- This topic has 3 replies, 3 voices, and was last updated 3 years ago by John Moffat.
March 2, 2019 at 7:01 am #507087unibuti
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Dear Sir, could you please help me with this problem?
There was a question about setting transfer price in ACCA past exam which is as follows:
C Co is the division selling components to Gearbox – another division of the same company and C Co is currently working to full capacity. The company’s policy is that divisions must always make internal sales first. C Co currently satisfies 60% of the external demand for its components. Its variable costs represents 40% of revenue.
The financial results of Co is as follows:
– External sales: $8010
– Sales to Gearbox: $7550
Here is what i did to determine the minimum transfer price
The current external sales are 8010, so 40% more sales could be made externally is 40%*(8010/60%)= 5340 -> this is the lost sales if Co makes internal sales instead of external.
-> Opportunity cost – lost contribution: 5340 * (100%-40% var cost) =3204
Plus: variable cost of internal sales: 7550*40%=3020
So the minimum price should be set is: 6224$
However, here is the answer to the question
From C Co’s perspective, of the current internal sales of $7,550,000, $5,340,000 could be sold externally if they were not sold to the Gearbox division. Therefore, in order for C Co not to be any worse off from selling internally, these sales should be made at the current price of $5,340,000.
As regards the remaining internal sales of $2,210,000 ($7,550,000 – $5,340,000), C Co effectively has spare capacity to meet these sales. Therefore, the minimum transfer price should be the marginal cost of producing these goods. Given that variable costs represent 40% of revenue, this means that the marginal cost for these sales is $884,000. This is therefore the minimum price which C Co should charge for these sales.
In total, therefore, C Co will want to charge at least $6,224,000 for its sales to the Gearbox division
Though I gave the same result as the answer, I was wondering whether my way of thinking was correct. And if I was right, could you please explain to me which method is more reasonable and regularly used?
Thank you!March 2, 2019 at 9:24 am #507123John MoffatKeymaster
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Yes – your way of thinking is correct.
As to which is more reasonable and regularly used, it does not matter – every transfer pricing question in the exam is completely different, and apart from understanding the basic ‘rules’ you get the marks however you approach it.March 2, 2019 at 5:22 pm #507209akshaykopite19
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How come $5340k forms part of $7550k as explained by the book?March 3, 2019 at 9:03 am #507250John MoffatKeymaster
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- Replies: 50555
C is working to full capacity. Therefore if they sell more externally they will be selling less to the gearbox division.
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