HPR harvests, processes and roasts coffee beans. The company has two divisions: Division P is located in Country Y. It harvests and processes coffee beans. The processed coffee beans are sold to Division R and external customers. Division R is located in Country Z. It roasts processed coffee beans and then sells them to external customers. Countries Y and Z use the same currency but have different taxation rates.

The budgeted information for the next year is as follows:

Division P

Capacity  ..........................................................................................1000 tonnes
External demand for processed coffee beans ..............................800 tonnes
Demand from Division R for processed coffee beans .................625 tonnes
External market selling price for processed coffee beans ...$11 000 per tonne
Variable costs ...............................................................................$7 000 per tonne
Annual fixed costs ................................................................$1 500 000
Division R
Sales of roasted coffee beans ..........................................................500 tonnes
Market selling price for roasted coffee beans ........................$20 000 per tonne

The production of one tonne of roasted coffee beans requires an input of one-and-a-quarter tonnes of processed coffee beans.
The cost of roasting is $2 000 per tonne of input plus annual fixed costs of $1 000 000.
Transfer pricing policy of HPR Division P must satisfy the demand from Division R for processed coffee beans before selling any to external customers.
The transfer price for the processed coffee beans is variable cost plus 10 percent per tonne.
Taxation
The rate of taxation on company profits is 45 percent in Country Y and 25 percent in Country Z.

Required:

(a) (i) Produce statements that show the budgeted profit after tax for the next year for each of the two divisions. Your profit statements should show sales and costs split into external sales and internal transfers where appropriate.

(ii) Discuss the potentiaI tax consequences of HPR’s current transfer pricing policy.

(b) Produce statements that show the budgeted contributions that would be earned by each of the two divisions if HPR’s head office changed its policy to state that transfers must be made at opportunity cost. Your statements should show sales and costs split into external sales and internal transfers where appropriate.

(c) Explain TWO behavioural issues that could arise as a result of the head office of HPR imposing transfer prices instead of allowing the divisional managers to set the prices.