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Qn 01; 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
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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 minutes15 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.

Qn 02; The Tupendane Bottles Company manufactures a soft drink. The company is organised into two departments, Glass and Filling. The Glass Department makes bottles and sells them to the Filling department. Each department manager receives a bonus based on the department’s net income.

In the market, bottle producers are charging the following prices for their bottles:
Number of cases per Month Total Charge Average Price per Case
Shs Shs
1,000 268,300 263.30
11,000 1,353,000 123.00
12,000 1,440,000 120.00
13,000 1,527,500 117.50
14,000 1,589,000 113.50
15,000 1,650,000 110.00

The costs per case in the Glass Department are as follows:
Volume per Month Glass Department cost per Case
11,000 Shs 107.10
12,000 105.20
13,000 103.50
14,000 101.80
The Filling Department’s costs (excluding bottle purchases) and selling prices are:
Volume per month Selling Price Cost per case
Shs Shs
11,000 380.00 243.20
12,000 375.50 240.90
13,000 372.00 239.10
14,000 368.00 237.60
15,000 362.00 235.70

The current capacities of the departments are 15,000 cases per month for Filling Department and 14,000 cases per month for the Glass Department.

Required:
(i) If market prices are used as transfer prices, what is the most profitable volume for each department and for the company as a whole? Show calculations to support your answer.
Assume that transfers and sales are made in units of one thousand and that the Glass Department is unable to sell its production in the outside market.
(ii) Under what conditions should market prices not be used in determining transfer prices?

Qn 03; Losama Limited consists of three divisions, which formerly were three independent manufacturing companies. Loyeti Corporation and Sadota Company merged in 1991, and the merged corporation acquired Masoka Company in 1992. The name of the corporation has subsequently been changed to LOSAMA Limited, and each company became a separate division retaining the name of its former company.
The three divisions have operated as if they were still independent companies. Each divisional management is responsible for sales, cost of operations, acquisition and financing of divisional assets, and working capital management. The corporate management of LOSAMA Limited evaluates the performance of the divisions and divisional managements on the basis of return on investment (that is, net income divided by invested capital). Masoka division has just been awarded a contract for a product which uses a component that is manufactured by the Sadota division as well as by outside suppliers. Masoka used a cost figure of Shs 400 for the component manufactured by Sadota in preparing its bid for the new product. This cost figure was supplied by Sadota in response to Masota’s request for the average variable cost of the component and represents the standard variable manufacturing cost and variable selling and distribution expense.
Sadota has an active sales force that is continually soliciting new prospects. Sadota’s regular selling price for the component Masoka needs for the new product is Shs 700. Sales of this component are expected to increase. However, the Sadota management has indicated that it could supply Masoka with the required quantities of the component at the regular selling price less variable selling and distribution expenses. Masoka’s management has responded by offering to pay standard variable manufacturing cost plus 35 per cent.

The two divisions have been unable to agree on a transfer price. Corporate management has never established a transfer price policy because inter-divisional transactions have never occurred. As a compromise, the corporate Assistant Finance Manager has suggested a price equal to the standard full manufacturing cost (ie no selling and distribution expenses) plus a 20 per cent mark up. This price has also been rejected by the two divisional managers because each considered it grossly unfair.

The unit cost structure for the Sadota component and the three suggested prices are shown below:
Regular selling price Shs 700
Standard variable manufacturing cost Shs 300
Standard variable manufacturing costShs 120
Variable selling and distribution expensesShs 100
Shs 520
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Regular selling price less variable selling
and distribution expenses (Shs 700 – 100) 600
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Standard variable manufacturing cost plus 35%
(300 x 1.35) 405
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Standard full manufacturing cost plus 20%
(420 x 1.20) 504
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Required:
(a) Discuss the effect each of the three proposed prices might have on the Sadota division management’s attitude toward intracompany business.
(b) Is the negotiation of a price between the Masoka and Sadota divisions a satisfactory method to solve the transfer price problem? Explain your answer.
(c) Should the corporate management of LOSAMA Limited become involved in this transfer price controversy? Explain