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Transfer Pricing

By Click to edit Master subtitle style Mehwish Jatoi Rabya Sultana Ume-Hani AR Shamoon Khan Barozai M. Farhan Farooq
5/19/12

Transfer Prices

Transfer prices are the amounts charged by one segment of an organization for a product or service that it supplies to another segment of the same organization.

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Purpose of Transfer Pricing


Making sound decisions When managers have to make decision regarding make or buy Minimizing costs and maximizing profits To reduce tax and duties etc

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Types of Transfer Cost

Cost based transfer pricing Market based transfer pricing Negotiating transfer pricing Arbitrary transfer pricing

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Market-based transfer price


In the presence of competitive and stable external markets for the transferred product, many firms use the external market price as the transfer price.

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Cost-based transfer price


The transfer price is based on the production cost of the upstream division. A cost-based transfer price requires that the following criteria be specified:

Actual cost or budgeted (standard) cost. Full cost or variable cost. The amount of markup, if any, to allow the upstream division to earn a profit on the transferred product.

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Negotiated transfer price


Divisional managers negotiate among each other

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Arbitrary transfer pricing


Deciding a price which would maximize over all profitability of the organization

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Transfer price (Formula)

Transfer price/cost = Contribution margin + opportunity cost Opportunity cost= Price to outsiders C.M

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Question

Division A manufactures an intermediate product for Division B which than converts products into final product. Division A is producing at its full Division A Division B capacity. Rs 11/ unit Marginal cost Marginal Cost Rs10/unit
Price for outsiders Rs 15/ unit

Required 5/19/12

Answer
Transfer price For Division A T.P = C.M + OC T.P= 11+(15-11) T.P = 11+4 = 15 Profit for Division B Profit = S.P-(T.P+VC) =35-15-10 =10 Profit per unit for Organization as a whole Profit= S.P- VC1-VC2 =35-11-10 =14
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Question 2
Manufacturing concern has got 2 division. 1 is fabrication and other is assembly division. The fabrication division transfers partially completed components to assembly division. VC for Fabrication division is Rs.300/per unit. The full cost incurred by fabrication division is Rs. 340/unit which includes Rs. 40/ Unit Fixed OH. The transfer price has been set Rs.374/unit with markup of 10% on full cost. Assembly division has special offer for its product @ Rs. 465/unit. The assembly division incurs an additional cost of Rs. 100/unit . Both the divisions have excess capacity.
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Required
(i)

What is assembly divisions manager likely to do regarding accepting or rejecting the special offer and why. Is this decision in best interest for the company as a whole How could the situation be remedy using the transfer price

(ii)

(iii)

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Solution
Data Selling price for Rs. 465/unit assembly division Transfer price Rs. 374/ unit from fabrication to assembly division Solution Additional cost by Rs. 100/ unit Revenue for 465 Assembly division Assembly Division Less: Receiving Price Less: 5/19/12 additional (374) (100) The assembly division would reject special offer because the marginal cost is greater than its revenue per unit.

Solution (ii) Company as a whole


Price V.C By Fabrication Division By Assembly Division C.M Less: FC Profit/ Loss 465 (300) (100) 65 (40) 25 It would be beneficial for the company if they accept that special order Because its able to cover its marginal cost

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Solution (III)
Just because the Fabrication Division has excess capacity so we dont have any opportunity cost. In this case out C.M= 300 and OC= 0 Transfer price From Fabrication Division to Assembly Division T.P = C.M + OC T.P= 300+0 T.P = 300+0= 300

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Question

A firm has north and south Division. North Division send partially completed product to south division which transform those partially completed goods into Final Product. The data for the company is given below Selling price Units 100 90 80 70 60 1000 2000 3000 4000 5000

North VC = Rs. 11/unit

South VC= Rs. 3 Selling price for FC = outsider= Rs . 15/ Rs. unit 20000 FC = 5/19/12 Rs. 40000

Required
(i)

Determine Transfer Price for north Division. At what quantity North Division would be ready to sell their product at Transfer price At what level firms profit would maximize

(ii)

(iii)

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Solution
Transfer Price T.P = C.M + O.C T.P = 7+(15-7) = 15

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solution

PROFIT CALCULATION FOR NORTH DIVISION @ TRANSFER PRICE


Units 1000 2000 3000 4000 5000 6000 TP Revenue 15 15 15 15 15 15 15000 30000 45000 60000 75000 90000 VC/ unit TVC 7 7 7 7 7 7 7000 14000 21000 28000 35000 42000 FC 20000 20000 20000 20000 20000 20000 Profit/ loss -12000 -4000 4000 12000 20000 28000

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Solution
Units Price VC VC Revenue (South) (North)
100000 180000 240000 280000 300000 300000 3000 6000 9000 12000 15000 18000

TFC

Profit/ loss

1000 2000 3000 4000 5000 6000 5/19/12

100 90 80 70 60 50

7000 14000 21000 28000 35000 42000

25000

65000

25000 135000

25000 185000

25000 215000

25000 225000

25000 215000

THANK YOU

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