dr. mahananda b chittawadagi research guide, bengaluru

Dr. Mahananda B Chittawadagi

Research Guide, Bengaluru Central University

Associate Professor of Commerce

KLE Society’s S. Nijalingappa College, 2nd Block Rajajinagar, Bengaluru-560010

IV Semester M.Com. Bangalore University

Strategic Cost Management- II.

Module 2: Transfer Pricing

Solutions to Questions from University Question Papers

Problem 1: Question Paper - June 2016, Q. No. 6. ABC Co. fixes the inter-divisional

transfer prices for its product on the basis of costplus a return on investment in division. The

budget for division A for 2015-16 is as under:

Fixed Assets Rs. 2,50,000

Current Assets Rs. 1,50,000

Debtors Rs. 1,00,000

Annual fixed cost of the division Rs. 4,00,000

Variable Cost per unit of product Rs. 10

Budgeted volume 2,00,000 units per year

Desired ROI 28%

Determine the transfer price for Division A.If the volume (in units) can be increased by 10%,

what will be the impact on transfer price?

Solution:

Step I: Calculation of Total Investment and Desired Return on Investment (ROI)

Particulars Rs.

Fixed assets 2,50,000

Current assets 1,50,000

Stock 1,00,000

Total investment in business 5,00,000

Desired return (5,00,000*28/100) 1,40,000





Step II: Calculation of Transfer Price

Particulars Rs.

Variable cost (2,00,000 units *Rs.10) 20,00,000

Fixed cost of Division A per annum 4,00,000

Total cost 24,00,000

Add: Desired return 1,40,000

Total amount to be charged 25,40,000

Inter-divisional transfer price per unit (Rs.25,40,000/2,0,000 units) 12.70

Step III: Impact on transfer price if the volume is increased by 10%

Budgeted volume per year: 2,00,000 units

Volume increased by 10%: 2,00,000*10%=20,000 units

Total Volume:2.00.000+20,000=2,20,000units.

Particulars Rs.

Variable cost(2,20,000 units * Rs.10) 22,00,000

Fixed cost 4,00,000


Add: Desired return on investment 1,40,000

Total amount to be charged 27,40,000

Inter- divisional Transfer price per unit = 27,40,000/2,20,000 units

12.45

************

Problem 2: Question Paper- June 2017, Q. No. 12. Vinayak Ltd. has two

manufacturing divisions AD &CD. Each division operates as an independent Profit Centre. AD

which produces two components BRITE and LITE has a capacity of 1,00,000 hours per annum.

The annual fixed overheads of this department amount to Rs.20 Lakhs. The product wise

variable cost data are as under:





BRITE (Rs. /unit) LITE (Rs. / unit)

Direct materials

Direct labor and variable overheads

10

140

5

35

Total 150 40

The direct labor and variable overheadsare Rs. 35 per hour. AD has a permanent customer for the

purchase of 15000 units of BRITE per annum at a selling price of Rs. 300 per unit.

The balance capacity is devoted to the production of LITE for which there is an unlimited sales

potential at Rs. 60 per unit.

CD assembles a product known as TITE using an imported component. The annual fixed

overheads of this division amount to Rs. 4 lakhs and the variable cost data per unit are as under:

TITE

Imported Component

Direct materials

Direct labor and variable overheads (10 hours at Rs. 25)

300

40

250

Total 590

The selling price of TITE is Rs. 700 per unit. With a view of minimizing the dependence on

imported components, the possibility of using the company’s own component BRITE, which is

similar to the imported component, was explored. The import substitution is possible with slight

modification in the manufacture of TITE, which in that case will take two extra labor hours per

unit. This means an increase of Rs. 50 in variable costs per unit of TITE. CD envisages a

production of 5000 units per annum of TITE.

You are required to present the division wise profitability and the profitability of the company as

a whole on the basis of the following conditions:

a) CD imports its requirements of 5000 components for the manufacture of TITE.

b) CD stops import and substitutes BRITE by drawing 5000 units of BRITE from AD at the

market price of Rs. 300 per unit.





c) Same situation as in (b) above except that CD gets relief of Rs. 50/- per unit (net transfer

price to CD is Rs. 250 per unit) of BRITE to compensate the increased labor and variable

overhead cost of CD.

d) CD revises its production program to manufacture 12000 units of TITE by drawing

10000 units of BRITE from AD at Rs. 250 per unit and imports the balance of 2000 units

of components at Rs. 300/- per unit. Due to installation of additional production capacity,

the annual fixed overhead of CD would increase by Rs.7,70,000. In order to induce CD to

the expansion program, do you think negotiated transfer price of Rs. 240for BRITE

would be agreed by AD? Give reasons and also comment on the best alternative (a to d)

for the company as a whole.

Solution:Details of the Question

Vinayak Ltd. has two manufacturing divisions AD & CD, each operates as an

independent Profit Centre.

AD division produces two components BRITE and LITE has a capacity of 1,00,000 hours

per annum.

The direct labor and variable overheads are Rs. 35 per hour

Direct labor and variable overheads- BRITE Rs.140 & LITE Rs.35

Labor hours required for BRITE:140/35=4hours & Lite:35/35=1hour per unit

AD has a permanent customer for the purchase of 15000 units of BRITE per annum at a

selling price of Rs. 300 per unit, capacity used:15000 units * 4hours=60,000 hours

The balance capacity is devoted to the production of LITE: 40,000 hrs (1,00,000-60,000),

number of units will be 40,000 (one hour per unit), for which there is an unlimited sales

potential at Rs. 60 per unit

The annual fixed overheads of AD division amount to Rs.20 Lakhs

CD division assembles a product TITE using an imported component of Rs.300, direct

material Rs.40 and direct labor & variable overhead Rs.250, total variable cost per unit

will be Rs.590. The annual fixed overheads of CD division amount to Rs. 4 lakhs

The selling price of TITE is Rs. 700 per unit





Calculation of division wise profitability and the profitability of the company as a whole

under various alternatives:

Calculation of Contribution per unit, per hour and assignment of Ranks

Particulars BRITE LITE TITE

Selling price per unit

Less: Variable cost per unit:

Direct Material

Direct labor & variable overheads

Imported Component (TITE)

300

10

140

--

60

5

35

--

700

40

250

300

Contribution per unit 150 20 110

The direct labor & variable overheads Rs.35

per hour for BRITE & TITE

LITE- 10 hours at Rs.25

Rs.140/Rs.35

4 hrs per unit

Rs.35/Rs.35

1 hr per unit

----

10 hrs per

unit

Contribution per hour 150/4=37.5 20/1=20 110/10=11

Ranking based contribution per hour I II III

Alternative–a: CD imports its requirements of 5000 components for the manufacture of TITE.

Statement of division wise profitability and the profitability of the company as a whole





Alternative- b:CD stops import and substitutes BRITE by drawing 5000 units of BRITE from

AD at the market price of Rs. 300 per unit

1. Calculation of new contribution of Division CD

Particulars Rs.

a) Selling Price

b) Less: Variable cost: Imported component

Direct materials

Direct labor and overheads

Extra variable cost(Rs.25*extra2Hrs.)

c) Contribution (a – b)

700

300

40

250

50

60

2.Statement of division wise profitability and the profitability of the company as a whole

(Rs.)

Division AD

Contribution:

BRITE (15000 Units X Rs. 150)

LITE (40000 Units X Rs. 20)

Total Contribution

Less: Fixed Expenses

Profit (a)

Division CD

Contribution: TITE (5000 units X Rs.110)


Profit (b)

22,50,000

8,00,000

30,50,000

20,00,000

10,50,000

5,50,000

4,00,000

1,50,000

Overall profit of the company (a + b) 12,00,000





Division AD:

Contribution

BRITE (15000 units to outside customers @ Rs. 150)

BRITE (5000 units to division CD @ Rs. 150)

LITE (20000 units @ Rs. 20) limited capacity (refer Note 1)

Total Contribution


Profit (a)

Division CD:

Contribution (5000 units @ Rs. 60)


Loss (b)

Overall Profit (14,00,000 -1,00,000)

22,50,000

7,50,000

4,00,000

34,00,000

20,00,000

14,00,000

3,00,000

4,00,000

1,00,000

13,00,000

Note 1: AD which produces two components BRITE and LITE has a capacity of 1,00,000 hours

per annum

Hours required per unit of BRITE 4 hrs. & LITE 1 hr. Since contribution per hour is highest in

case of BRITE, all 20,000 units(15,000+5,000) have to be produced by using 80,000 hours

(20,000 units * 4 hrs. per unit), hours left to produce TITE will be 20,000 (1,00,000-20,000), the

balance capacity is devoted to the production of LITE (20,000 units * 1 hour per unit)

Alternative -c:Same situation as in (b) above except that CD gets relief of Rs. 50/- per unit (net

transfer price to CD is Rs. 250 per unit) of BRITE to compensate the increased labor and

variable overhead cost of CD

1. Price of BRITE to CD Division is reduced by Rs. 50

Hence contribution per unit will be Rs. 250 – Rs. 150 = Rs. 100

2. Contribution of TITE when transfer price is Rs. 250





Particulars Rs.

Selling price

Less: Variable Cost: Direct Materials

Direct Labor (250+50)

Transfer price of BRITE (300-50)

Contribution of TITE

700

40

300

250

110

3. Statement of division wise profitability and the profitability of the company as a

whole

Rs.

Division AD

Contribution:

BRITE (15000 units for outside party @ Rs. 150)

BRITE (5000 units transfer to CD @ Rs. 100)

LITE (20000 units @ Rs. 20) limited capacity

Total contribution

Less: Fixed expenses

Profit (a)

Division CD

Contribution (5000 units @ Rs. 110)

Less: Fixed expenses

Profit (b)

22,50,000

5,00,000

4,00,000

31,50,000

20,00,000

11,50,000

5,50,000

4,00,000

1,50,000

Overall profit of the company is (a + b) 13,00,000

Alternative -d: CD revises its production program to manufacture 12000 units of TITE by

drawing 10000 units of BRITE from AD at Rs. 250 per unit and imports the balance of 2000

units of components at Rs. 300/- per unit. Due to installation of additional production capacity,

the annual fixed overhead of CD would increase by Rs.7,70,000. In order to induce CD to the

expansion program, do you think negotiated transfer price of Rs. 240 for BRITE would be

agreed by AD?





Statement of division wise profitability and the profitability of the company as a whole

(Rs.)

Division AD

Contribution:

BRITE (15000 units for outside party @ Rs. 150)

BRITE (10000 units to CD @ Rs. 100)

Total contribution

Less: fixed expenses

Profit (a)

Division CD

Contribution (10000 units with BRITE of AD @Rs. 110)

Contribution (2000 units imported component @Rs. 110)

Total contribution

Less: Fixed Expenses (4,00,000 + 7,70,000)

Profit (b)

Overall profit of the company is (a + b)

22,50,000

10,00,000

32,50,000

20,00,000

12,50,000

11,00,000

2,20,000

13,20,000

11,70,000

1,50,000

14,00,000

Comment:Alternative -d with maximum profit, is the best alternative among all.

*********

Problem 3: Question Paper- July 2018, Q. No. 11.M/s Foamstar has two divisions

Foam and Star. Foam manufacturers have an intermediate product for which there is no

intermediate external market. Star incorporates this intermediate product into final product which

it sells. One unit of the intermediate product is used in the production of the final product. The

expected units of the final product which Star division estimates it can sell at various selling

prices are as follows:

Net selling price (in Rs.) Quantity sold (in units)

1000 10,000

900 20,000

800 30,000





700 40,000

600 50,000

500 60,000

The costs of each division are as follows:

Foam Star

Variable cost per unit (Rs.) 110 70

Fixed cost (Rs.) 60,00,000 90,00,000

The transfer price is Rs.350 for the intermediate product and is determined on a full cost-plus

basis. You are required to:

a) Prepare profit statements for each division and the company as a whole for the various

selling prices.

b) State which selling price maximize profit for the Star division and the company as a

whole and comment on why the latter selling price is not selected by Star division.

c) State which transfer pricing policy will maximize the company’s profit under a divisional

organization.

Solution:

M/s Foamstar has two divisions Foam and Star.

Foam manufacturers have an intermediate product for which there is no intermediate

external market.

Star incorporates this intermediate product into final product which it sells.

Here Foam division transfers its intermediate product at Rs.350 per unit to Star division

which processes into final product.

One unit of the intermediate product is used in the production of the final product.





Fixed Cost: Foam’s Rs.60,00,000, Star’s Rs.90,00,000

Variable Cost per unit: Foam Division Rs.110. Star Division Rs.420 (Rs.70 + Rs.350

Transfer Price of intermediate product of Foam Division)

Profitability of Foam Division as a Profit Centre

Contributionper unit= SP(Transfer Price) – Variable Cost

350 – 110 = Rs. 240 contribution per unit

Profit =Contribution – Fixed Cost(Rs.60,00,000)

Units Total Contribution= Rs.240 * Units Profit=Contribution-Fixed Cost

10,000 24,00,000 (36,00,000)

20,000 48,00,000 (12,00,000)

30,000 72,00,000 12,00,000

40,000 96,00,000 36,00,000

50,000 120,00,000 60,00,00

60,000 144,00,000 84,00,000

Profitability of Star Division as a Profit Centre

Contribution per unit= Selling Price – Variable Cost

Variable cost includes Transfer Price ofFoam’s intermediate product +VC of Star

Variable Cost :350+70=Rs.420 per unit

Contribution per unit= Selling Price – Variable Cost (Rs.420)

Profit =Contribution – Fixed Cost (Rs.90,00,000)

Units Selling Total Sales Variable Cost= Contribution= Profit=Contribution-





Price value Rs.420*Units SP-VC Fixed Cost

10,000 1000 1,00,00,000 42,00,000 58,00,000 (32,00,000)

20,000 900 1,80,00,000 84,00,000 96,00,000 6,00,000

30,000 800 2,40,00,000 1,26,00,000 1,14,00,000 24,00,000

40,000 700 2,80,00,000 1,68,00,000 1,12,00,000 22,00,000

50,000 600 3,00,00,000 2,10,00,000 90,00,000 ------

60,000 500 3,00,00,000 2,52,00,000 48,00,000 (42,00,000)

*********

Problem 4: Question Paper- July 2019, Q. No. 12. Godrej Company is organized into

two divisions namely A and B produces three products, X,Y and Z.The following are the data

per unit:

Particulars X Y Z

Market Price (Rs.) 120 115 100

Variable Cost (Rs.) 84 60 70

Direct Labor Hours 4 5 3

Maximum Sales Potential (units) 1600 1000 600

Division B has demand for 600 units of products Y for its use. If Division A cannot supply the

requirement, Division B can buy a similar product from market at Rs. 112 per unit.

What should be the transfer price of 600 units of Y division B, if the total direct labour hour

available in Division A are restricted to 15,000?

Solution

a. Calculation of total labor hours required for the current level of production

Products Units Hours Total hours

X 1600 4 6,400

Y 1000 5 5,000





Z 600 3 1,800

Total hours required 13,200

Max. Direct labor hour available in Division A 15,000

Surplus labor hours in Division A (15,000-13,200) 1,800

b. Calculation of Contribution per unit, per hour and assignment ofRanks

Particular X Y Z

a) Sales 120 115 100

b) Less: Variable cost 84 60 70

c) Contribution per unit(a-b) 36 55 30

d) Number of Hours 4 5 3

e) Contribution per hour(c/d) 9 11 10

f) Ranking III I II

c. Utilization of Max.15,000 hours for the production of additional 600 units Y

d. C

a

l

c

u

l

a

t

i

o

n

of loss of contribution of Product X (in units): 1600-1300=300 units

Loos of Contribution (in Rs.): 300 units * Rs.36 contribution per unit of X =Rs.10,800

e. Calculation of Transfer Price=Variable Cost + Loss of Contribution

Variable cost of additional 600 units of Y at Rs.60 per unit: 600 * 60=Rs.36000

Loss of Contribution of Product X: Rs.10,800

Rank Products Units Hours Total hours

I Y 1600 5 8,000

II Z 600 3 1,800

Balance hours: 15000-(8000+1800)= 5200 hours

available for last ranked product X, which requires

4 hours per unit. 5200 hrs./4hrs.=1300units

III X 1,300(b/f) 4 5,200(b/f)

Total hours available 15,000 hours





Transfer Price: 36,000 + 10,800 = 46,800.

Transfer Price per unit: 46,800 / 600 units = Rs.78 per unit

***********

Problem 5. Your company fixes the inter-divisional transfer prices for its products on the basis

of cost plus a return on investment in the division. The budget for Division A for 1981-82

appears as under:

Fixed Assets Rs. 5,00,000

Current Assets Rs. 3,00,000

Debtors Rs. 2,00,000

Annual fixed cost of the division Rs. 8,00,000

Variable Cost per unit of product Rs. 10

Budgeted volume 4,00,000 units per year

Desired ROI 28%

Determine the transfer price for Division A?If the volume (in units) can be increased by 10%,

what will be the impact on transfer price?

Solution: a. Calculation of desired Return on Investment

Particular Rs.

Fixed assets 5,00,000

Current assets 3,00,000

Stock 2,00,000

Total investment in business 10,00,000

Desired return @ 28% (10,00,000*28/100) 2,80,000

b. Calculation of Transfer Price

Particular Rs.

Variable Cost (4,00,000 units *Rs.10) 40,00,000





Fixed Cost of Division A per annum 8,00,000

Total Cost 48,00,000

Add: Desired Return 2,80,000

Total transfer price for Division A 50,80,000

Transfer price per unit (Rs.50,80,000/4,0,000 units) 12.70

e) Impact on transfer price if the volume is increased by 10%

(4,00,000 units*10% = 40,000 units. Total units=4,00,000+40,000=4,40,000 units)

Particular Rs.

Variable cost(4,40,000 units * Rs.10) 44,00,000

Fixed cost 8,00,000


Add: Desired return on investment 2,80,000

Transfer Price of Division A 54,80,000

Transfer price per unit: 54,80,000/4,40,000 units 12.45

***************

Problem 6. Department X is a profit centre manufacturing products R, S and T. Each of the

products can be sold in the outside market to the extent of the following:

R 900 units

S 300 units

T 600 units

Market price per unit is Rs.24, Rs.23 and Rs.20 for R,S and T respectively. Other details are

given below:

Products R S T

Variable cost of production 17 12 14





Labor hours required 3 2 4

Product R can be transferred to department T, but the maximum quantity that might be required

for transfer is 400 units of R. The manager of department Y has powers to buy the product R

from the external market at a much cheaper price of Rs. 22.

What should be the transfer price for 400 units of R, if the total labor hours available in

Department X is:

a. 4,800 hours. b. 6,200 hours

Solution:

A. Calculation of total hours required for the current level of production

Product Units Hours Total Hours

R 900 3 2,700

S 300 2 600

T 600 4 2,400

Total hours required 5,700

B. Calculation of contribution per unit, per hour and assignment of ranks

Particular R S T

a. Selling price 24 23 20

b. Less: variable cost 17 12 14

c. Contribution per unit (a-b) 7 11 6

d. Number of hours 3hrs 2hrs 4hrs

e. Contribution per hour (c/d) 2.33 5.50 1.50

f. Rank (based on highest contribution per

hr.)

II I III





C. Allocation of 4800hrs

i. Utilization of 4800 hours without additional 400 units of R

Rank Product Units Hours Total hours

I S 300 2 600

II R 900 3 2700

Balance hours: 4800 – (600+2700) = 1500.

No. of hrs. required per unit of T: 4 hrs.

No. of units of T: 1500 hrs. /4 hrs.=375 units

III T 375(b/f) 4 1500 (b/f)

Total hours 4800

ii.Utilization of 4800 hours with additional 400 units of R (900+400=1300 units)


I S 300 2 600

II R 1300 3 3900

Balance hours: 4800–(600+3900) = 300.

No. of hrs. required per unit of T: 4 hrs.

No. of units of T: 300 hrs. /4 hrs.=75 units

III T 75(b/f) 4 300 (b/f)

Total hours 4800

iii. Calculation of contribution lost of Product T (in units): 375-75=300 units

Contribution lost (in Rs.): 300 units * Rs.6 contribution per unit of T =Rs.1800

iv.Calculation of Transfer Price=Variable Cost + Contribution lost

Variable cost of additional 400 units of R, at Rs.17 per unit: 400 * 17=Rs.6800

Loss of Contribution of Product T: Rs.1800

Transfer Price: 6800 + 1800 = 8,600

Transfer Price per unit: 8600/400 units = 21.5 per unit





D.Allocation of 6200 hours

i. Calculation of spare hours: Max. hrs. – Required Hrs. 6200-5700=500 hours

ii. Allocation of 6200 hours without additional units


I S 300 2 600

II R 900 3 2700

III T 600 4 2400

Total hours required 5700 hours

Spare Hours 500 hours

iii.Allocation of 6200 to produce additional 400 units of R (900+400=1300 units)

Rank product Units Hours Total hours

I S 300 2 600

II R 1300 3 3900

Balance hrs: 6200 – (600+3900) = 1700 hrs.

No. of hrs for product T: 4 hrs.

No. of units of T: 1700/4=425 units

III T 425(b/f) 4 1700 (b/f)

Total hours allocated 6200 hours

iv.Calculation of contribution loss of Product T (in units): 600-425=175 units

Loss of Contribution of T (in Rs.): 175 units * Rs.6 contribution per unit of T =Rs.1050

iv.Calculation of Transfer Price=Variable Cost + Loss of Contribution

Variable cost of additional 400 units of R, at Rs.17 per unit: 400 * 17=Rs.6800

Loss of Contribution of Product T: Rs.1050

Transfer Price: 6800 + 1050 = 7,850

Transfer Price per unit: 7850/400 units = 19.625 per unit





***************

Problem 7.Division A is a profit centre which produces X, Y and Z. each product has an

external market.

Particular X Y Z

External market price per unit (Rs.) 48 46 40

Variable cost of production per unit in division A (Rs) 33 24 28

Labour hours required per unit in division A 3 4 2

Product Y can be transferred to Division B, but the maximum quantity that might be required for

transfer is 300 units of Y.

The maximum external sales are

X-800 units

Y-500 units

Z-300 units

Instead of receiving transfer of product Y from Division A, Division B could buy similar product

in the open market at a slight cheaper price of Rs. 45 per unit.What should the transfer price be

for each unit for 300 units of Y, if the total labor hours available in division A are:

a. 3,800 hours.

b. b. 5,600 hours

Solution

A. Calculation of total hours for the current level of maximum external sales

Product External Sales inunits Hours Total Hours

X 800 3 2400

Y 500 4 2000

Z 300 2 600

Total hours required 5000 hours





B. Calculation of contribution per unit, per hour and assignment of ranks

Particular X Y Z

a. Selling price 48 46 40

b. Less: variable cost 33 24 28

c. Contribution per unit (a-b) 15 22 15

d. Number of hours 3hrs 4hrs 2hrs

e. Contribution per hour (c/d) 5 5.5 6

f. Rank III II I

C. Allocation of 3800hours without additional 300 units of Y


I Z 300 2 600

II Y 500 4 2000

Balance Hours: 3800 – (600+2000) = 1200

III X 1200/3=400(b/f) 3 1200 (b/f)

Total hours 3800 hours

D. Utilization of 4800 hours with additional 300 units of Y:500+300=800 units


I Z 300 2 600

II Y 800 4 3200

III X - 3 No bal. hours


Calculation of loss of contribution of Product X (in units): 400- Nil= 400units





Loss of Contribution of X (in Rs.): 400 units * Rs.15, contribution per unit of X =Rs.6000

Calculation of Transfer Price=Variable Cost + Loss of Contribution

Variable cost of additional 300 units of Y, at Rs.24 per unit: 300 * 24=Rs.7200

Loss of Contribution of Product X: Rs.6000

Transfer Price: 7200 + 6000 = 13200

Transfer Price per unit: 13200/300 units = Rs.44 per unit

E. Allocation of 5600 hours. Spare hours will be: 5600-5000=600 hours

Utilization of 5600 hours without additional 300 units of Y


I Z 300 2 600

II Y 500 4 2000

III X 800 4 2400

Total hours required 5000

Spare hours: 5600 – 5000 600

Utilization of 5600 hours with additional 300 units of Y (500+300 = 800 units)


I Z 300 2 600

II Y 800 3 3200

Balance Hours: 5600 – (600+3200) =1800 hours

No. of units of X:1800 / 4 hours = 450

III X 450(b/f) 4 1800 (b/f)


i.Calculation of loss of contribution of Product X (in units): 800-450= 350 units

Loss of Contribution of X (in Rs.): 350 units * Rs.15, contribution per unit of X =Rs.5250

ii.Calculation of Transfer Price=Variable Cost + Loss of Contribution





Variable cost of additional 300 units of Y, at Rs.24 per unit: 300 * 24=Rs.7200

Loss of Contribution of Product X: Rs.5250

Transfer Price: 7200 + 5250 = 12450

Transfer Price per unit: 12450/300 units = Rs.41.5 per unit ***********

Problem 8.Division Z is a profit centre, which produces four products-A, B, C and D. Each

product is sold in the external market also. Data for the period is as follows.

A B C D

Market price per units Rs.150 Rs.146 Rs. 140 Rs. 130

Variable cost of production per unit Rs. 130 Rs. 100 Rs. 90 Rs. 85

Labour hours required per unit 3 4 2 3

Product D can be transferred to division Y, but the maximum quantity that might be required for

transfer is 2,500 units of D.

The maximum sales in the external market are:

A-2,800 units

B- 2,500 units

C-2,300 units

D-1,600 units

Division Y can purchase the same product at a slightly cheaper price of Rs. 125 per unit instead

of receiving transfers of product D from division Z.

What should be the transfer price for each unit for 2,500 units of D, if the total labour hours

available in division Z are:

a. 20,000 hours b. 30,000 hours

Solution:

A. Calculation of number of hours required for the current level of production

Product Units Hours Total hours





A 2800 3 8400

B 2500 4 10000

C 2300 2 4600

D 1600 3 4800

Total hours 27,800 hours

B. Calculation of contribution per unit, contribution per hour and assignment of ranks

Particular A B C D

a. Sales 150 146 140 130

b. Variable cost 130 100 90 85

c. Contribution per unit (a-b) 20 46 50 45

d. Number of hours 3 4 2 3

e. Contribution per hours (c/d) 6.66 11.5 25 15

f. Ranking IV III I II

C. Allocation of 20,000 hourswithout the additional production of 2500 units of D


I C 2300 2 4600

II D 1600 3 4800

III B 2500 4 10000

Balance hours:20,000 – (4600+4800+10000)=600

No. of units of A:600/3=200 units

IV A 200 (b/f) 3 600 (b/f)


D. Allocation of 20,000 hours with additional production of 2500 units of D: 1600+2500=4100


I C 2300 2 4600

II D 4100 3 12300

Balance hours:20,000 – (4600+12300) = 3100





hours

No. of units of B:3100 / 4 = 775 units

III B 775(b/f) 4 3100(b/f)

IV A No bal hours


i.Calculation of loss of contribution in units:

B: 2500 – 775 =1725 units. A: 200 units

Loss of Contribution (in Rs.): B 1725 units * Rs.46 =Rs.79,350

A 200 units * Rs.20 = Rs.4000

ii.Calculation of transfer price=Variable Cost + Loss of Contribution

Variable cost of additional 2500 units of D, at Rs.85 per unit: 2500 * 85=Rs.2,12,500

Loss of Contribution of Product B: Rs.79,350 & A: Rs.4,000. Total=83,350

Transfer Price: 2,12,500 +83,350 = 2,95,850

Transfer Price per unit: 2,95,850 / 2,500 units = Rs.118.34

E. Allocation of 30,000 hours without the additional production of 2500 units of D

Spare hours: 30,000-27,800= 2200 hours


I C 2300 2 4,600

II D 1600 3 4,800

III B 2500 4 10,000

IV A 2800 3 8,400


Balance hours 2,200





F. Allocation of 30,000 hours with additional 2500 units of D (1600 + 2500 = 4100 units)


I C 2300 2 4600

II D 4100 3 12300

III B 2500 4 10000

Balance hours:30000 –

(4600+12300+10000)=3100

Units of A: 3100 / 3=1033.33

IV A 1033.33 (b/f) 3 3100 (b/f)


i.Calculation of loss of contribution in units: A: 2800 – 1033 =1767 units.

Loss of Contribution (in Rs.): A 1767 units * Rs.20 = Rs.35,340

ii.Calculation of transfer price=Variable Cost + Loss of Contribution

Variable cost of additional 2500 units of D, at Rs.85 per unit: 2500 * 85=Rs.2,12,500

Loss of Contribution of Product A: Rs.35,340

Transfer Price: 2,12,500 + 35,340 = 2,47,840

Transfer Price per unit: 2,47,840 / 2,500 units = Rs.99.136

*********

Problem 9. PH Ltd. Manufactures and sells two products, namely BXE and DXE. The

company’s investment in fixed assets is Rs. 2 lakh. The working capital investment is equivalent

to three months cost of sales of both the products. The fixed capital has been financed by term

loan lending institutions at an interest of 11% p.a. Half of the working capital is financed through

bank borrowing carrying interest at the rate of 19.4%. The other half of the working capital being

generated through internal resources.The operating data anticipated for 1982-83 is as under:

BXE DXE

Production per annum (in units) 5,000 10,000

Direct material/ unit:

Material A (price Rs. 4 per kg)

1 kg

0.75 kg





Material B (price Rs. 2 per kg) 1 kg 1 kg

Direct labour hours 5 3

Direct wage rate Rs. 2 per hour. Factory overheads are recovered at 50% of direct wages.

Administrative overheads are recovered at 40% of factory cost. Selling and distribution

expenses are Rs. 2 and Rs. 3 per unit respectively of BXE and DXE. The company expects to

earn an after-tax profit of 12% on capital employed. The income tax rate is 50%.

Required:

a. Prepare a cost sheet showing the element wise cost, total cost profit and selling price per

unit of both the products.

b. Prepare a statement showing the net profit of the company after taxes for the 2016-17

Solution:

Calculation of per unit Direct Material and Direct Labor Cost of BXE & DXE

Product Direct Material Direct Labor

A B Total

BXE Rs.4*1kg=Rs.4 Rs.2*1k=Rs.2 4+2=6 5hrs*Rs.2= 10

DXE Rs.4*0.75=Rs.3 Rs.2*1kg=Rs.2 3+2=5 3hrs*Rs.2=6

Cost sheet showing the element wise cost, total cost, profit and selling price per unit

Particulars BXE: 5000 units DXE:10000 units Totalof BXE

& DXE Per

unit

Total=

Per unit*5000

Per unit Total=

Per unit*10000

Direct Material Direct

Wages

6.0

10.0

30,000

50,000

5.0

6.0

50,000

60,000

80,000

1,10,000

Prime Cost

Factory Overhead (50% of

Direct Wages)

16.0

5.0

80,000

25,000

11.0

3.0

1,10,000

30,000

1,90,000

55,000

Factory Cost

Administrative Overhead

21.0

8.4

1,05,000

42,000

14.0

5.6

1,40,000

56,000

2,45,000

98,000





(40% of Factory Cost)

Cost of Production

Selling and Distribution

Overhead

29.4

2.0

1,47,000

10,000

19.6

3.0

1,96,000

30,000

3,43,000

40,000

Cost of Sales

Return on Fixed Capital

Return on Working

Capital

31.40

3.93

1.88

1,57,000

19,676

9,420

58.80

2.83

1.36

2,26,000

28,324

13,560

3,83,000

48,000

22,980

Selling Price 37.21 1,86,096 26.79 2,67,884 4,53,980

Calculation of total capital employed, return in capital and interest on capital

Particulars Total

Total Capital=Fixed Capital + Working Capital

Given Fixed Capital:

Working Capital: (Three months cost of sales of both the products) =383000*3/12

Total Capital

2,00,000

95,750

2,95,750

Return in Fixed Capital:70980*200000 / 2,95,750 = Rs.48,000 48,000

Return in Fixed Capital for BXE: (48,000 *157000 / 383000)=Rs.19,676

Return in Fixed Capital for DXE: (48,000 *226000 / 383000) =Rs.28,324

19,676

28,324

Per unit return on Fixed Capital of BXE: 19,676 / 5000 units = Rs.3.94

Per unit return on Fixed Capital of DXE: 28,324 / 10,000 units =Rs.2.83

3.94

2.83

Return of Working Capital: 70980*95750 /295750 =Rs.22,980 22,980

Return on Working Capital of BXE: (22980 *157000 / 383000) =Rs.9,420

Return in Working Capital of DXE: (22980 *226000 / 383000) = Rs.13,560

9,420

13,560

Per Unit Return on Working Capital: BXE 9420/5000 units = 1.88

Per Unit Return on Working Capital DXE 13560/10000 units = 1.36

1.88

1.36





Statement showing Net Profit of company after taxes

Particulars BXE DXE Total

Sales

Less: Cost of sales

1,86,096

1,57,000

2,67,884

2,26,000

4,53,980

3,83,000

Gross Profit

Less: Interest on Fixed

Capital:2,00,000*11%=22,000

Less: Interest on Working Capital:95750 50 * 19.4%

=9,288

70,980

31,288

Profit Before Tax (PBT)

Less: Tax 50%

39,692

19,846

Profit After Tax (PAT) 19,846

********

Problem 10. P.H. Ltd has two manufacturing departments organized into separate profit

centres known as the Basic unit and Processing unit. The Basic unit has a production capacity of

4,000 ton per month of Chemvax but at present its sales are limited 2,000 ton to outside market

and 1,200 ton to the Processing unit.

The transfer price for the year 1986 was agreed at Rs. 400 per ton. This price has been fixed in

line with the external wholesale trade price on 1st January 1986. However due to heavy

competition the Basic unit has been forced to reduce the wholesale trade price to Rs. 360 per ton

with effect from 1stJune 1986 but the same was turned down by the Basic unit.

The Processing unit refines Chemvax and packs the output known as Colour-X in drums of

50kgs each. The selling price of Colour-X is Rs. 40 per drum. The Processing unit has a potential

of selling a further quantity of 16,000 drums of Colour-X provided the overall price is reduced to

Rs.32 per drum. In that event it can buy the additional 800 ton of Chemvex from the basic unit

whose capacity can be fully utilized. The outside market will not however absorb more than the

present quantity of 2,000 ton.





The cost data relevant to the operations are:

Basic unit Processing unit

Raw materials/ ton Rs.70 Transfer price

Variable cost / ton Rs. 140 Rs. 170

Fixed costs / month Rs. 3,00,000 Rs. 1,20,000

You are required:

a. Prepare statement showing the estimated profitability for June 1986 for each unit and the

company as a whole on the following bases:

I. At 80% and 100% capacity utilization of the Basic unit at the market price and

transfer price to the Processing unit of Rs. 400 per ton.

II. At 80% capacity utilization of the basic unit at the market price of Rs. 360 per

tonand the transfer price to the processing unit of Rs. 400 per ton.

III. At 100% capacity utilization of the Basic unit at the market price and transfer

price to the Processing unit of Rs.360 per ton.

b. Comment on the effect of the company’s transfer pricing policy on the profitability of the

processing unit.

Solution:

I. At 80% and 100% capacity utilization of Basic unit of the Market Price and Transfer

Price to the Processing unit of Rs.400 per ton

i. Calculation of Contribution

Particulars Basic Unit: Produces

‘Chemwax’ of 3200 ton.

(Per ton)

Processing Unit-Receives1200 ton from

Basic unit. Packs its output ‘Colour-X’ in

one drum of 50kgs:

1200tons*1000kgs/50kgs=24,000 drums)

(Per drum)





Selling Price 400 40

Less: Variable Cost

Raw Material

Variable Cost

70

140

210

400

170

570 per ton*50kgs/1000kgs= 28.5

Contribution per unit 190 11.5

Total Contribution

Rs.190*3200 ton=

6,08,000

Rs.11.5*24,000 drums= 2,76,000

i. Profitability at 80% capacity of 3200 tons

Particulars Basic Unit Processing Unit Total

Contribution 6,08,000 2,76,000 8,84,000

Less: Fixed Cost 3,00,000 1,20,000 4,20,000

Profit 3,08,000 1,56,000 4,64,000

ii. Profitability of 100% capacity 4000 tons

Out of the 4000 tons of Basic Unit, 2000 tons to market and remaining 2000 tons, transfers to

Processing unit (existing transfers 1200 tons and additional 800 tons) and selling price per drum

reduced to Rs.32 from Rs.40

Particulars Basic Unit Processing Unit Total

Total

Contribution

4000 tons * 190= 7,60,000 2000 tons * 1000 kg/50 kg

=40,000 drums * 3.5=1,40,000

9,00,000

Less: Fixed

Cost

3,00,000 1,20,000 4,20,000

Profit 4,60,000 20,000 4,80,000

Noteon Rs.3.5: Contribution of Processing unit after reduction in price to Rs32 per drum

Particulars Rs.





Selling Price 32

Less: Variable cost (570*1000/50)= 28.5

Contribution per 3.5

II.At 80% capacity utilization of Basic unit at Market price of Rs 360 per ton (2000 tons)

and Transfer price to Processing unit of Rs 400 per ton (1200 tons)

Particulars Basic Unit Processing unit Total

Selling Price Rs 360 per ton Rs.40 per Drum

Less: Variable cost Rs 210 28.5

Contribution per unit Rs 150 11.25

Total Contribution For outside sale:

150*2000 tons=3,00,000

For transfer to Processing

unit:190*1200tons=2,28,000

Total:

3,00,000+2,28,000=5,28,000

11.5*24,000 Drums

=2,76,000

5,28,000+2,76,000

=8,04,000

Less Fixed Cost 3,00,000 1,20,000 4,20,000

Profit 2,28,000 1,56,000 3,84,000

3.At 100% capacity utilization of the Basic unit at the market price and transfer price to

the Processing unit of Rs.360 per ton.

Particulars Basic Unit Processing unit Total

Selling Price Rs 360 per ton Rs.40 per Drum

Less: Variable cost Rs 210 28.5

Contribution per unit Rs 150 11.25

Total Contribution 150*4000 tons=6,00,000

11.5*24,000

Drums =2,76,000

6,00,000+2,76,000

=8,76,000

Less Fixed Cost 3,00,000 1,20,000 4,20,000

Profit 3,00,000 1,56,000 4,56,000

dr. mahananda b chittawadagi research guide, bengaluru

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