Question

ABC Unicycle makes unicycles and has two divisions. Each division is evaluated as a profit center.

The Wheel division, located in Nambia, produces unicycle wheels and can choose to sell wheels on either the open market at $30 per wheel, or sell them to the Assembly division.

The Assembly division, located in Elbonia, assembles unicycles and can choose to either buy wheels from the Wheel division or purchase wheels on the open market.

            Wheel            Assembly

Cost per unit                                                 Division          Division

Direct Labour                                                $2.00               $6.00

Variable Materials                                         3.00                   7.00

Variable Overhead Costs                              4.00                   8.00

Fixed Overhead Costs*                                 5.00                   9.00

Other information

Maximum capacity                                        2,000              3,000

Current production volume                         1,800              2,600

Income tax rate                                             30%              10%

(Fixed overhead costs are based on current production volumes)

The Assembly division would like to purchase an additional 400 wheels from the Wheel division.

Required:

1. What is the likely range of transfer prices between the Wheel Division and Assembly Division?

2. What transfer price would the Head Office prefer for the additional sale of 400 wheels , given that tax authorities will accept any of the following transfer prices (additional information added Nov 22)
   1. Variable Cost ± 20%
   2. Market price
3. What are the benefits and drawbacks if the head office chooses the transfer price?

4. What are the pros and cons to the Wheel Division, Assembly Division if the Wheel division is change from a profit centre to a cost centre?
   

Answer 1

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