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Case-study 6-1 : Transfer

Pricing

Illustration - I

Solution : Lambda Company


For Product X
Standard cost = Material
Purchased Outside+ Direct
labor +Variable overhead+
Fixed overhead per unit

For Product Y
Standard cost= Material
Purchased Outside+ Direct
labor +Variable overhead+
Fixed overhead per unit+
Transfer price of X

=2+1+1+3=7
=3+1+1+4+8=17
10 percent return on
inventories and fixed
assets=0.1[ 30,000+70,0
00)/10,000]=1

10 percent return on
inventories and fixed
assets=0.1[ 15,000+45,0
00)/10,000]=0.6

Transfer price = 7+1 = 8


Transfer price=17+0.6=17.6

For Product Z:
Standard cost= Material Purchased
Outside+ Direct labour +Variable
overhead+ Fixed overhead per unit+
Transfer price of Y
=1+2+2+1+17.6=23.6

Illustration - II

Problem 2 - Lambda Company


(with additional information)
For Product X
Standard variable cost
=Material Purchased Outside+
Direct labor +Variable
overhead =2+1+1=4
Monthly charge=fixed
costs+10 percent return on
inventories and fixed assets
=3+0.1[ 30,000+70,000
/10,000]=4
Transfer price= 4+4=8

For Product Y
Standard variable cost =Mat
Purchased Outside+ Dir lab+VOH+
Transfer price of X =3+1+1+8=13

Monthly charge=FC+ 10 percent


return on inventories and FA
=4+10%[ 15,000+45,000 /10,
000]=4.6
Transfer price=13+4.6=17.6
Unit standard cost = Variable
cost+ Fixed cost
= 13+4=17

For Product Z:
Standard cost =Material Purchased
Outside+ Direct labor +Variable
overhead+ Fixed overhead per unit+
Transfer price of
Y=1+2+2+1+17.6=23.6

Illustration : III

Solution
Under possible competitive
price $26.00

Under possible competitive


price $27.00

If company maintain the


price at $28, the
profit=(28-23.6)
7,000=30,800

If company maintain
the price at $28, the
profit=(28-23.6)
9,000=39,600

If company follow the


possible competitive
price at $26, the
profit= (26-23.6)
10,000=24,000

If company follow the


possible competitive
price at $27, the
profit= (27-23.6)
10,000=34,000

Solution
Under possible competitive
price $25.00

Under possible competitive


price $23.00

If company maintain the


price at $28, the
profit=(28-23.6)
5,000=22,000

If company maintain the


price at $28, the
profit=(28-23.6)
2,000=8,800

If company follow the


possible competitive
price at $25, the
profit= (25-23.6)
10,000=14,000

If company follow the


possible competitive
price at $23, the
profit= (23-23.6)
10,000=-6,000

Solution
Under possible competitive price $22.00
If company maintain the price at $28, the
profit
=(28-23.6) 0=0
If company follow the possible competitive
price at $22, the profit
= (22-23.6) 10,000=-16,000

Summary : Comparison
between the options
If the company follows the competitive price, the
opportunity losses are shown as followed:
1. The possible competitive price is $27.00, opportunity
loss=39,600-34,000=5,600
2. 2. The possible competitive price is $26.00,
opportunity loss=30,800-24,000=6,800
3. The possible competitive price is $25.00, opportunity
loss=22,000-14,000=8,000
4. The possible competitive price is $23.00, opportunity
loss=8,800-(-6,000)=14,800
5. The possible competitive price is $22.00, opportunity
loss=0-(-16,000)=16,000

Further Questions and


Answers
a) With transfer price calculated in problem 1, is
division C better advised to maintain its price
at $28 or to follow competition in each of the
instances above?

Answer- So, no matter how much is the possible


competitive price, when the company maintain
its price at $28.00, it can get more profit than
follow the possible competitive price.

b) With the transfer prices calculated in Problem


2, is Division C better advised to maintain its
present price at $28.00 or to follow
competition in each of the instances above?
Answer- Because the answer to the Problem 2 is
the same as the answer to the Problem 1, so
the answer to this question is the same as the
question 3 (a).
Maintaining the price at $28.00, the company
can get more profit.

c) Which decisions are to the best


economic interests of the company, other
things being equal?
Answer- From the question 3 (a) and 3 (b),
no matter which method the company
use to calculate the cost, when the
company maintains the price at $28.00,
the company can maximum the profit.

d) Using the transfer prices calculated in


Problem 1, is the manager of Division C
making a decision contrary loss to the
company in each of the competitive pricing
actions described above?
Answer- No. The goal to the company is
maximum its profit, and as per calculation,
when the company maintains its price at
$28.00, it can get the most of profit, so the
manager has acted in the best interest of the
company.