I attached the full case i just need help in this question Question 2 Evaluate the implications of the following transfer pricing policies on each of the three divisions: Transfer price = absorption cost plus a 20% mark-up for the selling division Transfer price = incremental cost per unit: Transfer price = a negotiated price of 950 for Product X and 1,950 for product Y.

London plc Topic: Transfer Pricing, Negotiated Transfer Prices, Divisional Autonomy A mediator has been appointed by the head office of London plc to agree on the transfer price of products X and Y. London plc has one supplying division - Eastern Division, and two purchasing divisions - North Division and South Division. The original agreement was for the North Division to purchase X and the South Division to purchase Y from the Eastern division and the level of purchases to remain the same as the previous year. The mediator appointed by head office has only recently joined the company and is recently qualified. He has worked as the management accountant at another company but does not believe this helped him to get the job. Apparently this is the first time that a manager from head office has been asked to mediate in a dispute between divisions. Initially the mediator talked to the two purchasing divisions separately. The managers at the North Division gave details of current market prices for product X and argued that Eastern Division was not lowering its prices in line with other suppliers. North Division also complained about the new profit targets that have been set by the head office. Managers' were convinced that they must have the freedom to buy and sell outside the company if the outside prices are cheaper than internal prices. The managers at the South Division told a similar story. They gave details of how market prices had fluctuated in the last 6 months. Their conclusion was that market prices would continue to fall and therefore the Eastern Division must reduce its prices. Again managers also argued that they must have the freedom to buy and sell outside the company if the outside prices are lower than internal prices. Following a meeting with the Eastern Division, the mediating manager rejected all the claims raised by the two purchasing divisions and argued that the current arrangement had worked well and did not need changing. After returning to the head office the mediator wrote a short report summarising the details of the original agreement and a compromise proposal. Details of the original agreement The North Division purchases 3,000 units of product X from Eastern Division (the supplying division) and another 1,000 units from an external supplier. The market price for product X is 900 per unit. The South Division purchases 1,000 units of product Y from Eastern Division and another 1,000 units from an external supplier. Details of the revised proposal 1 Eastern division will continue to produce products X and Y. All of its production will be sold to the North and South Divisions. No other customers are likely to be found for these products in the short term given that supply is greater than demand in the market. The mediator carefully considered the issues raised by the managers and suggested the following compromise. He gave all of the divisions 7 days in which to comment. Eastern will manufacture 2,000 units of X for the North Division and 500 units of product Y for the South Division. North will buy 2,000 units of X from Eastern and 2,000 units from an external supplier at 900 per unit. South will buy 500 units of Y from Eastern and 1,500 units from an external supplier at 1,900 per unit. Eastern Division Data for 2014 Per unit data based on original agreement Product Direct materials Direct labour Variable overhead Transfer price Annual Volume X Y 200 200 300 1,000 3,000 units 300 300 600 2,000 1,000 units Budgeted fixed overhead costs - 4,200 for product X and 5,200 for product Y. Required: (Answer the following two questions independently) Question 1 Calculate the current profits for the three divisions as per the existing agreement and the increase or decrease in profits if the head office proposal is imposed on divisional managers. Discuss the problems faced by the mediator in this situation. Eastern Division Selling Price Variable Cost Contribution Margin X 1,000 700 300 Y 2,000 1,200 800 2 The market price will be as follows: X = 900 & Y = 1,900 Original Budget In or Ex Product Quantity Variable Costs Total Internal External X X 3,000 1,000 700 900 2,100,000 900,000 Internal External Y Y 1000 1,000 1,200 1,900 1,200,000 1,900,000 Total 6,100,000 Revised Budget In or Ex Product Quantity Variable Costs Total Internal External X X 2,000 2,000 700 900 1,400,000 1,800,000 Internal External Y Y 500 150 1,200 1,900 600,000 2,850,000 Total 6,650,000 Original Budget - Revised Budget = 6,100,00 - 6,650,000 = (550,000) decrease in profit Original Budget Quantity Variable Cost Total Internal External X X 3,000 1000 1,000 900 Total 3,000,000 900,000 3,900,000 Internal External Revised Budget X X 2,000 2,000 1,000 900 2,000,000 1,800,000 North Division: 3 Total 3,800,000 Original Budget - Revised Budget = 3,900,000 - 3,800,000 = 100,000 increase in profit Original Budget Quantity Variable Cost Total Internal External Y Y 1,000 1,000 2,000 1,900 Total 2,000,000 1,900,000 3,900,000 Internal External Revised Budget Y Y 500 1,500 2,000 1,900 Total 1,000,000 2,850,000 3,850,000 South Division: Original Budget - Revised Budget = 3,900,000 - 3,850,000 = 50,000 increase in profit Original Budget Quantity Variable Cost Total Internal External X Y 3,000 1,000 300 800 Total 900,000 800,000 1,700,000 Internal External Revised Budget X Y 2,000 500 300 800 Total 600,000 400,000 1,000,000 Eastern Division: Original Budget - Revised Budget = 1,700,000 - 1,000,000 = (700,000) decrease in profit North Division increase in profit by 100,000 South Division increase in profit by 50,000 Eastern Division decrease in profit by 700,000 Total of Division = ( 100,000 + 50,000 - 700,000 ) = 550,000 decrease The increase of profits in South and North divisions wasn't the best interest for the group it resulted in a decrease in total profit of the three divisions. 4 Problems faced by the mediator in this situation: 1- Problems of getting accurate data 2- Bias which is revealing all information 3- Personalities that have good negotiating skills this would help a lot Question 2 Evaluate the implications of the following transfer pricing policies on each of the three divisions: Transfer price = absorption cost plus a 20% mark-up for the selling division Transfer price = incremental cost per unit: Transfer price = a negotiated price of 950 for Product X and 1,950 for product Y. 5