MVideo Ltd produces televisions. The company operates with two divisions. These are the Electronics Division which makes a processor and the Assembly Division which puts together and sells the finished televisions to external customers. The Electronics Division sells one specific type of processor internally to the Assembly Division at a transfer price of 104 made up as follows:

Direct Materials

18.00

Direct Labour

20.00

Production Overheads

42.00

Total Cost

80.00

30% Mark-Up

24.00

Transfer Price

104.00

Production Overheads include an absorbed fixed element and a variable element. The variable element is 12 per unit.

The Assembly Division incurs further variable costs of 55 per television and estimates the following potential sales at various possible selling prices:

Price

Sales Volume

(Units)

400

1,500

350

2,100

300

2,700

250

3,000

200

4,000

Central management at MVideo have noted that budgeted sales for the television are lower than had been hoped. The Assembly Division management, however, have confirmed that the proposed budget provides the best possible contribution to divisional profits.

The Assembly Division have also suggested that a reduction of the transfer price to 65 would improve company profits and would still give the Electronics Division a reasonable contribution.

Requirements for question 3:

a) Produce a table to show total contribution for both MVideo Ltd overall and for the Assembly Division at each of the five possible prices. Identify the prices which maximise contribution for the company and for the Assembly Division.

b) Establish the likely effect on company profits of changing the transfer price to 65 as suggested by the Assembly Division.

(12 marks)

Question 3 continued....

c) Discuss the issues of encouraging divisional managers to take decisions in the interests of the company as a whole, where transfer pricing is used.

Please limit your answer to 500 words as a maximum.