4. B Ltd, producing a range of minerals, is organised 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 2 000 tonnes per month but at present sales are limited to 1 000 tonnes wholesale and 600 tonnes retail.

The transfer price was agreed at R200 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 pressure has forced the wholesale trade price down to R180 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 R4 a bag. It would sell a further 40 000 bags if the retail trade price. were reduced to R3,20 a bag.

data relevant to the operation are:

Wholesale group Retail group

R R

Variable cost per tonne 70 60

Fixed cost per month 100 000 40000

Required:

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 R200 per tonne and of R180 per tonne when producing at:

i. 80% capacity; and

ii. 100% capacity utilising 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.