Question

Q73

a) Discuss the three key objectives of transfer pricing

b) Winneba Fitness has two divisions (A and B). The company is makes fitness equipment. Division A produces the frame and Division B assembles components onto the frame. There is a market for both the sub-assembly and the final product. Each division has been designed as a profit centre. The transfer price for the sub-assembly has been set at the long-run average market price. the following data are available for each division:

GHS

Estimated selling price for final peoduct 30,000

Long-run average selling price for intermediate product 20,000

Incremental costs for completion in division B 15,000

Incremental costs in Division A 12,000

The manager of Division B has made the following calculation:

GHS GHS

Selling price for final product 30,000

Transferred - in cost (market) 20,000

Incremental cost for completion 15,000 35,000

Contribution (5,000)

Required:

i) Transfers should be made to Division B, assuming there is no excess capacity in Division A. Is the market price the correct transfer price?

ii) Division A's maximum capacity for this product is 1,000 units per month and sales to the intermediate market are now 800 units and assuming that for various reasons reasons, A will maintain the GHS20,000 selling price indefinitely; ( that is, A is not considering lowering the price to outsiders even if idle capacity exists): should 200 units be transferred to Division B and at what transfer price?

Answer 1

Requirement 73A:

Three key objectives of Transfer Pricing:

• Maximizing overall after-tax profits.
• Reducing incident of customs duty payments
• Reducing exchange exposure, circumventing exchange controls and restricting profit repatriation so that transfer firms affiliates to the parent can be maximized.

Requirement 73B:

(i) If there is no Excess Capacity in Division A, then the Transfer price should be Market Price.

(ii) As there is Excess Capacity in Division A, then the Transfer Price will be the manufacturing costs incurred to produce the product. Then, the Transfer Price be Incremental Cost in Division A = $ 12,000 for that Excess 200 units.