Page 118 - DMGT514_MANAGEMENT_CONTROL_SYSTEMS

Unit 5: Transfer Pricing

Division’S’ had recently acquired some specialized equipment that was used primarily to make Notes
this component. The manager cited the resulting high depreciation charges as the justification
for the price boost. He asked the president of the company to instruct Division ‘P’ to buy from ‘S’
at the ` 220 price. He supplied the following:
P’s annual purchases of the component 2000 units

S’s variable cost per unit ` 190
S’s fixed cost per unit ` 20
1. Suppose there are no alternative uses of the ‘S’ facilities:
i. Will the company as a whole benefit if ‘P’ buys from the outside suppliers for
` 200/- per unit?
ii. Suppose the selling price of outsiders drops another ` 15 to ` 185 should ‘P’ purchase
from outsiders.
iii. Suppose (disregarding ii above) that S could modify the component at an additional
variable cost of ` 10 per unit and sell the 2000 units to other customers for ` 225.
Would the entire company then benefit if P purchased the 2000 components from
outsiders at ` 200 per unit.

2. Suppose it is possible to lease out internal facilities:
iv. If internal facilities are leased out for ` 29000 p.a. should ‘P’ purchase from outsiders
at ` 200 per unit.

Solution:
1. (i) Company will not benefit if ‘P’ buys from outside:
Purchase cost from outside 2000 × 200 ` 400,000
Less: Saving in cost variable 1900 × 190 ` 380,000

by reducing output of S
Net Cost to the company as a whole ` 20,000
(ii) Company will benefit if ‘P’ buys from outside:
Purchase cost from outside 2000 × 185 ` 370,000

Less: Saving in cost variable 2000 × 190 ` 380,000
Net cost (benefit) to the company (` 10,000)
(iii) Company will benefit if ‘P’ buys from outside:
Purchase cost from outside 2000 × 200 ` 400,000

Add additional variable cost 2000 × ` 10 ` 20,000
Sale proceeds for other customs 2000 × 225 ` 450,000
Net cost (benefit) to the company (` 30,000)
2. (iv) The company will benefit if P buys from outside at ` 200 per unit

Purchase cost from outside 2000 × ` 200 ` 400,000
Less: Saving in cost (Variable) by reducing Div. S’s output 2000 × ` 190
` 380,000

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