Question 3 (18 marks) Best Bikes Ltd has two divisions, Frame and Assembly, which manufactures expensive bicycles. Frame division produces the bicycle frame, and Assembly division assembles the rest of the bicycle onto the frame. There is a market for both the subassembly and the final product. Each division has been designated as a profit centre. The transfer price for the frame has been set at the long-run average market price. The market price for the frame is $300 and the market price for the bicycle is $500 The two Division managers are compensated based on the Division operating income The following table shows the manufacturing cost per unit in the Frame and Assembly Divisions for 2017: Frame Assembly Direct material cost Direct manufacturing labour cost Manufacturing overhead cost Total cost per unit $80 $70a 180 60 $310 60 $180 Additional information a Direct material costs do not include cost of frame b Manufacturing overhead costs are 50% fixed and 50% variable in both divisions Fixed costs are allocated on per unit of production capacity. Required 1. From the point of view of the company, should the transfer be made to Assembly division if there is no unused capacity in Frame division? Why? Show your computations 3 marks 2. Assume that Frame division's maximum capacity is 800 frames per month and sales to the intermediate market are 500 frames. What is the minimum and maximum transfer price that would be acceptable for both divisions to transfer 300 frames to Assembly division? Show your computations 3 marks 3. Assume that the manager of Frame division has the option of a) cutting the external price to $280, with the certainty that sales will rise to 800 units or b) maintaining the external price of $300 for the 500 and transferring the 300 units to Assembly division at a price that would produce the same operating income for Frame division. What transfer price would produce the same operating income for Frame division? Is this transfer price acceptable for Assembly division? Why? Should Assembly division buy frames from external suppliers? 6 marks 4. If Frame division is in Bermuda, which has a tax rate of 10% and Assembly division is in Australia that has a tax rate of 30%, from the point of view of the company, should the transfer price be the maximum or the minimum possible transfer price? How this transfer price would affect the total tax paid by the company in both countries? Explain 3 marks 5. Discuss two possible problems a company might have if its operations are totally decentralised 3 marks Question 3 (18 marks) Best Bikes Ltd has two divisions, Frame and Assembly, which manufactures expensive bicycles. Frame division produces the bicycle frame, and Assembly division assembles the rest of the bicycle onto the frame. There is a market for both the subassembly and the final product. Each division has been designated as a profit centre. The transfer price for the frame has been set at the long-run average market price. The market price for the frame is $300 and the market price for the bicycle is $500 The two Division managers are compensated based on the Division operating income The following table shows the manufacturing cost per unit in the Frame and Assembly Divisions for 2017: Frame Assembly Direct material cost Direct manufacturing labour cost Manufacturing overhead cost Total cost per unit $80 $70a 180 60 $310 60 $180 Additional information a Direct material costs do not include cost of frame b Manufacturing overhead costs are 50% fixed and 50% variable in both divisions Fixed costs are allocated on per unit of production capacity. Required 1. From the point of view of the company, should the transfer be made to Assembly division if there is no unused capacity in Frame division? Why? Show your computations 3 marks 2. Assume that Frame division's maximum capacity is 800 frames per month and sales to the intermediate market are 500 frames. What is the minimum and maximum transfer price that would be acceptable for both divisions to transfer 300 frames to Assembly division? Show your computations 3 marks 3. Assume that the manager of Frame division has the option of a) cutting the external price to $280, with the certainty that sales will rise to 800 units or b) maintaining the external price of $300 for the 500 and transferring the 300 units to Assembly division at a price that would produce the same operating income for Frame division. What transfer price would produce the same operating income for Frame division? Is this transfer price acceptable for Assembly division? Why? Should Assembly division buy frames from external suppliers? 6 marks 4. If Frame division is in Bermuda, which has a tax rate of 10% and Assembly division is in Australia that has a tax rate of 30%, from the point of view of the company, should the transfer price be the maximum or the minimum possible transfer price? How this transfer price would affect the total tax paid by the company in both countries? Explain 3 marks 5. Discuss two possible problems a company might have if its operations are totally decentralised 3 marks
