Advanced: Market based transfer prices A group has two companies-

K Ltd, which is operating at just above 50% capacity, and L Ltd, which is operating at full capacity (7000 production hours).

L Ltd produces two products, X and Y, using the same labour force for each product. For the next year its budgeted capacity involves a commitment to the sale of 3000 kg of Y, the remainder of its capacity being used on X.

Direct costs of these two products are:

The company’s overhead is £126000 per annum relating to X and Y in proportion to their direct wages. At full capacity, £70000 of this overhead is variable. L Ltd prices its products with a 60% mark-up on its total costs.
For the coming year, K Ltd wishes to buy from L Ltd 2000 kg of product X which it proposes to adapt and sell, as product Z, for £100 per kg. The direct costs of adaptation are £15 per kg. K Ltd’s total fixed costs will not change, out variable overhead of £2 per kg will be incurred.
You are required to recommend, as group management accountant,

(a) at what range of transfer prices, if at all, 2000 kg of product X should be sold to K Ltd;
(14 marks)

(b) what other points should be borne in mind when making any recommendations about transfer prices in the above circumstances.
(6 marks) (Total 20 marks) CIMA Stage 4 Management Accounting-
Decision Making.LO1

Transcribed Image Text:

Direct materials X ( per kg) Y ( per kg) 18 15 14 Direct wages 10 (1 production hour) production hour)