Mabrook Cycles Ltd manufactures and sells both bikes and bicycle gear mechanisms. The company is split into two divisions: Division F and Division G. Both divisions are based in Oman.

Division F manufactures all elements of the bike except for the gear mechanism. Division F buys the gear mechanism from Division G, and then sells the completed bikes to external customers. Each bike requires one gear mechanism.

Division G manufactures gear mechanisms and sells them to Division F as well as to external customers.

The management of each division is assessed by corporate head office primarily on the basis of divisional profit before tax.

The following data is available for both divisions:

 

Division F

Current selling price of each completed bike                                                                                                        OMR 500

Costs per bike:

Gear mechanism purchased from Division G                                                                                                         OMR   90

Other variable costs per bike                                                                                                                                       OMR 200

Annual fixed overheads                                                                                                                                                 OMR 1.5 m

Annual production and sales                                                                                                                                10,000 bikes

Maximum annual external sales demand                                                                                                        10,000 bikes

 

Division G

Current external selling price per gear mechanism                                                                                             OMR 110

Current transfer price for sales to Division F                                                                                                         OMR   90

Variable costs per gear mechanism                                                                                                                          OMR   30

Annual fixed overheads                                                                                                                                 OMR 0.7m

Maximum annual production of gear mechanisms                                                             19,000 gear mechanisms

Maximum annual external sales demand                                                                                13,000 gear mechanisms

Maximum annual internal demand                                                                                            10,000 gear mechanisms

 

The current transfer price of OMR 90 charged by Division G to Division F has been calculated on the basis of variable cost plus 200%. Under the current system, Division F is not allowed to buy its gear mechanisms externally and must purchase them from Division G.; Accordingly, Division G is compelled to satisfy internal demand before selling to external customers.

However, Division F has recently identified that it could obtain an unlimited number of gear mechanisms of exactly the same specification and quality from outside the company at a price of OMR 80 per mechanism. In fact, the quality and specification is so similar that Division F believes it would not be a problem, if necessary, to buy some gear mechanisms externally and some internally. Divisional management and head office are therefore involved in discussions over possible changes to the current transfer pricing regime.

Note that Division G makes no cost savings by supplying internally rather than externally.

 

Required

a) On the basis of the current system, prepare profit statements for each division and also state the total profit for Mabrook Cycles Ltd as a whole. (The sales and cost figures in your profit statements should be split into external sales and internal transfers where appropriate).                          

b) Prepare profit statements for each division and also state the total profit for Mabrook Cycles Ltd as a whole under the assumption that the transfer price remains at OMR 90, but that Division F will be given the complete autonomy to choose whether to buy its gear mechanisms from external suppliers and that Division G will be free to satisfy external demand in preference to internal transfers.                                                                                         

c) Briefly compare your results from parts a) and b) above and identify, with reasons, a new transfer pricing system that should be acceptable to both divisions and to the company itself.             

d) Using the system, you have identified in part c), prepare profit statements for each division and also state the total profit for Mabrook Cycles Ltd as a whole. (The sales and cost figures in your profit statements should be split into external sales and internal transfers where appropriate.)