The BS Company is split into two profit centres: Chatter Division and Duncan Division. The divisions

are currently selling all their output to outside customers. Monthly data for both profit centres is as

follows:

Chatter and Duncan are both working at full capacity. The manager of Duncan is becoming worried

about the rising variable costs of units produced in the department. He is aware that it would be

possible, instead of buying raw materials from outside suppliers at a cost of 18, he could buy product

T from Chatter as raw material. One unit of T from Chatter would be further processed, at an

incremental cost of 1 per unit and could be used as a substitute material for two units in Duncans

output.

The manager of Chatter Division has suggested that the transfer price for 2,000 units of T should be

the market price of 40 per unit. The Duncan manager objects because this is higher than the cost of

raw materials currently purchased from outside suppliers. As a senior manager from the head office

of the BS Company, you are aware that if Chatter withdrew 2,000 units of T from the outside market,

the outside market price for the remaining output would rise to 43 per unit.

Required:

a) From corporate perspective, should Chatter transfer 2,000 units of T to Duncan each month? State

the reasons for your answer.

b) Suggest a possible range for a transfer price which should be satisfactory to the managers of both

divisions.

c) Why might market prices do not always represent the optimal transfer price for organisations?

Elaborate your answer with examples.

d) What are the risks of a wrongly set up transfer pricing system?