Advanced Cost & Management Accounting (MGT705)

This transfer price is obtained by deducting variable selling and packing expense from the external price

 

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Question: 

Division – A of Zeno Ltd. manufactures a single standardized product. Division – A sold some of the output to the external market whilst the remainder is sold to Division – B of the same organization. In Division – B, it is a subassembly in manufacturing of that Division’s product. The unit costs of Division – A’s product are as follows:

Costs Amount (Rs.)
Direct material 7.00
Direct labor 3.50
Direct expenses 3.50
Variable manufacturing expenses 3.50
Fixed manufacturing expenses 7.00
Variable Selling and packing expenses 1.75
Total 26.25

 

Annually 17,500 units of the product are sold externally at the standard price of Rs 52.50.

In addition to external sales, 8,750 units are transferred annually to Division – B at an internal transfer charge of Rs. 50.75 per unit.

This transfer price is obtained by deducting variable selling and packing expense from the external price

Division – B incorporates the transferred-in goods into a more advanced product. The costing detail of that advanced product is as under:

Costs Amount (Rs.)
Transferred-in item (from Div – A) 50.75
Direct material and Components 40.25
Direct labor 5.25
Variable Overheads 21.00
Fixed Overheads 21.00
Variable Selling and Packing Expenses 1.75
Total 140.00

 

Division – B’s manager disagrees with the basis used to set the transfer price. He argues that the transfers should be made at variable cost plus an agreed – minimal mark-up. He claims that his division is taking output that Division – A would be unable to sell at the price of Rs 52.50. Partly because of this disagreement, a study of the relationship between selling price and demand has recently been made by the sales director. The resulting report contains:

 

i. Division – A

a. Selling price (Rs.) 35.00 52.50 70.00
b. Demand (units) 26,250 17,500 8,750

 

ii. Division – B

a. Selling price (Rs.) 140.00 157.50 175.00
b. Demand (units) 12,600 8,750 4,900

 

The manager of Division – B claims that the study supports his case. He suggests that a price of Rs. 21 would give Division – A, a reasonable contribution to its fixed overheads while allowing Division – B to earn a reasonable profit. He also believes that it would lead to an increase in output and an improvement in the overall company profits.

 

Requirements:

As a student of “Advanced Cost & Management Accounting”, you are required to calculate the effect that the transfer pricing system has had on the company’s profits.

 

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