Mining Technologies Ltd (MTL) manufactures high-quality electronic equipment for mining companies. MTL has two divisions: Components and Products. Components Division produces only one electronic component: XT86 that is sold in the open market for $900 and is also used by the Products Division as an element of one of the equipment manufactured by this division: B12 (the Products Division manufactures and sells in the open market different types of equipment). The electronic equipment B12 is sold in the open market for $2,800. Each division has been designated as a profit centre.

Hint: be careful with the net selling price received for the selling division, the net purchase cost from external suppliers for the buying division, and the two ways the maximum price can be determined (comparing with the suppliers cost and looking whether the buying division gets a profit, or not, selling its product B12).

The following data are available for the Components Division:

Annual production capacity of XT86: 50,000 units

Budgeted production July 2022 June 2023: 50,000 units

Direct materials per unit: $180

Direct labour per unit: $200

Variable overhead per unit: $90

Fixed overhead per unit (based on production capacity): $80

Selling price to external customers (market price): $900

Selling commission per unit sold to external customers: 10%

The following data are available for the Products Division:

Annual production capacity of B12: 14,000 units

Sales of B12 estimated from July 2022 to June 2023: 10,000 units

Direct materials per unit (without XT86): $420

Number of XT86 components per unit of B12: 2

Direct labour per component: $380

Variable overhead per component: $120

Fixed overhead per unit (based on production capacity of B12): $150

Purchase price per unit of XT86 from external suppliers: $900

Transport costs per unit of XT86 purchased from external suppliers: $10

Selling price of B12 to external customers (market price): $2,800

Selling commission per unit of B12 sold to external customers: 10%

Corporate costs:

Fixed costs per year allocated to Components Division: $4,300,000

Fixed costs per year allocated to B12 (Products Division): $4,300,000

Requirement 1

Should transfers be made to Products Division if there is no unused capacity in Components Division? What is the maximum transfer price Products Division would accept?

Explain why the acceptable prices for Components Division and Products Division are different

Requirement 2

Assume that sales to external customers are only 30,000 units of XT86 at the selling price of $900 per component. At what price the other 20,000 components should be transferred to Products Division?

Explain why in this case the acceptable price for the Components Division and the Products Division are the same/different from the prices you got in requirement 1

Requirement 3

Based on the information provided in requirement 2, suppose that Components Division quoted to Products Division a TP of $800 per unit of XT86 for up to 20,000 units.

A) Prepare a contribution margin income statement for each division and for the whole company based on the information provided for the Components and Products Divisions and for the whole company.

B) From a critical analysis of the income statements prepared in a), explain the decisions the manager of the Components Division, the manager of the Products Division and the CEO of MTL would make regarding the transfer or not transfer of the 20,000 units of XT86 to products Division.

C) If MTL rewards each division manager with a bonus, calculated as 2% of division operating profit (if positive), what arguments would each division manager make to negotiate the transfer price that each of them prefers? Identify three arguments or actions each division manager can use in a negotiation to achieve the best transfer price for their division. How can they reach a negotiated transfer price? If you are the CEO of MTL, what would you do, or not, to achieve a decision of the transfer price?

Requirement 4

Making effort to sell 20,000 units of XT86 to the Products Division, the external supplier offered a reduced price per unit of $700.

The manager of the Components Division has the option of:

1. Cutting the external selling price to $800, with the certainty that sales to external customers will rise to 50,000, or
2. Maintain the external price of $900 for the 30,000 units of XT86 and transferring the 20,000 units to products Division at a price that would produce the same operating profit for Components Division as option a).

Which option would be the best option for each division and for the company as a whole? Analyse the two options and explain why the option chosen is the best option. Show your calculations of the contribution margin for each division and the company of each option. What is the transfer price for option b)?

Requirement 5

Assume that the external supplier reduced the selling price to $700 per unit of XT86 to the Products Division. The Components Division reduced the price for external customers to $800, but sales to external customers could be increased only to 45,000 units of XT86. Products Division wants to acquire as many as 20,000 units if the transfer price is acceptable. For simplicity assume that there is no external market for the final 5,000 units of Components Divisions capacity.

1. Using the general guideline, what is (are) the minimum transfer price (s) that should lead to the correct economic decision? Ignore performance evaluation considerations.
2. What is the range between the minimum and maximum transfer price the managers of component and products divisions can negotiate the final TP?

Requirement 6

Based on data from requirement 2, answer the following conceptual questions:

1. If Components Division is located in Vietnam and Products Division is located in Australia, from Mining Technologies Ltd point of view, what should be the transfer price for XT86? Explain. For simplicity assume there are no other costs involved in transferring the units of XT86. The corporate tax rate in Australia is 30% and in Vietnam is 20%.
2. The manager of Components Division asks the CEO of Mining Technologies Ltd for the transfer price be based on full cost plus a markup of 23%, instead of market price, which will be similar to a negotiated transfer price equivalent to the average between the minimum and maximum transfer price determined in requirement 2. Should the CEO agree with this proposal? Provide at least two arguments that support the decision of the CEO.

3. Based on requirement 1, identify the aim to achieve by the Products Division if they must accept the minimum transfer price offered by the Components Division, and define three possible objectives and performance measures related to Internal Business Processes perspective of the BSC that could make the Products Division to achieve this aim.