Yu plc (Mercury) manufactures and sells handbags. Mercury has two divisions which are located in different countries, Geeland and Teeland. Teeland is a more economically developed country and goods will normally sell for a higher price in Teeland.
Division A (Geeland) manufactures the handbags. This division sells the bags to Division B (Teeland) and also to external customers.
Division B (Teeland) undertakes some additional manufacture to the handbags (stitching of the name of specific brands, for example) and sells the handbags to external customers.
The budgeted information for the next financial year is as follows:
Division A (Geeland)
Anticipated external demand for handbags 110,000 handbags
Demand from Division B for handbags 255,000 handbags
Average external market selling price per handbag $89.00
Variable costs $61.00 per handbag
Annual fixed costs $2,000,000
Division B (Teeland)
Sales of handbags to external customers 255,000 handbags
Average external market selling price per handbag $97.00
Division A transfers goods to division B on the basis of variable cost. The cost of processing and manufacture for Division B is $5.00 per handbag and Division B has annual fixed costs of $ 1,500,000.
The Head Office (HO) of Yu is keen to impose fixed transfer prices upon the two divisions to avoid any arguments between the managers of the respective divisions. HO is also keen the ensure that Division A transfers the market requirement to Division B, given the higher profit that Division B can make.
Required:
Part A.
Assumption 1:It is assume that Division A have unlimited capacity.
Statement showing budgeted profit of both division's | ||
Particulars | Division A | Division B |
External Sales | $ 9,790,000.00 | $ 24,735,000.00 |
(110,000*$89) | (255,000*$97) | |
Sales to Division B | $ 15,555,000.00 | $ - |
(255000*$61) | ||
Total Sales | $ 25,345,000.00 | $ 24,735,000.00 |
Less:Variable cost | $ 22,265,000.00 | $ 16,830,000.00 |
(365,000*$61) | (255,000*$66) | |
Contribution | $ 3,080,000.00 | $ 7,905,000.00 |
Less:Fixed Cost | $ 2,000,000.00 | $ 1,500,000.00 |
Profit | $ 1,080,000.00 | $ 6,405,000.00 |
Assumption 2:It is assume that Division A have limited capacity of 255,000 handbags
Statement showing budgeted profit | ||
Particulars | Division A | Division B |
External Sales | $ - | $ 24,735,000.00 |
Sales to Division B | $ 15,555,000.00 | $ - |
Total Sales | $ 15,555,000.00 | $ 24,735,000.00 |
Less:Variable cost | $ 22,265,000.00 | $ 16,830,000.00 |
Contribution | $ (6,710,000.00) | $ 7,905,000.00 |
Less:Fixed Cost | $ 2,000,000.00 | $ 1,500,000.00 |
Profit | $ (8,710,000.00) | $ 6,405,000.00 |
Part b :Behavioural issues that could arise as a result of the Head Office of Yu imposing transfer prices on the Divisions.
Since the division A transfer bags at variable cost, its profit is low as compare to division B therefore manager of division B will not accept to transfer the bag at variable cost.
Dual pricing policy avoid this issue by calculating transfer price on the basis of opportunity cost or any other best alternate method.
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