1. Division of Aparna Company manufacturers product A, which is sold to another division as a component of its product; which is then sold to the third division C , which is ultimately sold by division C to outside market. Intra company transfer rule- standard cost plus a 10% return on fixed assets and inventory to be paid by the buying division.

Std. cost per unit Product A Product B Product CPurchase of outside material 40 60 20Direct labour 20 20 40Variable overhead 20 20 40Fixed overhead per unit 60 60 20Average inventory 14 lacs 3 lacs 6 lacsNet fixed assets 6 lacs 9 lacs 3.2 lacsStandard production 2 lacs units 2 lacs units 2 lacs units

a) Determine from the above data, transfer prices for Product A, B and standard cost for Product C?b) Product C could become uncompetitive since upstream margins are added. Comment.

Answer:

Transfer price of Product A:

Standard production = 2 lacs units

Outside material purchase cost = 40 X 2, 00,000 = Rs. 80, 00,000/-

Direct labour cost = 20 X 2, 00,000 = Rs. 40, 00,000/-

Variable overhead cost = 20 X 2, 00,000 = Rs.40, 00,000

Total Rs. 1, 60, 00,000

10% return on fixed assets and inventory= 0.1 X (14 + 6) = Rs.2, 00,000

Total transfer price Rs. 1, 62, 00,000

Transfer price per product = 1, 62, 00,000 / 2, 00,000 = Rs 81

Transfer price of Product B:

Standard production = 2 lacs units

Outside material purchase cost = 60 X 2, 00,000 = Rs. 1,20, 00,000/-

Direct labour cost = 20 X 2, 00,000 = Rs. 40, 00,000/-

Variable overhead cost = 20 X 2, 00,000 = Rs.40, 00,000

Total Rs. 2, 00, 00,000

10% return on fixed assets and inventory= 0.1 X (3 + 9) = Rs. 1, 20,000

Total transfer price Rs. 2, 01, 20,000

Transfer price per product = 2, 01, 20,000 / 2, 00,000 = Rs 100.6

(Note: While computing transfer price fixed cost is not considered)

Standard cost of product C:

Standard production = 2 lacs units

Outside material purchase cost = 20 X 2, 00,000 = Rs. 40, 00,000/-

Direct labour cost = 40 X 2, 00,000 = Rs. 80, 00,000/-

Variable overhead cost = 40 X 2, 00,000 = Rs.80, 00,000

Fixed overhead cost= 20 X 2, 00,000 units = Rs 20, 00,000

Total Rs. 2, 20, 00,000

Cost per unit = 2, 20, 00,000 / 2, 00,000 =Rs 110/-

b) While calculating the cost of product C, margins of product A, which is an input to Product B, which in turn becomes an input to Product C are added. Finally when the product is sold in the market, it may be priced more than the competitor’s product.

Another possibility is to reduce the margins added by Products A and B, and lower pricing the Product C