ABC Unicycle makes unicycles and has two divisions. Each division is evaluated as a profit center.

The Wheel division, located in Nambia, produces unicycle wheels and can choose to sell wheels on either the open market at $30 per wheel, or sell them to the Assembly division.

The Assembly division, located in Elbonia, assembles unicycles and can choose to either buy wheels from the Wheel division or purchase wheels on the open market.

Wheel Assembly

Cost per unit Division Division

Direct Labour $2.00 $6.00

Variable Materials 3.00 7.00

Variable Overhead Costs 4.00 8.00

Fixed Overhead Costs* 5.00 9.00

Other information

Maximum capacity 2,000 3,000

Current production volume 1,800 2,600

Income tax rate 30% 10%

(* Fixed overhead costs are based on current production volumes)

The Assembly division would like to purchase an additional 400 wheels from the Wheel division. Total fixed costs would not be affected by the sale of these 400 wheels to the Assembly Division.

Required:

1. What is the likely range of transfer price between the Wheel Division and Assembly Division?
2. What transfer price per unit would the Head Office prefer for the additional sale of 400 wheels, given that tax authorities will accept any of the following transfer prices
   1. Variable Cost - 20%
   2. Variable Cost +20%
   3. Market price
3. What are the benefits and drawbacks if the head office chooses the transfer price?

What are the pros and cons to making the Wheel division a cost centre?