- 20 Marks
MA – L2 – Q65 – Transfer Pricing
Prepare profit statements for Kumasi Construction Materials Ltd at 80% and 100% capacity with transfer prices of GH₵200 and GH₵180.
Question
Kumasi Construction Materials Ltd is organised into two trading divisions. Division A makes materials that are used to manufacture special bricks. It transfers some of these materials to Division B and sells some of the materials externally to other brick manufacturers. Division B makes special bricks from the materials and sells them to traders in building materials.
The production capacity of Division A is 2,000 tonnes per month. At present, sales are limited to 1,000 tonnes to external customers and 600 tonnes to Division B.
The transfer price was agreed at GH₵200 per tonne in line with the external sales trade price at 1st July which was the beginning of the budget year. From 1st December, however, strong competition in the market has reduced the market price for the materials to GH₵180 per tonne.
The manager of Division B is now saying that the transfer price for the materials from Division A should be the same as for external customers. The manager of Division A rejects this argument on the basis that the original budget established the transfer price for the entire financial year.
From each tonne of materials, Division B produces 1,000 bricks, which it sells at GH₵0.40 per brick. It would sell a further 400,000 bricks if the price were reduced to GH₵0.32 per brick.
Other data relevant are given below:
| Division A | Division B |
|---|---|
| GH₵ | GH₵ |
| Variable cost per tonne | 70 |
| Fixed cost per month | 100,000 |
The variable costs of Division B exclude the transfer price of materials from Division A.
Required:
(a) Prepare estimated profit statements for the month of December for each division and for Kumasi Construction Materials Ltd as a whole, based on transfer prices of GH₵200 per tonne and of GH₵180 per tonne, when producing at
(i) 80% capacity
(ii) 100% capacity, on the assumption that Division B reduces the selling price to GH₵0.32.
(b) Comment on the effect that might result from a change in the transfer price from GH₵200 to GH₵180.
(c) Suggest an alternative transfer price that would provide an incentive for Division B to reduce the selling price and increase sales by 400,000 bricks a month.
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