RETURN ON INVESTMENT VS RESIDUAL INCOME ANDTRANSFER PRICING

Hamilton Ltd has two divisions. The Forming Division produces moulds, which are then transferred to the Finishing Division. The moulds are further processed by the Finishing Division and are sold to customers at a price of $300 per unit. The Forming Division is currently required by Hamilton Ltd to transfer its total yearly output of 100 000 moulds to the Finishing Division at 120% of full manufacturing cost. Unlimited numbers of moulds can be purchased and sold on the outside market at $180 per unit.

The following table gives the manufacturing cost per unit in the Forming and Finishing divisions for 2018:

	Forming Division	Finishing Division
Direct materials cost	$24	$12
Direct manufacturing labour cost	17	20
Manufacturing overhead cost	64a	50b
Total manufacturing cost per unit	$105	$82

^aManufacturing overhead costs in the Forming Division are 20% fixed and 80% variable.

^bManufacturing overhead costs in the Finishing Division are 65% fixed and 35% variable.

Required

1. Calculate the operating profits for the Forming and Finishing divisions for the 100 000 moulds transferred under the following transfer-pricing methods: (a) market price and (b) 120% of full manufacturing cost.
2. Suppose that Hamilton Ltd rewards each division manager with a bonus, calculated as 2% of division operating profit (if positive). What is the amount of bonus that will be paid to each division manager under the transfer-pricing methods in requirement 1? Which transfer-pricing method will each division manager prefer to use?
3. What arguments would Scott Devon, manager of the Forming Division, make to support the transfer-pricing method that he prefers?