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- June 15, 2021 at 3:27 pm #625347
The Rotech group comprises two companies, W Co and C Co.

W Co is a trading company with two divisions: The Design division, which designs wind turbines and supplies the

designs to customers under licences and the Gearbox division, which manufactures gearboxes for the car industry.

C Co manufactures components for gearboxes. It sells the components globally and also supplies W Co with

components for its Gearbox manufacturing division.

The financial results for the two companies for the year ended 31 May 2014 are as follows:

W Co C Co

Design division Gearbox division

$’000 $’000 $’000

External sales 14,300 25,535 8,010

Sales to Gearbox division 7,550

–––––––

15,560

–––––––

Cost of sales (4,900) (16,200)* (5,280)

Administration costs (3,400) (4,200) (2,600)

Distribution costs – (1,260) (670) ––––––– ––––––– –––––––

Operating profit 6,000 3,875 7,010 ––––––– ––––––– ––––––– ––––––– ––––––– –––––––

Capital employed 23,540 32,320 82,975

* Includes cost of components purchased from C Co.

Required:

(a) Discuss the performance of C Co and each division of W Co, calculating and using the following three

performance measures:

(i) Return on capital employed (ROCE)

(ii) Asset turnover

(iii) Operating profit margin

Note: There are 4·5 marks available for calculations and 5·5 marks available for discussion. (10 marks)

(b) C Co is currently working to full capacity. The Rotech group’s policy is that group companies and divisions must

always make internal sales first before selling outside the group. Similarly, purchases must be made from within

the group wherever possible. However, the group divisions and companies are allowed to negotiate their own

transfer prices without interference from Head Office.

C Co has always charged the same price to the Gearbox division as it does to its external customers. However,

after being offered a 5% lower price for similar components from an external supplier, the manager of the Gearbox

division feels strongly that the transfer price is too high and should be reduced. C Co currently satisfies 60% of

the external demand for its components. Its variable costs represent 40% of revenue.

Required:

Advise, using suitable calculations, the total transfer price or prices at which the components should be

supplied to the Gearbox division from C Co. (10 marks)

(20 marks)

.The Rotech group comprises two companies, W Co and C Co.

W Co is a trading company with two divisions: The Design division, which designs wind turbines and supplies the

designs to customers under licences and the Gearbox division, which manufactures gearboxes for the car industry.

C Co manufactures components for gearboxes. It sells the components globally and also supplies W Co with

components for its Gearbox manufacturing division.

The financial results for the two companies for the year ended 31 May 2014 are as follows:

W Co C Co

Design division Gearbox division

$’000 $’000 $’000

External sales 14,300 25,535 8,010

Sales to Gearbox division 7,550

–––––––

15,560

–––––––

Cost of sales (4,900) (16,200)* (5,280)

Administration costs (3,400) (4,200) (2,600)

Distribution costs – (1,260) (670) ––––––– ––––––– –––––––

Operating profit 6,000 3,875 7,010 ––––––– ––––––– ––––––– ––––––– ––––––– –––––––

Capital employed 23,540 32,320 82,975

* Includes cost of components purchased from C Co.

Required:

(a) Discuss the performance of C Co and each division of W Co, calculating and using the following three

performance measures:

(i) Return on capital employed (ROCE)

(ii) Asset turnover

(iii) Operating profit margin

Note: There are 4·5 marks available for calculations and 5·5 marks available for discussion. (10 marks)

(b) C Co is currently working to full capacity. The Rotech group’s policy is that group companies and divisions must

always make internal sales first before selling outside the group. Similarly, purchases must be made from within

the group wherever possible. However, the group divisions and companies are allowed to negotiate their own

transfer prices without interference from Head Office.

C Co has always charged the same price to the Gearbox division as it does to its external customers. However,

after being offered a 5% lower price for similar components from an external supplier, the manager of the Gearbox

division feels strongly that the transfer price is too high and should be reduced. C Co currently satisfies 60% of

the external demand for its components. Its variable costs represent 40% of revenue.

Required:

Advise, using suitable calculations, the total transfer price or prices at which the components should be

supplied to the Gearbox division from C Co. (10 marks)

(20 marks)

For the above question, how to know if is it asking for minimum transfer only or is it asking for minimum and maximum transfer prices.

I calculated the minimum transfer price to be 8544000. I calculated the marginal cost to be 3204000 by multiplying the external sales of 8010000 with the variable costs percentage of 40%. Then I calculated the contribution lost value of 5340000, i.e. the value of external demand not satisfied. I don’t understand where I went wrong

The maximum transfer price calculated is 7172500. Are the net marginal revenue figure of 16885000 and external purchase cost figure of 7172500 correct?

Also which costs out of cost of sales, administration costs and distribution costs should be considered as marginal costs.

When calculating the minimum transfer price, the marginal cost was calculated as 40% of revenue because the question mentioned that variable costs are 40% of revenue for C Co. whereas when calculating the net marginal revenue figure for the maximum transfer price, the adjusted cost of sales figure was used. There was no mention of variable cost percentage for gearbox division as was the case for C Co.June 16, 2021 at 9:10 am #625395Please do not type out full questions like this. It is a past exam question and so ACCA has the copyright and so get annoyed when they are posted on websites. I have all past exam questions and so in future all you need to do is state the name of the question and the date of the exam.

The question wants the total minimum and maximum transfer prices.

We do not have enough information to be able to calculate the net marginal revenue for the Gearbox division and therefore the maximum TP will be the external purchase price of 7,172,500.

For the minimum price, C is currently selling 8,010,000 externally but this is only 60% of the external demand and so they could sell 8,010,000/60% = 13,350,000 externally, which is an extra 5,340,000. If they are to sell these to the gearbox division instead then they will have to charge 5,340,000. At present they are making sales to the gearbox division of 7,550,000, and so for the extra 7,550,000 – 5,340,000 = 2,210,000 they have spare capacity and can therefore transfer at the marginal cost of 40% x 2,210,000 = 884,000. Therefore the minimum total price is 5,340,000 + 884,000 = $6,224,000.

Therefore the transfer price will have to be between $6,224,000 and $7,172,500.

June 16, 2021 at 12:42 pm #625439Should not the value of 5340000 be multiplied by 60% to arrive at the contribution lost figure, because currently 5340000 is the value of revenue lost figure whereas in transfer pricing, it is the contribution lost figure which is used and not the revenue lost figure.

June 16, 2021 at 2:18 pm #625447Are the cost of sales figure, administration costs and distribution costs figure marginal costs or they are fixed costs.

June 16, 2021 at 4:25 pm #625471They could be either, but it is irrelevant for C because the question says that the marginal costs are 40% of revenue.

June 16, 2021 at 5:09 pm #625477Should not the value of 5340000 be multiplied by 60% to arrive at the contribution lost figure, because currently 5340000 is the value of revenue lost figure whereas in transfer pricing, it is the contribution lost figure which is used and not the revenue lost figure.

June 17, 2021 at 7:41 am #625507As I explain in my free lectures, the minimum TP is the marginal cost plus the lost contribution.

Since there is only one product here, then the marginal cost plus the lost contribution will be equal to the external selling price of 5,340,000.

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