PAS2253 Management Accounting II

Tutorial – Transfer Pricing

1. The Electronics Division of Syarikat Mekar produces electronic circuit boards. The following information is
provided.

Production capacity 120,000 units

Selling price to external market RM30
Variable cost per unit circuit board RM15
Fixed cost per unit circuit board (based on production capacity) RM6

Syarikat Mekar also has a Video Games Division which can use the circuit boards in its video games. At the
moment, the Video Games Division buys 10,000 units of circuit boards from the external market at a price of
RM29. The company sold all 120,000 units of circuit boards produced to the external market.

Required:

a. Assuming that you are the manager of the Electronics Division, what is the minimum price you are willing
to accept that will not jeopardise the profit of the division and your previous performance evaluation?
b. Now, as the manager of the Video Games Division, what is the maximum price you are willing to pay
without jeopardising the profits of the division and your performance evaluation?
c. Assuming that Syarikat Mekar now sells 110,000 units of circuit boards to the external market. What is
the minimum price that you are willing to pay so as not to jeopardise the profits of the division and your
previous performance evaluation?

2. Company A, one of the divisions within a group of companies, manufactures a component for Company B,
another division within the group. In the next period, Company B anticipates a requirement for 10,000 units of
the component. The component is currently purchased from Company A at a transfer price based on the full
cost. At the expected level of demand, the costs of Company A supplying the component to Company B in the
next period are expected to be:

Variable cost RM3.70 per unit

Fixed cost RM18,000 for the period

Company A would like to change the basis for the calculation of the transfer price of the component in order to
make a profit. However, an increase in the transfer price is being resisted by Company B, especially as the
component is also available from a supplier outside the group at a cost price of RM5.20 per unit.

Required:

a. Calculate the transfer price for the component for the next period if based on the full cost.
b. Calculate whether the group would gain or lose in the period if Company B purchased the component
entirely from the outside supplier.
c. Assume that purchase of the component, by Company B, entirely from the outside supplier would
release capacity in Company A. This surplus capacity could be used to generate a contribution of
RM20,000 in the period on another component. Determine the effect on group profit, and the effect on
the profit of each of the two divisions, in these circumstances.

3. The Speaker Division produces and sells speakers used in MP3 players. The variable cost of production per
unit and the variable cost of sales per unit is RM20 and RM5 respectively. The Speaker Division can sell in
the open market at RM36 or transfer internally to the MP3 Division. The MP3 Division currently buys a similar
model from China for RM33 per unit.
 PAS2253 Management Accounting II
Tutorial – Transfer Pricing

Required:

a. Calculate the transfer price acceptable to the MP3 Division for one unit of the speaker.
b. Calculate the transfer price per unit charged by the Speaker Division’s manager in the following
situations:
i. The division has excess capacity.
ii. The division does not have excess capacity.
iii. The division does not have excess capacity and the internal variable cost is reduced by RM4 per
unit.

4. Investment Centre A manufactures a single product which is transferred to another investment centre in the
same group. Budgets for next year for Investment Centre A include:

Sales 3,000 units

Variable costs RM40 per unit
Fixed costs RM100,000
Capital employed RM250,000

Required:

a. Calculate the transfer price of the product that will achieve a 20% return on capital employed (ROCE) for
Investment Centre A.
b. If the transfer price is set at RM85 per unit, calculate the number of units that would need to be sold for
Investment Centre A to achieve a return on capital employed (ROCE) of 16%.
c. Calculate the residual income (RI) for Investment Centre A based on the budget details above and the
transfer price of RM90 per unit and the cost of capital of 12% per annum.

5. Division B has asked Division A of the same firm to supply 6,000 units of component L763 this year for use in
one of its products. Division B has received a quotation of RM17.00 per unit L763 from an external supplier.
Division A has a production capacity of 30,000 units of component L763 every year. Division A expects sales
of component L763 to an external customer of 27,000 units with the price of RM18.00 per unit this year. To
fulfil orders from Division B, Division A has to reduce sales to the external customer. Division A produces
component L763 at a variable cost of RM9.00 per unit. The cost of packaging and delivery to the external
customer is RM1.00 per unit. This cost will not be incurred if component L763 is sold to Division B.

Required:

a. What is the range of price that would increase the profit of both divisions as a result of an agreement to
transfer 6,000 units of component L763 to Division B in the current year?
b. Is the transfer price within the interest of the firm as a whole? Explain.

6. A Microtec Division of Industri CRE produces microchips that are at present being sold in the external market.
The Customer Product Division of Industri CRE will be launching a new oven which requires a microchip and
has approached the Microtec Division for a quotation. The Microtech Division sells the microchip at a price of
RM47 and incurs a variable cost of RM12. The Microtech Division at the moment has excess capacity. The
Customer Product Division can obtain suitable microchips in the external market for RM41.

Required:

a. Determine the impact on profit to the company as a whole if the Customer Product Division buys chips
from the Microtec Division compared to buying from an external party.
 PAS2253 Management Accounting II
Tutorial – Transfer Pricing

b. Set the minimum price per unit of chip acceptable to the Microtec Division.
c. Set the maximum price per unit of chip acceptable to the Customer Product Division.
d. Will the answers for each item above change if the Microtec Division is operating at full capacity?

7. BBB Bhd manufactures pillows. The Cover Division makes covers and the Assembly Division makes the
finished products. The covers can be sold separately for RM5.00 and the pillows sell for RM6.00. The
information related to manufacturing for the most recent year is as follows:

RM
Cover Division manufacturing costs 6,000,000
Sales of covers by Cover Division 4,000,000
The market value of covers transferred to Assembly 6,000,000
Sales of pillows by Assembly Division 7,200,000
Additional manufacturing costs of Assembly Division 1,500,000

Required:

Compute the operating income for each division and the company as a whole. Use market value as the
transfer price. Are all managers happy with this concept? Explain.

8. Divisions A and B are investment centres within the AB Group. Division A manufactures a component,
especially for Division B. The anticipated requirements for, and costs and transfer price of, this component for
the year ahead are as follows:

Production 112,500 units

Variable cost RM5.70 per unit
Fixed cost RM2.40 per unit
Transfer price RM8.50 per unit

Company C, which is not part of the AB Group, has offered to supply the component to Division B for RM7.50
per unit.

Required:

a. Establish, based on the figures supplied above, whether it is worthwhile for the AB Group to continue to
manufacture the component
b. Determine whether Division A would benefit if the component were to be purchased from Company C.
c. Determine whether Division B would benefit if the component were to be purchased from Company C.

9. Renoir McKenna is comprised of two divisions, R and T. Division R manufactures a single product which has
the following standard production cost per unit, based on a budgeted output of 12,000 units in a given period:

RM per unit
Direct materials 16
Direct labour 12
Production overheads:
Variable 10
Fixed 22
60
 PAS2253 Management Accounting II
Tutorial – Transfer Pricing

In a typical period, Division R incurs additional non-production costs of RM20,000 for selling 2,500 units to the
external market for RM72 per unit. The remainder of Division R’s output is internally transferred to Division T
as an intermediate product. Division T’s unit standard cost of converting the intermediate product into its final
product is as follows:

RM per unit
Direct labour 9
Production overheads:
Variable 5
Fixed 8
22

Division T incurs additional non-production costs of RM57,000 per period for selling its final product to the
external market for RM118 per unit.

Required:

Calculate the profits for each of Division R and Division T for a period, using the following transfer prices:

a. market price
b. standard variable production costs
c. 110 per cent of full standard production costs

10. MF Bhd has two divisions; the Cutting Division prepares timber at its sawmills and the Assembly Division
prepares the cut lumber into finished wood for the furniture industry. No inventories exist in either division at
the beginning of 2022. During the year, the Cutting Division prepared 60,000 cords of wood for RM660,000.
All the lumber was transferred to the Assembly Division, where additional operating costs of RM6 per cord
were incurred. The 600,000 board feet of finished wood were sold for RM2,500,000.

Required:

a. Determine the operating income for each division if the transfer price from Cutting to Assembly is at the
cost of RM11 a cord.
b. Determine the operating income for each division if the transfer price is RM9 per cord.
c. Since the Cutting Division sells all of its wood internally to the Assembly Division, does the manager care
what price is selected? Why? Should the Cutting Division be a cost centre or a profit centre under the
circumstances?

11. The Machine Division has accepted an offer from an external supplier to supply special components for
RM37.00 per unit. To facilitate sufficient time and space for the production of this special component, the
Component Division has to reduce the production of other components such as YR24, that are currently being
produced by the Division. The YR24 is sold for RM40 per unit and requires RM28.00 per unit of the variable
cost of production. The packaging and delivery cost of YR24 is RM3 per unit. The packaging and delivery of
the special component are only RM1.50 per unit. The Component Division currently produces and sells
15,000 units of YR24 per year. The production and sales of YR24 will reduce by 20% if the Machine Division
introduces this new special component.
 PAS2253 Management Accounting II
Tutorial – Transfer Pricing

Required:

a. What is the range of transfer price that will increase the profits of both divisions as a result of the
agreement to transfer 4,000 units of special components from the Component Division to the Machine
Division?
b. Will this transfer price increase the interest of the company as a whole? Explain.

12. Tropical Food Industries operates in the food industry and has several divisions. The company gives authority
to the division manager whether to execute internal transfer or not. Currently, the Cocoa Division sells
100,000 kg of cocoa powder to the Cake Division. Cocoa powder is used as one of the ingredients in the
product of the Cake Division. The selling price of the cocoa powder per kilogram for the internal and external
market is a 40% markup with a full production cost basis. The following is the cost information for the Cocoa
Division:
Cost per kg
Direct material 0.50
Direct labour 0.30
Variable manufacturing overhead 0.40
Fixed manufacturing overhead 0.80

Fixed manufacturing overhead is determined at a full production capacity: RM800,000/1,000,0000 kg.

Recently, the Cake Division received an offer from Heavenly Yummy to supply cocoa powder at a price of
RM2.50. The Cake Division is interested in this offer.

Required:

a. Calculate the transfer price per kilogram for the cocoa powder that is transferred from the Cocoa Division
to the Cake Division.
b. Calculate the maximum and minimum transfer prices.
c. Assuming the Cocoa Division is operating at full capacity and sells all of its products to the external
market. The Cake Division’s manager has asked the manager of the Cocoa Division to reduce its selling
price. Will the manager of the Cocoa Division agree with the request of the Cake Division? Support your
answer with a calculation. Show the profit impact on each division and the company as a whole.
d. Assuming that the Cocoa Division sells as much as 95% of the full production level including internal
transfer sales. The Cocoa Division manager does not agree with the Cake Division manager’s request.
Calculate the impact on profit for each division and the company as a whole as a result of his refusal. Is
his action conflicting with the goal congruence of the company?

13. Elektronik Bagus produces various types of printers, scanners and facsimile machines in two divisions namely
the PFF Division and Component Division. The Component Division produces electronic components that can
be used in the products of the PFF Division. All division products can be sold to external customers. However,
from the beginning, almost 90% of the output has been used internally. Current policy states that the transfer
price must be at full cost. Recently, Kamal, the executive officer of Elektronik Bagus plans to investigate the
internal transfer policy. He is worried that the current methodology of setting transfer prices may cause the
decisions of division managers to lead to a sub-optimum situation. Part of his investigation is the information
about component Y34 used by the buying division in the production of its scanning machine, Model SC67.
The PFF Division sells 40,000 units of Model SC67 per year for RM42. Based on the current market
conditions, it is the maximum price the division can charge to Model SC67. The production costs of the
scanning machine Model SC67 is as follows:
 PAS2253 Management Accounting II
Tutorial – Transfer Pricing

RM
Component Y34 6.50
Direct materials 12.50
Direct labour 3.00
Variable overhead 1.00
Fixed overhead 15.00

The scanner production is efficient and no further reduction of cost can be implemented. The manager of the
Component Division indicated that he can sell 40,000 units (which is the division capacity for this component)
of component Y34 to buyers in the external market for the price of RM12 per unit. The PFF Division can also
buy this component for RM12 per unit from the external market. The Component Division Manager has
provided the following information:

RM
Direct materials 2.50
Direct labour 0.50
Variable overhead 1.00
Fixed overhead 2.50
Required:

a. Assuming Kamal can abolish the current transfer pricing policy and provide autonomy to the division in
setting transfer prices. Can you estimate the price that will be set by the manager of the Component
Division? What are the minimum and maximum transfer prices?
b. Estimate the impact on the production decision of Model SC67 if the new policy is executed. How many
components of Y34 will be bought by the manager of the PFF Division either internally or from the
external market?
c. Using the new transfer price set by the Component Division and your answer in requirement b, how
many units of component Y34 can be sold in the external market?
d. Based on your answer in requirements b and c, calculate the impact on profit to the company as a whole.
What has happened? Has Kamal’s decision to give additional autonomy to the division manager
something good or bad? Why?