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Hello Tutor hope your are doing well.
I had some doubts with Example 6 of Open Tution Study Text (Page No. 78).Where Sir has explained that the Transfer Price is between the Range of $20 to $25.
I was just wondering, why would Division B be willing to pay more than $20, because in case Division A tried to demand any price higher than $20, let’s just say $22. Wouldn’t it be sensible for Division B to better get it from Division A from external market rather than trying to have a deal with Division A internally.
There’s also a reference for such situation in ACCA’s Technical Article
“At this Transfer Price, the Selling Division would make just as much profit from selling internally as selling externally. Therefore it reflects the price that they would actually be happy to sell at.
They should not expect to make a higher profit on the Internal sales than on external sales”.
“Limited” demand from A
you are happy with 15 – 25
For A > 15
For B < 25 ( 35-10)
thus a sensible spread 15-25Ex 6 follows on
“Unlimited” demand from A
For A so a transfer price of greater than 20 is acceptable
For B < 25 (35-10) transfer price of less than 25 is acceptableFURTHER TO YOUR QUESTION ………
You are presuming that Division B is able to buy on the external market but the question does not say that it is possible for B to buy on the external market (only that A can sell on the external market).
More importantly, given that A has limited capacity there is unlimited external demand therefore the transfer price needs to be such as to incentivise A to prefer to sell to B rather than to sell to the external market.
If the transfer price was to be $20 then they have no incentive to prefer to sell to B.
(And the company as a whole will be better off if they sell to B rather than externally).Understood Tutor Thankyou.
There’s a question in study text of B.P.P
In a company with a divisionalised structure, Division A transfers its output to Division B.
Division A produces just one item, Component X. Division B makes and sells an end product that requires one unit of Component X1) Marginal cost of production in Division A $ 8 per unit.
2) Fixed overhead cost of production $ 3 per unit
Market price in the external market $ 16 per unit
Division B contribution from further processing Component X, before deducting the transfer cost $ 25 per unit.
Division A is not working at full capacity, and can meet in full the external market demand and the demand from Division B for internal transfers.
What should be the minimum transfer price per unit and the maximum transfer price per
unit for Component X in this situation?My question .
Firstly i was able to calculate the minimum transfer Price .
But Tutor here like you said above, “question does not say that it is possible for B to buy on the external market”. The answer that has been provided for maximum transfer Price is $ 16 per unit. It’s exactly what i meant to say in the above, w.r.t the question in Open Tuition’s study text.
Can the please help out I’m a bit confused. Because while solving this question i used your approach and stated maximum price as $ 25 a unit
Lets start with
Is there spare capacity?NO
Transfer at MC + OP cost (for using the item)YES – enough
Transfer at MC
There may well be saving on internal costs such as packaging.YES – not enough
Some at MC
Other at MC + OP costIf external market exists use the market price
There may well be saving on internal costs such as packaging.So the maximum transfer price would be $16 – Market Price
Thankyou Tutor.
But now I’m totally confused.
Because the very first question i.e. Example 6 of Open tution study text, why didn’t we then considered the external market price of $20 as the maximum transfer Price.And in the question of B.P.P you have stated. “If external market exists use the market price There may well be saving on internal costs such as packaging. So the maximum transfer price would be $16 – Market Price”.
Moreover as previously you have said.
The question of B.P.P has not stated anywhere that Division B can buy from outside or there has been any offer from the external supplier.Can you please help me out Tutor
We did consider in Ex 6
For A:
T.P. > 20
For B:
T.P. < 25
Sensible range between $20 and $25 p.u.When we consider the maximum transfer price, we are looking at transfer pricing from the point of view of the buying division.
The question we are asking is: what is the maximum price that the buying division would be prepared to pay for the product? The answer to this question is very simple and the maximum price will be one that the buying division is also happy to pay.The maximum price that the buying division will want to pay is the market price for the product – ie whatever they would have to pay an external supplier. If this is the same as the selling division sells the product externally for, the buyer might reasonably expect a reduction to reflect costs saved by trading internally.
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