Problem 13.13 (Transfer pricing at different capacity levels at reduced market price). PH. Ltd has two manufacturing departments organised into separate profit centres known as the Basic unit and Processing unit. The Basic unit has a production capacity of 4,000 tonnes per month of Chemvax but at present its sales limited to 2,000 tonnes to outside market and 1,200 tonnes to the Processing unit. The transfer price for the year 1986 was agreed at Rs. 400 per tonne. This price has been fixed in line with the external wholesale trade price on Ist January 1986. However due to heavy competition the Basic unit has been forced to reduce the wholesale trade price to Rs. 360 per tonne with effect from Ist June 1986 This price however was not made applicable to the sale made to the Processing unit of the company. The Processing unit applied for revision of the price as applicable to the outside market buyers as from Ist Jue 1986 but the same was turned down by the Basic unit. The Processing unit refines Chemvax and packs the output known as Colour-X in drums of 50 kgs each. The selling price of colour-X is Rs. 40 per drum. The Processing unit has a potential of selling a further quantity of 16,000 drums of colour-X provided the overall price is reduced to Rs. 32 per drum. In that event it can buy the additional 800 tonnes of Chemvex from the Basic unit whose capacity can be fully utilised. The outside market will not however absorb more than the present quantity of 2,000 tonnes. The cost data relevant to the operation are: Basic unit Processing unit Raw Materials/tonne Rs. 70 Transfer price Variable Cost/tonne Rs. 140 Rs. 170 Fixed costs/month Rs. 3,00,000 Rs. 1,20,000 Required: (i) Prepare statement showing the estimated profitability for June 1986 for each unit and the company as a whole on the following bases: (a) At 80% and 100% capacity utilisation of the Basic unit at the market price and transfer price to the Processing unit of Rs. 400 per tonne. (b) At 80% capacity utilisation of the Basic unit at the market price of Rs. 360 per tonne and the transfer price to the Processing unit of Rs. 400 per tonne. (c) At 100% capacity utilisation of the Basic unit at the market price and transfer price to the Processing (ii) Comment on the effect of the company's transfer pricing policy on the profitability of the Processing unit. unit of Rs. 360 per tonne. ILY