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:
|Variable manufacturing expenses||3.50|
|Fixed manufacturing expenses||7.00|
|Variable Selling and packing expenses||1.75|
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:
|Transferred-in item (from Div – A)||50.75|
|Direct material and Components||40.25|
|Variable Selling and Packing Expenses||1.75|
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.
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.