Chamwino Company Ltd has two divisions, A and B. The two divisions are considered to be investment centres and are evaluated on the basis of Return on Investment (ROI). In determining the value of invested capital, the company uses the net book value of total assets employed. Current assets usually average 10% of annual sales. The non-current assets for Division A currently have a net book value of Shs 200,000 and the non-current assets for Division B have a net book value of Shs 1,000,000. The combined total is Shs 1,200,000.

Division A produces and sales Timex watches and has been operating considerably below capacity. The selling price per watch is Shs 340. The standard cost breakdown for one watch at the current annual normal activity of 60,000 watches is as follows:
Direct material Shs 120.00
Direct labour (@ Shs 90/ hr) 90.00
Variable overhead (@ Shs 30/ hr) 30.00
Fixed overhead 50.00
Fixed selling and general overhead 35.00
Shs 325.00
======

One major material component for the watch is purchased from another company at Shs 75.00 each. The component can be replaced by an assembly (Assembly KQ 162) which is produced by Division B. In order to use this assembly, Division A would have to spend an additional five minutes of production time per watch for modifications.

Division B produces an electronic regulator in which KQ 162 is used. Standard cost for production and sale of assemblies and regulator are based on Division B’s current annual activity of 180,000 regulators. Maximum annual capacity is 144,000 production hours or 192,000 regulators.

Unit standard cost for Division B is as follows:
Assembly KQ 162 Electronic Regulator
Shs Shs
Direct material 15.00 40.00
Direct labour 22.50 67.50
Variable overhead 7.50 22.50
Fixed overhead 15.00 45.00
Fixed selling and general
overhead – 15.00
60.0 190.00

Production time in minutes 15 45*
* Includes the cost and production time of one assembly

The selling price of the regulator is Shs 210. The Manager of Division B is interested in supplying Assembly KQ 162 to Division A and is willing, given a suitable transfer price, to switch some production time from regulators to assemblies.

Required:
(i) Calculate the effect of the following on Chamwino Company Limited’ s overall annual net income:
(a) Division B uses only its excess capacity to produce assemblies for Division A.
(b) Division B supplies all the assemblies required by Division A.

(ii) (a) Calculate the minimum unit price acceptable to Division B for assemblies produced using only its excess capacity, assuming that the division wishes to earn 25% contribution margin ratio on transferred assemblies.
(b) Calculate the minimum unit transfer price acceptable to Division B if supplies all assemblies required by Division A, assuming Division B wishes to maintain its current level of net income.
(c) Calculate the maximum unit transfer price acceptable to Division A.

First you must not ask questions like this as a comment on a test – ask in the Ask the Tutor Forum.

Secondly, we do not answer homework questions! Unless it is a test question then you must have an answer in the same book in which you found the question and you should ask about whatever it is in the answer that you do not understand.

Thirdly, have you actually watched the free lectures on transfer pricing? The lectures are a complete free course for Paper F5 and cover everything needed to be able to pass the exam well.

Q2 – I worked out that the RI is higher for Y so therefore this should be the answer, but the comment says that this is wrong and the answer is X. Could you please explain, thank you

Yes – you have answered your own question 🙂
(I do suggest that you watch the free lectures on this – our free lectures are a complete course and cover everything needed to be able to pass the exam well 🙂 )

Q2
dont we have to compare residual income with the current return on investment decision?, and if we do have to then even division x wouldn’t choose to invest as it is lower than current

No need to assess your decision based on ROI because the question says If the residual income used for as the basis for investment decision, therefore, ROI is a distractor factor

msuya says

i need your help for the question below

Chamwino Company Ltd has two divisions, A and B. The two divisions are considered to be investment centres and are evaluated on the basis of Return on Investment (ROI). In determining the value of invested capital, the company uses the net book value of total assets employed. Current assets usually average 10% of annual sales. The non-current assets for Division A currently have a net book value of Shs 200,000 and the non-current assets for Division B have a net book value of Shs 1,000,000. The combined total is Shs 1,200,000.

Division A produces and sales Timex watches and has been operating considerably below capacity. The selling price per watch is Shs 340. The standard cost breakdown for one watch at the current annual normal activity of 60,000 watches is as follows:

Direct material Shs 120.00

Direct labour (@ Shs 90/ hr) 90.00

Variable overhead (@ Shs 30/ hr) 30.00

Fixed overhead 50.00

Fixed selling and general overhead 35.00

Shs 325.00

======

One major material component for the watch is purchased from another company at Shs 75.00 each. The component can be replaced by an assembly (Assembly KQ 162) which is produced by Division B. In order to use this assembly, Division A would have to spend an additional five minutes of production time per watch for modifications.

Division B produces an electronic regulator in which KQ 162 is used. Standard cost for production and sale of assemblies and regulator are based on Division B’s current annual activity of 180,000 regulators. Maximum annual capacity is 144,000 production hours or 192,000 regulators.

Unit standard cost for Division B is as follows:

Assembly KQ 162 Electronic Regulator

Shs Shs

Direct material 15.00 40.00

Direct labour 22.50 67.50

Variable overhead 7.50 22.50

Fixed overhead 15.00 45.00

Fixed selling and general

overhead – 15.00

60.0 190.00

Production time in minutes 15 45*

* Includes the cost and production time of one assembly

The selling price of the regulator is Shs 210. The Manager of Division B is interested in supplying Assembly KQ 162 to Division A and is willing, given a suitable transfer price, to switch some production time from regulators to assemblies.

Required:

(i) Calculate the effect of the following on Chamwino Company Limited’ s overall annual net income:

(a) Division B uses only its excess capacity to produce assemblies for Division A.

(b) Division B supplies all the assemblies required by Division A.

(ii) (a) Calculate the minimum unit price acceptable to Division B for assemblies produced using only its excess capacity, assuming that the division wishes to earn 25% contribution margin ratio on transferred assemblies.

(b) Calculate the minimum unit transfer price acceptable to Division B if supplies all assemblies required by Division A, assuming Division B wishes to maintain its current level of net income.

(c) Calculate the maximum unit transfer price acceptable to Division A.

John Moffat says

First you must not ask questions like this as a comment on a test – ask in the Ask the Tutor Forum.

Secondly, we do not answer homework questions! Unless it is a test question then you must have an answer in the same book in which you found the question and you should ask about whatever it is in the answer that you do not understand.

Thirdly, have you actually watched the free lectures on transfer pricing? The lectures are a complete free course for Paper F5 and cover everything needed to be able to pass the exam well.

nubian73 says

Q2 – I worked out that the RI is higher for Y so therefore this should be the answer, but the comment says that this is wrong and the answer is X. Could you please explain, thank you

nubian73 says

Ignore my question, I have just figured out what I did wrong!!!

John Moffat says

No problem – I am pleased that you have figured it out 🙂

olajumoke says

Hi John,

please can you explain why return on investment % is used against capital investment to generate profit instead of sales in question 5?

John Moffat says

Because the definition of ROI is profit as a % of the investment.

Have you watched the free lectures on divisional performance measurement?

caroline says

Please help..how do i convert cashflows into profits if the only infomation i have been given is the net present value for the years.?

John Moffat says

I have no idea which question you are referring to!!

Have you watched my free lectures before attempting this test?

jp says

Hi Sir,

Please can you explain Q2, I have the same answer as the comment above and am unsure as to why the answer says Division Y?

Thanks

jp says

RI is higher for Division Y hence why it is accepted, have I answered my own question?

John Moffat says

Yes – you have answered your own question 🙂

(I do suggest that you watch the free lectures on this – our free lectures are a complete course and cover everything needed to be able to pass the exam well 🙂 )

Aisha says

Q2

dont we have to compare residual income with the current return on investment decision?, and if we do have to then even division x wouldn’t choose to invest as it is lower than current

John Moffat says

No you don’t. The question asks what the decisions would be if they were based on residual income.

John Moffat says

That is correct (and the test should have shown it as having been correct when you submitted your answer 🙂 )

Fidelka says

Could anybody help me with solving this question? I don’t understand what to do with Cost of capital…

John Moffat says

Which question (there are 5 of them) ? 🙂

Fidelka says

The second one. About Residual Income. Thank you.

Fidelka says

I solved it as follows:

Division X:

1) $34.56m * 30% = $10.368m – Profit

2) $78.24m * 12% = $9.388’8m – notional interest at target return on amount invested

3) $10.368m – $9.388’8m = $ 0.979m – residual income

– ROI = 13.25% less than current by task

Division Y:

1) $21.12m * 24% = $5.068’8m – Profit

2) $53.28m * 12% = $6.393’6m – notional interest at target return on amount invested

3) $5.068’8m – $6.393’6m = $ (1.324’8m) – residual income

– ROI = 9.51% less than current by task

So only Division X is profitable…

Is it Correct?

Yahya says

No need to assess your decision based on ROI because the question says If the residual income used for as the basis for investment decision, therefore, ROI is a distractor factor