Ox Co has two divisions, A and B. Division A makes a component for air conditioning units which it can only sell to
Division B. It has no other outlet for sales.
Current information relating to Division A is as follows:
Marginal cost per unit $100
Transfer price of the component $165
Total production and sales of the component each year 2,200 units
Specific fixed costs of Division A per year $10,000
Cold Co has offered to sell the component to Division B for $140 per unit. If Division B accepts this offer, Division A
will be closed.
If Division B accepts Cold Co’s offer, what will be the impact on profits per year for the group as a whole?
My question is If Div B accepts the price of $140 per unit, it is actually making a savings of (165-140)= $ 25 per unit. This is because before Division A was charging 165 for the component? So it has an increase in profits on that basis. please correct me if the above is not well interpreted
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Transfer pricing-September 2016 specimen MCQ 14
8y ago#1The question asks for the impact on the profit of the whole group i.e. A and B together.
At the moment the group is paying $100 to produce each unit, but if the group buys from Cold Co they will be paying $140. So an extra $40 per unit or in total $88,000 (2,200 x $40).
However because they would close division A, the group will save the fixed costs of $10,000.
So a net reduction in profit of $78,000.
(The transfer price is not relevant - it is income of one division but a cost of the other division.)
My free lectures on transfer pricing will help you. The lectures are a complete free course for Paper F5 and cover everything needed to be able to pass the exam well.
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