Page 123 - DMGT514_MANAGEMENT_CONTROL_SYSTEMS

Management Control Systems

Notes Costs:
Variable manufacturing cost per unit ` 10
Variable selling costs
(On external sales only but not incurred on internal transfers) 1

Fixed manufacturing cost (based on 15,000 units) 4
15
5000 units are transferred annually to Division B at an internal transfer charge of ` 19, which is
obtained by deducting variable selling expenses from the external price since this expense is not
incurred for internal transfers.
The division B incorporates the transferred in goods into a more advanced product. The unit
costs of this product are as follows:
Variable manufacturing cost per unit ` 38
(Exclusive of transfer price)

Variable selling expenses per unit 1
Fixed overheads 12
51
Division B’s manager disagrees with the basis used to set the transfer price. He argues that the
transfers should be made at variable cost plus an agreed (minimal) markup since he claimed that
his division is taking output that Division A would be unable to sell at the price of ` 30.

Partly because of this disagreement, a study of relationship between selling price and demand
has been made for each division by the company’s sales director. The resulting report contains
the following table:
Customer demand at various selling prices:
Division A
Selling price ` 20 ` 30 ` 40
Demand 15,000 10,000 5000
Division B
Selling price ` 80 ` 90 ` 100
Demand 7,200 5000 2800
The manager of Division B claims that this study supports his case. He suggests that a transfer
price of ` 12 would give Division A a reasonable contribution to its fixed overheads while
allowing Division B to earn a reasonable profit. He also believed that it would lead to an
increase of output and an improvement in the overall level of company profits.

You are required:
1. To calculate the effect that the transfer pricing system has had on the company’s profits,
and

2. To establish the likely effect on profits of adopting the suggestion by the manager of
Division B of a transfer price of ` 12.

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