Q1)

Tunenep Company recently acquired a vegetable oil processing company. This company has an annual capacity of 2,000,000 litres and sold 1,400,000 litres last year at a market price of $4 per litre. Vegetable Oil Division was formed after the acquisition with the total capital employed of $10,000,000. The purpose of the acquisition was to furnish oil for the Cuisine Division. The Cuisine Division needs 800,000 litres of oil per year. It has been purchasing oil from suppliers at the market price. Production costs at full capacity of the vegetable oil company, now a division, are as follows:

Direct materials per liter $1.00

Direct processing labor 0.50

Variable processing overhead 0.30

Fixed processing overhead 0.40

Total $2.20

Management is trying to decide what transfer price to use for sales from Vegetable Oil Division to the Cuisine Division. The manager of the Vegetable Oil Division argues that $4.50, the current market price, is appropriate. The manager of the Cuisine Division argues that the cost of $2.20 should be used, or perhaps a lower price, since fixed overhead cost should be excluded. Outputs of the Vegetable Oil Division must first be sold to the Cuisine Division before they can be sold to outsiders for $4.5 per litre.

Tunenep Company is currently using returns on investment (ROI) and residual income (RI) to evaluate the performance of divisions. The company is currently using a 10% required rate of return.

(a) Prepare the marginal costing statement and compute the ROI and RI for the Vegetable Oil Division using a transfer price of $4.50. Note: Please indicate clearly the internal and external sales amount. (5 marks)

(b) Prepare a marginal costing statement and compute the ROI and RI for the Vegetable Oil Division using a transfer price of $2.20. Note: Please indicate clearly the internal and external sales amount. (5 Marks)

(c) What transfer price(s) do you recommend? Compute the ROI and RI for the Vegetable Oil Division using your recommendation. (8 marks)

(d) Comment on the possible impacts of the transfer prices used in your answer (a) and (b) above on the performance measures of both Vegetable Oil Division and Cuisine Division measured by ROI and RI. (7 marks)