TRANSFER PRICING

PROBLEM 11
A Company has two divisions. South division manufactures an intermediate product for which there is
no immediate external market. North division incorporates this intermediate product into a final product,
which it sells. One unit of the intermediate product is used in the production of the final product. The
expected units of the final product, which North division estimates it can sell at various selling prices,
are as follows:

Net selling price Quantity sold

(Rs.) (Units)
100 1,000
90 2,000
80 3,000
70 4,000
60 5,000
50 6,000

The costs of each division are as follows:

South Division North Division
(Rs.) (Rs)
Variable cost per unit 11 7
Fixed costs per annum 60,000 90,000

The transfer price is Rs. 35 for the intermediate products, and is determined on a full cost-plus basis.
You are required to:
(a) Prepare profit statements for each division and the company as a whole for the various selling
prices.
(b) State which selling price maximizes the profit of north division and the company as a whole and
comment on why the latter selling price is not selected by north division.
(c) State which transfer pricing policy will maximize the company’s profit under a divisional
organization. Assume that there is no capacity constraint.
(d) State the implications of transfer pricing policy in © above on south division’s profitability.

Problem 12
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 id as follows:
Particulars A B C D
Market price per unit Rs 150 Rs 146 Rs 140 Rs 130
Variable cost per unit Rs 130 Rs 100 Rs 90 Rs 85
Labour hours per unit 3 4 2 3

Product D can be transferred to division Y but the maximum quantity that might be required for transfer
is 2500 units of D.
The Maximum sales in the external market are:
A 2800 units
B 2500 units
C 2300 units
D 1600 units
Division Y can purchase the same product at a slightly cheaper price of Rs 125 per unit instead of
receiving transfer of product D from division Z.
What should be the transfer price for each unit for 2500 units of D, if the total labour hours available in
division Z are:
1. 20000 hours?
2. 30000 hours?

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Problem no 13
Fox Ltd. has Division A and Division B. The Division A produces Components which it sells to ‘outside’
customers and also transfer to the Division B. The Division B produces a product called the ‘Zoom’
which incorporates a Fox Component in its design.
Details of the production and operating costs for the next year are forecasted to be asfollows:

Division A Division B
Annual Fixed Costs - 15,00,000 Annual Fixed Costs - 25,000
Variable Cost (per component) - 175 Variable Cost per ‘Zoom’ (excludes transfer costs) -
350

Both Divisions have surplus capacity. Market analysis has indicated that the demand from
‘outside’ customers for Fox Ltd’s products is as follows:
(i) 4,500 components are sold at a unit selling price of 350; sales change by an average of
5 components for each 1 change in the selling price, per component;
(ii) 500 ‘Zoom’ are sold at a unit selling price of 1,100; sales change by an average of 125
‘Zoom’ for each 75 changes in the selling price per ‘Zoom’. It is an established practice for
the Division A to transfer components to the Division B at ‘Market selling price’.
You are required to calculate the, Unit Selling price of a ‘Zoom’ that should be set in order to
maximize For Ltd’s Profit. Selling Price Should also be exact to the nearest paisa. [Note: If P = a –
bQ then MR = a – 2bQ]

Problem no 14
Fox – 2- Tec Ltd. (F2TL) has Division ‘DX’ and Division ‘DZ’ with full profit responsibility. The
Division ‘DX’ produces component ‘X’ Which it sells to ‘Outside’ customers only. The Division ‘DZ’
produces a product called the ‘Z’ which incorporates component ‘X’ in its design. ‘DZ’ Division is
currently purchasing 2,500 units of Component ‘X’ per year from an outside supplier at a cost of
35 per unit, less a 10 percent quantity discount. ‘DX’ Division can sell its entire Component ‘X’ to
outside customers at the normal 35 price. Costs associated with manufacturing of a unit of
Component ‘X’ are as follows:
Variable Expenses 21
Fixed (Based on a capacity of 25,000 units per year) 9
F2TL’s now managing director agrees for internal transfer if an acceptable transfer price can be
worked out. Accordingly, he requires solution of following questions:-
1. If the ‘DZ’ Division purchases 2,500 units of component ‘X’ per year from the ‘DX’
Division, what price should control the transfer? Why?
2. Refer to your computations in (1) What is the lower limit and the upper limit for a transfer price?
Is an upper limit relevant in this situation?
3. If the ‘DX’ Division meets the price that the ‘DZ’ Division is currently paying to its supplier and
sells 2,500 units of Component ‘X’ to the ‘DZ’ division each year, what will be the effect on the
profits of the ‘DX’ Division, and the Company as whole?
4. If the intermediate market price for Component ‘X’ is 35 per unit, is there any reason
why the ‘DX’ Division should sell to the ‘DZ’ Division for less than 35? Explain

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