Management Control System -

Practice examples on Transfer Pricing

Ex#1 A manufacturing company has two divisions-X and Y. The output of X, which may be
sold in the market at Rs. 300 per unit, is also used as a component by Y for
manufacturing product. Y requires one unit of the component from X for producing every
one unit of the final products which is sold in the market at Rs. 500 per unit.
The budgeted production for X and Y are 3000 and 1000 respectively. The cost data for
the budgeted level of production in respect of two divisions are as follows:
Particular Division 'X” (Rs.) Division 'Y” (Rs.)
Material per unit 100 ?
Wages per unit 60 50
Variable overhead per 40 30
unit
Fixed overhead per unit 50 40

Show the divisional profits and profits of the company in case of transfer pricing policy
as per
1. Market Price Method 2. 110% Full Cost Method 3. Negotiated price of Rs. 290 p.u.
Ex#2 A manufacturing company has two divisions-X and Y. The output of X, which may be
sold in the market at Rs. 600 per unit, is also used as a component by Y for
manufacturing product. Y requires one unit of the component from X for producing every
one unit of the final products which is sold in the market at Rs. 800 per unit.
The budgeted production for X and Y are 3000 and 1000 respectively. The cost data for
the budgeted level of production in respect of two divisions are as follows:
Particular Division 'X” (Rs.) Division 'Y” (Rs.)
Material per unit 120 ?
Wages per unit 70 60
Variable overhead per 50 40
unit
Fixed overhead per unit 60 50

Show the divisional profits and profits of the company in case of transfer pricing policy
as per
1. Market Price Method 2. 110% Full Cost Method 3. Negotiated price of Rs. 490 p.u.
Ex#3 Two divisions of a company P & Q are located in two different countries having different
income tax rate – 30% in P and 20% in Q. Operating income of the divisions under
different transfer price methods are given as follows
Transfer Price Method Operating Income in Rs.
Division P Division Q
Market Price 40000 20000
110% of full cost 25000 35000
Negotiated Price 32000 28000
Suggest the most appropriate transfer price method that will maximize the
operating income of the company as a whole.
Ex#4 Division A of Lambda Company manufactures product X, which is sold to division B as
a component of product Y. Product Y is sold to division C, which uses it as a component
in Product Z. Product Z is sold to customers outside the company. The intra-company
pricing rule is that products are transferred between divisions at standard cost plus 10%
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 return on inventories and fixed assets. From the information provided below, calculate
the transfer price for products X and the standard cost of product Z.
Std. Cost per unit Product X Product Y Product Z

Material purchased 2.00 3.00 1.00

outside (Rs.)
Direct Labour (Rs.) 1.00 1.00 2.00
Variable Overhead 1.00 1.00 2.00
(Rs.)
Fixed Overhead per 3.00 4.00 1.00
unit (Rs.)
Standard volume 10,000 10,000 10,000
Average Inventory 70,000 15,000 30,000
(Rs.)
Net Fixed Assets 30,000 45,000 16,000
(Rs.)
Ex#5 Assume the same facts as stated in problem 4, except that the transfer price rule is as
follows: Goods are transferred among divisions at the standard variable cost per unit
transferred plus a monthly charge. This charge is equal to the fixed costs assigned to the
product plus a 10% return on average inventories and fixed assets assignable to the
product.
Calculate the transfer price for products X and Y and calculate the unit standard
cost for products Y and Z.
Ex#6 Division P of SF corporation manufactures product X, which is sold to division B as a
component of product Y. Product Y is sold to division C, which uses it as a component in
Product Z. Product Z is sold to customers outside the company. The intra-company
pricing rule is that products are transferred between divisions at standard cost plus 10%
return on inventories and fixed assets. From the information provided below, calculate
the transfer price for products X and the standard cost of product Z.

Std. Cost per unit Product X Product Y Product Z

Material purchased 4.00 5.00 2.00

outside (Rs.)
Direct Labour (Rs.) 2.00 2.00 3.00
Variable Overhead 2.00 2.00 3.00
(Rs.)
Fixed Overhead per 5.00 6.00 3.00
unit (Rs.)
Standard volume 10,000 10,000 10,000
Average Inventory 80,000 50,000 40,000
(Rs.)
Net Fixed Assets 40,000 30,000 20,000
(Rs.)

Ex#7 Assume the same facts as stated in problem 6, except that the transfer price rule is as
follows: Goods are transferred among divisions at the standard variable cost per unit
transferred plus a monthly charge. This charge is equal to the fixed costs assigned to the
product plus a 10% return on average inventories and fixed assets assignable to the
product. Calculate the transfer price for products X and Y and calculate the unit
standard cost for products Y and Z.

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Ex#8 Modiguard company has Glass Bottles division, which needs 10,000 tons of molten glass
p.a. in order to manufacture is bottles. At present, however, the Glass Bottles division
buys all of its molten glass from an external supplier at a price of Rs. 105. Data regarding
molten glass division is given below.
Output/ Sales Selling price Marginal cost Fixed costs
120 Per ton Rs. 65 per tone 7,20,000 p.a.
Determine the transfer price in the following scenarios.
1. No spare capacity in the Molten Glass Division.
2. Spare capacity in the Molten Glass Division and there is no demand from external
customers for these potential additional tons.
3. Limited spare capacity in the Molten Glass Division and maximum production
capacity of the Molten Glass Division is 45,000 tons p.a. Since there is demand from
external customers for 40,000 tons, this means that spare capacity is just 5000 tons.
4. Assume that the transfer price is based on full cost.
Ex#9 A company fixes inter divisional transfer prices for its products on the basis of cost plus
an estimated return on investment in its divisions. The relevant portion of the budget for
the Division A for the year 2016-17 is given below.
Particulars Amount in Rs.
Fixed Assets 5,00,000
Current Assets other than debtors 3,00,000
Debtors 2,00,000
Annual fixed cost for the division 8,00,000
Variable cost per unit of product 10
Budgeted volume of production per year 4,00,000
(units)
Desired return on investment 28%
You are required to determine the transfer price for Division A
Ex#10 A company has two divisions- A and B. Division A has budget of selling 2,00,000
number of a particular component X to fetch a return of 20% on the average assets
employed. The following particulars of Division A are also known.
Particulars Amount in Rs.
Fixed overheads 5,00,000
Variable cost Re. 1 per unit
Average Assets- Debtors 2,00,000
Inventories 5,00,000
Plant 5,00,000
However there is a constraint in marketing and only 1,50,000 units of the component X
can be directly sold to the market at the proposed price.
It has been gathered that Division B can take up the balance 50,000 units of component
X. A wants a price of Rs. 4 P.u. but B is prepared to pay Rs. 2 P.u. of X. Division A has
another option on hand, which is to produce only 1,50,000 units of X. This will reduce
the holding of assets by Rs. 2,00,000 and fixed overhead by Rs. 25,000.
You are required to advice the most profitable course of action for division A.
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Ex#11 The following information relates to budgeted operations of Division X of a
manufacturing company.
Particulars Amount in Rs.
Sales- 50,000 units@ Rs. 8 p.u. 4,00,000
Less- Variable cost @ Rs. 6 p.u. 3,00,000
Contribution Margin 1,00,000
Less: Fixed costs 75,000
Divisional Profits 25,000
The amount of divisional investment is Rs. 1,50,000 and the minimum desired rate of
return on the investment is the cost of capital 20%.
Calculate:
1. Divisional expected ROI and Divisional expected RI
Ex#12 A company has two divisions A and B. Division A manufactures a component which is
used by division B to produce a finished product. For the next period, output and costs
have been budgeted as follows.
Particulars Division A Division B
Component units 50,000
Finished units 50,000
Total variable costs- 2,50,000 6,00,000
Rupees
Fixed Costs Rupees 1,50,000 2,00,000
The fixed costs are separable for each division. You are required to advise on the
transfer price to be fixed for division A’s component under the following
circumstances.
A. Division A can sell the component in a competitive market for Rs. 10 p.u. Division B
can also purchase the component from the open market at that price.
B. As per the situation mentioned in (A) above, and further assume that division B
currently buys the component from an external supplier at the market price of Rs. 10 and
there is reciprocal agreement between the external supplier agrees to buy one product unit
from Division C at a profit of Rs. 4 p.u. to that division, for every component which
Division B buys from the supplier.
Ex#13 A company is engaged in the manufacture of edible oil. It has three divisions as
under:
(i) Harvesting oil seeds and transportation thereof to the oil mill.
(ii) Oil Mill, which processes oil seeds and manufactures edible oil.
(iii) Marketing Division, which packs the edible oil in 2 kg. Containers for
sale at ` 150 each container.
The Oil Mill has a yield of 1,000 kgs of oil from 2,000 kg of oil seeds during a
period. The Marketing Division has a yield of 500 cans of edible oil of 2 kg each
from every 1,000 kg of oil. The net weight per can is 2 kgs of oil.

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The cost data for each division for the period are as under:

Harvesting Division `
Variable cost per kg of oil seed 2.50
Fixed cost per kg of oil seed 5.00
Oil Mill Division `
Variable cost of processed edible oil 10.00 per kg
Fixed cost of processed edible oil 7.50 per kg
Marketing Division `
Variable cost per can of 2 kg of oil 3.75
Fixed cost per can of 2 kg of oil 8.75

The fixed costs are calculated on the basis of the estimated quantity of 2,000 kg of
oil seeds harvested, 1,000 kg of processed oil and 500 cans of edible oil packed by
the aforesaid divisions respectively during the period under review.
The other oil mills buy the oil seeds of same quality at ` 12.50 per kg in the
market. The market price of edible oil processed by the oil mill, if sold without
being packed in the marketing division is ` 62.50 per kg of oil.
Required:
(i) Compute the overall profit of the company of harvesting 2,000 kg of
oil seeds, processing it into edible oil and selling the same in 2 kg cans
as estimated for the period under review.
(ii) Compute the transfer prices that will be used for internal transfers from
(1) Harvesting Division to Oil Mill Division and (2) from Oil Mill
Division to Marketing Division under the following pricing methods:
(1) Shared contribution in relation to variable costs; and
(2) Market price.
(iii) Which transfer pricing method will each divisional manager prefer to
use?

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