ICAEW BIP · Chapter 5 · Question 8 of 9
Division X sets a transfer price of £60 per unit for a component it makes for Division Y. Division X has spare capacity, and its variable cost is £30 per unit. Division Y has found an external supplier offering the same component at £55 per unit and decides to buy 4,000 units externally. What is the effect of Division Y's decision on group profit?
Test yourself: pick an answer
Reveal answer & explanation
Correct answer: A) Group profit falls by £100,000
Explanation
From the group's point of view, making the component internally costs only the variable cost of £30, because X has spare capacity. Buying externally costs £55. Group profit therefore falls by (£55 - £30) x 4,000 = £100,000. Division Y's profit improves by £20,000, which shows a lack of goal congruence caused by a transfer price set too high.
More Transfer pricing MCQs
- Q1Which of the following is a main objective of a transfer pricing system in a divisionalised company?
- Q2Division A makes a component with a variable cost of £26 per unit and a fixed cost of £8 per unit. It sells the component externally for…
- Q3Division A makes a component with a variable cost of £26 per unit and sells all its output externally for £50 per unit. It is working at…
- Q4Division B buys a component from Division A, which has spare capacity. Division B can buy an identical component from an outside supplier…
- Q5If the buying and selling divisions are in the same tax jurisdiction, how does an increase in the transfer price for a component traded…