Page 113 - DMGT514_MANAGEMENT_CONTROL_SYSTEMS

Management Control Systems

Notes Option 1:
Division A Division B Total company
` lakhs ` lakhs ` lakhs
Transfer from Division B @ ` 10,000 per unit Expenses 0
10,000
B’s variable cost @ ` 7000 per unit 7000 7000
B’s annual fixed costs 15 15
Transfer from Division B @ ` 10,000 per unit Income 10,000 -
Total expenses 10,000 (–) 2985 7015
Note: Please note that transfer price does not affect the total company’s profitability (in one division it is
income and in the other division it is expense), it only affects the divisional profitability.
Option 2:

Division A Division B Total company
` lakhs ` lakhs ` lakhs
External purchase @ ` 7500 per unit 7500 7500
B’s variable cost @ ` 7000 per unit 0 0
B’s annual fixed costs 15 15
-
Total expenses 7500 15 7515
Hence, the first option is profitable since it gives the overall lower cost.

Practical problems on transfer pricing:

Example: The AB Company has two divisions: X and Y. One of the parts produced by
division X is used in the manufacture of a product that is assembled at Division Y. This part is not
unique and there is readily defined market such that X can sell outside the firm and Y can buy
from outside.

The following details are available in respect of Division X:
Capacity to produce the part 125,000 units
External sales at ` 100 per unit 100,000 units
Transfer to Division Y 25,000 units
Costs: Variable manufacturing cost per unit ` 84

Variable selling costs
(On external sales only but not incurred on internal transfers) 2
Fixed manufacturing cost (based on 125,000 units) 6

Fixed selling cost (based on 100,000 units) 1
Division Y represents the following data on the assumption of a volume of 25,000 units
(one part is needed for each unit of its own production):

Variable manufacturing cost per unit ` 100
(Exclusive of transfer price or outside purchase price)
Variable selling expenses per unit 6

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