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Transfer Pricing Strategies Explained

The document discusses various scenarios of transfer pricing, including market-based, capacity-constrained, and negotiated transfer pricing. It provides calculations for minimum transfer prices, profitability for divisions, and the impact of transfer prices on overall company profit. Key findings indicate that internal transfers can be beneficial and that transfer pricing strategies can significantly affect divisional profitability.

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anmol.talyan24
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7 views3 pages

Transfer Pricing Strategies Explained

The document discusses various scenarios of transfer pricing, including market-based, capacity-constrained, and negotiated transfer pricing. It provides calculations for minimum transfer prices, profitability for divisions, and the impact of transfer prices on overall company profit. Key findings indicate that internal transfers can be beneficial and that transfer pricing strategies can significantly affect divisional profitability.

Uploaded by

anmol.talyan24
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd

Q1.

Market-Based Transfer Price

Component Division sells a part externally at ₹1,200 per unit.


Variable cost per unit = ₹700
Fixed cost per unit (at normal volume) = ₹200
Systems Division wants to buy 3,000 units. Capacity available with Components division=
10% idle.

a. Should the transfer take place at market price?


b. Minimum transfer price?
c. Is internal transfer beneficial?

Solution:

a. Market price = ₹1,200

b. Minimum transfer price = Variable cost + Opportunity cost

Idle capacity = 10% → assume normal volume = 30,000 units


Idle = 3,000 units → no lost contribution.

Opportunity cost = 0

Minimum transfer price = 700 + 0 = ₹700

c. Is transfer beneficial?
Buying internally at ₹700 saves Systems division ₹500 per unit.

YES → internal transfer is beneficial.

Q2. Transfer Pricing With Capacity Constraint

The Parts Division can sell 20,000 units outside at ₹900 each.
Variable cost = ₹500
Industry Capacity (Industry demand) = 100,000 units
Internal demand = 10,000 units.

Production capacity of the Company: 50,000

Find the minimum transfer price.

Solution:

Demand outside = 20,000


Internal demand = 10,000

Minimum transfer price = Outside market price


Since there will be sufficient industry demand upto 100,000 the Company should charge
Market price as Transfer Price

Q3. Negotiated Transfer Pricing

Selling Division’s costs:


Variable per unit = ₹600
Fixed cost per unit = ₹200
External price = ₹950
Buying Division can import similar component for ₹850.

What range can negotiations occur in?

Solution:

Assume there is excess capacity in the market so the selling division is under pressure and
would reduce the price upto its variable cost since there is a fixed cost. The buying division
can negotiate the price within the following range:

Minimum: 600

Maximum price (buyer) = ₹850

Negotiation range = ₹600 to ₹850

Q4. Effect of Transfer Price on Divisional Profitability

X Division produces 50,000 units.


Variable cost = ₹300

Fixed cost: 1,00,000 at 100% capacity


Transfer price = ₹450
Y Division converts these into final goods at variable cost ₹200 and sells at ₹800. Fixed cost:
2,00,000 at 100% capacity

Find the profit of:

a. X Division
b. Y Division
c. Company overall

Solution:

There is surplus demand at industry level FOR X div.


a. X Division profit
Contribution = 50,000 × (450 – 300) -100000 = 50,000 × 150 -100000 = ₹75,00,000-
100000=7400000

b. Y Division profit
Revenue = 50,000 × 800 = 4,00,00,000
Cost = 50,000 × (450 + 200) +200000= 50,000 × 650+200000 = 3,25,00,000+200000

=73,00,000

c. Company profit
VC = 300 + 200 = 500 per unit
Profit = (800 – 500) × 50,000
= 300 × 50,000
= ₹1,50,00,000

Internal transfer price affects divisional profit but not total company profit.

Q5. Cost-Based Transfer Price – Full Cost Plus Markup

Manufacturing Division:
Variable cost = ₹400
Fixed overhead per unit = ₹150
Markup = 20% on full cost or 16.67% of full cost

Transfer price = ?

Solution:

Full cost = 400 + 150 = 550


Markup = 20% of 550 = 110
Transfer price = 550 + 110 = ₹660

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