Divisional performance 2019

Divisional Performance
Measurement
Dr. N. N. Sengupta

Learning Objectives
Understand the concepts of responsibilities centres in an organization.
Advantages and disadvantages of decentralization in a sizable organization.
Explain how to evaluate the performance of the various responsibilities
centres.
Understand the use of return on investment (ROI), residual income (RI) and
economic value added (EVA).
Understand the concept of transfer pricing

Introduction to Divisional Financial Performance Measures
Large companies produce and sell a wide variety of products throughout the world.
Because of complexity of their operations, it is difficult for top management to directly
control operations.
It may therefore be appropriate to divide a company into separate self deal of
independence.
A divisional manager has responsibility for both the production and marketing activities of
the division.
The danger in creating autonomous divisions is that divisional managers might not pursue
goals that are in the best interest of the company as a whole.
Consider financial performance measures that will motivate managers to pursue those
goals that will best benefit the company as a whole. In other words, the objective is to
develop the performance measures that will achieve goal congruence.

Intro..(Contd..)
Financial measures cannot adequately measures all those
factors that are critical to the success of a division.
Emphasis should also be given to reporting key non-financial
measures relating to such areas as competitiveness, product
leadership, quality, delivery performance, innovation and
flexibility to respond to changes in demand.
Performance measures should be developed that support
the objectives and competitive strategies of the
organization.
Divisional financial performance measures should therefore
be seen as one of a range of measures that should be used
to measure and control divisional performance.

Why divisions are created
Growing size of the organisation
Diversification of products
Geographical expansion
Better control & fixation of responsibility

Organisational Structure
Functional Structure
• In a functional structure only
the organization as a whole is an
investment centre
• A functional structure is where
all activities of a similar type are
placed under the control of a
departmental head.
Divisional Structure
• In a divisionalised structure the
organization is divided into
separate investment or profit
centres
• Divisionalised structures
generally lead to a
decentralization of the decision-
making process

Functional Organisational Structure

Divisional Organisational Structure

Advantage of Divisionalisation
Improved quality of decisions
Speedier decisions
Increases managerial motivation
Enables top management to devote
more time to strategic issues

Disadvantage of Divisionlisation
Sub-optimization and may promote a
lack of goal congruence.
More costly to operate a divisionalised
structure.
Loss of control by top management.

Advantages
and
Disadvantages
Centralization
and
Decentralization
1. Cost centre
2. Revenue centre
3. Profit centre
4. Investment centre
Responsibility
Accounting and
Centres
Advantages
and
Disadvantages
1. ROI
2. RI
3. EVA
Financial
Performance
Measures
1. Financial
2. Customer
3. Internal
4. Innovation &
learning
Four
Perspectives
Benefits
and
Limitations
Balanced
Scorecard
Divisional
Performance
Measures
Divisional performance measures

Centralization and Decentralization
(a) Centralized organization is an organization in which top management
makes most decisions and control most activities from the central
headquarters.
(b) Decentralization is defined as delegating authority to make decisions.
In general, a divisional structure will lead to decentralization of the decision-
making process and divisional managers may have the freedom to set selling
prices, choose suppliers, make product mix and output decisions and so on.

Organisational Segmentation by Responsibility
A responsibility center is an organizational unit
headed by an executive responsible for all its
activities – who is required from time to time to make
decisions regarding quantity and quality of tasks, the
amount of resources to be consumed in performing
the task.

Types of Responsibility Centre
Cost Centre
• Here managers are
responsible for costs
but not profits.
• Production
department, for
example is concerned
with cost of
production only.
Profit Centre
responsible for both
Cost and revenue but
does not have the
authority to take
investment decisions.
• Examples: Retail chain
stores like Reliance
fresh.
Investment Centre
responsible not only
for cost and profit
but has the authority
to take investment
decisions also.
• Example includes,
CPSU’s having status
of Maharatna like
ONGC etc.

Measures of Performance
Different Measures of Performance:
The measures of performance can be
classified into two categories:
• Financial measures of performance; and
• Non-financial measures of
performance.
A mix of financial and non-
financial measures of
performance should be employed

Financial Measures of Performance
Amount of Expense Incurred
Revenue Earned
Profit
Return on Investment (ROI)
Residual Income (RI)
Economic Value Added (EVA)

Non-Financial Measures of Performance
Employee Productivity
Marketing Effectiveness
Employee Morale and Attitude
Social Responsibility
Qualitative Aspects of Performance

Performance Measures - Benefits
Develops agreed measures of activity.
Clarifies the objectives of the organization.
Greater understanding of process.
Helps facilitate comparison between divisions.
Promotes accountability to stakeholder.
Helps in setting of targets for managers.
Helps facilitate comparison between different organizations

Performance Measures – Problems
PerformanceMeasurement–
Problems
Tunnel Vision
Undue focus on
measurements to the
detriment of other areas
Sub-optimization
Focus on one measurement
to the detriment of others
Myopia
Focusing too much on short-
term measures and not
looking long-term
Misrepresentation
Not presenting the data
correctly
Misiterpreting Misinterpreting the data
Ossifiation
Keepin of out of date
measures

Performance Pyramid
To build a strong house one must start with a proper foundation in order
to build a house which structurally sound and one that will last

ROI expresses divisional profit as a percentage of the assets
employed in the division
Assets employed can be defined as total divisional assets, assets
controllable by the divisional manager or net assets.

Return On
Investment
=
Investment
Turnover X Profitability
Profit
Investment
=
Sales
Investment
X
profit
sales

Return on capital Employed
If depreciation is ignored divisional profits will differ from published
profits. This could be a useful way to break the connection between
divisional performance appraisal and published profits. Published
profits may be affected by accounting adjustments, most of which the
divisional manager has no control over. (However, it is worth noting
that many analysts now use EBITDA, i.e. earnings before interest, tax
depreciation and amortisation to monitor companies' performance.
EBITDA is a reasonably close approximation to cash flow.)
If a division's asset base is valued at its replacement cost this will take
inflation into account and should also encourage divisional managers
to replace obsolete assets with more productive modern assets.

Wealth Acceleration
profitability
Investment turnover
Sick
Failure
Great enterprise
Very good health (Blue Chip)
Good health
Return on
Investment (ROI)
Sickness
+1
+1-1 -1

Micro-level performance pyramid
Plant
Capacity
turnover
Profit for owners – dividend = profit deployment
Profit before tax – tax = profit for owners
Together decide the ROI
Operating profit – Interest = Profit before tax
Premises
Capacity
turnover
Distribut-
-ion
Capacity
turnover
Inventory
sales
Recei-
-vables
Turn-
-over
Cash
Turn-
-over
Sales
volume
Sales
price
Variable
costs
Fixed
costs
i.e..
Operating profit
investment
Investment turnover
Profitability

Example:1 Return on Investment (ROI)
Division A Division B
Profit Rs.10,00,000 Rs. 20,00,000
Investment Rs. 40,00,000 Rs. 2,00,00,000
ROI 25% 10%
Division B earns higher profits but Division A is more profitable
ROI is a relative measure of performance that can be compared with other investments. It
also provides a useful summary measure of the ex post return on capital employed.
A major disadvantage of ROI is that managers may be motivated to make decisions that
make the company worse off.

Example: 2 Return on Investment (ROI)
Division X Division Y
Investment project available Rs.1,00,00,000 Rs. 1,00,00,000
Controllable contribution Rs. 20,00,000 Rs. 13,00,000
Return on the proposed project 20% 13%
ROI of divisions at present 25% 9%
The overall cost of capital for the company is 15%
The manager of X would be motivated not to invest and the manager of Y would be motivated to invest.
Consequently, the managers of both divisions would make decisions that would not be in the best interest of the
company. The company should accept only those projects where the return is in excess of the cost of capital of 15
% , but the manager of division X would reject a potential return of 20% and the manager of division Y would
accept a potential return of 13 %. ROI can therefore lead to a lack of goal congruence.

Advantages of ROI
As relative measures, it enables
comparisons to be made with divisions or
companies of different size.
It is used externally and is well understood
by users of accounts.
ROI forces managers to make good use of
existing capital resources and focuses
attention on them, particularly when funds
for further investment are limited.
Disadvantage of ROI
Disincentive to invest
Subject to manipulation
Lack of goal congruence
Not suitable for investment
decisions

Illustration 1
A summary of the most recent year’s financial results for the Theatres Division of Rio
Entertainment Ltd. is:
Sales Rs. 2,00,00,000
Operating profit Rs. 50,00,000
Capital employed(Investment)Rs. 5,00,00,000
Required:
Calculate the Return on Investment (ROI), net margin and asset turnover
for the division.

Solution:
ROI = (Operating profit ÷ Capital employed) × 100
= (Rs. 50,00,000 ÷ Rs. 5,00,00,000) × 100
= 10%
Net margin (profitability) = (Operating profit ÷ Sales) × 100
= (Rs. 50,00,000 ÷ Rs. 2,00,00,000) × 100
= 25%
Asset Turnover = (Sales ÷ Capital Employed) × 100
= (Rs. 2,00,00,000 ÷ Rs. 5,00,00,000) × 100
= 40%
These ratio are linked in that:
Net Margin × Asset turnover = ROI
i.e. 25 % × 40% = 10%

Illustration 2
The figures below summarise the recent financial results of the Footwear
division of Footgear Ltd.
2017-18 2018-19
Operating profit Rs. 20,00,000 Rs. 25,00,000
Capital employed Rs. 2,00,00,000 Rs. 3,00,00,000
Depreciation included in operating
profit calculation Rs. 7,00,000 Rs. 15,00,000
Replacement cost of fixed assets Rs. 4,50,00,000 Rs. 5,60,00,000
Required:
Calculate the division’s ROI for each year:
(a) using the conventional operating profit and capital employed figure;
(a) using profit before depreciation and replacement cost of fixed assets.

Solution
(a) 2017-18 2018-19
ROI 10% 8.33%
The effect of increasing the fixed assets between the two years has been to drive
down the division’s ROI.

Solution (contd..)
(b) 2017-18 2018-19
Operating profit before depreciation Rs. 27,00,000 Rs. 40,00,000
ROI 6% 7.1%
If depreciation is ignored and the replacement cost of the fixed assets is used as the
capital employed figure the ROI figure is lower in both years.

Residual Income (RI)
The Residual Income (RI) measure is an attempt to
overcome some of the drawbacks of ROI
RI is calculated by charging an investment centre with the
cost of the capital it employs i.e. notional or imputed
interest charge is made.
The division’s performance can then be measured by
comparing the profit it achieves, after the interest charge,
with pre-set target.

Example:3 Residual Income (RI)
Controllable residual income = Controllable profit less a cost of capital charge
on the investment controllable by the manager.
It is claimed that RI is more likely to encourage goal congruence
Division X Division Y
Proposed investment Rs. 1,00,00,000 Rs.1,00,00,000
Controllable profit Rs. 20,00,000 Rs. 13,00,000
Cost of capital charge (15%) Rs15,00,000 Rs 15,00,000
Residual income +0.5 – 0.2

The manager of division X is motivated to invest and the manager of division Y is
motivated not to invest.
If RI is used it should be compared with budgeted/target levels which reflect the
size of the divisional investment.
Cont….

Example 4 – Residual Income
A division with capital employed of Rs. 400,000 currently earns an ROI
of 22%. It can make an additional investment of Rs.50,000 for a five-
year life with nil residual value. The average net profit from this
investment would be Rs. 12,000 after depreciation. The division’s cost
of capital is 14%.
What are the residual incomes before and after the investment?
• Solution:
Before investment After investment
Rs. Rs.
Divisional profit ($400,000 × 22%) 88,000 100,000 (88,000+
12,000)
Imputed interest
(400,000 × 14%)
(450,000 × 14%)
56,000 63,000
Residual income 32,000 37,000

Advantage of
Residual Income
Achieve Goal congruence
• There is greater
probability that
managers will be
encouraged when
acting in their own
best interest of the
company.
More Flexible
• RI can apply a
different cost of
capital to
investment with
different risk
characterstics.
Disadvantage of
residual Income
Absolute measures
• it means that it is difficult to compare the
performance of a division with that of other
divisions or companies of a different size. To
overcome this deficiency, targeted or
budgeted levels of RI should be set for each
division that are consistent with asset size and
the market conditions of the divisions.
Residual income is an accounting-
based measure, and suffers from
the same problem as ROI in defining
capital employed and profit.

Illustration 3-Residual Income
The figures below summarise the recent financial results of the Footwear division of
Footgear Ltd.
2015-16 2016-17
Cost of capital 6% 6%
Required:
Calculate the division’s RI for each year:
(a) using the conventional operating profit and capital employed figure;
(a) using profit before depreciation and replacement cost of fixed assets.

Solution
(a) 2015-16 2016-17
Charge against profit for cost of
capital employed (Rs.12,00,000) (Rs.18,00,000)
Operating profit before charge of
capital employed Rs. 20,00,000 Rs. 25,00,000
Residual Income Rs. 8,00,000 Rs. 7,00,000
(Operating profit – charge for capital employed)
The effect of increasing the Capital Employed(Fixed Asset) between the two years has been to drive
down the division’s RI. This is because the extra profit is Rs. 5,00,000, while the extra capital employed
is Rs. 1,00,00,000 resulting in a return of 5 per cent on the extra investment, which is lower than the
company’s cost of capital.

Solution (Contd..)
(b) 2014-15 2015-16
Charge against profit for cost of
capital employed (Rs. 27,00,000) (Rs. 33,60,000)
Net profit before charge for
capital employed Rs. 20,00,000 Rs. 25,00,000
Net profit before depreciation Rs. 27,00,000 Rs. 40,00,000
Residual Income - Rs. 6,40,000
(Net profit + depreciation – capital charge)

Solution (Contd..)
If depreciation is ignored in the calculation of
profit, and the replacement cost of the fixed
assets is used as the capital employed figure, the
RI figure is lower in both years. The net profit
before depreciation has risen from Rs. 27,00,000
to Rs. 40,00,000, which is an increase of Rs.
1,10,00,000 (11.8%)extra assets employed (at
replacement cost). This figure is nearly twice as
high as the company’s 6% cost of capital.

Triple Bottom Line (TBL)
TBL expands traditional accountancy reporting systems, looking at social and
environmental performance, rather than simply financial performance. This can
be used to help encourage each division and manger within the organisation to
act in a socially responsible manner. TBL incorporates the three dimensions-
•measures the impact on resources, such as air, water, ground
and waste emissions.Environmental
•relates to corporate governance, motivation, incentives,
health and safety, human capital development, human rights
and ethical behaviour.
Social
•refers to measures maintaining or improving the company’s
success.Economic

Economic Value Added (EVA®)
EVA is an alternative absolute performance measure.
It is similar to RI and is calculated as follows:
EVA = net operating profit after tax (NOPAT) less
capital charge
Capital charge = WACC x net assets

Economic Value Added (EVA®)
During the 1990 ’s RI was refined and renamed EVA ™
• EVA® = Conventional divisional profit based on GAAP(EBIT)
- Tax
-NOPAT
– Cost of capital charge on Invested Capital
• Economic value added (EVA®) is a registered trade mark owned by Stern Stewart &
Co
Conventional divisional profit based on principles outlined for measuring divisional
managerial and/or economic profits.
Applicable Tax Rate
NOPAT-Cost of Capital=EVA

Calculation of NOPAT
• Costs which would normally be treated as expenses,
but which are considered within an EVA calculation
as investments building for the future, are added
back to NOPAT to derive a figure for 'economic
profit‘. Costs treated in this way include items such
as goodwill, research and development
expenditure and advertising costs
• Economic depreciation is a charge for the fall in
asset value due to wear and tear or obsolescence.
• Any lease charges are excluded from NOPAT and
added in as a part of capital employed.
• Another point to note about the calculation of
NOPAT, which is the same as the calculation of the
profit figure for RI, is that interest is excluded from
NOPAT because interest costs are taken into
account in the capital charge.
There are also
differences in
the way that
NOPAT is
calculated
compared
with the profit
figure that is
used for RI, as
follows:

Difference between Residual Income and Economic
value added (EVA®)
Economic value added (EVA®) is a registered trade
mark owned by Stern Stewart & Co. It is a specific
type of residual income (RI). However, there are
differences as follows:
(a) The profit figures are calculated differently.
EVA is based on an economic profit which is derived
by making a series of adjustments to the accounting
profit.
(b) The notional capital charges use different
bases for net assets. The replacement cost of net
assets is usually used in the calculation of EVA.

Advantage of
EVA
Real wealth of
shareholders
Less distortion by
accounting policies
An absolute value
Treatement of certain
costs as investment
thereby encouraging
expenditure.
Disadvantage
of EVA
Focus on short term
independence
Dependency on
historical data
Number of adjustment
needed to measure EVA
Comparison of like with
like.

EVA Calculation
An investment centre has reported operating profits of $21 million.
This was after charging $4 million for the development and launch
costs of a new product that is expected to generate profits for four
years. Taxation is paid at the rate of 25 per cent of the operating
profit. The company has a risk adjusted weighted average cost of
capital of 12 per cent per annum and is paying interest at 9 per cent
per annum on a substantial long term loan. The investment centre's
non-current asset value is $50 million and the net current assets have
a value of $22 million. The replacement cost of the non-current assets
is estimated to be $64 million.
Required:
Calculate the investment centre's EVA for the period.

Solution
Calculation of NOPAT $m
Operating profit 21
Add back development costs 4
Less: one year’s amortization of development cost ($4/4) (1)
24
Taxation at 25% (6)
NOPAT 18
Calculation of economic value of net assets $m
Replacement cost of net assets ($64 + $22) 86
Economic value of net assets = development cost 3
89
Calculation of EVA
The capital charge is based on the WACC, which takes into account of the cost of share
capital as well as the cost of loan capital. Therefore the correct interest rate is 12%.
$m
NOPAT 18.00
Capital charge (12% x 89$m) 10.68
EVA 7.32

Orange Grape Apple
Total invested capital 1,00,000 1,00,000 1,00,000
Debt / equity ratio 0.8 0.5 0.2
Shares outstanding 6,100 8,300 10,000
Pre tax cost of dept 16% 13% 15%
Cost of equity 26% 22% 20%
Operating income (EBIT) 25,000 25,000 25,000
The tax rate is uniform 35% in all cases.
(a) Compute the Weighted average cost of capital for each company.
(b) Compute the Economic Valued Added (EVA) for each company.
(c) Based on the EVA, which company would be considered for best investment? Give
reasons.
(d) If the industry PE ratio is 11x, estimate the price for the share of each company.
(e) Calculate the estimated market capitalization for each of the companies.
Illustration 4 : Economic Value Added (EVA)

Solution
Orange Grape Apple
Weight of debt (Wd) 0.8 0.5 0.2
Cost of debt post tax (Kd) [pre tax *(1-t)] 10.4% 8.45% 9.75%
Weight of equity (We) (1-Wd) 0.2 0.5 0.8
Cost of equity (Ke) 26% 22% 20%
Weighted average cost of capital (WACC)
[(Wd × Kd) + (We × Ke)]
13.52% 15.225% 17.95%
Invested Capital (Rs.) 1,00,000 1,00,000 1,00,000
EBIT (Rs.) 25,000 25,000 25,000
Less: Taxes @ 35% (Rs.) (8,750) (8,750) (8,750)
NOPAT (Rs.) 16,250 16,250 16,250
Less: Cost of capital (Invested capital ×
WACC)
(13,520) (15,225) (17,950)
EVA (Rs.) 2,730 1,025 (1,700)
Best Company Orange

EBIT (Rs.) 25,000 25,000 25,000
Interest (Rs.)(debt*Kd) pre tax rate 12,800 6,500 3,000
PBT (Rs.) 12,200 18,500 22,000
Tax 35% (Rs.) 4,270 6,475 7,700
Net Income (Rs.) 7,930 12,025 14,300
Shares (Rs.) 6,100 8,300 10,000
EPS 1.3 1.45 1.43
Price (P/E = 11) 14.30 15.94 15.73
Market Cap (Rs.) (No. of Share x MP) 87,230 1,32,302 1,57,300
Since the three firms have different capital structures they would be exposed to
different degrees of financial risk. One can adjust the PE ratio to recognize this risk.

Transfer Pricing
Three objectives must be fulfilled by a sound transfer pricing system:
Firstly, it should help to achieve goal congruence between the different
divisions and the corporation.
Secondly, it should enable a more or less accurate profit performance of
different profit centers or return on capital employed measurement of
investment centers.
Thirdly, it should enable a long-term evaluation of performance of different
divisions.

Different Basis of Transfer Pricing
Based on
Cost:
• Cost based transfer prices for inter-divisional
transactions can be based on actual costs or
standard costs. They may be based on the full
recovery of actual cost or marginal costs.
Based on
Market Prices:
• The market price offers a sound basis for transfer
price. It induces the producing divisional manager
to have an efficient control on production costs
cannot be passed on to the buying division.

Based on
Shadow Prices:
• The optimum prices for the output transferred on the services provided
by one division to another can be calculated by using a linear
programming model for the logistics flow to optimize a given function
(say, production or sales pattern) within given constraints. The price
thus obtained are called shadow prices, when variable costs are added
to the shadow prices, a set of transfer prices emerge that will optimize
the company’s profit.
Based on Dual
Prices:
• Sometimes two sets of transfer prices are used. The producing
division’s revenue may be credited at the outside sales price less a
percentage to take care of the selling and distribution costs. The
buying division may be charged the standard costs for the product. The
difference between the resultant two sets of prices may be charged to
central accounts, and ignored while consolidating the divisional profit
and loss statements.
Different Basis of Transfer Pricing (Contd..)

Illustration 5 : Transfer Pricing
Bisleri Soda Ltd. manufactures a product which is obtained basically from a series of mixing
operations. The finished product is packaged in the company made glass bottles and packed in
attractive cartons.
The company is organized into two independent divisions viz. one for the manufacture of the
end-product and other for the manufacture of glass bottles. The product manufacturing
division can buy all the bottle requirements from the bottle manufacturing division.
The general manager of the bottle manufacturing division has obtained the following
quotations from the outside manufactures for the supply of empty bottles:
Volume
(empty bottles)
Total purchases
Value (Rs.)
8,00,000 14,00,000
12,00,000 20,00,000

Illustration (Contd..)
A cost analysis of the bottle manufacturing division for the manufacture of empty
bottles reveals the following production costs:
Volume
(empty bottles)
Total cost
(Rs.)
8,00,000 10,40,000
12,00,000 14,40,000
The production cost and sales value of the end-product marketed by the product
manufacturing division are as under:
Volume
(bottles of end-product )
Total cost of end-product
(excluding cost of empty
bottles)
Sales value (packed in
bottles)
8,00,000 Rs. 64,80,000 Rs. 91,20,000
12,00,000 Rs. 96,80,000 Rs. 1,27,80,000

Illustration (Contd..)
There has been considerable discussion at the corporate level as to the use
of proper price for transfer of empty bottles from the bottle manufacturing
division to the product manufacturing division. This interest is heightened
because a significant portion of the divisional general manager’s salary is in
incentive bonus based on profit centre results.
As the corporate management accountant responsible for defining the
proper transfer prices for the supply of empty bottles by the bottle
manufacturing division to the product manufacturing division, you are
required to show for the two levels of volumes of 8,00,000 and 12,00,000
bottles, the profitability by using (i) market price and (ii) shared profit
relative to the costs involved basis for the determination of transfer prices.
The profitability position should be furnished separately for the two
divisions and the company as a whole under each method. Discuss also
the effect of these methods on the profitability of the two divisions.

Solution
Volume
8,00,000 bottles
(Rs.)
12,00,000 bottles
(Rs.)
(a) Glass Bottle Manufacturing Division:
Sales Revenue
Less: Cost of Production
Profit
14,00,000
10,40,000
20,00,000
14,40,000
3,60,000 5,60,000
(b) End Product Manufacturing Division:
Sales Revenue……………..(i)
Less: Cost of Production
Cost of Empty Bottles
91,20,000 1,27,80,000
64,80,000
14,00,000
96,80,000
20,00,000
Total Cost…………………….(ii)
Profit (i-ii)
Total Profit of the Company
(a+b)
78,80,000 1,16,80,000
12,40,000 11,00,000
16,00,000 16,60,000
(i) PROFITABILITY STATEMENT USING MARKET PRICE BASIS OF TRANSFER PRICING

(ii) PROFITABILITY STATEMENT USING SHARED PROFIT RELATIVE TO THE COSTS
BASIS
Volume
8,00,000 Bottles
(Rs.)
12,00,000
Bottles (Rs.)
Sales Revenue (i)
Less: Cost of Production of Bottle Division
Production cost of End Product Division
91,20,000 1,27,80,000
10,40,000
64,80,000
14,40,000
96,80,000
Total Cost…………………….(ii) 75,20,000 1,11,20,000
Total Profit of the Company (i-ii)
(a) Share of Bottle Mfg. Division
16,00,000
2,21,276
16,60,000
2,14,946
(b) Share of Product Division 13,78,724 14,45,036
Profit×CostofbottleDiv.
TotalCost
æ ö÷ç ÷ç ÷ç ÷çè ø
Solution (Contd..)

(iii) Determination of Transfer Price
Cost of production of Bottle Division 10,40,000 14,40,000
Add: Share of profit 2,21,276 2,14,964
Transfer Price 12,61,276 16,54,964
• The profit to the company as a whole
remains the same whatever is the method
of transfer price. However, market price
basis of transfer pricing yields more profits
for the bottle manufacturing division.
Effect of the
two methods of
transfer Pricing
or Profitability:
Solution (Contd..)

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Divisional performance 2019