Transfer Pricing Examples- Matz&u

1 Convert Coal in Coke.

80% of production used in furnance Coke Charge to furnace at $6 per ton 20% of coke is sold at $ 7.50 The total capacity is 80,000 tons. Variable cost per ton = $4.50 Fixed cost = $40,000 per year Expenses $60,000 per ton then the coke will sold at $6 per ton Marketing Expenses 0.50 perton . Increased in fixed decrease variable cost reduce by $ 1.50 per ton

2 Convert coke in Iron Outside purchase.then purchase price will be $5 per ton. Manager believe that it is not a profitable option

Requried no1: The transfer price become the cost of blast furnace and the company is interested to charge the cost at minium. The total capacity is 80,000 tons and company sold 80% of it which is (80,000 ton x 80%) = 64,000 tons and the variable cost is $ 4.50 which is less than $5 per unit Profit of Coke: Present Sale to Dept 2 Sale to Outsider

(64,000 x $6) (16,000 x$7.50) Total Sale Less:Cost (80,000 x $4.50) Less: Fixed cost Profit

Proposed:

Sale to Dept 2 Sale to Outsider

(64,000 x $5) (16,000 x$7.50) Total Sale

384,000 120,000 504,000 (360,000) (40,000) 104,000 320,000 120,000 440,000

Less:Cost (80,000 x $4.50) Less: Fixed cost Profit

(360,000) (40,000) 40,000

Required 2: Decision whether to invest money and sell entire coke to outside: Proposal: Sales (80,000 units x $6) Less: Cost of Sales: 1 Variable Cost (80,000 x $3) 2 Variable marketing exp (80,000 x 0.50) Total Variable cost 3 Fixed cost 4 Fixed Productive and Equip

40,000 60,000

Profit 5 Cost of purchasing by Furnace dept (64,000 tons x $5) Net Loss Present: Sales

(16,000 tons x $ 7.50) (64,000 tons x $6)

Less: Cost of Sales: 1 Variable Cost 2 Fixed cost

120,000 384,000

(80,000 x $4.50) Profit

3 Cost of Coke to Furnance dept (64,000 tons x $6)

$6 per ton

variable cost

will be $5 a profitable

oke to outside:

480,000 240,000 40,000 280,000

100,000

(380,000) 100,000 (320,000) (220,000)

504,000

360,000 40,000

(400,000) 104,000 (384,000) (280,000)

Required no. 1: For each of Product: Product

Capital Employed Turnover rate

Percentage of Profit to Sales

Sales Investment / Capital Employed

Net Income Sales

Rate of return on Capital employed

Capital employed ratio x % of prof

A

2,000,000 500,000

4 times

60,000 2,000,000

B

5,000,000 300,000

16.67 times

45,000 5,000,000

0.9 % = 16.67 times x 0.9% = 15%

C

3,000,000 600,000

5 times

175,000 3,000,000

5.83 % = 5 times x 5.83% = 29.15%

D

1,800,000 200,000

9 times

36,000 1,800,000

Required no. 2: Pay Back period for each product Product

Pay Back Period Investment Annual Cash Inflow

A

500,000 75,000

6.67 years

B

300,000 60,000

5.00 years

C

600,000 200,000

3.00 years

3 % 60,000 / 500,000 x 100 = 12% = 4 times x 3% = 12%

2.0 % = 9 times x 2% = 18%

D

200,000 60,000

3.33 years

Required no. 3: Discounted Cash flow (IRR) for Product D Cash inflow PV = Cash outflow 100,000 - 100,000 = 0 = IRR = DCF

26% 28%

3.465 3.269 0.196

26% Payback

Discounted Cash flow rate of return for Product D (0.132/0.196 x 2%) + 26% 27.35%

3.465 3.333 0.132

Rate of return on Capital employed

ployed ratio x % of profit to sales

0,000 x 100 = 12% 3% = 12%

es x 0.9% = 15%

5.83% = 29.15%

2% = 18%

Solution of Pb 27-1 Required no.1: Inventory turnover rate (19 A) Inventory turnover rate = Cost of Goods Sold Average Inventory

451,000 90,200 5

Required no. 2: Return Of Capital Employed (ROCE) ratio (after Income Tax) 19 A Return of Capital Employed ratio = Net Income Capital Employed

75,115 517,125 0.145 14.5%

W-1

Calculation of capital employed: Capital Employed = Equities = Total Asset = Current Assets + Non- current assets Current Assets Non- current assets CAPITAL EMPLOYED

167,125 350,000 517,125

Required no. 3: Rate of return (after income tax) on book value of total assets 19 B Rate of return (after income tax) = Net Income Book Value of total assets 57,125 521,450 0.11

W-1:

11% Calculation of net Income (after Income tax) for the year 19 B Sales (100,000 units x 8.40)

840,000

Less: Total variable cost Total Fixed cost

(100,000 units x 6)

600,000 125,750

Net income before Income tax Less: Income tax (50%) Net income after income tax W- 2:

Calculation of Book value of total assets (19 B): Value of current asset (840,000 x 22.25%)

350,000 (15,450)

Ratio of current asset to sale (19 A) 167,125 751,150

114,250 (57,125) 57,125

186,900

Value of non current asset Balance of non currnet asset (at start) of 19 B Less: Current year depreciation (19 B) BOOK VALUE OF TOTAL ASSETS (19 B)

Current asset Sales

(725,750)

0.2225

Note: Same ratio will be applied to 19 B

22.25 %

334,550 521,450

times

urrent assets

CA

FA TA

Required no. 1: Profit for 6,000,000 Cases a) Bottle Division

W-1

b) Cologne Division

c) The Company

Sales Revenue

10,000,000

63,900,000

63,900,000

Less: Cost of Sales PROFIT

(7,200,000) 2,800,000

(58,400,000) 5,500,000

(55,600,000) 8,300,000

Calculation of Cost: Cologne Division

48,400,000 + 10,000,000

58,400,000

The Company

48,400,000 + 7,200,000

55,600,000

Required no. 2: a) Bottle Division: Cases

2,000,000

Volume 4,000,000

Revenue

4,000,000

7,000,000

10,000,000

(3,200,000) 800,000

(5,200,000) 1,800,000

(7,200,000) 2,800,000

2,000,000

Volume 4,000,000

6,000,000

Less: Cost of Sales PROFIT b) Cologn Division: Cases

6,000,000

Revenue Less: Cost of Sales PROFIT c) The Company Cases Revenue Less: Cost of Sales PROFIT

25,000,000

45,600,000

63,900,000

(20,400,000) 4,600,000

(39,400,000) 6,200,000

(58,400,000) 5,500,000

2,000,000

Volume 4,000,000

6,000,000

25,000,000

45,600,000

63,900,000

(19,600,000) 5,400,000

(37,600,000) 8,000,000

(55,600,000) 8,300,000

Uniform Costing - Jain Narang Book Pg No. 5.307

Total Cost Less: FC

3,200,000 1,200,000

5,200,000 1,200,000

7,200,000 1,200,000

Variable Cost

2,000,000

4,000,000

6,000,000

Nos. of units

2,000,000

4,000,000

6,000,000

1

1

1

Variable cost per unit