Question from the Chartered Association of Certified Accountants, Professional Stage Module E, June 1996. (30 minutes)

Istana Division is part of the Marmaris Group. Istana Division produces a single product for which it has an external market which utilises 80% of its production capacity. Taman Division, which is also part of the Marmaris Group, requires units of the product available from Istana Division as input to a product which will be sold outside the group. Taman Division’s requirements are equal to 40% of Istana Division’s production capacity.

Taman Division has a potential source of supply from outside the Marmaris Group. This outside supplier can supply 75% of Taman Division’s requirement. The outside source may wish to quote a higher price if Taman Division only intends to take up part of its product availablity.

REQUIRED Discuss aspects of transfer pricing principles and information availability which will affect the likely achievement of group profit maximisation from the sourcing decisions made by Taman Division in the above situation. (15 Marks)