transfer pricing

CTD has two divisions – FD and TM. FD is an iron foundry division which produces
mouldings that have a limited external market and are also transferred to TM division.
TM division uses the mouldings to produce a piece of agricultural equipment called the ‘TX’ which is sold externally. Each TX requires one moulding. Both divisions produce only one type of product. If their own target residual income is achieved, each Divisional Manager is awarded a bonus equal to 5% of his or her residual income. All bonuses are paid out of Head Office profits.

The following budgeted information is available for the forthcoming year:
TM division/ FD division
TX per unit /Moulding per unit
External selling price ($) 500/ 80
Variable production cost ($) *366/ 40
Fixed production overheads ($) 60/20

Variable selling and distribution cost ($) 25/ **4
Fixed administration overhead ($) 25/4

Normal capacity (units) 15,000 20,000
Maximum production capacity (units) 15,000 25,000
Sales to external customers (units) 15,000 5,000
Capital employed $1,500,000 $750,000
Target RI $105,000 $85,000
* The variable production cost of TX includes the cost of an FD moulding.
** External sales only of the mouldings incur a variable selling and distribution cost of
$4 per unit.
FD division currently transfers 15,000 mouldings to TM division at a transfer price equal to
the total production cost plus 10%.
Fixed costs are absorbed on the basis of normal capacity.

-Calculate the bonus each Divisional Manager would receive under the current
transfer pricing policy and discuss any implications that the current performance
evaluation system may have for each division and for the company as a whole.

1. For TM division, how to calculate the profit?
– It says “The variable production cost of TX includes the cost of an FD moulding”
– Why would TX include the cost of an FD moulding? How to deal with it?