Comparison of divisional and group profits using different transfer prices B Limited, producing a range of minerals, is organized into two trading groups: one handles wholesale business and the other sales to retailers. One of its products is a moulding clay. The wholesale group extracts the clay and sells it to external wholesale customers as well as to the retail group. The production capacity is 2000 tonnes per month but at present sales are limited to 1000 tonnes wholesale and 600 tonnes retail. The transfer price was agreed at 200 per tonne in line with the external wholesale trade price at 1 July, which was the beginning of the budget year. As from 1 December, however, competitive pres- sure has forced the wholesale trade price down to 180 per tonne. The members of the retail group contend that the transfer price to them should be the same as for outside customers. The wholesale group refute the argument on the basis that the original budget established the price for the whole budget year. The retail group produces 100 bags of refined clay from each tonne of moulding clay which it sells at 4 a bag. It would sell a further 40 000 bags if the retail trade price were reduced to 3.20 a bag. Other data relevant to the operation are:

You are required to

(a) prepare estimated profit statements for the month of December for each group and for B Limited as a whole based on transfer prices of 200 per tonne and of 180 per tonne when producing at:

(i) 80% capacity (ii) 100% capacity utilizing the extra sales to supply the retail trade;

(b) comment on the results achieved under

(a) and the effect of the change in the transfer price;

(c) propose an alternative transfer price for the retail sales which would provide greater incentive for increasing sales, detailing any problems that might be encountered.

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Variable cost per tonne Fixed cost per month Wholesale Retail 70 60 100000 40 000