Question 6

Part 1 - Alpha division has an external market for product A which fully utilises its production capacity.

Required:

1. Explain the principle which would suggest that Alpha division should transfer product A to Beta division of the same group of companies at the existing market price.

[5 marks]

2. Explain circumstances in which Alpha division may offer to transfer product A to Beta division at less than the external market price and yet report the same total profit.

[5 marks]

Part 2 - The transfer pricing method to be used for an intermediate product between two divisions in a group is under debate. The supplying division wishes to use actual cost plus a 25% profit mark-up. The receiving division suggests the use of standard cost plus a 25% profit mark-up. A suggested compromise is to use revised standard cost plus 25% profit mark-up. The revised standard cost is arrived at after taking into account the appropriate elements of a planning and operational variance analysis at the supplying division.

Required:

3. Discuss the impact of each of the above transfer pricing methods and their acceptability to the supplying and receiving divisions.

[10 marks]

Part 3 - An intermediate product is manufactured in limited quantities at three divisions of a group and is available in limited quantities from an external source. The intermediate product is required by four divisions in the group as an input for products to be sold externally. The total quantity of intermediate product which is available is insufficient to satisfy demand at the four user divisions.

Required:

4. Explain the procedure which should lead to a transfer pricing and deployment policy which will result in group profit maximisation.

[5 marks]

Total: 25 marks