Perniagaan Minyak Zaiton Dara recently acquired an olive oil processing company that has an annual capacity of 2,000,000 liters and that processed and sold 1,400,000 liters last year at a market price of RM4 per liter. The purpose of the acquisition was to furnish oil for the Cooking Division. The Cooking Division needs 800,000 liters of oil per year. It has been purchasing oil from suppliers at the market price. Production costs at capacity of the olive oil company, now a division, are as follows:

RM Direct materials per liter 1.00 Direct processing labour cost 0.50 Variable processing overhead 0.24 Fixed processing overhead 0.40 Total 2.14

Management is trying to decide what transfer price to use for sales from the newly acquired company to the Cooking Division. The manager of the Olive Oil Division argues that RM4, the market price, is appropriate. The manager of the Cooking Division argues that the cost of RM2.14 should be used, or perhaps a lower price, since fixed overhead cost should be recomputed with the larger volume. Any output of the Olive Oil Division not sold to the Cooking Division can be sold to outsiders for RM4 per liter.

(a) Compute the operating income for the Olive Oil Division using a transfer price of RM4. (b) Compute the operating income for the Olive Oil Division using a transfer price of RM2.14.

(c) Decide on the transfer price and compute the operating income for the Olive Oil Division using your recommended transfer price. (d) Negotiated transfer prices is one general method of determining transfer prices. Explain what negotiated transfer prices are all about.