Page 124 - DMGT514_MANAGEMENT_CONTROL_SYSTEMS

Unit 5: Transfer Pricing

Solution: Notes
1. We have seen that transfer pricing as such does not affect the profitability of the company’s
profits, since in one dept., it is expense and in other department, it is income which
balances at the total company level. At transfer price of ` 19, the company’s profits will be
as follows:

Division A Division B Total company
` ` `
External sales – 10000 units @ ` 30, 3,00,000 3,00,000
External sales – 5000 units @ ` 90, 4,50,000 4,50,000
Transfer to Division B @ ` 19 transfer 95,000
price – 5000 units
Total income 3,95,000 4,50,000 7,50,000

Division A Division B Total company
` ` `
Transfer from Division A @ ` 19 per unit 95,000
A’s variable cost @ ` 11 for external sales 1,60,000 1,60,000
and @ ` 10 for interdivision. Transfer
Annual fixed costs
A’s @ ` 4 for 15000 units 60,000 60,000
B’s @ ` 12 for 5000 units 60,000 60,000
B’s variable cost @ ` 39 on 5,000 units 1,95,000 1,95,000
Total expenses 2,20,000 3,50,000 4,75,000
Profit 1,75,000 1,00,000 2,75,000

2. At the transfer price of ` 12, the effect on total company's profitability will be as follows:
Division A Division B Total company
` ` `
External sales – 10000 units @ ` 30, 3,00,000 3,00,000
External sales – 5000 units @ ` 90, 4,50,000 4,50,000
Transfer to Division B @ ` 12 transfer 60,000
price – 5000 units
Total income 3,60,000 4,50,000 7,50,000-

Division A Division B Total company
` ` `
Transfer from Division A @ ` 12 per unit 60,000
A’s variable cost @ ` 11 for external sales 1,60,000 1,60,000
and @ ` 10 for interdiv.transfer
Annual fixed costs
A’s @ ` 4 for 15000 units 60,000 60,000
B’s @ ` 12 for 5000 units 60,000 60,000
B’s variable cost @ ` 39 on 5,000 units 1,95,000 1,95,000
Total expenses 2,20,000 3,15,000 4,75,000
Profit 1,40,000 1,35,000 2,75,000

The total profit of the company remains the same at ` 2,75,000.

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