Review Questions

01. Alpha group has two companies:

K Ltd, which is operating at just above 50% capacity, and

L Ltd, which is operating at full capacity (7,000 production hours).

L Ltd produces two products, X and Y, using the same labour force for each product. For the next year its
budget capacity involves a commitment to the sale of 3,000kgs of Y, the remainder of its capacity being
used on X.

Direct costs of these two products are:

X Y

Direct materials 18 14

Direct wages 15(1 production hour) 10 (2/3 production hour)

The company’s overhead is Rs.126, 000 per annum relating to X and Y in proportion to their direct wages
at full capacity, Rs.70, 000 of this overhead is variable. L Ltd prices its products with a 60% make-up on
its total costs.

For the coming year, K Ltd wishes to buy from L Ltd 2,000 kgs of product X which it proposes to adopt
and sell, as product Z, for Rs.100 per kg. The direct costs of adoption are Rs.15 per kg. K Ltd’s total fixed
costs will not change but variable overhead of Rs.2 per kg will be incurred.

You are required to recommend, as group management accountant,

a. At what range of transfer prices, if at all, 2,000 kgs of X should be sold to K Ltd,

b. What other points should be borne in mind when making any recommendations about transfer
prices in the above circumstances.

02. Beta Company, an appliance manufacturer, has always sold its products though wholesalers. Year
2020, its sales were Rs.2000,000 and its net profit 10% sales.

As a result of the increase in appliance sales though departmental stores and mail-order business
establishments, the company is considering elimination of wholesalers and selling directly to retailers.

It is estimated that this would result in a 40% drop in sales, but net profit would be Rs.180,000 due to
the estimation of middlemen. Fixed expenses would increase from Rs.20,000 to Rs. 300,000 owing to
additional warehouses and distribution facilities.

You are required to find out:

i. Whether the proposed change would raise or lower the break-even point in rupees? By how
much? Give the reason.
ii. What would be the sale volume in rupees which would enable Beta company to obtain as much
profit as it made last year?