Advanced : Calculating an opti mum price when there Is no intermed iate mark et and unit variable cost is not constant A group of highly integrated divisions wishes to be advised as to how 11 should set transfer prices for the following interdivisional transactions:

(a) Division L sells all its output of product LX to Division M. To 1 kg of LX . D1vis1on M adds other direct materials and processes it to produce 2 kg of product MX which it sells outside the group.

The price of MX is influenced by volume offered and the following cost and revenue data are available: Division L:

The following cost increases are expected at different levels of production of MX per annum:
Other direct At 140000kg p.a. increase to £1.75 per kg materials: At 160000kg p.a. increase to £2.00 per kg Processing: At 180000kg p.a. increase to £4.00 per kg

(b) Division N manufactures two products, NA and NB, whose variable production costs and selling prices per units are:

Direct labour is paid at £4.00 per hour. FIXed overhead is £72000 per annum and total capacity is 960000 man-hours per annum.
Div1sion N sells product NA either to Division P or outside the group and Division P can buy from either source. Product NB is sold only outside the group. When NA and NB are sold outside the group, variable selling costs of £1 .00 and £3.00 per unit respectively are incurred.

You are required to:

(a) recommend, with supporting calculations and explanations, the most apporpriate narrow range of transfer price per kg for product LX as between the two divisions; assume that any changes in output are in steps of 1 0 000 kg of product LX and 20000kg of product MX; (12 marks)

(b) recommend, with supporting calculations and explanations:
(i) the most appropriate transfer price of product NA as between Divisions Nand P:
(1) on the assumption that Divis1on N can JUSt sell all of, but no more than, its capacity; (3 marks)
(2) on the assumption that Division N could sell more than its existing capacity, thought he market price stays the same; (7 marks)
(ii) in the case of (i) (2) above, what quantities of NA Division P should buy from Division N.

Transcribed Image Text:

The variable costs of LX are (per kg): Direct materials Direct labour 4.00 2.00 6.00 The following cost increases are expected at different levels of production per annum: Direct materials At 60 000 kg p.a. increase to 5.00 per kg At 90 000 kg p.a. increase to 5.50 per kg At 100 000 kg p.a. increase to 6.00 per kg Direct labour: At 80|000 kg p.a. increase to 2.50 per kg At 100 000 kg p.a. increase to 3.00 per kg Fixed overhead: Under 70 000 kg 210 000 p.a. 70000-79 999 kg 260 000 p.a. 80000-89 999 kg 280 000 p.a. 90 000 or more kg 310000 p.a. Division M: To produce 1 kg of product MX, the following variable cost is incurred for each 0.5 kg of LX used: Other direct materials Processing cost 1.50 3.50 5.00 per kg MX produced