Performance measurement

Bath Co is a company specialising in the manufacture and sale of baths. Each bath consists of a main unit plus a set of bath fittings. The company is split into two divisions, A and B. Division A manufactures the bath and Division B manufactures sets of bath fittings. Currently, all of Division A’s sales are made externally. Division B, however, sells to Division A as well as to external customers. Both of the divisions are profit centres. The following data is available for both divisions:

Division A

Current selling price for each bath

$450

Costs per bath:

Fittings from Division B

$75 $200

Other materials from external suppliers Labour costs

$45 $7,440,000

80,000

Annual fixed overheads

Annual production and sales of baths (units)

Maximum annual market demand for baths (units)

80,000

$80

Division B

Current external selling price per set of fittings Current price for sales to Division A

Costs per set of fittings:

$75

$5

Materials

$15 $4,400,000

Labour costs Annual fixed overheads

Maximum annual production and sales of sets of fittings (units) (including internal and external sales)

180,000 80,000

Maximum annual external demand for sets of fittings (units)

Maximum annual internal demand for sets of fittings (units) The transfer price charged by Division B to Division A was negotiated some years ago between the previous divisional

managers, who have now both been replaced by new managers, Head Office only allows Division A to purchase its fittings from Division B, although the new manager of Division A believes that he could obtain fittings of the same quality and appearance for $65 per set, if he was given the autonomy to purchase from outside the company. Division B makes no cost savings from supplying internally to Division A rather than selling externally

Required:

(a) Under the current transfer pricing system, prepare a profit statement showing the profit for each of the divisions and for Bath Co as a whole. Your sales and costs figures should be split into external sales and inter-divisional transfers, where appropriate.

(b) Head Office is considering changing the transfer pricing policy to ensure maximisation of company profits without demotivating either of the divisional managers. Division A will be given autonomy to buy from external suppliers and Division B to supply external customers in priority to supplying to Division A.

Calculate the maximum profit that could be earned by Bath Co if transfer pricing is optimisesd.
(c) Discuss the issues of encouraging divisional managers to take decisions in the interests of the company as a whole, where transfer pricing is used. Provide a reasoned recommendation of a policy Bath Co should adopt.

Tutor. In part b, the examiner has used $65 as transfer price. I used $20. The range of transfer price was 20-65. So am I correct or it is necessary to use $65. We can use any value of range, right?