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CMA Intermediate · Management Accounting · Transfer Pricing

Division M (variable cost Rs 50 per unit) supplies Division N, which converts the part into a product selling for Rs 200 with further variable cost of Rs 70 per unit. M has spare capacity. An outside supplier offers N the part at Rs 85. Group profit is to be maximised, and N's demand is 4,000 units. Which statement is correct?

Internal transfer adds Rs 1,40,000 to group profit. Because M has spare capacity, the group's relevant cost is Rs 50 against Rs 85 outside, saving Rs 35 per unit on 4,000 units. Other revenues and costs are identical under both options.

  1. AInternal transfer adds Rs 1,40,000 to group profit versus buying outsideCorrect
  2. BInternal transfer adds Rs 2,00,000 to group profit versus buying outside
  3. CInternal transfer lowers group profit by Rs 1,40,000
  4. DGroup profit is the same either way

Explanation

For the group, internal sourcing costs M's variable cost Rs 50, while external costs Rs 85. Saving = 35 per unit x 4,000 = Rs 1,40,000. The selling price and N's conversion cost are common to both options. Rs 2,00,000 wrongly uses a Rs 50 saving.

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