Page 120 - DMGT514_MANAGEMENT_CONTROL_SYSTEMS

Unit 5: Transfer Pricing

Notes
Example: A company has two divisions viz. machine division and tractor division. The
machine division operates at full capacity and tractor division at 50% capacity. Machine division
produces two products, crane shafts and tyre rims using the same labour force for each product.
The direct wages rate per production hour is ` 4. During the next year, its budgeted capacity of
36000 direct labour hours involves a commitment to sell 440 units of tyre rims. The balance
capacity will be used for production of crane shafts. Consumption of material in a unit of crane
shaft and tyre rim is 20 kgs and 10 kgs respectively.
Cost data are:
Crane shafts Tyre rims
(` per kg.) (` per kg.)
Direct material 38 30
Direct wages 28 20
The machine division’s overheads amount to ` 648000 per annum relating to crane shafts and
tyre rims in proportions to other direct wages, out of this, ` 360000 is variable overhead at full
capacity. Machine division prices its products with 25% markup on its total cost. If machine
division sells products to tractor division, then saves 4 per kg. in variable cost for not incurring
selling and distribution overhead.
The tractor division wishes to buy 75 units of crane shafts from machine division for being
processed into HOCL tractors, to be sold at ` 8000 per tractor. The processing material and wages
cost are ` 1500 per tractor. Each tractor requires a one-craft shaft and sufficient demand of crane
shaft also exists in normal market. The fixed cost amounts to ` 140000 per annum.
You are required:
1. To calculate the cost and selling price per kg. of products of machine division for normal
sales.
2. To prepare a report showing the profitability of machine division and tractor division and
company as a whole for each of the following situations:

(i) The machine division transfers crane shafts at a price applicable to outside customers
on the basis of total cost.
(ii) The machine division transfers crane shafts at a price based on total cost less credit
for selling and distribution expenses of ` 4 per kg. Which will not be incurred in
respect of sale of tractor division?
(iii) The machine division manufactures the quantity of crane shafts required by tractor
division by employing overtime payable at double the normal wages rate and
transfer at marginal cost less ` 4 per kg being selling and distribution cost not
incurred in respect of sale to tractor division. The machine division sells the entire
regular production to outside customers at usual price.

Solution:
Total overheads per year ` 648000
Less: Variable overheads ` 360000
Fixed overheads per year ` 288000
Variable overheads per hour = 360000/36000 = ` 10 [1]

Fixed overheads per hours = 288000/36000 = ` 8 [1]

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