a. Zonal Tango (ZT) Plc

Transfer price per unit for Alba Division: ₦

Residual Income 700,000

Notional interest (12% x 4,000,000) 480,000

Net profit 1,180,000

Divisional fixed cost 160,000

Contribution 1,340,000

Variable cost (900,000 x 4.90) 4,410,000

Total revenue 5,750,000

Less: External revenue (700,000 x 6.80) (4,760,000)

Internal revenue (a) 990,000

Excess/idle capacity (900,000 – 700,000) (b) 200,000unit

Transfer price (a/b)/unit ₦4.95

Therefore the transfer price that Alba division should quote is ₦4.95/unit as computed above.

b. Selling price of Beta Division: ₦

Residual income 500,000

Notional interest (10% x 3,000,000) 300,000

Net profit 800,000

Divisional fixed cost 140,000

Contribution 940,000

Plus Variable cost further of processing cost (200,000 x ₦4.50) 900,000

Plus Transfer price (200,000 x ₦4.95) – input cost 990,000

Total revenue (c) 2830,000

Quantity to sell (D) 200,000unit

External selling price (c/d) ₦14.15

c. Assumptions

i. Beta Division gets all inputs internally from Aba.

ii. The applicable variable costs for both Alba and Beta are the same.

iii. There is no transfer from Beta to Alba.

The transfer price to Beta Division will be sub-optimal for the company as a whole because ₦6.80 is sold to other customers and ₦4. 95 is the price charged to the division as required to provide ₦1.85 per unit. The sub-optimal decision making also can be due to the buying division recognising the fixed cost of ₦160,000 and mark-up (Profit –residual income and imputed capital cost) as selling division variable cost of ₦4.95 when it should have been ₦4.90 regarding the transfer price.

d. Circumstances in which a negotiated transfer price should be used instead of market based price

Negotiated transfer prices are prices agreed between managers of profit centres. Negotiated transfer prices are used in situations where profit centre managers are given autonomy to agree transfer prices. This is usually in circumstances where an external intermediate market price does not exist.

An advantage of this is that if the negotiations are fair and honest, the managers should be willing to trade with each other on the basis of the transfer prices agreed.

A negotiated transfer price can be used instead of a market-based price in the following specific circumstances:

i. Absence of a market price: When there is no external market for the product or service being transferred, or the market is not well-established, finding a comparable market price can be difficult or impossible. In such cases, negotiation between the divisions becomes necessary;

ii. Custom or unique products: When the product or service being transferred is customised or unique to the company’s operations, there may not be a comparable product available in the market. This uniqueness necessitates a negotiated price that reflects the specific characteristics and costs associated with the item;

iii. Internal performance measurement: When a company uses transfer prices for internal performance evaluation and management purposes. A negotiated price can be tailored to better reflect the performance of the divisions involved, aligning with the company’s internal performance metrics and incentive structures;

iv. Temporary market conditions: When external market prices are volatile or influenced by temporary conditions that do not reflect the long-term value of the product or service. A negotiated transfer price can provide stability and predictability in such cases;

v. Capacity utilisation: When the supplying division has excess capacity, it may be willing to negotiate a lower transfer price to utilize its resources more effectively. Conversely, if the supplying division is at full capacity, it might negotiate a higher price to reflect opportunity costs; and

vi. Regulatory and tax considerations: When there are tax implications, especially in multinational corporations. Transfer pricing can affect the allocation of income and expenses between different tax jurisdictions. Negotiating transfer prices may help in compliance with international transfer pricing regulations and in minimizing tax liabilities.