Advanced: Optimal output and transfer price where the market for the intermediate product is imperfect Engcorp and Flotilla are UK divisions of Griffin pic, a multinational company. Both divisions have a wide range of activities. You are an accountant employed by Griffin pic and the Finance Director has asked you to investigate a transfer pricing problem.

Engcorp makes an engine, the Z80, which it has been selling to external customers at £1350 per unit. Flotilla wanted to buy Z80 engines to use in its own production of dories; each dory requires one engine. Engcorp would only sell if Flotilla paid £1350 per unit. The managing director of Engcorp commented:

‘We have developed a good market for this engine and £1350 is the current market price. Just because Flotilla is not efficient enough to make a profit is no reason for us to give a subsidy.’

Flotilla has now found that engines suitable for its purpose can be bought for £1300 per unit from another manufacturer. Flotilla is preparing to buy engines from this source.

From information supplied by the divisions you have derived the following production and revenue schedules which are applicable over the capacity range of the two divisions:

Requirements

(a) Ignoring the possibility that Flotilla could buy engines from another manufacturer, calculate to the nearest 100 units:
(i) the quantity of Z80 production that would maximize profits for Griffin pic, and (ii) the consequent quantity ofZ80 units that would be sold to external customers and the quantity that would be transferred to Flotilla. (8 marks)

(b) Explain the issues raised by the problems of transfer pricing between Engcorp and Flotilla, and discuss the advantages and disadvantages of the courses of action which could be taken. (10 marks)

(c) Discuss the major considerations in setting transfer prices for a profit-maximizing inter¬ national group. (7 marks)
(Total 25 marks)
ICAEW P2 Management Accounting

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Engcorp's data for Z80 engines Flotilla's data for dories Total Total cost revenue of producing dories Total revenue Annual number Total manufacturing from outside excluding from sales of units cost sales engine costs of dories (000) (000) (000) (000) 100 115 204 570 703 200 185 362 $120 1375 300 261 486 1670 2036 400 344 598 2220 2676 500 435 703 2770 3305 600 535 803 3320 3923 700 645 898 3870 4530 800 766 988 4420 5126