Chartered Accountant Final Examination

8/13/2019 Chartered Accountant Final Examination

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TRANSFER PRICING

Question 1: Godrej Ltd is a manufacturing company of which division ABC

manufactures a single standardized product. Some of the output is sold extremely

whilst the remainder is transferred to division XYZ where it is a subassembly in the

manufacture of that divisions product. ABC has the capacity (annual) to produce

30,000 units of the product. The unit costs of division ABCs product are as under:

Direct material 40

Direct labour 20

Direct expenses 20

Variable manufacturing overheads 20

Fixed manufacturing overheads 40

Sells and packaging expenses-variable 10

150

Annually 20,000 units of the product are sold externally at the standardprice of 300 per unit.

In additional to the external sales, 10,000 units are transferred annually

to division XYZ at an internal transfer price of 290 per unit. This transfer

price is obtained by deducting variable selling and packing expenses from

the external price since those expenses are not incurred for interna

transfers.

Division XYZ incorporates the transferred in goods into a moreadvanced product. The unit costs of this product are as follows:-

Transferred in-term (from division ABC) 290


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Direct material and components 230

Direct labour 30

Variable overheads 120

Fixed overheads 120

Selling and packing expenses variable 10

800

Division XYZs 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 because his division is taking output that division

ABC would be unable to sell at the price of 300.

Partly because of this disagreement, a study of the relationship between

selling price and demand has recently been carried out for each division by

the companys sales director. The study has brought out the following

demand schedule:

DIVISION ABC

Selling price () 200 300 400

Demand (units) 30,000 20,000 10,000

DIVISION XYZ

Selling price () 800 900 1000

Demand (units) 14,400 10,000 5,600

The manager of the division XYZ claims that this study supported his case.

He suggest that a transfer price of 120 would give division ABC a

reasonable contribution to its fixed overheads while allowing division XYZ to

earn a reasonable profit. He also believes that it would lead to an increase

of output and an improvement in the overall level of company profits.REQUIRED:-

(1) Calculate the effect of the transfer price of 290 per unit on

companys operating profit. Calculate the optimal product mix.


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(2) Advise the company on whether the transfer price should be revised

to 120 per unit. (ICAI ADOPTED, Nov2012, ICWA FINAL)

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Question 2:AB Ltd. makes component C and billing machines. Division A

makes component C that is used in the final assembly of the machine in

Division B. (one unit of Component C is used per machine). Component C

has a outside market also. A and B operate as profit centres and h can take

its own decisions. The following data is given in the existing scenario for

Division A and B, under which Division A has enough special and externa

demand to use its capacity and hence is offering B rates of 800 /unit for

quantity up to 750 units and 900 /unit for more than 750 units, so that its

outside contribution is not affected by transfers to B. A and B can sell any

quantity up to the maximum indicated under units sold without affecting their

future demands.

Division A Division BEternal market

( normal sales)

(Special

sales)

External market

(normal sales)

Selling Price(`/u) 1,000 800 4000

Variable manuf. cost(/u) 600 600 1,500* (*excluding

Component C)

Variable selling cost(.u) 100** - 200** (** Not incurred oninter division

transfers)

Total variable cost (/unit) 700 600 1700* (*excluding

component C)

Contribution (/unit) 300 200

Units sold 1250 750 900

Production capacity 2000 units 900 units

For the next period, A requires for its own use in its selling outlets, 50 units

of billing machines produced by B. Bs manager proposes as follows:

Option I-B will supply 50 machines to A on its variable manufacturing cost

basis provided A supplies to B, 500 units of Components C at As variable

manufacturing cost basis.


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Option II- Both A and B resort to total variable cost per unit basis

applicable to normal external sale,, through neither A nor B incurs any

selling cost on inter division transfers. A will be given 50 machines for its

use. A will have to supply B all the 900 units that B requires.

Option III- Both A and B use the external market selling price (i.e. 1,000

and 4,000 /unit for 900 units of Components C and 50 machinesrespectively).

From a financial perspective advise Division As manger what he should

choose. Support your advice with relevant figures.

What is the change in the rate of discount per unit given by B to A (based on

unit transfer price to market price ratio) from option I to Option II?

(note: Students need not work out the total cost statements. Steps showing

relevant figures for evaluation are sufficient). (ICAI ADOPTED)SOLUTION:-

A has the following options

Option No. 1

Benefit on receiving 50 machines 95,000

{4000 ( 600 + 1500)}X 50

Loss for A on 500 units of C transfer to department B

500(unit) X 200i.e. Contribution to be lost for special sale 1,00,000

A:- (5000)

OPTION NO.2

As benefit on 50 Machines 80,000

(4000 ( 700 + 1700) X 50

Loss on 900(unit) transfer to B

Rev. 900 X 700Cost 900 X 600

Benefit on transfer 900 X 100

Benefit would have been on 750 X 200 =150000

External sale 150 X 300 = 45000 (1,05,000)


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(195000 90,000) 1,95,000 (25,000)

Working Note-1

The relevant cost for department A would be 600 & 1500 which otherwise to

be purchased from outside market for 4000. Hence benefit would be 1900

on 50 machines.

OPTION NO. 3Benefit on 50 Machine Cost

(4000 4000) 50 = Nil

Benefit on 900(unit) transfer to B

Extra revenue : Extra benefit

750 X ( 1000 800) 1,50,000

150 X 100 15,000

1,65,000Its better to select 3rdoption due to higher benefit.

The difference of Transfer Price between option 1 & 2 (From department B

to department A)

Transfer Price as per 1stoption = 2100

Transfer Price as per 2ndoption = 2400

= 300

Discount as % of Market Price = 300/4000 X 100 = 7.5%.-----------------------------------------------------------------------------------------------------

Question 3: Bajaj Ltd. consists of the X Division and the Y Division. X

Division produce two different components, the new high performance ALFA

and an older product called BETA. These two products have the following

cost characteristics:

ALFA BETA

Material Parts 20Labour 2 hours 140 280

Parts 10 hours 140 70

Annual overhead in X Division is 10,00,000 all fixed. The X Division

capacity is set at 50,000 hours per year.


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To date, only one customer has developed a product utilising ALFA, and

this customer orders a maximum of 15,000 ALFA per year at a price of 600

per unit. If Bajaj Ltd. cannot meet his entire demand, the customer curtails

his own production. The rest of the Xs capacity is devoted to BETA, for

which there is unlimited demand at 120 per unit.

The Y Division produces only one product, a GAMA, which requires a

complex circuit board imported at a price of 600. The GAMA costs are:

GAMA

Material

Labour

Circuit board

Other parts

5 hours @ 100

600

80

500

The Y Division is composed of only a small assembly plant and all overhead

is fixed at a total of 20,00,000 per year. The current market price for the

GAMA is 2000 per unit.

The Production manger discovered that with minor modifications, a single

ALFA could be substituted for the circuit board, currently used by Y division,

the modification would require an extra one hour of labour by Ys staff for a

total of 6 hours per unit of GAMA. Y has, therefore asked X Division to

declare a transfer price at which X Division would sell ALFA a internally.Required

1.Y expects to sell 6,000 of GAMA this year. From the overall point of view

Bajaj Ltd., how many X should be transferred to Y Division to replace circuit

boards?

2:- What should be the transfer Price for such 6000 units.

3.if demand for the GAMA rises to 12,000 units at a price of 2000 per unit

how many of 12,000 units should be built ALFA? (All other data

unchanged).

SOLUTION:- Hours Ranking

Alpha 15000 X 2 30,000 I

BAJAJ

X

Beta 40,000 X 1/2 20,000 II


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Y Board Total 50,000

X Division has no spare capacity, hence in order to produce extra unit of

Alpha for transfer, X division will have to sacrifice the required labour hours

from the product having least Contribution/hour.

STATEMENT OF RANKING

ALPHA BETASelling Price 600 120

Variable Cost 300 80

Contribution per unit 300 40

Hours per unit 2 1/2

Contribution per hour 150 80

Ranking I II

STATEMENT OF OPTIMUM PRODUCT MIXUnit Hour per unit Hours

ALPHA 15000 2 30,000

BETA 40,000 1/2 20,000 (B/F)

50,000

The requirement of Y division is 6000 (u) of ALPHA to replace circuit board

which can be produced by division X by releasing labour hour from BETA

subject to the interest of Company.STATEMENT OF COMPARATIVE COST ( 6000(unit))

Manufacture Per unit Purchase Per Unit

ALPHA

V.C 300 Purchase cost of

Board

600

+ Contribution to be lost 2 hour X

40/

160

460

+ Extra Cost to be incurred by Y 100

Total Relevant Cost 560 Purchase Cost 600

X division can produce extra units of Alpha as 6000(unit) for Y division but


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maximum unit would be 20,000/2 = 10,000 (unit).

(ii) Transfer Price would be 460 for each unit of ALPHA up to 6000 (unit)

TRNASFER PRICE = 460 to 500.

(iii) If the requirement of Y dept. increase to 12,000(unit) than X dept can

produce of transfer 10,000(unit) of ALPHA by reducing its product BETA.

However in order to produce & transfer over and above 10,000(unit) X dept.will have to reduce existing demand of ALPHA which should be reduces

subject to the interest of Co.

STATEMENT OF COMPARITION COST

Manufacture Purchase Cost

V.C. 300

+ Contribution lost 300 Purchase Cost 600600

+ Extra Cost 100

700 600

X dept. should not produce & transfer over and above 10,000(units) of

ALPHA.

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Question 4: A manufacturing Company has two Division X and Y. Theoutput of X can be transfer to Division Y.

Division Y has always purchased its requirements of component from

Division X. But when informed that Division X was increasing its transfer

price to 170, the manager of Division Y decided to look at outside

suppliers.

Division Y buys the component from an outside supplier for 140. But

Division X refuses to lower its Price.The management has the following information:

Ys annual purchase of the component 2,000 units

Xs variable costs per unit 110


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Xs fixed cost 20000

Required

(i)Calculate Transfer Price in each of the following cases.

(ii) Suppose there are no other alternative use of Xs facilities, Will the

company as a whole benefit, if Division Y bought the component at 140

from an outside supplier ?

(iii)If X did not produce the material for Y, it could use the facilities for other

activities resulting in a cash operating savings of 70,000. Should Y then

purchase from outside sources?

(iv) Suppose there are no other alternative use of Xs facilities and the

market price per unit for the component drops by 35. Should Y now buy

from outside? (ICAI & ICWA Final Adopted)

SOLUTION:-

(ii) STATEMENT OF COMPARITIVE COST

Per unit

Manufacture Purchase

Variable

Cost

110 Purchase

cost

140

110 140

Decision:- Its better to manufacture in house.

In other words we can say the Company will not be in benefit position if

division y would like to purchase the component from outside market

because purchase cost is more than its variable cost.

STATEMENT OF TRANSFER PRICE

Cost to be incurred 110+ benefit to be lost -

Minimum Transfer price 110

(iii) STATEMENT OF COMPARITIVE COST

Per unit


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Variable

Cost

110 Purchase

cost

140

110 140

STATEMENT OF COST BENEFIT

Loss on purchase 60,000

Benefit from release capacity 70,000

Net Benefit 10,000

Decision:- Its better ot purchase component from outside market. Release

capacity of supply division should be utilized for other activities thereby

Company can achieve incremental benefit of 10,000. In other words we can

say Y should be purchased from outside market.


Cost to be incurred due to transfer 110

+ benefit to be lost due to transfer 70,000/2000 35

Transfer price (Minimum) 145(IV) STATEMENT OF COMPARITIVE COST

Per unit


Variable

Cost

110 Purchase cost 105

110 105

Decision:- Its better to purchase the component from outside marketbecause Purchase cost is less than the variable cost.


Cost to be incurred 110


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+ benefit lost -

Minimum T.P. 110

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Question 5:A company has a division A producing three products called

X,Y,Z. Each products can be sold in open market in the following manner

The maximum external sale are X 800 units, Y 500 units, Z 300 units.X Y Z

Selling price per unit

Variable cost of production in Division A

Labour hours required per unit in Division A

96

33

6

92

24

8

80

28

4

Product Y can be transferred to Division B, but the maximum quantity that

might be required for transfer is 300 units of Y.

Division B could buy similar product in the open market at a price of 45 perunit. What should the transfer price be for each unit for 300 units of Y, if the

total labour hours available in Division A are: (a) 13000 hours (b) 8000

hours (c) 12000 hours. (C.A. Final & ICWA Final 2011)

SOLUTION:-

STATEMENT OF LABOUR HOURS 13000 Hrs.

External Sale Qty Hours Per Unit Hours

X 800 6 4800Y 500 8 4000

Z 300 4 1200

Requirement 10000

Availability 13000

Spare 3000

Division A can produce 300 units of product Y & transfer to Division B at its

relevant cost by utilizing, its spare capacity.STATEMENT OF TRANSFER PRICING

Per Unit



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+ benefit to be lost -

Minimum T.P. 24

Transfer Price - 24 to 45.

Ii:- If we have 8000 Labour hours than it means such labour hours are the

limiting factors which means we are utilizing in optimum manner.


X Y Z

Contribution/unit ( 63 68 52

Labour Hours/ unit 6 8 4

Contribution/Hour () 10.5 8.5 13

Ranking II III I

STATEMENT OF OPTIMUM PRODUCT MIX(Present)Unit Hour per unit Hours

X 800 6 4800

Y 250 8 2000 (B/F)

Z 300 4 1200

8000 Hours

In order to produce 300 units of Y, for the purpose of transfer, the company

requires 300 X 8 = 2400 labour hours which should be managed by not

producing product of Y ( 2000 Hours) and X ( 400 Hours)

STATEMENT OF TRANSFER PRICING Per unit


+ cont. to be lost

A:- 2000 Hours X 8.5 17,000

B:- 400 Hrs. X 10.5 p.u. 4200

21,200/300 70.66Transfer price 94.66

III:- 12000 Hours

If we have 12000 Labour hour than after utilizing in external demand the co

will have surplus labour hour 12000- 10,000 2000 labour hour which can


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be utilized for producing 2000 = 250 (u) of Y for transfer price in order to

produce and transfer price next 50 units, the co. will have to reduce 50 X 8

= 400 labour hour from external demand of Y.


Cost to be incurred 24 X 300

+ Contribution to be lost400 hrs X 8.5 3400

Transfer value 10,600

/ Quantity 300

Min. Transfer Price 35.00

Transfer Price 35.33 to 45.

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Question 6: Reliance is a group having of four different companies.Reliance Power . Reliance Petro, Reliance Chemical and Reliance Refinary.

Reliance Refinary proposes to place a contract for a component to be used

in one of its new products and in accordance with Reliance policy has to

obtain quotations from any suitable company within the group and at least

one outside company.

Within the group Reliance Power is approached as the most suitable

company and submits a quotation of 3000. In order to do the job, howeverReliance Power will need to sub-contract some of the work to Reliance

Petro and some to Reliance Chemical.

Arrangements between the companies for this sub-contract are as follows:

Reliance Power will buy from Reliance Petro a parts at a price of 300.

Reliance Power will buy from Reliance Chemical components at a price of

1,500.

Reliance Power total costs (including purchases from Reliance Petro and

Reliance Chemical) for the Reliance Refinary contract are 2,400.

The following information is also given:

1: The variable costs of each group company relating to the work for which it


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Power Petro Chemica

Variable Cost

(60% of 600)

360 Variable

Cost

240 Variable cost 1000

+Fixed Cost 240 Fixed Cost 250

Own cost 600 Fixed Cost 60 Own Cost 1250

+ Purchase Cost 1500 + Profit Purchase Cost -Petro Transfer Cost 1250

Chemical 300 Purchase

cost

Nil Profit 250

Transfer Cost 2400 1500

+ Profit 600

Transfer Price 3,000 300

Note:- All Calculations are in reverse order.STATEMENT OF COMPARATIVE COST


Cost to be incurred Purchase Cost 2000

Reliance Power 360 (outside)

Petro 240

Chemical 1000

1600 2000Decision:- Its better to produce the component in house & transfer

because relevant cost is less than its Purchase cost. Further we can say

fixed cost are sunk for Reliance Power, Petro & chemical & profit unrealized

due to internal transfer (spare capacity)

(ii) WHAT would ne your decision in above situation if reliance chemical is a

profit centre.

STATEMENT OF COMPARATIVE COSTCost to be incurred

Reliance Power 360

Petro 240 Purchase Cost 2000


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Chemical 1000

+ Contribution to be lost

Reliance Chemical 500

2100 2000

In this situation its better to purchase the component from XYZ Co.

because Purchase Cost is less than Relevant Cost.-----------------------------------------------------------------------------------------------------

Question 7:A company has two divisions. Division A produces a Product

which is used by division B in making a final product.

Division A has a capacity to produce 3,000 units and the whole quantity can

be transferred to Division B. The transfer price for such component would

be 250 per unit which division A would like to charge from division B.

Division B however, can purchase from the outside market at 220 each

The selling price of final product is 500.

The variable costs Division A is 180 and fixed costs 10000 . The variable

costs of Division B in manufacturing the final product by using the

component is 180 (excluding the component cost). Present statements

indicating the position of each Division and the company as a whole taking

each of the following situations separately:

(i) What transfer price would you fix for the component in each of the

following three circumstances?

(iI)If there are no alternative uses for the production facilities of A, will the

company benefit if division B buys from outside suppliers at 220 per

component?

(iii) If internal facilities of A are not otherwise idle and the alternative use of

the facilities will give an annual cash operating saving of 50,000 to DivisionA, should Division B purchase the component from outside suppliers?

(iv)If there are no alternative uses for the production facilities of Division A

and the selling price for the component in the outside market drops by 50


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should Division B purchase from outside suppliers?

SOLUTION:-

(ii) STATEMENT OF TRNASFER PRICE

per unit


+ benefit to be lost -

Minimum Transfer Price 180

Transfer Price = 180 per unit to 220 per unit.

STATEMENT OF PROFIT (WITH TRNASFER)

Deptt. A Deptt. B Co.

Transfer(Revenue)

180 X 3000 Sale 3000 X 500 Total Project

Less: Cost 180 X 3000 Own

Cost

180 X 3000 A -

Profit Transfer Cost 180 X 3000 B 4,20,000

PROFIT 4,20,000 Total 4,20,000

STATEMENT OF PROFIT (WITHOUT TRANSFER)

B Co.

500 X 30003000 X 220 A -

180 X 3000 B 3,00,000

3,00,000 Total 3,00,000

On the basis of above analysis we can say its better for the Co. if

department B receives 3000(unit) from department A.

(iii) STATEMENT OF TRANSFER PRICE

per unit


+ benefit to be lost due to transfer 50

(1,50,000/3,000) Minimum Transfer Price 230


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STATEMENT OF RPOFIT (WITHOUT TRANSFER)

A Deptt A B Deptt B Co.

Cash saving 1,50,000 Rev. 15,00,000 A 1,50,000

- cost - - Purchase cost 3000 X 220 B 3,00,000

- Own Cost 3000 X 180

Net Benefit 1,50,000 3,00,000 Total 4,50,000

STATEMENT OF PROFIT (WITH TRANSFER)

Deptt. A B Co.

3000 X 230 Revenue 15,00,000

3000 80 Less Transfer Cost 3000 X 230 A 1,50,000

Purchase Cost 3000 X 180 B 2,70,000

1,50,000 Benefit 2,70,000 Total 4,20,000Its better to purchase the entire requirement of B from outside market due

to higher benefit.

(iii) STATEMENT OF TRANSFER PRICE


Minimum Transfer price 180

STATEMENT OF PROFIT (WITHOUT TRNASFER)

AB

Co.

Revenue 15,00,000

Less Purchase Cost 3000 X 170 A -

Own Cost 3000 X 180 B - 4,50,000

4,50,000 4,50,000

STATEMENT OF PROFIT (WITH TRANSFER)

A B Co.

Revenue 3000X 180 Revenue 15,00,000

Cost 3000 X 180 (-) Transfer 3000 X 180 A -

(-)Own Cost 3000 X 180 B 4,20,000

--- 4,20,000 Total 4,20,000


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(ii) In view of the companys overall interest, calculate the customer wise

units to be produced by A in 2010.

(iii) Assuming that A follows its best strategy between what values of

transfer price will B be able to negotiate with A, so that As best strategy is

unchanged in 2011. (ICAI Adopted)

SOLUTION:-For Department A

If transfer unit & order unit become less than 10,000 unit better to incur

variable cost 5 per unit.

Transfer unit/Order units are more than 10,000 (units) better to incur Fixed

Cost 50,000.

Indifference Point = 50,000/5 = 10,000(unit)

STATEMENT OF RANKINGOption External Sale

Up to 30,000 unit

Special order

15000 units

Transfer to B

< 45,000 unit

Transfer to B

45000 unit

Selling Price ( 65 55 55 60

-Variable Cost ( 35 35 35 35

_ Selling &

distribution (

10 - - -

Cont/unit( 20 20 20 25

Selling & distribution Cost would be 50,000 instead of variable element because in

option no. 2 & or Option No. III, Quantity exceeds 10,000 (unit)

The best strategy for Dept.A would be as under

i:- Transfer to B : 45000 unit

ii:- External Sale : 5000 unit

STATEMENT OF PROFIT (A)

Contribution transfer to B 45000 X 25 12,25,000

External Sale 5000 X 20 10,00,000

Less: Fixed Cost


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30,000 unit 4,30,000

10,000 unit 1,00,000

10,000 unit 1,00,000 6,30,000

Less: Selling & Distribution 50,000

Profit 5,45,000In 2010 Best strategy for A


Options External Sale up to

25000 unit

Special order

10,000 unit

Transfer to B

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Chartered Accountant Final Examination