QUESTION 2 (25 MARKS) Lucky Cetak Bhd (LCB) sells and repairs photocopy machines. The company has operated many years with two departments, the Sale Department and the Service Department, but the departments had no autonomy. The company is now thinking of restructuring so that the two departments become profit centers. The Sale Department This department sells new photocopiers. The department sells 2,000 copiers per year. Included in the selling price is RM60 for a one year guarantee. All customers pay this fee. This means that during the first year of ownership if the photocopier needs to be repaired the repair costs are not charged to the customer. On average 500 photocopiers per year need to be repaired under the guarantee. The repair work is carried out by the Service Department, under the proposed changes, would charge the Sales Department for doing the repairs. It is estimated that an average the repairs will take 3 hours each and that the charge by the Service Department will be RM136,500 for the 500 repairs. The Service Department This department has two sources of work, the work needed to satisfy the guarantees for Sales Department and repair work for external customers. Customers are charged at full cost plus 40%. The details of the budget for the next year for Service Department revealed standard costs of: Part Labour Variable Overheads Fixed overheads At cost RMI5 per hour RMI0 per labour hour RM22 per labour hour The calculation of these standards is based on the estimated maximum market demand and includes the expected 500 repairs for the Sales Department. The average cost of the parts needed for a repair is RM54. This means that the charge to the Sales Department for the repair work, including the 40 % mark-up, will be RM136,500. Proposed Change It has now been suggested that LCB should be structured so that the two departments becomes profit center and the managers of the departments are given autonomy. The individual salaries of the manager would be linked to the profit of their respective departments. Budgets have been produced for each department on the assumption that the Service Department will repair 500 photocopiers for the Sales Department and that the transfer price for this work will be calculated the same way as the price charged to customers. However the manager of the Sales Department has now stated that he intends to have the repair done by another company, Surya Fotokopi Enteprise (SFE), because they have offered to carry out the work for a fixed fee of RM180 per repair and this is less than the price that the Sales Department would charge. Required: a) Calculate the individual profit of the Sales Department and the Service Department, and of LCB as a whole from the guarantee scheme if: i. The repairs are carried out by the Service Department and are charged at a full cost plus 40%. (5 marks) ii. The repairs are carried out by the Service Department and are charged at marginal cost. (5 marks) iii. The repairs are carried out by SFE. (4 marks) b) Explain, with reason, why a full cost transfer price model may not be appropriate. (5 marks) c) SW Bhd and AL Bhd are members of the same group. SW Bhd supplies its output to AL Bhd, as well as selling to external parties. SW Bhd has capacity to produce up to 500,000 litres a week. The external market demand is 350,000 litres per week, and previously AL Bhd demanded 100,000 litres per week. AL Bhd has now advised SW Bhd that it will require 250,000 litres per week from January 2018. SWAL Group policy will evaluate the performance of group companies on the basis of their individual profits, and set the transfer prices that will encourage the maximization of group profits. Required: Explain how an appropriate transfer pricing policy would provide a satisfactory basis for appraising the performance of individual companies. Comment on the implications of this policy for the maximization of group profits. (6 marks)
