Transfer Pricing means Price charged by One Department to another Department on Inter qqDepartmental Transfer/Sale of Goods or Services. Each Department will be treated as Seperate Profit Centre even if not mentioned in Question.
Minimum Price to be Charged by Transferring Department: -
If Transferring Department have Spare Capacity (i.e. Demand of Product or Service is less than Production Capacity of Transferring Department): - In such Transferring Department wiling to transfer at Cost ( at Variable Cost).
If Transferring Department doesn't have Spare Capacity : - In such case Transferring Department will charge Variable Cost plus Opportunity Cost ( i.e Loss of Profit Due Inter Departmental Transfer) or we can say at Market Price. Maximum Price that Transferee is willing to pay:- Transferee willing to pay Maximum Price of Goods or Service Not More than Market Price plus Savings Due to Inter House or Inter Department less any additional Cost to be incurred by Transferee due to In house Purchase.
Example:-
XYZ Ltd has 2 Department M and N. Department N Produce Product D which Requires Raw Material C which Produced by Department M. Department M have Production Capacity of 1000 Units and Department N Requires 600 Units of Raw Material. Variable Cost to Produce Per Unit of C is Rs. 40 and Market Price of Per Unit of C is Rs. 60.
1. What will Department M will Charge from Department N if Market Demand of Product C is :-
a) 1000
b) 400
c) 800
2. What will be the Maximum Price will Department N willing to Pay Department if
a) If Department N will Save Rs. 5 Per Unit of C on Transportation Cost.
b) If Department N have to incurre Rs. 10 Per Unit of C on Modification.
Solutions:-
1. a) Department M will Charge Market Price from Department N as M Department has No Spare Capacity.
1. b) Department M will Charge Variable Cost from Department N as Spare Capacity.
1. c) Department M will Charge Market Price for 400 Units and Variable Cost for 200 Units
2. a) Department N can Pay Maximum Price Per Unit is Rs. 65 i.e. Market Price plus Savings in Cost
2. b) Department N can Pay Maximum Price Per Unit is Rs. 50 i.e. Market Price minus Additional Cost to be incurred.
Minimum Price to be Charged by Transferring Department: -
If Transferring Department have Spare Capacity (i.e. Demand of Product or Service is less than Production Capacity of Transferring Department): - In such Transferring Department wiling to transfer at Cost ( at Variable Cost).
If Transferring Department doesn't have Spare Capacity : - In such case Transferring Department will charge Variable Cost plus Opportunity Cost ( i.e Loss of Profit Due Inter Departmental Transfer) or we can say at Market Price. Maximum Price that Transferee is willing to pay:- Transferee willing to pay Maximum Price of Goods or Service Not More than Market Price plus Savings Due to Inter House or Inter Department less any additional Cost to be incurred by Transferee due to In house Purchase.
Example:-
XYZ Ltd has 2 Department M and N. Department N Produce Product D which Requires Raw Material C which Produced by Department M. Department M have Production Capacity of 1000 Units and Department N Requires 600 Units of Raw Material. Variable Cost to Produce Per Unit of C is Rs. 40 and Market Price of Per Unit of C is Rs. 60.
1. What will Department M will Charge from Department N if Market Demand of Product C is :-
a) 1000
b) 400
c) 800
2. What will be the Maximum Price will Department N willing to Pay Department if
a) If Department N will Save Rs. 5 Per Unit of C on Transportation Cost.
b) If Department N have to incurre Rs. 10 Per Unit of C on Modification.
Solutions:-
1. a) Department M will Charge Market Price from Department N as M Department has No Spare Capacity.
1. b) Department M will Charge Variable Cost from Department N as Spare Capacity.
1. c) Department M will Charge Market Price for 400 Units and Variable Cost for 200 Units
2. a) Department N can Pay Maximum Price Per Unit is Rs. 65 i.e. Market Price plus Savings in Cost
2. b) Department N can Pay Maximum Price Per Unit is Rs. 50 i.e. Market Price minus Additional Cost to be incurred.
