Process Co has two divisions, A and B. Division A produces three types of chemicals: products L, M and S, using a common process. Each of the products can either be sold by Division A to the external market at split-off point (after the common process is complete) or can be transferred to Division B for individual further processing into products LX, MX and SX.

In November 20X1, which is a typical month, Division As output was as follows:

Product Kg

L 1,200

M 1,400

S 1,800

The market selling prices per kg for the products, both at split-off point and after further processing, are as follows:

$ $

L 5.60 LX 6.70

M 6.50 MX 7.90

S 6.10 SX 6.80

The specific costs for each of the individual further processes are:

Variable cost of $0.50 per kg of LX

Variable cost of $0.70 per kg of MX

Variable cost of $0.80 per kg of SX

Further processing leads to a normal loss of 5% at the beginning of the process for each of the products being processed.

Required

1. Calculate and conclude whether any of the products should be further processed in Division B in order to optimise the profit for the company as a whole.

It has been suggested that Division A should transfer products L and M to Division B for further processing, in order to optimise the profit of the company as a whole. Divisions A and B are both investment centres and all transfers from Division A to Division B would be made using the actual marginal cost. As a result, if Division A were to make the transfers as suggested, their divisional profits would be much lower than if it were to sell both products externally at split-off point. Division Bs profits, however, would be much higher.

Required

(b) Discuss the issues arising from this suggested approach to transfer pricing.