Crispy Clothes Ltd has several operating divisions, all of which are run separately as investment centres. Two of its divisions are the Condenser Division (Condenser), which manufactures and sells condenser tumble dryers, and the Heating Division (Heating), which makes Heat Exchangers. Below is Condenser’s budgeted profit statement for the coming year, which is based on a sales volume of 15,000 units. Condenser has capacity to produce 20,000 units. A key component of the condenser tumble dryers is a heat exchanger. These are currently purchased externally at $280 per unit.

 

Below is Heating’s budgeted profit statement for the coming year, which is based on a sales volume of 64,000 units. Heating has capacity to produce 75,000 heat exchangers. The specifications of the heat exchangers that Heating makes are slightly different to the ones that Condenser uses, and so far Heating has been selling all of its heat exchangers externally.

 

Condenser’s manager recently engaged an independent firm to conduct market research into the likely impact of a sales price reduction on demand. The research indicated that a 5% reduction in selling price will increase sales volume by 20 per cent, or 3,000 units. Condenser has sufficient excess capacity and can produce this higher volume without any increase in fixed costs.

After learning the above, Condenser’s manager approached Heating’s manager, and asked if they would sell heat exchangers internally to them, as Condenser’s manager wants all heat exchangers to come from one supplier. Condenser’s manager offered to pay $120 for each unit, and pointed out that the slightly different specifications would mean that Heating’s direct material costs would be reduced by $4 per unit. In addition, Heating wouldn’t have to worry about variable selling costs for these units, due to the internal sale.

Required

1) Assume that Heating’s manager’s bonus is based on divisional profit. Will Heating’s manager make a “goal congruent” decision if Crispy Clothes requires that the transfer price be set using the general transfer pricing rule?

2) Assume instead that Crispy Clothes requires divisions to adopt a “negotiated price” approach to setting transfer prices, and that Heating and Condenser managers need to negotiate a price for the heat exchangers. What range would the transfer price have to fall within in order for it to be acceptable to both divisions? Explain your answer.

3) Even if a seemingly acceptable transfer price is offered to Heating, what other considerations or concerns might Heating have before agreeing to supply units to Condenser?
 

Sales revenue Manufacturing costs: Heat Exchanger Other direct material Direct Labour Variable overhead Fixed overhead Total manufacturing costs Gross Margin Operating expenses Variable selling Fixed selling Fixed administrative Total operating expenses Net profit before taxes Per unit ($) 1,600 280 148 120 180 128 856 744 72 76 152 300 444 Total ($000s) 24,000 4,200 2,220 1,800 2,700 1,920 12,840 11,160 1,080 1,140 2,280 4,500 6,660