Based On Session 5 – Responsibility Accounting & Transfer Pricing

Self Study Questions – Prepare for sessions week commencing 19th Feb

As always you will receive marks for answering 5 multiple choice questions on this topic. The best way to prepare is to do
the questions and read the relevant text as the questions will often be directly based on the self study work.

Question 1 (c/o open tuition.com ACCA resources)

Part i. Division A has costs of $20 per unit (p..u.) and transfer goods to Division B which has
additional costs of $8 p.u.
Division B sells externally at $30 p.u.
The company has a policy of setting transfer prices at cost + 20%.
The managers of the 2 divisions receive a bonus which is based on exceeding a target ROI
Required:
(a) Calculate the transfer price
(b) Calculate the profit made by the company overall
(c) Calculate the profit reported by each division separately
(d) Determine the decisions that will be made by the managers and comment on whether or
not goal congruent decisions will be made.
(e) Determine a sensible range for the transfer price in order to achieve goal congruence.

Part ii. Division A make a product which has standard costs of $15 p.u & last year the actual costs
per unit were $16.21. Division B would like to purchase the product, Division B have additional costs
of $10 p.u. Division B sells externally at $35 p.u. Division A can sell part-finished units externally for
$20 p.u..

Required:
a) Assuming that Div A has limited demand externally, and A has unlimited production capacity,
determine a sensible range for the transfer price in order to achieve goal congruence.
b) Assuming there is no spare production capacity determine a sensible range for the transfer
price in order to achieve goal congruence.

Question 2 (Adapted from ACCA P5)

You are the management accountant of the SSA Group which manufactures an innovative range
of products to provide support for injuries to various joints in the body. The group has
adopted a divisional structure. Each division is encouraged to maximise its reported profit.

Division A, which is based in a country called Nearland, manufactures joint-support appliances

which incorporate a'one size fits all people' feature. A different appliance is manufactured for
each of knee, ankle, elbow and wrist joints.

Budget information in respect of Division A for the year ended 31 December

2010 is as follows:

Knee Ankle Elbow Wrist

Support appliance Sales units (OOO's) 20 50 20 60
Selling price per unit ($) 24 15 18 9
Total variable cost of sales ($'000) 200 350 160 240

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 Each of the four support products uses the same quantity of manufacturing capacity. This
gives Division A management the flexibility to alter the product mix as desired. During the
year to 31 December 2010 it is estimated that a maximum of 160,000 support products
could be manufactured.

The following information relates to Division B which is also part of the SSA group
and is based in Distantland:

1. Division B purchases products from various sources, including from other divisions in
SSA group, for subsequent resale to customers.

2. The management of Division B has requested two alternative quotations from

Division A in respect of the year ended 31 December 2010 as follows:
Quotation 1- Purchase of 10,000 ankle supports.
Quotation 2- Purchase of 18,000 ankle supports.

The management of the SSA Group has decided that a minimum of 50,000 ankle
supports must be reserved for customers in Nearland in order to ensure that customer
demand can be satisfied and the product's competitive position is maintained in the
Nearland market.

The management of the SSA Group is willing, if necessary, to reduce the budgeted sales
quantities of other types of joint support in order to satisfy the requirements of Division B
for ankle supports. They wish, however, to minimise the loss of contribution to the Group.

The management of Division B is aware of another joint support product, w hich is

produced in Distantland, that competes with the Division A version of the ankle support
and which could be purchased at a local currency price that is equivalent to $9 per
support. SSA Group policy is that all divisions are allowed autonomy to set transfer prices
and purchase from whatever sources they choose. The management of Division A intends to
use market price less 30% as the basis for each of quotations 1 and 2.

Required:
a) The management of the SSA Group have asked you to advise them regarding the appropriateness of
the decision by the management of Division A to use an adjusted market price as the basis for the
preparation of each quotation and the implications of the likely sourcing decision by the management
of Division B.
Your answer should cite relevant quantitative data and incorporate your recommendation of the prices
that should be quoted by Division A for the ankle supports in respect of quotations 1 and 2, that will
ensure that the profitability of SSA Group as a whole is not adversely affected by the decision of the
management of Division B.

b) Advise the management of Divisions A and B regarding the basis of transfer pricing which should be
employed in order to ensure that the profit of the SSA Group is maximised.

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 xample
Transfer Pricing: self study suggested answers

Question 1
Part i. Division A has costs of $20 p.u., and transfer goods to Division B which has additional costs of
$8 p.u.
Division B sells externally at $30 p.u.
The company has a policy of setting transfer prices at cost + 20%.
Calculate:
(a) the transfer price
(b) the profit made by the company overall
(c) the profit reported by each division separately
Determine the decisions that will be made by the managers and comment on whether or not goal
congruent decisions will be made.
(a) Transfer price = 20 × 1.2 = $24 p.u.
(b) Selling price 30
Costs: A 20
B8 28
Profit $2

(c) A B
Transfer price 24 Selling price 30
Cost 20 Transfer in price 24
Profit $4 Costs 8 32
Loss $(2)

(d) Division B will be demotivated as they will have less of chance to receive a bonus (ROI would be
diluted). This means that they would properly not care very much about the quality of this
product & if they felt their bonus was unachievable other products (think expectancy theory).
Another issue is fairness, it is unlikely that this is close to a market price (who would sell at a loss).
This means that performance couldn’t be measured fairly and as we will see humans don’t like
inequity. Net result = lack of goal congruence

(e) min = £20 (marginal cost) max = £30- £8 (marginal revenue). So £21 but this could be adjusted to
reflect capital employed in production

Part ii. Division A has costs of $20 p.u., and transfer goods to Division B which has additional costs of
$8 p.u..
Division B sells externally at $30 p.u.
(a)
Sensible range between $15 and $25 p.u.

(b) Sensible T.P. between $20 (standard cost + opportunity cost) and $25 p.u. (marginal revenue)

Message use standard cost not actuals to motivate managers to improve

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 Question 5 ACCCA answer

Alternative answer to question 5a: Transfer pricing

Rule 1: Ask – is there a competitive market for the ankle support? Yes, there is so Division A would
set their transfer price as the market price less any costs not incurred because the product is
transferred internally rather than sold externally.

Transfer price set by Div A = $15 less [30% x $15] = $10.50

But Div B can buy the support externally for $9.00, so the internal transfer would not go ahead.

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 Rule 2: Ask - is there spare capacity? For Quote 1, yes there is spare capacity of 10,000.

Transfer price set by Div A = marginal cost = $350/50 = $7.00 per ankle support

As this is less than $9.00, the internal transfer would go ahead.

Rule 3: Ask – are there production constraints? For Quote 2, yes, there is insufficient spare capacity
and another 8,000 supports are needed.

Is there another item with a lower contribution? Yes, wrist supports at $5.00 each.

Transfer price set by Div A = marginal cost + opportunity cost = $7.00 + $5.00 = $12.00 each for 8,000
supports.

This is more than $9.00, so do not go ahead.

Test:
Minimum transfer price set by supplier > marginal cost +any lost contribution

If there is spare capacity, then this is $7.00. If there are constraints, this is $12.00.

Maximum transfer price accepted by purchaser < lower of net marginal revenue and external
purchase price

Net marginal revenue is $10.50 and external purchase price is $9.00

Therefore overall transfer price must be between $7.00 and $9.00.

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