project note

Padhuka's Students' Handbook on Strategic Cost Management & Performance Evaluation - CA Final Answer: Transfer Price 6. A has no spare capacity and has adequate demand in a competitive Situation Relevant Costs market. But on units transferred to B, if incurs ? 10 per unit as additional (i.e. VC + Trpt Costs + SFC OC) Foxed Transport Cost and 10,000 as Fixed Expenses irrespective of the Costs 10,000 to be absorbed by the number of units transferred. number of units transferred. Concept Illustration: SI No. 0 (*) Division having more advantage G is the Transferring Division and R, the Receiving Division in a Company. R has a demand for 20% of G's production advantage in each of the following independent situations, assuming no inventory build-up. capacity which has to be first met as per the Company's Policy. State with reason, which Division, G or Renjoys more Reason G's Production Level 60% 80% 60% 100% 80% 100% 90% M 15 (Only the Sl. No. Column and last Two Columns need to be written in the Answer Books). Reason G transfers to Rat Transfer Price equal to Full Cost; No markup Market Price Marginal Cost Market Price External Demand 40% Division having more advantage Answer: SI. No 0 (ii) (ii) (iv) G G R Recovery of Above Marginal Cost with Slackness in Demand. Transfer Price = Market Price, inspite of no external market G. No incentive to G for Internal Transfer. Only Marginal Cost is reimbursed. Transfer Price = Market Price, Opportunity cost is fully recovered. 3. Transfer Pricing Conflicts 13.3.1 Conflicts between Divisions and Company 1. Objectives and Conflicts: The criteria for ficing Transfer Prices are - (a) Goal Congruence, (b) Management Effort, price can serve all of these criteria. They often conflict and managers are forced to make trade-offs. Some situations of conflicts between objectives are - (a) Goal Congruence vs Performance Evaluation: The Transfer Price that leads to the short-run optimal economic decision is relevant cost. If the Transferring Division has excess capacity, this cost will be equal to Variable Cost only (since Opportunity Costs are Nil). The Transferring Division will not recover any of its Fixed Costs when transfers are made at Variable costs, and will therefore report a Loss. (b) Goal Congruence vs. Divisional Autonomy: In case of failure of a division to achieve the objective of "Goal Congruence', the Management of the Company may dictate their Transfer Price'. If a Transfer Price is imposed on the Manager of the Supplying Division, the concept of divisional autonomy and decentralisation is undermined. (C) Performance Evaluation vs Profitability: A Transfer Price that may be satisfactory for evaluating divisional performance may lead divisions to make sub-optimal decisions when viewed from overall Company perspective. Conflicts between Divisions and Company as a whole: If Divisional Managers are given absolute free hand" in decision making on Transfer Prices, there is a possibility that divisional goals may be pursued, ignoring overall Company interests. This may force the top Management to interfere in decision-making. However, interference of top Management and "dictating a Transfer Price" on the divisions is usually the main basis of conflict between a Division and the Company as a whole. Conflicts Resolution: To resolve transfer pricing conflicts, the following transfer pricing methods can be suggested - (a) Dual-Rate Transfer Pricing System, and/or (b) Two-Part Transfer Pricing System. 2. 3. 13.3.2 Dual Rate Transfer Pricing System 1. Dual-Rate Transfer Pricing uses two separate Transfer Prices to price each inter-divisional transaction, as under - 13.6 returCA 1 S8352 and running intamat tacities anly EXE 18.00 Suspu) 15.000 units tus) (1.15,000 15 (7.10,000 hrs 10hrs) un 25,000 23,333 (23,133 units 165 ) 38,49,945 15,000 units (5.000 units 112 pu) 40,95,000 en gesme Manum Contribution to the Company. The resultant Maximum Prome - Prodhontis - 25,95,000 3. Sub Contracting Options available to the Company EXE = 38,500 units WYE = 31,500 units Dept Own Production (simum) (WN 2a) 35,000 units Sub Contract 38,500 - 35.000 3.500 units (bal.lig) Own Production (maximum) (WN 2a) 23,333 units Sub Contract 31,500 23,333 8,167 units (bal.fig) 1 1 35.000 2,333 (0/0) 1,167 units 2 - 37,333 units (Le 3,500-2,333) uts (maximum) (WN 2b) Ered of above decision: (a) Own Production (Dept 1 & 2) 35,000 units (b) Sub-Contracting Dept 1 only 2,333 units Sub-Contracting Dept 1 & 2 1,167 units Total 38,500 units 23,333 4,667 (1/1) 3,500 units 2 28,000 units (1.0.8,167 4,667) uts (maximum) (WN 25) Effect of above decision: (a) Own Production (Dept 1 & 2) 23,333 units (b) Sub-Contracting Dept 1 only 4,667 units (C) Sub-Contracting Dept 1 & 2 3,500 units Total 31,500 units 120 4. Profit Statement using Sub-Contracting Facilities as per above options EXE Particulars WYE 375 3540 a) Selling Price per unit 2 193 (DJ VC per unit in Department 1 (WN 1b) 138 OVC per unit in Department 2 (WN 1c) 318 () Sub-contract cost per unit in Department 1 3 138 321 (e) Sub-Contract cost per unit in Department 2 3150 215 Contration perunt in case of - Own Prod in both Dept 1 & 2 (a bc) 117 1 Sub-Cont Dept 1 & Own Prod Dept 2 (a-d-c) 1 Sub-Contract in both Dept 1 and 2 (a-d-e) 87 (g) Total Contribution Farned Own Prod in both Dept 1 & 2 (35,000 utsx 117)= 40,95,000 (23,333 utsx 165)= 338,49, Sub-Cont. Dept 1 & Own Prod Dept 2 (2,333 uts x ? 99) = 2,30,967 (4,667 utsx 146) = 7 6,81 Sub-Contrat in both Dept 1 and 2 (1,167 uts x ? 87)= 1,01,529 (3,500 uts x 136) = 4,76 Total of above Contribution 344,27,496 350,07 3 99 9.136 Total Total 38,500 units 31,500 units WYE 540 193 182 212 192 4. Profit Statement using Sub-Contracting Facilities as per above options Particulars EXE (a) Selling Price per unit 375 (b) Own VC per unit in Department 1 (WN 1b) 120 (C) Own VC per unit in Department 2 (WN 1c) 138 (d) Sub-Contract Cost per unit in Department 1 138 150 (e) Sub-Contract Cost per unit in Department 2 Contribution per unit in case of - 117 Own Prodn in both Dept 1 & 2 (a-b-c) 165 99 Sub-Cont. Dept 1 & Own Prodn Dept 2 (a-d-c) 87 136 Sub-Contract in both Dept 1 and 2 (a-d-e) (9) Total Contribution Earned Own Prodn in both Dept 1 & 2 (35,000 utsx 117)=740,95,000 (23,333 utsx 165)= 38,49,945 Sub-Cont Dept 1 & Own Prodn Dept 2 (2,333 uts x 799) = 2,30,967 (4,667 utsx 146) = 6,81,382 Sub-Contract in both Dept 1 and 2 (1,167 uts x 87)= 1,01,529 (3,500 uts x 136) = 4,76,000 50,07,327 * 44,27,496 Total of above Contribution 146 = 40.00 23.00 21.00 4.42 FERA Solution: Particulars Use of Regular Material Use of Cheaper Material 36 + 1/3rd * 48.00 Given (a) Direct Material 20+10% = * 22.00 22 + Re. 1 = (b) Direct Labour 20 + 5% 21.00 20 + 5% = (C) Variable Overheads Nil 84 x 5 /95= (d) Adjustment for Rejecon (Note 1) 91.00 88.42 (e) Total Variable Cosi p.u. (a + b + C + d) 1,36,50,000 31,32,63,000 Total VC =1,50,000 units x (e) 34,50,000 * 34,50,000 (g) General Fixed OH (see Note 2) 4,00,000 (h) Quality Tesng Costs 1,71,00,000 1,71,13,000 (1) Total Cosis (f + 9 + h) Note 1: Adjustment for rejection may also be taken as 5% of 84.00 = 4.20 p.u. Note 2: General Fixed OH = 20 x 1,50,000 units) + 15% thereon = * 34,50,000. Decision: At the normal volume of output (1,50,000 units), it is preferable to use the Regular Direct Materials, as there is a cost savings of 1,71,13,000 - 1,71,00,000 = 13,000. Note: If Adjustment for rejection is taken as 4.20 p.u, the cost savings will be * 20,000