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Let me try and explain part (c) with a simple example.
Suppose first that the transfer price was just the variable cost of (say) $10 per unit. The shop might then be prepared to sell at $11 per unit which would make a profit for the shop. But the problem then is that this profit might not be enough to cover the fixed costs incurred by the other division.
If, instead, the transfer price included fixed costs and as a result was higher at (say) $15 per unit, then the shop would have to charge more than $15. Although then the fixed costs would be covered, then problem then is that by charging a much higher price they might sell a lot fewer. It might be better to have charged a lower price and maybe sold a lot more.I hope that helps a bit.
With regard to part (d), I can’t really add much to what the examiner has said in his answer. The main problem is that the manager of the shop is likely to lose motivation if he is forced to buy internally and not allowed to decide for himself. We want the manager to be motivated to make the shop more profitable. (The free lectures on divisionalisation will help you here.)
so for part (a) we can coclude that adding fixed cost will not be a sensible approach . As I have watched the lectures , sir i have one doubt that wether they sell it for higher profit or lower profit from div a to div b … from the companys overall perspective it will not have any effect ryt ?
b) If suppose they are allowed to buy from outside at a lower cost then it will increase the profit of the division as well as the overall profit of the company ryt ?
For the company overall it makes no difference, but what it can affect is the motivation and decisions of the individual managers.
(Have you watched the free lectures on transfer pricing?)
yes i watched . why ? Iam able to understand all thee numericals which you teach and the explanation also but iam not able to convert it into the answers ( the theory part ) .
whats the solution for this problem .? and from your 35 yrs experience will tranfer pricing come for the june session for 10 or 15 marks ?The whole point about transfer pricing is that we want the divisional managers to be motivated, and to do whats best for their division but make sure that what is best for their division is good for the company as a whole.
If all decisions are made centrally (rather than allow the managers to make their own decisions) then we don’t even need a transfer price – it is just one big company – but that would mean just telling the managers what to do would make them less motivated. We want them to be motivated because we want them to help make the business more profitable.
Anyway I say about the exam can only be an educated guess. My guesses for this June’s exam are on the main F5 page of this website (and because of the MCQ’s there is likely to be something on transfer pricing, whether it is in Section A or Section B).
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