Effect of alternative transfer pricing methods on division operating income. (CMA, adapted) Ajax Corporation has two divisions. The Mining Division makes toldine, which is then transferred to the Metals Division. T he toldine is further processed by the Metals Division and is sold to customers at a price of $180 per unit. The Mining Division is currently required by Ajax to transfer its total yearly output of 400,000 units of toldine to the Metals Division at 110% of full manufacturing cost. Unlimited quantities of toldine can be pur¬

chased and sold on the outside market at $108 per unit. To sell the toldine it produces at $108 per unit on the outside market, the Mining Division would have to incur variable marketing and distribution costs of $6 per unit. Similarly, if the Metals Division purchased toldine from the outside market, it would have to incur variable purchasing costs of $3.60 per unit.

The following table gives the manufacturing costs per unit in the Mining and Metals Divisions for the year 2007:

Mining Metals Division Division Direct materials $14.40 $ 7.20 Direct manufacturing labour costs 19.20 24.00 Manufacturing overhead costs 38.40* 30.00*

Manufacturing costs per unit $72.00 $61.20

*Manufacturing overhead costs in the Mining Division are 25% fixed and 75% variable.

Manufacturing overhead costs in the Metals Division are 60% fixed and 40% variable.

908 2.

Required 1.Calculate the operating incomes for the Mining and Metals Divisions for the 400,000 units oftoldine transferred under each ofthe following transfer-pricing methods:

(a) market price and

(b) 110% offull manufacturing costs.

Suppose Ajax rewards each division manager with a bonus, calculated as 1% of division operating income (if positive). What is the amount of bonus that will be paid to each division manager under each of the transfer-pricing methods in requirement 1? Which transfer-pricing method will each division manager prefer to use?

What arguments would Brian Jones, manager of the Mining Division, make to support the transfer-pricing method that he prefers?