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Question 3 (b) Division A in one country having 40% Tax Rates and Division B in another Country having 20% tax rates. Now there are 2 options
1) Either Division B could buy 18000 units at 9 $ per unit from Market from its own country or
2) Division B could buy from A ( 18000 units at 10.50 $ per unit) In order to be able to supply these 18000 units Division A had to forgo contribution on 8000 units X 5 $ per unit for another product.
It has been asked to explain which option is better !Answer given by ACCA ,I am unable to understand.
My take on question is
1) A division has to pay 40% tax and B division pays 20% tax , so unless rules and regulations in Country ( Division A) and another Country ( Division B) do not prohibit – there should be every attempt to allow B division to make more profit so instead of transferring at 10.50 $ per unit , let B division buy at 9$ per unit and make more profit so that Company as a whole pay less tax.
2) In this question at what price B division would sell the product is NOT given. In ACCA answer , they have calculated tax benefit for Division B on the basis of purchase price by Division B, which is beyond my comprehension.Kindly make me understand and also comment whether my premise of allowing division which has got lesser rate of tax to make most profit is right and acceptable.
Kindly help.
Q1. You are right but divisions have autonomy to set their own transfer prices and DivA has decided to use market price less 30%, ie 10.50.
Q2. Profits are taxed, but profits =revenue – costs
Therefore profit after tax = Revenue less tax on – (Costs – tax on costs).
The revenue is constant under both arrangements so the decision can be made using costs and the tax saving on costs.
Dear Sir
In this solution given by ACCA why they are comparing Division A Sales of 60,000 wrist supports. The question is whether Division B should buy from at adjusted Market price of 10.50 per unit or at local market rate of 9 per unit in distland.
I am unable to understand the answer,If Division B is buying from market at 9 per unit then why Sale of wrist units ( 60000 X 5 ) is to be considered that is 1st question and by buying at 9 per unit in market how come we should calculate tax at 20% on purchase price. This is really putting me under stress. Kindly explain.Question (b)
After considerable internal discussion concerning Quotation 2 by the management of SSA Group, Division A is not prepared to supply 18,000 ankle supports to Division B at any price lower than 30% below market price. All profits in Distalnd ( Division B) are subject to taxation at a rate of 20% . Division A pays tax in Nearland at a rate of 40% on all profits.
Advise the management of SSA Group whether the management of Division B should be directed to purchase the ankle supports from Division A or to purchase a similar product from local supplier at 9 per unit in distaland.Supporting calculations to be provideded ( 8 marks)Answer
Now there are 2 scenarios either
1)B should buy at 10.50 per unit from A or
2) B should buy at 9 per unit from Market in its own country
1)Option 1
Since tax rates in A’s country are at 40% and B’s country at 20% . It does not make sense for A to charge 10.50 per unit to B especially when the same quality product is available in B’s country at 9 per unit thereby allowing to make more profit to A and paying tax at 40% on it.
10.50 X 18000 units = 189,000 minus variable cost 126000= 63000 X 40% Tax =25200=Tax component
Division B after buying at 10.50 per unit will be making less profit ( and also notional loss of 9 per unit minus 10.50 per unit) as such reduced Tax liability
2)Option 2
Now Division B is buying at 9 per unit from market and then process and sell it to make profit in the market since final selling price is not given -tax liability of profit at 20% would certainly be lower.
A will not have not have any impact on profit – since B is buying from market.As such on the basis of this analogy – Option 2 of allowing B to buy from market makes sense and logical.
Now this answer DOES NOT MATCH with ACCA answer as far as CALCULATIONS PART is concerned. However my answer choice and ACCA answer choice of allowing B to buy from market GETS MATCHED.
Kindly advise as an EXPERT , will you give any consideration to my answer and whether it is acceptable.My further query on such questions is
1)Whether we should be worrying about tax components or
2)Profit after Tax ComponentsKindly give your comments on my answer and about 2 issues raised further.
Deep
Your exam is on Monday. I don’t think it is useful for you to worry about this question. It’s a once-off and the current examiner does not go for this style.
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