Page 116 - DMGT514_MANAGEMENT_CONTROL_SYSTEMS

Unit 5: Transfer Pricing

Opportunity cost of losing sale of 50000 units Notes
` 7, 00,000
Variable cost of production of 25000 units @ ` 84 ` 21, 00,000

Less opportunity cost of cost sales (as per above)
` 7, 00,000
Lowest transfer price of 25,000 units
` 14, 00,000

14, 00,000
Hence, transfer price per unit = ` 56/unit
25,000

Example: AB Cycles has two divisions, A and B, which manufactures bicycles. Division
A produces bicycle frames and Division B assembles rest of the bicycle on the frame. There is a
market for subassembly and the final products. Each division has been treated as a profit centre.
The transfer price has been set at the long run average market price. The following data are
available for each division:
Estimated selling price of final product - ` 3000/- per unit

Long run average market price of subassembly - ` 2000/- per unit
Incremental cost of completing subassembly in Division B - ` 1500/- per unit
Incremental cost in Division A - ` 1200/- per unit.
Required:
1. If Division A’s maximum capacity is 1000 units p.m. and sales to the intermediate market
outside are now 800 units. Should 200 units be transferred to Division A on long-term
average market price basis?
2. What should be the transfer price if manager of division A should be kept motivated?
3. If outside market increases to 1000 units, should Division A continue to transfer 200 units
to Division B or sell entire production to outside market?
The answer should be backed up by explanations and relevant calculations.
Solution:
These are markets for (i) final products, that is, complete cycle and (ii) subassemblies. Capacity
restriction is 1000 units in division A which produces bicycle frames.
Option 1: Complete Cycle
Now contributions on production of complete cycle:
Sales per unit ` 3000

Low variable cost Div. A 1200
Div. B 1500 ` 2700

Contribution ` 300

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