Question 2 Transfer Pricing and Risk Management

(A) The Ace computer company, based in Hamilton, has two divisions. These are the Motherboard Division and the Computer Division. The Motherboard Division assembles micro-motherboards that could then be used by the Computer Division to produce a range of tablet computers. The cost associated with assembling these motherboards are: Direct materials $7.50

Direct labour $1.50

Variable overhead $2.25

Fixed overhead $3.75

Total cost $15.00

Other expenses incurred by the Motherboard Division are: Fixed selling and administrative expenses $450,000 Variable selling expense (per unit) $ 0.75

Note that variable selling expenses are avoidable if the micro-motherboard is transferred internally. The micro-motherboard can be sold on the external market for between $21 and $22. At present, the Motherboard Division is selling the micro-motherboards to external customers for $22. The Motherboard Division can produce 300,000 micro-motherboards per year. However, due to a recessionary economic environment, for the next year the Motherboard Division will only be able to sell 150,000 micro- motherboards on the external market. The management team has decided that to achieve their organisational objectives, the Motherboard Division is to also sell its micro-motherboards to the Computer Division. Currently, the Computer Division purchases an equivalent motherboard from an external supplier for $21.50. For the next year, the Computer Division manager estimates that the division will require between 130,000 and 160,000 micro-motherboards.

Required: (a) Calculate the minimum transfer price that the Motherboard Division would be prepared to accept. Explain your answer. (4 marks) (b) Compute the maximum transfer price that the Computer Division would be prepared to accept. Explain your answer. (2 marks) (c) Explain, giving reasons, whether the internal transfer should take place. (5 marks) (d) Describe how the transfer pricing between the two divisions might change if the Motherboard Division was in Australia, and the Computer Division was in India. (4 marks) (B) (i) Explain which one of the three types of transfer prices (cost based, market based or negotiated) is most likely to elicit desirable management behaviour in an organisation. Give reasons to support your answer. (4 marks) (ii) Outline the role of activity based costing in transfer pricing. (5 marks)