Tutorial 9 Transfer Price

Chengruizhi Ma
1. Profit for both Divisions
• Division A:
• Revenue = 10.50 x 80,000 = £840,000
• Variable costs = (3.9 x 80,000) + (0.3 x 50,000) = £327,000
• Fixed costs = 350,000 + 60,000 = £410,000

• Profit = 840,000 - 327,000 - 410,000 = £103,000

1. Profit for both divisions

• Division B

• Revenue = 32 selling price x 30,000 = £960,000

• Variable cost = 19.2 x 30,000 = £576,000

• Fixed cost= £400,000

• Profit = 960,000 - 576,000 - 400,000 = £(16,000)

2. Will Division B purchase more uppers??
• Transfer price = 10.50 - 0.30 = £10.20
 
• Division B
• 
• Revenue = 28 x 50,000 = £1,400,000
• Variable cost = (19.2-0.3) x 50,000 = £945,000
• Fixed cost = £500,000
• 
• Profit = 1,400,000 – 945,000 – 500,000 = £(45,000)
• 
• Division B would be worse off at this price so no incentive to take extra volume.
3. Will Division B purchase more uppers??
• Division A
•  Sell 50,000 uppers to Division B, and sell another 50,000 to external markets
• Revenue = (6.50 x 50,000) + (10.50 x 50,000) = £850,000
• Variable cost = (3.9 x 100,000) + (0.3 x 50,000) = £405,000
•  The variable marketing expense only relates to the pair of upper sold to outside
market

• Fixed cost= 350,000+60,000

• Profit = £850,000 - 405,000- ( 350,000 + 60,000) = £35,000
3. Will Division B purchase more uppers?
• Revenue = 28 x 50,000 = £1,400,00

• Transfer price decreased from 10.5 to 6.5

• Variable cost = (19.20-4) x 50,000 = £760,000

• Fixed cost= 500,000

• Profit = 1,400,000 - 760,000 - 500,000 = £140,000
• For the two divisions together profit would be £175,000, the manager of Division
A will not be happy because the profit is lower, Division B will be willing to
purchase more uppers because the profit situation has improved greatly.
 4. The lump sum payment
• If Division A supplied 50,000 uppers at a price of £3.90 per pair Division B's profit would be:
•  Transfer price has reduced by 6.6 from 10.5 to 3.9
• 50,000 x 28 – 50,000 x (19.2-6.6) - 500,000 = £270,000
•  Division A:
• 50,000 x 3.9- 50,000*3.9- Fixed cost
•  And Division A would make no profit on these sales to Division B
• The Division B should compensate the Division A, the Division B purchase 50,000 uppers
from Division A, which is 50% of Division A’s production capacity, the Division B should
compensate Division A with 50% of Division A’s fixed manufacturing and administration cost
• 350,000*0.5=175,000
 5. Solutions
• This would result in Division B making profit of 270,000 - 175,000 = £95,000
• Division A:
• 
• Revenue 10.50 x 50,000 = £525,000
• 3.90 x 50,000 = 195,000
• 175,000
• ----------
• 895,000
• 
• Variable cost 3.90 x 100,000 = 390,000
• 0.30 x 50,000 = 15,000
• 
• Fixed cost 350,000+60,000= 410,000
• ----------
• 80,000

• Total Profit= 95,000+80,000= 175,000

• The Division A will not be happy, 80,000 is lower than the current profit 103,000, the compensation payment should be
198,000, in this case, the profit of Division A equals to the current level.