Q.1) The Top Company Ltd has two divisions X & Y.

One of the parts produced

by X is being used by Division Y in its manufacturing process. This part is not unique
and there is readily defined market such that X can sell to outside firms and Y can
buy from outside.
The following data is available in respect of division X:
Capacity to Produce the part 125000 units
External Sales at Rs 100 per unit 100000 units
Transfer to division Y 25000
Costs:
Variable Manufacturing cost per unit Rs 84
Variable Selling Cost per unit Rs 2
(on external sales only but not incurred on internal transfer)
Fixed Manufacturing Cost (based on 125000 units) Rs 6
Fixed Selling Cost (based on 100000 units) Rs 1
The division Y represents the following data on the assumption of volume of 25000
units.
Variable manufacturing expenses per unit Rs 100
(excluding internal transfer price/outside purchase)
Variable Selling Expenses per unit Rs 6
Fixed manufacturing cost Rs 10
Fixed selling expenses Rs 4
Selling price per unit Rs 240

Required –
1. If division X could sell 125000 units at Rs 100 each in the open market what
transfer price, the central management would prefer in order to provide proper
motivation to division Y?
2. As a management accountant would you advise division Y to buy the product
at the transfer price determined in 1 above?
3.Assume transfer price as in 1 above and if selling price for division Y’s product drops to Rs
200 should you buy at that price? Would this be desirable from the point of the firm, why?

Solution – 1.) X selling the product to outsiders at Rs.100

Selling Price 100

-Variable Cost (Prodn) 84
-Variable Cost (Selling) 2
Contribution 14
-Fixed Cost (Prodn) 6
-Fixed Cost (Selling) 1
 Profit 7
Minimum Transfer Price Could be = Variable Cost Of production +
Contribution Lost
= 84 + 14
= 98
(Justification)
For transferring the product X must get its VC of Production - 84
It must get its FC of Production - +6
It must get its FC of selling - +1
X must earn the profit - +7
----------------
X must charge a TP of 98 .

2. As a management accountant of Division Y would you advise the purchase at TP of 98

Y Purchases Y Purchases from

from X at outside at Rs 100
TP 98
Selling Price 240 240
-Variable Cost (Production) 100 100
-Variable Cost ( Bought Out Item) 98 100
-Variable Cost (Selling) 6 6
Contribution 36 34

Since the option to purchase the item from X at TP of 98 gives better contribution, division Y
should go for this transaction.
3. If sales price of division Y’s product drops to Rs 200, whether the TP of 98 will be acceptable

Co. uses Co opts to sell the

product of X Product of X in
in division Y Open market at
100
Selling Price 200 100
-Variable Cost (Production) 100 84
-Variable Cost (Bought Out Item) 84
-Variable Cost (Selling) 6 2
Contribution 10 14

Since from company’s point of view selling the product of division X to outside buyer gives
better contribution than transferring it to division Y.
2. The Power Lite division manufactures batteries that it sells primarily to the Y
division for inclusion with that division’s main product. Last year 20% of the
batteries were sold to the other companies at a price of Rs.10 each. The remaining
batteries went to the Y division. Cost data for the year are presented for Power Lite
is as under –

Units Produced 5,00,000

Manufacturing Cost (Rs.) 30,00,000
Marketing Cost (Rs.) 1,00,000
Administrative Costs (Rs.) 8,00,000

Required – A. What will be the transfer price of batteries if the company uses
1. Market price?
2. Market price less marketing costs
3. A transfer price that will yield a net income of 10% on sales for Power
Lite?
B. Prepare a schedule showing the Power-Lite divisions net income for
each of the transfer pricing alternatives computed.

Given
Power Lite Division
Units Produced 5,00,000
20% Units Sols Outside 1,00,000
80% Units Sold to Latern Div. 4,00,000
Market Price @ Rs 10.00
Production Cost 30,00,000/5,00,000 @ Rs. 6.00
Marketing Cost 1,00,000/5,00,000 @ Rs. 0.20
Administration Cost @ Rs. 1.60
8,00,000/5,00,000

A) i) TP as MP = Rs 10.00
ii) TP = MP - Marketing Cost = 10.00 – 0.20 = 9.80
iii) Set TP such that it should give 10% profit on sales price

Production Cost 6.00

Marketing Cost 0.20
Administration Cost 1.60
Total Cost 7.80
Profit 0.87
Selling Price i.e. TP 8.67
 B) PLD’s Net Income under various options of TP

Transfer Price @ Rs.10.00 Transfer Price @ Rs. 9.80 Transfer Price @ Rs.
8.67
Sales Sales Sales
5,00,000@ 10 50,00,000 1,00,000 @ 10 10,00,000 1,00,000 @ 10 10,00,000
4,00,000 @9.8 39,20,000 4,00,000 @8.67 34,68,000
Total Sales 50,00,000 49,20,000 44,68,000
Total Cost@7.8 39,00,000 39,00,000 39,00,000
Profit 11,00,000 10,20,000 5,68,000

3. ABC Co Ltd. has two divisions Relay Division (RD) and Motor Division (MD).
Other information given is –
RD – It can manufacture 50,000 Relays (a kind of switch) per year at a variable cost
of Rs,12 per unit and selling price is Rs. 20 per unit. Each relay requires one labour
hour to complete.
MD – It has developed a new model of Motor for which a new model of Relay is
required. There are two options to procure this new model of Relay:
a. To buy from an external supplier @ Rs 15 per unit (Annual requirement
50,000 units)
b. To be manufactured by RD which has to give up its entire present business.
The variable cost of manufacturing a new model is Rs.10 per unit.
The MD also has to incure Rs.25 as variable cost and the selling price per unit is
Rs.60.
Advise whether the RD should give up its existence business to manufacture a new
model of relay for MD OR
The latter should procure the new model from the market?

Solution: -
1. Option I – Develop new relay model in RD and transfer it to MD

Relay Division (RD) Motor Division (MD) Total

Sales 50,000 @ 10 TP 5,00,000 Sales 50,000 @ 60 30,00,000

(Treating VC as TP)
Variable Cost @10 5,00,000 VC (Purchase cost 5,00,000
from RD @ 10)
VC @ 25 12,50,000
(Production cost)
 Contribution NIL 12,50,000 12,50,000

2. Option II – Let MD procure from outside supplier & RD continue the production of old
model relays
Relay Division (RD) Motor Division (MD) Total

Sales 50,000 @ 20 MP 10,00,000 Sales 50,000 @ 60 30,00,000

Variable Cost @12 6,00,000 VC (Ext. Purchase 7,50,000

cost @ 15)
VC @ 25 12,50,000
(Production cost)
Contribution 4,00,000 10,00,000 14,00,000

The above table option II show that if MD procures its new model of relays from outside
supplier it leads to earning better contribution i.e. 14,00,000 to the company. This also entails
RD to sell outside and run profitably.
However with Option I company’s contribution gets reduced by 1,50,000. Therefore transfer
transaction should not be made.

From RD’s point of view the Minimum TP should be equal to VC + Contribution lost, which
comes out to be Rs.18 {10 + (20-12)}. But as the MD is able to procure the relay at Rs.15 this
TP may not advisable to MD.

4. Amit Industries has two divisions A & B. Division A has a capacity of

manufacturing 1,00,000 boxes per year. The selling price is Rs.30 whereas the
variable cost is Rs.16 per unit and fixed cost is 9,00,000 per year. Division B is also
using the same box but it is purchasing 10,000 units per year at a cost of Rs.29 per
unit.
Find out the transfer price in following cases:
a. If division A has sufficient idle capacity to handle requirement of division
B.
b. If there is no idle capacity in division A, should there be any transfer at this
price?
c. If there is no idle capacity in division A, however Rs.3 in variable cost can
be avoided on interdivision sales, due to reduced selling costs.
 a. Option I- Division A has idle capacity i.e. it can produce more but can not sell the
additional produce. In this situation whatever it can sell to division B over above the
variable cost is acceptable to it. Division A’s opportunity cost is Zero i.e. it is not
loosing any contribution on account of transfer.
Contribution Lost per unit = ZERO
Therefore
Minimum TP = VC per unit + Contribution Lost per unit
= 16 + 0
= 16

But to provide motivate division A, by carrying negotiations, TP may be set any

where between Rs.16 to 29. (as division B is in a position to get the said product from
open market at Rs.29)

b. Option I – Division A has NO IDLE capacity i.e. whatever it can produce it can sell.
Therefore in this situation division A need not reduce its transfer price below the market
price. And any such transfer required to be made must compensate for the total contribution
lost by A on account of such transfer.
Contribution Lost per unit = Rs14 {30-16}
Therefore
Minimum TP = VC per unit + Contribution Lost per unit
= 16 + 14
= 30
However note that division B is also able to get its requirement at Rs.29, therefore no
transfer is possible between the divisions.

c. Division A has no idle capacity, but it can save variable cost of Rs.3 on internal transfer to
division B on account of reduced selling cost.

Therefore in this situation Varibale Cost of Div. A = 16-3 = 13

Minimum TP = VC per unit + Contribution Lost per unit

= 13 + 14
= 27

Again here to provide proper motivation to division A, TP mat be set between Rs.27 to