Questions

Overview

You work for Bonanza International PLC as a Management Accounting trainee. The company was established in 1978 and has built up a reputation as a cost-efficient organisation which has customer value and quality at the centre of its vision.

Over the last few weeks a number of jobs have been sent to you to complete, you are required to present your findings for each of the jobs into a portfolio for your line manager who will use your work to present information to the Board of Directors.

Job 1

Your organisation has several divisions including the Steel Division and the Brinkman Division, whilst the other divisions are completely autonomous, these two, trade together and have had a long-standing transfer price for the component the Steel division make and sell to the Brinkman division for inclusion in their final product, which is high tech security cameras for homes and businesses.

A complaint has been received from the Manager of the Steel division (Shirley Thomas) that the current transfer price is unfair to her division and you have been asked to investigate.

You find:

The Steel Division is currently required by Bonanza International to transfer its total yearly output of 400,000 units of the component X to the Brinkman Division at 110% of full manufacturing cost.

The Brinkman Division undertake further processing and the final camera is sold to customers at a price of 150 per unit

Unlimited quantities of component X can be purchased and sold on the outside market at 90 per unit. To sell the Component X it produces at 90 per unit on the outside market, the Steel Division would have to incur variable marketing and distribution costs of 5 per unit. Similarly, if the Brinkman Division purchased component X from the outside market, it would have to incur variable purchasing costs of 3 per unit.

The following table gives the manufacturing costs per unit in the Steel and Brinkman Divisions (For Brinkman this excludes the transfer cost of component X) for the year 2019: Page 3 of 5

	Brinkman Division
Direct materials	12	6
Direct manufacturing labour costs	16	20
Manufacturing overhead costs	32	25
Manufacturing costs per unit	60	51
	Steel Division	Brinkman Division
Direct materials	12	6
Direct manufacturing labour costs	16	20
Manufacturing overhead costs	32	25
Manufacturing costs per unit	60	51

Notes: Manufacturing overhead costs are, 25% fixed and the remaining variable in the Steel Division, and 60% fixed and the rest variable in the Brinkman Division.

Bonanza International rewards each division manager with a bonus, calculated as 1% of divisional operating profit

Required:

In your portfolio to your manager you must address the following issues in a section labelled JOB 1:

a) The current transfer price is based on full cost plus a mark-up, compare and contrast this method of transfer pricing with using the market price method. Use numerical illustrations to support your evaluation of the methods, ensure you comment on which method if any would be more acceptable to Shirley Thomas.

b) Provide a recommendation to your manager as to where in your opinion the transfer price should be set.