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Division A, which is a part of the ACF Group, manufactures only one type of product, a Bit,
which it sells to external customers and also to division C, another member of the group.
ACF Group’s policy is that divisions have the freedom to set transfer prices and choose their
suppliers.
The ACF Group uses residual income (RI) to assess divisional performance and each year it
sets each division a target RI. The group’s cost of capital is 12% a year.
Division A
Budgeted information for the coming year is:
Maximum capacity 150,000 Bits
External sales 110,000 Bits
External selling price $35 per Bit
Variable cost $22 per Bit
Fixed costs $1,080,000
Capital employed $3,200,000
Target residual income $180,000
Division C
Division C has found two other companies willing to supply Bits:
X could supply at $28 per Bit, but only for annual orders in excess of 50,000 Bits. Z could
supply at $33 per Bit for any quantity ordered.
Required:
(a) Division C provisionally requests a quotation for 60,000 Bits from division A for the
coming year.
(i) Calculate the transfer price per Bit that division A should quote in order to
meet its residual income target. ? (6 marks)
(ii) Calculate the two prices division A would have to quote to division C, if it
became group policy to quote transfer prices based on opportunity costs. ?
(4 marks)
(b) Discuss, with supporting calculations, the impact of the group’s current and
proposed policies on the profits of divisions A and C, and on group profit. ?
(10 marks)I want to know what the part B is asking about? What is the current and Revised policy here and what to explain and how to show calculations for 10 marks. Could you please explain in detail?
Current- division A has the freedom to set the transfer price for selling to division C.
This means that division A can choose any transfer price that allows it to meet its target residual income.Division C has found two other suppliers, x at $28 an and z at $33 per bit,
Under the proposed policy, the group wants to quote transfer prices based on opportunity costs.
This means that division A would have to consider the opportunity cost of selling to division C instead of external customers.
To calculate the impact on profits, you need to compare the profits under the current and proposed policies for divisions A and C, as well as the overall group profit.
How the profits be calculated on the proposed policies.
There is no sales and coste figure given for Division C.
Div C obj is to maximise RI
Therefore look for the cheapest source of supply for bits.You are looking for the affect on the divisions contributions/profits and the group.
A sells externally and to Div C, Div C just buys from A or external or a mixture of both
What does that do to Group profitC will choose 40,000 from Div A at $22 and the remaining 20,000 from Z at $33 = $1,540,000
as 60,000 from x will cost $1,680,000
This also benefits the group as there is no opportunity cost to transferring the bits internally to CYou can look at the answer in your exam kit
Can I also add this is not a past exam style question – hence no year next to it in the indexIt is given in kaplan kit and the answer which has been provided seems to be unclear and creating a confusion to understand.
As there is nothing to be compared of and the individual profits cannot be derives so the effect on individual division’s profit is being difficult to derive here
To calculate the impact on profits, you need to compare the profits under the current and proposed policies for divisions A and C, as well as the overall group profit.
Calculate the profit under the current policy for division
Total revenue – Total variable cost – Total fixed cost
Then
Calculate the profit under the current policy for division C, the total cost of purchasing bits from division A as transfer price per bit * req quantity
Now the overall group profit under the current policy
Sum the profits of divisions A and C
Repeat the above steps for the proposed policy, considering the opportunity cost of selling to division C.
Once you have calculated the profits under both policies, you can compare them and discuss the impact on the profits of divisions A and C, as well as on group profit.
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