“TRANSFER
PRICING”
(Amended as per current pattern of ICAI Examination
Including selected question of ICMA &ICWA exams)
1
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 division’s product. ABC has the capacity (annual) to produce
30,000 units of the product. The unit costs of division ABC’s 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 XYZ’s 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 company’s sales director. The study has brought out the following
demand schedule:
DIVISION ABC
200
300
400
Selling price (`)
Demand (units)
DIVISION XYZ
30,000
20,000
10,000
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
company’s 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)
(Special
sales)
External market
(normal sales)
Selling Price(`/u)
Variable manuf. cost(`/u)
1,000
600
800
600
4000
1,500*
Variable selling cost(`.u)
100**
-
200**
Total variable cost (`/unit)
700
600
1700*
Contribution (`/unit)
Units sold
Production capacity
300
200
1250
750
2000 units
(*excluding
Component C)
(** Not incurred on
inter
division
transfers)
(*excluding
component C)
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. B’s 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 A’s variable
manufacturing cost basis.
4
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 A’s 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
A’s 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)
5
(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
It’s 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
` 20
Parts
Labour 2 hours × ` 140
280
½ 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.
6
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 X’s 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 Y’s 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
7
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
( 6000(unit))
Per unit
Purchase
Per Unit
300
Purchase cost of 600
Board
+ Contribution to be lost 2 hour X 160
40/ ½
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
8
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 it’s 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
V.C.
+ Contribution lost
Purchase 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:
Y’s annual purchase of the component
2,000 units
X’s variable costs per unit ` 110
9
X’s fixed cost
` 20000
Required
(i) Calculate Transfer Price in each of the following cases.
(ii) Suppose there are no other alternative use of X’s 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 X’s 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
Purchase
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
+ benefit to be lost
Minimum Transfer price
(iii)
110
110
STATEMENT OF COMPARITIVE COST
Per unit
10
Manufacture
Variable
Cost
Purchase
`
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
+ benefit to be lost due to transfer
Transfer price (Minimum)
110
70,000/2000 35
145
(IV) STATEMENT OF COMPARITIVE COST
Per unit
Manufacture
Variable
Cost
Purchase
110
Purchase cost
105
110
105
Decision:- It’s 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
6
10.5
8
8.5
4
13
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
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
14
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
15
Variable Cost
(60% of 600)
+Fixed Cost
Own cost
+ Purchase Cost
Petro
Chemical
Power
360
Variable
Cost
240
600
Fixed Cost
1500 + Profit
Petro
240 Variable cost
300
Nil
Purchase
cost
60
Fixed Cost
Own Cost
Purchase Cost
Transfer Cost
Profit
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)
Chemical
1000
250
1250
1250
250
1500
`
2000
360
240
1000
1600
2000
Decision:- It’s better to produce the component in house & transfer
because relevant cost is less than it’s 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
16
Chemical
1000
+ Contribution to be lost
Reliance Chemical
500
2100
2000
In this situation it’s 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
180 X 3000 Own 180 X 3000
Cost
Transfer Cost
180 X 3000
PROFIT
4,20,000
Total Project
`
A
-
B
Total
4,20,000
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
18
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
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
4,20,000
It’s 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
15,00,000
`
Less Purchase Cost
Own Cost
A
3000 X 170
A
3000 X 180
B
4,50,000
STATEMENT OF PROFIT (WITH TRANSFER)
B
Co.
Revenue 3000X 180
Revenue
Cost
(-) Transfer 3000 X 180
(-)Own Cost 3000 X 180
4,20,000
3000 X 180
---
15,00,000
-
4,50,000
4,50,000
`
A
B
Total
4,20,000
4,20,000
19
It’s 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)
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
2010
2011
50,000
25,000
50,000
30,000
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 B’s 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?
20
(ii) In view of the company’s 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 A’s 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
-Variable Cost (`) 35
_
Selling
& 10
distribution (`)
20
Cont/unit(`)
Special order Transfer to B Transfer to B
15000 units
< 45,000 unit 45000 unit
55
55
60
35
35
35
-
-
-
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
External Sale
Less: Fixed Cost
45000 X 25
5000 X 20
12,25,000
10,00,000
21
30,000 unit
` 4,30,000
10,000 unit
` 1,00,000
10,000 unit
` 1,00,000
6,30,000
Less: Selling & Distribution
In 2010
50,000
5,45,000
Profit
Best strategy for A
STATEMENT OF RANKING
Options
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
-
Transfer to B < Transfer to B
45000 unit
45000 unit
45
50
35
35
-
20
II
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
22
2011–12 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
Variable Cost
+ Fixed Cost 10,00,000 /1,00,000
Total Cost
+ Mark Up
30% (15,00,000)/1,00,000
Transfer Price
4.5
34.50
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
` 80 Lakhs
Capital employed
` 750 Lakhs
23
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 ALFA’s 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
2160
160 X 1200,000
Contribution
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
24
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 it’s 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:
25
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 A’s 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 A’s capacity.
The minimum transfer prices that should lead to the correct economic
decision?
SOLUTION:A: Deptt.
Revenue
Costs
B: Deptt.
Co.
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
800
(500)
300
Co.
27
-Cost
1200
Transfer
Cost
B’s Cost
2000
A
800
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.
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
` 1200 – ` 1500 per unit.
(iii) STATEMENT OF CONTRIBUTION
Co.
A
`
B
`
0 -200 Unit
External sale 800 X 2000 Sale
Transfer price 200 X 1500 Less Cost
Cost
1000 X 1200 Transfer
Own Cost
200X 3000
A
200X 1500 B
200X 1500
7,00,000
28
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
Contribution
800 X 800
900
750 X 900
1950 ` per unit
1200
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
Transfer price
Next 100 units
` 1550 per unit
1200
350
1550
` 1200 – 1500 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
Y′s factory at the stated price of ` 85 per unit.
Additional information is given below:
Production capacity ( unit )
Demand ( Unit)
Direct materials (external supplier rate)
Direct labour
Selling price in external market
Figures `/unit
X
Y
20,000
30,000
14,000
26,000
Z
40,000 unit
42,000 unit
` 40
` 85
` 135
` 30
` 50
` 45
` 95
` 155
` 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
Division B
` 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
50
25
20
13
24 *
144
160
14
2
26
Selling price in outside market
Selling price to B
Selling price to S Ltd.
160
144
-
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
External Sale Transfer
Selling Price (` Per unit)
160
144
Variable Cost (` Per unit)
95
95
Selling & Distribution (`)
13
-
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)
300
250
Variable Cost (` Per unit)
66
40
Purchase cost (` Per unit)
Contribution/unit
160
160
74
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
`
= 78,00,000
=2,88,000
38,40,000
17,16,000
19,56,000
Contribution as per option 2
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
Contribution
19,60,000
Revenue
-
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
Transfer
600
Sale 1000 tonne
Retailer
Selling Price=200
PROFIT STATEMENT
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
1000 X 180
1000 00
2000 X 70
10,000
2,30,000
Retailer
Revenue
Less Cost
Transfer
Cost
Fixed Cost
Profit
Co.
1,00,000 X 3
1000 X 200
1000 X 60
20,000
20,000
2,30,000
20,000
2,50,000
STATEMENT OF PROFIT Capacity – 100% Transfer Price 180
Wholesaler
Exp. Sale
Less Costs
Variable Cost
Fixed Cost
1000 X 180
1000 80
2000 X 70
10,000
Retailer
Revenue
Less Cost
Transfer cost
Cost
Fixed Cost
Co.
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, A’s
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)
20
Selling price per unit in the outside market (`/unit)
200
Current selling price to B (`/ unit)
190
Additional variable labour cost of reworking defectives (`/unit)
100
Selling price of reworked defectives (`/unit)
Fixed costs for the month (`)
Maximum demand from B at present (no. of units)
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 it’s 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 latter’s 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 it’s
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 X’s 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 X’s
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
` 90 per unit for the entire quantity ordered
For order quantity 2,500 – 5,000
` 80 per unit for the entire quantity ordered
For order quantity more than 5,000
` 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 A’s 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 B’s 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
Rental
income
A
B
3,00,000 Sale
(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
Less Cost
Cost
-
- own cost
Net benefit
3,00,000 Benefit
Co.
`
3,00,000
38,00,000
41,00,000
STATEMENT OF PROFIT
Rev.
A
20,000 X 220=44,00,000
Sale
B
1,50,00,000
Co.
49
- Cost
20,000 X 190 = 38,00,000
- Cost
-own
cost
6,00,000
42,00,000
70,00,000
A
B
38,00,000
6,00,000
38,00,000
44,00,000
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
38,00,000
Co.
A
B
7,20,000
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 M’s
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
Per unit (`)
4
16
20
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
Direct materials
Direct wages
36
30
28
20
The company’s 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)
54
Toy
6000
4
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 it’s 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
55
(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
Y
6000 X 168
1000 X 243.6
2000X 243.6
Revenue
Bicycle
2000 X 300
Less
X
Transfer
2000X243.60 Y
Cost
Less
Variable
Cost Toy
6000 X 88
Cost
2000 X 34
Bicycle
1000 X 126
Fixed
Cost
1,00,000
Co.
5,06,800
(55,200)
2000 X 121
Fixed Cost 3,36,000
56
5,06,800
(55,200)
(ii) STATEMENT OF PROFIT
4,51,600
Co.
Toy
Bicycle
Transfer
X
6000 X 168
1000X243.6
2000X 238.6
Less
V.Cost Toy
Bicycle
6000 X 88
1000 X 126
Profit
Fixed Cost
Toy
Bicycle
Transfer
3,36,000
4,96,800
Y
2000 X 300
Rev.
Less
Cost
2000X 34
Tr.Cost 2000 X 238.6
Fixed
Cost
X
Y
4,96,800
(45,200)
1,00,000
(45,200)
(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
4,51,600
Co.
2,61,600
1,90,000
Less: V.Cost
Toy
Bicycle
Fixed Cost
6000 X 88
3000 X 126
2000 X 121
3,36,000
2,61,600
1,90,000
4,51,600
(iv) STATEMENT OF PROFIT
X
Revenue
Revenue
Y
300 X 2000
Co.
57
Toy
Bicycle
6000 X 160
3000 X 243.6
2000 X 151
Less: Cost
TOy
Bicycle
Transfer
Fixed Cost
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
If Processed with At transfer price
product Y from
Division A
If processed with
` 400
similar product
from the market
Direct
wages
200
180
Variable
production
overhead
Variable selling
overheads
Selling price
` 150
`100
` 1200
`150
` 110
` 1100
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
Y
220
Z
120
3
50
4
55
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
59
X Sale
Y
Extra
Transfer
Z Sale
150 X 4000
Sale 220 X 2000
160 X 3000
120 X 3000
- Fixed cost
Cost
Transfer 3000 X 400
Cost
Factory 2,00,000
cost
A
B
13,80,000
8,50,000
5,00,000
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
15,60,000
B
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
60
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
(v)
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 company’s 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.
61
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
62
Transfer Price
a/b
616
`
Next 1000 units
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
External Sale
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
63
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)
800
440
Variable Cost (`)
Labour hours required/unit 3
500
350
300
310
4
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
64
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
300
500
800
900
27000
2000
50000
2400
48000
5300
125000
case, on 300 units transfer of Y,
300
800
600
900
27000
3200
62000
1800
36000
5900
125000
loss on production of X by 200
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
65
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 A’s net profit is maximum.
(ii) Division B’s net profit is maximum.
(C) Find out at what level of output the company will earn maximum profit,
66
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
No.
of Sales
Component
Components Revenue at cost @ `90
average
price
`
`
Manufacturi Total Cost
ng cost of B
Div.
Profit/(Loss)
`
`
`
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)
67
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
(62,500)
3,00,000
4,12,500
75,000
(12,500)
(6,00,000)
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
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
68
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 A’s product Z = ` 35 X 3 = `105
Transfer Price = ` 105 X 150% = ` 157.50.
Division A’s 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.
------------------------------------------------------------------------------------------------------
69