- This topic has 7 replies, 2 voices, and was last updated 8 years ago by
.
- Posts
Hello. Ican’t understand the solution for the following practice questions example, please help.
Division A sells externally and to division C. Divisions have freedom to set transfer prices. Company uses RI. Cost of capital 12% a year.
Division A.
Budget:
max. capacity 150 000 units
external sales 110 000 units
external S. P. $35 /unit
VC $22/unit
FC $1080000
capital employed $3200000
Target RI $180000Division C
Found two other companies willing to supply:
X could supply at $28 but only for annual orders in excess of 50000 units.
Z could supply at $33 for any quantity.
Division C requests a quotation for 60000 from division A.For solution of Tranfer price they give Contribution earned from external sales as 90 000@($35-$22)
Can you please explain, how do they come to this 90000 units?Since A has a maximum capacity of 150,000 units, then if they supply the 60,000 to C then it means they will only be able to sell externally the remaining 90,000.
Sir, I have another question on this example. In the end they give “the two prices that would have to quote to division C”: 40000 (150000-110000)at marginal cost of $22 and 20000 (110000-90000) at external SP of $35. Why is this so? Should we rely on budget and which is the unused capacity may be sold at marg. cost and which exceeds should be sold at external SP? if so, could you please tell the reason behind this.
Thank you so much for your help.The unused capacity can be transferred at anything above marginal cost because they are not causing a loss of external sales and therefore there is no lost contribution.
Any transfers in excess of the unused capacity will mean the loss of external sales, which means that they will lose contribution and therefore the transfer price has to be at least the marginal cost plus the lost contribution as per the normal rule (which here is the same as the external selling price).
Have you watched my free lectures on transfer pricing? Our lectures are a complete free course for Paper F5 and cover everything needed to be able to pass the exam well.
Now I understand. Thank you for your explanation. I listened to your lectures and now I see how they are applied to this example.
- You must be logged in to reply to this topic.