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Wednesday, January 5, 2011

Model Test – Final -TRANSFER PRICING

Model Test – Final
TRANSFER PRICING

                                                              SUGGESTED ANSWER

1. Division Z is a profit center which produces four products A, B, C and D. Each product is sold in the external market also. Data for the period is:

Particulars

A

B

C

D

Market price per unit (Rs.)

Variable cost of pdn per unit (Rs.)

Labour hours required per unit

150

130

  3

146

100

  4

140

90

  2

130

85

 3

 

Product D can be transferred to division Y but the maximum quantity that may be required for transfer is 2,500 units of D.

The maximum sales in the external market are:

                        A              2,800 units

                        B               2,500 units

                        C              2,300 units

                        D              1,600 units

Division Y can purchase the same product at a price of Rs.125 per unit from outside instead of receiving transfer of product D from Division Z.

 

What should be the transfer price for each unit for 2,500 units of D, if the total labour hours available in division Z are 20,000 hours?

 

Solution:

Ranking of products when availability of time is the key factor

Particulars

A

B

C

D

Market price

Less: Variable cost

Contribution p.u(Rs)

Labour hours p.u

Contribution /labour hour

Ranking

Maximum demand (units)

Total hours

Allocation of 20,000 hours on the basis of ranking

150

130

  20

  3

 6.67

   IV

2,800

8,400

600 *

146

100

46

 4

11.5

   III

2,500

10,000

10,000

140

90

50

 2

25

 II

2,300

4,600

4,600

130

  85

 45

  3

 15

   I

1,600

4,800

4,800

* Balancing figure

Note: Time required for meeting demand of Rs.2, 500 of product D for division Y is 7,500 hours. This requirement of time for providing 2,500 units of product D for division Y can be met by sacrificing 600 hours of product A (200 units) and 6,900 hours of product B(1,725 units)

 

Transfer price = variable cost + opportunity cost

                       =  Rs.85+(Rs.6,900 X 11.5 + 600x6.66)

                                                    2500

                            = Rs.85 + (79350 + 4000)  = Rs(85+33.34) = Rs.118.34

                                                    2500

2. P Ltd has three divisions – X, Y and Z, which makes 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. Direct selling overhead representing commission to external sales agent is avoided on all internal transfers. Division Y additionally incurs Rs.10 per unit and Rs.8 per unit on units delivered to external customers and Z respectively. Y also incurs Rs.6 per unit picked up from X, whereas external suppliers supply at Y's factory at the stated price of Rs. 85 per unit.

 

Additional information is given below:

 

                                                                                    Figures Rs/unit

                                                                                 X                                    Y                     Z

Direct materials (external supplier rate)                  40                      85                   135

Direct labour                                                             30                      50                     45

Sales Agent's commission                                          15                      15                     10

Selling price in external market                             110                    170                   240

Production capacity (units)                                  20,000              30,000               40,000

External demand (units)                                      14,000               26,000               42,000

 

You are required to discuss the range of negotiation for Managers X,Y and Z for the number of units and the transfer price for internal transfers.    

 

Answer:

 

Analysis of range of negotiation for manager of Division X

                                                                                                                       (Figures in Rs.)

(a)                                                       Division X

                                                   

  

 

 


                                  Outside sales                                 Sales to Y (Range)

 

    Selling price                              110                  70           ----         79

(-) Commission                               15                   --                           --

   Net selling price                           95                  70                          79

    Variable Cost                              70                   70                          70

   Contribution per unit                    25                   0                            9

   Units                                         14,000              6,000                    6,000

   Total contribution

  (Units X contribution per unit)    3,50,000             0                      54,000

 


Analysis of Range of negotiation for Manager of Division Y

Division Y

 

  


                             Outside sales                                      Sale to Z

                                              

                              From A      From outside                     From A   From outside

Price range          ----    70       79          85                           70         79          85

Add: Transport               6         6           --                             6           6           -- 

                                       76      85          85                           76         85          85

Add: Direct labour         50      50          50                           50         50          50      

                                       126   135        135                         126       135        135

 

Add: Delivery cost           10     10          10                            8            8            8

                                        136   145       145                         134        143       143    

Add: Sales commission    15      15        15                            -             -           -  

Total cost                        151   160        160       134           134         143       143

Selling price                    170   170        170       134           135         135       135  

Contribution                      19     10         10          0              +1           -8          -8

 

Range of negotiation:

Manager of Division X will sell 14,000 units outside at 110 per unit and earn a contribution of Rs.3.5 lakhs.

 

Excess capacity of 6,000 units can be offered to Y at a price between 70( Th variable manufacturing cost at X) and Rs.95 (the maximum amount to equal outside contribution). But Y can get the material outside @ 85. So, Y will not pay to X anything above (Rs.85 -6) = Rs.79 to match available external price.

X will be attracted to sell to Y only in the range of 71 – 79 Rs.per unit at a volume of 6,000 units. At Rs.70, X will be indifferent, but may offer to sell to Y to use idle capacity.

 

Z will not buy from Y at anything above Rs.135. If X sells to Y at 70 per unit, Y can sell to Z at 134 and earn no contribution, only for surplus capacity and if units transferred by X to Y at Rs.70 per unit.

 

Y

Z

Provided X sells to Y at Rs.70 per unit

Sells 4,000 units to Z at 134(Indifferent)

Buy 4,000 units from Y at 134(attracted)

Sells 4,000 units to Z at 135 (Willing for a contribution of Re.1)

Indifferent, since market price is also 135

 

For buying from X at 71-79 price range, Y will be interested in selling to Z only at price 136-143, which will not interest Z.

Thus Y will sell to Z only if X sells to Y at Rs.70 per unit and Y will supply to Z maximum 4,000 units.

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