transfer 4000(u) to department Z due to
32

reduction in profit 32,000 ( 23,14,000 2282,080) ----------------------------------------------------------------------------------------------------Question 15: X Ltd. has two divisions, A and B, which manufacture products A and B respectively. A and B are profit centres with the respective Divisional Managers being given full responsible and credit for their performance. The following figures are presented :
Division A ` Per Unit Direct material cost Material A, if transferred from Division A Material A, if purchased from outside Direct labour Variable production overhead Variable selling overhead Selling price in outside market Selling price to B Selling price to S Ltd. 50 25 20 13 160 144 Division B ` Per unit 24 * 144 160 14 2 26 300 250 (Other than A)

Other Information: To make one unit of B, one unit of component A is needed. If transferred from A, B presently takes product A at ` 144 per unit, with A not incurring variable selling overheads on units transferred to B. Product A is available in the outside market at ` 160 per unit for competitors. B can sell its product B in the external market at ` 300 per unit, whereas, if it supplied to X Ltd. subsidiary, S Ltd., it suppliers at ` 250 per unit, and need not incur variable selling overhead on units transferred to S Ltd. S Ltd. requires 6,000 units and stipulates a condition that either all 6,000 units be taken form B or none at all. A (Units) B Units

33

Manufacturing capacity 20,000 28,000 Demand in external market 18,000 26,000 S Ltd.s demand 6,000 or zero Assume that Division A and B will have to operate during the year. What is the best strategy for: (i) Department A? ii) Department B, given that A will use its best strategy?(ICAI adopted, RTP) SOLUTION:STATEMENT OF RANKING

Option
Selling Price (` Per unit) Variable Cost (` Per unit) Selling & Distribution (`)

External Sale Transfer

160 95 13 144 95 -

52 49 Contribution/unit(` Per unit) Ranking I II The best strategy for Dept A would be as under:i:- External sale 18,000 (u) ii:- Transfer to B 2,000 (u) The resulted Contribution for Department A = 18000 X 52 + 2000 X 49 Contribution = ` 10,34,000. (ii) The best strategy for department B would be as under:Department B would like to receive 2000 (unit) from dept. A

STATEMENT OF RANKING for more than 200 units External Sale Transfer to S
Selling Price (` Per unit) Variable Cost (` Per unit) Purchase cost (` Per unit) Contribution/unit 300 66 160 74 250 40 160 50
34

Now we have two option OPTION I External Sale 26,000 unit Spare Capacity 2,000 unit OPTION II External sale 22,000 unit Transfer to S 6,000 unit Spare -Contribution as per option 1 Revenue 26,000 X 300 - Cost Transfer Cost 2000 X 144 Purchase Cost 24,000 X 160 Variable Cost 26,000 X 66 Contribution as per option 2 Revenue 22000 X 300 6000 X 250 Transfer Cost 2000 X 144 Purchase cost 26,000 X 160 Own Cost 28,000 X 40 Selling & Dist. 22,000 X 26 ` 66,00,000 15,00,000 2,88,000 41,60,000 11,20,000 5,72,000 ` = 78,00,000 =2,88,000 38,40,000 17,16,000

19,56,000

Contribution

19,60,000

We should select option no. 2 due to higher contribution. ----------------------------------------------------------------------------------------------------Question 16:- SURYA Ltd. Makes Three Products A, B and C in Division A, B and C respectively:
A B C
35

Direct Materials (excluding material A for Divisions B and C) 4 15 20 (`/unit) 2 3 4 Direct Labour (`/unit) 1 1 1 Variable overhead (Re/unit) 15 40 50 Selling price to outside customers (`/unit) 5,000 2,500 2,500 Existing Capacity (No. of units) 3,750 5,000 4,000 Maximum External demand (No. of units) Additional fixed costs that would be incurred to install additional ` 24,000 ` 6,000 ` 18,700 capacity Maximum Additional units that can be produced by additional 5,000 1,250 2,250

B and C need material A as their input. Material A is available outside at ` 15 per unit. Division A supplies the material free from defects. Each unit of B and C requires one unit of A as the input material. If B purchases from outside, it has to pay ` 15 per unit. If B purchases from A, it has to incur in addition to the transfer price, ` 2 per unit as variable cost to modify it. B has sufficient idle capacity to inspect its inputs without additional costs. If C gets material from A, it can use it directly, but if it gets material from outside, which is at ` 15, it has to incur ` 2 for inspection charges. A has to fix a uniform transfer price for both B and C. What is the best strategy for each division and the company as a whole? SOLUTION:Ponds Wholesale Sale 1000 tonne PROFIT STATEMENT Transfer 600 Retailer Selling Price=200

1:- STATEMENT OF PROFIT TRANSFER PRICE=200 Capacity 80% Wholesale Retailer Company `
Revenue ` Revenue 60,000 X 5
36

Ex.Sale 1000 X 180 Cost Transfer 600 X 200 Transfer Cost 600 X 200 Whole Sale 1,78,000 - Cost 1600 X 70 Cost 600 X 60 Retail 1,24,000 - Fixed 10,000 Fixed Cost 20,000 Cost Profit 1,78,000 Profit 1,24,000 Total 3,02,000 Ii:- STATEMENT OF PROFIT TRNASFER PRICE 180 Capacity 80% Wholesaler Retailer Company Revenue Revenue 60,000 X 5 ` ` Exp. Sale 1000 X 180 Cost Wholesale 1,66,000 Transfer 600 X 180 Transfer 600 X 180 Retailer 1,36,000 Cost Cost 1600 X 70 Cost 600 X 60 Fixed Cost 10,000 Fixed Cost 20,000 Profit 1,66,000 Profit 1,36,000 3,02,000

STATEMENT OF PROFIT Capacity 100% Transfer Price 200

Wholesaler Exp. Sale Transfer Less Costs Variable Cost Fixed Cost Profit Wholesaler Exp. Sale Less Costs Variable Cost Fixed Cost 1000 X 180 1000 00 2000 X 70 10,000 2,30,000 Retailer Revenue Less Cost Transfer Cost Fixed Cost Profit Retailer Revenue Less Cost Transfer cost Cost Fixed Cost Co. 1,00,000 X 3 1000 X 200 1000 X 60 20,000 20,000 2,30,000 20,000

2,50,000 Co.

STATEMENT OF PROFIT Capacity 100% Transfer Price 180

1000 X 180 1000 80 2000 X 70 10,000 1,00,000 X 3 1000 X 180 1000 X 60 20,000 2,10,000 40,000

37

Profit 2,10,000 Profit 40,000 2,50,000 ----------------------------------------------------------------------------------------------------Question 17: XYZ Ltd, has two division, A and B Division A makes and sells product A, which can be sold outside as well as be used by B. A has a limitation on production capacity, that only 1,200 units can pass through its machining operations in one month. On an average about 10% of the units that A produces are defective. It may be assumed that out of each lot that A supplied, 10% are defectives. When a sells in the outside market, the defective are not returned, since the transportation costs make it uneconomical for the customer. Instead, As customers sell the defectives in the outside market at a discount. But when B buys product A, it has to fix it into its product, which is reputed for its quality. Therefore, B returns all the defective units to A. A can manually rework the defectives, incurring only variable labour cost and sell them outside at ` 150 and not having to incur any selling costs on reworked units. If a chooses not to rework, it can only scrap the material at ` 30 per unit. B can buy product A from outside at ` 200 per unit, but has to incur ` 10 per unit as variable transport cost. B can insists to its outside suppliers also that it will accept only good units. A incurs a variable selling overhead only on units (other than reworked units) sold outside. The following figures are given for the month: Variable cost of production Dept. A (`/unit) 120 Variable selling overhead (`/unit) Selling price per unit in the outside market (`/unit) Current selling price to B (`/ unit) Additional variable labour cost of reworking defectives (`/unit) Selling price of reworked defectives (`/unit) Fixed costs for the month (`) Maximum demand from B at present (no. of units) 20 200 190 100 150 36,000 630
38

The outside demand can be freely had up to 900 units. Given the demand and supply conditions, you are required to present appropriate calculations for the following: (i) Evaluation of the best strategy for A in the present condition. (ii) If B can buy only up to 540 units and the outside demand is only 600 units, how much should A charge B to maintain the same level of profit as in (i) above? (ICAI adopted)

SOLUTION:Working Note 1 Defective ----------- Sale as it ` 30 Sale after 150 100 Rectifying = ` 50 Option 2 is better Best strategy means how much quantity should be produced & utilized either for external sale and transfer so that the profit of department A be maximized. STATEMENT OF RANKING External Sale Transfer to B With defective Selling Price 200 190 150 - Variable Cost 120 120 120 - Selling & distribution 20 X 100 expenses 60 70 (70) Net 100 unit be the base for computation. Contribution/100 unit A:- In external sale 60X 100 = 6000 B:- From transfer to B Revenue 100 X 190 = 19000 (-) Variable Cost 100 X 120 = 12000 Contribution 7,000
39

(-) Return 10( u) X 190

1,900 5,100

(+) Benefit on 10 ( u) ( 150 100 ) 10 500 Net Contribution 5,600 = 5600 OR Effective contribution = 70 X 0.9 = 70 X 0.1 = 56 On the basis of above calculation we can say its better to produce and best strategy would be as under. 1200 (unit) A:- External sale ---- 900 (u) B:- Transfer to B ----- 300 (u) Resulted Contribution from A:- 900 X 60 +300 X 56 = ` 70,800 STATEMENT OF CONTRIBUTION A Revenue 900 x 200 Transfer 300 X 190 _______ 2,37,000 Cost Variable Cost 1200 X 120 1,44,000 Selling & Distribution 900 X 20 18,000 Contribution 75,000 Return ( 190 X 30) (5,700) Benefit from defective units ( 150 100)30 1,500 Present Benefit 70,800 (ii) Total desired units Present Benefit 70,800 Contribution from external sale ( 600 X 60) 36,000 Balance 34,800 Loss on return (60 X 70) 4,200 39,000 / Qty 540
40

Desired Contribution Per unit Variable Cost

72.22 120.00 192.22 -----------------------------------------------------------------------------------------------------Question 18: Company has two manufacturing divisions A and B Division: A has a capacity of 96,000 hours per annum. It manufactures two products X and Y as per the following details: X Y 60 Direct materials ` 300 Other Variable costs @ 80 per hour ` 320 80 Selling price ` 800 160 Maximum sales units 15,000 Unlimited Division B produces product Z whose particulars are as under: ` Imported components 800 Direct materials 120 400 Other Variable costs @ ` 40 per hour 1450 Selling price The fixed overheads amount to ` 30 lacs and ` 5 lacs per annum respectively for Division A and B. With a view to minimizing the dependence on imported component, the company explored the possibility of the Division B using the product X as substitutes for imported component. This is possible provided Division B spends two machine hour entailing an additional expenditure of ` 80 per component on modification of the product X to fit into the product Z. The production of Z Division B is 5000 units per annum. Division B seeks a discount of ` 80. So that the transfer price of product X can be set at ` 720 each. You are required to present division wise profitability and the profitability of the company as a whole on the basis of the following conditions: 1. Division B imports its requirement of components.
41

2. Division B stops importing the component and obtain 5,000 units of product X for being used as substitute from Division A at the latters usual market price of ` 800 per unit. 3. Same condition as (ii) above but Division B gets a relief of ` 80 per unit of product X in that case the transfer price has been set by Division A at ` 720 per unit. [RTP, Nov. 2009] SOLTUION:Division A has 96000 Manufacture Cost hours which is a limiting factor. It indicate division A utilize these manufacture hours in optimum manner. STATEMENT OF RANKING X Y 180 20 Contribution/unit (`) Hours Per unit 4 1 45 20 Contribution /hour (`) Ranking I II STATEMENT OF OPTIMUM PRODUCT MIX Unit Hour per unit Hours X 15000 4 60,000 (1st Ranking) Y 36000 1 36000(B/F) Total 96000 STATEMENT OF PROFIT Deptt. Co. A ` B ` Contribution 15000 X 180 Rev. 5000 X 1450 Less Costs 36000 X 20 Less Cost Factory Cost 30,00,000 Purchase Cost (500 X 800) 4,20,000 Cost 5000 X 520 1,50,000 Profit 4,20,000 Fixed Cost 5,00,000 Profit 1,50,000 5,70,000 (ii) IF Department A transfer 5000(u) of X to department B for replacing
42

imported component then department A will reduce the manufacture Cost hour from product Y. Requirement for X 5000 X 4 =20000 Reduction from Y = 20,000 Revised product mix A X External sale 15000 Transfer 5000 Y External Sale 16,000 STATEMENT OF PROFIT A B Co. Revenue 15000X 180 Revenue 5000 x1450 Revenue 5000 X 180 Transfer cost 5000 X 800 A 9,20,000 Cost 16,000 X 20 Extra Cost 5000 X 80 B (2,50,000) Cost 30,00,000 Cost 5000 X 520 Factory Cost 5,00,000 Profit 9,20,000 Profit (2,50,000) (6,70,000) (iii) STATEMENT OF PROFIT A B Co. Revenue 15000X 180 Rev. 5000 x1450 Revenue 5000 X 100 Less Transfer 5000 X 720 cost Cost 16,000 X 20 Extra Cost 5000 X 80 A 5,20,000 Cost 30,00,000 Cost 5000 X 520 B 1,50,000 Factory Cost 5,00,000 Profit 5,20,000 Profit 1,50,000 Total 6,70,000 ----------------------------------------------------------------------------------------------------Question 19: In a company, division A makes product A and Division B makes product B. One unit of a needs one unit of B as input. State the unit transfer price to be adapted by the transferring Division A to B in each of the following independent situations:
43

(i) There is a ready market for A. There are no constraints for production or demand for A and A does not incur any external selling cost. (ii) Supply is more than demand for A. External market resorts to distress price for A and this is expected to last for a temporary period. The product cannot be stocked until better times. (iii) Product A is highly specialized. Internal specifications are too many that B has to only buy from A. (iv) A has excess capacity. It can transfer any quantity to B. Goal congruence is to be achieved. (v) A has no spare capacity, has adequate demand in a competitive market. (vi) A has no spare capacity and has adequate demand in a competitive market. But on units transferred to B, it incurs ` 10 per unit as additional transport cost and ` 10,000 as fixed expenses irrespective of the number of units transferred. (ICAI ADOPTED) SOLUTION:1:- A dept. Can produce & transfer to department B by utilizing its production capacity ( unlimited) without reducing market demand hence minimum Transfer Price should be at variable cost. 2:- Supply department has sufficient spare capacity hence Transfer Price should be at variable cost. 3:- In this situation the output of A & the input of B is not marketable hence Transfer price should be total cost + reasonable markup instead of minimum price or variable cost. 4:- Transfer Price would be variable cost to Purchase Cost. 5:- Transfer Price would be Market Price i.e. relevant cost Cost to be incurred XX + contribution to be lost due to transfer XX XX 6:- Transfer Price = Relevant Cost Cost to be incurred due to transfer XX
44

Variable Cost + Transport Cost + Average fixed Cost + Contribution to be lost

XX XX XX

XX XX ----------------------------------------------------------------------------------------------------Question 20: M Ltd. makes two products, X and Y, in their respective divisions. Each unit of Y needs one unit of X. Divisions X and Y are profit centres and can function according to their divisional interests. In the external domestic market, X can sell either 6000 units at `1,000 per unit or 5000 units at ` 1,120 per unit. X has a production capacity of 7000 units, with each unit requiring 2 hours. Y also has a production and demand of 7000 units. Y can buy product X from outside as follows: Order Quantity Price for the entire order (Units) (` /u) 6001 7000 900 4001 6000 920 2001 4000 1,000 0 2000 1,120 Y resorts to bulk purchase to avail maximum possible discount. (i) There is an export order (that may either be fully accepted or fully rejected) for X to supply 800 units @ ` 900 per unit. (ii) There is an offer to hire out Xs capacity of 1600 hours at `130 per hour. The hiring offer may either be fully accepted or fully rejected. (iii) Y will not buy from X at any price more than it will incur in the outside market. Y does not place restrictions on quantities to be supplied by X, provided its pricing condition is not violated. Given that any one or more of the offers may be accepted, what will be Xs best strategy? What will be the corresponding transfer price? [A detailed cost statement is not essential. Only figures relevant for decision
45

making are required to be considered under each analysis. (ICAI ADOPTED)

Solution:
Capacity of X division = 7000 units X has the following option to sell following number of units:
Option Domestic Market Export Transfer Hiring out (equivalent unit)

I 6000 800 200 II 5000 800 1200 III 5000 2000 IV 5000 800 400 800 According to the condition given in (iii) for procurement policy of Y, For 7000 units, maximum amount Y is agreeable to pay at market rate i.e ` 900 per unit = 7000 ` 900 = ` 63,00,000 If X transfers 1200 units to Y, It has to incur expenses for 5800 units from market = = 5800 ` 920 = ` 53,36,000 It means for 1200 units from X, Y will pay = ` 63,00,000 53,36, 000) = ` 9,64,000 = ` 803.33 per unit If X transfers 2000 units to Y and Y buys 5000 units,, Y can pay to X only = ` ( 63,00,000 5000 920) = ` 17,00,000 = ` 850.00 per unit If transfer of less than 1000 units to Y, X can claim transfer price of ` 900 per unit Realization (`) Option I Option II 6000 1000 + 800 900 + 200 900 5000 1120 + 800 900 + 1200 803.33 ` 69,00.000 ` 72,84,000

Option III 5000 1120 + 2000 850 ` 73,00,000 Option IV 5000 1120+ 800 900 + 400 900 plus `66,80,000 plus contribution from hiring out Above table shows that Option III is preferable in comparison to Option I &II.
46

If Option III for X, transfer price will be ` 850.00 per unit. For taking a decision on option IV, contribution from equivalent unit from hiring out has to be compared with contribution from minimum sales realization of ` 775 because sales realization of ` 775 per unit from equivalent 800 units gives the amount of ` 6,20,000 which makes up the gap between option III and option IV. In that case, transfer price will be ` 900 per unit. ----------------------------------------------------------------------------------------------------Question 21: Boush & Lomb Ltd. Produces two kinds of products, X (lenses) and Y (Swimming goggles) in divisions X and Y respectively. X is an input for Y and two units X are needed to make one unit of Y. The following data is given to you for a period: X Y `/u of X `/u of Y External Demand (units) 3,000 3,000 Capacity (units) 7,000 2,500 100 410 Selling Price `/u (outside market) 20 25 (excluding X) Direct Materials 40 55 Direct Labour & Variable Overhead If division Y buys X from outside, it has the following costs:
For order quantity 2,499 or less For order quantity 2,500 5,000 For order quantity more than 5,000 ` 90 per unit for the entire quantity ordered ` 80 per unit for the entire quantity ordered ` 70 per unit for the entire quantity ordered

Required:Evaluate the best strategies for Division X and Y. (ICAI Adopted) SOLUTION:(i) For best strategy in division X, we should prepare STATEMENT OF RANKING Option External Sale Transfer 100 100 Selling Price (`/unit)
47

Variable Cost Contribution (`/unit)

60 40

60 40

X dept. would like to transfer to department Y at ` 100 by reducing the market sale or transfer at variable cost ` 60 by utilizing spare capacity. On the other hands Y department can purchase from outside market at ` 90. Hence Y department would not like to pay any amount more than ` 90. Best strategy for X A:- External sale 3000 units @ 100 B:- Transfer to Y 4000 @ 60 Best strategy for Y ( Input) Req of y = 2500 X 2 = 5000 (unit) Y has following option 1:- Receive 4000 from X & purchase 1000 from outside market. Purchase cost = 4000 X 60 + 1000 X 90 = ` 3,30,000 2:- Purchase 5000 from market = 5000 X 80 =` 4,00,000 3:- Purchase 5001 from Market = 5001 X 70 = ` 3,500,70 The best strategy for department Y would be to purchase 1000 (u) from market and 400 from X due to least cost. ----------------------------------------------------------------------------------------------------Question 22: AB Ltd. has two divisions A & B. A produces components, two units of which is required for one unit of final product produced by division B. Division A has a capacity to produce 20,000 units and entire quantity is supplied to Division B @ ` 200 per unit. Variable Cost of component at Division A is ` 190 and fixed cost is ` 20 per unit. For final product of Division B, per unit variable cost (excluding component) is ` 700, Fixed cost ` 200 and Selling price is ` 1500.
48

Division A has placed a proposal for increasing the transfer price to ` 220 i.e. their market price. Division As facility can be rented out @ ` 3.00 lakh annually. Division A argument is that instead of making loss on transfer, facilities can be rented out. Division Bs argument is that it can buy the same component from outside market @ ` 210. Division A has given another proposal to augment its capacity to 40,000 units with an investment of ` 15 lakh so that it can sell 20,000 units to external market and transfer 20,000 units to Division B at ` 210 per unit. Fixed cost for Division A will go up by ` 1.00 lakhs. You have evaluate the following and give your views: (a) Division A facilities rented out and Division B buys components @ ` 210 from outside market. (b) Division A sells components to outside @ ` 220 and Division B buys components @ ` 210 from market. (i) (c) Proposal of enhancement of capacity of Division A to 40,000 units. (Assume capital cost @ 12%. (ICWA Final, ICAI RTP)

SOLUTION:STATEMENT OF PROFIT
A Rental income 3,00,000 Sale Less Cost Cost Net benefit - own cost B

Co. 3,00,000 38,00,000

3,00,000 Benefit A 20,000 X 220=44,00,000

(20,000/2) X A 1500=15,00,000 20,000 X 210 = B 42,00,000 700 X 10000 = 70,00,000 38,00,000 Total B 1,50,00,000

41,00,000 Co.
49

STATEMENT OF PROFIT
Rev. Sale

- Cost

20,000 X 190 = 38,00,000

- Cost -own cost

42,00,000 70,00,000 38,00,000

A B

6,00,000 38,00,000 44,00,000 Co.

6,00,000

STATEMENT OF PROFIT
A Rev. 20,000 X 220 - Cost 20,000 X 210 40,000 X 190 -A.F.C 1,00,000 Opp.Cost 1,80,000 7,20,000 B Sale 10,000 X 1500 - Purchase Cost 20,000 X 210 -own cost 10,000 X 700

A B

7,20,000 38,00,000

38,00,000

45,20,000

On the basis of above analysis we can say 3rd option would be better due to higher net benefit. -----------------------------------------------------------------------------------------------------Question 23: Division W, which is part of the XYZ group, is based in country A and has the capacity to manufacture 1,00,000 units of product B each year, the variable cost of producing a unit of B is 15 and the division can sell 85,000 units eternally per annum at 25 per unit. Division D is part of the same group and in based in country L. Division D purchases 40,000 units of product B each year from O (which is not part of XYZ group), which is also based in country L. D pays a sterling equivalent of 20 per unit. If Division D were to purchase all unit of product B from division W, division W would set a transfer price of 22. Given that there are no selling costs involved in transferring units to division D, this would give division W the same contribution on internal and external sales. Division W would give priority to division D and so the order from some external customers would not be met. Required Determine from whom division D should purchase product B in each of the following circumstances if the aim is to maximize group profit. The tax rate in country A is 30% and the tax rate in country L is 50%.
50

The tax rate in country A is 50% and the tax rate in country L is 20%. You may assume that changes in contribution can be used as a basis of calculating changes in tax charges and that division D is able to absorb any tax benefits from the profit it generates on other activities. [ICMA London adopted] SOLTUION A- 30% L-50% A-W 1,00,000 Capacity 85000 Sale B 15,000 Spare Capacity L- D : 40,000(u) 20 22 Working Note1 :W Variable Cost Selling Price. Contribution External sale 15 25 10 Transfer 12 22 10 STATEMENT OF NET COST BENEFIT If D purchases from W D excess cost (20 22 ) 40,000 80,000 Tax saving 40,000 Net benefit A (40,000) Incremental benefit to W 1,50,000 Tax Burden@ 30% p.a. 45,000 B 1,05,000 Overall profit for the Co. (A +B) is 65,000 if D purchased 40,000 from W instead of purchasing from market. Working Note:No transfer Transfer Capacity 1,00,000 1,00,000 Ex. Sale 85,000 60,000 Transfer 40,000 Spare 15,000 51

Out of total transfer unit 40,000, 25,000 represents existing sale. Cont/unit remain same. 15000 represents spare capacity utilization which realize contribution 15000 X 10 = 15000 . (ii) STATEMENT OF NET COST BENEFIT If D purchase from W, D excess Cost (22 20) 40,000 (80,000) Tax Saving 16,000 (64,000) Incremental benefit to W ( 15000 X 10) 1,50,000 Tax burden @ 50% 75,000 75,000 Overall profit for the Co. (A +B) i.e. 11,000 if D purchase 40,000 u from W limited of purchasing from outside. ----------------------------------------------------------------------------------------------------Question 24: A Company has two manufacturing Divisions M & N. For the next period output and costs have been budgeted follows: Division M Division N Units 1,00,000 1,00,000 Material cost ` 2,50,000 ` 6,00,000 Labour cost ` 1,50,000 ` 2,00,000 Fixed Cost ` 10,00,000 ` 20,00,000 You are requested to advise on the transfer price to be fixed for Division Ms component under the following situation: 1. Situation 1: Division M sells the component in a competitive market for ` 20 per unit. Division N can also purchase the component in the open market at that price. 2. Situation 2: As per the situations in 1, but assessing that Division N currently buys the component from an external supplier at the market price of ` 20 and there is a reciprocal agreement between the external supplier and another Division O within the group. Under this agreement the external
52

supplier agrees to buy one product from Division O at a profit of ` 5 per unit to that division for every component which Division N buys from the supplier. (ICAI Adopted, ICWA Final) SOLUTION:Working Note:M Variable cost 4.00 Selling Price 20.00 Quantity 1,00,000 Sapre (i) STATEMENT OF TRANSFER PRICE Cost to be incurred + Cont. to be lost due to transfer Transfer Price (ii) STATEMENT OF TRANSFER PRICE Cost to be incurred due to transfer 4 + Cont. to be lost due to transfer 16 + transfer to be lost due to transfer 5 Transfer Price 25 ----------------------------------------------------------------------------------------------------Question 25: A Manufacturing Company has two divisions, viz., X and Y . X operates at full capacity and Y operates at 60% capacity. X produces two products, Bicycle and Toy using the same labour force for each product. The direct wages rate per production hour is ` 5. During the next year, its budgeted capacity of 42,000 direct labour hours involves a commitment to sell 6,000 kg of Toy. The balance capacity will be used for the production of Bicycle. Cost data are: Bicycle Toy (units) (units)
53

Per unit (`) 4 16 20

Direct materials Direct wages

36 30

28 20

The companys overhead amount to ` 7,56,000 per annum relating to Bicycle and Toy in proportion to their wages. At full capacity ` 4,20,000 of this overhead is variable. X prices its products with 40% mark up on its total costs. Y wishes to buy 2,000 units of Bicycle from X for upgrading and than upgraded Bicycle to be sold at ` 300 per unit. The processing materials and wage cost are ` 30 per unit and the variable overheads amount to ` 4 per unit. The fixed costs amount to ` 1,00,000 per annum. Variable overhead includes ` 5 per Unit of selling and distribution expense which will not be incurred in respect of sale to Y. Prepare a report showing the profitability of X and Y and the Company as a whole for each of the following transfer price methods: (i) X transfers Bicycle at a price applicable to outside customers. Selling and distribution expenses of ` 5 per unit which will not be incurred in respect of the sale to Y. (ii) X Transfer Bicycle at a price applicable to outside customers less credit for selling and distribution expenses of ` 5 per unit which will not be incurred in respect of the sale to Y. (iii) X Transfers Bicycle at marginal cost as reduce by ` 5 per unit of selling and distribution expenses. (iv) X manufactures the quantity of Bicycle required by Y employing overtime payable at double the normal wage rate and transfers at marginal cost less ` 5 per unit. Being selling and distribution costs not incurred in respect of sale to Y. X sells the entire regular production to outside customers at the usual price. (ICWA Final) SOLTUION:Bicycle 3000 6 18,000 (B/F)
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Toy

6000

24,000 42,000

Working Note 1:STATEMENT OF OVERHEAD Fixed Per unit Basis Variable Per unit overhead overhead Bicycle 30 X 3000 1,80,000 60 1,44,000 48 (5 X 6 X3000) TOy 20 X 6000 2,40,000 40 1,92,000 32 (5X4X6000) 2,10,000 4,20,000 3,36,000 Wages = Wages per unit X Output Working Note 2:STATEMENT OF SELLING PRICE BICYCLE TOY Material 36 28 Labour 30 20 Variable Overhead 60 40 Variable Cost 126 88 + Fixed overhead 48 32 Total Cost 174.0 120 + Mark Up 69.6 48 Selling Price 243.6 168 Point to be remember Cost + Markup = Selling Price It means its only a relation. If management estimates any markup % like 40% then accountant can analyse the existing Selling price by adding 40% markup to the cost & further we can say if there is any change in cost then profit amount would be changed accordingly because Selling remain constant. CALCULATION OF TRANSFER PRICE IN each of the following case:(i) 2000, at a price applicable to customer Transfer Price = 243.6
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(ii) At a price applicable to outside customer Transfer Price = 243.6 5 = 238.6 (iii) Transfer Price = 126 5 = 121 (iv) 3000 in single shift ( 10AM to 6 Pm) 2000 in Over Time working (6 PM to 10 PM) 2000 bicycle STATEMENT OF COST (Overtime Working) Per Unit 36 Material Labour Basic 30 60 Over Time Premium 30 60 Variable Overhead 156 Transfer Price = 156 5 = 151 Basis 30 Basic 30 Over time Premium 30 Over Time Premium 60 Over Time Pay 60 Over time pay 90 (i) STATEMENT OF PROFIT
X Revenue Toy Bicycle Transfer Less Variable Cost Toy 6000 X 168 1000 X 243.6 2000X 243.6 Y Revenue Bicycle 2000 X 300 Less X Transfer 2000X243.60 Y Cost Cost 2000 X 34 Co.

5,06,800 (55,200)

6000 X 88

Bicycle

1000 X 126

Fixed Cost

1,00,000

2000 X 121 Fixed Cost 3,36,000

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Profit

5,06,800 (55,200) (ii) STATEMENT OF PROFIT

X 6000 X 168 1000X243.6 2000X 238.6 Rev. Less Cost 2000X 34 Tr.Cost 2000 X 238.6 Y 2000 X 300

4,51,600
Co.

Toy Bicycle Transfer Less V.Cost Toy Bicycle Fixed Cost

X Y

4,96,800 (45,200)

6000 X 88 1000 X 126 3,36,000 4,96,800

Fixed Cost

1,00,000 (45,200) 4,51,600

Toy Bicycle Transfer

(iii) STATEMENT OF PROFIT X Y 6000X168 Rev. 2000X300 1000X243.6 Less 2000X121.0 Tr.Cost 2000X X 121 Cost 2000 X 34 Y Fixed 1,00,000 Cost 6000 X 88 3000 X 126 2000 X 121 3,36,000 2,61,600 X

Co.

2,61,600 1,90,000

Less: V.Cost

Toy Bicycle Fixed Cost

1,90,000 Y 300 X 2000

4,51,600 Co.
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(iv) STATEMENT OF PROFIT

Revenue Revenue

Toy Bicycle Less: Cost TOy Bicycle Transfer Fixed Cost

6000 X 160 3000 X 243.6 2000 X 151

Cost Tr.Cost Cost Fixed Cost

151 x 2000 X 34 X 2000 Y 1,00,000

3,21,600 1,30,000

6000 X 88 3000 X 126 2000 X 151 3,36,000 3,21,600 1,30,000 4,51,600 ----------------------------------------------------------------------------------------------------Question 26: DLF Company has two divisions whose activities and related cost are given below: Division A: Products X Y Z 480 460 400 Selling price (`) 330 240 280 Variable cost/unit (`) 8000 5000 3000 Capacity of production (units) 3 Hr. 4 Hr. 2 Hr. Machine hour/ Unit Division B: Has a capacity to produce 3000 units of product KX taking input as product Y from division A. It has also option to buy a similar product as Y from the market. The cost and selling price per unit are as given below:
Material cost Direct wages 200 Variable production overhead ` 150 `150 Variable selling overheads `100 ` 110 Selling price

If Processed with At transfer price product Y from Division A If processed with ` 400 similar product from the market

` 1200 ` 1100

180

There is capacity constraints of Division A in terms of machine hour of 38000 hours. Fixed cost of Division A is ` 5 lakhs and that of division B is ` 2
58

lakhs each. Required (a) Calculate profitability of the company if the transfer price of Y from Division A to Division B is fixed at ` 400 on the basis of market price of similar product. (b) Give comments of fixing the transfer price based on market price. (c) Calculate the impact on profitability if capacity of Division B is enhanced to 5,000 units by making capital expenditure of ` 10 lakhs at 10% cost of capital and transfer price is true market price, i.e. `460. [RTP 2011)

SOLUTION:Division A has 38,000 machine hours but requirement of machine hours to meet 100% capacity would be 8000 X 3 + 5000 X 4 +3000X2 = 50,000 Hrs. which means 38,000 represents limiting factor.

STATEMENT OF RANKING
Contribution/unit (`) Hours per unit X 150 3 50 Y 220 4 55 Z 120 2 60

Contribution per hour (`) Ranking III II I STATEMENT OF PRESENT OPTIMUM MIX Unit Hours per unit M. Hours X III 4000 3 12000 Y II 5000 4 12000 20,000 +8000 Z I 3000 2 6000 38,000 STATEMENT OF PROFIT
A Contribution ` Rev. B 3000 X 1200 C

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X Sale Y Extra Transfer Z Sale - Fixed cost

150 X 4000 Sale 220 X 2000 160 X 3000 120 X 3000 5,00,000

Cost Transfer 3000 X 400 Cost Factory 2,00,000 cost

A B

13,80,000 8,50,000

13,80,000

8,50,000

22,30,000

(iii) STATEMENT OF NET COST BENEFIT TO CO. ` Per unit Loss due to transfer in department A (400 460) 60 Benefit due to transfer price in department B Benefit with transfer 1200 400 = 350 Benefit with purchase = 1100 400 -440 = 260 90 Net benefit 30 Incremental benefit 30 X 3000 to the Co. if division A transfer 3000 (u) to division B. (iv) STATEMENT OF PROFIT
A Contribution X Y Z Factory Cost 4000 X 150 5000(460-240) 3000 (120) 5,00,000 15,60,000 Revision cost Transfer Cost Own Cost Factory Cost Opp. Cost B 5000 X 1200 5000 X 460 5000 X 450 2,00,000 1,00,000 11,50,000 Co. A B 15,60,000 11,50,000

27,10,000

Change in Profit = 27,10,000 - 22,30,000 = 4,80,000. ----------------------------------------------------------------------------------------------------Question 27: A Company has two manufacturing divisions X and Y. X has a capacity of 96000 hours per annum. It manufactures two products. DELTA and GAMA as [per the following details. Delta Gama Direct Materials 240 64 Other variable costs at `64/hour 256 64
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Selling price in the outside market 640 158 Division Y produces product Wheels as per the following details: ` /unit Imported components 640 Direct Materials 96 Other variable cost at ` 40 per hour 320 Selling price in the outside market 1,160 The fixed overheads for X and Y are ` 20 lakhs and ` 2 lakhs respectively. With a view to minimizing dependence on the imported component, the company has explored a possibility of Division Y using product Delta instead of the imported component. This is possible provided Division Y spends 2 machine hours entailing an additional expenditure of ` 64 per component on modification of product Delta to fit into wheels. Production and sales of Wheels in Division Y is limited to 5000 units per annum. (i) What will be maximum transfer price per unit that Y will offer? (ii) In each of the following independent situations, state with supporting calculations, the minimum transfer price per unit that X will demand from Y, if 5000 units are required by Y. DELTA GAMA (UNITS) (UNITS) If Market demand is restricted to 20,000 20,000 If Market demand is restricted to 15,000 10,000 If Market demand is restricted to 18,000 24,000 In which of the above situations in (ii) will the Management step in and compel X to sell to Y in the interest of overall companys profits? (ICAI adopted) SOLUTION:(i) Maximum price per unit offered by Y ( receiving department) would be an amount so that after incurring 64 per unit the total amount become = Purchasing Cost of imported component.
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(v)

i.e. 64 + X = 640 X = 576 per unit Units Delta Gama If market demand is restricted to 20,000 20,000 If market demand is restricted to 15,000 10,000 If market demand is restricted to 18,000 24,000 1:- If x department has 96000m hours then such machine hours to be considered as key factor which indicates x department utilize in optimum manner. STATEMENT OF RANKING DELTA GAMA Selling Price 640 158 Variable Cost 496 128 Contribution/Unit 144 30 Machine hours per unit 4 1 36 30 Ranking I II STATEMENT OF OPTIMUM PRODUCT MIX Delta 20,000 4 80,000 Gama 16,000 1 16,000 96,000 STATEMENT OF TRANSFER PRICE For 4000 units ` Cost to be incurred + Contribution to be incurred + Contribution to be lost 4000 X 4 = 16,000 hrs X 30 Transfer Value (a) Quantity (b) 496 X 400

4,80,000 24,64,000 4,000

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Transfer Price Next 1000 units

a/b

616

Cost to be incurred 496 X 1000= 4960000 + Contribution to be lost 1000 X 4 hrs = 4000 hrs X 36 1,44,000 Transfer Value 6,40,000 / Quantity 1,000 Transfer Price 640 Average Transfer Price = 24,64,000 + 6,40,000/ 4000 + 1000 =620.80 per unit In order to produce 5000(u) as extra production of Delta to replace imported component for the purpose of transfer price. X department require 5000 X 4 = 20,000 hrs which can be accommodate from the product having least contribution per hour i.e. 16,000 hrs. from GAMA & 4000 hours from regular production of DELTA.

(3) STATEMENT OF PRESENT HOURS

Sale Hour Per Hrs unit DELTA 15000 4 60,000 GAMMA 10,000 1 10,000 Required 70,000 Available 96,000 Spare 26,000 EXTRA 500 (u) of Delta can be produced & transfer by utilizing spare capacity at its Variable Cost i,e, 496. 3:- STATEMENT OF AVAILABLE HOURS External Sale Sale hour per unit Hours DELTA 18,000 4 72,000 GAMA 24,000 1 24,000 REQUIRED 96,000
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External Sale

STATEMENT OF TRANSFER PRICE For 500 units Cost to be incurred 496 X 5000 + Contribution to be lost 5000 X 30 X 4 6,00,000 30,80,000 / Quantity 5,000 616 (iii) In 1st & IIIrd situation mgt. would not compel to division X for transfer of 5000(u) of DELTA because in this case the transfer price + extra burden 64 would exceed purchase cost of imported material but in 2nd case due to spare capacity Transfer price 496 + extra cost 64 is 560 which is less then Purchase Cost of imported component. ----------------------------------------------------------------------------------------------------Question 28: Division A Produce three products X,Y, and Z Cost per unit and other details are given below:X Y Z 500 450 400 Market Price (`) Max Demand(units) Variable Cost (`) Labour hours required/unit 3 800 440 500 350 4 300 310 3

Division B requires 300 units of Y. Similar product is procured by it @ ` 430. Division A operates as a profit centre. Work out a transfer price not affecting Divison A, if labor hours available to division A are (i) 4400 hours (ii) 5900 hours. SOLUTION:X Y Z 60 100 90 Contribution per unit (`) Labour Hours per unit ( units) Contribution per Labour hour (`) 3 20 4 25 3 30
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Ranking on Contribution 3 2 1 (i) If only 440 hours available, production of Division A will be: When sold in outside market Transfer to Division B Product Units Labour Contribution(`) Units Labour Contribution Hours Hours (`) Z 300 900 27000 300 Y 500 2000 50000 800 X 500 15000 30000 100 Total 4400 107000 On 300 units transfer of Y, loss on production of X 900 27000 3200 74000 300 6000 4400 107000 by 400 units will cause

loss of contribution of ` 24,000.Thus 300 units transfer should make up loss @ ` 80 per unit. Thus transfer price of ` 430 satisfies the same. (ii)If only 5900 hours available, production of division A will be: When sold in outside market Transfer to Division B Product Units Labour Contribution(`) Units Labour Contribution Hours Hours (`) Z Y X Total In this 900 27000 2000 50000 2400 48000 5300 125000 case, on 300 units transfer of Y, 300 500 800 900 27000 3200 62000 1800 36000 5900 125000 loss on production of X by 200 300 800 600

units will cause loss of contribution of ` 12,000.Thus 300 unit transfer should make up loss @ ` 40 per unit. In the case, transfer price may be fixed at ` 390. Division A will earn higher contribution of ` 18,000 for its extra effort. And a transfer price of ` 430 will give Division A ` 30,000 higher contribution. ----------------------------------------------------------------------------------------------------Question 29: A Company has two manufacturing divisions operating on
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profit centre basis. Division B makes a product X which requires a particular component which can be sourced only from Division A. Each unit of product X requires one unit of that particular component. The demand for product X is not steady and order for increased quantities can be obtained by reduction in the price. The Manager of division B has given the following forecast: Sales per day Average Price per unit of X units ` 5,000 400 10,000 300 15,000 250 20,000 200 25,000 180 30,000 150 The manufacturing cost (excluding cost of component from Division A ) of X in Division B is ` 15,00,000 on first 5,000 units and @ ` 60 per unit in excess of 5,000 units for up to 15,000 units and thereafter @ ` 50 per unit for unit in excess of 15,000 units. Division A incurs a total cost of ` 5,62,500 per day for an output of up to 5,000 units of component and then total cost will increase by ` 3,37,500 per day for every additional 5,000 component manufactured. The manager of division A has requested for transfer price for component X at ` 90 per unit. You are required to: (a) Prepare a divisional profitability statement at each level of output for Divisions A and B separately. (b) Find out the profitability of the company as a whole at the output level where (i) Division As net profit is maximum. (ii) Division Bs net profit is maximum. (C) Find out at what level of output the company will earn maximum profit,
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if the company is not organized on profit centre basis. SOLUTION:STATEMENT OF PROFITABILITY OF DIVISION A No. of Components Transfer Total Cost of Profit/ (Loss) Price Components @ ` 90 `

`
5,000 10,000 15,000 20,000 25,000 30,000 4,50,000 5,62,500 (1,12,500) 9,00,000 9,00,000 13,50,000 12,37,500 1,12,500 18,00,000 15,75,000 2,25,000 22,50,000 19,12,500 3,37,500 27,00,000 22,50,000 4,50,000 STATEMENT OF PROFITABILITY FO DIVISIONB
Manufacturi Total Cost ng cost of B Div. Profit/(Loss)

No. of Sales Component Components Revenue at cost @ `90 average price

`
19,50,000 27,00,000 34,50,000 41,50,000 48,50,000 55,50,000

`
(50,000) 3,00,000 3,00,000 (1,50,000) (3,50,000) (10,50,00)

5,000 20,00,000 4,50,000 15,00,000 10,000 30,00,000 9,00,000 18,00,000 15,000 37,50,000 13,50,000 21,00,000 20,000 40,00,000 18,00,000 23,50,000 25,000 45,00,000 22,50,000 26,00,000 30,000 45,00,000 27,00,000 28,50,000 (c) Profitability of the Company as a whole (i) At the level of output (30,000 units) maximum profit.

of A Division for its

`
At level of output of 30,000 units Division A profit (max) At same level of output of 30,000 Division B Loss 4,50,000 (10,50,000)
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units Loss for the Company ` (6,00,000) At the level of output (15,000 units)* of B Division for its maximum profit.

`
At level of output of 15,000 units Division B profit (max) At same level of output of 15,000 Division A profit units
Profit for the Company

3,00,000 1,12,500
` 4,12,500

Note:- Division B will has same profit of ` 3,00,00 for either level of 10,000 units or 15,000 units, but Division A will have no profit at 10,000 unit level. Hence both the Divisions should aim at 15,000 unit level for the purpose of goal congruence). LEVEL OF OUTPUT FOR MAXIMUM PROFIT FOR THE COMPANY WHEN IT IS NOT ORGANISED ON PROFIT CENTRE BASIS
No. of Sales Cost of Manufacturing Total Cost at Components revenue at components cost average at Division Division B price A Profit/(Loss)

5,000 10,000 15,000 20,000 25,000 30,000

20,00,000 30,00,000 37,50,000 40,00,000 45,00,000 45,00,000

5,62,500 9,00,000 12,37,500 15,75,000 19,12,500 22,50,000

15,00,000 18,00,000 21,00,000 23,50,000 26,00,000 28,50,000

20,62,500 27,00,000 33,37,500 39,25,000 45,12,500 51,00,000

(62,500) 3,00,000 4,12,500 75,000 (12,500) (6,00,000)

The maximum profit is at output level of 15,000 units. -----------------------------------------------------------------------------------------------------Question 30: Division J and A are in M Group. Division J manufactures part N. Three units of part N are used in product Z manufactures by Division A. Division J has no external customers for part N. Division J
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transfers part N to Division A at variable costs (` 35 per part) plus 50%.The variable cost to division A of manufacturing product Z is ` 50 per unit. This ` 50 does not include the cost of part N transferred from Division J. Division A can sell the following number of units of product Z earning the associated levels fo marginal revenue: Units sold 1 2 3 4 5 Marginal 300 270 240 210 180 revenue ` How many units for product Z should management of division A sell if they wish to maximize divisional profit?

SOLUTION:The variable cost of parts for division As product Z = ` 35 X 3 = `105 Transfer Price = ` 105 X 150% = ` 157.50. Division As variable cost per unit of Z = ` 50. Total Variable /marginal cost to Division A = ` 207.50. Division A will sell until marginal cost = marginal revenue. It will therefore sell 4 units. ------------------------------------------------------------------------------------------------------

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