Exel Division is part of the Super Group. It produces a basic fabric which is then converted in other division within the group.
The fabric is also produced in other divisions within the Super Group and a limited quantity can be purchased from outside the group. The fabric is currently charged out by Exel Division at total actual cost plus 20 per cent profit mark-up.
(a) Explain why the current transfer pricing method used by Exel Division is unlikely to lead to:
(i) Maximization of group profit and
(ii) Effective divisional performance measurement.
(b) If the supply of basic fabric is insufficient to meet the needs of the divisions who convert it for sale outside the group, explain a procedure which should lead to a transfer pricing and deployment policy for the basic fabric for group profit maximization.
(c) Show how the procedure explained in (b) may be in conflict with other objectives of transfer pricing and suggest how this conflict may be overcome.