Question 1

The transfer pricing system operated by a divisional company has the potential to
make a significant contribution towards the achievement of corporate financial
objectives.

Required
(a) What is transfer pricing and where is it applicable?
(b) Discuss the three problems with transfer pricing
(c) Explain the potential benefits of operating a transfer pricing system within a
divisionalised company

Question 2
ALTO and TENOR are divisions of symphony Ltd. ALTO division produces and
supplies a memory chip (the Alto chip) to TENOR division. The variable cost to
ALTO division of producing a memory chip is T.shs 12,500.
a) If the memory chip can be sold to customers outside Symphony Ltd at a unit
price of T.shs 30,000 ,a and TENOR division can obtain alternative memory chips
from other suppliers at T.shs 30,000 a chip , what transfer price would you
recommend?
b) TENOR division‘s requests for memory chips amount to 2,000 per month. ALTO
division is capable of producing 2,500 chips per month and selling all in the
external market at a unit price of T.shs 30,000. If ALTO were to limit its sales in
the external market to 500 chips per month, it would be able to fetch a price of
T.shs 38,000 per chip. Recommend a suitable transfer price.
c) Suppose the Alto chip has been specifically designed to meet the requirements of
TENOR division and therefore has no external market, what would the suitable
transfer price be?

Question 3
Chamwino Company Ltd has two divisions, A and B. The two divisions are considered
to be investment centres and are evaluated on the basis of Return on Investment (ROI).
In determining the value of invested capital, the company uses the net book value of
total assets employed. Current assets usually average 10% of annual sales. The non-
current assets for Division A currently have a net book value of Shs 200,000 and the
non-current assets for Division B have a net book value of Shs 1,000,000. The combined
total is Shs 1,200,000.

Division A produces and sales Timex watches and has been operating considerably
below capacity. The selling price per watch is Shs 340. The standard cost breakdown for
one watch at the current annual normal activity of 60,000 watches is as follows:
Direct material Shs 120.00
Direct labour (@ Shs 90/ hr) 90.00
Variable overhead (@ Shs 30/ hr) 30.00
Fixed overhead 50.00
Fixed selling and general overhead 35.00
Shs 325.00
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One major material component for the watch is purchased from another company at
Shs 75.00 each. The component can be replaced by an assembly (Assembly KQ 162)
which is produced by Division B. In order to use this assembly, Division A would have
to spend an additional five minutes of production time per watch for modifications.

Division B produces an electronic regulator in which KQ 162 is used. Standard cost for
production and sale of assemblies and regulator are based on Division B's current
annual activity of 180,000 regulators. Maximum annual capacity is 144,000 production
hours or 192,000 regulators.

Unit standard cost for Division B is as follows:

Assembly KQ 162 Electronic Regulator
Shs Shs
Direct material 15.00 40.00
Direct labour 22.50 67.50
Variable overhead 7.50 22.50
Fixed overhead 15.00 45.00
Fixed selling and general
overhead - 15.00
60.0 190.00

Production time in minutes 15 45*

* Includes the cost and production time of one assembly

The selling price of the regulator is Shs 210. The Manager of Division B is interested in
supplying Assembly KQ 162 to Division A and is willing, given a suitable transfer price,
to switch some production time from regulators to assemblies.
Required:
(i) Calculate the effect of the following on Chamwino Company Limited' s overall
annual net income:
(a) Division B uses only its excess capacity to produce assemblies for Division
A.
(b) Division B supplies all the assemblies required by Division A.

(ii) (a) Calculate the minimum unit price acceptable to Division B for assemblies
produced using only its excess capacity, assuming that the division wishes
to earn 25% contribution margin ratio on transferred assemblies.
 (b) Calculate the minimum unit transfer price acceptable to Division B if
supplies all assemblies required by Division A, assuming Division B
wishes to maintain its current level of net income.
(c) Calculate the maximum unit transfer price acceptable to Division A.

Question 4
The Tupendane Bottles Company manufactures a soft drink. The company is organized
into two departments, Glass and Filling. The Glass Department makes bottles and sells
them to the Filling department. Each department manager receives a bonus based on
the department's net income.

In the market, bottle producers are charging the following prices for their bottles:
Number of cases per Month Total Charge Average Price per
Case
Shs Shs
1,000 268,300 263.30
11,000 1,353,000 123.00
12,000 1,440,000 120.00
13,000 1,527,500 117.50
14,000 1,589,000 113.50
15,000 1,650,000 110.00

The costs per case in the Glass Department are as follows:

Volume per Month Glass Department cost per Case
11,000 Shs 107.10
12,000 105.20
13,000 103.50
14,000 101.80
The Filling Department's costs (excluding bottle purchases) and selling prices are:
Volume per month Selling Price Cost per case
Shs Shs
11,000 380.00 243.20
12,000 375.50 240.90
13,000 372.00 239.10
14,000 368.00 237.60
15,000 362.00 235.70

The current capacities of the departments are 15,000 cases per month for Filling
Department and 14,000 cases per month for the Glass Department.
Required:
a) If market prices are used as transfer prices, what is the most profitable volume
for each department and for the company as a whole? Show calculations to
support your answer. Assume that transfers and sales are made in units of one
 thousand and that the Glass Department is unable to sell its production in the
outside market.
b) Under what conditions should market prices not be used in determining transfer
prices?