Material prices influence - Research Paper Example

Question 2a) Monthly profit position for each of L Ltd and M Ltd if the sales of L Ltd :i. at their present levelParticularsMLSelling prices920Sales in litres750000250000Sales in drums3000010000Total sales270000200000Raw materials-9Other cost53Total VC for a month150000120000Fixed costs6000040000total cost210000160000Profit6000040000Assumptions1. 1 drum = 25 litres2. Current production capacity of L ltd if 1000 kilolitres p.m3. Current production level of L ltd is 75%4. Production and sales are same, no stock in hand(ii) at their higher potential level indicated by the market research, subject to a cut in price of 20%.

ParticularsMLSelling prices916Sales in litres750000450000Sales in drums3000018000Total sales270000288000Raw materials-9Other cost53Total VC for a month150000216000Fixed costs6000040000Total cost210000256000Profit6000032000b) i. Difficulties when the market prices are used as transfer price produces under the conditions outlined in (a) (ii) above.When the market prices are used as the transfer prices, it is disadvantageous for L ltd. This is because, it is planning to reduce its selling price by 20%, thereby increasing its sales by 80%.

If this reduction in selling prices happens, then the profits enjoyed by L Ltd decreases even though there is an increase in sales by 80 %. The raw material prices are same for L ltd. There is no decrease in the raw materials which is purchased from M Ltd. As the production increases for L ltd, the raw material consumption also increases and which should bring down the raw materials cost down. The raw materials cost charged by M ltd, is based on the market price and hence, it does not benefit L Ltd.(ii) Factors to be.

This is because, it is planning to reduce its selling price by 20%, thereby increasing its sales by 80%. If this reduction in selling prices happens, then the profits enjoyed by L Ltd decreases even though there is an increase in sales by 80 %. The raw material prices are same for L ltd. There is no decrease in the raw materials which is purchased from M Ltd. As the production increases for L ltd, the raw material consumption also increases and which should bring down the raw materials cost down.

The raw materials cost charged by M ltd, is based on the market price and hence, it does not benefit L Ltd. As an accountant, I would consider the dual approach to fix the transfer prices. M ltd is currently selling for two parties, one L Ltd and other external parties. For L Ltd, the transfer price can be based on full cost approach and for the external customers, it can be based on the market prices. The actual cost of production should be estimated, including the research and development cost and other costs that are traceable to the division.

A full cost absorption approach can be adopted to overcome these kind of problems.