Question

Betsy Ltd produces garden furniture in its two divisions A and B. Division A produces the garden chairs and then transfers them to Division B, who varnish them and sell them to national garden centres for £60 per chair.

The budgeted data for the month is:

Division A Division B

Units transferred/sold 25,000 25,000

Annual fixed costs £65,000 £35,000

Material costs per unit £7 £2

Labour costs per unit £6 £4

Other variable costs per unit £2 £2



Required: a. Prepare profit statements for each of the divisions and also for the company as a whole, if the transfer price from Division A to B is: (i) £20 per unit (ii) £25 per unit

b. Comment upon the results with the 2 different transfer prices and on the motivational impact on the two divisional managers.

c. Discuss the problems that arise specifically when determining transfer prices where divisions are located in different countries

Answer 1

a(i)	Transfer Price Equals 20
		Division A	Division B	Company as a whole
	Units	25,000	25,000	25,000
	Sales	500,000	1,500,000	1,500,000
	Transfer Price Cost		500,000	-
	Material cost	175,000	50,000	225,000
	Labour Cost	150,000	100,000	250,000
	Other Variable Overhead	50,000	50,000	100,000
	Gross Margin	125,000	800,000	925,000
	Fixed Costs	65,000	35,000	100,000
	Net Income	60,000	765,000	825,000

a(ii)	Transfer Price Equals 25
		Division A	Division B	Company as a whole
	Units	25,000	25,000	25,000
	Sales	625,000	1,500,000	1,500,000
	Transfer Price Cost		625,000	-
	Material cost	175,000	50,000	225,000
	Labour Cost	150,000	100,000	250,000
	Other Variable Overhead	50,000	50,000	100,000
	Gross Margin	250,000	675,000	925,000
	Fixed Costs	65,000	35,000	100,000
	Net Income	185,000	640,000	825,000

b.

Most of the times the performance of the manager is done on the basis of the Divisional profitability.

So, If the Transfer price is reduced from 25 to 20 than the profitability of the Division transferring the goods will come down and the conflict of interest will arise between the divisional managers.

Division A Manager will argue against the price reduction and Division B will argue in favour of price reduction.

But overall in both the scenario (25 or 20) the profit of the company will be same.

c. When the divisions are located cross-border then in case of divisional transfer of goods and services taxation issues arise. The transfer price should be fixed in a manner that reflects the arm length price.

Arm Length price determination involves Transfer Price study and the extra cost is involved in this.

In case of the Cross-border transfer, the company may have to pay the tax on the markup to the other divisions also.

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