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- 20 Marks
Question
Lamiokor and Zenator are two divisions of Tsorkor group. Lamiokor division manufactures an intermediate product known as component A which has no external market. Zenator division incorporates this intermediate product, component A, into a final product that it sells to external customers. One unit of component A is used in the production of one unit of the final product. Lamiokor has quoted a transfer price of GH¢45 for each unit of component A.
The details of monthly production costs for each division are as follows:
Lamiokor Division:
- Variable cost: GH¢15 per Component A
- Product Specific Fixed Cost: GH¢50,000 (Incurred only by Lamiokor division and specifically for the production of Component A)
Zenator Division:
- Variable cost: GH¢9 per unit
- Product Specific Fixed Cost: GH¢75,000 (Cost incurred only by Zenator when converting component A to the final product)
The relationship between monthly external customer demand and selling price of the final product is as follows:
| Month | Demand (Units) | Selling price per Unit (GH¢) |
|---|---|---|
| 1 | 1,000 | 120 |
| 2 | 3,000 | 100 |
| 3 | 4,000 | 90 |
| 4 | 5,000 | 80 |
| 5 | 6,000 | 67 |
Required:
a) Explain FOUR (4) objectives of transfer pricing.
(4 marks)
b) Based on a transfer price of GH¢45 per component A, prepare the monthly profit statement for:
i) Lamiokor Division (6 marks)
ii) Zenator Division (6 marks)
iii) Tsorkor Group (4 marks)
Answer
a) The main objectives of a transfer pricing system:
- To achieve goal congruence. The transfer prices should be such that actions that will increase a division’s reported profit will also have the effect of increasing the company’s reported profit. This maximizes the likelihood that the division managers will act in the company’s best interests.
- To ensure that divisional autonomy is maintained. In principle, a company’s top management could simply issue precise instructions to divisions as to what goods to transfer to each other, in what quantities, and at what prices. However, most organizations prefer allowing divisional autonomy to harness the benefits it offers.
- To ensure that the information provided (e.g., division Profit & Loss Accounts) is useful for evaluating the economic performance of divisions and the managerial performance of division managers.
- Minimizing global tax liability. Companies can use transfer pricing to transfer profits and costs to other divisions internally to reduce their tax burden.
b)
i) Lamiokor Division:
| Month | Demand (Units) | Transfer Price (GH¢) | Variable Cost (GH¢) | Contribution/Unit (GH¢) | Total Contribution (GH¢) | Fixed Cost (GH¢) | Profit/Loss (GH¢) |
|---|---|---|---|---|---|---|---|
| 1 | 1,000 | 45 | 15 | 30 | 30,000 | 50,000 | (20,000) |
| 2 | 3,000 | 45 | 15 | 30 | 90,000 | 50,000 | 40,000 |
| 3 | 4,000 | 45 | 15 | 30 | 120,000 | 50,000 | 70,000 |
| 4 | 5,000 | 45 | 15 | 30 | 150,000 | 50,000 | 100,000 |
| 5 | 6,000 | 45 | 15 | 30 | 180,000 | 50,000 | 130,000 |
ii) Zenator Division:
| Month | Demand (Units) | Selling Price (GH¢) | Variable Cost (GH¢) | Transfer Price (GH¢) | Contribution/Unit (GH¢) | Total Contribution (GH¢) | Fixed Cost (GH¢) | Profit/Loss (GH¢) |
|---|---|---|---|---|---|---|---|---|
| 1 | 1,000 | 120 | 9 | 45 | 66 | 66,000 | 75,000 | (9,000) |
| 2 | 3,000 | 100 | 9 | 45 | 46 | 138,000 | 75,000 | 63,000 |
| 3 | 4,000 | 90 | 9 | 45 | 36 | 144,000 | 75,000 | 69,000 |
| 4 | 5,000 | 80 | 9 | 45 | 26 | 130,000 | 75,000 | 55,000 |
| 5 | 6,000 | 67 | 9 | 45 | 13 | 78,000 | 75,000 | 3,000 |
iii) Tsorkor Group:
| Month | Demand (Units) | Selling Price (GH¢) | Variable Cost (GH¢) | Contribution/Unit (GH¢) | Total Contribution (GH¢) | Fixed Cost (GH¢) | Profit/Loss (GH¢) |
|---|---|---|---|---|---|---|---|
| 1 | 1,000 | 120 | 24 | 96 | 96,000 | 125,000 | (29,000) |
| 2 | 3,000 | 100 | 24 | 76 | 228,000 | 125,000 | 103,000 |
| 3 | 4,000 | 90 | 24 | 66 | 264,000 | 125,000 | 139,000 |
| 4 | 5,000 | 80 | 24 | 56 | 280,000 | 125,000 | 155,000 |
| 5 | 6,000 | 67 | 24 | 43 | 258,000 | 125,000 | 133,000 |
Alternatively:
Adding the profits from both divisions:
| Month | Lamiokor Profit/Loss (GH¢) | Zenator Profit/Loss (GH¢) | Group Profit/Loss (GH¢) |
|---|---|---|---|
| 1 | (20,000) | (9,000) | (29,000) |
| 2 | 40,000 | 63,000 | 103,000 |
| 3 | 70,000 | 69,000 | 139,000 |
| 4 | 100,000 | 55,000 | 155,000 |
| 5 | 130,000 | 3,000 | 133,000 |
- Topic: Transfer Pricing
- Series: NOV 2021
- Uploader: Dotse