Ama and Khosi are divisions of Amakhosi Ltd., which is a highly diversified group. Divisions operate as independent

profit centers. Ama manufacturers a single component which it sells to the automobile industry while Khosi supplies the

wholesale trade with a particular model of air conditioner which it assembles. Due to the slow economic growth in South Africa

because of the COVID-19 pandemic, the automobile industry has been struggling and hence, neither division is operating

at full capacity. Extracts from the budget for the year ending 30 June 2021 are as follows:

Amaunits

Khosiunits

Maximum annual capacity

75,000

15,000

Annual production and sales

52,500

9,000

None of the styles is intergroup

Standard cost per unit:

R

R

Materials

20.25

1,447.50

Direct labour (variable cost)

18.00

615.00

Overhead-Variable

15.75

135.00

-Fixed

36.00

615.00

90.00

2,812.50

Standard fixed overhead rates or based on budgeted production and are charged as a percentage of direct labour costs.

Divisions

Ama

Khosi

R

R

Market price at budgeted volumes

133

2,950

Both divisions are faced with keen competition, which has been aggravated by the recession. In view of this, it is

unlikely that sales can be increased at the budgeted price. However, both managers are of the opinion that in the

present circumstances the budgeted price and volume combination will maximize profits.

Just before finalising its budget, Khosi was approached by a new customer who has offered to purchase 2,440 units

per month at a price of R2,950 each. The units required are a modified version of the existing model and needs some

special components. In addition, extra piping at a cost of R50.50 per unit will be needed. The assembly time is expected

to increase by 14% hence the direct labour and variable overhead costs will increase proportionately.

The managing director (MD) of Khosi is confident that the components which Ama manufacturers could be adapted at

minimal cost to meet the specifications for the special order. Ama's MD estimates that the adoption would cost an

additional R10.50 per component but that did the divisions fixed costs would remain the same. Although no intermediate

market exists for the modified components, Ama's MD offers to supply Khosi at the market price of the normal component i.e., R133 each.

He considers this to be fair because of the additional modification costs. Six components are needed for each new air conditioning unit

Required:

PART ONE

(a) Calculate the impact of the special order on the budgeted net profit of:

(i) The group

(ii) The division Ama and Khosi at the transfer price off R133 for each component

(b)Calculate the possible range of the transfer price.

PART TWO

(c) Evaluate the proposed transfer price for the special order considering the objectives of transfer pricing.

(d) Recommended transfer price for the components, clearly explaining the basis of your choice.

Provide supporting calculations where necessary.